Episode 140 – Rapid Growth Is Not For Everyone w/Sarah Delevan

April 15, 2024

Dr. James Richardson (00:21):

Welcome everybody. I have this time Sarah Delavan on the show, and she is a financial consultant, a podcast host, and good food advocate with over 15 years of experience building a supporting regional and sustainable food systems. She’s the founder and CEO of Sarah Delevan Consulting and the Good Food CFO. She’s worked over the last 10 years focusing heavily on supporting mission-driven food businesses, farmers, ranchers, and fishers in achieving profitability and financial sustainability so that they can actually secure a much needed place in our food system. So I’m happy to have you on the show, Sarah. Thanks for joining me.

Sarah Delevan (01:05):

Yeah, thanks for having me. Happy to be here.

Dr. James Richardson (01:07):

I don’t have a lot of guests as you know. I’ve been looking for a while. I’ve been waiting for somebody that I could have on the show to talk about a couple, well, some very controversial but important financial topics that they are, they’re right front and center for a lot of the people listening to my own show, to most of the people selling under a million dollars a year, this is basically their world, right? Is margin and surviving. And then some of them have an ambition, which is I just want to be profitable as soon as can. So maybe we tackle the beast first, which is let’s do it. What is the value of setting a margin and then sticking to it, and how should people think through that?

Sarah Delevan (01:49):

Yeah, what I love to teach is the idea of what gross margin is and how it impacts two things, your cashflow and your need to take on debt or to leverage debt to grow your business.

(02:07):

So when you think about setting your gross profit margin, especially when you are in years zero through, let’s say two at least oftentimes I say zero to five, I think you have to think about what is my capability to take on debt? How much money do I have at my disposal to grow my business? What is it going to cost me to launch and grow my business and how much more cash do I need? Because that is going to inform where you need to be with your gross profit margin. If it costs a dollar to make your product and you sell it for $2, you have got a 50% gross profit margin. So you’ve essentially made the dollar back that it costs you to make the product. You’re paying for that essentially, because here’s another idea we need to be clear on. No business has money inherently from the beginning. You’ve borrowed it from somewhere. It’s either been invested or you’ve got a loan or something. So that $1 really needs to be paid back after you generate the revenue and then you’ve got one more dollar to make another unit. That’s it. You haven’t generated any money to pay an operating expense to cover any of your rent,

(03:23):

And you’re making just one more unit. So if you’re generating less than 50% profit margin, you’re essentially not making enough to make one more unit.

Dr. James Richardson (03:32):

Right. That’s why it pivots around that number. Yeah,

Sarah Delevan (03:34):

Exactly. And if you’re making more than 50% than 60, for example, then you’re making enough to make one more unit of product and then some. So this is to me, a pivotal concept, and I don’t believe in there’s a right or a wrong margin. There is facts around what your margin means for your cashflow, for your ability to produce product to increase the amount of product you’re producing and how much debt you may have to leverage in order to achieve your business goals.

Dr. James Richardson (04:06):

To follow up on what you’re saying, if you have a 70% margin on a product that costs you $2 to make, you’re going to wholesale it for $6.66, and now you’re making bank, right? You’re actually making money. You could probably afford marketing and promotions. The problem is that’s your wholesale price. And that leads to another problem we’re going to get to in a little bit, which is strategic pricing.

Sarah Delevan (04:30):

Yeah. Well, because nothing happens in a vacuum, right? Let’s,

Dr. James Richardson (04:34):

So the consequence of taking a target gross margin is that you wind up with extremely high wholesale pricing that makes you very happy, except when you go and try to sell it to Whole Foods, UNFI.

Sarah Delevan (04:48):

Yeah, they’re not going to want to pay.

Dr. James Richardson (04:50):

They’re going to laugh, laugh because $6.66 and $2 isn’t necessarily a bad pretty common unit price when you have no leverage with the coman right? In the beginning, that’s probably what you are going to pay for a lot of stuff. $6.66, you double that roughly to get into Whole Foods or something, and you’re talking about a 13, $14 retail product. I mean, this is basically artisan food.

Sarah Delevan (05:14):

Well, I think you said something that’s very critical to go back to. If we are in the early stages of the business and we aren’t leveraging a coman, my question is, is it actually the time to sell to Whole Foods? And my assumption is that the answer is no.

