Q: Can I have some examples of how grocery prices are set?
A: Let's look at two, very different examples: cheese and cereal.
For most foods, the biggest factor is the price of commodities. For foods like packaged salads or cheese — consisting mainly of a core ingredient, with little else involved — commodity costs can make up between 60 percent and 80 percent of the cost of the product, says Steve McLaughlin, a pricing expert in Bain & Company's retail and consumer products practices.
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For foods where more manufacturing is involved, like cereal, commodity costs can account for less than 60 percent of the cost, he said. The rest of the cost goes into things like manufacturing, packaging, delivery, marketing and innovation — that is, adding value to products by creating new flavors or different sizes, or boosting quality.
Even pricing experts are reluctant to get more specific than that because there is so much variation among products. But McLaughlin did give a general breakdown of the price a grocery store might pay for a typical food product:
- About 35 percent: Raw materials — though the proportion of the cost coming from this can vary depending on the type of product.
- About 15 percent: Converting raw materials into food — a cost that includes plants, labor and utilities.
- About 10 percent: Packaging.
- Between 5 and 10 percent: Selling and distributing the product.
- About 10 percent: Advertising, along with research and developent to come up with new products.
- About 5 to 10 percent: The cost of managing the business.
- About 15 percent: Operating margins — as in how much profit a company makes on its sales, before interest and taxes.
And don't forget, this is a breakdown of how a food company might price a product it sells to retailers, like grocery stores. When the supermarket sells the item to you, some profit will get added to the price — a profit margin of 20 to 30 percent is typical.
Q: What's happening now with commodities?
A: Those prices have been coming down, partly because the recession is reducing demand. In tough times, companies idle their plants and people cut back on driving and spending. That all means less demand for fuel, and less demand means lower prices.
Corn, wheat, dairy have all fallen too for a variety of reasons, including slumping demand. That means farmers may not plant as much, which could eventually bolster prices by lessening the supply.
