Want to make better business decisions? Know your cost of production

3.5 min read

Daily price fluctuations and overall rising costs are stressful, especially when trying to get your food or beverage business up and running to earn a profit.

Processors have faced unprecedented volatility, says SKUFood partner Peter Chapman, who provides food industry suppliers with strategies to differentiate their product and grow their business.

According to the FCC Q4 Quarterly Economic and Financial Market Update, food inflation is expected to remain inflated for the foreseeable future. While supply chain disruptions and labour challenges should continue to ease, it’s difficult to pinpoint when a return to normal will arrive.

In the food processing industry, which is very much a business of pennies, Chapman says, and where even incremental changes can potentially have a significant impact on the bottom line, now is the time for a careful examination of costs. This is particularly true for small and medium-sized businesses with tight cash flows.

Price increases mean boosted communications

Chapman says processors should know when category managers and retail partners review the cost of goods within categories and be well-prepared to have the conversation about rising costs in their business.

Many major grocery chains typically only consider price adjustments during specific times. A category manager for jam at Sobeys, for example, might only be willing to look at the cost of goods sold in a four-week window once a year.

“They might do jam in March, peanut butter in April and honey in May,” Chapman explains. “They can’t be bombarded by suppliers coming at them all year.”

At the same time, it’s important to maintain contact with retailer partners in advance of that annual review to keep them apprised of rising costs within your business.

“You lay the groundwork so that when it comes time to have that conversation, a price increase is almost a foregone conclusion,” Chapman says. “Have the conversation all the time about costs, so they know what’s going on.”

Considerations before cutting SKUs

Major food and beverage businesses, including Coca-Cola and Mondelez, reduced the number of SKUs they produced in the past to right-size their business. But restructuring at the small and medium-size business level needs to be carefully considered and not based solely on an individual SKU’s performance at the store.

A company might sell lots of one SKU, but those sales are coming at a deep loss. At the same time, cutting a beloved SKU can have negative implications beyond potential cost savings, says Kyle Burak, an FCC Senior Economist.

“Maybe you don’t sell a lot of a certain SKU, but maybe customers value it quite a bit more,” Burak says. “If that key product input is something we see rise a lot, maybe it is something you have to temporarily halt to save costs. Don’t make rash decisions.”

It’s crucial processors have a system to track their cost of production and work continuously to adjust that price.

The decision to discontinue a SKU should factor in your costs and supply of ingredients, packaging and marketing spend – all elements of processing and production. Take the time to review the angles before making the final decision.

Be sure to check agreements with key ingredient suppliers before cutting a SKU to ensure the agreement can be adjusted before it expires.

“Just because you cut a SKU, you could be losing revenue and locked into the costs for another six to 12 months,” Burak says.

Lock-in prices

Whenever possible, lock-in long term agreements, including prices, with suppliers. A guaranteed rate when prices for raw ingredients are fluctuating can provide some much-needed cost certainty.

“You don’t want to get into a situation where you’re selling below cost,” Burak says.

Know your price

It’s crucial that processors have a system to track their cost of production and work continuously to adjust that price. Review gross profit item-by-item to determine if the price is correct.

“If a price increase is needed, consider reducing the pack size to keep the price per unit the same, making it easier to pass on cost increases to customers,” Burak says. If you usually assess prices every six months, consider doing it monthly right now.

The shipping views

Chapman says food and beverage processors should also examine other components of their business, particularly the cost of getting products to store.

“It’s a given that you have to ship but are there ways you can do it more efficiently?” he says.

Consider reducing the shipping frequency or using bigger or more pallets to get the most shipping value for your buck.

To help calculate the costs of producing your food product, check out this downloadable worksheet.

Article by: Chris Powell

Money & Finance