The Case:

Fiction Chocolataire, incorporated in early 2010, is a chain of retail stores that sells a variety of hand-made chocolates. The entrepreneur, Wendy, who founded the firm is passionate about chocolate making and servicing customers, and has been doing a wonderful job over the last two years. She currently runs three outlets in Chennai, including one inside the airport. At the store level, each outlet is profitable and she’s currently self-funded. Consumers in Chennai love her chocolates and her pricing is comparable to chocolates like Lindt and Cadbury’s luxury chocolates. The entrepreneur believes she is now ready to scale up, and has already started receiving enquires from people in other cities.

Now, as part of her growth plan, she has set herself a target of 50 stores, across India by December 2014. What should her scaling-up strategy be?

The Expert:

Vijay Rajagopal is an Investment Manager at Peepul Capital, which is an India-centric Private Equity fund. The fund manages approximately US $600 million and makes growth capital investments into companies, with a preference towards consumer-centric products/services.

Rajagopal completed his Bachelor’s degree in Chemical Engineering as a batch topper from BITS, Pilani and holds an MBA from the Indian Institute of Management, Ahmedabad. He has also completed all three Chartered Financial Analyst (US) levels. Overall, he has extensive experience across private equity, management consulting and investment banking.

For this case study, Rajagopal draws from his and Peepul Capital’s experience of working closely with and observing several of its portfolio companies including UniverCell —­ a leading mobile retailer, Oriental Cuisines – a chain of multi-brand restaurants and MedPlus – a pharmacy retail chain.

The Expert says:

Let us first look at the positives of the fictional company. It seems to me that the two-year-old company has a good early-stage brand. In addition to selling chocolates through its retail outlets, it also has the backend presence in terms of making its own chocolates. This is good, since this directly brings supply chain and product quality /mix under its control. Also, the entrepreneur, Wendy, seems to have her bearings right in terms of her passion and her focus on profitability. Both these provide a good platform to take the next leap forward.

At a broad level, with the information we have currently, I’d like to divide the expansion plan into three different growth phases.

Phase 1 – the foundation phase (First year)

Phase 2 – the stabilisation (preparation for ramp-up) phase (Years 2 and 3) and

Phase 3 – the rapid and aggressive growth phase (Years 4 and beyond)

Let us now discuss, in detail, the key aspects one needs to keep in mind in the foundation and stabilisation phases and then touch upon the aggressive growth phase (since it is early to make exact plans for this phase).

Phase 1: The foundation

In this phase, I’d recommend the entrepreneur to ‘get the basics right’. It is a phase, where she can probably open about three or four retail stores in one more city. UniverCell, for example, when it grew rapidly, had a focused expansion strategy of expanding in one state, dominating it and then moving on to the next one. Drawing a parallel, I’d like to suggest a phased growth strategy to Fiction Chocolataire. Doing rigorous study and analysis before launching in a new market (which could be a city in this case) and then scaling up within that market is a recommended approach. The analysis should cover factors governing choice of location and estimation of cap-ex (capital expenditure), op-ex (operational expenditure), customer footfalls etc.

The most important elements of this phase are:

People: Hiring the right people for the company at the right time is one of the single largest success factors for any entrepreneur. At this phase, it is vital to bring in the functional heads – the ones leading operations (including procurement) and marketing in the early part of the first year and then, finance and human resources, a little later. Marketing is a crucial function, especially in this branded food category of chocolates addressing the premium customer segment. The marketing head needs to handle both brand building and promotions at the store level.

Branding: Investing time and resources into building a brand early on in a company’s life and getting the positioning right in the customer’s mind pays rich dividends as the company scales up. The brand recall and customer-connect results in significant non-linear returns to the company. Especially with premium chocolates, a combination of an excellent brand along with reasonably price-inelastic customers can result in a high level of profitability.

Hence, in this phase, I’d recommend serious, intelligent branding spends after identifying the right media-mix.

Tracking key metrics: Let me highlight some of the key operating metrics that are important – sales per square foot per store, same store sales and EBITDA at the store level (Earnings before interest, taxes, depreciation, and amortization). In addition to rigorously tracking these metrics, it is equally important to act based on what you find, and take swift corrective action. Wendy could give herself a reasonable time-line to break-even at the store level based on her own experience and market feedback. Then, if she finds that, due to factors not in her control, the store doesn’t look like showing reasonable growth or becoming profitable in the near future, she should take corrective action and shut down that particular store. Do not pump in good money after bad.