(05:32):

So one of my other philosophies that I think is core to what we teach is go into your most profitable channels first. And of course you have to have a strategy and you have to have branding and everything needs to make sense and work together. But you can sell maybe a $14 product or two, it doesn’t need to be $14, maybe it could be $12. Your D2C, I love a 70% margin D2C as a starting point. If you’re a brand that wants to eventually grow into distribution and sell to Whole Foods, start in your most profitable channels, especially in the very beginning, you know what I mean? Make sure you understand your customer, make sure that your product’s actually resonating with them. Is your branding working? You know what I mean? Own your backyard. Get some clout behind your brand and your business, get your volumes up and then go to Whole Foods. Folks who especially don’t have a ton of money or a lot of debt to leverage, maybe aren’t interested or able to get a ton of investment, which is most businesses, most people going straight into big retail is a bad financial decision.

Dr. James Richardson (06:46):

And you go to Expo West, you walk around the booth and everyone’s listing their retailers, and it’s like, well, and then you sort of start making up your business model based on what you saw on the list of current retailers on somebody’s booth, just like nothing about them. They could be 50 million company, it could be 200 million.

Sarah Delevan (07:02):

One of the reasons that the good food CFO exists, and we are right now a podcast and a website that has financial tools, very simple, inexpensive financial tools to help early-stage brands, but really we view ourselves as an emerging media company. And we are trying to be, as you said, upfront, a little bit of a contrarian voice saying, Hey, big media is sort of getting this wrong. Stop chasing fast growth. Stop chasing this national dream. There’s ways to build businesses where you can make money, have a very comfortable life, build local economy, do really good things for yourself and others that don’t look anything like that. And I think that there are super unique brands that, and I’ve got two of them in my client roster where it’s like National does make sense. Let’s do it in a way that also makes sense financially for those brands. But the majority of them, there’s a size in between that is right for them and financially is very positive, very good.

Dr. James Richardson (08:04):

But I think you were talking about earlier the idea of picking a size, almost a revenue range where you’re going to be comfortable and the math works.

Sarah Delevan (08:13):

Yeah, I refer to that as right sizing. I can give you an example, a story of a client of ours, amazing pasta brand was in Whole Foods and several other stores selling really good volume, but just constantly in a cashflow crunch. And due to the margins we’re at high thirties to mid forties in terms of the gross product margin. It was a frustrating place for her to be. And the realization was for this instance, and I don’t know, maybe you can tell me if this is the case for most businesses, but there’s a chasm, I think that’s the right word, between being small but big enough where it’s taking constant investment and you’re not really able to hang onto a lot of cash, but to get to the next level where the volume is there takes a huge amount of investment, but also so in infrastructure and in other things.

(09:09):

And that founder really sat down with me one day, it was in a very stressed manner and said, I think I just need to tear this all down. And I said, well, let’s talk about what do you actually want? I think it’s important to know what do you want your day to day to look like? Do you enjoy working with these distributor partners? And she had great distributors that she worked with, but she wasn’t really connecting with her end customer. The life of her business wasn’t what she dreamed of it to be. And she had this financial frustration in it all and needed more money. And what she wanted was more of a neighborhood shop where she could connect with people and provide her pastas to certain restaurants and certain wholesale customers. So we, of course ran the numbers. We didn’t tear it all down overnight, but we ran the numbers. We looked at what made sense or what could make sense. And at the end of the day, she pulled out of distribution. So she pulled out of wholesale and some of those other, those relationships, she still does what I call direct to retail. So independent stores, smaller retail sales, she sells to restaurants and she’s got her shop. And when I tell you that her cashflow changed almost overnight, I’m not exaggerating.

Dr. James Richardson (10:29):

Yeah, sure.

Sarah Delevan (10:30):

Took a little longer for the profit to show up on the P&L, but cash changed virtually immediately, and she could hire more help inside her business.

Dr. James Richardson (10:41):

There you go.

(10:41):

Could pay herself more. So now everything has changed and her business from the outside looks unquote smaller, but it is healthier than ever and she’s happier.

