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Help!!© 1997 Stuart Daw "My coffee costs have skyrocketed, and it's not even the season for a Brazilian frost. Do I go up and not even tell the customers? Maybe I should just take a few bags out of the kit and keep my unit cost the same. I can't work the old reliable solution of cutting bag weights — too hard to do nowadays, what with all those specialty stores and their fancy 3.3 ounce weights. The public is getting too smart, and I still have some 1.1 ounce people out there that couldn't reasonably be cut anyway." Such is the dilemma facing OCS people today. But one aspect of high prices of which I hope most are now aware, is that one does not have to double selling prices to offset a doubling of coffee costs. It used to be that most operators who viewed as sacred a gross profit percentage of, say, 50%, would try to maintain that 50% regardless of how much coffee costs increased. But it is dollars that go to the bank. Percentages do not. And 50% or any other percentage as a quantitative measure for a whole business is meaningless relative to any specific account. The only criterion for measuring account profitability is the dollar gross profit yield of the sale, and the cost of generating that sale. By cost of the sale I mean the total cost in direct and indirect expense allocable to it. Getting hung up on percentages is understandable. It isn't just the misleading information one hears at conventions when, for example, some speaker tells operators about his gross profit percentage. Surprisingly, bank managers too can be hopelessly inept at understanding. More that one operator has had a conversation with a banker who notices the GP percentage in a given period has dropped from the same period last year. The conversation could go something like this: BANKER: Your gross profit is down from 50% to 33 1/3%. YOU: Yes, but my gross profit dollars are the same. BANKER: Looks like a bad sign to me. What happened to your margin? MARGINALLY EXASPERATED YOU: What difference does it make, as long as the GP dollars are the same? BANKER (in his best better-be-careful tone): But your sales have increased a lot in a year, and your bottom line has shown no improvement. Frankly, the bank might become concerned that as a business person you should be making a lot more money on such a fast growing business. You know we always become leery of a business person who wants to grow just for growth's sake. YOU (by now a bit scared): But my sales have not increased. I am in a commodity driven business and, you see, coffee costs have doubled since last year, and I had to raise prices to offset them, creating the illusion of more business. BANK MANAGER (with the air of a college professor): Your coffee costs have doubled, but your prices have not doubled. Maybe that's why you're not making any more money! Your return on assets has fallen to boot. YOU: But not my return on investment. The increased value of my assets is entirely set off by increased debt, apart from after tax profits left in the business. Trying to tell him that you only had to raise prices to offset the commodity costs, and that no other elements of expense were affected, requires standing on your head and preaching a sermon on an accounting and pricing exercise that seems simple to you, but dumbfounds others like him. (A slight disclaimer here: one expense that does increase is the cost of money you may have borrowed (i.e. from suppliers) to finance the higher inventory and receivable levels.) I am reminded of a debate on national television a while ago, when I faced off on a CNBC news program against New York consumerist advocate Richard Kessel. He was upset that coffee companies were raising prices in spite of having some inventory bought at lower prices, when the cause, a Brazilian frost, came after that year's crop had already been picked. I posed the following question to him: "If you buy a pound of coffee for a dollar and sell it for two dollars, but have to replenish your inventory by buying back a pound of green coffee for three dollars, have you made a dollar or lost a dollar?" Kessel tried to change the subject, so I pressed him for an answer, to which he replied, "You are not the moderator." So I helped him: "You made a dollar on paper, but lost a dollar in cash, and to boot, you had to pay taxes on the dollar you never saw." To which the moderator commented with a smile that he would have to play back a tape of the show to consider that proposition. So an equation that would seem simple to a grade two student becomes foggy to someone who has been indoctrinated and formed a mindset on this issue— bank managers and some OCS operators as well. But don't be swayed, and forget percentages per se. Remember the bucks. Stick to bucks, and may the bucks stick to you. © 1997 Stuart Daw
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