'economy Of Scale', Can You Apply It To Your Cake Business?
Business By AZCouture Updated 20 Oct 2012 , 3:53am by mydearbakes
I found this article today and I think it hits home.
http://www.nytimes.com/2012/09/09/magazine/whats-a-4000-suit-worth.html?_r=1&pagewanted=all
Also, here is a very brief explanation of Economies of Scale:
http://www.investopedia.com/video/play/what-is-economies-of-scale#axzz25nmYqCWq
I read that same article yesterday, it was very interesting. There may be something of a parallel between bespoke hand-tailoring and the super-premium segment of cake decorating (where custom cakes are thousands of dollars instead of hundreds and specific skillsets like architecture, engineering, and art are needed), but IMO it is easier for the rest of the cake decorating market to structure their processes for maximum efficiency.
Not being able to leverage economies of scale is not necessarily a bad thing...the problem with bespoke suits is that while supply is very low, demand is also very low, which means there is no upward pressure on prices. The product itself is also durable and lends itself to outsourcing fairly easily, unlike cakes.
That said, if you are interested in expanding your business over the long term (or your state requires a commercial kitchen) this is a critical concept that needs to be baked into your business plan. Without processes designed to take advantage of economies of scale it will be next to impossible to make a profit while meeting payroll and paying for your commercial kitchen.
A comparison could be made to new cake decorators severely undercutting the market and offering an alternative that's "good enough" for the majority of customers (similar to Greenfield's made-to-measure suits or even suits from China, although their lower prices are driven by true cost advantages instead of mispricing). If market prices are too low, no amount of efficiency will enable your business to flourish and expand unless you change your target market.
I didn't read the article, but economies of scale are an ongoing part of my business model.
For example, when I went into business two years ago, I paid more for just about everything. My prices and my profits were based on those numbers. As I have found alternatives over time, My profit margin has increased with no real changes in the way I do business.
When I did the business plan for my retail store, I based costs and profit on my current expenses and knew that I was happy with the numbers as they were. Today I met with a restaurant wholesaler and he gave me my new wholesale proces on the same premium ingredients that I now use with a savings of about 35%. That savings is pure profit, as it directly relates to the cost of my ingredients.
The idea of economies of scale is to cut costs, not through cheaper products, but through a lower cost on the same quality.
Another example is my rent on the retail space. I could just have a bakery, as this alone will justify the rent, but I wasn't satisfied with that. Out of the same space, three separate businesses will be run, each with the ability to justify all expenses and rent alone. So by upping the output of the square footage, two of the three businesses are essentially pure profit less direct expenses of the product.
Another example would be cost structure on high volume orders. My corporate accounts send cupcakes to many clients in one order. I give a small discount, but because of the high volume of only one product, my overall profit is up because the labor expense is down.
Economies of scale is a path to pure profit because it involves you doing the exact same thing at a lower cost.
Great post AZCouture.
I'm glad you brought up the topic as I feel it ties in to an issue I've been thinking about. I figure I'll go ahead and share it here.
For an order I have next week I'll be making 6 dozen cupcakes in 6 different flavors with accompanying SMBCs i.e. one dozen of each flavor. I couldn't help thinking: It takes me just as much time/utilities/activities (clean up e.t.c) to make one batch of cupcakes (24) as it does a half batch (12), so for each dozen, I'm using say 100% input to create only 50% of the possible output. It keeps nagging at me that I need to find a way to be more efficient.
For an order I have next week I'll be making 6 dozen cupcakes in 6 different flavors with accompanying SMBCs i.e. one dozen of each flavor. I couldn't help thinking: It takes me just as much time/utilities/activities (clean up e.t.c) to make one batch of cupcakes (24) as it does a half batch (12), so for each dozen, I'm using say 100% input to create only 50% of the possible output. It keeps nagging at me that I need to find a way to be more efficient.
One possible solution would be to make an entire batch for each and freeze half (either the batter or the finished cupcakes).
This might require more work, but if you structure your recipes so only incremental changes are needed to change flavors (i.e. adding extracts), you could make an entire batch of your base recipe, then separate half out before baking and make the necessary additions.
For an order I have next week I'll be making 6 dozen cupcakes in 6 different flavors with accompanying SMBCs i.e. one dozen of each flavor. I couldn't help thinking: It takes me just as much time/utilities/activities (clean up e.t.c) to make one batch of cupcakes (24) as it does a half batch (12), so for each dozen, I'm using say 100% input to create only 50% of the possible output. It keeps nagging at me that I need to find a way to be more efficient.
One possible solution would be to make an entire batch for each and freeze half (either the batter or the finished cupcakes).
