Mark to Market is a term whose frequency of use increased in late 2008 with the collapse of complex derivatives and options based on ill advised mortgages to American home buyers. Basically GAAP (Generally Accepted Accounting Principles) compelled financial firms to reduce the value of paper they held at Book Value (Purchase Price) as market conditions deteriorated and residential real estate values plummeted. The concept of Mark to Market was created to determine the credit/debit status of Margin traders in the Commodity Markets but is important in valuing the contracts and commitments of coffee brokers and roasting companies (less so the inventory of retail companies).
Coffee growers, brokers and buyers typically use the Commodity price for coffee as a baseline to determine specialty coffee prices. An example would be where a Specialty Coffee is determined to be valued "C" plus a fluid amount depending upon quality (ie "C" plus $1.20). This method of valuing specialty coffee is a simple linear equation, easy to understand with a transparent and logical baseline. If a coffee was purchased at "C" plus $1.20 at harvest, and the commodity price falls after the date of the contract, the coffee is worth less and should be reflected that way in your balance sheet.
Most brokers continuously adjust their pricing with the rise and fall of commodity price...most.
One exception is the purveyors of ultra high end coffee. These coffees don't come to market through normal channels, and so there may be an argument to be made that it's value is delinked from the commodity price, however there is very little transparency or logic in this type of valuation. If the commodity price fluctuates freely and the price of ultra high end coffee remains constant, the value of high end coffee is arbitrary and based on purchase price rather than market conditions. Currently many ultra high end coffee sellers would have secured their inventory while the "C" was floating near historical highs in 2011. Beginning late 2011 coffee commodity prices began to deflate, theoretically reducing the value of all coffee under contract. The problem for newer brokers working on bank loans and margin is that they cannot reduce the value of their contracts without jeopardizing their debt to equity ratio displayed in the Balance Sheet. The reality is that the broker uses a formula to determine purchase price, whether it is a simple equation or differential calculus, there is a formula. If there is a formula to determine value at purchase, then the same formula should be used to reduce the value as the price of the underlying commodity deteriorates.
I have been sampling some self declared ultra high end coffees recently whose pricing is completely detached from the realities of our current market. While considering the value gap I came to the conclusion that the coffee was not poor quality but poorly bought, handcuffing the marketability going forward. It is clear to me that some of these coffees are looking for naive buyers who are captivated by scarcity and marketing material rather than realistic value propositions. My advise is to check your coffee prices as they track throughout this past year, if your prices haven't fallen for similar purchases at a rate that tracks the "C", then you are likely paying for your brokers mistakes and you need to make them aware of the inconsistencies. Paraphrasing Benjamin Graham, "Price is what you pay...Value is what you get".
Showing posts with label Pricing. Show all posts
Showing posts with label Pricing. Show all posts
Wednesday, September 19, 2012
Monday, March 28, 2011
Direct Trade: Who Gets the Upside?
The relationship between Roasters and Importers in Developed Countries and Growers has received plenty of review and critique. I don't want to dig too deeply into the social and environmental aspects of this relationship, but want to focus on an interesting idea that deserves consideration.
As we all know we are in a time of high green coffee prices and one would think this condition would provide fantastic cover for growers, but hot markets fed to a certain degree by speculative interests, can crash quickly if demand falls short of supply once new plantings begin producing in a year or so. In an effort to protect growers from catastrophic price shocks various schemes have been devised to provide a price floor. This price guarantee acts as a sort of crop insurance for growers who still must produce enough crop to cover production costs and G&A with the threat of ruin hidden in every weather forecast.
The price run up can also present problems for growers who may have sold early in the year, only to see the value of what they contracted increase wildly as experienced this year. This condition may encourage some to hold coffee off the market this year in the hope of higher prices, but like tulips and real estate, when there are no buyers, there's no market.
