Eleven Questions for Paul Stack of Marco

I have posted several times on the subjects of manual brewing and equipment purchasing as they apply to financial statements and profitability modelling. As a special feature heading into the Specialty Coffee Association of America annual trade show and conference in Houston Texas, I have posed some questions to Paul Stack of Marco located in Dublin Ireland. Marco is on the leading edge of technical innovations in hot water delivery systems suited to shops and roasters alike.
Coffeekings: Marco and Uber project may be something unknown to many in the North American coffee business. What core business was the company founded on?
Paul: Marco is 30 years old this year, which is surprising to some. The core business is the design and manufacture of hot water delivery systems for the food and beverage industry. This is embodied in the design and production of both hot water systems and automatic filter (drip) coffee machines. However we only sell hot water systems in North America for now.

Coffeekings: Innovation, research and development, and entrepreneurship are extremely challenging at the best of times. Do you perceive Marco in an R&D/building phase or approaching a marketing/management phase of the business cycle?
Paul: Both, to be honest. Innovation and R&D is incessant in Marco. It is our future. Parts of our business are very much on the marketing/management side but probably more so in the more traditional mature Marco markets.

Coffeekings: There are plenty of examples within the coffee industry that support the notion that great talent is attracted to great companies. Marco is also blessed with some knowledgeable and skilled staff. Tell me about some key staff and what they contribute to the company.
Paul: People are attracted to companies which will offer them an experience aligned with their own personal and professional ambitions. To be part of something they believe in. We have a lot of great people and I am loathe to single any out. An exception- Drewry Pearson, our Managing Director is something of a visionary and singular in the drive for innovative product offerings with an underlining belief in continuous education. We have very knowledgable and caring people looking after customer service including after sales care. To use sporting parlance, they play in a position to which they are suited. They give the business a solid spine. Our R&D team is a great mix of abilities from mech eng to software design to industrial design to innovation and research into market need. I could go on but it's a bit trumpet-blowing. In short, we have a good team.

Coffeekings: Ireland is undergoing a very challenging time for businesses and finance due largely to banking and real estate collapses. Describe for me the sentiment among Irish businesses regarding access to needed credit, availability of willing buyers for your products, and prospects for the future.
Paul: Ireland has been gorging in the greedy trough for too long and it's payback time. As always with these things, those who gorged and those who pay are misaligned. Established businesses like our own are lucky to have cash strength and a strong banking history, allowing us to continue to invest in our chosen strategic direction even in the face of market uncertainty and revenue dips in our home market in '09/'10. Newer companies with great opportunities are being hamstrung by the lack of credit available. Some banks in Ireland are money collection bureaux rather than financing institutions. Thus, the gears of Irish recovery are sticking as the lubricant that is fluid financial structures is lacking.The core economy in Ireland is strong. A stupid decision to make bank debt sovereign debt is the millstone we carry as a nation. For that, business sentiment is a mixture of simmering anger tinged with embarrassment as brand Ireland has taken a blow.

Coffeekings: Ireland is a touchstone for millions of Diaspora generations removed from the Island, and in many ways has always influenced the world well beyond their population. On my first visit I was struck by how advanced Bewleys on Grafton Street was compared to North American counterparts in terms of quality and traceability. To what do you credit the incredible depth of coffee talent in such a small population?
Paul: I'm not sure the coffee talent in Ireland is that deep, loud maybe...... Regarding coffee and Ireland, Patrick Bewley was at the forefront of a lot of what has become the Irish speciality coffee scene. He invested heavily in the SCAE, both personally and professionally. He was a founder member and is a past president of SCAE. In his own company he invested heavily in the training and education of his staff. Most of the coffee companies in Ireland with speciality leanings have either a founder or some of their team who is ex-Bewleys, including Marco. In the last five or so years Drewry Pearson has taken up the baton, more so from a patron viewpoint nationally while being at the forefront internationally, being a board member of the SCAE and WBC (now WCE). Nationally, he was the prodding stick behind 'internationalising' the Irish Coffee Championships, the SCAE Gold Cup and a strong education content in the Irish industry.

