why does a jar of jam cost $10?

This question comes up now and then and when it does I usually have to bite my lip. Why? Because to answer a question like this requires more time than is socially appropriate to expand on such a topic. I do farmers markets on weekends and demos in supermarkets during the week. Easily I can encounter 1000 people a week. Most of the time people taste stuff and if they like it they just buy it. But in these difficult economic times it is perfectly OK for a shopper to pause and say “$10 for jam?”

So considering I am stuck home nursing a cold and am in a grumpy mood what better time than now to address this sticky subject.

I would like to preface this by saying not too long ago I was the average shopper who was mystified by the pricing of products and had no idea about the behind-the-scenes world of food manufacturing and supermarkets. Well, having been thrust into this industry by chance, we have had to learn it inside and out by trial and error.

The easiest way to explain pricing of food is to use an analogy we can all relate to. Our income and our monthly expenses. We all have jobs (usually working for other people) and get a fairly reliable income. Let’s just say that income is $60,000 a year. Then you have your expenses such as rent/mortgage, utilities, credit card payments, food, insurance etc. Let’s say those all add up to around $40,000 a year. That means you have $20,000 left over to do what you like with it. This is how most households work.

Now, all of a sudden let’s say you are sick of the job you have and want to do your own thing. Or maybe you got laid off and can’t find a job. And for lack of better jobs, let’s say you want to be a baker and make bread since that is your passion. You quit your job and announce to friends and family “I am baker.” If you are unemployed you just say “I will become a baker.”

Of course I am making things very simple here. Anyhow, kiss that $60,000 goodbye. Now you have no money and no job. And you still have that $40,000 you need to make every year to survive.

To start any business requires a double set of expenses: your personal and business. In this case, the $40,000 in expenses you have for your personal life will now get doubled for all the expenses of running a business. Doubling things is pretty accurate, but it can be higher. So now your yearly obligations will be around $80,000 in bills.

In the world of food manufacturing it is against the law to make any food for sale in your home. There are many reasons for this but it comes down to public safety. All food manufacturers and food manufacturing facilities must adhere to a dizzying array of laws and regulations about the space the food is prepared in. Special floor surfaces, plumbing, ventilation and all kinds of details that just do not exist in a home kitchen. Then there is the fear of pets sleeping on the kitchen counter, someone smoking in the next room etc. And all food manufacturing spaces must be inspected by either the city or state health departments. (city governs restaurants and state food manufacturing). Inspectors just don’t want to be visiting people’s houses.

Anyhow, as a future baker, you will need a kitchen outside your house and in an area zoned for this use. No, you cannot build it in your garage since this is a residential zoned area. You will need to either find an existing bakery you can rent by the hour now and then, rent one just for yourself or you will have to build one from scratch. In terms of rent, commercial rent is high for two reasons. One, any type of retail rent, say a bakery in the middle of town, is high traffic and therefore expensive. Rent for spaces in industrial areas are high since the square footage for commercial buildings is larger. No matter how you slice it, beyond renting an apartment to live in or a house, you now will have a second rent: your business. Then there is the cost of buying all the equipment from ovens, mixers, tables – the list is huge. Feeling a little nervous about these required financial obligations? You better be!

Unless you have a stash of cash you can tap into, you will need to get loans to pay for all of this. On average to start up a venture like this where you can rent by the hour an existing facility that already has the equipment, the upfront costs aren’t too high. However, in the long term a shared facility won’t allow you to grow. At some point you will need to establish your own space. And the cost for this is at least $150,000. At least. So you need to get a loan. The downside is unless you have a proven track record as a baker, you will not find any bank to give you a loan since in their mind your rate of failure is pretty sure. You have no experience as a baker and why should they trust you. In today’s world the chances of getting any type of loan to start a business is nil. But a few years ago when we started we did. We were lucky.

So, somehow you manage to get a loan (yes the interest rates will be high due to your inexperience), find a space, buy equipment and are ready to roll. Now for us, it took three years to get to the ready to roll on our own aspect. And the heartache, disasters and every other horrible thing that could have gone wrong did. It nearly drove us mad. But we will gloss over this. All the horrors of getting started are behind you and now you can finally bake your bread. We also need to make the distinction between whether your business will be retail or wholesale. Retail is you have your own bakery in a business district and can sell directly to people. Wholesale is you make your bread in a kitchen in some industrial section with no foot traffic and you plan to sell to stores. This is what we did since retail rent is very high. You decide to save money and be a wholesale baker.

This is where the pricing complexities come into play. Suppose you will work 8-hour days six days a week. And in this time you can make 2000 loaves of bread each week. You are working at maximum capacity by yourself. And let’s say your monthly financial obligations for personal and business total $6666 a month ($80,000 divided by 12). How much do you charge for each loaf of bread? Easy. You can make 8000 loaves a month, and to make the $6666, you just need to charge 83 cents a loaf. Sounds pretty cheap huh? You can even raise the price to $3 a loaf and then you will make a profit besides breaking even. But we have to factor in all the ingredients to make the bread you have to buy each week, and the packaging to put it in. All of a sudden when you factor in the ingredients and packaging, on top of your personal and business financial obligations, the cost to make just one loaf of bread jumps up to $3. Now, all of a sudden you are not even making enough money to pay all your bills. You are in the red – short $666. So you recalculate the cost of your bread so you can make a profit. First you tack on 33 cents so now you are breaking even.

