Overhead and Break Even

Selling Cider: The Real, Rural Catch-22

January 8, 2017January 8, 2017 @AppleEllie2 Comments

The phone rang about 8 times and then a harassed voice said ‘Hello?’ I had my pitch script ready. “Hi, my name is Eleanor, I’m calling from Eden Ice Cider Company up in West Charleston Vermont. I’m coming through your area next week and am hoping I can set a time to stop by for just a few minutes and give you a taste. Is there a time on Tuesday or Wednesday that would work for you?” “Uhhh, where are you from? Vermont? Okay. Umm Tuesday at 2PM – I can only give you 10 minutes.”

Thank God for the Vermont Fresh Network. It was started back in 1996 to connect restaurants and institutions directly with local farmers who were shut out of the food distribution network. They practically invented the concept of farm-to-table. My sales strategy was basically to look up the website of every restaurant on their list, check their wine and dessert lists and see if they had any sweet dessert wines listed. I identified about 20 restaurants and 10 stores and started calling. You could tell that had we not been from Vermont, these very busy folks would not have made time for us. As it was, we were able to set up one trip down the West side of the state, and one trip down the East side, and see a total of 27 buyers. Off we went to sell our little stock. At the end of 3 weeks, we had visited everyone and 26 of the 27 had purchased! Very exciting indeed.

Then there came the call at 3PM on a Thursday from The Equinox Resort in Manchester – “We need three more cases for an event this weekend. Can you bring them tomorrow?” Of course I said yes. We couldn’t be difficult to deal with for this large account, it was bad enough they couldn’t just add it on to an order with one of their usual distributors. I dropped everything on the schedule the next day and set off – down Route 91 to Rockingham, up Route 103 to Chester, and then Route 30 across to Manchester. 6 1/2 hours later I was back at the farm. You don’t need me to draw a cute chart to show that the economics of that don’t work!

It seemed so simple. It’s pretty easy to sell 150 gallons of ice cider, or 500 gallons of hard cider just going to the local farmer’s market and self-distributing in an immediate radius, but unless the cider is one a part of a diversified farm, or a sideline for people who otherwise have day jobs, $5,000 take home pay for the year does not make a real business. How could we increase sales without increasing expenses more (see earlier post “Breaking Bad or Breaking Even“)?

THIS is the question that a lot of small food and drink businesses don’t spend enough time on up front, including my own. Everyone focuses on the production economics, and they fail to look hard at the sales economics. Here’s how to start.

There are five typical channels through which you can sell your brand – in person markets, on-premise at your site, direct shipping to consumers not near your site, self-distribution to stores and restaurants, and sales to distributors. For each one of them, you need to estimate the likely sales volume, the price you will receive, and the likely expenses you will incur in that channel to support those sales. Your variable production cost is generally the same, assuming you are selling the same bottles through the different channels. So you can calculate the contribution that each channel makes to your overhead and profit. Also make note of which sales expenses are fixed versus variable. You have the same break-even issues in sales channels that you do in production.

So here’s the sales dilemma that underdogs face. I’ll go into more detail on each one of these channels in future posts, and they can be fine-tuned for sure, but this is the big picture:
– Farms are located where land is cheap, and people are scarce. Without population density and location traffic, the farm store and self-distribution options tend to be low volume.
– Direct shipping is hugely complicated by individual state laws, regulations, licensing and reporting requirements
– Farmers markets are generally profitable, but limited in growth potential
– Distributors are the lowest margin option, but hold the largest potential for growth, however the expenses required to support distribution relationships are higher than one might think, and achieving sell through for a niche product at a higher price point with low brand awareness requires a marketing budget and capability that is beyond most of us.

Ideally you would be able to fine-tune your sales channels to achieve a decent contribution to overhead and profit, say 22%. The problem is that the easy high profit channels are small and you don’t get enough from them to cover fixed costs and achieve your sustainable scale. The more you grow, the more you have to rely on low contribution channels which means you have to grow more than you would in higher contribution channels. This puts the pressure on to keep increasing scale, which means selling even more, and around you go again.

Catching 22%, it’s the rural-life version of Joseph Heller’s satirical double-bind. Clearly we underdogs are crazy, we just can’t admit it.

