Educating Sommeliers Worldwide.
By Beverage Trade Network
Margins are always a sensitive subject and never static. They are like spirals – they either travel upwards or downwards but seldom are they on an even keel. Margin is much more than the cost of goods sold (COGS)… a flexible margin strategy is a key to profitability and the bottom line… it’s about balance in order to optimize volume and the overall take and making sure that your list is constantly pushing the margin up the spiral.
Margins are what makes a business: at its simplest, you sell a product or service at a higher price than it costs you to buy. But anyone in business knows that it’s not as simple as that because too high a margin, just as too low a margin, can lead to a loss (and even the eventual failure of a business).
Anyone running a beverage program will be very aware of the cost of goods sold (COGS): inventory cost, minus ending inventory, is the most basic calculation used by management. Yet it’s not the best business tool when looking to optimize the commercial opportunity and improve overall bottom line figures.
A more effective tool is contribution margin (CM), the manipulation of margins, if you will, as a means both to attract more customers and earn more from each.
Contribution margin – the selling price minus variable costs, or the ability to cover all costs with revenue – is a far better means of looking at pricing and to determine the profit that various margin and sales levels will generate. Clearly, it’s important to account for all costs, and not just those ‘big costs’ (like staff, rents and rates, and the actual cost of product), but also the ‘little things’ that can add up as well, like breakages, the printing of wine lists, or by-the-glass wine preserving equipment (plus the gas capsules that make them work), and the decanters and candles involved in serving wines, and even the laundering of napkins used in pouring and serving.
Volume is a key component in margin manipulation and it’s the relationship between volume and profit that really needs to-underlie margin strategy and overall business goals in order to find the right balance, and so achieve a higher net profit.
This doesn’t necessarily mean reducing a wine’s price, it could just as well mean raising the price to its market worth – the value it has to the purchaser. There are any number of factors that will determine these new price points, starting with the venue itself and the clientele it attracts. Once you’ve got the shackles of a straight COGS calculation out of the way, it’s time to test the price sensitivity of your venue’s clientele, current, and potential.
The start point– it’s really a useful rule of thumb – is to mark up the lowest cost wines by four times the wholesale price paid for the wines, medium cost wines by 3 times, and highest cost wines by two.
Of course, it’s not that straightforward because, in most situations, the more expensive wine the less likely it makes business sense to mark up with a margin even as high as this. So, a wine costing several hundred dollars, or even thousands, on a wine list might well be carrying a margin of 20% or even 10%, otherwise, it would be likely near impossible to sell these more expensive wines.
It can also make business sense to adjust margins in order to promote, say, a small or artisanal producer from a small region, or lesser-known varietals, or as part of a promotion of a wine region as a whole, whilst at the same time applying somewhat higher margins on bigger names with better-known varietals and regions.
Quality perception also comes into the equation. Consumers often equate price with quality, and this can work in two ways. Pricing high may indeed mean that people believe in the quality, but set it too high and the volume potential is also likely to be lost: for the business, this could mean that the return on investment is unacceptable and any cash tied up in stock could be better used elsewhere in the business. Yet pricing some wines too low can also affect volume sales, but this time because customers may think that it can’t taste that good at that price point.
As mentioned before, it’s all about adopting a more flexible attitude to applying margins, arriving at the right balance by testing what works for your establishment. Margin flexibility addresses a highly competitive market situation, one where many, if not most, customers have considerable choice in terms of venues: a carefully thought out margin strategy can work to keep existing customers (more) loyal as well as encouraging potential customers to come and try your venue.
Looking at what this means in practical terms, a bottle where the wholesale price is, let’s say, $30, and only 2 are sold for $90 each during one service cycle, could indicate that, regardless of its COGS margin of 33%, it’s been priced too high. It can pay to test a lower price to see if this increases sales rates with the effect that it generates a higher overall profit contribution through an uplift in volume, even though the individual margin has been reduced.
Using contribution margin calculations would also help highlight a situation where, although COGS returns were being met, the overall contribution margin is actually uneconomic. An example of this would be a bottle bought in for $20which sold just 4 bottles at $60, whilst contributing the same 33% return as the more expensive bottle,it’s nevertheless a low overall contributor and should either be removed from the list or have its price increased to see if this may actually lift the volume.
There are worse situations which risk being hidden by slavish adherence to standard COGS margins. Take a $5 wine where you’re selling 20 or 30 bottles a day at $20:whilst providing both a high sales volume and the right COGS return it’s unlikely that this sort of margin is really sustainable even in the medium term (notwithstanding any link to a food offer and the inherent margin in this). This wine is also more than likely reducing the potential sales of other, higher contribution margin, wines.
Having a margin strategy can play a direct and meaningful role in ensuring the weakest contributors are weeded out… volumes of the highest priced wines are optimized, as is their contribution to profit take, all the while using the capital to best advantage… and the highest volume wines make the greatest contribution possible for the business.
Alistair Morrell – Editor - SommelierBusiness.com