Dr. James Richardson (10:51):

Underneath your margin concern. The elephant is sort of do I do distributed routes to market or not? Because that’s, to me, whenever I’ve looked at P&Ls of smaller brands, that’s where it all blows up is once you put UNFI, KeHE, DPI, any of these people in there, they essentially consume all the pennies you need for promotion and reinvestment.

Sarah Delevan (11:14):

And I think where people get in trouble is that they have no idea what those relationships look like. And even when you know, okay, this is how this works, you still don’t have a good amount of clarity on what the actual fees and things are going to be, what check or what invoice they’re going to hit, how it’s going to impact your cashflow.

Dr. James Richardson (11:32):

And I think the problem is by the time you figure them out, you’re in the relationship. And that continues to be an issue. Just in the second edition of my book behind me, I actually, I threw in a price waterfall sidebar, which is not the kind of pricing analysis you do because it’s not geared towards being profitable. It’s actually designed to terrorize my readers to show you that if you have a competitive price, $5 competitive premium price, that’s a nationally scalable premium price per unit that can work. That’s brutal. That’s absolutely brutal. And when you’re doing UNFI to Safeway, you wind up with so little money, it’s frightening. And so I just wanted to put that table in my book just to make people realize

Sarah Delevan (12:15):

That’s a really good idea. And I think if I might talk for a minute about when you read my bio, we talk about regional food systems and supporting good food businesses. I’m a firm believer in that our food system is both broken and corrupt,

Dr. James Richardson (12:31):

But

Sarah Delevan (12:31):

You are competing against conglomerates.

Dr. James Richardson (12:35):

Yeah,

Sarah Delevan (12:36):

It’s brutal with tons of debt on their balance sheet that they can leverage. So when you hear, oh, they’ve got a 30% profit margin, yeah, they’re using the millions of dollars on their balance sheet to fund either the production or their operations, and then they can still look profitable on the P&L. That is not what your business can do.

(12:56):

And I like to ask the question, do you want to compete with them? Do you need to compete with them? And I have this sort of overarching mission of I want our food industry to change. And I don’t know that no, it won’t change if every food company’s and every food founder’s goal is to get really big and sell to General Mills get really big and sell to PepsiCo, right? Because then the consolidation just keeps getting worse and worse and worse, and our choices become fewer and fewer and fewer. So I have an ulterior motive to suggesting to brands that they stay a bit smaller, perhaps stay out of national retail,

(13:42):

Can sell at a higher margin and still have it be a fair price to your consumer, the people in your supply chain. And I have a hope that access and things become more available. What if instead of trying to sell into it, we create something outside of it?

Dr. James Richardson (13:57):

Well, I mean we know that the last quarter century that the growth in local and specialty brands or the convergence of local and specialty has been pretty steady. It continues to grow pretty well. And that just because of the increasing wealth of consumers, honestly in specific cities, Including

Dr. James Richardson (14:16):

Where I used to live in Seattle, it’s fueling because they’re willing to pay, they’re willing to buy $12 jars pasta sauce.

Sarah Delevan (14:26):

But okay, I’m going to push back a tiny bit.

Dr. James Richardson (14:27):

So I think

Sarah Delevan (14:28):

Because what goes into the $6 jar of tomato sauce, I live in California, so I see the trucks overflowing with ripened tomatoes going to the Hunt factory. You know what I mean?

Dr. James Richardson (14:43):

Where our positions converge is that it makes the most financial sense. It also makes more strategic sense to build a local business from a distribution perspective, prove that you can grow it off of the intrinsic properties of the original design, basically. Does it have that SkinnyPop kind of effect, essentially do something and then wait for the market to deliver that crazy above-average velocity? And then I think that’s when you should then sit down and say, oh, do I now have the right to scale nationally? That’s where I think you’re absolutely right because I think the default should be I’m just building a local business. It’s just more fun.

Sarah Delevan (15:21):

It’s very fun and completely, you hit the nail on the head is like if you play this out, you’re a brand new product, a brand new brand, and you’re trying to launch into, we’ll just keep using Whole Foods. They don’t know you need data to prove to them that they need you on the shelf. So if you can deliver the data that, listen, this is selling like hotcakes. Our customer is your customer, you want us in here, you have more negotiating leverage. So I don’t understand why you would want to go into a negotiation without anything to leverage. You know what I mean? No, I

Dr. James Richardson (16:03):

Don’t either.

