Coffee product line extension for underserved local market

Business Plan

Australia has the world's leading coffee culture. This can be threatening to firms unprepared for it, but for firms with a great product that will appeal to Australia's savvy consumers, there is plenty of opportunity. One such product is the lever espresso machine, something that delivers exquisite espresso and gives the home barista a chance to "become one with the shot."

The Lever espresso machine from Espresso Art is a high-end product that specifically appeals to Australia's savvy coffee consumers. It will be priced higher than the baseline "good" home espresso machine but because of its lack of automated parts, it will be priced much lower than the comparable top-of-the-line automated machine. A price point of $1,200 has been set. The Lever will be distributed both on the company's website and through a distributor of high-end home espresso making equipment. The promotional campaign will be based on word-of-mouth, coffee connoisseur-specific advertising and an information campaign from both Espresso Art and the distributor.

The Lever will be hand made at a plant outside either Sydney or Melbourne, so that the company is close to the epicenters of Australian coffee culture. The facility will be small with room for expansion to meet expected increases in demand. The company will focus on intrinsic forms of motivation to attract espresso lovers to work in the company and help it grow. Commitment to the art of espresso is a critical component of hiring, and word of mouth will be used to fill openings, rather than using traditional means of hiring.

The project will take a year to bring to fruition. It is expected that a small loss will be incurred in the first year, to be financed by debt. Production levels in the second year and beyond should deliver profits, and by the end of the third year Espresso Art should be operating at its desired capital structure and be seeking ways to expand beyond the Australian market.

Background

Australia has one of the world's richest coffee cultures. In recent years, Australia has taken the lead in cultivating coffee culture at both the high end and in the mainstream market. Australian drinks like the flat white can be found on cafe menus around the world. Ex-pat Australians run trend-setting cafes in London, Berlin, Singapore, Edinburgh, Hong Kong and beyond, such that Australian coffee culture now rivals that of North America's Pacific Coast for world influence. The domestic market consumes 2.4kg of beans per person on average and coffee consumption has doubled in the past thirty years. In 2008, sales of hot drinks surpassed $1.35 billion and by 2013 these are expected to be $1.473 billion (Wong, 2010), with coffee the biggest component of that figure at over 55% share. Cafes are a $7.5 billion business domestically (Carmody, 2004)

The Australian market is particularly sophisticated, having been established as a major coffee nation for several decades. Indeed, Starbucks has struggled as it has moved into Australia and was recently forced to close ae of its Australian outlets due to "challenges unique to the Australian market," essentially meaning a lack of interest on the part of Australian consumers for that company's relatively low quality coffee (AFP, 2008). With the size and sophistication of the Australian coffee market, competition is fierce and the pace of innovation rapid, but there is also a significant amount of opportunity, because the population is so receptive to new coffee ideas and products. The trick is to avoid making the same mistake Starbucks did and offering Australians a product that is poorer than that to which they have become accustomed.

Keeping this in mind, it is reasonable that Australians might want to be able to make cafe-quality espresso at home. Most home machines are poor, while some are decent. However, the premium machine makers often do not make a home version of their products, until now. A new company, Espresso Art, is launching a home version of a traditional lever espresso machine. These machines would allow espresso lovers to brew to a higher standard at home than has ever been available before. Relying more on manual technology allows this machine to be more affordable than other home machines and is perfect for the hands-on Australian coffee geek. The Australian market has been determined to be sophisticated enough to launch this type of machine.

Marketing Issues - Product

There are a number of marketing issues that need to be addressed, generally relating to the four Ps of marketing -- product, price, place and promotion. The short version is that these machines are high end products for the sophisticated consumer. They produce exceptional espresso and provide the consumer with a unique hands-on experience suitable for serious espresso lovers. The price will be at the high end for home machines. The price-quality relationship, however, will be favorable because of the lack of automation technology. Place will reflect the distribution of the machine, both through online ordering and through a distributor in the country. The promotion aspect will address both the identification of the target market and the strategy that Espresso Art will utilize to reach these customers.

The product is a lever espresso machine, also known as a piston espresso machine. When the espresso machine was invented in the 1950s, it was a lever machine. The user manually pushes the piston or lever instead of pushing a button, and the result is a more direct connection with the espresso. This is important to serious coffee lovers because there are so many variables that go into a quality espresso. Australian consumers in particular have come to understand that bean quality, roast quality, grind, temperature and pressure all contribute to the best espresso shot, and the Espresso Art Lever gives the user more control over these variables than do modern espresso machines. They are the soul of brewing, an experience described as almost Zen-like by some professional baristas (Home Barista.com, 2007).

