Expansion Analysis: “The Rest of the Story”

Growth – the all-American measure of success. But what kind of growth? And how do you measure growth in relation to success? For too many job shops and contract manufacturers, intelligent and well-intended owners settle for sales volume alone as the primary indicator of achievement. There’s more to it than that.

Don’t get me wrong; sales are important. I’m not trying to appear un-patriotic or anything, but my premise here is that often growth – or expansion – occurs without an effective analysis or understanding of the underlying costs.

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For most shops, growth means expansion of existing facilities – or the opening of additional sites. However, expansion costs money and the analysis really has two aspects: finance and marketing. The financial analysis answers the question, “What do we need?” and the marketing analysis answers the question, “What will we get?”

Let me illustrate what I mean with an example from the folks who are best at this: the Golden Arches – McDonald’s. Do they know their costs? You bet, down to the last McCrumb. Suppose they are looking at a new location. By accurately knowing their fixed and variable costs, they can calculate a break-even sales volume level.

Where do they find this accurate cost information for the new store? Well, they only have thousands of existing outlets to use as models, so by knowing how much they need to invest and their target return on investment (ROI), they can calculate the required profit. Then, considering the target profit as “fixed” – the cost of money – they can easily calculate the required sales to cover the costs and supply the necessary profits. Half done: “What do we need?”

At the same time, the marketing folks conduct a “demographic survey.” In other words, they do their marketing homework and analyze the target market area. By projecting “most likely” customer volume – and knowing the average per customer expenditure – they can accurately predict sales. The other half: “How much will we get?” Now it’s complete.

Next, the marketing and finance people meet and put the puzzle together. If what you will get is greater than what you need, it’s a “go.” The other way around, and it’s a “no-go.” I leave it to you to assess how often they’re right. However, I will make the following observation – such an analysis is not possible unless you know your costs.

Several years ago, one of my clients comes to me ready to expand. He has four stores and is opening a fifth one. Naturally, I ask him: “What are your fixed costs?” His answer, generally speaking: “I haven’t got the foggiest idea. How can I find out?” My suggestion, of course, is to look at the other four stores. So he tells me annual fixed costs are $220,000 per year. Knowing this client, I apply Murphy’s Law and arrive at a figure of $250,000.