Manufacturing your product

Introduction

By now you have your commercial recipe complete and your product specification documents finalized. You have tested your packaging and are aware that your product will still have to meet specific regulations (see Food safety regulations and other government regulations).

Now you are ready to start commercial production.

In this section you will learn about:

• product costing models
• co-packing
• setting up your own manufacturing facility
• finding the right equipment
• managing inventory

Product costing models

The ability to accurately measure the total cost of making your product is crucial. To do this you can use a product costing model which can help you calculate all the variable costs associated with making your product.

Your product costing model gets more complex as your business grows. You can use a simple product costing model, or download OMAFRA’s On-Farm Processing Recipe-Based Costing Tool which will allow you to analyze the impact of changes in recipe, ingredient costs or packaging size on product margin.

A simple product costing model helps you calculate the direct unit cost, also commonly referred to as the cost of goods sold, per jar, package or case of your product and includes the sum of all direct costs (labour, ingredients, procurement, utilities, equipment, space, packaging, waste management, financing production). Strawberry jam is used in the following example:

Labour per unit

Assign a cost to your labour per unit even if you are using unpaid labour that is a non-cash cost. The minimum wage in Ontario (2022) is $15.00 per hour. Statutory costs (Workplace Safety and Insurance Board (WSIB), Canada Pension Plan (CPP), Employment Insurance (EI), Employer Health Tax (EHT), Vacation Pay and housing (where applicable)) can add another 20% to that cost, so the minimum labour cost is $18.00 per hour.

Employing temporary foreign workers and offshore labour can incur an additional 10% for costs associated with airfare, housing and local transportation costs as well as an additional 14-15% for statutory deductions.

Through this model, calculations will be used with the general labour cost and not the student labour cost of $14.10.

If it takes 4 hours to prepare, assemble, package and clean up, using 3 workers to make 500 units, the minimum labour cost would be:

Total labour cost = ($18.00 × 4 hours) × 3 workers = $216

Labour cost per unit = $216 ÷ 500 units = $0.43

Procurement

As a small business it is common to use your personal vehicle and time to purchase and pick up ingredients and packaging. Assume it took 1 hour to drive and purchase ingredients and packaging. The cost then includes 1-hour labour ($18.00) plus a travel charge for kilometers on the vehicle (50 kilometers valued at $0.50 per kilometer).

Procurement cost = $18.00 + (50 × $0.50) = $43.00

Procurement cost per unit = $43.00 ÷ 500 units = $0.09

600 jars were bought but at this scale, the variance is less than a half of a cent, so it is overlooked.

Ingredients per unit

Add up all the ingredients used to make your jam.

250L of strawberries at $0.75/L, 50kg of sugar at $2/kg and 2kg of pectin at $10/kg. The unit cost would then be:

Ingredient cost = (250L × $0.75/L) + (50kg × $2.00) + (2kg × $10/kg) = $307.50

Ingredient cost per unit = $307.50 ÷ 500 units = $0.62

Utilities per unit

You leased a municipally inspected kitchen from a local service club or faith community and therefore are not charged separately for utilities but they are included in the lease rate. The utility cost per unit is treated as “0”. In this case, utilities are part of the space costs. When a facility includes separate charges for water, sewer, electricity and natural gas or propane; they must be calculated. Utilities are a major direct source of Greenhouse Gas emissions from manufacturing.

If we assume that the 4 hours of production time to make 500 units is 1/40^th of a month (a month being 20 working days), we can then estimate the impact of utilities on the cost of making a product.

The formula would then be 1/40^th of the cost of each monthly bill.

Utilities cost = (water ÷ 40) + (sewer ÷ 40) + (electricity ÷ 40) + (natural gas ÷ 40)

Utilities cost = (0 ÷ 40) + (0 ÷ 40) + (0 ÷ 40) + (0 ÷ 40) = 0

Utilities cost per unit = 0 ÷ 500 units = $0.00

Equipment costs per unit

You purchased $245.00 worth of canning equipment. In order to calculate the contribution of this investment per unit of production you need to estimate the number of units you expect to make in a year. Assume you expect to make 3,000 units of jam. Because this is small equipment that can be depreciated in the year of purchase, the equation is as follows:

Equipment cost per unit = $245.00 ÷ 3000 units = $0.08

While this approach is acceptable for smaller purchases, the costs of larger equipment purchases should be spread across the life of the asset and not fully costed out in the year of purchase.

