How does the cost of production affect the cost of a plant?
December 10, 2018 By Cassandra Smallman
As a business owner, would you invest in plants that you knew would cost more to produce than the return? Without a compelling return on investment, the obvious answer is no, but there is a chance that you might be doing exactly that. In our last article, we explored how consumers attach value to a plant and how that should be considered when growers assign prices. Now it’s time to look at how the cost of production should affect the price as well.
How do you currently determine your wholesale pricing? Do you review your production costs year after year? Do you ask your customers what they charge at retail? There’s no magic formula that will work perfectly for all businesses, however there are some considerations that all business owners should be mindful of.
Determining the variable and fixed costs of production
Pricing is a mathematical process that takes into account your costs and your margins. It’s an important step in ensuring you are operating a viable and sustainable business, and yet, instead of working through this process, many growers calculate their price based on what others charge. From equipment costs to fertilizer and everything in between, all of these factors should be taken into account when setting your price. Since the value you assign to the shipped end product has a direct impact on the health of your business, it should be a reflection of all the costs you incur.
These product costs fall into fixed or variable production costs, which are familiar terms to most business owners. Your fixed costs for production include equipment, facility costs, and growers’ salaries. Variable costs are things like labour, supplies (fertilizer, seed, etc.), packaging, and shipping. Add all of these costs together to determine your total cost of production, which can then be used to calculate your breakeven point before adding your margin to each plant.
A similar approach can be taken to allocate fixed costs. A common approach in plant production is to calculate the total of your fixed costs and divide it by the total square feet of growing space. Assign each plant an approximate percentage based on how much growing space it occupies. That same percentage can be used to determine how much of your fixed cost should be assigned to each plant.
Calculating wholesale price
Here’s an example to help illustrate this process. ABC Greenhouse has 50,000 sq. ft. of growing space allocated to one of their varieties. Each individual plant requires 0.5 sq. ft. of space, so they can grow 100,000 plants at a time. Fixed costs (FC) for the greenhouse add up to $75,000 and incur an additional $90,000 in variable costs (VC) each growing season. By doing some simple calculations (shown below), they’ve established that the FC for each plant is $0.75 and the VC is $0.90. That means the breakeven point (how much they need to charge to cover the costs of production) is $1.65 each. An industry average of 30 per cent margin is then applied, establishing a final wholesale price of $2.15 each.
Fixed costs per plant =
(Total fixed cost) ÷ (Total growing space) × (Growing space per plant)
$75,000 ÷ 50,000 sq. ft. × 0.5 sq. ft./plant
Total plants =
(Total growing space) ÷ (Growing space per plant)
50,000 sq. ft. ÷ 0.5 sq. ft./plant
= 100,000 total plants
Variable costs per plant =
(Total variable costs) ÷ (Total plants)
$90,000 ÷ 100,000 plants = $0.90/plant
Price per plant at 30% margin:
Start with the formula for calculating margin.
Margin = (Selling price – Total costs) ÷ Selling Price
Plugging in the values you know and substituting ‘x’ for the unknown selling cost per plant.
0.3 = (x – ($0.75+$0.90)) ÷ x
x = $1.65 ÷ 0.7
x=$2.36 per plant.
Editor’s note: This differs from the calculation for markup. Markup is calculated as a fraction of total costs, so with a 30% mark-up (1.3 x ($0.75 + $0.90))= $2.15, leaving substantial margin on the table! (Another reader recommended a 40% margin. See follow-up note at the end of the article.)
How your margin relates to the recommended retail price
Do you know how much customers are paying for your plants in-store? That’s a number that all wholesale greenhouse and nursery growers should know for all of their plants. The going retail price of your product provides you with a benchmark for how much you can charge your wholesale customers, while still providing them with a fair margin for themselves. It also gives you a key indicator for how well you’ve priced your plants. If the retail markup is unusually high, that may indicate an opportunity to raise your own margin as well. In contrast, a very low markup could mean that demand for your plants is low, and retailers are struggling to sell them. A lower markup from the grower could give the retailer enough incentive to continue committing shelf space to their plants.
The retailer will need to apply their own margin to the wholesale purchase price to keep their business operational as well, while ensuring that customers will pay their retail price. For a 100 per cent markup of $2.15, that puts the retail price at $4.30. If the grower’s markup is already too high, retailers will stop ordering those plants or seek a further discount from the grower. That can be a difficult hurdle to overcome as a wholesaler because you are then taking a loss on the product you have already grown.
Understanding how a consumer values a plant before investing in growing it will ensure that your wholesale business doesn’t take any unnecessary losses. A retailer will always protect their margin, and a consumer will seek the best prices, leaving you to determine whether a plant is worth growing, or if you can grow another species that offers a better margin for everyone in the supply chain.
By considering all the factors discussed here, not only will you ensure your wholesale business’ profitability, but it will help to standardize the way retailers and wholesalers calculate pricing.
Editor’s follow-up note: This article was updated in the margin calculation section, after a reader pointed out that the original calculation showed markup, rather than margin – an important difference. He also suggests setting a 40 per cent margin, in order to give sales some leeway when working with loyal customers.
Using the example in this article and starting with the formula for calculating margin.
Margin = (Selling price – Total costs) ÷ Selling Price
Plugging in the values you know and substituting ‘x’ for the unknown selling cost.
0.4 = (x – ($0.75+$0.90)) ÷ x
x = $1.65 ÷ 0.6
x=$2.75 per plant.
Cassandra Smallman is a marketing specialist for LinkGreen, an online ordering and supply chain technology solution in the lawn and garden industry. For information about how LinkGreen could help your business, visit linkgreen.ca
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