Part IV: Ingredient prices challenge profitability

The rapid, steep increase in ingredient and fuel costs has forever changed the accounting landscape for bakeries. To keep up with the increased costs of doing business, bakeries have raised their retail prices significantly during the past year. This practice, while necessary, has created new challenges to keeping tabs on profitability. Tracking labor is one of them.

Bakery owners and managers need to be aware of how their labor reports and profit and loss statements have been altered by abnormal increases in retail prices. “If you continue to measure the performance of your bakery based upon reports of labor and ingredient cost percentages, then you may be completely misled by your past experience of what represents a good labor percentage or a bad ingredient cost,” says Karl Schmitt, co-owner, Deerfields Bakery, Buffalo Grove, Ill.

To help retail bakeries keep their labor costs in check, in this article, Schmitt explores why the past metrics have changed and how to create a new labor report that is independent of retail prices and changes in pay rates.

During past more stable times, typical bakery business metrics were about 30 percent ingredients, 30 percent labor and 40 percent overhead and profit. So, a bakery with $1 million in sales had $300,000 in ingredient costs, $300,000 in labor and $400,000 for rent, insurance, etc. and profit.

Let's assume this hypothetical bakery's ingredient costs jumped 33 percent from $300,000 to $400,000, and the bakery responded with a 15 percent retail price increase. This brings sales to $1.15 million with ingredient costs at $400,000; labor should not change at $300,000, leaving 450,000 for overhead and profit, which is $50,000 more than before.

Consider customer counts

If the bakery didn't lose any customers with the price increase, it should have that extra $50,000 to cover additional fuel costs, etc. and profit. But, look at what happened to the labor cost percentage in this scenario. It is now $300,000 divided by $1,150,000, which is 26 percent. In the past, if you had a 4 percent drop in your labor percentage, you would be ecstatic. But now you have a 4 percent drop just because of the math. Here's the rub: if a bakery starts running the old 30 percent labor cost benchmark with the new prices, then it likely has become inefficient without realizing it. Also, examine the new benchmark for ingredient costs: $400,000 divided by $1,150,000 is roughly 35 percent.

This demonstrates that it is unnecessary to raise retail prices sufficiently to maintain the original ingredient cost benchmark of 30 percent. The 15 percent increase in retail prices has not only covered the increase in ingredients, but has left $50,000 extra in the coffers. Of course, you can expect upward pressure on wages, because the employees must be suffering from the increase in ingredient and fuel costs as well.

It is even more likely that bakery customer counts have fallen as families feel the pinch on their pocketbooks. With falling production volume, the natural tendency is for employees to slow down in order to stretch their day to a full 8 hours. Unfortunately, when production levels drop significantly, bakery owners are forced to reduce their staff in order to remain solvent. The new metrics are difficult for most of us to accept, and if you share your labor reports with your managers, it will be even more difficult for them to accept.

By measuring labor costs in terms of productivity rather than costs, owners can create an entirely new report that managers can use to improve labor efficiency and provide workable goals for staff. Owners should still look at the traditional labor percentage because it reflects the “true” labor cost. Since the new approach is designed to measure productivity rather than labor costs, a higher number is better than a lower number. Owners need to keep in mind that the new metric should be lower than it has been in the past. This new report is ideal to share with lower level management, who may not understand that the new labor metric should be lower than ever before.

The new productivity report will work best by using a different technique for each department within the bakery, but for this demonstration, we'll use the sales department. A reasonable way to measure the productivity of sales employees is by measuring the average number of customers they handle per hour. This can be accomplished by dividing the number of customers that you have for the week by the number of hours worked by the sales employees for the week. We are looking at productivity rather than cost, so overtime hours are simply added to the regular hours without the time-and-a-half factor.

Typical POS software and payroll software provide all the information you will need. If you've retained the reports from previous years, you can do historical comparisons. Here is how it is done. Divide the number of customers you have for the week by the number of hours worked by the sales employees for the week. Let's try an example using the numbers for my bakery for the week ending 9/28/08. Customer count was 2,854 and hours worked by the sales department was 344 regular time and 19 overtime, so 2,854 divided by 363 (the sum of 344 plus 19) yields 7.9.

Compare productivity over time

This new metric is a management tool for the sales manager (rather than an owner's report) because it doesn't fluctuate with retail prices or pay increases, which makes historical comparisons more legitimate. You may be wondering what this new metric measures; technically it's the average number of customers that are handled by the sales customers per hour worked by them. The number isn't particularly interesting by itself, but it is valuable as a means to compare the productivity of the sales employees from year to year.

The Sales Department Dashboard below provides a manager with the key statistical information necessary to gauge the performance of the department each week. The Productivity Index bar graph compares productivity for the week ending 9/28/08 with the same week in the prior two years. In this case, the chart illustrates that the department did much better in 2006 than in the two subsequent years. Remember, this productivity index is independent of any changes in the pay rates of the employees and/or the change in retail prices of the items sold.

The next graph, Retail Sales, shows retail sales for the same week in 2006 through 2008. This shows that sales fell in 2007, but recovered in 2008. The “hidden” bad news is that prices were substantially increased in 2008, so the relative sales ought to be good because of price increases.

The Customer Count graph tells the manager whether or not his/her customer base is expanding or contracting. While the economy has a big influence on customer count, it is important for the sales team to provide customers with exemplary service, so customer counts continue to grow.

Customer Ticket is simply the average size of each purchase. It is computed by dividing the sales total divided by the number of customers. The sales total is obviously dependent upon the price charged for each item. The large increase in 2008 retail prices makes the comparison of 2008 average ticket size to previous years somewhat misleading. It is important that owners point that out to their sales department managers, or they may assume they are doing an outstanding job increasing the average ticket size through suggestive selling.

The next two sections are simply a comparison of the regular and overtime hours worked by the sales department employees for the week ending 9/28 for 2008, 2007 and 2006. This is raw data and doesn't reflect if fewer or more customers may have shopped for the week being studied in each of the three years. The overtime graph is the one that a manager should be concerned about.

The final two sections of the dashboard are the most important. The first of the two illustrates whether or not the manager has reached his/her goal for the week, and the final section is simply the new goal. This dashboard was printed on 9/29/08, and the schedule of work hours for the sales department would have already been set for the week ending 10/05/2008. Consequently, the next goal is for the week beginning 10/6/08.

In this case, the goal is 363 hours. That number is computed by dividing the customer count for the week ending 9/28/08 by the customer count for the same week in 2007. In this case, it is 2,854 for this year and 2,937 for last year. Always divide this year's number by last year's, which results in 0.972 for this example.

This ratio is then multiplied by the total number of hours (regular plus overtime) for the week beginning 10/06/2007. In this case, the total number of hours for that week was 373, so 373 times 0.972 is 363. This calculation makes the goal (hours worked by sales department) equal to same number of hours worked last year after an adjustment is made for the increase or decrease in customer counts. It is the manager's job to schedule the employees, so the department does not exceed the 363 hours allotted for the week.

Of course bakery owners still need to look at traditional labor percentages that reflect “true” labor cost. But, this new dashboard of indexes should provide a proficient management tool and a better view of labor productivity based on how customer counts are trending.

This concludes Modern Baking's special report Ingredient Prices Challenge Profitability.

Part 1

BAKERS NAVIGATE THE PERFECT STORM

Part 2

ADJUST YOUR BAKERY BUSINESS

Part 3

MANAGE RETAIL PRICES FOR TRUE PROFIT

Part 4

KEEP LABOR COSTS IN CHECK

For the complete report and additional information on the state of ingredient costs and the baking industry, visit www.modern-baking.com.