Vol. 127 - NO. 39

Blog Startup CPG

SINCE 2019

Pricing 101:
A Beginner’s Guide for Pricing Your CPG Product

David Downing is the Co-Founder and CEO of ChipMonk Baking, a Houston-based specialty bakery that produces delicious low-carb, gluten free, keto, and diabetic friendly desserts. The company currently self-manufactures their products but has also worked with contract manufacturers on larger orders.

Why Your Product Price is Important

One of the most critical early-stage activities any CPG business owner needs to tackle is determining the price for your product. Why is nailing the price so important?

  1. Pricing determines how much profit you generate with each sale. This dictates the underlying financial feasibility of your business and will also determine how much you can invest into things like customer acquisition costs and marketing.
  2. Your product’s price tells a story to potential and existing customers. The right price should portray value and give customers confidence in your product. It may even signal to customers how frequently they should be consuming your product. Your price is your ultimate customer acquisition tool. Oh, and that does not mean the lowest price is always the best!
  3. Pricing for CPG products can be difficult to change once set. The last thing you want to do is “bait and switch” your customers by starting off with one pricing structure and later on switching to something different because you got the numbers wrong. This is definitely something you want to get right the first time, so put some effort into the pricing process.

Pricing Strategies

Economists have spent years developing various pricing strategies that businesses can adopt, but I believe there’s really three strategies you should employ together to achieve the best all-around price. These are:

1. Value-based pricing

Set your prices according to what consumers think your product is worth. Is your product the only thing like it in the world and would provide huge value to consumers (e.g., the iPhone when it first came out)? If that’s the case, the value of the product is probably significantly higher than the underlying cost, and you should price it accordingly.

2. Competitive pricing

What are your competitors charging for their products? You need to make sure you’re aware of the competitive landscape, and, if your product is similar to others, it likely should be priced similarly. This thinking can apply to entire product categories as well. Price anchoring comes into play here, where consumers have certain price expectations for well-known or habitually consumed categories. For example, someone generally knows what a gallon of milk “ought to” cost, so if you sell milk you need to make sure you’re paying attention to the price of milk in general. With regards to how you market your product, you should try your best to avoid anchoring your product’s price into a cheaper category. For example, at ChipMonk Baking, we try to avoid lumping our products in with “regular” cookies because most people anchor the price of a cookie to those super cheap value boxes you can pick up at Walmart or other big box stores. Those prices simply aren’t feasible for a small startup, so we do what we can in our marketing message to show how our keto cookies are much more than your run-of-the-mill cookie.

3. Cost-plus pricing

This is one of the simplest pricing strategies. You just take the product production cost and add a certain percentage to it. I would argue that this is where you should start, because at the end of the day you must understand your product’s costs to understand what profits or gross profits can be generated off of whatever pricing you land on.

Step by Step Guide for Setting a Price

Note: I’ve created a Google Sheet Tool you can use to walk through the below steps with your own product. Here is the link: CPG Product Pricing Tool

Step 1: Calculate your Cost of Goods Sold (COGS)
The key with this step is to not leave out any of the less obvious costs. I’m going to use cookies as the base example here, but you can apply this to any product. The numbers below are for illustrative purposes only but you can swap them out for your own to calculate your COGS.
The Cost of Goods Sold for a packaged cookies includes:

  • Ingredients: $0.50
  • Labor: $0.40

To calculate labor costs, determine how many labor hours it takes to make a single cookie and multiply it by the market rate for labor. For example, let’s say it takes me 4 hours to make 200 cookies. That means each cookie takes 0.02 labor hours to produce. If you assume a $20 per hour labor rate, that means each cookie costs $0.40.

  • Packaging: $0.20 (make sure you include all levels of packaging here. The bag the cookie goes into plus the cardboard box or case you pack and/or ship it in)
  • Shipping: $1.35

Shipping cost will vary greatly between direct-to-consumer and business-to-business sales channels. Generally, e-commerce or direct-to-consumer shipping costs will be much higher because the shipments are smaller and more expensive on a unit basis. I recommend you calculate a DTC shipping cost and a wholesale shipping cost.

  • Transaction fees: Typically 2-4% of the sales price. Let’s say $0.10
  • Promotion Spend: Some companies like to bake spend on advertising and promotions directly into their cost of goods sold since you’re pretty much guaranteed to have to spend it anyways. I don’t personally do this since promotional spend is something that can be changed rapidly vs. other input costs, but if you want to include it a good rule of thumb is 10-15% of your sales price.

