A Marginal Challenge

February 22nd, 2011 | Simcha Weinstein | Comments Off on A Marginal Challenge

Recently, I have received a flurry of email questions about margin and pricing. On occasion this will happen, where the questions I receive tend to focus around one particular topic. I’m not sure why margin is taking center stage at this time, but I am happy to address the issue with the following article that I first wrote several years ago and remains very relevant. To all those who are having margin issues or are focusing on pricing and margin right now – I hope this helps.

Perhaps the biggest challenge that any manager or department head faces in the retail food business is achieving their target margin. One of the biggest obstacles to achieving said margin is accurate pricing. Most everyone assumes they know enough basic math to price their product, after all there are typically only three variables involved – cost of goods, weight or volume, and target margin you are wishing to achieve. Where it’s most easy to stumble is in putting these variables together as the correct formula. While being a math wizard is not necessarily a criterion for being a good manager, having a basic understanding of pricing formulas is necessary. No matter how much you excel in other areas of management, ultimately your performance evaluation boils down to the profitability of your department. Key to the success of any section of a store is achieving or exceeding your target margin. If you are not making money on the product you sell, your business is ultimately in trouble. A variety of factors are usually considered when there is a margin problem: rotation, ordering, size of displays, etc., but typically at play in a margin crisis is pricing. To fix a margin problem, you simply don’t raise prices – that would be a disastrous formula. What you do examine is to make sure that you are pricing correctly. Here a few recommendations for ensuring good pricing habits:

Understand What Margin Is: The first step is to understand the concept of margin – to know the theory. By definition margin is the difference between the cost of goods (including shrink) and the selling price of an item. When expressed as a percentage, it is the margin revenue divided by the sales revenue. In other words, it is the gross profit of the item sold. If for example, a 50 lb. sack of potatoes cost $10.00 and you achieve $15.00 in sales from it, then your margin is $5.00, or as a percentage, 33%.

Margin vs Mark-up: Unfortunately margin is often confused with mark-up. When an item is being priced there is a tendency to define the process as “marking up” an item. This can easily lead to serious pricing issues. When you mark-up an item you multiply the price of the item by whatever percentage you want to achieve. So, in the example above, if we want to mark-up the $10.00 item by 33% we will realize a price of $13.33. Even though the item was marked up by 33%, the actual margin on an item that costs $10.00 and sells for $13.33 is only 25%. Unfortunately, by marking a product up by 33%, it is easy to believe that you are realizing a 33% margin, when in fact the result is much less.

How to Price for Margin (an example):
1.) Determine margin objective 33%
2.) Convert to a decimal .33
3.) Subtract from 1.00 (answer is called a “reciprocal”) .67
4.) Find cost $10.00
5.) Divide cost by reciprocal ($10.00/.67) $14.92
6.) Round up to price point $15.00

This may seem a bit complicated at first, but it works every time and will soon become second nature as part of your pricing strategy.

Accurate pricing does not guarantee that you will always achieve your target margin. There are many factors that all work together to accomplish this end. One thing is very certain: if you are pricing your product below the margin you are trying to achieve, there is absolutely no way possible that you can achieve your margin. Price accurately and perform your operational tasks smartly and you will typically have no problems hitting the bull’s-eye of your target margin.