❖ Part of the Coffee Shop Financial Performance series
Raising coffee’s value in the eyes of consumers: a starting point
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Over the summer we wrote a couple of articles establishing the need for the coffee industry to raise the perceived worth of coffee in the eyes of consumers.
- We think, by and large, that a cup of coffee is too cheap
- More specifically, that there is not sufficient variation at retail in the pricing between the lower end and the higher end of specialty coffee
- That too many coffee shops have too similar propositions and formats
- Consumers have different needs and aspirations that are either not being met, or are being poorly met, by the market
- That many consumers are willing to pay more for coffee, but the key constraint to raising prices is the culture of benchmarking within the coffee community
- That alternatives exist to raising prices, but for many operators their options are, in practice, more limited because of the current structure of the market
So, assuming you wish to charge more for coffee, maybe the best place to start is by doing some analysis on your current product range and proposition.
Not all products are equally profitable, nor have equal opportunity for profitability
Many coffee businesses have dozens, if not hundreds, of SKUs. A SKU is a ‘stock keeping unit’ and is a variation of a product. With each product variation, the number of SKUs grows exponentially. Most coffee shops have a core range of espresso-based coffees:
- small milk drink (a cortado, or call it what you want)
- Flat White (or similar 6oz milk drink)
- Latte (or similar 8oz milk drink)
and many also have:
- long macchiato
- 10 oz milk drink, and/or
- 12 oz milk drink
That’s just five to eight products. But if you offer single and double shots, have a guest espresso option, use both 2% and 4% milks plus two milk-substitutes – and offer those drinks both to drink on site and to take away: a range of six coffees has 88 SKUs; a range of seven has 104 SKUs.
It’s a useful exercise to work out how many SKUs you have across your espresso, tea, filter and food ranges. A decent POS system should tell you. For many coffee shops, it’s well into the hundreds.
Why coffee shops have so many SKUs
Many shops add SKUs as they grow, in order to grow. A journey where a shop starts with a narrow range of products, and then — following customer demand — adds various options is quite typical. This is often financially and operationally justifiable, as it is often cheaper and faster to acquire customers by broadening your proposition to meet their aspirations than it is to reach new customers with your existing menu.
However, periodically, and especially as a shop approaches its operating capacity or market share, you need to focus your business’s attention on SKUs and customers that are more profitable.
Maybe the best way to work out the profitability of a SKUs is:
- By the gross profit of a SKU over a period of time
In general, the longer the period the better, up to the point where the timeframe extends to include a) seasonal variations that are difficult to account for or b) historic changes in the product range that make a nonsense of gross profit data.
Start by trying to get accurate data for a month or a quarter and creating a snapshot of your business’s position. Then, if you are ambitious, and have good data, you can attempt to see how the gross profit has changed for each SKU over a longer period of time, such as a year.
It’s important to note that thinking about profitability in this way is much more powerful than calculating the gross profit margin of a product. For example, compare these hypothetical, but realistic, profit calculations for two SKUs:
If you were to calculate only the respective gross profit margins, you would be inclined to think that these two SKUs were broadly equally profitable. In practice, many SKUs’ additional operational complexity and limited sales mean that when the extra time (staff cost) and effort (when attention is given to this SKU it can’t be focused elsewhere) is taken into account, it’s likely that a good number of your SKUs produce limited, or even no, contribution to your overall profitability.
Key SKUs drive profitability
What’ll you’ll probably discover is that a small number of your SKUs generate most of your profit. People often like to quote a principle named after the Italian economist Vilfredo Pareto’s observation that an unequal relationship exists between inputs and outputs. This principle posits that
It follows that, in terms of product management, business operators should
- launch new products that they think could contribute to the business’s profitability
- aim to maximise the profit of a product over its lifespan
- end poor performing and products that have reached the end of their lifespan
- attract and retain customers that purchase your most profitable products
There are many ways coffee shops can add greater value, but before we discuss them in greater detail we need to cover off some other business concepts in future articles and you’ll need to perform the above analysis (as best as you can with the software and data you have) so you know where you are currently at on your journey.
We’ll pick up the conversation in a couple of weeks. In the interim, let us know if you require clarification, have a valuable critique, or are happy to share the insights from your data with us. We’re on all the normal channels.
Updated on 4 September 2020