Because of its lack of automation, the Espresso Art Lever espresso machine is one that requires a higher degree of training and skill for its effective use. As such, it will largely appeal only to those who are willing to take the time to acquire this skill (wanna-be professionals), or to those who already have this skill (former professionals). In either case, the market is a niche one. The product not only produces a high quality shot but is highly durable, because of the simple nature of its parts. The Lever machine is durable and relatively lightweight, which means that it is portable as well, unlike most serious espresso machines. Thus, it may also have an appeal to customers who move frequently, or travel with a car frequently. Other home machines, if portable, do not produce professional quality espresso; alternately, they are cumbersome and have strict water and electricity requirements that make them unsuitable for transport.

Marketing Issues -- Price

The price of the Espresso Art Lever machine will be competitive with other higher-end home machines. There are few regularly-produced lever machines available to the home consumer Australia -- most in use are either vintage machines or professional machines that have been purchased for the home. The price will reflect the premium quality of the machine, but compared with a conventional espresso maker the price will be lower because of the manual nature of the product. Most are sold only on eBay, for prices ranging upwards of $1,800. New models of lever machines are available in Europe for around €1000, depending on make and model, but these seldom find distribution in the Australian market.

According to random talk on coffee-related Internet sites, a commonly-cited benchmark for home machines is the Rancilio Silvia, which retails on MyShoppingAustralia.com.au for $749. The highest-end machine on the home market is the Marzocco G3, which retails for $7,200 on CoffeeParts.com.au. Knowing that the price ceiling for the home machine is that high allows for the Espresso Art Lever to be priced slightly higher than the Silvia.

There are a number of elements to pricing strategy -- positioning, cost and demand curve the most important (Allen, 2011). The first of these is positioning -- the product should be positioned as superior to the Silvia but without high end brand recognition or electronic components it cannot be priced anywhere near the G3. This hints at a price point somewhere slightly higher than the Silvia, between $800-1200. The second element of pricing strategy is the cost of the product. In this case, the materials cost per unit is $75 and the labor cost per unit is $125. Marketing and transportation costs are $50. With a markup of 100% expected both to the distributor and then to the consumer, the price point could be as low as $1,000, but a higher price point would deliver a greater contribution margin. The demand curve is also an important pricing consideration. For example, an introductory price would be at the lower end of the acceptable range would allow for greater market penetration. This depends on the price elasticity of demand. Given the scarcity of lever machines on the market and the unique nature of the niche market, price elasticity of demand is expected to be low. There may not be many prospective consumers, but those who want this product will be keen and are unlikely to be strongly price sensitive. The best price would therefore be at the high end of the range, $1,200. This means that the selling price to the distributor would be $600, for a contribution margin of $350 per machine when sold through the distributor, or $950 if sold through the company website. These figures have been included in the contribution margin analysis.

Marketing Issues -- Place

Distribution for a niche product is a tricky proposition. Consumers are often far apart, meaning that it is difficult to use a storefront retail location to reach these consumers. The Australian market -- in particular with respect to high end espresso -- is focused on the major cities. This implies that retail might be possible in Sydney or Melbourne in particular. However, the chosen distribution route is through two channels. The first is the Internet, through the company's own website. The company has the ability to control its own marketing message through this route, and can build a direct interaction with consumers. The Internet is a favored way to reach customers of niche products, because it has global reach and sales can be conducted from a single physical location. Consumers can find the company's offering through search functions as well as through more conventional advertising means (Brynjolfsson, Yu & Smith, 2006). Product on the Internet should be priced the same as product sold through the distributor. This will avoid undercutting the distributor, allowing the company to secure one. The company will be able to reach consumers in all parts of Australia, however, and will also allow for a higher contribution margin on products sold through the company's online store.

In addition, a distributor will be used. There are a number of distributors of high-end coffee equipment in Australia, a reflection of the market's sophistication. 5 Senses Coffee is a distributor of high end equipment with a location in Victoria and one in Western Australia (FiveSenses.com.au, 2011). They sell both commercial and domestic equipment, but do not presently carry a lever machine. A distribution partner such as 5 Senses, should they choose to go with us, would be able to reach customers in the major urban areas, and would be able to offer some after-sales service as well. They would typically take a 100% markup, so that must be accounted for in the price as well.

Marketing Issues -- Promotion

Even though the Espresso Art Lever machine appeals to sophisticated consumers, the premium pricing and steep learning curve means that there will need to be a sophisticated promotional campaign in order to sell the machines. The message will focus on two key elements -- the experience of the lever machine and the high quality of the espresso that the machine delivers. The literature will be highly visual, the only real way to convey the sensory experience that the customer will receive. This will include visuals of both the machine and the espresso. The sales pitch will focus on the uniqueness of the lever experience in particular, to differentiate the machine from other high end espresso machines on the market. An additional component will be an education and training component, to reduce customer apprehension about the steeper learning curve of using the lever machine.

