ArticlePDF Available

Pricing, costs and profit in food retailing

Authors:

Abstract and Figures

Viewed from a theoretical-economic approach, the consumer price contains the costs of production, processing and trading, as well as the profit share related to these activities. In practice, particularly in the food sector, this kind of linear accumulation has rarely succeeded. In the case of foods, due to a decrease in consumption and vertical competition, not only the profit share, but often some of the costs could not be made good either in the selling price. This failure has an impact on agricultural producers and the food industry, whereas in commerce, the profit-need could be realised easier. In the formation of a food consumer price there are diverse practices in use from the simple markup pricing method to the complex marketing strategies-based price-forming. This paper presents the results of price analyses done in the course of food retail activity investigation.
Content may be subject to copyright.
Acta Alimentaria, Vol. 32 (1), pp. 95–101 (20023)
0139-3006/2003/$ 20.00 2003 Akadémiai Kiadó, Budapest
Preliminary communications
PRICING, COSTS AND PROFIT IN FOOD RETAILING
F. E. BUZÁS
Department of Farm Business Management, Faculty of Agricultural Economics and Rural Development,
University of Debrecen, Centre of Agricultural Sciences, H-4032 Debrecen, Böszörményi út 138. Hungary
(Received: 3 January 2001; revision received: 18 March 2002; accepted: 16 April 2002)
Viewed from a theoretical-economic approach, the consumer price contains the costs of production,
processing and trading, as well as the profit share related to these activities. In practice, particularly in
the food sector, this kind of linear accumulation has rarely succeeded. In the case of foods, due to a
decrease in consumption and vertical competition, not only the profit share, but often some of the costs
could not be made good either in the selling price. This failure has an impact on agricultural producers
and the food industry, whereas in commerce, the profit-need could be realised easier. In the formation
of a food consumer price there are diverse practices in use from the simple markup pricing method to
the complex marketing strategies-based price-forming. This paper presents the results of price analyses
done in the course of food retail activity investigation.
Keywords: economics of retailing, marketing costs, price analyses
Retail prices, especially those for food, are widely used as an indicator in business.
From the approach of economic theory, the consumer price contains the costs of
production, processing and trading, as well as the share of income related to these
activities (and value added taxes). In practice, particularly in the food sector, this linear
accumulation has rarely succeeded, because the demand and supply conditions (e.g.
certain commitments, branch interests, etc.) greatly modified the structure and measure
of food price. Below, I present the results obtained by examining food prices in which I
lay special emphasis on analyses of retailing costs, profit and the most commonly used
pricing techniques.
Pricing in theory
Economic theory tells us that profits are maximised when marginal costs are equated
with marginal revenues. Conceptually, this is a very helpful idea, but its actual use is
beyond the capabilities of most retail organisations. As with many business firms, the
average retailer is unaware of the true nature of his cost and demand functions. He is
firmly committed to a traditional markup system that largely ignores marginal
considerations (DOUGLAS & DONALD, 1969).
96 BUZÁS: PRICING, COSTS AND PROFIT IN FOOD RETAILING
Acta Alimentaria 32, 2003
Markup (Mup) may be defined as the difference between the cost of an item and its
retail price (Rp) and is usually expressed as a percentage of the retail price: Mup% =
Mup/Rp. The retailer calculates selling prices for individual items by dividing the
known cost (C) by one minus the markup percentage. DOUGLAS and DONALD (1969)
created the following formulae:
C = RpMup or C = Rp (1 – Mup%)
C = Rp – (Mup% Rp)Rp = C / (1 – Mup%)
The major problem in the above case is the measurement of costs. In the food
industry the precise definition of the average cost of any given product is easy to obtain,
using the latest management support systems. However, it is very difficult to apply to
the retail trade and merchandising because of the variety of products and almost
impossible in the case of supermarkets where the number of commercialised products
rises into the tens of thousands. Under market conditions, markup pricing may lead to
optimal pricing behaviour, when the competitors have the same cost structure and use
the same markups.
Target return pricing considers also those costs which show the planned return on
investments related to products (REKETTYE, 1999). The method used for pricing is the
following:
P = AFC +
Qs
TFC
+
Qs
rI
Where: AFC – average fixed cost TFC – total fixed costs Qs – planned quantity r
– profit rate I – invested capital.
This method can only be used in food commerce in specialised shops which sell
small numbers of products e.g. in specialised shops, discount stores or in category
management, with respect to a given group of products. It is not in use in domestic
market.
