Ten Watch-Outs When Launching a New Food Product (Part 1)

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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 numbers 6 through 10 are in a subsequent post:

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 Local Forager Advises Start-Up Entrepreneurs

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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.

Crowd Funding Waiting on SEC Rules

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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.

Five Strategies that Influence Food Business Valuations

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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.

 

Seven Steps to Doing a Breakeven Analysis for a Manufacturing Business

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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:

  • Revenue
  • Variable Cost
  • Fixed Cost
  • Profit

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.