Gross Margin is Everything
The Business of Food
by Jennifer Barney
Gross Margin is Everything
4-min read
Doesn’t matter if your ultimate goal is to sell or keep your business, to have either choice means first you have to survive. I’m talking to you, food startup investors and founders.
What does a healthy business model look like for a food startup? Here are two examples (this is overly simplistic to prove a point):
At first glance both businesses look good – they are equally profitable, and they have the same COGS. But their margin structures are different: Business A spends more on deductions (trade spend) but less on SG&A (payroll and marketing) than business B. Why does this matter?
Because gross margin.
Gross margin is lifeblood. It is what separates the viable from the doomed. It allows you to grow your company by contributing more towards the functions that enable expansion. It is what investors look for when deciding whether to give you funding.
It used to be investors could pour a ton of money into a startup and outpace competitors. Gone are the days when a food brand can exit or go IPO in a couple years with a huge burn rate on a revenue-based deal. Well capitalized startups, whether self-funded or not, will only survive by becoming profitable sooner with an economically sustainable model.
To keep above-the-line expenses down, most businesses focus on COGS and stop there. While COGS is important, you don’t want to sacrifice product quality just to chase a number. So while you mind the COGS, don’t overlook deductions – the percentage of revenue you’re spending with the distributor and retailer.
Side note on deductions: D2C (direct-to-consumer) has no deductions, and we all know Covid has accelerated online grocery shopping (in fact many brands have made significant progress going the D2C route exclusively) but for the purposes of this example, let’s assume both business A and business B have an equal mix of brick-and-mortar and D2C.
I don’t want to diminish the importance of offering discounts – but this is where most brands get bullied and lose control. The sad story of spend that was either unauthorized or not executed at shelf is all too common. How you stay on top of this is with great sales and marketing teams. Which brings us to payroll contributions.
Great people aren’t cheap, and you get what you pay for. A lot of businesses look like A with low to no SG&A. When you’re first starting out, it’s a one-person show and there’s no payroll because the founder is doing everything – which is great – but not sustainable.
If you’re a supplier-owner, and think you will save on SG&A “until you get big” by folding the startup into your other business (because Suzy in accounting can do all the back-end sales and your nephew will sell on the side) you’ll never get there because 1) lack of CPG expertise, and 2) this is not a part-time job.
So what will happen with business A over time: SG&A will grow at the expense of profits, continuing to invest in the company loses its luster, and outside investors will be turned off no matter what the top line looks like.
You want to look more like Business B. Think of strong gross margin as your ticket to survival.
All my best,
Jennifer
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I'd love to hear from you - get in touch at jennifer@3rdandbroadway.com