Pricing Strategy Consulting for Restaurants & Food Chains
When it comes to pricing strategy consulting for restaurants and food chains, SC2 highly recommends that you consider establishing a distributor prime agreement to manage your food service distribution costs. The typical distributor prime agreement will require 80-90% of purchases to be made from the prime vendor, along with other contractual considerations that seek to address supplier costs.
By having SC2 work on your behalf with a food service distributor, we are confident in saying that we will achieve a mutually beneficial agreement that will ultimately result in lowering your costs. Once executed, distributor prime agreements enable you to focus your efforts on running the business rather than constantly bidding out consumer products and tracking price fluctuations. Additionally, a distributor prime agreement will typically improve overall operational and product consistency.
There are several critical pieces of information that SC2 will address during the negotiation of any food service distributor prime agreement:
SC2 will strategically navigate and address the most important consideration in negotiating a food service distributor program – establishing an advantageous pricing structure. There are two common distributor prime agreement pricing strategies: cost plus fixed price and cost plus percentage.
Under the cost plus fixed price model, the distributor adds a fixed amount to each product purchased. For example, if we negotiated a $2.30 per case mark up, then each case would be marked up by this amount over the distributor's cost. In other words, if SC2 negotiated a manufacturer delivered cost on a case of salad dressing that cost the distributor $20.00, then the invoiced price to the restaurant would be $22.30. This is a very common pricing structure for national food service chain distributor master agreements but is much rarer in regional and local food chain service programs. Whenever possible, SC2 will negotiate a cost plus fixed price agreement. Having a fixed cost agreement has the benefit of not resulting in increased distribution costs when consumer product prices trend upwards.
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When negotiating a fixed price contract, SC2 determines the average price per case so that the effects of the proposed agreement can be better understood. Calculating the average price per case will provide a better understanding of any proposed fixed price mark up.
Mark Up vs Margin
While a percentage mark-up is the difference between the consumer product cost and the invoice price, the margin is the percentage difference between the invoice price and the profit. This may seem very confusing, but the example below will illustrate this critical difference.
Markup Percentage = Gross Profit Margin/Unit Cost
Cost Mark-Up Invoice Price
$40.00 15% $46.00 ($6.00 gross profit margin)
Gross Margin Percentage = Gross Profit Margin/Sales Price
Cost Margin Invoice Price
$40.00 15% $47.06 ($7.06 gross profit margin)
As Exhibit 1 indicates, a 15% mark-up contract will be $1.06 cheaper per case for a $40.00 product than a 15% margin contract. When negotiating and reviewing distributor prime agreement contract bids, it is critical to understand whether a contract is based on a mark-up or margin. For example, a distributor 15% margin contract may seem better than a 16% mark-up because of the lower percentage, but, in fact, the 16% mark-up contract is the better option. Not understanding this distinction can result in a 2-3% loss in profitability. SC2 will walk you through all of these nuances.
Once SC2 determines the pricing structure, the next big hurdle is defining cost. In almost all cases, a distributor prime agreement will define cost as the distributor's cost before deducting any off-invoice discounts they receive. These off-invoice discounts are allowances that distributors receive from the manufacturer for the specific products purchased by the food service consumer. These allowances, or rebates, are "off-invoice" so that all cost plus contracts are not based on the distributor net cost after the allowances are deducted, but rather on the larger invoiced cost of the products. To help further ensure that operators do not claim stake to these allowances, Sysco and US Foods have renamed these allowances as "earned income" to dissuade operators from attempting to tap into this revenue stream. In most cases, SC2 will be able to negotiate a prime agreement that defines cost as the net product cost after these allowances have been deducted. Because of the impact that these back-end allowances can have on distributor profitability, prime agreements will also typically state that operators are not eligible to take advantage of supplier rebate programs. SC2 will work to have these taken down to a net cost.