Vintage (Cidrage?): The Surest Sign of a Cider Underdog

December 26, 2016 @AppleEllie5 Comments

We set up our first bottling line during June of 2008, seven months after pressing, and 8 months after the apples were harvested at Scott Farm and Champlain Orchards. In our 800 square foot basement we had a pallet of bottles in cartons, a little bottle sparger that screwed onto the tap over our basement sink, a plastic bottle tree to dry the bottles, a hose that ran from the tank through a pump to a small filter to our little 4-head gravity filler, then finally a hand corker resting on a piece of plywood set on two saw horses. Friends and family had volunteered to come and help our first bottling in return for ice cider.

The team: One person sparging bottles, one person at the filler, one person on the corker, and a final person wiping the bottles and putting them back into the cartons. We would pull them out again for labeling and capsuling another day. Four people working a good eight hours to bottle a little over two thousand bottles. Not to mention two hours to get everything sanitized and set up, and another ninety minutes at the end to clean everything up. Let’s just say that labor efficiency wasn’t our priority that day – although we noticed a clear linear relationship between good tunage on the boom box and the pace of the line. The only casualty was the guy on the corker, who couldn’t raise his right arm above his waist for two days afterward. As his wife I took a little heat for that. But hey, we were done for the year – one day of bottling for inventory with a retail value of a little over $26,000. One day, one year, one batch of ice cider.

As a cider producer, we are technically a Winery, so we are subject to federal wine regulations, yet we cannot use a number of wine terms on our labels because we use apples instead of grapes. We produce our ciders with the same techniques and values as used by vintage wine makers, one harvest = one cider, but are prevented from communicating that on our labels with a ‘vintage’ date. Or maybe we need a new word, since ‘vintage’ itself has ‘vin’ referring to grape wine in it. Perhaps we should argue for the ability to have a ‘cidrage’ date?

There are all sorts of differences between a cider made in one annual batch from fresh, harvest-pressed apples and aged for at least 6 months before release, versus a cider made from concentrate or from apples pressed out of cold storage, fermented quickly for 2 weeks and released 2 or 3 weeks after that. Regardless of whether the outcome is pleasing to your palate in either case, a ‘cidrage’ cider is an underdog cider because of the significant economic disadvantages of producing one batch per year. What are those disadvantages? One is lower asset utilization, the other is higher working capital requirements. In this post I’m going to cover asset utilization. I’ll cover working capital later.

In my last post ‘Breaking Bad or Breaking Even‘, I described how equipment is considered an asset, to be expensed over 7 years. Now consider the impact of producing multiple 4 week batches of cider one after the other throughout the year, rather than one batch per year for the same volume of product. If Cidery A produces 2,000 gallons of one ‘cidrage’ cider once per year, they might invest in two 2,000 gallon tanks, one of which will be full most of the year (the other is to pump into). Cidery B produces 2,000 gallons of 4-week cider. That means they can produce about 10-12 batches per year, so they only need to invest in two 200 gallon tanks. Even though the cost of the 2,000 gallon cost is less than 10 times the cost of the 200 gallon tank, Cidery B has significantly lower equipment costs, so their fixed costs are lower, their break-even volume is lower, and their profitability is higher at each volume of production.

Bottling equipment is a little more complicated, but basically Cidery B can size their bottling equipment for a 200 gallon bottling day, whereas Cidery A may need to use larger equipment capable of bottling 2,000 gallons in only 1 or 2 days. So just to reiterate, for the same annual gallons of production, a true ‘cidrage’ producer can incur 4 to 5 times the equipment cost of a 4-week cider producer. Now that’s an underdog for you.

Breaking Bad or Breaking Even

December 18, 2016December 18, 2016 @AppleEllie4 Comments

It’s been lovely hearing from those of you who have signed up to follow Cidernomics. A number of you have asked “So what scale IS sustainable?” There is no easy answer. That’s the whole project I’m on. This post gets at just some of the basics needed to start figuring it out. Meanwhile, keep the questions and comments coming!

Just up the road into Canada there is a medium sized producer of ice cider, run by an interesting woman who had succeeded in getting a contract to export to the Nicolas chain in France. All of a sudden she was building out more space and putting in some much larger tanks. We benefited from this because she was happy to part with 4 600L tanks and a 4-head gravity bottle-filler for less than $2,000. We didn’t own a truck, so my man was going to take the Toyota Highlander SUV and bring the stuff back in 2 or 3 trips.

