While retail bakers increased prices this year to encounter skyrocketing commodities costs, did they raise them enough? Bakery
owner Karl Schmitt shares his methods for
answering this question and scrutinizing
bakery P&Ls in this challenging economy.
When one or two ingredient prices go up, bakery operators can simply refigure retail prices to return a fair profit from their customers. But, when nearly every ingredient price increases at the same time, as they did this year, raising retails gets more complicated.
Two key questions arise. First, how will your customers react to these price increases? And second, have you increased prices enough for true profitability?
Last month's article, Adjust Your Bakery Business, offered insight to the first question. Most bakery operators are finding little resistance to price increases from their customers because rising food costs are not exclusive to bakery items. And, consumers are more aware of the commodities crisis thanks to media attention and bakery trade associations joining forces to call attention to the problem.
“Our guests [customers] have been very understanding of the higher prices. We have heard few complaints,” says Tammy Kampsula, bakery director for United Supermarkets, Lubbock, Texas.
Other bakers fear the low customer resistance to the price increases is actually a sign of fewer customers coming in the door. The price boundary between getting the sale and losing the customer can be fuzzy.
“Most bakers are reporting that customers aren't complaining because they aren't coming in to complain,” says Karl Schmitt, co-owner, Deerfields Bakery, Buffalo Grove, Ill.
How retail prices affect customer counts is difficult to track and variable depending on the bakery. But, bakers can use a few cost accounting methods to determine how much to raise prices to return a profit.
To help retail bakers get a better handle on their retails, Schmitt shares his methods and attempts to help you answer two important questions: What impact have the commodity prices had on your business and have you increased your prices enough?
Bakery operators use several common methods to reconfigure retail prices. Although tedious, one option is to recalculate the ingredient cost of every formula and every product in order to increase your prices on a product-by-product basis. Another common method is to simply look over your profit and loss (P&L) statements and examine the percentage of ingredient expense relative to the sales and increase your prices appropriately. The second method works well if you either: perform a complete physical inventory of your ingredients at the beginning and end of the month while holding your retail prices unchanged; or compute the ingredient cost percentage using three consecutive months with unchanged retail prices, i.e. three months of data either before or after you change prices.
Schmitt offers another fairly simple method to help you estimate the impact of soaring prices on your P&L statement with just one month of data and you can use that information to icrease your retail prices. The first step is to enter all of the invoices from your ingredient suppliers for a current month into a spreadsheet program, like Microsoft Excel. Most bakery accountants separate commodity costs from paper costs, so that should reduce the amount of work required. Initially, you need only four columns of data for each invoice:
Column A - units received
Column B - name of item purchased (with unit size)
Column C - most recent price of unit (price based on last invoice of the month)
Column D - extended price using a formula (A times C) [See table p. 33]
Now, go back and add two more columns of data for each row:
Column E - price paid for each product purchased this year using invoices for the same month last year
Column F - extended price using a formula (A times E). [See table on this page]
Here are a couple of helpful hints to follow while you perform this exercise:
The increase in ingredient cost that you can expect from last year to this year can be computed by simply dividing the sum of Column D by the sum of Column F. Each bakery is likely to find the result to be slightly different because of its variety of products sold and prices paid for its raw materials. For Deerfields, the above calculation resulted in a value of 1.174.
It's extremely important to know exactly what that 1.174 represents. Deerfields' ingredient cost last year prior to increasing its retail prices was running about 28 percent. If retail prices remained the same as last year, then expect new ingredient cost to be 28 percent times 1.174, or 32.872 percent.
Once you've raised your prices and determined the effect the increase in commodity prices had on your ingredient costs, the next question becomes even more critical. Have you increased your prices enough?
It's unlikely that in response to the soaring commodity prices you have raised all of your retail prices by the same percentage. Most bakers apply different percentage increases to varying groups of products. Consequently, it is necessary to compute the “average” increase for your entire product line. Calculating a simple average of all items wouldn't be accurate because some groups of products sell better than others. So, bakers need to determine a “weighted” average.
Accountants can use a number of methods to compute this weighted average. These three methods offer different degrees of accuracy:
Method 1 is straightforward as long as your cash registers give you customer counts. Simply divide your retail sales for the week by the number of customers for the week. Then, do it again for the same week from last year. Take the result of these two average ticket sizes, and divide the 2008 average by the 2007 average. That should give you an amount like 1.127. This number is analogous to the number you computed for the increase in ingredient costs as outlined earlier, but this number is about your price increase. To express the number as a percentage, just subtract 1 from it and multiply the result by 100. In the example of 1.127, the percentage would be 12.7 percent.
