What's Up With Mark Up PART TWO

I will never forget the day I sat in a regional office of a dairy department category manager for a rather large supermarket chain. She was talking about how she had to maintain a 35% gross in her category and she was describing how she was determining which retails to raise in order to offset her ad markdowns and maintain her budgeted margin bill out. I was shocked, she was actually raising everyday retails in order to manage her ad markdowns. I still shake my head when I think about that admission. With that being said, perhaps it is time to talk a bit more about markup and gross margin.

First however, we should probably define markup; or rather define the difference between markup and gross margin, according to produce guy anyway. Markup achieves the retail necessary to generate a given gross margin need. It is not the same as the gross margin markup.
Typically one may hear a retailer say something like "we have to mark everything up 50%". When what they actually mean is that they have to maintain a 50% gross margin, or 50% gross margin bill out. So here is the difference; if you take an item that costs one dollar and mark it up 50% you end up with a $1.50 retail and a 33.3% gross margin, not 50% (.50/1.50=.33.3). In order to reach a 50% gross .margin, the retail of any item must be twice the cost. So, if that one dollar item is marked up enough to generate a 50% gross profit, the retailer is actually marking that item up 100%, not 50%. Just do the math: An item that cost one dollar and sells for two dollars has a one dollar profit, and one dollar profit divided by a two dollar retail equals 50% gross margin. Now I know this may be splitting hairs, but facts are facts. However, for the purpose of this article we will use these terms the way one usually hears them; markup is margin.

OK, so now we have my version of the difference between markup and gross margin. Now let's take a look at how markup is used and in many cases misused. Since I am talking within the world of produce specifically and retail in general, it only seems appropriate to talk about markup/bill out as it relates to produce operations.

Like other perishable departments, produce has a myriad of categories from fresh bulk to fresh packaged to shelf stable branded, to packaged, dated items that require refrigeration. The question is how they should be managed from a "markup" standpoint. Should every SKU be marked up 50% to maintain bill out? I hope not. But more and more, it seems that retailers are overburdened with, or perhaps preoccupied with bill out. Why is this?

It is just my opinion, but the expectation of margin return for most produce operations is just too high! I would hazard to guess that the average produce operation has to produce gross profit margins somewhere in the 41% to 44% range. That is not to say that in the big picture there are those operations in areas of the country with very dense populations and high sales per store that probably have to achieve a 47% or 48% gross while stores in rural areas may be in the 37% to 38% gross profit range. Either way, just think about what that means for bill out. If one considers the fact bill out need is moderated by shrink factors; chances are that the average produce operation generates a bill out somewhere in the neighborhood of 50% to 55%. Now that includes ad markdowns that are in the range of 20 to 25 points on gross, and comprise oh, lets say 25% of sales on average. What does that mean? First it means that 25% of your sales have a bill out of only 20% to 25% margin. Secondly it means that individual SKU markup has to be through the roof to maintain margin "bill out"! No doubt about it. Managing enough bill out to maintain margin is difficult.

Okay you say, so what is the result of such a demand on bill out? Well first lets start with retail creep. I would define retail creep as the process in which retails begin to creep higher and higher in order to maintain an ever ending demand to increase bill out and margin results. After all how are you going to support your quarterly BUY ONE GET ONE FREE ad if you don't have something north of 50% gross built into items suited for such an ad? Or better yet, what are you going to do if the market is keeping your banana retail down so low you can only achieve a 38% gross on your number one SKU?

Before you know it, retails on items that are not primary consumer focal items with low to no shrink begin to rise in retail. As a result these items (that only move a fraction of the dollars high volume fresh items) require a 50% gross when in actuality they should only require a gross in the 33% to 38% range to maintain movement and relevance to the consumer. Once that margin bill out is tasted though, it is like a drug addiction. We should probably call it "Bill Out Crack". Not only does this never ending need for higher bill out hurt the movement of items currently in stock, it hurts the chances of new items being successful because of the markup a retailer feels they must place on any new item. As a result many items are turned away because the retailer feels the retail will be too high for it to be successful! Think about that for a second. If a retail might be too high for a new item, what does that say about retails currently in stock if the same markup criteria is used? Wouldn't 35% gross on a new $1.00 sale be better than 50% of no sale?

There is no doubt that managing the appropriate bill out for a retail operation; produce or other wise is a difficult proposition. However, the fact is that there are perils in raising bill out too high. Especially in highly competitive markets. Retail creep can negatively impact those areas of you operation that bill out is meant to overcome. So how does one start to re-evaluate bill out and start to maximize sales and margin with out taking a margin hit first? Well I guess that is the million dollar question. One we will work to uncover.

Stay Tuned
Produce Guy
Alliance Fresh Produce Solutions.