If you have decided to embark on the launch of a new food product, you should have a financial plan which captures the expected revenue and costs, so you understand the required investment, and don’t unexpectedly run out of cash before you hit your breakeven point. Based on my experience helping numerous clients put together such projections, I’ve developed a list of ten items you want to be sure to consider when pulling together financial projections for a new food business. Numbers 1 through 5 are discussed below, and I will be posting 6 through 10 next week:
1. Yield loss – It is not sufficient to simply cost out your bill of materials and multiply by the number of packages or cases you project you will sell. Invariably, there is going to be some “yield loss” of purchase raw and packaging material, i.e., material you purchase which does not make it into the final product you ship. The exact amount which is lost will vary based on the nature of your product, the ingredients and packaging material you use, your production process and controls, and whether it is produced in small or big batches, along with a host of other factors. If you are self-manufacturing, you should make efforts to closely measure your actual material consumption on a batch-by-batch basis, which will give you a better understanding of how the material you consume may exceed what makes it into the finished product. If you are working with a co-packer, you should push for a conversation about what yields they are experiencing, (and if they can be improved), as ultimately you are the one who is paying for them.
2. Quality Assurance / HACCP – If you are self-manufacturing, and have not yet developed and implemented a HACCP plan, you will be required to soon as the FDA steps up regulatory efforts to assure the safety of this country’s food supply. HACCP stands for Hazard Analysis of Critical Control Points, as described in Title 21, Section 120 in the Code of Federal Requirements. Unless you are yourself a food safety expert, or already have one on your team, this will probably entail hiring a consultant who has a strong background in good manufacturing practices and food safety. The cost will vary depending on the complexity of your manufacturing set-up; a client of mine was quoted $15,000 to write the HACCP plan by an extremely qualified consultant. Just getting the plan in place is only the first step, you then need to have to have people trained and available for the ongoing record keeping which represents the “C” in Control. This could be an added expense.
3. Scheduling factors – If you think realistically about the sales demand for your new food or beverage product, you will realize that it is impossible to know the weekly fluctuation in sales, which may be a problem, since your manufacturing capacity will probably remain fairly constant. This will leave you one of two options: 1) Make to ship or 2) Make to order. Either one has an added cost which is easy to forget to build into your plan. “Make to ship” will likely involve some unabsorbed factory labor in the slow weeks, and perhaps some overtime payments in the weeks in which you push to meet peak demand. “Make to order” involves tying up cash and space with inventory. You need to anticipate which method will work best for you, and plan for the resulting costs. If your product is to be manufactured by a co-packer, unless it is a perishable product, they will probably prefer to do the bulk of your production in less-frequent, long continuous runs and any requests on your part for them to do otherwise may trigger higher co-packer charges from them to you.
4. Free goods / slotting allowance – once your product is manufactured and packaged, you are ready to get it on store shelves, and see how many consumers buy it each week. But there may be a catch. Because of the high failure rate for new items, many retailers will charge you a “slotting fee” to shelve your new food item, to help allocate some of the cost of these failed products from them to you. There is no industry standard for what this fee might be, but in some instances it has run as high as $25,000 per item to get it shelved in all of the units of a major supermarket chain. Some retailers might stock your new item for less, and others may accept “free goods” as an alternative, it’s up to you to negotiate, and find retailers that are less harsh in what they demand to put you on their shelves. According to Forbes, today 13% of food manufacturers’ revenue goes to trade spending, which includes both discount programs as well as slotting allowances.
5. Sampling – in-store product demos are a proven way to make consumers aware your new product is on the store shelf and consider buying it for the first time. Demo costs include the person or agency you hire to run it, the cost of the product and any miscellaneous supplies. A client of mine with an early stage food product has been spending $15,000 to $20,000 per quarter on demos, just to give a sense of how the expenses can add up. They are in a very competitive category, and need to give consumers a reason to switch. But the alternative may be worse: if your new product doesn’t show sufficient “case turns” after an initial time period, the retailer may delist it, and then you have lost the opportunity to sell plus your initial slotting allowance.
Whole Foods Market local “forager” Elly T. advised an attentive group of 30+ entrepreneurs on how to apply and thrive in her company’s local supplier program, speaking at a meeting of NY Foodies on 3/19/13. Here is Elly’s advice:
- To be considered for the Whole Foods local supplier program, go to your local store and ask to speak to someone in grocery leadership or store leadership.
- Every store has its own autonomous decision making authority, but the leadership team is always busy, so if you don’t hear back the first time, try again, don’t get discouraged.
- If you are accepted, that is where the work begins, you have to be ready to compete, e.g., by funding demos, so consumers will become aware of your product.