Space costs

You rented a municipally inspected kitchen for $40.00 per hour for four hours. As mentioned earlier, the space or rental costs may include costs such as utilities if not charged separately. The cost for this batch is as follows:

Space cost = $40.00/hour × 4 hours = $160.00

Space cost per unit = $160.00 ÷ 500 units = $0.32

Shrinkage cost

Your product costing model should include a cost for shrinkage which is the portion of your inventory that is lost during production. A common example of shrinkage is the under-filling or over-filling of product in jars.

Shrinkage is expressed as a percentage and can be calculated by taking the value of jars your recipe should produce divided by the actual value of jars produced, then multiplied by 100.

If your calculations show for every 500 jars produced, you lost $50.00 worth of product. Therefore, the cost of shrinkage on the filling line is $0.10 per unit.

Packaging and labels costs

You bought 600 jars/lids at $1.12 per unit and 600 labels at $0.24 each. During the process (to package and label 500 units), 32 jars were broken prior to labelling and an additional 4 were lost after labelling. There were 16 defective labels. To calculate the unit cost of packaging it is important to include lost packaging. However, left over packaging that will be used in the future must not be calculated in the cost. In this case the batch used 536 jars and lids at $1.22 and 520 labels at $0.24.

Packaging and labels cost = ($1.22 × 536) + ($0.24 × 520) = $778.72

Packaging and labels cost per unit = $778.72 ÷ 500 units = $1.56

Waste management cost

Waste management is the cost of managing waste that arises from making a product. It is a cost that needs to be calculated to avoid it becoming unaccounted for. The costs involved include labour, tipping fees and vehicle use. This example assumes you take waste plastic overwrap from containers, waste containers and broken glass to the local dump which takes 1 hour and is a 50-kilometer round trip. The local tipping fee for less than 1000 kilograms is usually around $10.00. The formula is 1 hour of labour + a kilometer charge + tipping fees.

Waste management cost = $18.00 + (50 km × $0.50/km) + $10.00 = $53.00

Waste management cost per unit = $53.00 ÷ 500 units = $0.11

Operating financing cost

It costs money to run a business. Even a micro-business may start with an operating loan. It is prudent to calculate the cost of borrowing in your product costing model. As a rule of thumb, make this calculation on a yearly basis. Assume you borrow money for a year and sell all your product over that year. An average rate of disappearance would mean that you hold inventory, on average, for half of a year.

For this example, assume that you borrowed $2,000 from a private source for a year at 8% interest, which is $160.00 per year. To calculate the cost of making these 500 units, we add up all the costs and multiply by 4%, which is the operating interest cost of the portion of the loan used over six months.

Operating financing cost = (Labour + Procurement + Ingredients + Utilities + Equipment + Space + Packaging + Waste Management) × 0.04

Operating financing cost = ($216.00 + $43.00 + $307.50 + $0.00 + $40.00 + $160.00 + $778.72 + $53.00) × 0.04 = $63.93

Operating financing cost per unit = $63.93 ÷ 500 units = $0.13

For illustrative purposes, these figures are summarized in Table 1. A selling price per unit of $9.00 is used.

This tool allows you to identify accurate ingredient costs, track labour and utility impacts, and identify a gross margin. It is important to do a product costing model on each production run, for every product until you get to a consistent cost. You should also conduct this exercise monthly and adjust for input cost changes as the business grows.

A product costing model does not include:

• the cost of promotions or promotional materials
• labour and management cost of sales and marketing
• bad debts
• the cost of purchasing a business
• licensing and franchise costs
• administrative and sales office costs
• the cost of shipping finished goods

These costs are paid out of gross margin. As your business grows, many companies find it useful to undertake activity-based costing for these items when gross margin exceeds $1 million.