Bulk products or the lower value-added products can be sold at low profit-share.
The low profit earned per product purchase is balanced by selling in greater quantity. In
general, the method of (markup based) market-lead pricing is the most widespread, as it
is used not only by mini-markets (groceries) but also by discount stores and even
hypermarkets.
The market circumstances in demand may vary depending on location, population,
per capita net income, as well as on the willingness to consume and consumer habit.
Also, competition in the region may be a factor. The starting point in pricing is the
purchasing price, which may vary, depending on the purchasing source. The market-
lead pricing methods are variable and differ from the commercial strategies for products
(KOTLER, 1998), I will not go into further detail, about this matter, as it would bring us
on to a different line of investigation.
It must be mentioned that pricing is not only an economic question, but it has legal
aspects, which assure normal and honest competitive conditions (BAUER & BERÁCS,
1998).
BUZÁS: PRICING, COSTS AND PROFIT IN FOOD RETAILING 97
Acta Alimentaria 32, 2003
Pricing in practice
At the beginning of the 1990s, average markup of retailed foods was 20 to 22%. These
percentages increased until the middle of the decade. With the spread of multinational
market-chains, the degree of markup slowly decreased, due to the increased intensity of
competition. “Losses” were compensated by the chains by increasing quantity and
applying modern commercial and marketing techniques (BELYÓ, 1998). According to
the statistical data in 1997, markups in the food-wholesale sector ran 15–17% and 19–
20% for the ratail trade (KUBIK, 1997).
The study of marketing costs, degree of markup and different sources of income
are used to analyze the structure of food prices. Operational costs (e.g. energy, wages
and logistics) set the lower limit for markups The upper limit varies according to
payable demand.
In the framework of this price study, I analysed the economic situation and price-
calculation system of supermarkets of two different commercial chains, emphasizing
the investigation of marketing cost and profit. On the basis of collected data and related
literature (TETRA PACK, 1996), it was possible to create a model which shows the real
profit and profitability conditions of retailing for a given product or group of products.
This model not only allows the demonstration of the profitability of merchandising
a certain specific product or group of products, but may also be useful in analysing food
chains (from farmer to consumer), especially when comparing costs and earnings on (or
between) different levels of the chain (NEMESSÁLYI & BUZÁS, 1996).
1. Material and methods
The data were collected using questionnaires and interviews from 18 stores of two
different commercial chains with an average of 350–400 m2 selling space. The ratio of
food and non-food products was 70/30% and the number of merchandised products
ranged between 4–6.000.
The costs and incomes of a particular store represent average values calculated
from operation records. One part of the figures shown in the model (buying- and
consumer price, quantity sold, working time input, hourly wages, logistic costs) also
represent average values in the model and are independent variables. The costs of
cooling, cleaning, direct selling, gross- and net markup are dependent variables of the
model. The income – other than net markup (margin) – per product was calculated by
adding the following variables: interest, listing (or shelf) fee and marketing
contribution. These variables were calculated using the average of the fees applied by
the studied chains.
98 BUZÁS: PRICING, COSTS AND PROFIT IN FOOD RETAILING
Acta Alimentaria 32, 2003
2. Results and discussion
Table 1 shows the yearly turnover, the purchased value of sold products, the operational
costs and income calculated from the averages of yearly account statements.
Table 1. The measure and structure of the yearly turnover in the studied stores (average data)
Denomination Mill. HUF/year %
Net turnover 183.35 100
Purchased value of sold products 141.04 76.9
Costs 34.23 18.7
Income (EBIT) 8.06 4.4
Source: Calculated by own data collection
All studied shops were profitable and on the average the net markup (which
contains both the profit and cost) varied between 20–40% of the net turnover. Figure 1
indicates the structure of the average net markup.
Fig. 1. Distribution of costs and profit in the ratio of net markup. Calculated by own data collection
Wages make up the largest portion of costs; business (administrative) expenses of
the stores are also large and include the costs of logistics and storage. Depreciation,
promotion and packaging show smaller ratios of the whole.
The pricing of most products is done centrally, on the basis of a markup, with the
use of a price multiplier which is the quotient of the selling and purchasing price. In the
case of some basic food products, the sales manager of a given shop can modify the
price multiplier, depending of the conditions of supply and demand or competitors’
BUZÁS: PRICING, COSTS AND PROFIT IN FOOD RETAILING 99
Acta Alimentaria 32, 2003
prices. Daily consumption goods (e.g. milk and bread) are purchased directly from the
suppliers, while durable foods (e.g. sugar, sunflower oil and canned foods) are
transported from a central warehouse by order, and are a burden on logistic costs. These
were calculated as 4% of the net income, including the cost of transportation. My data
largely corresponded with that in the related literature (STAUDER, 2000).