Determining only the prime agreement pricing structure is not sufficient when evaluating the overall strength of a particular distributor prime agreement contract. Two competing prime agreements that have the same mark-up and the same cost definition will not result in the same product pricing. Each distributor is able to negotiate different manufacturer pricing based on their overall product purchasing volume. Because of this, certain distributors may be strong in some categories and weak in others, based on the specific purchasing profiles of their food service consumers. Therefore, it is important for SC2 to ensure that a potential supplier is positioned best in the market for the specific product needs of a restaurant. The best way for SC2 to determine this is by requiring a market basket report during the negotiation process. A market basket report will analyze the performance of your top twenty to thirty products and provide the theoretical pricing under the proposed contract for a historical time period (usually the last complete month). It is important to ensure that each distributor submitting contract bids completes the market basket for the same historical time period so that accurate pricing comparisons can be done. Using these reports, SC2 can compare the value of competing contracts, as well as compare the contracts to past pricing.
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When SC2 is providing its pricing strategy consulting services by negotiating a valuable prime agreement, it is only possible when a restaurant operator considers the food service distributor costs as well. By lowering supplier costs, operators are able to achieve additional value. One of the most effective ways that a restaurant can reduce distributor costs is by managing the delivery drop size. This often means that a restaurant will agree to order less frequently to increase the amount of cases on each delivery. It is common for a prime agreement to create drop size bracket incentives which lower the mark up of products based on the drop size of each delivery.
SC2 believes that it's absolutely critical that any prime agreement provide a restaurant with the right to negotiate pricing directly with manufacturers, and that any negotiated manufacturer pricing will be respected by the distributor and invoiced as deviated prices. By having SC2 negotiate on your behalf pricing directly with suppliers, restaurants are able to get product pricing on key products that is often better than the distributor cost (before backing out the off-invoice allowances). Because these deviated prices often reduce or eliminate the off-invoice allowances that a distributor receives from the manufacturer, a standard prime agreement will not allow this practice unless negotiates for it!
Audit Privileges & Data Entitlements
It is important that any distributor prime agreement include audit privileges by the restaurant operator. In a standard audit privilege clause, an SC2 and the restaurant will be able to provide notice to the distributor that they wish to audit the cost of specific products to ensure that the restaurant is being billed properly. Often, the distributor will provide a limit to the number of products that can be audited. As technology advances in the food service industry continue to be made, it is important to include a data rights clause that will require a distributor to provide your purchasing data to SC2 to audit your invoices.
SC2 recommends that every prime agreement have a thirty or sixty day out clause that enables the termination of the agreement for any reason. That being said, we may be able to get a better contract without such a clause. If you are willing to lock in for a period of time without the option of switching distributors, SC2’s advice would be to negotiate the best agreement you can with the out clause in place, and then ask for a better deal at the end if you agree to strike the clause.
Understanding the cost of extending credit to a restaurant needs to be taken into consideration by the food service operator. Agreeing to shorter payment terms will typically result in the ability to achieve a reduced mark up on your products. Further SC2 will recommended that an incentive for payments made quicker than the contracted payment terms call for. Having this incentive enables a restaurant the flexibility to pay faster when cash flow allows, ultimately reducing the cost.
Special Orders & Slotting
The prime agreement should require the distributor to stock particular products required by a restaurant that are not normally stocked in the distributor warehouse. Typically, there will be minimum usage requirements that an operator will need to abide by for such products. Twenty cases per month is a typical threshold.
SC2 recommends that the distributor prime agreement address the substitution policy for products that are out of stock. Typically, restaurants will require notification prior to delivery of substituted products when the cost of the product exceeds the cost of the originally ordered product. Further, it is not uncommon to set an acceptable threshold for how often products can be substituted.
As you can see there are many areas of expertise required to negotiate prime agreements with a foodservice distributor. If you are ready to employ a tested industry veteran in SC2, feel free to reach out to me directly at (303) 883-3355 or email at mark.hampton@SC2.guru.
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