Pricing Your Food Product

2007

Module designed by Tera Sandvik, LRD, Program Coordinator; Julie Garden-Robinson, PhD, LRD, Food and Nutrition Specialist;and Kathleen Tweeten, MBA, Director, Center for Community Vitality, Community Economic Development Extension Specialist

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Presurvey Before we begin let’s take a presurvey to

see how much you already know. Click here to begin the presurvey.

I have my product, but how much is it

worth?

When selling a product, make sure you make enough profit to cover your:

Fixed costs Variable costs

Cost

Fixed Cost Fixed costs are expenses that must be

paid no matter how many goods or services are offered for sale.

Some examples are: Rent Utilities Insurance Internet service

Variable Costs Variable costs are expenses that change

with the number of products offered for sale.

Some examples are: Raw materials (jars, sugar, etc.)

The more products you sell, the more raw materials you need to produce the extra products.

Electric power to run machines Cost of maintaining inventory

You have ways to reduce fixed costs per unit sold.

If you sell more units, the percentage of fixed costs is reduced. For example: Variable cost = $1.50 Fixed cost = $50 Units sold = 100 Price per unit = $4

%Fixed cost = 25% If units sold increased to 200:

%Fixed cost = 14%

$1.50 x 100 units = $150

$150 + $50 = $200 (total cost)

$50/$200 = 25%

$1.50 x 200 units = $300

$300 + $50 = $350

$50/$350 = 14%

Which of the following is a fixed cost?A. SugarB. RentC. Jars

Click to see the answer.

Which of the following is a variable cost?

A. InsuranceB. RentC. Sugar

Click to see the answer.

Now that you know what fixed and variable costs are, let’s move on to break even analysis.

The break even point is how many products you must sell to cover your costs.

We’ll go through an example on the next slide, followed by a link that will give you your break even point.

Example Variable cost (VC) = $2.50 Fixed cost (FC) = $500 Price per unit (PPU) = $5 How many units (A) must you sell to break

even? (VC x A) + FC = PPU x A (2.50 x A) + 500 = 5 x A 500 = 5A – 2.5A 500 = 2.5A 500/2.5 = A A = 200 units must be sold to break even

Go to the following link using the same numbers as the previous example and you should get the same answer of 200 units.

http://www.dinkytown.net/java/BreakEven.html

In case you forgot: Variable cost = 2.50 Fixed cost = 500 Price per unit = $5 Hint: Expected unit sales is anything greater than

1.

In the previous examples, the break even point was 200 units.

If more than 200 units are sold, you will have a profit; if less than 200 units are sold you will have a loss.

Plug the following numbers into the break even calculator. Is there a profit or a loss? Variable cost = $2 Fixed cost = $300 Expected unit sales = $200 Price per unit = $4

Click to see the answer.

Go to: http://www.dinkytown.net/java/BreakEven.html

Profit

Plug the following numbers into the break even calculator. What is the break even point? Variable cost = $3 Fixed cost = $400 Expected unit sales = $200 Price per unit = $6

Click to see the answer.

133 Units

Go to: http://www.dinkytown.net/java/BreakEven.html

Marginal cost Marginal cost by definition is the change in

cost that results from changing the output by one unit. Basically it’s the difference in variable costs

based on units sold. For example:

Variable cost = $200 for 15 units sold Variable cost = $215 for 16 units sold Marginal cost difference = $15

The difference between variable costs

Marginal cost Go to: http://hspm.sph.sc.edu/Cost.html

for a more in-depth, interactive explanation about marginal costs.

Remember to come back after exploring the Web site.

What is marginal cost?A. The change in cost that results from

changing the output by one unitB. The cost of overheadC. The charge for permanent part-time laborD. None of the above

Click to see the answer.

Pricing your product You have a few ways to price your product:

Cost-plus pricing Cost-based pricing Percent food cost pricing Contribution pricing Working-back method (expected return)

Before moving on to pricing methods, let’s review a couple of terms and go over a couple of new ones.

Fixed costs are expenses that must be paid no matter how many goods or services are offered for sale.

Variable cost are expenses that change with the number of products offered for sale.

Direct costs are directly related to the production of a product. Cost of sugar to make jelly is a direct cost.

Indirect costs are not directly related to the product, but have to do with overall production. Rent would be an indirect cost.

