Unit Economics – What does it cost to sell my products at retail?

A common question in the early stages of a venture into the retail space is “how much should I account for in costs of markups and margins?”. It’s a hugely important question. While there are many costs to account for between you, the supermarket, and the consumer, there are three that are most important to account for:

  1. Distributor markup
  2. Retailer Gross Profit Margin
  3. Promotion

Let’s look at each of these elements.

Odds are that you’ll need a distributor to help you get your products to stores. This is the case for most early-stage brands because distributors specialize in niche products that don’t sell at the same velocities as well established, big brands that retailers typically buy directly from the vendor. The distributors that you’ll most likely be working with are Kehe and UNFI. There are many more, but these two distributors cover the entire US as well as Canada. They have extensive reach and, in some cases, are the preferred distributor at major retailers. A nice part about working with a distributor is that hitting minimum order quantities is not as challenging (theoretically) as shipping directly to one retailer. The logic is that the distributor serves many retailers, not just one, therefore making it easier to carry more inventory. Of course, there are many distributor DCs in their networks, so you must focus on winning distribution in each trading area served by the DC you are targeting. (Don’t worry, you can be selective of which markets you want to trade in). Now that we’ve covered the value of the distributor, we must acknowledge their right to be fairly paid for their services. Distributors work from an upcharge that is applied to your list cost. This is how they collect revenue to cover their costs to serve the retail and ultimately fuel their business model. Upcharges can have a broad range. I’ve seen upcharges as low as 6% and as high as 23%. There are many reasons for this broad range. Firstly, upcharges are different for almost every retailer. Secondly, they vary by the level of service the distributor has agreed to supply to the retailer. (For a general idea of their services, check out their websites in the links above). Lastly, not all retailers are the same. Distributors consider the cost to serve a retailer’s business (volume, locations, distance etc). For the purposes of figuring distributor upcharge into your list cost, I recommend using 20%. Some would suggest 15%, but I prefer a more conservative figure due to the importance of this exercise. You don’t want to under account, or you may end up with unit costs and retail prices much higher than planned. To assist you with the exercise, let’s look at an example. Your 12-pack case cost is $10.00. With the markup assumption of 20%, your cost to the retailer would be $12.00 or an additional 17¢ per unit. In other words, before upcharge, your unit cost would be 83¢. With upcharge, it’s $1.00. This has material impact on the retail. We’ll cover that next.

SRP, or Suggested Retail Price, is something that you’ve probably thought about quite a bit. Up to this point, you may have been guessing at the costs we’re talking about here. We’ve figured the first piece out. Now that you know roughly what you need to capture for distributor markup, you need an estimate of what Gross Profit Margin to use for the retailer. I suggest 40%. The reason I do is that odds are your product will be fitting into a niche or specialty role for the retailer. For products in the ‘specialty’ space, gross margins can range from 35% to 45%, and sometimes more. Obviously, these numbers will vary depending on the retailer and the category, but accounting for 40% should allow you the room you need to operate and figure what your list cost should be. Keeping with our previous example, your cost from the distributor is $1.00. Based on 40% gross margin, your retail would be $1.69 (40.8%). If this is higher than you first planned, don’t panic. Remember that we’re working from an average distributor markup of 20%. If you have a large natural retailer on your target list and you happen to know that their distributor markup is only 9%, then you have room to work with that retailer on an everyday allowance to achieve a better retail price in their stores. Easy to do that. Not so easy to manage if you haven’t accounted enough for these costs along the way. A good segue to promotion…

Winning distribution is one thing. Keeping it is another. Once your product hits shelves, the clock starts ticking. In more competitive categories, the clock ticks faster. Your job in ensuring that your product moves from the shelf into consumers’ carts repeatedly really begins before you win the distribution. By now, you hopefully have built a fandom for your brand. Now that you are in store, it is critical to capitalize on the equity you’ve been building. Promotion at the retailer is your vehicle to do so. The retail environment is intensely competitive. Shelf space, display space, and ad space are all limited commodities. Building your business will depend in part on securing a high quality of merchandising. Giving your retailer a promotional allowance is important but getting a fair reflection of that allowance to the shopper and getting more than just a shelf tag is more important. The highest quality of merchandising as defined by IRI or Nielsen is a price discount, a print advertisement, and a display. This is the highest quality because it will get the most amount of shopper attention. Shoppers largely shop the circular and notice products that are on display. These are behaviors you want when potential shoppers are in their store. Eyeballs on your products! I would add one tactic that would make your merchandising even better and that is live sampling. A product demonstration naturally draws interest from shoppers, and nothing is better than having that consumer in the store, enjoying the product, with the product on display and on sale. Trial is your job and this is the #1 way to achieve it.

Promotion is important, so how do we account for it. Very simply, you should target a % of your sales. I recommend 10% as a starting point. As usual, this could vary greatly depending on your category. Typically, when you pass a promotion through a distributor (often referred to as an “MCB”), distributors and retailers look for at least a 15% allowance (this is 15% of their cost. In our example, using $1.00, a 15% MCB is 15¢ per unit.) You may offer additional amounts (sometime lump sum amounts) to encourage displays. So, if we’re offering a 15% allowance and maybe more, how do we end up spending only 10% if that’s our target? The answer lies in the balance of “promoted” and “non-promoted” volume. If all goes well, there will be consumers buying your products off shelf at full price. This is your “non-promoted” volume. Since you have little or no promotional spending on “non-promoted” volume, your spend on these cases will be 0-1%. (The exception to this is if you have put an allowance in place for a lower everyday retail price.) When you balance out your promotional spending for your fiscal year, you’ll be looking at your total sales and your total spending. Your spending will be an average of your promotional rate (i.e. 15%) and your non-promotional rate (i.e. 0-1%). Where it lands exactly will be answered by the split of volume between the promotional and non-promotional rate. Hopefully, your loyal fans are shopping your products off promotion and therefore helping you balance out those special deals. Let’s say in the early going, your promotional/non-promotional volume split is 50/50. Using rates of 15% and 0%, your spend would land at 7.5%.

There is a ton of work that you will inevitably do as you grow your business and learn what promotional strategies are most efficient and most effective. There’s an industry within our industry known as Trade Marketing, and rightfully so. For most companies, the largest expense on the P&L after COGS tends to be promotional spend (aka trade spend). I’ll be posting more about promotion soon, so stay tuned for more information on this important topic. If you’d like to receive a free consultation to look specifically at your unit economics, please click here so we can connect live.

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