Mar 8th 2011 Issue
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Measuring profitability in a tea store

Charles Cain - Mar 8th 2011

Measuring profitability

Attracting the passing shopper

Beautiful retail spaces are expensive!

Five months after opening Adagio's first Tea Experience retail store (and three months after the second), it's clear that we've captured the attention of the industry and the interest of the consumer. We've managed to design and implement a new approach to tea sales that has successfully put the focus on the leaf itself (70% of our sales are dry, bulk tea). The challenge now is to fine tune the operation and our approach to reach that elusive promised land of profitability.

The fact that our new retail stores are not currently turning a weekly profit, while mildly disappointing, is not particularly surprising. Black Friday, the day after Thanksgiving, got it's name because that's the day that most retailers traditionally make it "into the black". In other words, most retailers aren't profitable through 90% of the year. They rely on the surge of holiday sales to make the year profitable.

The tea industry is no different. Based on past experience and conversations with tea shops across the country, I'm expecting 40% of Adagio's retail store sales to come in the 4th quarter, with as much as 20% of annual sales coming in December alone. That said, we still have some work to do before I can confidently predict a profitable year for my little piece of Adagio's larger business.

There are five key metrics that I'm tracking as we tweak our approach and operation in search of a balance that drives short term growth and long term profitability:

1. Rent should be less than 25% of sales. Really I'd like to see rent below 20% of sales, but I can make do with 25%. The differentiating factor here is the dramatic range in rents between urban and suburban areas and different parts of the country. I've bid on retail space at rents (including all pass-throughs like insurance, common area maintenance, etc) ranging from $35 per square foot up to $400 per square foot in the greater Chicagoland area. If you're in a less expensive part of the country, you may be able to find rents in the $20s. At the end of the day what you're buying is quality foot traffic. Rent is one factor that I won't cut corners on. It's a LOT less expensive to pay for a location with high traffic than it is to try and bring customers to a mediocre location.

2. Labor costs should be 30% of sales or less. I've hired a salaried, full time manager for each store, and each manager is given a budget for part time payroll. The baseline for that budget is not tied to sales, but rather the minimum staff required to run the store. You need one or two people on the floor whether you expect $300 in sales or $1,000 in sales. I've found that we don't need a third person on the clock unless we're expecting sales to exceed $1,200 for the day. As sales rise above the "minimum staffing level", total labor costs should track at or below 30% of sales. I also have to to factor in any benefits, payroll taxes and insurance costs. It's all part of the cost of labor.

3. All other non-product related expenses should be less than 8% of sales. This category includes utilities, marketing, office supplies, cleaning supplies, insurance and other miscellaneous expenses. I should be able to break even with these expenses at 8%, but my long term target is to keep non-product expenses to 5% of sales.

4. Total Cost of Goods Sold should be 40% of sales or less. If you've been doing the math, you know that 25% rent, 30% labor, and 8% other expenses has already eaten up 63% of every dollar I sell. If I hit the metrics above, I'm losing money if I have to pay more than $3.70 for a product that sells for $10. In addition, Cost of Goods Sold (COGS) covers a lot more than just what I pay for product. I also have to factor in credit card fees (approx. 2% of sales), shipping, and packaging.

Shipping can quickly eat up profits. For example, a lot of the teaware companies are in California. Shipping teaware from LA to Chicago often costs between 10% and 15% as much as the product. In order to keep my COGS under 40%, I would need to buy a teapot for $20, pay $3 to ship it, and then sell it for $65. That's just to break even, and doesn't include packaging.

Packaging can vary dramatically depending on your average sale. Assume I buy 4oz of tea for $2.00, pack it in a $1 tin, give the customer a $0.50 shopping bag, and include in the bag a $0.50 brochure about my company. The tea cost me $2 and the packaging cost me $2, so I need to sell that for $10 in order to break even, and that doesn't include shipping.

5. The size of my average sale is one of the most important measures of profitability. My target is $20 or greater. This metric ties into most of the other measures of profitability I've given. If we can achieve a large average sale, we need to attract fewer customers and may get by with a smaller space. Fewer customers also reduces labor costs as a percentage of sales. Finally, larger sales decrease the relative cost of marketing collateral and packaging (the flier and shopping bag cost me $1 whether I make a $5 sale or a $50 sale).

I know that if I choose a good location, design an attractive store, carry quality products, and offer good customer service, I will get a certain number of customers coming through my door every day. It is much easier to entice those customers into spending more money than it is to attract new customers to walk through the door. The hardest challenge of all is convincing potential customers to change their existing patterns to come to where my shop is.

I see passing shoppers as a relatively fixed commodity driven by location, weather, the economy and all sorts of things I can't control once I've signed the lease. My challenge is to maximize the sales to that existing and relatively fixed flow of customer traffic. The average order size is one of the most important metrics of my success.

NOTE: This logic leads to the obvious danger of hard-selling the customer and achieving a short term gain (large sale) at the expense of a long-term loyal customer. I REFUSE to engage in sales tactics that are any more aggressive than sharing our passion for tea with the customer and attempting to introduce them to a product that they will genuinely enjoy.

I've seen a number of tea shops (both chains and independents) open their doors with average order sizes down as low as $10. These same operations typically see a slow climb as the staff becomes more efficient and the customer base becomes familiar with the brand and graduates from "testing the waters" to diving into the wonderful world of premium tea. Some tea shops achieve average holiday sales of upwards of $45 depending on product mix and customer demographic. My model is based on the assumption that we can turn a profit with an average sale of $20 or greater.

It should be a sobering reality check for anyone looking to get into the tea business that even with all of Adagio's strengths, profitability in the stores is not a slam dunk. Without question, I've been blessed with every advantage. I learned the ins-and-outs of tea retail by spending five years with TeaGschwendner, the world's most successful tea retailer with more than 145 stores in 9 countries on four continents. I was able to combine my insights with Adagio's already established international brand, direct from the source supply chain, industry-leading online presence, proven product collection, and strong balance sheet. In spite of all of these advantages, the old saying remains true... If it were easy, everyone would do it.

The good news is that these are "break even" percentages. In other words, a small tea store might break even at $300,000 in sales with rent at $75,000 (25%) and labor at $90,000 (30%). However, as sales rise to $500,000, rent stays steady at $75,000 (now 15% of sales) and labor and other factors rise, but more slowly than sales. Tea retail can be incredibly rewarding and very profitable, but it's definitely not easy.

In my next article I'll describe the strategies that we are employing to capitalize on the great locations that we have, and increase sales while leaving the customer thirsty for more.

Adagio Teas