• riccardo

Restructuring a sandwich shop and the secret to any implementation


 

I recently helped my father restructure his small sandwich shop in Italy. The experience allows us to talk about the two main factors arguably characterizing a successful business implementation: bottom-up approach and maniacal control of variable costs. This post argues that, while top-down approaches are very effective during initial brain-storming and subsequent periodic controlling, the implementation must be executed with a bottom-up approach, in turn related to variable costs. Variable costs have often appropriate levels, however, those levels are often “wrong”, meaning not representing reality; here it comes the need for maniacal control through a bottom-up approach. True, this argument may apply differently to manufacturing vs technology companies, however, we will show that the distinction is more subtle than we may think, and the argument below applies to any sound and long-lasting business endeavor.


I have almost always seen implementations fail - starting from mine - when executed 1 on 1 on the initial top-down planning. While companies often work when analyzed from a high-level view, at the same time they often leak from the bottom, up to the overall failure. That issue particularly affects small companies which usually lack structured reporting financials. Even big businesses can fail at reporting leakages, that is because financials always have shortcomings – if interested, though not strictly related to variable costs, see my previous posts on employee stock options and the hidden math of share buybacks. Moreover, even though financials can highlight problems, they cannot solve them.


Note: a company profit & loss statement (P&L) is usually greatly affected by the cost of the employees. However, we are not discussing here which is the major cost affecting the profitability of a business. What we are discussing are the issues that make ultimately fail something initially promising on paper.


The whole argument is not strictly related to consumer goods, nor services, nor some sort of hardware business; with the appropriate distinctions, this is likely to be true in general. Moreover, while variable costs are likely to hit the profit & loss statement (P&L) more severely during the start-up phase of a new venture where “buy components” are usually numerous - transferred in time to “make” through CAPEX investments - variable costs will stay in a measure related to the type of business. While outsiders to the tech industry often think technology companies are lucky enough to have very low variable costs, that is usually not true. The impact of data, computing, and cloud-space is very similar to the one of the variable costs of a restaurant or a gasoline station.


My father’s shop is not in a main square in Rome, it is a small town’s shop - a BAR in a small town for those familiar with the term. Most of the people in town go back home for the lunch break, and that is just to say that retail prices must be kept under control if you want to make some business. Being costs given, margins are not necessarily low in percentage terms, but being low in euros ones, they can easily vanish. Therefore, supply-chain, operations, and everything around them must be tightly managed.


A business that does not sell is doomed to fail, however, a business that sells but does not control variable costs is doomed to fail as well, because the more it sells, the more it loses. There is none, or limited, economy of scale on variable costs. Usually, we are all good at setting variable costs in such a way that our venture will be profitable, therefore, variable costs are seldom too high. Among the selling price, the purchasing cost, and the required margin, anybody should be able to move those numbers around as desired on paper. The problem is in the actual implementation. Variable costs are very tough to control, and they end up being often wrong (i.e. different from planned or highly variable). Variable costs are likely to be variable to a second degree, meaning, variable not only with sales, but also with other parameters related to our operations (e.g. shipping costs), suppliers (e.g. purchasing costs), the market ( e.g. a combination of the previous two and more). The expert reader might be asking: “are we including consumables and variable overheads in this discussion, or we are considering only raw materials and components?”. That is a legitimate question, and I would suggest we include all of them, as well as any storage cost, shipping cost, handling, etc. The only difference will be that consumables and variable overheads are likely to have a slightly better economy of scale compared to components and raw materials. For my father’s shop, we are including all those consumables and other variable costs that go with sandwiches: kitchen supplies, other supply-chain-related costs, etc. For example, my father makes weekly trips to buy ingredients wholesale, and that has costs attached to it, plus second-degree variability. Other than the cost of the actual trip, those wholesale purchases often have variability in their costs because stores might be terminating a sale, and that is particularly true for small businesses without signed contracts. If all that seems trivial because small, that is the actual issue that makes many businesses fail. I have often seen fail those similarly and repeatedly disregarding small things which end up eating the margin initially planned top-down.


A particular focus is required when it comes to internal operations and people. Ultimately it is all about people. An employee using 3 slices of ham in a ham and cheese sandwich where we accounted for 2 slices in our cost structure, can break the whole machine – again, remember the small margin my father is presented with. Repeat the same inefficiency for a few of the components and consumables, and each sandwich can soon be selling at cost or even above it. Thereafter, the more we sell, the more we lose. Even reusing the sheet of paper that goes inside the oven to heat the bread, can make or break the venture. Sometimes I have found useful to give employees modular units of raw material; that is usually inefficient from a purchasing point of view, but at least we have better control of the cost per unit. Conversely, big units left to the employee to divide and distribute works on paper but often fail in practice.


In my experience, the ultimate solution to everything above is to spend time on the “manufacturing floor”. Anybody involved with an implementation cannot do it on excel or at a desk, s/he must spend time in the operations to perceive the main dynamics. A big part of this is because, as we have already mentioned, businesses are ultimately made of people. Two identical manufacturing floors, with identical tools and processes, can run very differently if people inside the two plants have different levels of experience. There are still factors tough to express in an excel sheet, and they can only be observed live. Going back to my father’s shop, the good results we are seeing at least in this initial phase after restructuring are mainly related to time spent making some trips to the wholesale store, preparing some products, talking to employees, and working close to them trying to mimic their gestures.


To conclude, so far we have not mentioned the customer because that is more in the strategic and planning phase, whereas we wanted to focus here on the implementation. However, the customer comes back when it is about monitoring the implementation and evaluating whether it suits customers and their preferred experience. Again, that is something that only a maniacal bottom-up approach can manage and any required adjustment is likely to impact variable costs. It is possible then that investments in CAPEX are necessary to bring variable margins back to acceptable levels, but that is once again driven by variable costs.