Forrest Gump’s Momma always said “Life was like a box of chocolates. You never know what you’re gonna get.” One of the joys of my work is the variety of businesses, and business ideas, I am involved with. Recently I reviewed a business idea to produce novelty boxes of chocolates. It’s a good case study to highlight common pitfalls one can encounter when starting a business based on a ‘good idea’.
The startup founder has a great idea, the sort of idea friends and family would be very supportive of. An idea that if they were to attend craft fairs, and perhaps produce their own eBay/Etsy online store, they could make some money at a price of £15 per box. I’d buy them!
Their maths for the price of acquiring chocolates and printing cartons add up to costs of £8 – £10 so there’s a surplus of £5 – £7 from the £15 selling price. Although they’re paying VAT in the costs of ingredients and packaging, they’re not adding VAT to the selling price. In simple maths terms it looks like they make a gross profit of 33% – 47%. They feel they’re on to a winner!
Imagine if they could also sell their products in High Street stores – maybe even supermarkets! Sure, they will need some staff to help with production, but if they could sell a thousand boxes a month, well, that’s £5,000 – £7,000 of gross profit. The UK’s chocoholics get through, on average, about 11kg of chocolate every year, so how about ten thousand boxes a month? 10,000 boxes a month means £50,000 – £70,000 of gross profit …in a month!
Except it doesn’t. If the £15 price is to be maintained when the chocolates roll out to the High Street and volumes grow, VAT will have to be accounted for. This means the selling price is now £12.50+VAT. The High Street retailers will likely want a profit margin of around 50%, so will need to buy at £6.25 per box. Which is less than the costs. Even with VAT reclaimed from £8 – £10, the net costs are £6.66 – 8.33. Can these costs be reduced, or can the product command a higher price?
Tip 1: You need to be able to make the products, and a profit, at less than half of the target RRP, net of VAT. (If you plan to one day export, you’ll need to be able to accommodate an overseas agent’s margin too.)
Appalled by the ‘greed’ of retailers, the feisty founder argues that they will ‘use the Internet’ instead – after all, they can use eBay, Etsy, Shopify and Amazon for much lower costs. Then there are Facebook, Instagram, Pinterest and Twitter to exploit. On the face of it, all these are much cheaper than giving away half the price to shops.
However, whereas the High Street chains could conceivably place orders for pallets of boxed chocolates, Internet sales are single (or several at best) product transactions. It’s 1,000 times as much paperwork (and time) to sell single products than to sell one consignment of 1,000 boxes to a reseller. It also costs more than anyone imagines to cause volume sales through the famous Internet shopping portals. High Street chains and brands spend, and have for years spent, millions advertising to consumers and building their reputation. To compete head-on with the High Street is not something one can achieve with Facebook Likes.
Tip 2: Compare the costs of ‘giving away’ 50% of the RRP to land big orders against the full costs of selling single products to the masses. There are merits to doing some of both.
One more thing: even as a hobby or ‘lifestyle business’ there are important regulations concerning food, particularly with regard to hygiene and labelling. Friends and family may trust your kitchen, general diligence and avoidance of nuts but the general public is accustomed to relying on Food Standards. The costs of equipment and training for compliance are something else to consider in determining the viability of the business idea – not to mention trading safely and legally!
Tip 3: Make sure you meet regulatory requirements for your business idea.
So: is this idea dead in the water? Not necessarily. My next step was to create one of my ‘parametric calculators’ for business modelling. With this powerful tool we were able to ascertain that volumes in the order of 10,000 – 15,000 boxes per month (120,000 – 180,000 per year*) will create a profitable, scaleable business. The calculator also determines the size of premises, number of employees and, most importantly, the amount of capital required to start the business properly.
* (For comparison, Cadbury’s sells over 8 million boxes of Milk Tray every year.)
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