Sarah Delevan (16:05):

I try to stress transparency and conversation. So a brand I was working with was selling into the home goods stores and one product sold in really low margin, but they did it. I wasn’t a part of that decision making process, but they came to me afterward and it was like, we’re struggling with cash, we’re not profitable. We have these great accounts. What do we need to do? And we looked at the numbers and so it was like, okay, when we’re up for renegotiation with these different, and it wasn’t just Home Goods, there were some other ones, we need to have some level of transparency. No, I cannot lower my price to this because this is what I’m making. I think that they don’t care. They don’t need to know, but it doesn’t mean that we can’t tell them and make them aware because, or if you’re in a position where they want you on shelf because you’re selling well and you say, I need to make X number of dollars, therefore I need to sell this to you at this price point, or I can sell it to you here at this price point, but I’m not going to do the promos as frequently as you want me to.

(17:14):

We’ve seen it work where the buyer meets you where you need to be. And then we’ve seen it in the HomeGoods case where they were like, no, we only want it at this very low price. And the founder was prepared to walk away if that was the answer. And she did. But her cashflow is better off for it. And her product, her brand is growing, her sales volume is growing. No one, I think retailer is going to make or break you make the right financial decision for you.

Dr. James Richardson (17:46):

The challenge is when you, and this I think is more of a creation of just, I dunno, a modern media tales of entrepreneurial success where we skip all the backstory on the founder and their net worth and all these other things. And then we are like Airbnb. Voilà. I’m very public and I said it, I made it more explicit in the new addition of the book is that this game, if you want grow a national CPG business is general. I mean, the odds that this is going to work out for you as a middle-class founder with no particularly high net worth are pretty slim.

Sarah Delevan (18:21):

Yeah. I think, yeah, obviously investment is important, but I also think we make the rich richer. And so yeah, just a little plug for, maintain as much ownership of your business as you can.

Dr. James Richardson (18:40):

,I think if you started a business out of particular mission to support local food ways than the likelihood that, I dunno, my experience, the likelihood is that you’re harboring some ambitious desire to become huge at Walmart is pretty low. I

Sarah Delevan (18:55):

Don’t mean

Dr. James Richardson (18:56):

That that intersection I don’t encounter very

Sarah Delevan (18:58):

Well.

Dr. James Richardson (18:59):

Maybe you encounter it more, but

Sarah Delevan (19:01):

I do encounter it. As I noted at the beginning of our conversation, I have two brands that make sense to be national because of what they’re doing. Of course, I’m not a predictor of the success of brands. I am not going to say that, but they’re not another jam, they’re not another granola. You know what I mean? And they have something that is unique, that is different, that is setting them apart and hopefully we can get them there in a way that makes financial sense for everybody

Dr. James Richardson (19:32):

Involved. Yeah, I think

Sarah Delevan (19:34):

Should we sort of

(19:36):

Back to the idea of margin? I’m just thinking about the beginning of our conversation. What is margin? And I think we are talking about a couple of things like you need to make a decision. I think you need to know as a brand, what do you want to be as a founder? What do you want your life inside your business to be like? And to the life of your team to be like, what do you want to accomplish? What are the most important things for you and for your brand? And for me, it’s like include that in the decision on how big do we get, how small do we get? What channels do we sell in what margin makes sense for us? And a big takeaway is that the idea of right sizing for me is you can make it work and you can make money at various sizes.

Dr. James Richardson (20:31):

Yes. I think that’s really important for people to understand. Thank you for coming on the show. I think this is what you’re doing is really important because most people, their best end state will be a small local business that’s break even to profitable. And so the quicker they understand how to set it up for that, I think the happier they’re going to be.

Sarah Delevan (20:48):

Yeah, I agree.

Dr. James Richardson (20:50):

So cool. Well thanks for your time, Sarah. I will make sure to post links to your courses, too.

Sarah Delevan (20:57):

Amazing. Thanks so much for having me, James. This was really fun and I appreciate you taking the time to talk with me.

E-mail Sarah at : [email protected] 

Website: thegoodfoodcfo.com

Instagram: @thegoodfoodcfo YouTube: @thegoodfoodcfo

LinkedIn: @Sarah Delevan