Promotion will be carried out through two channels -- the online marketing material and through advertisements. The online material will be the most detailed in nature, as the company will have room on its website for this. The distributor's website will also contain this information. The advertisements will be focused on creating interest in the consumer for the product. They will lead the consumer to the distributor's website, where they will find the information about the machine. The advertisements will be strategically placed in coffee-centric magazines, both trade and consumer, print and online. The ability to do this is one of the reasons that the Australian market is perfect for this launch.

Operational Issues

There are a couple of key operational issues that need to be taken into consideration. The company should be located close to the expected major markets, but in a location where costs are relatively low. A location in either Sydney or Melbourne would have prestige, and signal that the company is in a hub of coffee culture, however. Knowing that, a low cost location for a workshop will be found in an industrial park, presumably on the outskirts of Melbourne but possible outside Sydney. The shop's needs are relatively minimal with respect to specialized equipment. The parts for the machine will largely be ordered from suppliers either in Italy, the United States or Australia, with some of the finer components being produced in the shop. The machines will be assembled in the shop. The shop itself will not need to be large -- a typical suite at an industrial park suffice. Rent in outlying areas should be relatively low -- perhaps as low as $2,000 per month.

The company will start life as a single-person company, with the proprietor both building the machines and handling all of the paperwork. This will dramatically reduce overhead, although there is reason to believe that if the business appears as though it is going to be successful a technician will be hired to help with manufacturing and an office staff member may also need to be hired. At present, however, production is going to be manual and by hand. It should take 1-3 days to produce a machine, depending on the amount of time the proprietor is able to dedicate to the task on a given day. It is expected, however, that only around 1-2 machines per week will be built. This will meet an aggregate demand of around 100 machines in the first year. It is hoped that demand will double in each of the successive years, either through success in the Australian market or through expansion into the U.S. And Asian markets.

There is little in the way of specialized equipment that will be needed to build the machines. Parts that require complex tool-and-dye work, for example, will be purchased from external suppliers. A number of supplier options are currently being investigated. The manufacturing facility will have some extra space initially, as expansion is expected as demand is expected to increase in the second and third years in particular. Demand may peak after the third year, simply because of the niche nature of the product. Its durability implies that there may not be many repeat customers in the early years -- they will not need to come back to us except for servicing.

Some hired expertise may be required at times for specialized tasks. This can include accounting, legal or building the website. Payment for these will come from the startup capital and will be expensed. Financing is a key element of the operations plan, as the business will require financing to begin operations. Because of the niche nature of the product and the hand production, it is expected that sales will grow slowly, but will eventually reach a level that will allow expansion of the product line and a sustainable dividend paid to the owner.

The shop will also include a small section for servicing existing machines. These high performance machines will require servicing or perhaps even parts replacement after a year or two. It is expected that the owners of Espresso Art Lever espresso machines are dedicated espresso drinkers who will pull 15-20 shots per week and will probably be keen to show off their home barista talents to visitors as well. With this heavy usage, the machines will require regular servicing. This will be a source of ongoing income for the company and will supplement earnings from the initial sale of the machines.

Financial Projections

As with any new venture, the financial projections for Espresso Art and its Lever espresso machine are based on best estimates. This means that while the market has been investigated, the fact that the product is new means that nobody truly knows how it will be received by the market. The purpose of the financial projections, therefore, is to test ownership's numbers for the soundness of the business idea. The estimated demand in year one is 100 machines, doubling in year two and again in year three. The variable costs have been outlined earlier as $75 in materials and $125 in labor, with a further $50 in marketing and transportation costs, mostly the latter. There are also fixed costs to be considered as well in the contribution analysis, which are estimated to be around $75,000 for rent, utilities and the proprietor's salary. The sales figures are based on an estimated 75/25 split between those sold via the distributor and through the company's website. The basic contribution analysis/income statement is as follows:

Contribution Analysis

/Income Statement

Year

1

2

3

Sales

Average Price

Variable Costs

Contribution

50000

100000

200000

Fixed Costs

75,000

75,000

75,000

Net Income

-25,000

25,000

125,000

The balance sheet is calculated on the basis of 75% owner's equity and 25% debt. The debt will be derived mainly from credit cards. Bank credit is not expected to be available for this venture, given that the business is entirely unproven at this point. This is going to be the target capital structure for the firm, in order to take advantage of leverage. However, the credit cards will be swapped out for bank loans once the firm is profitable. The total startup costs, not including the expected first year loss, are around $15,000 for equipment and $1,500 for an initial inventory of direct materials. A further $2,000 will be required to set up the office. The remaining initial funds are already incorporated into the ongoing expenses such as marketing expense and fixed costs. On the balance sheet, inventory is taken as 4 completed machines plus 10 machines' worth of materials. Accounts receivable is assumed to be one month's worth of sales (30 day credit). The balance sheets for the first three years are therefore as follows:

Balance Sheet

Year

0

1

2

3

Cash

10000

2000

Accts Rec

0

19200

Inventory

12600

Current Assets

11500

19900

39800

Fixed Assets

15000

15000

15000

20000

Total Assets

26500

24950

34900

59800

Liabilities

29950

14900

15000

Equity

20000

-5000

20000

44800

Total L&E

26500

24950

34900

59800

What these figures show is that a viable business can be made using this model. The firm will be profitable in the second year, although not significantly so. By the third year, the company will be generating profit and will be able to set the ideal level of debt, with growing equity. By this point, the firm will have added new machinery to expand capacity and will have added staff, which are included in the direct labor component of variable costs. It is important to know at what level of sales the business will be viable. In this case, the business is viable if the sales targets are met. Given the strong coffee culture in Australia, it is expected that this demand will exist in the marketplace even though this is a niche product. Expansion beyond 400 units per year would likely require geographic expansion into the North American or Asian markets.

Cash Flow

Year

1

2

3

Start Cash

10000

2000

Net Income

-25000

25000

125,000

Change Fixed Assets

0

0

-5,000

Change Acc Rec

-4800

-4800

-9600

Change Inventory

-1650

-3150

-6300

Change Financing

23450

-15050

End Cash

2000

108200

Human Resources Management

There will not be any employees initially, but within a year or two the hiring process is expected to begin. The employees will be hired on the basis of need. Human resources will be in compliance with all laws of Australia and of the state in which the business is incorporated. It is important that the best people be hired, for a couple of reasons. One is that Espresso Art intends to market a premium product with premium pricing. As such, the customers are going to be relatively wealthy professionals with high demands. These customers are going to demand a high quality product free of defects and they are also going to demand a high level of service. The use of a distributor to help market the Lever espresso machine will assist with delivering a high level of customer service. The quality of the in-house staff, is of critical importance. That the company is small also demands that all staff members hired are able to work closely together to deliver these results.

To that end, there are going to be two key elements to the human resources strategy. The first is identifying the best employees. Initially, the strategy is going to be to utilize word of mouth within the coffee community to identify potential staff members. Passion for espresso is going to be key to developing a common sense of mission among all staff members. This sense of mission is going to contribute strongly to the intrinsic motivation that will be key to the company's success. As a small company, extrinsic forms of motivation will be financially unviable, thus the reliance on intrinsic form of motivation. Having staff that come from within the rich coffee community in Australia will also help to ensure that they can be vouched for. In a small company, identifying and training staff is a time consuming process that takes the owner away from other important tasks. Thus, having staff that can be selected on the basis of personal recommendations from trusted individuals will help shorten that time frame. Later on, when the company becomes more professionalized, different policies can be in place but in the short run an emphasis should be placed on expediency.

The second key tenet of the human resources strategy is ownership. Espresso Art wants employees that it can grow with. As such, the company will offer ownership stake in the company as a form of enticement. Ownership stakes have been shown to attract better quality workers, improve performance (Tice, no date), increase employee interest in the company's well-being, increase retention and possibly even raise capital. The loyalty that this program will engender will ensure full commitment from the employees that are hired to the long-term success of the company and will help gain some creative input from these employees as well. They are going to be part of something special and Espresso Art wants them to feel that way.

As the company grows, human resources management will be a critical element to the firm's strategy. Employees are critical to maintaining the firm's high standards both of product and of customer service. The company's ability to maintain employees and to train them adequately is one of the biggest constraints to growth. In the first few months, when there is just the proprietor this will not be an issue but thereafter, when key tasks must be delegated, the firm needs to be positioned with a strong employer brand that attracts the top talent available, even if the ability to pay top dollar wages and benefits is not there.

Implementation Timetable

Bringing a project such as this to fruition is a complex proposition. There are a number of elements that must be addressed, including the product, the financing, the marketing strategy and the legal and accounting aspects of the project. It can take anywhere up to a year to start a business of this nature, assuming that the product is largely ready for market. The creation of the business plan is the first step towards this process. The following steps during the early stage of the startup are to scout for properties, register the business, compile of list of permits and licenses that need to be acquired and begin to sort out the financing issue (Fimark.net, no date). These pre-planning stages are necessary to set the business up for the work that comes later. This stage is specifically set up to accommodate these tasks because they are critical, sometimes overlooked and usually take more time than the entrepreneur expects them to.