Price multiplier does not mean the profit or the profit-margin of products which
were put into circulation. We need more information to determine the profit of the
product. First of all, we have to determine the selling cost of the product. If we know
the direct selling cost, we can calculate the net margin, which means the product’s
profit. In addition to profit margin, there are other incomes which have nothing to do
with price factor, such as: interest (which comes from delayed payment) shelf-fee
listing fee, or marketing contribution. Table 2 shows the cost and income situation of
some selected foods with the help of a price-calculation model.
Model calculations show interesting results. As mentioned, the selling price is
formed generally with the help of price-multiplicators (R), which in fact, are in
accordance with gross markup (N2).
The level of gross margin depends on consumer demand. In case of “everyday”
products, which represent less added value (such as bread, poly-packed milk) small
(less) margins are used because of the strong competition between the shops.
If we restrict a product’s income-analysis only to price factor, we see that net-
markup (J1) – which in fact means the profit of the product – is negative, in the cases of
bread and poly-milk, that is brought at a loss because of high average selling cost (I).
There are also other incomes besides price factor, which are usually able to
compensate this loss (J2, J3, J4). Among these we have to mention the following:
interest earnings (J2) come from delayed payments (20–40 days or more)
shelf (or listing) fee (J3) (according to the model, this price is 50,000 HUF/year in
the cases of bread and poly milk, and 100,000 HUF in the rest), for products of
higher added-value or quality (marked) products, this fee can be more than 5-
600,000 HUF/year.
Marketing contribution (J4) means a monetary contribution of suppliers to the retail
business’s advertising activity (publication of leaflets, local advertisements, facing),
which is generally 2–4 per cent of the product’s return from sales.
This is why even in cases of loss-making products considering these extra
incomes, cost-rated profitability (P) is favourable and, in some cases, of incredibly high
value. In addition to the aforementioned incomes, there are other incomes such as “list-
holder fees”, bonuses (depending on turnover), or “stores opening fees”, multinational
chains have introduced, which are not included in the model. This extra income does
not appear in specific shops or supermarkets, but improves the profitability of the chain
as whole.
100 BUZÁS: PRICING, COSTS AND PROFIT IN FOOD RETAILING
Acta Alimentaria 32, 2003
Table 2. Price and markup calculation model in the case of selected foods
Poly-packed
milk
UHT Milk
White
bread
Crystal
sugar
Sun-
flower oil
AQuantity sold per week (kg, l) 845 390 455 780 520
BPurchasing price (HUF/kg, l) 140 156 136 143 235
c1Reception time (minute/week) 78 18 90 30 30
c2No. of engaged workers (head) 3 3 2 3 3
c3Time for product setout (min./week) 85 39 65 52 52
c4Nr. of engaged workers (head) 2 1 2 1 1
CDirect labour cost (HUF/week) 2485 574 1912 876 876
DCooling costs (HUF/week) 994 0 0 0 0
ECleaning costs (HUF/week) 350 0 0 0 0
FDirect selling costs (HUF/week) 3829 574 1912 876 876
GLogistic costs (HUF/week) 02758 04986 5441
H1
Losses (% of purchased stock value) 0.5 0.1 0.2 0.2 0.1
H2
Losses (HUF/week) 592 61 124 223 122
IAverage selling cost (HUF/l, kg) 5.23 8.70 4.47 7.80 12.38
J1Net (markup) profit-margin (HUF/l, kg) 1.48 12.09 2.08 9.02 14.22
KNet price (HUF/l, kg) 143.8 176.8 138.4 159.8 261.6
LVAT (HUF/l, kg) 17.25 21.21 16.61 19.18 31.39
MSelling price-including VAT (HUF/l, kg) 161 198 155 179 293
N1
Net markup (%) 2.68 13.32 1.76 11.76 11.32
N2
Gross markup (%) 15.00 26.92 13.97 25.17 24.68
J2Interest (7%/year) HUF/l, kg 0.82 0.91 0.79 0.83 1.37