Co-manufacturing and co-packing your product

Before you consider co-manufacturing or co-packing your product, make the product on a small scale first, perhaps in a food incubator or a commercial kitchen. If you have outgrown your incubator or commercial kitchen and are ready to scale up, you may want to outsource the manufacturing process.

A co-packer or co-manufacturer is an established food manufacturer that processes and/or packages your product according to your specifications within their facility for a fee. There is a distinct difference between co-manufacturers and co-packers, though the terms are often used interchangeably, or simply called “co-packers”.

Co-packing consists of packaging and labelling.

Co-manufacturing includes product development, manufacturing and sometimes ingredient sourcing in addition to packaging and labelling.

In most cases, companies are looking for co-manufacturers. Co-manufacturers have become an important competitive advantage for food businesses as they create operational efficiencies by allowing companies to fulfill large projects without taking on extra staff and equipment. A co-manufacturer may not be right for you in the early stages of production because they often have minimum volume requirements.

If you decide to use a co-manufacturer, choose carefully and implement an agreement that ensures your co-manufacturer is processing and packaging the product according to your specifications. Monitor your co-manufacturer to ensure the processing, packaging and final product meets your standards.

Advantages of co-manufacturing

Advantages to co-manufacturing include:

• maintaining product consistency and costs
• maintained and current facilities and equipment
• compliance with government regulations (federal, provincial, municipal)
• manufacturing expertise
• trained production personnel
• improved efficiency
• better quality control
• reduced start-up time
• ongoing technical support from their personnel
• the ability to manufacture at a pace that matches your market’s needs
• the ability to put your time and financial resources toward building your brand and business

Disadvantages of co-manufacturing

Disadvantages of using a co-manufacturer include:

• lacking control of production operations
• the requirement for a minimum volume of production
• being limited to the co-manufacturer’s production schedule and packaging options
• the need for a confidentiality agreement

Choose a co-manufacturer

Before you contact potential co-manufacturers, define your specific needs. Consider:

• the size and type of container used to package product
• cost per unit
• run times and frequency
• the levels of food safety standards and certifications your product requires
• special requirements (such as gluten-free or nut-free)
• the price you are willing to pay for their services
• the quality that must be maintained
• the volumes you need produced
• the distribution and delivery methods required (determine if this something your co-manufacturer offers or if a contract is required through a third-party logistics company)
• your desired level of involvement during processing
• availability of warehousing
• specialized equipment needed
• intellectual property rights and ownership
• writing clear instructions for ingredients, packaging, product testing, ingredient sourcing and legal and insurance needs

In addition to meeting your needs, create a list of co-manufacturers. Key considerations may include:

• producing similar products, or similar products with different seasonal requirements
• having excess capacity
• operating the type of specialized equipment you require
• having a good reputation in the industry

Schedule a site visit of each potential facility to understand their:

• processing line(s)
• set-up and cleanliness
• recent inspection reports
• copies of federal and provincial licenses (where applicable)
• quality control certifications
• references from other clients
• business reputation and stability
• willingness to meet your requirements

As a condition of your final selection, ask the co-manufacturer to conduct a test run for quality and cost. Plan to be there for the run so you can deal with any issues that come up. Sign a non-disclosure or confidentiality agreement prior to conducting the test run.

Co-manufacturing costs and gross margin

After the test run, the co-manufacturer will give you a breakdown of the fixed and variable costs of producing your product in their facility. Ensure fixed and variable costs are identified as part of your co-manufacturing agreement. This is your product costing model from which you will derive your gross margin. If you were targeting for a 40% gross margin before you used a co-manufacturer, you can expect to target for a 25% gross margin when someone else produces and packs your product.

Generally, if you can offer the co-manufacturer high volumes or long-term business, you will be able to negotiate a better agreement.

Use your business plan to find the maximum retail price consumers are willing to pay for your product. Do this calculation to determine if you can afford this co-manufacturer:

If this number does not match your business plan goal, you may need to find another co-manufacturer.

