Top Stories » Expert Columns » Profiles & Trends

How do you set prices in your store? Do you have a documented process to guarantee that you capture all of the costs to bring in each product? Do you evaluate the expected sales volume at various price points -- along with the associated contribution margin -- before determining the price? Or is your system more along the lines of "these things need to get out on the floor; look and see what the ones on the shelf are marked and then price these at the same amount"?
Knowing the true cost of your products and pricing accordingly is one of the most significant things a retailer can do to maintain or improve their financial bottom line. But all too often, costing and pricing are a focus only when a store first opens or when a completely new product is brought onboard. Meanwhile, as shipment after shipment of replacement product arrives, the established price is simply transferred to the new merchandise, whether or not the underlying product cost has changed. Sometimes, those changes are significant and a product goes from being a moneymaker to a money loser without anyone noticing.

Cost vs. Price: There is a Difference!
It seems obvious to most retailers that the cost of a product (what we pay for it) differs from the price (what we sell it for). It is, after all, that difference that accounts for our profit (or lack thereof). How could anyone confuse cost and price? Well, if common language usage is any indication, many people are confused, including many employees. Start paying attention. A customer picks up a bottle of olive oil off of the shelf and asks, "What does this cost?" Of course, she is asking what it will cost her to buy it, not what your cost was. But a staff member may answer the question incorrectly, thinking that he or she was referring to the original cost of the product. Be mindful of how you personally use "cost" and "price" and actively teach your staff the difference.

Costing is a Science
How much did this product cost us? There is a right answer to that question, but it is not always an easy one to find. A product's total cost includes the raw cost of the item itself (per piece or per pound), the cost of freight to get it into your store, a yield calculation, and any peripheral costs associated with packaging the product for sale. Allocating freight, calculating for yield, and allocating peripheral costs may be handled differently from business to business, but consistency within one organization is important. The method we use at Zingerman's is outlined below.

Total Cost = [(Raw Cost, plus Freight Cost) divided by yield%] plus peripheral costs
- Raw Cost: For products sold by the pound, this is simply the cost per pound. For packaged products, it is the item price (case price divided by number of items in the case).
- Freight: Sometimes freight is included in the per-pound or -case price. Often, however, a separate freight charge or even a separate freight invoice exists.
- Yield: For products that arrive raw and are then cooked, the yield is the difference between the raw weight and the cooked weight (e.g., the yield for corned beef is approximately 55 percent). Often, there is some loss involved in carrying extremely perishable products, such as produce, and you should factor it into the yield calculation. Although it is common to assume that yield is not a factor for dry goods, make sure to take your sampling policy into account when calculating your yield. At Zingerman's, we assume one bottle/jar per case will be used for samples, so a case of 24 would actually yield only 23 saleable items.
- Peripheral Costs: If the product is always portioned into a container, served on a plate with a pickle, or packed into a gift box, make sure you include the cost of those "extras."

Pricing is a Craft
There is no single, ideal price for a product. Although real math is involved in pricing, there is also a good mixture of gut feel that comes from knowledge of the market and of your particular customers. Most retailers have a target cost of goods/food cost that they use as a starting point in their pricing. For example, 50 percent is a common food cost target for olive oil. Does this mean that you should simply figure the total cost of a bottle of oil, double that amount, and get out your price gun? Not if you want to maximize your bottom line. Here are a few things to keep in mind:
- Price minus cost equals contribution margin. Contribution margin is the amount of money a product contributes towards your business's financial bottom line.
- A product may have a high contribution margin per unit, but if you sell very few units, that product's overall contribution to your bottom line may be small. As has been said many times, "You can't take percentages to the bank."
- On the other hand, a product that you sell lots and lots of may have a significant bottom-line impact, even if the contribution per item is small.
- Certain price points (e.g., $5, $10, $12, $20) are "hot spots" that you want to keep in mind when setting prices.
- Some products are widely available and consumers will be expecting your prices to approximate what they would pay elsewhere. This may require you to price these products at a price that is lower than your target.
- On the other hand, products that are exclusive to your store offer an opportunity to receive a higher contribution margin that can offset the lower margin on more generic products.
Taking all of these factors into account, along with what you know about your specific market and customer base can enable you to come up with an initial best-guess price. Then take five additional minutes to "test" that price. Here's how. First, how many units do you think you'll sell at this initial price? Fifty a week? Okay, then figure the contribution margin, assuming you sell 50 at that price. Then pick two prices below your initial price and two prices above it. For each price, make an educated guess at how much more (or less) you would sell at that price. Calculate the contribution margin for each price. Which price has the biggest contribution margin? Go with that price. The more you do this exercise (and be sure to follow up to see how the actual sales compare to your forecast), the better you'll get at setting prices that maximize contribution margin and send dollars directly to your bottom line.
Costing and pricing are not exercises to be done once per product and then put on automatic pilot. Take the time to teach your staff the difference between cost and price, how to calculate total product cost, and how to forecast expected sales levels at various price points. Effective costing and pricing are the lifeblood of a retailer's financial success and the more people in our organizations who understand the basics, the better the chances are that all of our products are priced to improve -- not penalize -- our financial bottom line. (Note: we have a very simple Pricing Worksheet that we use at Zingerman's to calculate the contribution margin of a product at various retail prices. If you'd like to see a copy, e-mail me at mbayless@zingermans.com.)

Maggie Bayless is the managing partner of ZingTrain, which is the consulting arm of Zingerman's, the specialty food retailer in Ann Arbor, Mich. If you have specific topics you would like to see addressed, please send your suggestions to Maggie at mbayless@zingermans.com.