- Don’t get caught up in product claims, and be especially cautious about putting claims on your front label.
- Know what your top values are, you might not be able to afford to be all things to all people.
- Success is often based on the entrepreneur building a strong relationship with Whole Foods and showing commitment to their brand.
Here are NY local vendor profiles, to see some of the success stories to date.
Back in December, two different early-stage entrepreneurs got in touch with me, both of whom were looking for equity funding for their projects. One was marketing a beverage product, and the other was an innovative high tech product. In both cases their questions revolved around how they could get equity funding, what was involved, what would make someone a good source, and what would determine how much ownership they had to sell to raise the funds they needed.
The bald truth is that pre-revenue companies are disadvantaged when it comes to trying to raise equity from anyone other than “friends and family.” The lack of an in-market sales history leads any potential investor to demand a lower valuation then the owner typically will accept. The potential investor needs that lower valuation in order to achieve a high return on his or her investment, to compensate for the risk of failure. When investor and entrepreneur cannot agree on a valuation, the equity funding does not take place. It is for this reason, more than any other, that the vast majority of successful start-ups are self-funded. According to celebrated scholar Amar Bhide’s survey of business owners who made the Inc 500 list, 55% initially capitalized their business from personal savings, 6% from credit cards, 13% from friends and family, 7% from bank loans or mortgages, and only 7% from Angels or Venture Capitalists.
Kickstarter’s success in helping artists, musicians, film makers, game designers and the like fund their projects has captured the attention of those who would use crowd funding to do the same for entrepreneurs. Kickstarter was founded in April of 2009, and through October of 2012, had led to pledges of $399 million for projects that went on to get funded for the full amount (on Kickstarter it’s all or nothing.) Importantly, Kickstarter cannot be used to offer financial returns or equity.
Approximately 2/3’s of successfully funded Kickstarter projects have been in the range of $1,000 to $9,999. Most entrepreneurs looking for initial equity funding for their business need considerably more funds than this. If they have insufficient funds of their own, they can seek equity from friends and family. Another alternative is to register with a portal such as CircleUp, which believes “great entrepreneurs deserve funding from passionate investors” and whose technology is “allowing accredited investors to find, vet and invest in companies in a new way.”
To be an “accredited investor” requires demonstrating net worth of at least $1,000,000 (excluding primary residence) or income of $200,000 (or $300,000 including spousal income), criteria which exclude most Americans. Proponents of Crowd Funding believe that easing this restriction on non-accredited investors will lead to greater funding of entrepreneurial start-ups and faster job creation.
Enter North Carolina 10th District Congressman Patrick McHenry, currently serving his fifth term, who introduced legislation which evolved into the Crowd Funding provisions of the Jumpstart Our Business Startups (JOBS) act (H.R. 3606) which was signed into law by President Obama on 4/5/2012. The Securities Exchange Commission (SEC) was tasked to create and implement regulations within 270 days, which they failed to do. An SEC spokesman was quoted by the “NY Times” on 1/6/13 as saying they were “working very hard” on the new rules needed to implement the provisions of the JOBS act.
It is really not in the Security Exchange Commission’s DNA to be comfortable with the new Crowd Funding provisions in the JOBS act, as tightly controlling the exemptions to securities registration regulations has been one of their main lines of defense against securities fraud. For example, the SEC website page titled “Risky Business: Pre-IPO Investing” cautions pre-IPO investors, “remember, if it’s neither registered nor an exemption, it’s probably illegal.”
With that as a backdrop, it should come as no surprise that the Securities Exchange Commission came out against the Crowd Funding provisions of the JOBS act. Much to the chagrin of Congressman McHenry, the biggest push against the bill from the SEC came after the House had already passed it by a 390-23 margin on March 8th of 2012. This opposition came in the form of a speech by SEC Commissioner Luis Agular, which was posted on the SEC website on March 16, 2012, and a March 13th letter from Chairman Schapiro to Senator Tim Johnson of South Dakota and Senator Richard Shelby of Alabama, the Chairman and Ranking Member, respectively, of the Senate Committee on Banking, Housing and Urban Affairs.
The timing of the Security Exchange Commission opposition to the JOBS act Crowd Funding provisions, coming after the House had passed the bill, understandably rankled Congressman McHenry. To get a flavor for this check this YouTube video of SEC Commissioner Mary Schapiro (now retired) testifying on June 28, 2012 before the House Committee on TARP, Financial Services, and Bailout of Public and Private Programs chaired by Congressman McHenry, starting at 36:40., leading up to 38:53 where Congressman McHenry complains about “being sideswiped by a regulatory body at the 11th hour” as well as asking Chairman Schapiro “do you have my [mailing] address?” Despite the flurry of last-minute SEC objections to the Crowd Funding provisions in the JOBS act, the Senate went on to pass it by a 73-26 vote on March 26, 2012.
