Why a coffee shop example?

The number of coffee shops in major cities throughout the world has exploded over the past two decades. The coffee shop "industry" is characterised by a small number of major chains and a vast number of small, often unsophisticated operators. Many of these small operators are attracted by the high gross margins on offer, both on the coffee itself and on many of the typically stocked food items. The flip side, however, is that it is a highly competitive industry, overheads can be relatively high and logistics - especially personnel management - can be difficult.

Many of the small players enter this industry with little experience, and even less understanding of how to undertake a structured analysis of their prospects. A sizeable proportion exit quickly for the same reason. There is a high rate of churn at the smaller end as players come and go, often understanding too late why they were not successful.

We have used the coffee shop for this example because it is based on a simple model and examples can be found virtually everywhere. It is as good an example as any of an industry in which potential entrants would benefit from undertaking a formalised qualitative/quantitative assessment process before they commit tens of thousands of dollars in start-up costs. This example is based on a proprietor who comes to realise he has a problem some time after opening.

The example

Assume a new operator opens an outlet in a high-income, mixed commercial/residential precinct in a major city and trades successfully for a couple of years. With new commercial developments in adjacent neighbourhoods, however, and a predominantly young and mobile demographic, he is finding that his trade is falling. While he has been able to trim casual staff and other variable costs quite quickly, the premium rents he is locked into - subject to quarterly cost of living increases - and other fixed costs are significantly eroding his margins. He is unsure what he should do.

Qualitative review - the business model story

With clients in a situation such as this, we will typically take them through a qualitative business model review. This is a structured process through which the client can firstly systematically analyse all relevant factors currently impacting upon the business, or likely to do so in the forseeable future. Following that review, the process will assist the client to generate new ideas about alternative pathways which are designed to either avoid obstacles seen to be looming or to maximise exposure to favourable trends which have been identified. For information about the process we use for a qualitative review, please see the Business model analysis - qualitative page.

Our coffee shop proprietor wants to undertake a qualitative review as he is not confident that he has a good enough understanding of his options. Here is a brief list of some of the things which might emerge from a qualitative review. (These are based on a very quick deconstruct/reconstruct exercise - see chart example here. Note that some of these would be more appropriately categorised as marketing ideas. Nonetheless, they are the types of ideas which will flow from most kinds of qualitative analysis exercise.)

• Enter into a joint venture with one or more of the operators who have recently opened coffee shops in neighbouring districts with a view to spreading certain fixed costs across several outlets.
• Commence an online ordering system which would allow patrons to nominate a fixed pick-up time each morning, thereby allowing a better allocation of work flows to casual staff.
• Perhaps linked with the online ordering system, patrons could opt in to a pre-pay system under which they receive discounts for prepayments on fixed orders a week ahead. The aim of this would be both better cashflow and reduced workload at the till in busy times.
• Introduce a swipe card system under which purchases are recorded with an electronic read and cash is settled weekly. While slightly adverse in cashflow terms, this would have the advantage of processing orders much more quickly at peak times.
• Introduce cups and mugs emblazoned with cafe logos and sell them at cost with the coffee, with customers qualifying for discounts on refills. This eliminates staff time and washing costs and provides an inexpensive form of mobile advertising.
• Research the most popular magazines and newspapers for residents of his neighbourhood and stock several copies of these on a daily, weekly or monthly basis.
• Provide a bank of computers with Internet access on a complimentary basis.
• Adopt a sports theme and provide banks of screens throughout the shop showing recent and classic sports events on a continuous loop.
• Linked with the immediately preceding point, he might choose to forge relationships with local sporting clubs, perhaps by hiring and operating a mobile coffee van for several training nights in order to build a profile. He could also look at sponsorships and/or discount vouchers for club members.
• Begin a series of promotions in which patrons are issued with a ticket for each purchase. Winners receive two free coffees each day for a month, but must be present at the draw to win.
• Arrange to sub-lease a small floor stall in the most populous office building near his shop and hire a casual worker to operate it for two or three hours each weekday morning as workers are arriving.

Quantitative review - the business model numbers

Whether a qualitative assessment is undertaken or not, it is all too frequent that people embark upon new business ventures or projects without a proper understanding of how the business model will work in a quantitative sense. At Wingarra BMI, we specialise in the design and construction of a wide range of spreadsheet models to assist in the process of assessing business models, budgeting, etc. For more information about this service, please see the Business model analysis - quantitative page.

Before it would be possible for our coffee shop proprietor to make an informed decision about a way forward, he would need to know how each of those options he shortlists (many ideas generated through the qualitative assessment process will eventually be discarded - this is understood at the outset) will perform across a wide range of scenarios. If we look at the prepay/discount option above (the third option), for example, just some of the variables he should model are as follows:

• Discount ranges for prepayments - e.g. 2.50% to 10.00% or 15.00%
• Prepayment periods - e.g. 5 days, 7 days
• Additional units sold per week as a result of offering this scheme
• Additional sales of food and other merchandise as a result of the increased trade
• Margins on these product items
• Additional staff required to handle the extra traffic
• Additional capital equipment requirements - e.g. another espresso machine if volumes are high enough.

Without modelling all of these variables and testing a range of values for each, the proprietor will have no idea what the financial consequences will be. As but one example of this, it may well be that such a scheme could generate an additional 15% of unit sales. Prepayments on these will obviously be cashflow-positive, but the extent of the discount - 5.00%, 10.00%? - will have a major impact on the overall result. That is, a superficially attractive option based on immediate cashflow advantages and increased unit sales may prove to be unprofitable when fully analysed. It is only through comprehensive and sophisticated modelling of alternative scenarios that a business proprietor can make an informed decision about the best way forward.