Drafting an agreement

Once you've selected a co-manufacturer, draft an agreement and ensure both parties agree to its terms and conditions. Ensure your lawyer has reviewed the agreement before you sign.

The agreement should include:

• supplies and ingredient sourcing and specifications
• processing, packaging and labelling
• record keeping
• inventory control
• testing and product approvals (the level of tolerance you have for deviations from your product specification document)
• quality control, safety and recall processes
• production scheduling and completion dates including minimum orders
• cost agreement and payment terms
• a non-compete clause
• liability insurance and workers' compensation

Consider the co-manufacturer’s openness, enthusiasm, corporate goals and ability to produce your product to ensure a good business relationship. You must have trust and confidence in your co-manufacturer, as well as a strong quality-control program that will detect any issues.

Find a co-manufacturer

Ask your network of food industry insiders for their recommendations on co-manufacturers and co-packers. You can also reach out to the Agricultural Information Contact Centre at 1-877-424-1300 or ag.info.omafra@ontario.ca for a referral to an economic and business advisor or for recommendations.

Sometimes highly specialized products or products with a low volume cannot be serviced by a local co-manufacturer. In this event, alternatives include:

• going out of province/country
• using a municipally-licensed and inspected food establishment
• investing in your own facility

Remember to consider all additional costs and high-level regulatory requirements for the products you want to produce.

High-level regulatory considerations for food products include:

• alcoholic beverage production requiring federal licensing
• meat, seafood, dairy and vegetable production requiring federal licensing and inspection for products to be sold outside of the province
• supply-managed products (dairy, cheese and poultry products) requiring export quota to be exported out of Canada
• abattoirs and dairy/cheese facilities for products sold inside of Ontario being provincially inspected and licensed
• primary processing of fruit and vegetables requiring provincial licensing
• other local food products needing to be made in a municipally-inspected facility

Setting-up your manufacturing facility

If you decide to operate your own plant, you can either lease or purchase an existing building, or you can construct a new one. Do your research into how much it will cost to renovate an existing building versus building a new one just for your needs.

These four factors will also influence your decision to build or buy/lease:

• location
• zoning laws
• food plant design
• renovations (existing building)

The location

You know the old saying, “Only three things matter in real estate: location, location, location”? This also applies to setting up your plant.

Make sure you consider:

• the cost to lease or own the building or building lot
• how close it is to your customers and market
• whether a workforce with skilled and unskilled labour (depending on your needs) is nearby
• how close it is to your raw material supply
• ease of trucking and freight access (it may be worth paying a little extra if it will save you a lot in shipping costs)

Zoning

Be sure to check the zoning by-laws for the location you have selected. Call the city planning department to find out if your business needs any other permit to operate there (see Municipal regulations in Food safety regulations and other government regulations).

If the property you want to use is not zoned for a food business, you can apply for a re-zoning. This takes time and may delay your business for as long as it takes the municipality to make zoning changes. Be prepared, your application may not be approved based on the land-use policy for that area.

Contact the planning department of your municipal office for more information.

Food plant design

Naturally, you will want your plant to operate as efficiently and cost-effectively as possible. You also must meet all the federal, provincial and municipal requirements. Here are some other things to consider about your plant’s design:

General rule: 1,000 square feet for $100,000 in sales, 2,000 square feet for $200,000 in sales and so on.

Your bank may require a phase one environmental assessment if you are buying a site, leasing or changing the use of an existing facility. You can get help from a certified environmental consultant.

Taking over an existing building? Ask for proof that it was used for food processing. This may help you meet your food safety standards. Depending on your product, upgrading a facility to meet food safety requirements (for example, BRC or SQF) could be costly (see Food safety).

Make sure the facility you are considering has space for the equipment required to produce your products such as, a cooler, freezer or ovens.

Make a list of any necessary repairs and ensure that any new construction meets the requirements defined by the regulations.

Know your energy consumption and have an expert on your management team manage it. See next section for more information about energy monitoring and targeting.