This might require more work, but if you structure your recipes so only incremental changes are needed to change flavors (i.e. adding extracts), you could make an entire batch of your base recipe, then separate half out before baking and make the necessary additions.
One possible solution would be to make an entire batch for each and freeze half (either the batter or the finished cupcakes).
This might require more work, but if you structure your recipes so only incremental changes are needed to change flavors (i.e. adding extracts), you could make an entire batch of your base recipe, then separate half out before baking and make the necessary additions.
That is a great idea Jason, thank you. Three of the flavors have a similar base, so I'll probably be able to knock those out together.
I couldn't help thinking: It takes me just as much time/utilities/activities (clean up e.t.c) to make one batch of cupcakes (24) as it does a half batch (12), so for each dozen, I'm using say 100% input to create only 50% of the possible output. It keeps nagging at me that I need to find a way to be more efficient.
That is a good point. I think about things like that a lot too. It is just as much work for a two tier to serve 12, as it is for 24, and even 50 for that matter. Not a big difference in ingredient cost either. Heck, a 50 serving cake with minimal detailing has the potential to be a LOT less work than a cake to serve 12. So much to consider. Reaaaaaally makes me want to take some business classes and see where I'm doing ok, and where I might have some 'duh!' moments.
I'm always in the black, I don't waste product, my customer base is steady...but I know I can do better.
It is just as much work for a two tier to serve 12, as it is for 24, and even 50 for that matter. Not a big difference in ingredient cost either. Heck, a 50 serving cake with minimal detailing has the potential to be a LOT less work than a cake to serve 12.
I came to the same conclusion, which is why I put together a sliding scale of per-serving prices, with high prices per serving for small cakes and lower per-serving prices as cakes get larger. The price drop is less than the cost savings in order to maintain increasing margins as you scale up.
It is just as much work for a two tier to serve 12, as it is for 24, and even 50 for that matter. Not a big difference in ingredient cost either. Heck, a 50 serving cake with minimal detailing has the potential to be a LOT less work than a cake to serve 12.
I came to the same conclusion, which is why I put together a sliding scale of per-serving prices, with high prices per serving for small cakes and lower per-serving prices as cakes get larger. The price drop is less than the cost savings in order to maintain increasing margins as you scale up.
AZCouture, I agree. I believe Jason's point is pointing at a way to encourage the customer to buy not necessarily more cake but just enough cake that we maximize the input that goes into the cake. For the example I used, I think finding a way to encourage the client to decide on 24 cupcakes per flavor rather than 12 would maximize what I put into the cake.
Jason could you please expand on the bolded point? I don't quite understand.
Here's the sentence from that article that sums it up: "Bespoke suits like expensive couture gowns are great for building a reputation, but they are lousy for business."
I love doing fancy individually designed cakes, but it takes longer to do those than the basic pearls and swirls because of the learning curve/figuring it out curve/planning necessary curve. For a pearls and swirls basic wedding cake (which AZCouture and I have discussed at length 
) I can whip one out in an hour start to finish, where a more complicated cake could take three times that long. If, for argument's sake, I charge $400 for one three tiered cake, and add $100 for "difficulty," I could be making $1200 gross in three hours from the basic ones, when the more complicated one would make me $500. The fancy designer cake will look great on my facebook page and website, but it's losing me money in the long run.
I've figured out ways to do things faster after doing this for 16 years, and that's the way to make more money in this business. That and cutting your costs, which you should be trying to do all the time anyway. I'm going to be scaling back on how many cakes I make next year, but I want to try to stay at the same profit level. I can do that by reducing costs, cutting out advertising that doesn't give a good return, etc.
I believe Jason's point is pointing at a way to encourage the customer to buy not necessarily more cake but just enough cake that we maximize the input that goes into the cake.
Actually it is a way to encourage the customer to buy more cake, since the more servings you can make in a baking session, the more efficient you are. This is pretty straightforward when selling single tier cakes with flat costs (e.g. "you can get a 10" instead of an 8" for only $10 more"), but it also works for per-serving prices if your formula takes into account the pricing curve leveling off slightly. Obviously if someone wants 100 servings I'm not going to try to sell them 200, but if you have an excellent product your customers (and their guests) will appreciate leftovers.
The price drop is less than the cost savings in order to maintain increasing margins as you scale up.
As cakes get larger, your cost per serving drops due to process efficiencies and fixed overhead. If your price per serving drops at the same rate, the entire benefit of this is realized 100% by the customer, but if you don't drop your price per serving at all there will be no incentive to for customers to increase the size of orders so you won't recognize the cost savings at all.