Our biggest concern was coming back across the border. It’s not like you can hide a stainless steel tank under a coat in the back seat. We had no idea what kind of rigmarole we would need to go through – paperwork, exorbitant duty charges, official signatures, pledging of first-borns, etc. He eased up to the border guard in Lane 1 at the Port of Derby Line and rolled down the window. Yup, he was told to pull into the parking area and go inside the border station to see the customs officer on duty. Man, if this didn’t work our back up plan was pretty much unaffordable.

After waiting in line a mere 10 minutes or so, he got to the front and explained that he had two stainless steel wine tanks purchased second hand. The border guard asked what price we had paid, and proceeded to hand him a form. “Write a one sentence description here, put the value here, and sign it here.” he said, “That will be $10.75.” Done! Piece of cake! We really were going to try this ice cider thing after all. Three trips and three hours later, it was all in our basement. If we’d had a big enough vehicle, it would have only cost us $10.75 for the one trip. We were delighted to spend just $32.25.

Along with the tanks and the filler, we had purchased a small press and some plastic containers to freeze the juice outside for the ice cider process. We also needed a pump, small filter, hoses, some fittings, and some kind of corker, capsuler and labeler. These all fall under the category of “plant & equipment” in the broader category of “fixed assets”. Going back to the question at the end of the value chain post “Apples to Cider to You” – can I make money at $12.60 per bottle of ice cider FOB price? – knowing my fixed versus my variable costs is the key to the answer.

Variable production costs: apples and/or apple juice, production supplies (yeast, filter pads, etc.), bottles, corks, labels, capsules, cartons, and any hourly labor cost for pressing, bottling, labeling etc. Calculate these per bottle, and make sure to allow for some waste.

So, if my FOB price is $12.60 and my variable costs add up to $6.50, then the incremental money I’m going to bring in from each bottle I sell = $6.10. Also known as marginal contribution.

Fixed production costs: equipment, rent, utilities (mostly at our scale).

OK, so you don’t count the full cost of equipment in one year – that’s what depreciation is for. Most equipment is assumed to have a useful life of 7 years, so take 1/7 of the equipment cost as your annual fixed equipment charge. (We’ll talk about the difference between cash flow and profitability later.)

Overhead: Then you have all sorts of things that are typically considered “overhead” – sales, marketing, general, administrative expenses. For simplicity’s sake we’ll just call this all fixed cost. However, in future posts, I’m going to do a pretty deep dive on sales economics where we’ll parse that more finely.

The basic concept of break-even is the math that tells you how many bottles you have to sell at your marginal contribution rate to cover your fixed costs, after which the marginal contribution of each bottle goes toward your bottom line profit. In this example, if my total equipment purchases are $18,000, and I estimate that office, utilities, marketing and sales will cost me $5,000 per year, then I will need to sell (($18,000/7) + $5,000)/$6.10 = 1,241 bottles of ice cider, or just about 100 12-bottle cases, to break even.

You have to play around with this quite a bit, because 1) your variable costs per unit are different depending on the quantity you purchase, as we saw in the label example in “Economies of Scale, Cider Style“. And 2) fixed costs are really only fixed for a certain range. For example, you can make anywhere from 100 – 600 liters of cider in a 600 liter tank, after which you have to purchase a new tank.

The trick is to know where the ‘steps’ are in your fixed costs, and see if the volume at the steps will be sufficient to break even or better. In the diagram below, you want to be in situation B as you grow. Situation A is truly Breaking Bad. This picture is one of the key issues I worry about with small food/drink businesses!

My capacity at that point was 1600 liters (3 full tanks plus one to pump into, less some loss during fermentation). That’s 2,068 375ml bottles, and the variable costs of $6.50 per bottle are what I expected to pay to produce and bottle at that quantity. So theoretically, I could generate $6.10 of incremental profit on every bottle over 1,241: (2,068 – 1,241) x $6.10 = $5,044 of profit on a little over $26,000 in revenue. I would be paying myself a little over $1,000 in hourly wages as part of my variable production cost, and I could pay 5% interest on the $18,000 I invested in equipment, and take home another $4,000 or so for the year that it would take to produce and sell the ice cider. Sounds good, and might work as a secondary ‘hobby’ income, but it’s not going to support me at that level. So I’ll need to grow beyond that. (SO easy to say…)

If you are being smart, you spend a lot of time calling vendors and asking for quotes at different quantities and building a sophisticated spreadsheet that lets you model the picture of growth with some precision. (If you don’t know how to use Excel, find someone who does!) On the other hand if you are being romantic, what the hell. This is why they say that to make a small fortune in the wine – or cider – business it helps to start with a large one.