So what happens next? Eventually the SEC will probably step forward and put regulations in place to enact the Crowd Funding provisions of the Jobs Act, although this may not happen until 2014. Sites like CircleUp, which are already well established, and working within the current regulations, possess the infrastructure and market presence to accommodate the additional (non-accredited) investors who will be eligible to invest under the new JOBS act provision once the SEC completes the rules-writing process. Potential investors and entrepreneurs will still often disagree on valuations, especially for pre-revenue companies, but broadening the pool of potential investors in start-ups should be a good thing for the U.S. economy, provided the proper safeguards are put in place to implement this new law without opening the doors for scam artists.
On our family vacation over Labor Day weekend, we went hiking with friends along the shore of Lake Tahoe’s Emerald Bay, and afterward stopped by the Sunnyside Restaurant in Tahoe City for a late-afternoon snack. There was a very large noisy party inside in the bar area, but fortunately plenty of empty tables on the deck with a wonderful view of Lake Tahoe. So we were both dismayed to learn from the hostess that they could not seat us, as the kitchen could not keep up with the customers they already had. “Come back next weekend, we’ll have plenty of room to fit you in,” we were told as we left for another restaurant down the road.
Then this past weekend, we took an hour long drive north to Stuart’s Farm in Granite Springs, NY to pick up some apple cider, apples and pumpkins. The Stuart Family has had this farm since 1828, and I’ve been taking my family there since 1986. They are a bit off the beaten track, and used to be mainly a destination for school groups and Yorktown locals, but word seems to have gotten out. On a crisp fall day, their visitor count is well up from anything I can recall, but easily accommodated by their expanded parking. The prices are a lot higher then I remember too: $9 for a gallon of apple cider, the same price charged by Fairway Markets in NY City, and $.79/lb for pumpkins.
All of which got me thinking that the folks at Stuart’s Farm seem to know a whole lot more about running a seasonal business than the owners of the Sunnyside Restaurant.
But what exactly are the keys to success for running a seasonal business? Based on my experience, I would boil it down to these five things:
- Understand both your peak season and off-season demand – Stuart’s Farm seemed to have this well understood, while Sunnyside Restaurant did not.
- Service as much of the peak season demand as you can do economically – temporary labor is often a good solution, provided you don’t damage the brand, due to poor quality or service.
- Avoid price discounting during the peak season – once we had made the drive to Stuart’s Farm, I was pretty well committed to buy the cider, and to buy the pumpkins, regardless of the price. And if I had decided not to, there was someone else right behind me in line who would have. So there was no reason for Stuart’s to be offering any discounts, the cider and pumpkins were sure to sell out.
- Avoid advertising in peak season – it only exacerbates the seasonality of the business. This was a lesson I learned earlier in my career, as financial manager on the team that successfully launched Jell-O Pudding Snacks. The plant in Mason City, Iowa could not keep up with demand in the fall, yet the marketing team insisted on back-to-school advertising. I convinced the marketing team to stop doing this, as it made no economic sense to whip up demand beyond the point at which we could service it.
- Plan your cash flows carefully – the money you make in peak season has to last you through the off season. After nearly 200 years of continuous ownership of the farm, it seems as thought the Stuart family has this one mastered!
What are the strategies employed by mid-sized food companies that help improve their valuation? That is the question I was recently asked to answer by AxialMarket, which is “pioneering how private companies connect with capital.”
My interview served as the catalyst for a blog posting addressing the importance of these strategies: 1. Product Differentiation, 2. Purchasing Capabilities, 3. Cost Reduction, 4. Channel Management, and 5. International Presence.
To see the entire blog post on the AxialMarket site, click here: “Five Strategies that Boost Agri-Business Valuation.”
And thanks again to Cody Boyte, Marketing Director at AxialMarket, for both the idea and the interview which served as the springboard for this blog posting.
Two years ago my article: “Time For That Mid-Year Budget Tune-Up” was published by the New York Enterprise Report, pointing out to their readers that mid-year provides a unique opportunity for business owners to get a better grasp on how their business performing.
Assuming they created a budget at the start of the year, and take the time to compare actual results to budget.
Recently, I’ve had a few good chances to “walk the walk” with some of my clients, and it’s been an interesting experience on a few counts:
- Used second quarter actual results to gain a clearer understanding of packaging costs and direct labor costs per case for an early stage snack manufacturer. I had estimated both too aggressively in my business plan financial projections. To catch this required that this client’s bookkeeper be very accurate in booking actual cost of goods sold to each individual element, which she was.