Design your production line to work in the most efficient manner. Talk to a manufacturing consultant for the most efficient design.

Consider the ergonomics. If possible, use rolling conveyors, for less walking, lifting and turning. This will contribute to the health and safety of your employees.

Have two doors: one for shipping and one for receiving. This will help avoid potential for cross contamination.

Make sure your plant has floor drains, washable walls, suitable hand-washing facilities, washrooms that do not open onto the production floor, a change room, and a separate area for storing packaging goods, ingredients and finished goods. These should all conform to the certification stipulations by the Canadian Food Inspection Agency.

Think of the future. Can your business expand in this space?

Energy monitoring and targeting

Energy monitoring and targeting (M&T) systems are designed to manage and reduce energy costs. They provide essential feedback so you can set an accurate budget for what production will cost in terms of your energy use. They also make your business more environmentally sustainable by reducing greenhouse gas emissions (see Sustainability and corporate social responsibility).

M&T systems will:

• identify and explain increases or decreases in energy use
• establish trends for your energy use (daily, weekly, seasonal, operational)
• allow you to forecast energy use when planning business changes
• identify where energy is being wasted
• monitor how your business reacts to changes
• develop performance targets for energy management programs
• link the rate of energy use to improvements and/or setbacks in your environmental performance
• improve operating equipment efficiency
• give you control over your energy consumption

Renovations (or retrofit) required in an existing building

If you are considering using an existing building, find out if it was originally designed for food processing. If so, it may already be registered federally (for export markets) or provincially (for provincial markets) which can save you some work. If you are leasing, sometimes the owner will pay for the renovations you need to make the building suit your needs. You should consider this during your leasing negotiations.

Note: Whether you set up your own facility or choose a co-packer, you may need to find specialized equipment.

Finding the right equipment

During the product development phase, you identified what type of equipment you need to manufacture your product. Now you need to find a source for this equipment. Even if you choose a co-packer, you may need to supply some of your own equipment, especially if your production requires a specialized step such as canning.

It is important to use the same type of equipment you used in your product development, although it may need to be a larger version capable of handling production-scale volumes. Any change in the way you manufacture your product could have an impact on its consistency, food safety and cost.

Go back and ask your product developer where they bought their equipment. Talk to other food processors you met through industry associations and supplier trade shows. Trade shows are discussed further in the Marketing section of this guide.

Look online for auctions to secure good used equipment or ask your equipment supplier for a lease to own option.

You can check these online resources:

• Packaging Consortium
• Thomas
• Canadian Packaging - Buyers Guide
• Frasers
• Scott’s Directories (Canadian version of MacRae’s Blue Book)

Inventory management

Inventory can be seen, counted and weighed. It includes all the raw ingredients and materials you have on hand for manufacturing, works in progress and your finished products.

Your inventory is worth a lot of money. You must manage it carefully, so you can maximize the amount of money you make from it. Any amount of inventory that is wasted or lost is the same as lost money. As a small business, you cannot afford those losses.

Managing inventory is a balancing act. On one hand, you need to have product available for customers to buy. If you do not have enough, you could lose a sale. On the other hand, too much inventory can hurt your cash flow. The money you spent on that inventory could have been in the bank earning interest or used for other business needs. You also run the risk of your product expiring which is money wasted.

The costs of inventory are called holding costs. These include all your ingredients and raw materials, as well as the costs of storage facilities, insurance on your ingredients and materials, loss, breakage, spoilage, equipment break down and the interest on capital you could have gained if the money was not tied up in inventory.

In order to properly manage your inventory, you must:

• keep an adequate supply of product for customers — do not overproduce, this will help you keep costs low
• use up your inventory, while maintaining adequate profits
• keep raw material stocks low — volume purchases are usually discounted

One of the simplest management inventory systems is called ABC Analysis.

In ABC analysis, you divide stock items into three classes: A, B and C. That is, those items accounting for 80%, 15% and 5% of your total inventory costs. Once your stock is divided into these classes, you can control the stock.