What I'm proposing for consideration is for interested direct traders to not only set a minimum price, but provide an upside for the grower should prices increase, eliminating for the grower the opportunity cost of selling early. (Opportunity Cost is the price difference between what was paid to the farmer, and what the farmer could have sold for later in the year if prices go up) This mechanism would also encourage farmers to sell instead of holding coffee off the market by providing the real chance of further revenue and zero chance of losing revenue. For all involved this would also provide more transparency and information in determining the actual amount of coffee available in any year by flushing out coffee being held back, also dampening the likelihood of significant price moves throughout the year. Essentially this would provide extra grower income should prices rise, while reducing the likelihood of significant price changes through greater transparency.
Roasters and Importers are in a much better position to adjust to higher prices by passing real per pound costs onto wholesale customers than are producers who's costs fluctuate vastly per pound harvested depending on yield. While this sort of scheme is anathema to all capitalist theory, any price scheme already offends those sensibilities. The form and function of this upside pricing scheme is something best determined by individual roasters and importers but is completely reasonable when considered alongside all of the factors and benefits we quote in support for direct trade.
I"m curious whether any roasters and importers are already using some sort of mechanism to provide extra revenue, and would be happy to learn the details.
Food for thought.
As we all know we are in a time of high green coffee prices and one would think this condition would provide fantastic cover for growers, but hot markets fed to a certain degree by speculative interests, can crash quickly if demand falls short of supply once new plantings begin producing in a year or so. In an effort to protect growers from catastrophic price shocks various schemes have been devised to provide a price floor. This price guarantee acts as a sort of crop insurance for growers who still must produce enough crop to cover production costs and G&A with the threat of ruin hidden in every weather forecast.
The price run up can also present problems for growers who may have sold early in the year, only to see the value of what they contracted increase wildly as experienced this year. This condition may encourage some to hold coffee off the market this year in the hope of higher prices, but like tulips and real estate, when there are no buyers, there's no market.
What I'm proposing for consideration is for interested direct traders to not only set a minimum price, but provide an upside for the grower should prices increase, eliminating for the grower the opportunity cost of selling early. (Opportunity Cost is the price difference between what was paid to the farmer, and what the farmer could have sold for later in the year if prices go up) This mechanism would also encourage farmers to sell instead of holding coffee off the market by providing the real chance of further revenue and zero chance of losing revenue. For all involved this would also provide more transparency and information in determining the actual amount of coffee available in any year by flushing out coffee being held back, also dampening the likelihood of significant price moves throughout the year. Essentially this would provide extra grower income should prices rise, while reducing the likelihood of significant price changes through greater transparency.
Roasters and Importers are in a much better position to adjust to higher prices by passing real per pound costs onto wholesale customers than are producers who's costs fluctuate vastly per pound harvested depending on yield. While this sort of scheme is anathema to all capitalist theory, any price scheme already offends those sensibilities. The form and function of this upside pricing scheme is something best determined by individual roasters and importers but is completely reasonable when considered alongside all of the factors and benefits we quote in support for direct trade.
I"m curious whether any roasters and importers are already using some sort of mechanism to provide extra revenue, and would be happy to learn the details.
Food for thought.
Sunday, February 6, 2011
Manual Brew Costing Part II
I've felt the need to dig a little deeper into Manual Brew Costing since it is a relatively new revenue stream for many coffee shops, and very different metrics apply to determining it's profitability. I really appreciated the comments, and hope to provide some more info for discussion. So here goes my second instalment in a complete workup of Manual Brewing.
My first assumption is that Batch Brewing and Manual Brewing are perfect substitutes from the consumers perspective. That means that a customer would be equally happy ordering a manual brew coffee and a batch brewed coffee in most circumstances.
Second, I am assuming that most customers are accustomed to ordering their coffee as a batch brew, and therefore it is the default order for most customers. Because it is the default, most customers are acquainted with "normal" wait times when ordering a batch brew, and are familiar with normal pricing associated with it. This is important because if Batch Brewing is the default, the exogenous inputs of "Wait time" and "Price" affect only Manual Brewing.
