Friendly Co-op Target Profit Breakeven Variable Cost Ratio CMR
Friendly is a member-owned Cooperative grocery store that specializes in locally grown organic products. The Co-op currently has two locations and is well regarded in the community as an advocate for healthy eating and living.
Friendly's manager, Doug Stinson, has approached you for help in evaluating whether Friendly should open a store at a third location. The idea of a third location arose in part because Friendly is currently averaging $1,300 per square foot in annual sales, a volume that has raised concerns about the Co-op's physical capacity for future growth. Friendly's current locations are in busy areas and further physical expansion of these stores is not feasible.
Doug informs you that consumers have a growing awareness of the benefits of healthy lifestyles. Concerns about global warming also have led to a preference for locally grown (defined as < 250 miles from the store) produce, poultry and meat products. Doug believes that Friendly has a strong network of local suppliers and that he can continue to offer the same quality of local products in the third store. However, he also believes that competition in this product-space will intensify; he has heard rumors that a national chain is planning to open a large store in the area and other local competitors have begun to offer greater variety in organic products.
Doug provides the data in tables 1 and 2 for your consideration. In this table, labor cost includes the costs of persons who receive the products, stock the shelves, help customers, and staff the checkout lanes. Doug believes that opening a new location would increase central office expenses marginally.
a. Calculate Friendly's annual fixed costs and break even sales for the third store under the best and the worst case scenarios. (Best case considers the low end of cost estimates.) What sales are required for a 10% return on the amount invested into the new store?
b. Repeat exercise A assuming that Friendly will build a 10,000 square foot store.
c. Please prepare a short memorandum to the Board of Directors of Friendly Co-op indicating (1) Whether Friendly should open a store in a third location, (2) If so, what should be size of this store and (3) Other factors to consider. Please support your recommendations with suitable financial and market analysis.
Table 1: Select Data
Costs prior to start up
Land Depends on actual location. Could range from $300,000 to $500,000 for the parcel. Note that Land does not depreciate.
Building cost @ $150 to $180 per sq. foot. Depreciated over 40 years.
Other equipment (forklifts) Estimated at $350,000. 5-year life
Furnishings (shelves etc.) @ $75 per sq. foot. 4-year life.
IT equipment Estimated at $200,000. 4-year life
Professional fees @ 7.5% of building, other equipment and furnishings. Added to relevant cost and amortized over a 40, 5 or 4 year life as applicable. Included in base for property tax.
Contingency @ 10% of land, building, equipment, IT outlays, and furnishings. Included in depreciable amount and base for property tax.
Manager 1 person @ $60,000 per year
Department heads 4 persons @ $50,000 per year
Administrative staff 2 persons @ $30,000 per year
Property tax @ 2% per year on cost of land and buildings only.
Power $3,000 per month
Water $1,000 per month
Waste disposal $1,000 per month
Repair and janitorial $7,000 per month
Purchase cost of goods sold 0.6000 per sales $
Labor cost 0.1800 per sales $
Credit cards 0.0150 per sales $
Variable overhead 0.0600 per sales $ (includes any expense at central office)
1. Assume that Friendly borrows all money needed for construction and startup. Ignore interest cost in your computations and analysis.
2. Initial stocking of shelves will cost $30 per square foot.
3. The data in the table are for a 20,000 square foot store. The staffing and utilities cost for a 10,000 square foot store would be approximately 80% and 70% of the cost of a 20,000 square foot store. For simplicity, assume that store size will not affect any other cost.
Table 2: Select Data on Market Conditions
Population 125,000 persons or about 45,000 households; 4% growth rate.
Number of groceries 8 stores with an estimated 275,000 square feet
Current market share ~10%
Current sales for Friendly ~$22 million per year
1. Friendly Co-op is situated in a college town with a large medical center.
2. Friendly has a 35% share of the market for organic foods in the market. Organic items account for about 30% of Friendly's total sales.
1. Figure out the total investment for a given store size. Do 2 variations for each size - best and worst case scenario for costs. Compute 10% of this number as the profit target.
2. Begin by computing the total fixed costs on an annual basis. Assume straight line depreciation for ease. This total will include annual operating costs (e.g., salaries) plus the depreciation on the initial investments.
3. Compute the variable cost ratio, and CMR.
4. Compute sales revenue required to breakeven and to achieve the required profit target.
5. Juxtapose the required revenue against the market data to assess the risk involved - is the required sales level achievable? How does the implied sales/ sq. ft compare against industry norms? Competition? Our own stores?
6. Make recommendation.
7. A more "real-world" analysis will include growth rates for market size and costs. It also will do a NPV model of the problem. However, the tenor of the analysis does not change, even though it becomes much more complex.