Coffeekings: I had been following the progress of Uber boiler online for some time before marveling in Anaheim at its beauty, advanced technology and logical solution to problems faced in manual brew methods. Please describe the problem it was designed to solve and some technological barriers to achieving success.
Paul: As most know, the Uber Boiler was the result of a one off project with a nascent London coffee company called Square Mile Coffee Roasters in 2008/2009, at the time comprising the impressive trio of James Hoffmann, Anette Moldvaer and Stephen Morrissey. Our challenge was to produce one under counter water delivery system with counter top font to deliver water to within 1 degree Celcius of a chosen temperature, which could pour directly onto a weighing platform. This would allow James et al cup coffees with accuracy allowing them highlight nuances. While we already had undercounter systems, their accuracy was approx +/-2.5C and there was no weighing platform. Tightening the accuracy was the key challenge. The rest was packaging and having a will to do it.

Coffeekings: Where are the uber boiler manufactured and how much time is required to take one from shop drawing to tabletop? Have you considered licensing the technology to larger manufacturers and focusing on marketing and distribution?
Paul: Uber Boilers are manufactured in our production facility in Dublin, about 7 miles from the city centre. We build four Ubers per run. Build time from punching steel to boxed Uber is 4 days. As the Uber Boiler is a constant work in progress I haven't considered licensing the technology. Is someone interested ?

Coffeekings: It seems to me that the past 5 years or so have become a period where companies are applying increasingly advanced technologies to address problems posed by increasingly simpler brewing techniques. One of the problems I see with manual brewing is the increased labour and wait time. How has the uberboiler addressed these problems?
Paul: It has and it hasn't. That's a bit Irish, eh? It has by giving the Barista a workstation from which (s)he need not move and can engage with a customer, thus maximising efficiencies and customer service. More importantly, it hasn't as it is not designed to decrease wait time. The ECOBOILER & ECOSMART series do that.

Coffeekings: The most visible elements of the high-end coffee market communicate at length about the subtle nuances and characteristics of their coffees cupping profiles. This sort of customer interaction can pay big dividends but only if the customer can distinguish the traits too. What about the uberboiler increases the chances of successfully brewing coffee to reveal the desired profiles.
Paul: Precision. At its heart is the UberBoiler's capability to allow the Barista change every brew variable, from coffee to water ratio (+/-0.5g) to contact time (+/-1s) to temperature (+/-0.1C) to turbulence (via flow rate and flow direction).

Coffeekings: Marketing and distribution are for me big black holes for profits and cash flow. What is the marketing strategy for Marco and how are you addressing distribution in North America?
Paul: Never a truer word spoken. We never targeted North America. The uber project dragged us there. It would have been too big a step for us to set up Marco USA when that opportunity presented. La Marzocco USA handle our brand and our product in North America, exclusively in the US. The alignment of both companies' brand positioning, strategic intent and vision coupled with the simple fact that we get on well made it an easy decision.


Coffeekings: One thing I like to repeat to staff is we don’t get to choose our customers, they choose you. Are there any customers using Marco’s products and services that surprise you by not fitting the target customer profile. Is anyone using the uber boiler for products other than coffee and do you market to any other industries?
Paul: It's a great question to which I am unsure how to answer. Our products are used widely in catering institutions where the need is often basic regarding brewing but crucial regarding reliability, ease of use and service. Cost of ownership and our products' energy-saving credentials are fast becoming as big a decision factor as the customary features of well-designed, well-made kit which do the job. Regarding Uber Boiler, it's main and happiest home is the cupping room or the Barista-driven brew bar. It is also used in gourmet tea shops.

Repayment of Capital Investments

Knowing and understanding our Financial Statements is vital to developing an appreciation of where your business value is currently and where it is headed.
When we look to start a business there is typically an investment made either using personal wealth, or more often borrowed money with the expectation of future profits. Sometimes this equals a substantial amount of money, mostly applied to equipment or leasehold improvements, and sometimes the purchase of another business. These assets are organized in the balance sheet under the heading Long Term or Capital Assets, and conversely, Long Term Liabilities for the outstanding loan amount. (Don't forget that the Long Term Assets value are depreciated by about 20% per year as their usefulness is consumed.)