Using these assumptions I have come up with the following equation to represent the consumers demand for Batch Brewed and Manual Brewed Coffee:
Demand for Coffee = Brewed Coffee + (Manual Brewed Coffee/Wait Time and Price)
In this equation, the + sign indicates that both are substitutes for each other and combined demand equals total demand for coffee. (I understand that in parts of Europe the Americano factors strongly, but I'll examine that at a later date.)
It has been pointed out to me that Intelligentsia is successfully using all manual brewing and achieving a high profit through efficiency by brewing approximately 4 brews in 6 minutes negating my 7.5 minute assumption. I spent some time thinking about this, and of course came to the conclusion that efficiency is best met when output is maximized, ie a busy shop like Intelligentsia. So the question is how can a smaller operation achieve the same efficiency? I think the equation provides some revealing info.
If Brewed and Manual are perfect substitutes, then eliminating one simply means more volume of the other. If a shop eliminates Batch Brewed (like Intelli) the full volume shifts to Manual Brewed where there is the possibility of achieving efficiency though volume. Further, because there is no Batch Brewed Coffee, the expectations for speed and pricing may be altered negating the drag on demand by the denominator in the equation. (Assuming there isn't a super fast direct competitor next door tempting impatient customers away) In the equation, the default was Batch Brewed, and the drag was placed on Manual because it introduced unfamiliar inputs of extra time and elevated price. However, eliminate Batch, and the default changes to Manual. I expect that there would need to be a transition period where staff would build skill levels and determine best sequencing, as well as a period of preparing customers for a change. I still have serious reservations about whether cost effective manual brewing is possible in most situations, but am intrigued.
I'm sure Intelligentsia went through this exercise, but thinking through it step by step helped me realize that perhaps in the right circumstance, labour can be applied efficiently in Manual Brewing. I will sit on this for a few days and expand on it by costing a manual brew only shop with quicker brew times and maybe an equation that capture the Supply side of the transaction.
Please share your comments, they help me work through things I hadn't thought of and bring different perspectives to an important subject.
My first assumption is that Batch Brewing and Manual Brewing are perfect substitutes from the consumers perspective. That means that a customer would be equally happy ordering a manual brew coffee and a batch brewed coffee in most circumstances.
Second, I am assuming that most customers are accustomed to ordering their coffee as a batch brew, and therefore it is the default order for most customers. Because it is the default, most customers are acquainted with "normal" wait times when ordering a batch brew, and are familiar with normal pricing associated with it. This is important because if Batch Brewing is the default, the exogenous inputs of "Wait time" and "Price" affect only Manual Brewing.
Using these assumptions I have come up with the following equation to represent the consumers demand for Batch Brewed and Manual Brewed Coffee:
Demand for Coffee = Brewed Coffee + (Manual Brewed Coffee/Wait Time and Price)
In this equation, the + sign indicates that both are substitutes for each other and combined demand equals total demand for coffee. (I understand that in parts of Europe the Americano factors strongly, but I'll examine that at a later date.)
It has been pointed out to me that Intelligentsia is successfully using all manual brewing and achieving a high profit through efficiency by brewing approximately 4 brews in 6 minutes negating my 7.5 minute assumption. I spent some time thinking about this, and of course came to the conclusion that efficiency is best met when output is maximized, ie a busy shop like Intelligentsia. So the question is how can a smaller operation achieve the same efficiency? I think the equation provides some revealing info.
If Brewed and Manual are perfect substitutes, then eliminating one simply means more volume of the other. If a shop eliminates Batch Brewed (like Intelli) the full volume shifts to Manual Brewed where there is the possibility of achieving efficiency though volume. Further, because there is no Batch Brewed Coffee, the expectations for speed and pricing may be altered negating the drag on demand by the denominator in the equation. (Assuming there isn't a super fast direct competitor next door tempting impatient customers away) In the equation, the default was Batch Brewed, and the drag was placed on Manual because it introduced unfamiliar inputs of extra time and elevated price. However, eliminate Batch, and the default changes to Manual. I expect that there would need to be a transition period where staff would build skill levels and determine best sequencing, as well as a period of preparing customers for a change. I still have serious reservations about whether cost effective manual brewing is possible in most situations, but am intrigued.