One of the problems with method 1 is that you likely have lost a significant number of customers due to the economy and your increase in prices. These “lost” customers also likely have something in common that makes a direct comparison of this year's average ticket size with last year's potentially invalid. It really depends on your bakery. Method 1 might be good for a donut shop, but not very good for a full-line retail bakery. It doesn't work for Deerfields full-line bakery as the percentage turned out to be different for each of its three locations.
Method 2 should be fairly self-explanatory as it is similar to the work done on the ingredient price comparison outlined earlier in this article. Here are a few hints:
If you have too many custom cakes to individually reprice using last year's prices, then use the average ticket size (for cake sales only) for this year and 2007. Multiply the 2008 sales of custom cakes by the ratio of the 2007 average cake ticket to the 2008 average cake ticket to get the total “repriced” sales for the 2007.
Method 2 is appropriate for a small retail bakery with only one location. Method 3 may be more appropriate for a multi-unit retailer (MUR), who may find it easier to use production reports exclusively or a combination of production reports and POS reports. Again, it depends upon your bakery.
The goal is to use a method that is reasonably accurate and not too time consuming. This doesn't have to be an exact science. Remember, three or four monthly P&L statements will eventually confirm the results computed and indicate whether or not your business is profitable. However, under the current state of soaring commodity prices, bakers need to react quickly. A one-month P&L statement is not reliable unless your accountant is accurately using the accrual method of accounting.
Let's assume for this discussion that you computed the weighted average increase in ingredient costs last month to be 17.4 percent. And, this month, you have increased prices by a weighted average of 12.7 percent over last year. Have you increased your prices sufficiently to cover the cost of the increase in commodity prices?
A superficial answer would be “no” because the 17.4 percent is higher than the 12.7 percent. You also may think you need to increase your prices by 17.4 minus 12.7 or 4.7 percent to bring your business “in line” with last year's results. These conclusions may be incorrect because when you increase your prices, you are increasing not only the portion of the price “ear-marked” for the ingredient cost, but also the amount ear-marked for labor, overhead and profit by the very same percentage.
Let's try to answer the original question with an easy example. Assume that prior to increasing your prices, you project annual sales to be $1 million. Further assume that in previous years your average ingredient cost has been 28 percent.
Using the method discussed in Part I, assume you computed the increase in ingredient costs to be 17.4 percent. Multiply $1 million by 28 percent to get $280,000 as your normal budget for ingredients. Now, multiply that by 17.4 percent to get $48,720. This represents the “extra” money needed to pay for the increase in commodity prices.
Assume that your weighted average increase in price was the 12.7 percent from above. The revenue the new prices will bring is one million times 12.7 precent, or $127,000. You should have “extra” revenue of $127,000 minus $48,720, or $78,280 that is available for the increase in future wages or other expenses that might also be on the rise.
In this case, the retail prices have been increased sufficiently to cover the expected increase in food costs, and the additional money will be needed to cover the wage inflation that is sure to come.
After raising your prices, you may have noticed that your labor percentage looks very good. Beware that the drop may mask a work slowdown. Next month's article will be devoted to unmasking this hidden loss of productivity with a new method to track labor.
|A. Units||B. Product||C. 2008 Price||D. Extended|
|50||Flour Patent - 50#||22.83||1,141.50|
|6||Yeast - case||28.81||172.86|
|8||Drivert - 50#||36.71||293.68|
|12||Oil Soybean Salad - 35#||27.80||333.60|
|Multiply the number of units (Column A) by the 2008 price (Column C) to calculate the extended price (Column D).|
|A. Units||B. Product||C. 2008 Price||D. Extended||E. 2007 Price||F. Extended|
|20||Flour Patent - 50#||22.83||456.60||16.93||338.60|
|6||Yeast - case||38.81||232.86||26.83||160.98|
|8||Drivert - 50#||36.71||293.68||36.37||290.96|
|4||Oil Soybean Salad - 35#||27.80||111.20||16.46||65.84|
| Divide the sum of Column D by the sum of Column F to calculate the price increase. |
2008 Extended Price ÷ 2007 Extended Price = 1.277867
Karl Schmitt is C.E.O. and treasurer of Deerfields, a family-run retail bakery in the Chicago area with three locations: Deerfield, Buffalo Grove and Schaumburg, Ill. His training in accounting is from his previous career as a pension consultant and actuary.
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