Any coffee shop owner would hopefully understand that this capital investment needs to be repaid, and therefore any net profit is not in truth profit, but a repayment of capital until the debt is settled. In most cases this period of repayment equals 4-5 years which coincidentally is the same period of time over which the value of the investment nets to zero through depreciation. Usually we have paid monthly for 4-5 years and in the end we have zero value on the balance sheet to show for our investment except a great deal of depreciation. But all is not lost as this is the time where the assets fully return all of the profit to the company rather than servicing a loan and is the most important time in a business cycle. Given careful and attentive servicing, most well purchased equipment and leaseholds can continue to deliver utility beyond their cycle of depreciation.

Do not fall into the trap of replacing perfectly functional equipment and putting yourself back on the repayment treadmill. If your competitive advantage is tied to exhibiting the latest equipment, you have put your coffee shop in a similar situation as a pharmaceutical company that needs to spend constantly on research or risk precipitous drops in revenue. By necessity these business models require constant investments of capital that either carry interest payments, or rob owners of personal net profit.

If we fully comprehend the literal meaning of Repayment of Capital Investments, it is clear that the money spent initially was an investment and not a cost of doing business. We all know that an investment is a wise one if and only if it makes us more money than we spent. Those of us with investment accounts vested in various Stocks can quickly glance at our monthly statements and determine the present value of money invested and make a determination of whether our advisor knows what he/she is doing. As a coffee shop owner, apply the same critical values to your investment in capital expenses. If you are as rigorous with business investments as you are with personal, you will come to the conclusion that the investment only returns value once it has been paid for and that the most prudent path for future capital investments is to pay for them with past savings rather than future profits. Remember: Keep Capital Investments employed beyond the repayment period!

Investing in Equipment

For most coffee businesses equipment should be an investment, not a marketing tool, and that is why it is critical for coffee businesses to understand the financial impact of significant purchases on our profit and cash flow.
A typical espresso machine can be fairly assessed at a 4-5 year lifespan given regular maintenance. That lifespan can be increased indefinitely with complete rebuilds. If we purchase an espresso machine, we are expected to depreciate it over 5 years until it ceases to be a capital asset on our balance sheet. The fact that it's balance sheet value is depleted is offset by the fact that it is no longer a long term liability in the form of a bank loan. If we regularly maintain our machine, we have the potential to benefit from the utility of a machine which has already been paid for and depreciated. Think about driving around your 5 year old car...no payments...same utility.

Lets compare two new espresso machines, one costing $5,000 and the other $20,000.
We will assume that the $5k machine is capable of producing the same quantity of espresso beverages per hour. We will also assume that the $20k machine does produce a better, more consistent espresso. I don't want to explore the technical merits of one machine over another, just how the cost impacts our profitability.
In both cases, the machinery will be financed at 10% (high rate for some, low rate for others), although it is always better to purchase outright with cash accumulated from profits. Obviously paying $5k cash is significantly more accessible for most coffee businesses than $20k, but we will assume both are financed.

Loan amount: $20,000
Interest Rate: 10%
Loan Term Months: 48
Monthly Payment: $507.25
Total Paid: $24348.08
Interest Paid: $4348.08


Loan amount: $5,000
Interest rate: 10%
Loan Term Months: 48
Monthly Payment: $126.81
Total Paid: $6087.02
Interest Paid: $1087.02