I'm sure Intelligentsia went through this exercise, but thinking through it step by step helped me realize that perhaps in the right circumstance, labour can be applied efficiently in Manual Brewing. I will sit on this for a few days and expand on it by costing a manual brew only shop with quicker brew times and maybe an equation that capture the Supply side of the transaction.
Please share your comments, they help me work through things I hadn't thought of and bring different perspectives to an important subject.
Wednesday, January 26, 2011
Manual Brew Costing
I am ambivalent about the positive and negative aspects of manual brewing other than it's value as a profit centre which meets a consumer demand. I am concerned that many of those who advocate manual brewing are supplying a product in the hope customers buy, instead of producing a product the customers demand. That being said, I want to examine the unique costing that applies to manual brewing so that coffee shop owners might determine whether it is right for them.
For this costing, I will use a tool that many of you are using, the excellent Intelligentsia app for iphone, and focus on the pour over method.
For this we need:
28g of whole bean coffee which I will assume $10/lb wholesale cost
V60 Dripper
V60 filter Cost $0.065
Hario Kettle or Similar
Burr Grinder
Digital Scale
Vessel to brew into
While the prescribed brew time is 2.5 minutes, I am assuming a total prep and brew time of 7.5 mins. Prep time includes water boil, coffee weighing and grinding, filter pre wash, and brew.
The costing looks something like this:
Bean Cost
454g/28g =16.21
$10 (bean cost)/ 16.21 = $0.62
Filter Cost
= $0.065
Labour Cost (Using my local minimum wage for barista's $10.25)
$10.25 x 1.15(payroll tax) = $11.78
7.5 mins/ 60mins = .125
$11.78 x .125 = $1.47
Cup and Lid (if needed)
$0.25
Cost of Goods Sold (COGS)
$0.62 + $0.065 + $0.25 = $0.935
Total Cost
0.62 + 0.065 + 1.47 + 0.25 = $2.405
I am going to try to work out a retail price using a couple of different methods.
First Method:
I have stated a couple of times in this blog that an excellent target for labour is 20-30% of revenue. I am going to ignore the fact that while one person is preparing the pour over, that revenue also needs to partially cover the cost of the labour required to take the order and only focus on the single barista. If I use the 20-30% guideline, then the retail cost should be between $1.47 X 3.33= $4.90 and $1.47 x 5 = $7.35
If we back out cost we can figure out the contribution each pour over makes to General and Administration by doing the following:
$4.90 - 2.405 = $2.495
$7.35 - 2.405 = $4.945
Second Method:
If we use a typical gross profit margin of .70 to calculate a retail price
$0.935 / 30 x 100 = $3.11
If we subtract labour cost from this number we get,
$3.11 - $1.47 = $0.707
From this calculation $0.707 represents the contribution each pour over would make to G&A costs and hopefully some profit.
Third Method:
Using a guideline for labour productivity and revenue per employee hour of $50, and the fact that a barista can do 8 pour overs per hour at 7.5mins per pour, we can calculate how much money we need to charge to hit the target.
$50 / 8 = $6.25
Contribution G&A = $6.25 - $2.405 = $3.845
While I don't profess to know all of the variables present in anyone else's coffee shop, I definitely think that these figures represent an excellent guideline for pricing your pour over. Remember that my labour calculation does not include labour required to take the order, or any management/back office labour. Given the increased labour cost associated with manual brewing, calculating based on gross margin is likely a mistake. Conversely, because labour is so high, applying high labour ratios to manual brewing likely prices it beyond any demand curve. A calculation based on overall labour productivity seems to yield more predictable pricing, and permits increased profit or more approachable pricing by increasing the efficiency of the barista.
In general, I think it's safe to conclude that if you are pricing your pour over coffee under the $4.00 mark, you should take a very hard look at your numbers.
