Results of a recent survey by Simbe and Coresight Research suggest that 70% of retailers lose at least 5% of their operating margin to common in-store inefficiencies like stockouts and poor promotional execution. For a CPG brand whose success is measured not just by its sales velocity but also by its profitability, this loss can be a significant problem if left unaddressed.
As such, it’s important to be proactive in coming up with a strategic plan for managing retail operating expenses, one that looks beyond the obvious costs. To achieve this, it’s important to understand both the standard expenses of doing business and the hidden costs that can quietly erode your profitability.
In this article, we’ll discuss some of the most common monthly expenses and some hidden costs related to going into retail. We’ll also guide you through some steps you can take to avoid these hidden costs, protect your bottom line, and ensure a sustainable CPG growth.
Hidden Costs Associated With Operating a Retail Business
Beyond the standard monthly expenses, there are less obvious costs that can significantly impact your operating margin. These hidden costs, which are miscellaneous and often unpredictable expenses that usually arise from inefficiencies and oversight, can significantly affect your profit margin.
Here are some financial risks and costs beyond the basic cost of goods sold that can surprise CPG brands that want to successfully expand to retail:
Margin Erosion from Deductions, Fees, and Chargebacks
Your negotiated margin is rarely what you actually receive. Retailers and distributors impose a variety of fees, including standard deductions that can range from 8% to 12% and chargebacks for perceived non-compliance, which directly erode your profits.
Moreover, “free fills”, or free product offerings made to secure shelf space, and those “buy-now-pay-later” initiatives can be considered as a direct, upfront cost of goods.
High Upfront Costs of Channel Entry
Slotting fees, also commonly referred to as “slotting allowances” or “pay-to-stay fees”, are charges paid by manufacturers to a retailer to secure shelf space for their products. This cost may vary dramatically between retail channels, and are particularly high in larger and more conventional channels.
Slotting fees are one of the major upfront costs incurred by those wanting to enter retail and may require a significant capital investment before your first sale is even made.
Channel Conflict Impacting DTC Sales
If not managed properly, your retail strategy can cannibalize your more profitable direct-to-consumer (DTC) business and directly impact your DTC revenue. You may risk losing sales when you lose direct customers and even the “Buy Box” on Amazon from third-party sellers who acquire your product through retail distribution and undercut your online price.
How to Avoid These Hidden Costs
Knowing how to reduce operating expenses in retail can help you anticipate even the hidden costs that can significantly impact your business, which, in turn, can allow you to implement clear strategies to protect your profitability. Here are some ways to avoid the hidden costs of going to retail:
1. Proactive Financial Planning and Margin Optimization
The best defense is a strong financial foundation. Before entering retail, ensure your product margin is at least 45%, with 55% being ideal, to create a buffer that can absorb unexpected fees and deductions. A solid financial plan should forecast for these costs, not just the standard ones.
2. Strategic Channel Selection
Mitigate high entry costs by being strategic about where and how you launch. It’s usually a safer approach to start small and go for the natural or local channels before going for the larger channels, rather than starting immediately with the more conventional retailers.
This “natural before conventional” approach allows you to enter the market with lower slotting fees and test your product before committing the significant capital required for conventional channels. It helps minimize upfront financial risks associated with immediately launching your CPG brand in national distribution or in the core conventional channels.
3. Smart Packaging and UPC Strategy
To prevent channel conflict and protect your DTC margins, create distinct packaging and universal product codes (UPCs) for your retail products. This simple step makes it much more difficult for unauthorized third-party sellers to list your retail products on online marketplaces, safeguarding your pricing integrity.
4. Maximizing Expert Partnerships
The most effective way to avoid costly emergencies is to partner with an experienced CPG broker or consultant like VDriven, preferably even during the planning stages of your retail entry. These brokers have established networks that they can utilize to negotiate the best possible terms, including, for example, the best free fill agreement and the lowest retail margin.
Reliable CPG brokers can also help in deductions management by using their knowledge and CPG industry experience to effectively detect and dispute invalid deductions.
Efficient Retail Operations With VDriven
Effectively managing your operating expenses in retail goes beyond a simple monthly budget. It requires a deep understanding of the entire retail ecosystem, a strategic plan to mitigate both obvious and hidden costs, and the foresight to protect your margins at every turn.
At VDriven, our CPG industry experience allows us to assist CPG brands wanting to achieve success as they expand into retail. Our comprehensive services, including strategic CPG consulting and brokerage, are specifically tailored to meet the needs of brands wanting to implement smart solutions for sustainable CPG growth and profitability.
If you’re ready to build a retail strategy that protects your bottom line, our team at VDriven can help. Contact us today to gain expert guidance for a successful expansion to retail.
