BeanScene looks at the financial realities of starting a coffee roastery, common mistakes people make, and how they can be avoided.
Over the past few years, hundreds if not thousands of coffee roasters have set up shop around Australia, with lenders, co-roasting facilities, and contract roasters having lowered the bar of entry to the industry. However, the sudden rise of coffee roasters has created a competitive landscape sometimes called oversaturated, meaning new players may struggle to thrive.
According to Tim Mazzarol, Winthrop Professor specialising in small business management at the University of Western Australia (UWA), Australia has many mechanisms in place to support someone looking to start a small business.
“The coffee roasting and café industries are seemingly perennial, and a business can really get going if it finds a good niche and is well managed,” Tim says. “The overall climate in Australia is relatively good for small business and the ease of starting a business is better than most other countries with a fair bit of support in a whole raft of areas.”
Andrew Low, Co-founder of Ordermentum, has seen the sudden rise of coffee roasters firsthand through the online B2B ordering platform, which has more than 200 roasters using the system. As former Managing Director of Toby’s Estate, he also understands the challenges of running a successful roastery.
“The traditional journey to becoming a specialty roaster is largely through a barista pathway. They’re often an enthusiast who works on a machine, gets into home roasting, does some sample or guest work at a small roaster, or works as an apprentice for one of the big guys, then goes off to start their own company,” Andrew says.
“Specialty coffee in 2010 had 10 major players and everyone else was trying to catch up. Now there’s hundreds. The number of cafés has also doubled, so the average kilogram used per venue went down and it got harder to make money off an account.”
Despite the tougher climate, Andrew says it’s still possible for a well-run roasting business to turn a solid profit.
FROM THE BEGINNING
When starting a company, UWA’s Tim says it’s important to begin working on a business model and not just a plan and strategy.
“The focus of the business model is largely on identifying what opportunities you can take up within this particular area and what your customer value proposition is,” he says. “You’ve got to be able to say what’s unique about your business and why it’s valuable to customers.”
After the business model is laid out, a well-considered business plan needs to be designed, factoring in how much money it will need to run.
“You will always need more money than you think, so ensure you have enough working capital – money you have on hand and are able to spend,” Tim says. “If a person has reasonable resources – unless they’re trying to raise very large amounts – credit is not hard to get from banks.
“I also suggest going into business with other people. It’s not impossible to do it alone, but most successful start-ups are team-based, so find partners who can share the workload, strategic thinking, and costs by putting their own capital in.”
Once the model and plan are laid out, the next step is to think about the legal structure of the business.
“If you’re going to be roasting coffee, you need to at least consider employment, work health and safety, and quality assurance. An incorporated business structure would be a good start and it’s not that difficult to set up,” Tim says. “You’ll need to get an accountant with business experience and register the business with a state/territory group or the Australian Securities and Investments Commission if you plan on going interstate. A lot of this can be done online.”
Most importantly when starting a business, Tim says to seek out and take good advice at every opportunity.
“People struggle when they fail to think carefully about these things, don’t take advice, and get excited by the opportunity, launch in, and work it out as they go along,” he says.
“There’s always going to be a level of that, plans often don’t work out and you’ve got to be flexible and adaptable, but that shouldn’t be your sole approach to running a business.”
SETTING A PRICE
Ordermentum’s Andrew says while many would-be roasters have a good understanding of coffee, few have experience running a business.
“Very few – if anyone – starts roasting as a profit-led project. What most roasters do is make a product, see if someone buys it, and at the end of the month, ask ‘do I have any money in the bank?’” Andrew says.
“The risk of this strategy is that they buy the most expensive, highest grade, best tasting coffees they can find, and without really understanding their gross margin and the role of blending to achieve a target cost of goods and ultimately a satisfactory profit margin, they are actually roasting themselves to a financial loss.”
One of the simplest ways to determine price is to use a cost-plus model, taking the amount it costs to produce the coffee and add the profit margin – usually 50 to 65 per cent for a blend. This model is common in markets with low competition, but as specialty coffee increased in popularity across Australia, the average quality of competing coffee has risen, and it has become harder for roasters to set their own prices.
Instead, Andrew says coffee has become a price taking category, meaning the market determines how much a product can be sold for based on supply and demand.
AT WHAT COST?
With the average wholesale sales price for a kilogram of coffee sitting between $20 to $30 according to the BeanScene 2019 Roasters Directory, a figure Ordermentum estimates through its live coffee index is trending downwards, Andrew says roasters without a strong brand identity may struggle to sell coffee at a higher price point.
With prices largely predetermined, roasters must instead focus on adjusting their cost base, beginning with their blends. Despite record low coffee prices, Andrew says it hasn’t resulted in roasters paying lower prices for the finished bag of coffee.
“The green component is only one element of the total cost. The rest is in the supply chain,” Andrew says. “There’s freight, landing costs, tax, and duties that have to be paid to get the coffee here. The average kilogram price of green used to be about $6. Now, it’s more like $9.50 or closer to $14 if you’re buying high-grade coffee from an importer.”
To get the most out of their coffee, Andrew suggests roasters be prudent when developing their blends.