I am including a quote from a recent article in Esquire Magazine by Todd Carmichael "375 cents (n) — An insane amount to pay for any single cup of coffee, unless of course one is at the foot of the Spanish Steps and in the company of a potential sexual partner above one's standing. If in Brooklyn, however, see also: Nigeria scam; bridge for sale."
While I acknowledge the article causes a great deal of negative reactions from those prone to comment, it is none the less valid and typical of most coffee consuming public. The problem is, price your pour over under $4 and you risk losing money, price it higher and you risk offending customers.
Try using some of the methods I've suggested and plug in your own numbers to determine whether pour overs are contributing to your profitability or even covering costs.
For this costing, I will use a tool that many of you are using, the excellent Intelligentsia app for iphone, and focus on the pour over method.
For this we need:
28g of whole bean coffee which I will assume $10/lb wholesale cost
V60 Dripper
V60 filter Cost $0.065
Hario Kettle or Similar
Burr Grinder
Digital Scale
Vessel to brew into
While the prescribed brew time is 2.5 minutes, I am assuming a total prep and brew time of 7.5 mins. Prep time includes water boil, coffee weighing and grinding, filter pre wash, and brew.
The costing looks something like this:
Bean Cost
454g/28g =16.21
$10 (bean cost)/ 16.21 = $0.62
Filter Cost
= $0.065
Labour Cost (Using my local minimum wage for barista's $10.25)
$10.25 x 1.15(payroll tax) = $11.78
7.5 mins/ 60mins = .125
$11.78 x .125 = $1.47
Cup and Lid (if needed)
$0.25
Cost of Goods Sold (COGS)
$0.62 + $0.065 + $0.25 = $0.935
Total Cost
0.62 + 0.065 + 1.47 + 0.25 = $2.405
I am going to try to work out a retail price using a couple of different methods.
First Method:
I have stated a couple of times in this blog that an excellent target for labour is 20-30% of revenue. I am going to ignore the fact that while one person is preparing the pour over, that revenue also needs to partially cover the cost of the labour required to take the order and only focus on the single barista. If I use the 20-30% guideline, then the retail cost should be between $1.47 X 3.33= $4.90 and $1.47 x 5 = $7.35
If we back out cost we can figure out the contribution each pour over makes to General and Administration by doing the following:
$4.90 - 2.405 = $2.495
$7.35 - 2.405 = $4.945
Second Method:
If we use a typical gross profit margin of .70 to calculate a retail price
$0.935 / 30 x 100 = $3.11
If we subtract labour cost from this number we get,
$3.11 - $1.47 = $0.707
From this calculation $0.707 represents the contribution each pour over would make to G&A costs and hopefully some profit.
Third Method:
Using a guideline for labour productivity and revenue per employee hour of $50, and the fact that a barista can do 8 pour overs per hour at 7.5mins per pour, we can calculate how much money we need to charge to hit the target.
$50 / 8 = $6.25
Contribution G&A = $6.25 - $2.405 = $3.845
While I don't profess to know all of the variables present in anyone else's coffee shop, I definitely think that these figures represent an excellent guideline for pricing your pour over. Remember that my labour calculation does not include labour required to take the order, or any management/back office labour. Given the increased labour cost associated with manual brewing, calculating based on gross margin is likely a mistake. Conversely, because labour is so high, applying high labour ratios to manual brewing likely prices it beyond any demand curve. A calculation based on overall labour productivity seems to yield more predictable pricing, and permits increased profit or more approachable pricing by increasing the efficiency of the barista.
In general, I think it's safe to conclude that if you are pricing your pour over coffee under the $4.00 mark, you should take a very hard look at your numbers.
I am including a quote from a recent article in Esquire Magazine by Todd Carmichael "375 cents (n) — An insane amount to pay for any single cup of coffee, unless of course one is at the foot of the Spanish Steps and in the company of a potential sexual partner above one's standing. If in Brooklyn, however, see also: Nigeria scam; bridge for sale."
