To Co-Pack or Not to Co-Pack That is the Question???????
To Co-Pack or Not to Co-Pack that is the question??????
By Mark L Ainsworth
You have developed a great consumer product idea. You have lots of interest from retailers in your consumer product. Should you open your own production plant or have someone Co-Pack for you? These are the dilemmas of many startups these days.
To help you understand when the scale tips and when you should go into manufacturing your own product in your own plant, I will explain how to analyze how to give yourself the good data to make that decision.
Capital is hard to come by, so building sales and volume is paramount. You should always invest your capital that you have fundraised into growing sales, not running a plant.
The first step is to understand your costs. A properly laid out Profit & Loss (P&L) statement is key. What are Costs of Goods (COGs) and what are S, G&A (Sales, General & Administrative) costs? This is truly the mistake made by most entrepreneurs. GAAP (Generally Accepted Accounting Principles) dictate that structure. Improper architecture or score keeping of a P&L can result in a margin that is not true based on industry standard. This can result in insufficient margin dollars to run your business, which can be catastrophic to its survival.
What are typical Costs of goods?
GAAP says Cost of Goods is, everything that it costs to make your product such as:
Raw Materials, Ingredients, labels and packaging
Labor: Manufacturing, shipping, receiving, transportation, storage.
Insurances: Allocated Workers Comp, Business Owners Ins, Allocated health insurance (meaning the portion of insurance that covers those particular employees)
Rent: The square footage of production, warehouse, storage and packaging space (Not including office space)
Utilities: Electricity and gas expenses
Freight: Cost to deliver to a customer in a specific region
Packaging Costs: Any dies or setup fees to make your product
Fuel Expenses: For transportation of product
Uniform Expenses
Depreciation Expenses: All equipment purchased for manufacturing the product
Equipment Rental or interest on purchases of equipment
Outside Services: Temp Labor for production
Misc. COGS: Any other expenses directly related to manufacturing the product
Based on GAAP principles a business should have a Gross Profit Margin of 30-37% (We will use approx. 30% for our illustration) based on industry benchmarks. Your Gross Profit Margin needs to cover your S, G & A costs.
GAAP says that S, G&A costs are:
Labor: Sales, Marketing & Administration
Commissions: Sales and Brokerage
Insurances: Allocation to theses departments of the companies insurance expenses
Telephone & Internet expenses
Web & Email Hosting expenses
Sales Expenses: Travel, Entertainment, Trade Shows, Business development
Office Supplies
Postage
Bank Service Charges (Merchant Fees)
Samples and Shipping of Samples
Dues and Subscriptions
Licenses and Permits
Outside Services: Accountants, lawyers, and any temp labor
Once your P&L is properly structured and your costs are all captured you can properly price your product. Pricing your product is KEY to your success. If you don’t capture all your costs you will not be able to properly price your product, and you will not have enough money to cover your bills. It is frustrating to understand your costs of doing business if you don’t have a good accountant that can help you sort this out. If your accountant has experience in your industry it will be the key to the success of your business. Paying a good accountant is a check, no matter how big, I am happy to sign every month and so should you.
How do you know that you have enough volume to move into your own plant? Well with a properly structured P&L it is a simple few calculations:
Find Gross Profit Dollars per unit: Sale Price(unit)-COGS(unit)= Gross Profit $(unit)
What is the Budget S, G&A: Define that monthly cost to run your business?
How many cases do I need to sell to cover my S, G&A overhead: Divide your monthly S, G&A cost by the Gross Profit $ per unit. This give you the number of cases you need to sell.
Example:
$30.00 (unit sale price)-$20.00 (unit COGS) = $10.00 (unit Gross Profit $)
100,000 (S, G&A monthly overhead costs)/ $10.00 (unit Gross Profit $)= 10,000 units.
This, according to our calculation you need to sell on average 10,000 units a month to cover your overhead.
If you can go a whole year through the cyclical world of retail and the volume is consistently enough to cover your overhead then yes, it is time to open your own facility.
I hope this illustration is simple and helps you make good educated decisions. The biggest mistake that entrepreneurs make is putting most of what should be COGS into S, G&A and they never have enough margin dollars to cover expenses. When that happens it doesn’t matter if your grow 200-300% in a year you still will not make enough money to cover all your businesses’ expenses and you will still have loss at the bottom of your P&L. You will need to continually fundraise to keep your business alive versus grow.
If you are coming up short on the volume of units you are moving it would be a smarter decision for you to co-pack and focus all your capital on growing your unit volume (sales), and not operating a plant.
Working with a co-packer in the beginning has many advantages. They normally have better equipment therefore having better lean production standards, and can make the product for less than you can. It allows you to focus primarily on your distribution channel and distribution points (retailers), which are vital to any business. The down side to working with a co-packer is the minimum run of your product could be much larger than you really want to make. You may have to do 100,000 units versus the 10,000 you would make at a time yourself. But these are the trade offs positive or negative I think most startups make the mistake of going into their own plant too soon and eat up capital. I’d rather spend the capital/money on something that I can sell versus a monthly expense like operating a plant below efficiency (because we are a startup) that gives nothing back in return.
Remember…nothing happens with out a sale.
