Markup vs. margin – know these metrics for better customer communication
Markup and category margin are two important calculations in the food industry.
Two terms we often hear in the food industry are markup and category margin. Some people believe these are the same thing, or they use the wrong calculation. But to be clear, 40% markup and 40% category margin are different.
Markup is a calculation where a percentage increase is applied to the cost of production (COP). Food producers or processors often use this when they know their COP and can apply a markup percentage to cover other costs such as overhead, marketing spend, trade spend, financing, taxes, admin, distribution and desired profit.
If a food processor’s COP is $1.50 per unit and they’ve determined they require a 40% markup to cover these costs and deliver a profit, they would calculate their selling price as follows:
Selling price = COP x (1 + markup %)
Selling Price = $1.50 x (1 + 0.40)
Selling Price = $2.10
In this example, the 40% markup delivers $0.60 per unit.
Food processors should always have a thorough understanding of their cost of production. This includes your ingredients, inputs, processing, labour and packaging. Every time you make or produce one product, you’ll incur these costs.
Don’t underestimate the markup you need. Every percentage point drives up your selling price, but if you don’t have enough markup, you’ll never succeed. There are a lot of costs associated with operating in food. Often trade spend, marketing spend and distribution costs are estimated too low. Understand the investment required to sell the products, and don’t assume your customer will order full pallets when it’s convenient for you.
Understanding category margin
Retailers use category margin (sometimes referred to as gross margin) and their cost of goods to determine retail prices.
If we use our $2.10 selling price calculated by the processor – the retailer will apply the category margin of 40% to determine the retail price.
Retail price = Cost of goods sold (COGS) / (1 – category margin %)
Retail price = $2.10 / (1 - 0.40)
Retail price = $2.10 / (0.60)
Retail price = $3.50
In this example, the 40% category margin delivers $1.40 per unit.
The retailer starts with the cost of goods sold, which is the selling price of a supplier. Retailers will do their best to negotiate the best price, using their knowledge of the category and cost of other items in their category.
Category margins tied to overall business costs
Category margin is the percentage it costs them to run their business. Category margin can be a huge source of frustration for producers and processors. On the shelf, you see retailers making too much money. The category margin covers costs to operate the department, the store and the overall business. Category managers are assessed on their ability to meet or exceed their category margin, so it’s difficult to get them to reduce the percentage.
It’s important to understand the differences between these two calculations. In our example, the 40% markup delivered $0.60 per unit, whereas the 40% category margin delivered $1.40 per unit.
Speak to customers with their terms
Markup and category margin are two important calculations in the food industry. Processors need to understand both and be able to communicate with their customers about each metric. You can strengthen your relationship with your customer when you understand the terms and how the category managers look at their business.
Article by: Peter Chapman