But then you realize that breaking even isn’t good enough. Remember you used to make $60,000? You have accounted for the $40,000 but your pricing forgot to allow you the same spending money as before you quit your job, which was $20,000 extra. This paid for emergency repairs to your car, house, buying presents and going out to eat now and then. So you have to factor in your fun money. You do the math and figure out this $20,000 is $1666 a month. So you tack on an extra 83 cents per loaf to make this extra money. I mean you are working an extra day each week compared to your last job so you might as well make the same money right? Now with the 83 extra cents your loaf’s price will be $3.83.

But wait. It gets even worse. Since you are a wholesale baker, and will be selling to stores, there are some additional prices that come into play. For one, since you are so busy baking all the time, you need to hire someone to deliver the bread each day. Companies that act as a go between manufacturers and stores are called distributors. They basically have a huge fleet of trucks and tons of storage space. Grocery stores love distributors since they carry many, many different products, from milk to cheese to meat to bread to fruit and vegetables. For grocery stores that don’t have that much storage other than what is on the isles of the stores, distributors not only allow them to store stuff, but they can order many different things at once and have them delivered on the same day.
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So you find a distributor. They usually mark up what they buy from manufacturers 15 percent of the cost of your product for this convenience.

Now your loaf costs $4.28.

So let’s just say the distributor buys all your 8000 loaves each month. Normally when you are a new business demand isn’t that high, and that will send your earnings down into the red. Imagine if you only were selling 4000 loaves a month? You would be in big trouble. You would have to raise your prices even more – say double so the loaf would cost $8.56. But we are being optimistic here. The distributor buys the 8000 loaves you make each month and this is where the sudden leap in pricing takes place.

Grocery stores are expensive businesses to run. They have high utility bills from all the refrigeration, high insurance costs, high labor costs (most employees in grocery stores are in unions). So it is normal practice for stores to mark up anywhere from 30-60 percent. That means, when the distributor delivers your bread to a grocery store, which buys it for the $4.28, if they mark it up 50 percent, the price on the store shelf will be $8.56. And if you had to raise your prices even more, as the scenario where you had to sell the loaf for $8.56, that loaf would then cost an astounding $17.12!

But wait, there are more costs in store! Let’s say that the 8000 loaves just aren’t enough each month. You are always broke and low on money since out of the blue expenses materialize. You decide the only way to make more money is to make more bread. So you decide to get a part time employee to help, and you also decide to sell this extra bread to areas further away. Say the next state over. Now, you have to factor in the cost of the employee into the bread. If you own a business in San Francisco, the minimum wage is almost $10. And say this person works 20 hours a week. So you have to then factor in the cost of an extra $800 a month. Of course this can be offset by making more bread and making more money right?

However, distributors and grocery stores that are further away from where the manufacturer is based want some hands on attention. They want someone to visit the store to see if things are in stock and they want someone to organize demos of your product. The companies that do this are called brokers. Most big distributors and big grocery chains require you to have a distributor before they buy your product. Now, the broker wants to make money too, so all of a sudden you have to raise your price per loaf even more. And then to pay for the demos of your products the going rate is $30 an hour. Factor in at least one demo per day for a month (they are usually three hours long) and you have some big expenses offsetting these extra earnings. Depending on the broker and how many demos you do the cost can skyrocket.

All of a sudden, you realize that your loaf of bread you want to sell to the next state will cost $2 more a loaf. Now it will be $10.56. And that is a pretty pricey loaf of bread and few people will want to buy. Even the loaf for $8.56 is almost double the price of other loafs in the supermarket.

This is when people will say “$10 for a loaf of bread?” and you will have to bit your lip because you have no choice but to charge that much.

Now, there is one other factor that I forgot to mention that also makes starting a business difficult. Everything in the business world is priced on how much you buy. So, when you are buying 50 lb sacks of organic flour, if you just buy a few each week, you pay let’s say $20. But if you were to buy 30 sacks a week you would pay only $10. As a small business owner you pay the maximum price for everything.

And this is where bigger, more established companies have the advantage over you. Your loaf of bread that costs almost $10 is twice the price of another company that sells theirs for $4.40. Both are organic, both tastes great (though you think yours is better of course). The reason the competition can charge less is probably since they have lower costs after paying down their debt over the years and they buy in such massive quantities they pay just a fraction for ingredients compared to you. The price they can sell their loaf to the distributor is only $2.

So can you see why all small businesses are doomed from the start? They have high operating costs and their cost to buy supplies is the most. The only way to survive is to slowly grow so you can lower your prices. The unfortunate fact is only a tiny percentage of small businesses survive.

Next time you see an expensive bottle of olive oil or honey or loaf of bread, instead of saying “Oh my god! This is robbery!” think about what I have said and all the factors that go into making the final price of a product. Nine times out of ten, the most expensive products will be from tiny, newer companies paying top dollar to do business in a world dominated by huge companies with very low costs. These products are usually made by hand with more care than in a big factory, and usually they are worth their price in how delicious they are since in general they use top quality ingredients. And finally, they are directly supporting people crazy enough to start their own business.

I suppose half the thrill of starting your own business is the race against the clock with the odds stacked against you from the start. Race car drivers, speed skaters, and entrepreneurs all love the adrenaline rush associated with risk. That is half the fun.