2020 has been quite the year for horticulture, and the industry has faced its fair share of obstacles. However, it’s not impossible to turn a profit. Charlie Hall, chief economist for AmericanHort and co-chair of the advisory council of Seed Your Future, discussed how growers could leverage the economy to increase their business’ bottom line during his Cultivate’20 Virtual session, “Pricing to Win Series: Supply Side Dynamics of Pricing.” Check out the three biggest takeaways from his presentation:
1) Knowing your production and marketing costs is vital in establishing a price floor.
Hall described different models and principles to maximize profits on the supply side of business. To be successful, growers must establish their price floor and their price ceiling. Growers should never sell products below their price floor, he said.
“In order to margin mix your product offering, you will need those costs before you can do any sort of sensible SKU rationalization and figuring out which products that you should be growing,” Hall said.
Using their cost structure, and factoring in the current economic climate, growers can calculate their price floor, or the minimum amount they can charge for their product.
Growers must know their production and marketing costs within their operation, and to do so requires growers to have a firm grasp of both direct costs and overhead costs.
“You’ve got to be able to allocate those overhead costs in a manner where you're capturing all of those, right? You don't want to leave any overhead costs on the table that you're not covering,” Hall said.
“I prefer to think of price in terms of the value provided. The product price, as long as it exceeds our cost of goods sold, the cost of providing that good or service, that's our incentive to sell,” he said. “As long as value that is perceived by the buyer exceeds our price, that’s their incentive to buy.”
But how can growers affect perceived value so that consumers will recognize value to be higher than the price they're paying? That's where marketing efforts come into play, he said.
2) Knowing what your customers want and how much they are reasonably willing to pay is essential in establishing a price ceiling.
Elasticity is important. If a growers’ demand is inelastic and they raise their prices, even though they may sell fewer units — which is expected with a normal good because consumers demand less of it as price increases — total revenue for the grower will still increases, he explained.
“How do we make our demand more inelastic? Well, it goes back to our marketing efforts, relative to the prices of substitutes. We can influence that perceived value in such a way that it makes a demand for our product more inelastic,” Hall said. “The beauty is, that when there's a Great Recession or a Great Shutdown (as we are calling this recession), then it makes our demand more inelastic and we're deemed to be essential.”
In the short run, there are going to be price increases relative to the inputs that growers use to create healthy, eye-catching plants. If growers don't raise prices, their median profit margins will shrink.
“We've been dealing with this cost-price squeeze for a long time. It's about time we deal with it in a way that we don't have to worry about it and we get the prices that we need to, but we're going to have to get the willingness to pay up,” Hall said.
Growers must emphasize the benefits, rather than features, of plants, plant products and services. When calculating costs, it’s essential to know why variable costs vary from grower to grower, which could be influenced by:
- Size of operation
- Managerial practices
- Market channel
- Type of facilities
- Availability of labor
- Time of year
- Volume of production
- Facility layout
- Product mix
“Everyone's costs are different, and you've got to have to calculate the cost for your firm, or you're going to be eaten alive,” Hall said.
3) Push the pencil (or spreadsheet) to determine sales and profit goals and develop a pricing strategy to meet them.
Overhead costs, also known as fixed or indirect costs, must remain constant as production increases. The more plants (units) growers produce, the cost per unit decreases. Overhead costs include:
- Salaries + burden
- Rental costs
- Heating expenses
- Other utilities
- Dues and subscriptions
- Travel and entertainment
- Office expenses
- Professional fees
- Bad debt
To allocate overhead costs, Hall recommends the “square-foot-weeks” method:
- Determine total annual overhead costs
- ÷ the # of weeks greenhouse is fully utilized
- ÷ the # of square feet of usable bench space
- = overhead costs per square foot per week
- x the # of weeks plant (flat) is in production
- x the # of square feet occupied per plant (flat)
- = total overhead per plant (flat)
“Folks, if you're not allocating overhead, you're basically dying a slow death. That's it. You're dying a slow death because of that,” Hall said.
He also mentioned overhead allocation refinements to keep in mind, such as:
- Multiple-spacing crop
- Space utilization
- Hanging baskets
- Unheated space adjustment
- Seasonal variations (e.g. utilities)
“We have to also consider that our cost structure is corollary to our supplier's cost structure and our downstream customers’ cost structure, and sometimes there's overlap,” Hall said.
Industry value chain dynamics affect pricing, and he discussed pay-by-scan pricing models and third-party merchandising scenarios to demonstrate his point. When growers are faced with these situations, they often leave money on the table.
“You've got to account for shrink at the retail level. You've got to account for the cost of the merchandising services and account for the profit margin on providing those merchandising services. It's just a great illustration of the relationship that your pricing, as an intermediary in this business — is impacted by what's happening upstream and downstream in the supply chain,” Hall said.
He said the same thing holds true for independent garden centers and landscapers. If growers can show that their product line has limited retail decline over time, it will be important to garden centers and creates loyalty.
Growers must figure out how to reach their price ceiling, and do so, they must develop some type of system to help them configure costs.
“You’ve got to have some cost spreadsheets (or modules within your ERP software) to keep track of costs accurately,” Hall concluded.