For example, let's say a 50-serving cake (your smallest and least efficient cake) costs you $3/serving and a 100-serving cake costs you $2.50/serving. If your profit margin is 20%, you could price the 50-serving cake at $3.60. But if you price the 100-serving cake the same way ($3) you would probably be underpricing the market (assuming your 50-serving price is on target). What you can do is gradually lower the price between 50 and 100 servings, but not by as much as your cost savings, so your 100 serving price might be, say, $3.30. So with a 50-serving cake you might try to upsell another 10 servings for an additional $30 (50 * $3.60 = $180, 60 * $3.50 = $210)...the customer might think "wow, only $3/serving!" but in reality the price has only been lowered by 10 cents to $3.50/serving. The difference between the cost savings and the lowered price is pure profit.
In practice, you could either manually price out tiers (e.g. 50-60 servings is X, 60-80 is X*0.9, 80-120 is X*0.8, etc.), or you could plot your servings vs. desired price based on the share of profitability you want to keep and use Excel to fit a trend line to the results. For my example above, an approximate fit for the price per serving would be 5.9 divided by the eighth root of the number of servings. In Excel, this would be =5.9/(<servings>^( 1/8 )).
Once you have this formula, you can plug any number of servings into Excel and you'll instantly have a price with as much decimal precision as you want, although you'll probably want to quote the final price rounded to the nearest dollar instead of telling the customer their cake costs $3.536577 per serving.
From a microeconomics perspective this matches the left side of the long run average total cost curve. If you expand enough you will eventually hit diminishing returns, but most custom cake shops won't reach that kind of volume, and by the time you reach that point you'll probably be able to afford to hire your own full-time financial analyst.
http://www.investopedia.com/exam-guide/cfa-level-1/microeconomics/marginal-average-total-cost-curve.asp
Thanks for breaking it down like that Jason. Just when I think I have this pricing thing down, I find something new to learn. I'm going to look into incorporating this and the suggestion Costumeczar brought up about working faster. I'm beginning to understand why some fancy shmancy cake decorators still provide simpler, less customized cakes for the clients on a budget. Using Costumeczar's example, three of those can be knocked out for more profit than one super complicated design within the same time period.
As i sit here waiting for my tasting appointment clients to show up, another example comes to mind. Doing tastings all at once, on one day or at an open house kind of setup is a lot more economical than doing them one at a time throughout the week. One setup, one cleanup, everything done in one shot. If you do them individually here and there you have to stop what you're working on, set up each time, clean up each time, and it ruins the flow of your schedule.
Deep thoughts this week:
1. How can you not get rich selling $500 cakes [suits]?
1.5. Insist on making them perfect.
[and take 40 hours on each cake....and don't pay yourself a wage.....and feel sorry for all the brides that can't 'afford' a 'nice' cake for their wedding that has 200 guests.....and the pitiful mother who 'needs' a 3-tier/fondant/Disney/cake with hand made fondant figures of Snow White, 7 dwarves, the Evil Queen, the apple, the Crow, the Prince, the horse, and lots and lots and lots of sugar jewels in a faux mining cave, with a recording of Heigh Ho coming from inside the cake for $95 because she doesn't have enough money.....
AND/OR [i:3516fb376c]insist[/i:3516fb376c] on refunding the entire $95 for the Snow White cake PLUS a free 2nd and 3rd birthday cake for the little darling because Snow White's hair was dark brown instead of jet black]
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AZ~~I love you for posting this gem of a thread!
Deep thoughts this week:
1. How can you not get rich selling $500 cakes [suits]?
1.5. Insist on making them perfect.
[and take 40 hours on each cake....and don't pay yourself a wage.....and feel sorry for all the brides that can't 'afford' a 'nice' cake for their wedding that has 200 guests.....and the pitiful mother who 'needs' a 3-tier/fondant/Disney/cake with hand made fondant figures of Snow White, 7 dwarves, the Evil Queen, the apple, the Crow, the Prince, the horse, and lots and lots and lots of sugar jewels in a faux mining cave, with a recording of Heigh Ho coming from inside the cake for $95 because she doesn't have enough money.....
AND/OR insist on refunding the entire $95 for the Snow White cake PLUS a free 2nd and 3rd birthday cake for the little darling because Snow White's hair was dark brown instead of jet black]
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AZ~~I love you for posting this gem of a thread!
Bwahahahaha! Apti, you have a special spot in my heart
Plus one $500 cake a week will earn a gross income of what, $26000 annually? Let me retire to Tahiti on that...not.
Wow, thanks for sharing! Being trying to find an article like this to read. =)
To be honest, the cake decorating industry is saturated. (depends on which country you are in)
Achieving economies of scale definitely puts you in front of your competitor I guess =)
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