Cost-plus pricing This is a simple and popular way to price a

product/service. You buy 100 products for $1,000.

$1,000/100 = $10 This is the basis for which you sell each product.

If you want a 20% profit, you should sell the product for $12 (120% x $10).

This method allows you to cover all direct costs and generate a profit.

The downside is you have not considered the needs of the market or compensated for any indirect costs.

Use the cost-plus pricing method in the following example.

You buy 50 products for $1,000 and want to make a profit of 30%.

What’s the selling price?

Click to see the answer.

$1,000/50 = $20

$20 x 130% = $26

The selling price should be $26.

Cost-based pricing Cost-based pricing uses unit costs of

ingredients, expenses and labor to determine the price.

Costs will fall under fixed or variable costs. You need to know your total costs before you

can find your break even point. Once you know your total costs, figure out

how much you must sell your product for to cover them.

Then add your profit.

Cost-based pricing example Fixed costs = $200 Variable costs = $5 Units = 100 You want a profit of 20%

$200 + (100 x $5) =$700 Total costs = $700

$700/100 = $7 (If you sold them for $7 you would break even)

$7 x 120% = $8.40 The selling price should be $8.40 to cover costs

and make a 20% profit.

Use the cost-based pricing method in the following example. Fixed costs = $100 Variable costs = $3 Units = 50 You want a profit of 20%. What’s the selling price?

Click to see the answer.

$100 + (50 x $3) = $250 Total costs = $250

$250/50 = $5 (If you sold them for $5.00 you would break even)

$5 x 120% = $6 The selling price should be $6 to cover costs and

make a 20% profit.

Percent food cost pricing Percent food cost pricing is based on the

theory that food cost makes up about 40 percent of the price.

To establish a price, multiply the food cost by 2.5 (40 percent times 2.5 = 100 percent).

This method commonly is used for catering businesses, but only if a product does not require a great deal of labor or if ingredients are not very expensive.

Use the percent food cost pricing method in the following example.

It costs you $2 to make a club sandwich.

What should the selling price be?

Click to see the answer.

$2 x 2.5 = $5

You should sell the sandwich for $5.

A. Cost of laborB. Kitchen remodeling costC. Insurance costD. Food cost

Click to see the answer.

What information do you need to figure out percent food cost pricing?

Contribution pricing Contribution pricing allows you to cover all

direct costs (per product), but also allows a contribution toward indirect costs and profit.

The next slide will walk you through an example.

Use the contribution pricing method in the following example.

Your product has a direct cost of $50 and you want to make a contribution of $20 to indirect cost and profit.

If indirect costs are $1,000 and you want to make a profit of $300, how many products do you have to sell?

Click to see the answer.

$1,000 + $300 = $1300 (indirect cost + profit)

$1,300/$20 = 65

You need to sell 65 products to cover indirect cost and make a $300 profit.

Working-back method This method is most useful for smaller

businesses.  If a business sells 100 products each month

and the total costs (fixed, direct, indirect, etc.) for the month are $1,000 and the business owner expects to cover all his costs and make a profit of 50%, he must sell $1,500 worth of products.

Therefore, the business owner sells his products at:

 $1,500 / 100 units = $15 per product

Working-back method cont. If your price is higher than the competitor

using this method, offer something more to compensate for the higher price.

For example: A competitor charges $100 for a cake. As a

result of using this pricing method you charge $120. To prevent losing customers to the cheaper business, upgrade your service to include delivering the cake.

The extra quality in the service may require slightly longer hours, but it will compensate for the higher price.

Use the working-back pricing method in the following example.

You sell 200 products each month. Total cost = $500 You want a 50% profit What should your selling price be?

Click to see the answer.

500 x 150% = 750

750/200 = $3.75

You should sell your product at $3.75 to make a 50% profit.

We hope this module has helped you determine what your product is worth. Use this module, along with the other modules, to get you on your way.

Post-survey Let’s see what you’ve learned. Click here to begin the post-survey.

•The last slide shows additional resources. •After the slideshow is done go to “File” and click on “Print.” •A box will open up. •Click on “Slides” under “Print Range.” •Type in “38” and click on “okay.”

Additional Resources University of Omaha

http://ecedweb.unomaha.edu/lessons/euse2.htm Interactive Tutorial

http://hspm.sph.sc.edu/COURSES/ECON/Cost/Cost.html