“If you start with more modestly priced Brazilians or Colombians, then blend in some higher graded African, Costa Rican, or Guatemalan centrals, you can get a really nice blend at a sustainable price,” Andrew says.
Roasters also need to factor in wastage when determining their costs. When green coffee is roasted, the moisture loss can result in a 15 to 18 per cent reduced yield depending on the bean and roaster. That’s before breakage, product samples, and discarded coffee that fails quality assurance testing. This means when determining the cost of their coffee, roasters need to scale up the prices of their green beans accordingly.
BEYOND THE BEAN
Though a roaster’s costs extend far beyond green beans, Andrew says many fail to consider essential factory overheads – warehouse costs, packaging, gas and electricity, labour, and storage – and other expenses when handling finances.
“There’s a whole series of unit economics around how much it costs to just turn a roaster on. You also need to pay for everything that gets the doors opened and closed,” he says. “When thinking about costs, it’s not just the beans. Each of these factory costs need to be broken down and factored into the price per bag.”
However, there is another key expenditure item of coffee roasters that Andrew says is too often left out of the equation – the capital cost of equipment.
“If you provide an account with an espresso machine and grinder, it can cost as much as $30,000. In a lot of cases, the roaster acts as if the customer gets this for free when looking at their profit per bag, but what they should be doing is allocating that machine depreciation cost into the product,” Andrew says.
For instance, it costs the roaster $128 per week to keep a $20,000 machine and grinder with an average life of three years in a café. For a smaller account buying 25 kilograms per week, that equates to more than $5 per kilogram.
“If you’re selling coffee for $26 per kilogram and buying green for $8.50 per kilogram, at 80 per cent yield, that’s $10 once roasted, plus $3 for packaging and labour, you’re making a gross profit of $13. But when you factor in other costs – $5 for factory overheads, $2 for trading terms and delivery, and $5 for the machine – you’re only making a net profit of $1 on an accrual basis,” Andrew says. (see Figure 1.)
“As an industry, not just in roasting but across the entire hospitality sector, we need to start questioning: ‘Do I make money from this customer once all costs are truly considered?’”
MONEY IN THE BANK
A wholesale account could also be costing a roaster by simply not paying upfront or on time.
“Trading terms, like letting someone pay you in one or two weeks’ time, seems free but it’s not,” Andrew says. “Roasters will tell me they make $100,000 per week, but if that money is sitting in someone else’s bank account, it’s not earning them interest, and they can’t put it towards something that makes money somewhere else. That’s before you consider late payments and bad debts.”
Incentivising customers to pay without terms or via automated payment can help provide security to the roaster as they avoid bad debt and actually increase terms to the café.
“The next logical step for a café might be to find an non-bank lender for easy approval finance and buy their own equipment. Once purchased, they can work out that it’s saving the roaster, say, $2 per kilogram, then go to the roaster and ask for the coffee to be that much cheaper,” Andrew says.
“The roaster shouldn’t be upset about that because it’s saving them money too and increasing their cashflow by reducing fixed asset purchases. When you add the working capital saving of the venue paying faster, it actually makes the account more profitable. So, the roaster could say ‘fine, I’ll take the $2 per kilogram off, but I want you to pay at time of order instead of on trading terms seven days later’.”
Once a roastery has found its footing and developed a customer base, new problems can arise if the business grows too quickly.
“Growing it is the riskiest thing you can do for a business because you’re moving outside your knowledge of how to do what you’re doing,” UWA’s Tim says. “There’s also the issue of working capital. As you grow a business, it will need more available money, not less.”
Tim encourages small businesses to act carefully and sustainably when considering growth.
“You need to think about what cash you need, how quickly you can get paid, and manage your accounts and overhead so you can bring down your break-even point,” he says.
“You have to work to be efficient, lean, and reduce the amount of working capital you’ll need as you scale. A big part of this is cash flow – making sure you’ve got a cash flow budget forecast and that you don’t find yourself in the wrong cycle. It only takes one large account to not pay up or default to be put a lot of businesses out of existence.”
OUT OF THE RED
With coffee roasting an increasingly competitive market, Andrew of Ordermentum says it’s important that businesses make decisions that are viable in the long term.
“We’ve done analysis for our roasters and often find that their top five accounts are actually losing them money. They get excited by the prospect of a 50-kilogram-per-week account and shower them with discounts and machinery,” Andrew says.
“We need to change that mindset. If a café asks for a second grinder for single origins, they’d need to sell a lot to make it worthwhile, and the roaster needs to determine if doing so is viable.”
To help coffee roasters make these decisions as well as monitor their cash flow, Ordermentum has developed a free financial modelling tool in which businesses can enter their costs and revenue to ensure they are making a sustainable profit.
“If your profit calculator is coming up short, you may be able to cut one or two dollars per kilogram out from product costs, but at a certain point, that’s a dangerous strategy that compromises product quality,” Andrew says.
“I’m a fan of open book costings. I hope for the day that roasters are able to walk into a café with this calculator, show how much they spend to buy and roast their coffee, and justify why they charge what they charge. If you focus your company resources and energy on delivering the best quality product and customer service, you will spend a lot less time and energy defending the price you charge.”
This article appears in the December 2019 edition of BeanScene. Subscribe HERE.
For more information, visit www.ordermentum.com