Based on the above, the total COGS for a single cookie-pack would be $2.55

Step 2: Set a Target Gross Margin % to Calculate a “Minimum Price”

Here are two equations you need to know by heart:

Gross margin = (Sale Price – COGS)/Sale Price

Gross profit = (Sale Price – COGS)

Your gross margin and gross profit effectively tell you how much you make on each sale of your product. The gross profit on your sales is the money you’ll be using to cover all the costs that are not directly related to the production of your product (e.g., things like rent, utilities, insurance, payroll). The more gross profit you can generate with each sale, the faster your business can become profitable as a whole. Higher margin products also give you more flexibility to invest money into marketing and sales efforts (allowing for faster growth).

A good rule of thumb with specialty food products is that you want a gross margin of at least 40%. 50% or higher would be ideal.

So, let’s start by calculating what price we’d need on the cookie to achieve a 40% margin:
Gross margin = (Sale Price – COGS)/Sale Price

40% = (Sale Price – $2.65)/Sale Price

Sales Price = $4.25

Step 3: Compare your “Minimum Price” to Competition and Perceived Value

Now that you know what price you would have to have to generate your target margin, you should compare that price to similar products that are already available on the market. Check out Amazon or Google Shopping and search for things like your product. You can also walk through your local store and see if there are any similar products on the shelves.

Is your price in the same ballpark?

If you’re price is much lower, congratulations! You can look into raising your price (for better margins) or use your lower price point as a strategic tool to drive sales and take market share from the competition.

If it’s much higher, you’ll have to either:

  1. Figure out a way to lower your Cost of Goods Sold so you can offer better pricing. Sometimes this can happen as you scale the production of your product, but be careful about betting on lower unit costs as you grow since generally the cost of inputs (ingredients, packaging, etc.) simply go up with time via inflation.
  2. Market your product in a way that justifies its premium price. Explain to consumers why they should be happy to spend a little extra on your product because of its unique value propositions.

If you don’t think either will be possible, it may be time to reassess your underlying product and go back to the drawing board on your business plan before you get too far down the road.

A Note on Distribution vs. Direct-to-Consumer Pricing

As mentioned before, your sales channel needs to be considered when you set your pricing. Typically, you will have higher pricing for direct-to-consumer sales (due to higher costs of shipping, advertising, and transaction fees) than for distribution or wholesale sales. When you are selling your product to a distributor or retailer that will ultimate be reselling it, you need to keep in mind what gross margins they will need as well.

For example, let’s say you sell your product to a distributor who then sells the product on to a grocery store where the product will be available for purchase by the end consumer.

Distributors often want to make 15-25% margin and grocery stores often target 30-40%, though these numbers are highly dependent on your product category.

Let’s assume your distributor wants a 20% margin and the grocery stores they are selling to want a 30% margin. You, however, still want a 40% margin.

COGS = $2.55

Your price to distributor = $4.25 (gives you a 40% margin)

Distributors price to grocery store = $5.31 (gives distributor a 20% margin)

Grocery store’s price to end consumer = $7.59 (gives grocery store a 30% margin)

Now look at that final number, as that is what consumers are going to see and make their purchasing decision off of. If that price is far too high compared to your category or competitive products, you probably need to think through how to adjust pricing (e.g., maybe you should offer a smaller size product with a lower COGS so its pricing is more acceptable to the end consumer).

It’s critical to understand the multiple “layers” of margins that your product will face depending on where and how you are selling. That’s why it’s often recommended that newer companies that don’t have a lot of capital try to go the direct-to-consumer route first, because there are fewer “middle-men” taking a piece of your margin along the way. I recommend you go through the above steps and develop a pricing model for both your e-commerce and wholesale businesses.

Final Thoughts on Product Pricing

Your product’s price is one of the most critical factors that will determine how successful you will be. In some cases, doing a basic pricing exercise can help you determine whether a new product idea is even feasible to begin with. Be mindful that over time many of the inputs that help determine your pricing will change, so make sure you regularly review your pricing model so you are in line with your target margins and the category / competitive landscape.
If you have any questions, comments, or want to connect on this topic or anything else related to specialty food startups then shoot me a message at david@chipmonkbaking.com or find me on LinkedIn here: https://www.linkedin.com/in/david-downing-16784023/. Thanks for reading!

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