Co-packing lets emerging food and beverage brands grow without building a plant. But it also makes it easy to misjudge margins. Founders often take the co-packer's tolling fee, add ingredients and packaging, compare it with the price they sell at, and call the difference their gross margin.
That number is almost always too high. The costs that sit between the quote and the shelf don't show up on the co-packer's invoice, and many of them land in different parts of the income statement, or don't show up until months later.
Where the margin goes
1. Yield loss and shrink
Every run loses product: line startup and changeover waste, underfills, damaged cases and samples pulled for testing. If you buy ingredients and packaging for 10,000 cases and receive 9,700, your cost per good case is about 3% higher than the quote implies.
2. Freight in both directions
Shipping your ingredients and packaging to the co-packer, then finished goods to a warehouse or distributor, is a real product cost. It's often booked to an operating expense account, which makes gross margin look better than it is.
3. Warehousing and handling
Storage, pallet in/out fees and pick-and-pack charges add up quickly, especially when minimum run sizes force you to hold several months of inventory.
4. Minimum runs and inventory risk
Co-packers set minimum batch sizes. If your sales velocity can't keep up, you carry extra inventory, tie up cash, and eventually write off product that ages out or goes past its code date.
5. Quality and testing
Lab testing, third-party audits and certifications are part of what it costs to produce a sellable case.
6. Trade spend and retailer deductions
This is usually the biggest gap. Promotions, slotting, free fills, distributor programs, spoilage allowances and unexplained deductions on remittances all reduce what you actually collect. Under U.S. GAAP (ASC 606), most of these payments to customers are a reduction of revenue, not a marketing expense. Many young brands book them as expenses, which overstates both revenue and gross margin.
An illustrative example
Here's how the math can play out for a single case of a beverage product. The figures are illustrative, not from any client, but the pattern is common.
| Per case | Quoted view | True landed view |
|---|---|---|
| Price to distributor | $18.00 | $18.00 |
| Less trade spend and deductions (12%) | — | ($2.16) |
| Net revenue | $18.00 | $15.84 |
| Co-packer tolling fee | $6.00 | $6.00 |
| Ingredients and packaging | $5.00 | $5.00 |
| Yield loss (3%) | — | $0.33 |
| Freight in and out | — | $1.20 |
| Warehousing and handling | — | $0.40 |
| Quality testing | — | $0.15 |
| Expired and damaged product | — | $0.30 |
| Total cost per case | $11.00 | $13.38 |
| Margin per case | $7.00 (39%) | $2.46 (15.5%) |
Illustrative figures. Margin percentages are calculated on net revenue.
On paper, this brand earns $7.00 a case. In reality it earns $2.46, before a dollar of salaries, marketing or overhead. That's the difference between a business that can fund its own growth and one that burns cash faster the more it sells.
The danger is scaling a bad margin. If each case earns too little to cover overhead, growth makes losses bigger, not smaller. Investors and lenders will find this in diligence, so it's better to find it first.
How to fix it
- Build a landed standard cost for every SKU. Include every cost from raw materials to delivery: tolling, materials, yield, freight, storage and testing. Update it at least quarterly, and whenever a co-packer or freight rate changes.
- Record trade spend correctly. Treat payments to customers as a reduction of revenue, and track them by customer and program, so you see true net price by channel.
- Reconcile deductions every month. Match each retailer and distributor deduction to an approved program. Dispute the ones that aren't valid; unchecked deductions are a common and quiet source of lost margin.
- Size runs to your velocity. Balance co-packer minimums against how fast product actually sells. A slightly higher tolling fee on a smaller run can cost less than writing off expired product.
- Prune unprofitable SKUs and channels. Once you see margin by SKU and customer, some products or accounts will clearly lose money. Reprice, renegotiate or drop them.
- Review variances monthly. Compare actual costs per case with your standard each month, so cost creep from co-packers, freight or ingredients shows up in weeks, not at year end.
The bottom line
Co-packing is a smart way to grow, but only if you know your real margin per case. Getting there takes a cost model, clean accounting for trade spend, and a monthly routine of reviewing it. It's one of the first things I look at with any food or beverage brand, because almost every other decision depends on it.
Want to know your true margin per case?
I can build a landed cost model for your SKUs and show you where the margin is going. Start with a 30-minute call.
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