Marty Bombenger….Key West Restaurant Consulting
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.
A Case In Point
When I took over as the Food & Beverage Director of the U.S. Olympic Training Center (OTC) in Colorado Springs they were using lots of suppliers. As many as 15 to 20 vendors a week.
Sensing the need to do something different, I invited the major vendors in the area to submit a proposal if they were interested in being considered as a prime vendor. In short, the program would be a year-long, non-contractual agreement whereby the OTC would agree to purchase a major portion of its total food purchases (50% to 70%) from one supplier in exchange for a fixed “mark-up” (not price) on their products.
In a notice to the prime vendor candidates, I included a quote sheet (called the Prime Vendor Quote Sheet below) outlining the products and specification of the OTC’s principle products and the quantities purchased in a typical week. Each vendor was asked to quote their current prices on those products and how they would determine their mark-up on each product (cost plus a percentage or cost plus a fixed amount per unit) over the term of the prime vendor program, which in this case was 1 year.
We noticed these benefits as a result of going on the prime vendor program:
1. Reduction in food cost: Immediately after implementing the prime vendor program, the OTC’s food cost per meal dropped 10% while maintaining the same menu using the same ingredients.
2. Fewer vendors and invoices to deal with. Instead of dealing with nearly 20 vendors and lots of deliveries and invoices, the number of vendors dropped to 5 or 6. Fewer people and paperwork to deal with.
3. Less purchasing activities: Prior to the prime vendor program, the OTC had a full time purchasing clerk. That position was no longer needed and was phased out.
4. Better vendor service. The prime vendor became much more responsive to special requests and to situations that required immediate action.
5. Improved product consistency. Food was now coming from one source, not the low-bidder of the week. This meant better food quality and consistency.
6. Closer vendor relationship. There was now the incentive for the sales rep to provide more attention, and to maintain a good working relationship.
“Yeah, But . . . “
One common response to a prime vendor arrangement is that the vendor will ratchet the prices up once they know you’re not watching them like a hawk. Sure that’s possible, but now we’re talking about being a sizeable account which the supplier knows will be put out to bid again within a year. If they do play games with the pricing, chances are you’ll find out sooner or later.
There is an element of trust involved in a prime vendor relationship. The question you need to answer is, “will a supplier intentionally inflate prices if it puts them in jeopardy of losing a big customer?” Sure it’s possible but it’s hardly a smart business move on the part of any supplier who wants you as a customer over the long term.
Speaking of trust, in this type of arrangement trust goes both ways. You’ll always have another supplier come to you with a better price on a case of tomato sauce today or box of ribs tomorrow, but the point is sticking with the prime vendor as much as possible to get the lowest “overall” prices day after day (and spend your time in more productive activities). Once you start cherry-picking the best deals out there product by product you defeat the purpose of a having prime vendor and it probably won’t work.
Does Prime Vendor Make Sense For Your Restaurant?
There’s really only one way to find out, try it! While not a panacea, virtually every operator I’ve met who has tried prime vendor, say they’d never go back to competitive bidding again.
RestaurantOwner.com members can download the following forms and templates to make the prime vendor evaluation process faster, easier and enhance your changes of getting the best possible deal:
Cover Letter Template – Use this to describe, to each prime vendor candidate, the prime vendor program your are proposing, how they can submit a proposal to you, and the basis you’re going to use to select your prime vendor.
Prime Vendor Spec Sheet – To get the best deal, you need to be aware of all the important factors to consider in structuring your prime vendor arrangement. Includes delivery frequency and time, order lead time, method of ordering, credit terms and other key factors you can negotiate on to improve your bargaining position and lower your prices.
Prime Vendor Quote Sheet – Here’s where you list the product specifications and average weekly usage of your principal products. The vendor candidates use this to fill in their current price quote for each product and the formula used to determine each product’s price (the vendor’s cost plus a percentage or the vendor’s cost plus a fixed amount per unit).
Prime Vendor Summary Sheet – This is a summary sheet to collect and summarize all the candidates’ quotes and pricing formulas. Makes it easy to compare each candidate’s bid in total and product by product.