J3Listing (or shelf) fee (HUF/l, kg) 1.18 5.13 2.20 2.56 3.85
J4Marketing contribution (2%) HUF/l, kg 2.8 3.12 2.72 2.86 4.7
OTotal profit (HUF/l, kg) 0.52 18.13 0.91 12.42 19.44
PCost-rated profitability (%) 9.92 208.39 20.35 159.18 156.99
RPrice multiplier 1.15 1.27 1.14 1.25 1.25
Source: Calculated by data collected from retail stores
Where:
A, B, - variables J3 = Lf / ww / A
C = c1/60 × c2 × awe + c3/60 × c4 × awe Lf = listing (or shelf) fee (HUF/year)
c1, c3 ,c2, c4 variables ww = working week/year (50)
awe = average wage (HUF/h) J4 = B × (1+ Mco%) B
D, E calculated by own data
F = C + D + E
Mco = marketing contribution in %
of purchased value of product
G = A × K × Loc% K = M L
Loc = logistic costs in % of net turnover L = M/1,12
H1, Mvariables N1 = (J1 + I) × 100/B
H2 = A × B × H1 N2 = (L + J1 + I) x 100/B
I = (F + G + H) / A O = J1+J2+J3+J4
J1 = K I P = O/I × 100
J2 = B × (1 + r% /12) B R = M / B
r = interest (7% in every cases)
BUZÁS: PRICING, COSTS AND PROFIT IN FOOD RETAILING 101
Acta Alimentaria 32, 2003
3. Conclusions
The most important findings are the following:
Model calculations show that a price that means real income cannot be created
by markup pricing or using a price multiplier in every case;
the model is suitable for considering the average selling costs and profit only as
average non-price incomes;
on the basis of real average costs and incomes, one may calculate the real
profitability conditions. The data we calculated also show that by using efficient
merchandising tools, a more advantageous assortment is creatable where supply-
demand conditions are adequate;
furthermore, the model can also be used to analyse different vertically integrated
chains on the basis of studying costs and incomes, or even added value, in order to
compare the economic situation of primary producers, processing industry and retail
traders.
References
BAUER, T. & BERÁCS, J. (1998): Marketing. (Marketing.) Aula Kiadó, Budapest, pp. 292–296.
BELYÓ, P. (1998): A belkereskedelem 12 éve. (The 12 years of the internal trade.) Statisztikai Szemle, 76 (1),
65.
DOLAN, R.J. & SIMON, H. (2000): Árképzés okosan. (Power pricing.) Geomédia Kiadó, Budapest. p. 47.
DOUGLAS, J.D. & DONALD, L.T. (1969): Retailing – an economic view. Indiana Univ. Publ., pp. 173–175.
KOTLER, P. (1998): Marketing menedzsment.
551–557.
NEMESSÁLYI, ZS. & BUZÁS, F.E. (1996): The major vertically integrated industries’ costs and income
position from producer to consumer. V. Agrárökonómiai Tudományos Napok, Gyöngyös, Vol. II., pp. 276–
277.
KUBIK , december 18, 34.
REKETTYE, G. (1999): Az ár a marketingben.
pp. 97–111.
STAUDER, M. (2000): Development of food distribution systems in Hungary with a special view at trade
logistics. AKII, Budapest 8 sz. p. 35.
TETRA PACK (1996): Profit a dobozban. (Profit in the box.) Progresszív Magazin, 4 (7), 31.
ResearchGate has not been able to resolve any citations for this publication.
A belkereskedelem 12 éve. (The 12 years of the internal trade.)
  • P. Belyó
BELYÓ, P. (1998): A belkereskedelem 12 éve. (The 12 years of the internal trade.) Statisztikai Szemle, 76 (1), 65.
The major vertically integrated industries' costs and income position from producer to consumer
  • Z S Nemessályi
  • F E Buzás
NEMESSÁLYI, ZS. & BUZÁS, F.E. (1996): The major vertically integrated industries' costs and income position from producer to consumer. V. Agrárökonómiai Tudományos Napok, Gyöngyös, Vol. II., pp. 276-277.
Az ár a marketingben
  • G Rekettye
REKETTYE, G. (1999): Az ár a marketingben.7KHSULFHLQWKHPDUNHWLQJ0V]DNL.|Q\YNLDGy%XGDSHVW pp. 97-111.
Development of food distribution systems in Hungary with a special view at trade logistics. AKII, Budapest 8 sz
  • M Stauder
STAUDER, M. (2000): Development of food distribution systems in Hungary with a special view at trade logistics. AKII, Budapest 8 sz. p. 35.
Vevöagazat. (Customer branch.)
  • P. Kubik