- One difficulty in doing this analysis was the client’s inattention to actual case sales. This data was not captured at the time of sale, and was too difficult for them to pull together at quarter end. We backed into estimated case sales using actual revenue, and a general understanding of what average revenue per case should be. Don’t let this happen to you. All business owners should do their best to define a unit of sale, and track these units. It is invaluable information for doing revenue and cost analysis.
- I was called into a company I had never done work for before to give a point of view on what was their break-even point, as they were confused by gross margin which fluctuated by 10 percentage points up and down from month to month. I’ve seen this at other companies that don’t have a mature cost accounting system, and don’t make a monthly entry for change in inventory. This company was overvaluing their finished good inventory at the expected future sales price, which meant that the more they produced, the better it made their gross margin appear in that month. Don’t let this happen to you!
- Got a more established client back on track analyzing and acting on material usage at their factory. Their production team members had gotten in the bad habit of blaming nearly all off-standard material yield results on bad cycle inventory counts. The solution: told the production team they had to get one of their people to participate in the monthly inventory count, and sign off on the physical count of raw and package material at the time it happened.
It’s August and your firm’s CPA might be on vacation at Cape Cod, the Hamptons or the Jersey Shore. But it’s still a great time to use the first half year actual accounting results to gain a sharper understanding of what is really happening at your business, both good and bad.
A food industry client recently asked me to help them calculate their breakeven point, which is the Revenue they needed to achieve and be at zero profits. Here are the steps I went through to complete the analysis:
1. I reviewed their p&l from QuickBooks, to understand what was in each major category:
- Cost of Goods Sold: ingredient costs, direct labor, and a third category which was called Fixed Cost of Production, and included all of the other factory overhead, such as support personnel, rent, insurance, depreciation, repair and maintenance, and so on.
- Other Expense, which included outbound shipping, marketing and selling, office expense, and staff salaries
2. I asked the client what was their ability to manage Direct Labor up or down, in response to higher or lower unit sales volumes and learned that he could do that to a fairly great degree. So in this cae I assumed that direct labor really had two components:50% was variable (i.e., would change in direct relations to sales/production), and 50% was fixed. The % split may be very different for your business.
3. Now it was time to create an Excel model to make this work easier to do, review and document. I created an Excel spreadsheet with four rows:
- Variable Cost
- Fixed Cost
Using the client’s actual 2011 p&l results, I populated this simple spreadsheet, so that the Variable Cost included the Ingredient Costs, plus 50% of the Direct Labor (see point 1) , while the fixed cost included 50% of the Direct Labor, plus the Fixed Cost of Production and Other Expense.
4. Next I inserted columns to the spreadsheet for Revenue at 80%, 85%, 90%, 95%, 105%, 110%, 115% and 120% of actual 2011 results. For example, assuming that 2011 actual revenue was $2.0 million for this client, the spreadsheet would model possible results from $1.6 million to $2.4 million.
5. I then went on to add formula which adjusted the Variable Cost in relationship to Revenue, taking it up or down by the same percentage from the actual 2011 results. Fixed Cost was kept constant for all the lower and higher Revenue columns.
6. In all cases, Revenue – Variable Cost – Fixed Cost = Profit, so I added this formula in the Profit row for all nine columns. In this instance, it became immediate apparently where the breakeven point was. If you are modeling a business that has Revenue that is either more than 20% above, or more than 20% below the breakeven point, you will have to broaden the range of possible Revenue outcomes to determine the breakeven point.
7. This is a description how to do a very simple breakeven model, so is intended as a good starting point, not the final word. There are a lot of additional considerations, that need more complex modeling than what I have described above, including the following:
- Some of the Other Expense may also be variable, including shipping costs and brokerage expense.
- In the real world, at some point increases in Revenue will max out the client’s current manufacturing capacity.
- Direct Labor may go up and down in a step-wise function, e.g., when a second shift is added or eliminated.
- Growing Revenue also usually requires additional working capital, for accounts receivable and inventories, which the company may lack, if it is cash constrained
- Using the last complete year’s actual reported results is expedient, but may miss out on recent cost trends
Good luck doing your breakeven analysis! If you have questions on the above, please post them in the comments section, or send me an email at David@RudofskyAssociates.com.
I was walking by C.P. Yang Korean grocery at 73rd and Columbus earlier this afternoon, and saw a delivery truck drop off some spectacular looking lilacs from Sharon, CT. They literally dropped them on the sidewalk in front of the entrance to the store, and drove off.
