Matching Prices to Market Outlets
August usually sees a plethora of produce, fruits, and value-added products showcasing at the farmers' markets and through on-farm retail farm stands. Summer and fall holidays stoke the grilling season for mart producers and the beginning of the school year fuels more demand in market-ready wholesale opportunities. Diversifying your market outlets can be good for business, but not if you don’t offer a range of prices that reflect achieve profitability. One price point does not fit all market outlets.
Keep in mind that all farm-to-fork players involved in the food supply chain include not only product purchase costs but also their desired profit margin. In general, a wholesaler will offer products to a retailer with a 30 percent profit margin. Then, the retailer will offer food products to customers at a retail price that includes the wholesale purchase price, the costs incurred to get the products to the store and stocked on the sales floor, plus another 30 percent profit margin.
Producers who can sell their product directly to consumers can compete on quality and costs since much of the middle man expenses are avoided. However, there is a limit to the market share that can be captured through direct-to-consumer. The long-term success of your business may depend on your ability to market your products across a range of customers. Spending some time calculating your prices will better prepare you to calculate your profitability across a variety of sales channels.
Realistic and reliable pricing begins with accurate record keeping. Key factors in deterring your prices are the total cost of production per unit or group plus your desired profit margin. Your cost of production must include your variable costs plus your fixed costs. Variable costs are those directly related to the production of the product. These vary with the number of units produced. For example, one steer versus a group of steers. Variable costs include items such as the price of the calf, feed costs, labor, hauling, processing, packaging, etc. This number is referred to as your “cost of goods sold” (COGS).
The term “margin” was noted earlier in this article and referred to the percent of profit the retailer included in their pricing formula. Producers should consider a “gross margin” when setting prices. Producer gross margins are often set at 40 percent for direct-to-consumer sales and 25-30 percent for wholesale accounts. The gross margin is the percentage of income resulting from the sales of a product after paying the cost of goods sold. Including a gross margin percent based on specific market factors for different outlets, will help in the decision process for entering different market channels.
The cost of production must also reflect your fixed costs. These are the costs that must be paid even if you don’t produce a product. Examples of fixed costs are rent, taxes, interest on loans, internet service, contractual services such as accounting, etc.
Knowing your variable and fixed costs for a product and the total sales amount you project for that product, you can calculate your gross profit for each product class. Gross profit = total sales - total expenses. Producers can calculate the gross profit for each product sold in different market outlets.
By knowing your variable and fixed production costs and determining your desired gross margin on your product sales, you can determine profitable pricing for your products across various market channels. This approach to determining a selling price is referred to as cost-margin-based pricing.
This approach includes:
- Determine your variable costs of production for a product. Don’t forget to include your marketing costs for this product too.
- Determine the gross margin you need for offering this item in your product line.
- Divide your variable costs (cost of goods sold) by (100%-gross margin%) to get the minimum price you should accept for your product.
For a pound for grass-fed ground beef with a desired gross margin of 40 percent and COGS of $4.57 per pound, the selling price would be: $4.57/ (100%-40%) = $4.57/60% = $4.57/.60 = $7.60
In this example, charging $7.60 per pound for the grass-fed ground beef will return $3.03 per pound to the farm ($7.60-$4.57) before fixed costs are paid.
If the same pound for grass-fed ground beef is sold to a wholes buyer and the gross margin is set at 20%, the formula reads: $4.57/ (100%-20%) = $4.57/80% = $4.57/.80 = $5.71
In this example, charging $5,71 per pound of grass-fed ground beef will return $1.14 to the farm ($5.71-$4.57) before fixed costs are paid.
A producer’s decision to market their products directly through different market channels should be based on calculations from the farm’s records. Different market outlets will require different levels of pricing. Using the cost-margin-based pricing formulas to determine these different pricing levels will reveal the profit potential or loss back to the farm.
Mastering Marketing is produced by Ginger S. Myers and is published periodically containing important seasonal marketing information.