Starting your own food business is an exciting venture.
But once you start to get deeper into the food industry, odds are you’ll come across business terms you’ve never heard before.
Here’s a quick guide to some of the most common (and most important!) food business terms you might encounter.
Cost of goods sold. This is the total cost of everything used to make your final product including:
- ~ Ingredients (plus the shipping costs to get those ingredients)
- ~ Packaging (jars, bottles, boxes, labels, etc.)
- ~ Labor (in-house production or co-packing)
To price your product for retail, you will want to have as accurate of a COGS as possible. For an easy-to-follow guide to calculating your COGS, check out this article by The Balance Small Business.
Gross profit margin. Simply put, this is the money left once you subtract the COGS from the final revenue. Stated as a percentage or dollar amount, the GPM is used to determine the efficiency of a company by comparing the costs of producing a product to its revenue. The higher the GPM, the more efficient the company. It’s calculated as:
- ~ (Revenue — COGS) / Revenue
Here’s an example:
Between January and March you sold 3,000 packages of chocolate chip cookies at $4 each, for a total revenue of $12,000. The COGS for each package is $1.25. To calculate your GPM:
- ~ Revenue: $12,000
- ~ COGS: $3,750 ($1.25 x 3,000)
- ~ GPM: 68% ($12,000 — $3,750)($12,000) or $8,250 ($12,000 — $3,750)
The GPM can help you to determine how to make your business more profitable. Increasing sales and decreasing costs will result in a higher GPM, and more money left over to invest back into your business.
This is the net profit margin, or the amount of money left after you subtract business expenses from the GPM. In other words, it’s your final profit.
For most small business owners, the idea of making money from selling your products is an exciting prospect. But to determine how much money you made, it’s important to figure out your NPM.
Here’s an example:
Say you’ve sold 430 units of honey at $6 each, with a COGS of $2.60 per unit.
- ~ Revenue: $2,580
- ~ COGS: $1,118
- ~ GPM: $1,462
Next, you need to determine your total expenses. These can include labor, distributor costs, farmer’s market booth fees, vendor fees, travel costs, sample and demo costs, etc.
- ~ Samples: $50
- ~ Farmer’s market booth: $15
- ~ Labor: $125
- ~ Total expenses: $190
To find your final NPM, you subtract your expenses from your GPM.
- ~ NPM: $1,272 ($1,462 — $190)
So at the end of the day, the take-home profit is $1,462. Just with like the GPM, the best way to increase your net profits is by increasing sales, and decreasing costs.
This is the return on investment, or how much money is earned based upon the initial amount of money invested. The ROI is an indicator of how well a business is performing and can make the company appear more attractive to prospective investors. Think about it this way; if you had $5,000 to invest, you would want to make a profit on that investment. The higher the ROI of a business, the more likely you would be to invest in it.
The ROI is calculated as (Total gain on investment — cost of investment) / Cost of investment
Let’s say you invest $4,000 in a company, and receive $5,000 back in return. The ROI would be:
- ~ ($5,000 — $4,000) / $5,000
- ~ ROI = 20%
If you hope to grow your business through the use of investors, having a high ROI is a great first step.
The Manufacturer Suggested Retail Price, or MSRP, is the recommended price of your product for retail sale. Depending on the store, the actual cost of the product may be higher or lower than the MSRP.
Discounts and Promotion Terms
A type of promotion, manufacturer chargebacks (MCB) are allowances charged to a manufacturer by a distributor. In the food industry, MCBs are often used by food brokers when negotiating orders for a product with retailers. The discount is given to the retailer by the distributor, who then charges the manufacturer for the promotional amount.
MCBs are a less common type of promotion and are generally used on an initial order of a product as an incentive to the retailer to carry it in the store.
More common than MCBs, off-invoice promotions are discounts given to distributors by manufacturers, which are then passed on to retailers. OI discounts are determined by the manufacturer and are available to all retailers that carry the product.
Scan down promotion
This is a type of promotion negotiated between a manufacturer and a retailer. Unlike OI promotions where the distributors receive the discount and pass it on to any retailer, scan down promotions are store-specific. The amount of the discount is then paid by the manufacturer directly to the retailer after the promotional period.
For example, say you manufacture ready to drink protein shakes with a shelf price of $3.50 and are looking to run a promotion with Whole Foods stores. You’ve decided on a two-week promotional period, with a discount of $0.50 off each unit. At the end of the promotion your numbers might look something like this:
- ~ Total amount of goods sold with promotion: $2,625 (750 units sold x $3.50/unit)
- ~ Sales with promotion: $2,250 (750 units sold x $3.00/unit)
- ~ Scan down amount paid to retailer: $375 ($2,625 — $2,250)
So at the end of the promotion, you will end up paying Whole Foods $375.
Scan down promotions can be especially beneficial for small businesses looking to offer sales. Unlike OI discounts where retailers can buy as much discounted product as they want, scan down promotions mean you are only paying for items sold.
Everyday low pricing is a type of promotion in which products are sold at discounted prices during a long-term period, usually at least six months. Traditionally priced somewhere between the non-discounted and discounted prices, EDLP requires less promotional advertising.
Big retail chains, such as Walmart, or wholesale clubs, such as Costco, use this pricing strategy.
Manufacturing and Distribution Terms
Also known as contract packers, co-packers are companies that manufacture and package products for clients. For small businesses who don’t have space or capital for commercial kitchens of their own, co-packers help businesses to scale up their production and meet increasing demand.
To find out if your business is ready for a co-packer, check out this article here.
This refers to the manufacturing of a product that is then packaged and sold under a retailers private label. Often called “store brands,” these include brands like Kirkland at Costco and 365 Everyday at Whole Foods.
Food brokers are independent marketing sales agents who help negotiate sales between buyers (stores, restaurants, etc.) and manufacturers. Food manufacturers generally use them in place of hiring full-time sales staff.
Once products are on store shelves, brokers can also assist with in-store marketing, including organizing demos, passing out samples, and educating staff. To learn more about the pros and cons of hiring a food broker, check out this article.
When businesses grow in size, they will typically use a food distributor to help streamline the distribution process. Traditional food distributors buy products directly from manufacturers, store them in warehouses, then transport and sell them to retailers.
Online distributors, such as Pod Foods, use online marketplaces to let retailers view and select items, which are then transported directly from the manufacturer to the retailer. By eliminating the need for warehouse storage, online distributors allow small businesses to price their products reasonably, without paying the high costs of using a traditional distributor.
Here’s a great article about how online distribution benefits food manufacturers.
This is the number of SKU’s a company has on the shelf. For example, if you are selling three flavors of potato chips, with two facings per product, your brand would be taking up six spots on the shelf. The more facings you have, the more noticeable your products become to buyers, which can be extremely beneficial in highly competitive markets.
This is the prime real estate in a retail store. Products placed at eye level on the shelf are seen more easily by customers and have a 35% higher chance of selling. In an average store, eye-level shelves are typically four to five feet off the ground.
Having your products on these shelves isn’t cheap. Eye level shelves come with high prices, and the most profitable products usually take the spots.
Check back soon for Part 2 to learn more of the food business terms you should know!