Product Choice Decision

I Caff’d My Brass Off is the best purveyor of fine coffee in the world. At least, according to them. So they essentially offer 3 sets of products: retail coffee, roasting equipment, and coffee beans. Last year they did $2 million of sales from their coffee bar outside the store and warehouse, they sold $9 million worth of roasting equipment and $14 million worth of beans, either as Kona, Shmona or…whatever.

But on a total of $25 million in sales, they lost a million bucks, and their credit lines are tapped - they have to start making money. They just aren’t sure how to do it. Luckily, they’re all watching this video. The backstory:

Most companies sell more than one product. And each product carries different profit margins or contribution margins of dough back to the company. Each product also carries more needs for resources--like…in order to sell the roasting equipment, the company has to employ super-smart people who really know their stuff, and are selling to coffee aficionados who really know their stuff. So hiring those people is, uh, expensive versus the simple baristas outside serving coffee to retail customers who barely need to be literate, and will someday be replaced by robots.

Totally different resource needs for those two very different products. Another example. If you had a stationery store - like...one that sells high-quality paper for weddings, funerals, bar mitzvahs and pet birthdays, not one that stands still it wouldn’t be crazy to have that business sell $3 million worth of paper and contribute only $100,000 in pretax profits because paper sales are highly competitive and very low margin and, well, there’s Amazon.

And then there is the mom n’ pop stationery biz, with 3 little old ladies in the back room, happy to make minimum wage as they draw calligraphy all day. That biz might only have 300 grand of sales, but contribute, say, $120 grand in profits.

Only one tenth the revenue, it contributes more in profits. So margins matter, and the character or style or structure of the business that product lines are in, matters a whole lot. OK, back to coffee.

I Caff’d My Brass Off has similar dynamics. First think about the retail store. Because it’s serving food, it has to hold to certain standards of cleanliness, city ratings and inspections, offer parking, and various benefits to employees. It takes 10 employees to serve the $2 million in coffee, at average load to the company of 60 grand each, or 600k in employee costs. That is, each employee makes 45k a year, and then costs the company another 15k in pension, benefits, insurance, overtime and other costs to keep them employed.

Then it has to rent the extra finished non-warehouse space - another 100 grand a year. City inspections and that whole cleanliness thing add another 100 grand in costs. And then there’s the coffee itself and cups and washing and product things that add another 200. It’s reasonably profitable. As a unit, it contributes about a million dollars to the bottom line.

And the owners love it because the people who drink there are coffee snobs, and give almost free market research in describing what they like or don’t like about a given roast. Then there’s the roasting equipment biz. The owners complain all the time about the high salaries of the people who sell the equipment. The company doesn’t make each roasting bin - they just assemble it and then titrate it so that it can chemically optimize whatever custom grind that other coffee shops want to build and serve on their own.

The network of coffee shops is amazing, and they all respect I Caff’d My Brass Off, because the PhDs in coffee who make the equipment are so awesome. On $14 million of revenues, the company - when inspecting everything as a stand-alone business (meaning: if they shut down the coffee retail biz and the bean distribution biz)... would have $8 million in hardware product costs, $2 million in assembly costs and another $2 million in everything else… from insurance to warehousing to shipping to website management and so on.

So, hm. This is odd. The retail coffee biz pours a million bucks in profits to I Caff’d. And this business, on $14 million of revenues, pours in another $2 million. So the beans biz? At $9 million in revenues is losing over $3 million. Why? Spoilage. Bad marketing campaigns. A highly competitive marketplace with everyone from grocery stores to Amazon being better at selling beans.

The process was the business love child of the idiot son of the founder, a common problem in American business, but here the process of selling mass beans into the consumer marketplace requires a different skill versus selling high-end coffee to snobs. The disconnect shone a light on the resource constraints--in human capital. Not enough companies focus on this element, the brains of their employees and the ability to collectively contribute to good or optimal answers in resource allocation.

Huge amounts of resources were being poured into growing a bean distribution business, which is a low margin, almost-anyone-can-do-this-thang, instead of taking the nicely profitable retail store and high-end roasting business and being nicely profitable. The constraint here was the capital deployed into the money-losing commodity business of bean selling, and sacrificing the ability to integrate even further backward in the assembly of the roasting hardware.

The optimal resource allocation then takes the scarce resource of human knowledge in making coffee roasters for small, snooty cafes and spends more on that process, shutting down the beans direct marketing biz. The change makes the company go from losing half a mil a year or so, to making a few mil in cash profits, which it can then deploy, leveraging the genius coffee roasting brains it already has to become more powerful in that smaller but way-higher-margin business.

So...that’s how product choice decisions work in a nutshell. Er…in a beanshell.