Look at the total burden to the company for each machine represented by the Total Paid number. The difference in purchase price is $15k but the total financed burden is $18,260.98 or an extra $380.44 per month over 48 months. The same utility is withdrawn from the machine in the form of beverages per day, but one machine cost significantly more to produce those beverages. I have already discussed the impact on the balance sheet, but the income statement is also adversely affected by the burden of lease/loan payments and amortization expense, reducing profit at the end of the year.
Choosing a $20,000 espresso machine over a $5,000 or even $10,000 is likely tied to an expectation that the equipment will elevate status, quality perceptions, and increase revenue. These are marketing decisions since identical utility from a less expensive option was foregone in favour of an effort to increase awareness/buzz. Coffee Companies with competitive advantages based upon location, skilled baristas, exceptional service etc, don't need to constantly upgrade equipment in order to maintain buzz. Theoretically I would argue that any expense over and above significantly cheaper options should be identified as Goodwill rather than Capital Assets.
Choosing the more expensive option is also a strategy which is a long term expense, since every year a newer, more sophisticated model with more buzz will hit the market. Heaven forbid that your closest competitor engage in similar strategies, resulting in an espresso gear arms race ;) Review your purchases, remember that every dollar added to General and Admin Expenses is a dollar of reduced profit. Every coffee business needs to purchase equipment, just make sure that your purchases impact on financials are known before the decision is made. Last, if you are expecting a jump in revenue when you make a luxury purchase, measure it, confirm or debunk it and learn from it. If it doesn't increase your revenue, you have just made yourself significantly poorer.

Balance Sheet Simplified

The Balance Sheet is always in balance.(Refer to Balance Sheet Page and Sample Balance Sheet to familiarize yourself with terms and look of Balance Sheet)
The Balance Sheet is comprised of:
1. Assets (things we own); Current and Long-term
2. Liabilities (things we owe); Current and Long-term plus Equity (shares owned by shareholders/owners)

The reason Equity is a Liability is that the company owes money to the shareholders if and when they decided to sell their shares in the company. For most coffee businesses, there are likely between 1-5 shareholders who have each contributed funds in exchange for a percentage ownership. The percentage ownership is reflected in number of shares owned by each individual. For example, in our Sample Balance Sheet Page, there exists 100 common (voting) shares. If a partner owns 20% of the company, they own 20 common shares. (I will post more on Common and Preferred Shares soon)

The most important thing to know is the following equation:

ASSETS = LIABILITIES + EQUITY

ASSETS are for our purposes:
Short Term; cash on hand, bank accounts, investments and receivables
Long-term; equipment (tables, chairs, coffee makers and espresso machines) and leasehold improvements (things you've done to the space you rent, but cannot remove when you leave, ie cabinetry, flooring, washrooms)
When we add these things together we know, because we are working on a Balance Sheet, that the Liabilities plus Equity will equal this figure.

LIABILITIES are:
Short Term; accounts payable under 1 year(suppliers, rent, utilities, taxes payable)
Long-term; bank loans (note: there is usually a note listed in the Financial Statements outlining the terms of any outstanding loans, and lease agreements)

Example: In this simple example, our Balance Sheet is truncated, but clean and clear. We have $2,000 in cash, 20k in the bank, 50k in equipment and 72k in total assets. On the other side of the Balance Sheet, we owe 5k to suppliers, are making payments on a 20k bank loan, and as an owner we have 47k in value built up in the company.

ASSETS
cash 2,000
bank account 20,000
equipment 50,000
total 72,000
LIABILITIES
accts payable 5,000
bank loan 20,000
equity 47,000
total 72,000

If we decide to upgrade some equipment and take a bank loan for $20,000 out to do this, our new Balance Sheet will look like this.

ASSETS
cash 2,000
bank account 20,000
equipment 70,000
total 92,000
LIABILITIES
accts payable 5,000
bank loan 40,000
equity 47,000
total 92,000

Our Balance Sheet has grown, but the shareholders didn't profit, in fact cash flow will now need to be diverted to service the new debt, thereby reducing the profit at the end of the year. There are many different ways we could have acquired the equipment without taking on a new loan, lease, lease to own, pay cash, or issue preferred shares. Each has a cost associated with them, some more costly than others.
A very important factor I have omitted is the fact that new equipment depreciates the moment we take possession. (think new cars) This depreciation always happens at a constant rate determined by Generally Accepted Accounting Principles, normally 10-20% per year. This means that we need to reduce our ASSET equipment account by 20% of 70k each year, and if we do that, we need to reduce our LIABILITIES account by the same amount because we are working on a Balance Sheet. If we are reducing the value of equipment by 20% per year, and we are not paying off the equipment by more than 20% per year, we need to reduce the equity account by the difference to keep the sheet balanced. This means less value for the owners.
Play around with these concepts, apply them to your own situation and let me know if you find this helpful.