While I acknowledge the article causes a great deal of negative reactions from those prone to comment, it is none the less valid and typical of most coffee consuming public. The problem is, price your pour over under $4 and you risk losing money, price it higher and you risk offending customers.
Try using some of the methods I've suggested and plug in your own numbers to determine whether pour overs are contributing to your profitability or even covering costs.
Thursday, January 6, 2011
Pricing Baked Goods (Perishables)
When pricing baked goods or any perishable at your coffee shop you need to consider them very differently than any other product you sell. If, for example you have 10 coffee makers on the shelf, it is likely you will continue to sell them until all of them are sold. You may wish to discount them as stock gets old, but you will eventually sell through all of the coffee makers.
With baked goods, sandwiches, anything with a very short shelf life, you may not have the opportunity to sell all of your daily stock because you ordered too many, it was a bad weather day and traffic was reduced, or any one of a thousand reasons cafes have slow days. For this reason you need to think of them very differently, and price them differently.
Use this equation to determine target price from a known target margin.
Target Price = unit cost/((100-target margin)/100)
Example 1:
one dozen muffins:
purchase $12
re-sell $1.50 each
Break Even 8 x $1.5 = $12
Target Price = $1/(100-33)/100 = $1.50
Therefore our coffee shop does not make a single penny on any one of the first 8 muffin sales, it only pays back what we paid for them. All of the profit lay in the final four muffins. If we have a quiet day and we fail to sell at least 8 of our 12 muffins, we lost money on our muffin sales that day. As the day gets on towards 4pm and our baked goods sales slow, we may choose to discount, which further reduces profit especially if we are reducing more than the last 4 muffins.
Example 2:
one dozen muffins:
purchase $12
re-sell $2 each
Break Even 6 x $2 = $12
Target Price = $1/(100-50)/100 = $2
In this example we only need to sell 6 of our muffins to break even, pricing being the key factor. By moving the price up from 33% margin to 50%, we have set up conditions to make it unlikely that we will fail to profit from our perishables.
If our margin is: 25% we only break even when we sell 9 of 12 muffins
33% we only break even when we sell 8 of 12 muffins
50% we only break even when we sell 6 of 12 muffins
Remember, when dealing with perishables we calculate profit not on a per unit basis, but as a group because at the end of the business day, they are worthless if unsold.
Let me know if this is helpful, and if you have any pointers that you'd like to pass along.
With baked goods, sandwiches, anything with a very short shelf life, you may not have the opportunity to sell all of your daily stock because you ordered too many, it was a bad weather day and traffic was reduced, or any one of a thousand reasons cafes have slow days. For this reason you need to think of them very differently, and price them differently.
Use this equation to determine target price from a known target margin.
Target Price = unit cost/((100-target margin)/100)
Example 1:
one dozen muffins:
purchase $12
re-sell $1.50 each
Break Even 8 x $1.5 = $12
Target Price = $1/(100-33)/100 = $1.50
Therefore our coffee shop does not make a single penny on any one of the first 8 muffin sales, it only pays back what we paid for them. All of the profit lay in the final four muffins. If we have a quiet day and we fail to sell at least 8 of our 12 muffins, we lost money on our muffin sales that day. As the day gets on towards 4pm and our baked goods sales slow, we may choose to discount, which further reduces profit especially if we are reducing more than the last 4 muffins.
Example 2:
one dozen muffins:
purchase $12
re-sell $2 each
Break Even 6 x $2 = $12
Target Price = $1/(100-50)/100 = $2
In this example we only need to sell 6 of our muffins to break even, pricing being the key factor. By moving the price up from 33% margin to 50%, we have set up conditions to make it unlikely that we will fail to profit from our perishables.
If our margin is: 25% we only break even when we sell 9 of 12 muffins
33% we only break even when we sell 8 of 12 muffins
50% we only break even when we sell 6 of 12 muffins
Remember, when dealing with perishables we calculate profit not on a per unit basis, but as a group because at the end of the business day, they are worthless if unsold.
Let me know if this is helpful, and if you have any pointers that you'd like to pass along.
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