Tuesday, April 14, 2020

More Incentives To Bake Less Bread

Previously I pondered whether my local bakery will choose to make money or bread while there is a Covid-19 wage subsidy. They should be close to four times more profitable if they were to reduce bread production by two thirds. Now we rely even more on bakers altruism to get bread since the incentive to reduce baking has been further increased. Where the previous  rewards were provided from community resources, these new baking reduction incentives oblige landlords to chip in.

So far, I can report my local bakery has remained altruistic, or perhaps ignorant, and I can still get as much bread as I want at previous prices. While acquiring some of their delights yesterday I was able to check the assumption in the previous analysis that Covid-19 would not reduce sales.  They told me "on some days they are selling as much as $500 more than they would have expected and on other days less, but on average sales haven't changed".

The new incentive is an obligation on landlords to provide reduced and deferred rent. The Financial Review explains "In practice, if a qualifying tenant suffered a 30 per cent fall in revenue, then at least 15 per cent of total cash flow relief would be rent-free or waived and the remainder would be deferred." The Grattan Institute's program director of budget policy and institutional reform, who wants larger rent reductions funded by additional community assistance to landlords, says rent is usually 20% of normal costs. Updating the model for this new incentive gives the revenue distribution in figure 1 and profitability as a proportion of original revenue in figure 2.
Figure 1 - Comparison of bakery revenue distributions with Jobkeeper plus rent reduction scenarios. Source: Model

Figure 2 - Comparison of original profitability with Jobkeeper  and rent reductions
Source: Model

That gets absolute bakery profitability up by a factor greater than four so the bakery can generate more profit in the next six months of Jobkeeper  than would normally be achieved in two years. The landlord funded anti baking incentives are much smaller than community funded incentives but they make it a bit less likely the baker can ignore the temptation to increase profit and a bit more likely I'll have to eat less bread and more rice in a few months time.

Saturday, April 4, 2020

Will My Bakery Choose To Make Money or Bread?

May You Live In Interesting Times

I delight in bread from the local bakery. The anticipation as I walk a few minutes from home to acquire the treasure, the smell of the shop, the choosing and the build in excitement as I head back home to savour the prize. It's especially good if it's still warm but will it still be affordable and available in the new world of wacky economic incentives?
Artisan Bread Is A Treasure

The bread is not much more expensive than factory bread and with everyone getting double the previous unemployment benefit or at least 70% of the pre coronavirus median wage it is a small luxury we should all be able to afford. I expect the demand for artisan bread will increase as the customer base sits at home pondering the delights of the next meal but the bakery owner has a strong incentive to leave  more than 30% of existing customers unsatisfied.

Without government incentive the bakery will be making at least as much profit as before and probably a little more but if turnover can be reduced by 30%  the bakery can make a motza. Flour is cheap so rent and wages would be most of the bakery's expenses, let's guess wages are two thirds. Staff work two shifts daily seven days a week and they are part time. From friends that have worked there I've learned they pay minimum wage, so the $1500 per employee will mean a pay rise for staff while taking out direct  wage costs for the bakery. There is still some staff overheads so overall staff expenses are reduced by perhaps 75%. The previous and new revenue distribution is shown in Figure 1.

Figure 1 - Comparison of bakery revenue distributions with two Jobkeeper scenarios. Source: Model

Profit before was perhaps 5% of turnover but now it is 11%. That is lot more profit as a proportion of turnover but on a 30% lower turnover, it's less impressive but still more dollars. But how is the bakery to achieve the turnover reduction? The best way is to increase prices but if a 30% price rise reduced bread sales by 30% turnover would be unchanged and the bakery still wouldn't get Jobkeeper. Assume prices are doubled to reduce by roughly two thirds the quantity of bread sold they open less days, then that will lower expenses again. Lets assume wage costs are halved again and other expenses are halved, but rent is fixed so that rises as a proportion of costs. This produces a fabulous 40% profitability but again on a lower turnover. The profit under all these scenarios as a proportion of original turnover is shown in figure 2.

Figure 2 - Comparison of original profitability with Jobkeeper profitability. Source: Model

There is still nearly four times the original total profit achieved.  In the next 6 months the bakery can generate as profit that normally would take nearly 2 years. How good is that? For the bakery great, but for me not so much. I'll probably have to go back to factory bread and if the factory responds the same way I'll be eating perhaps a third of the bread I eat now while paying twice as much.

I hope the bakery owner cares more about making bread than making money.