You Can’t Put Percent Margins in the Bank
By Mark Meckler, Ph.D., November 10, 2014
Strategy Short by Mark Meckler, Ph.D.,
Why percentages can lead you astray
Wise entrepreneurs know that what you earn is driven by the actual volume of dollars (or other currency) you make per transaction. As we demonstrate carefully in our menu engineering lesson under Controlled Operations, a nice plate of spaghetti and meatballs may cost you $4, and be sold for $12. With a 66% gross margin, or food cost percent of 33% that is right in line with industry averages. You get $8.00 per sale contributed toward covering your overhead costs and adding to profits. Meanwhile that “Prime Rib Palace” discount steak and brew restaurant down the street fetches $19.95 per transaction, at only a 50% gross margin (or a whopping 50% food cost percent) is contributing $10.05 toward overhead and profits with each sale. Which business model is better? The business model with the percent advantages or the one with the dollar advantages? This paper uses the percent margin analogy to describe just how hard it is to make it as a production brewery versus a brewpub.
Value Chain for Production Breweries
Now let’s look at the value chain for breweries in the traditional 3-tiered system:
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You may zoom in on this high-resolution image. You will see that the gross margin (per pint of beer) for making beer at a production brewery (Operations) is 60%, and this only translated into $0.23 of actual dollar volume per pint sold by the brewery. Meanwhile, the distributor margin is only 25%, less than half that of a brewery – but the distributor’s dollars earned per pint is $0.30. In the traditional “three tiered” system in the USA, all the pints go through distributors, so the unit volumes (amount of pints sold) are the same. The retailer margin is 30%, and the retailer dollar volume per pint sold is $0.83. Which business would you rather be in? Now think of a brewpub that internalizes (or “integrates”) this value chain, collapsing and funneling all those roles, and their margins into one business. That’s $1.36 dollar volume for every pint a brewery sells through its own brewpub or tasting room. Take that to the bank!!
Wise managers do not get led astray from the true goals [watch 'Wisdom' under Leaderships & Culture]. In business, the financial goal is consistently depositing more assets into the bank than one withdraws to pay for expenses. The financial goal is not pursuit of high percentage measures, and you don’t deposit or pay bills with percentages. Margin percentages are statistical indicators that are related to the goal, but are not the goal itself. Don’t be fooled, keep your eyes on the cash.