I went to do another errand, and then circled back to ask the man tending to the flower stand how much for a bunch of lilacs, which at this point were lying by his feet, but not yet divided into bunches.
“They are not ready for sale yet, I paid $200 for all of them, but I have to count them, to find out how many bunches, so I know how much to charge” he told me.
“Aah, a cost accountant, I do cost accounting too,” I related, hoping to make a connection, and close the deal. “How about if I pay you $10 for one bunch?” This is the price I saw for a bunch of lilacs being sold at a nearby store, but I wanted my bunch from this fresh delivery.
“No I have to count them first, they are not ready for sale,” came the terse reply, with no indication of when these particular lilacs might be on the market.
I guess this story is an example of why Cost Accountants usually don’t get promoted into Sales I thought to myself, as I shrugged my shoulders and walked off, lilac-less.
I always advise my clients to only pursue Cost Accounting studies when the investment of time can pay back through better understanding of potential cost savings, or better informed pricing strategy. But enough of that, I’m off to try to buy a bunch of freshly picked lilacs, which hopefully have been both costed and priced by now, and ready for sale.
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Business model is a term with multiple meanings, depending on the context.
In its broadest sense, it describes the way a company has chosen to conduct business: what revenue sources does it aspire to, which markets, segments, channels, and how does it fulfill that business when it gets it?
In a more specific sense, a business model is an analytical tool that allows business managers to test the financial outcome of various business strategies or decisions described above, by mathematically modeling the cause and effect of each decision, individually and collectively. If the models are skillfully built and used, they can provide huge informational benefit, and at a fraction of the cost of actually going to market.
As such, a business model is a way to identify the most profitable set of business decisions, while avoiding a painful “trial-and-error” approach.
The Internet is still so new, we can see companies with starkly different business models battling each other in the same space. For example, Angie’s List and Yelp both went public within the last five months. Both are forums for consumer feedback on goods and services, but their business models actually could not be more different.
Yelp’s reviews are freely available on the internet, while Angie’s List reviews are only available to paid members, after a free introductory period in new markets. Angie’s List feels that a loyal membership base and strong service provider loyalty are the strengths of its business model. Yelp cited its attractive business model in its S-1 document, prior to its 3/2/2012 initial public offering, and in particular it ability “to attract a large audience of consumers with almost no traffic acquisition costs and a diverse customer base of local business and national brand advertiser.”
So far, neither company has distinguished itself as having a clearly advantageous business model. Working on the premise that its member reviews are valuable information worth paying for, Angie’s List was able to raise $114 million from investors in November of 2011, despite having been consistently unprofitable since its founding in 1995.
Embracing the spirit that reviews should be made freely available to build internet traffic, which is coveted by its advertisers, Yelp raised $96 million in early March of 2012, giving it a market cap of approximately $1.3 billion. This is a pretty rich valuation for a company which had losses of $7.4 million on revenues of $58.4 million for the first nine months of 2011. Maybe this is a market segment where the best business model is yet to be found.
The same debate between free and gated access to content is being played out by newspaper and magazine publishers. Recently I’ve been noticing that content is freely available once I find the location of the “click through this ad” button on my screen. Often it is on the upper-right hand corner of the screen, but now always. I have a sneaky suspicion that every second it takes me to find the button that lets me move on from the ad to the content is being counted by the publisher, and sold to his advertisers. This is a business model I can live with.
My wife and I recently attended a seminar on the impact of digital media on newspaper and magazine publishers, and the panelists collectively agreed that they need a better way to monetize content they put on the web. One of the ideas put forward was compensating journalists whose content is put on the web based on the amount of traffic it generates. My wife raised a concern that this is not what she is looking for from the “New York Times” and others, and the attendees burst into applause.
These days, it is harder to come up with a new business model in food retailing, but people keep trying. A few years ago, Really Cool Foods opened a store on the Upper East Side, selling only their own product – convenient, ready-to-eat, high quality – which apparently was manufactured somewhere out on Long Island. They attracted a few consumers, confused a few others, or as one Yelp respondent posted: “It looks like a market from the outside…but where is the produce section? And the kitty litter aisle? And the butcher case? “ Retail rents are so high in Manhattan that store owners have to make use of every available square foot, and this store simply didn’t. Now a couple of years later, I see a store selling prepared organic and raw foods opened up on Amsterdam Avenue in the Upper West Side, using the same approach, and again exclusively selling food made in their parent company’s factory. Is their food good enough to make this business model work for them better than it did for Really Cool Foods? Time will tell. For now, I can check out their reviews on Yelp…..for free.