A computer program can help code your stock into the three classes or you can do it yourself by following these steps:

• determine the value of each item by multiplying its cost times the number of units sold
• rank all those items by dollar value in ascending order (lowest to highest)
• calculate the percentage of dollar value of each item (total all the dollar values, divide each item by the total and then multiply by 100)
• determine the cumulative percentage for: 1) the number of items and 2) the dollar volume based on the totals for A and B
• classify the items according to A, B and C groupings

You can find many examples of ABC analysis and how it applies to inventory storage online by doing a search of ABC analysis or the ABC method.

ABC analysis

ABC analysis allows you to identify the products in your inventory that have a high influence on your inventory costs. This way you can focus on the most critical items. It can also help identify categories of inventory that require tighter security or special care in storage. It can even help determine how to physically stock your inventory, so items accessed most frequently are closer at hand.

ABC analysis follows the 80/20 rule: 80% of a company’s total inventory cost is caused by only 20% of all items.

Just-In-Time (JIT)

Another method of controlling stock is Just-In-Time (JIT). This means carrying a minimum amount of inventory and buying only as needed or against orders in hand. That way you deliver product just in time.

In order to make JIT work for you, you need to work very closely with your suppliers and customers. You need to know you can get ingredients exactly when you need them so you can meet a customer’s request. And you need to know you can deliver. Be sure that you make time for tasks like delivery, logistics and clearing customs when using this method.

Product returns/recalls

Product returns happen when your customers find that your products don’t sell, are overstocked or have a problem such as damage to their packaging. An agreement that you will replace damaged product at your cost of goods may avoid your customer from adding further penalties for additional handling and administration. You will minimize this cost by avoiding the shipment of damaged cases and dented or poorly labeled product.

Sometimes a food and beverage manufacturer must recall their product from customers due to a government recall or customer complaint. This could be because a product is expired, spoiled or contaminated with an allergen or bacteria that if eaten, can make a person very sick. Regardless of the reason recalls reduce profits.

You can keep returns to a minimum by having protocols in place that ensure your product maintains its highest possible quality once it leaves your plant.

Many companies do this by:

• using packaging that protects and prevents the product from contamination
• making sure that everyone who handles the product knows how to properly store and transport it
• developing clear inventory control procedures
• using a special code on the package that identifies the exact date the food was produced and even the exact machine or production run
• using systems that will tell you if the temperature was not maintained correctly during distribution
• incorporating a traceability system into their production in order to follow the movement of a food product and its ingredients through all steps of production

Keep a record of the recall as it may reveal problems in production or distribution that you need to correct.

Product specifications

Specification sheets are an essential part of a quality product. They are used for:

• standard procedures
• raw material specifications
• finished product standards
• daily formulation records
• product inspection reports

Dealing with product that is off specification

The specification documents you developed are used to ensure that the product leaving the processing plant is of the required quality. These documents contain detailed specifications about packaging, storing, cooking, ingredients, physical appearance and batch processing (see Product specification documents).

Options for dealing with product that is off specification might include:

• reprocessing the material
• selling the material to a processor of animal feed
• disposing of the substandard material
• donating the material to charitable organizations
• donating the material to charitable organizations

However, there are challenges to each of these methods. Donated foods generally must meet the same labelling and health and safety standards as foods sold to the general public. Blending and reworking food makes it harder to track batches. Animal feed processors require high quality products and disposal costs of waste can be substantial. The best way to avoid product that is off specification is to take the appropriate precautions to prevent the problem in the first place.

Checklist

• I have assessed the benefits of co-packing versus setting up my own manufacturing facility.
• I have chosen a co-packer and done a test run.
• The co-packer has signed a confidentiality agreement.
• I have carefully selected a location based on knowledge of zoning regulations.
• I assessed the food plant design for efficiency and for the health and safety of the staff.
• I have set up an inventory management system.
• I know my energy consumption and have an expert on my management team in charge of managing it.
• I have identified any specialized equipment needed.
• I have determined a method for managing my inventory.