A tight handle on costs: The motto is to be ‘lean and mean’ with a top-driven cost-conscious mindset across the company. It is a simple point, but very crucial at this stage. In order to incentivise employees suitably, rather than loading on higher fixed costs in terms of pay, the smarter thing to do would be to explore stock options and/or a higher performance-based variable component.

Supply chain: Instead of having smaller chocolate-making machines at every outlet, what could be more advantageous would be to explore a hub-and-spoke model. This would mean producing the finished chocolates in a common location (hub) and then delivering it to multiple outlets in that city. This ensures that there is a good element of quality control. Also, instead of multiple small machines at the outlets, fewer large ones at the hub would be more optimal from a cost viewpoint. Additionally, there are economic benefits in terms of not needing to have people at every store manning the production.

At this stage, we also need to identify the key risks in this business and find suitable ways of mitigating them. In this case, the primary risks could be

Product risk (Low quality of chocolates, non-uniformity of taste in all outlets etc),

Retail operations risk (mis-management of in-store operations, inordinate expansion without a focus on ROI etc)

People risk (not having the right management team)

Phase 2: Stabilisation (preparation for ramp-up)

In the second and third years of operation, the company needs to consolidate, create a rock-solid platform and prepare itself for the rapid growth in the next phase.

I’d recommend manageable growth here rather than a very aggressive expansion plan. Maybe, Wendy could open 12-15 more stores in these two years.

The key aspects one needs to keep in mind in this phase are:

Systems, processes and procedures: Ensuring that systems and processes are in place, and getting them right is important. The company needs to have the right MIS (management information system) and must have documented the standard operating procedures. These systems should be able to support a much bigger weight in terms of store-count and sales when the company hits the ground real hard, later. The key items need to be documented since a lot of experiential knowledge and expertise may be only inside the entrepreneur’s head.

Hire people at the next level: It is now that the entrepreneur needs to hire more people at the junior level depending on the requirement – be it in retail operations or marketing or sales staff.

Modify the marketing mix: The company might need to shift the marketing mix in terms of reducing the branding expenses and increasing the store-level/local marketing spends. They could do this especially for the newer stores, in order to generate more customer traction there.

Ability to be nimble: Stay nimble. Be flexible in terms of experimenting with fresh ideas – be it new product launches or creative cost-cutting measures or innovative promotions.

Product mix: This one depends on the nature and complexity of the new products that we intend to launch. I’d recommend sticking to the company’s core offering (hand-made chocolates) in the first year. In the second phase, they could look at launching one or two more additional products (say, a chocolate milkshake or a choco-chip cookie) with the same premium positioning. The final launch should happen after sufficient customer surveys and market research. All new products need to have been identified before the start of the next phase, at which stage there should be no effort expended in further experimentation.

Phase 3: Aggressive growth

At this point, here are some broad ideas to ponder over:

Assuming phase 2 went off well, there is a potential to open 15-20 stores per year for the next two years across India’s top 20 cities. The market potential in cities beyond the metros and mini-metros is humongous.

Tilt product mix into higher-margin products: Different hand-made chocolate product categories would be at varying price ranges. It would be good to explore changes in product-mix and how it could be tilted in the direction of higher-margin products.

Going the e-commerce route: This is a fantastic opportunity if leveraged upon in the right manner. The strong brand pull and the offline store traction could propel online sales, which in turn could have rub-off effects on newer stores. It is important to get the supporting eco-system like logistics, payment gateways etc. right while expanding through this channel.

In each and every phase, the one thing I’d recommend the entrepreneur to focus on is to relentlessly track the key operating and financial metrics, and to act upon what she observes, while still keeping her intuitive sense intact. I believe that on being guided by these broad strategic and operational directives that have been laid out above, this company really has the potential to go great guns. Go Fiction Chocolataire!

IN BRIEF

Vijay Rajagopal, Investment Manager at Peepul Capital, recommends that the chocolataire-entrepreneur plan out her growth strategy in three phases – foundation, stabilisation (preparing for ramp-up) and aggressive growth.

Foundation Phase:

Open 3-4 stores in year 1

Focus on hiring senior people, branding, tracking key metrics, maintaining a handle on costs and supply chain

Stabilisation Phase:

Open 12-15 stores in years 2 and 3, put together

Focus on systems, processes and procedures, hiring more people, marketing push towards more store-level marketing, staying nimble and revamping the product mix

Aggressive Growth Phase:

Open 15-20 stores per year

Think about growth through e-commerce, tilt product mix towards higher margin products, in addition to maintaining checks on all the afore-mentioned aspects