Why Competitive Bidding Leads to higher Food Costs

The Easiest Way to Cut Your Food Cost 10%

While there are few absolutes in this business this is one - "Engaging in ongoing competitive bidding practices to get the lowest prices actually leads to higher food costs, not lower."

That's right. Contrary to what most of us, who have grown up in this business have been taught, having an ongoing purchasing process that revolves around using lots of vendors, comparing bids, price shopping and buying from the lowest bidder NOT only doesn't save you any money but ends up costing you in several ways.

To prove my point, how many professionally managed, large chain operators employ ongoing competitive bidding practices? ZERO, NONE, NADA! Every large chain uses one primary purveyor to supply 80% - 100% of it's food products. How many independent operators do this? Probably less than 10%, easily less than 20%.

And who makes more money at the restaurant level, the typical chain or independent restaurant? According to industry averages published by NRA the average independent nets about a nickel or 5% of sales before federal and state income taxes. Having worked with several chain operators and from perusing the annual reports and 10-Ks of many publicly held chains, the average restaurant level net income before corporate overhead and income taxes is around 12% - 15% of net sales.

The fact that chain restaurants are 2 to 3 times more profitable than independent operations may not be entirely due to purchasing practices but I'm sure it's a factor, possibly a big one.

Distraction from High-Return Activities

Another factor to consider is the amount of time it takes to constantly evaluate bids, deal with lots of vendors and put away lots of deliveries, lots of small deliveries, that is. Using a prime vendor frees up management time that can be better spent on high return activities like taking better care of your customers and developing your people. In my mind, trying to save 25 cents on a case of green beans is hardly a high return activity worthy of much owner or management time.

What Determines Supplier Prices?

There are four basic elements that go into the pricing formula of most suppliers.

Product Costs: What it costs the vendor to purchase the products from their suppliers such as manufacturers, growers and other wholesalers. The more they buy, the lower their costs are so there's a built-in incentive for suppliers to move lots of product.

Administrative & Selling Costs: Includes the cost of servicing the account and processing the orders. Factors that can affect these costs include order processing time, lead time, order frequency, number of invoices processed, specialty products needed and credit terms. Another point is that these costs are basically fixed and suppliers want to spread these costs over as many sales dollars as possible.

Delivery & Handling Costs: This boils down to cost per drop. The drop cost to deliver 1 case to your back door is about the same as it costs to deliver 100 cases. To a supplier, bigger orders mean less delivery cost per dollar of product delivered. Number of deliveries per week and the time of the day you will accept deliveries can also affect these costs.

Profit on the Account: This is the percentage mark-up or gross profit in dollars the supplier needs to make an account profitable after considering all the factors discussed above and the potential volume on the account.

The key point is that if you find ways to lower the vendor's cost of servicing your account and give them the opportunity to make more profit "dollars", they are usually willing to work on a lower "mark-up." As a result, you get lower overall prices and other important benefits too, which I'll discuss further below.

Give Suppliers the Opportunity to Make More Money on Your Account

Yes, you read that right. It's in everyone's best interest to position a supplier to make more money on your account in return for something . . . LOWER PRICES! Here's how it works . . .

Smart suppliers don't just look at the percentage mark-up on an account. What's more important is the potential total gross profit in dollars they can make. For example . .

Assume you buy around $600,000 of food a year. You currently spread your purchases around to 2 or 3 broadline distributors and several specialty suppliers. You spend about $100,000 a year with Distributor A and Distributor A is adding a 20% markup to everything they sell you  (Case 1). Do you think Distributor A might be willing to work on a smaller margin percent if they could get more, a lot more of your business?

As you see, it makes economic sense for Distributor A to work on a smaller margin % IF it means converting you from a $100,000 account into a $500,000 account. You can see in Case 2, Distributor A has the opportunity to more than double their gross profit dollars on the account even though they gave up a large slice of their average markup % to get more of your business.

Bill Marvin