The Coffee Roaster's Lease Decision
Ridgeline Roasters is a small wholesale coffee business roasting 1,200 kg per month in a rented industrial unit. Its lease expires in three months. The owner, Priya, has two options. Option A: renew the current 300 m² unit at $4,200 per month. Option B: move to a 500 m² unit at $6,800 per month, which would allow a second roaster and a small dispatch dock. A second roaster costs $85,000 and would lift capacity to 2,000 kg per month, but the business currently sells only 1,150 kg per month and its largest customer, a café chain, has hinted it may cut orders by 30% next year. Priya's gross margin is $9 per kg. She has $60,000 in cash and would need a loan at 9% interest for the roaster. Staff would need retraining, costing about $8,000. Her accountant warns that fixed costs must be covered before any expansion pays off.
1. Calculate and compare the monthly fixed cost position of each option, then advise Priya on which lease to choose. Justify your recommendation with figures.
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Option A fixed costs: rent $4,200 per month. No new loan, no retraining.
Option B fixed costs: rent $6,800 + loan interest. The loan needed is $85,000 − $60,000 = $25,000 if she uses all cash, or $85,000 if she preserves cash. At 9% on $85,000, interest is about $7,650 per year, or roughly $638 per month. Add retraining amortised over, say, 12 months ($667/month) and rent, giving approximately $8,105 per month before any variable costs.
Break-even gap: Option B adds about $3,900 per month of fixed cost. At a $9 gross margin per kg, she needs roughly 433 extra kg sold per month just to cover the added fixed costs - that is, sales of about 1,583 kg against current sales of 1,150 kg.
Judgement: The demand signal is negative, not positive. The café chain's possible 30% cut would reduce volume by about 345 kg, pushing sales to roughly 805 kg. Under those conditions Option B's extra capacity is idle and the added fixed costs become a loss. Recommend Option A (renew), or negotiate a shorter lease with an option to expand, because the expansion only makes sense once demand is confirmed above roughly 1,600 kg per month.
2. Identify the operations risks in Option B and explain how Priya could reduce them without abandoning expansion permanently.
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Risks:
- Capacity mismatch - buying 2,000 kg of capacity against 1,150 kg of demand creates idle assets and spreads fixed costs over fewer kg, raising unit cost.
- Customer concentration - one café chain can remove 30% of volume; losing it after signing a larger lease leaves Priya committed to rent she cannot service.
- Financial risk - a loan at 9% adds a fixed obligation that must be paid regardless of sales, reducing her buffer if demand falls.
- Operational disruption - retraining and a move can cause quality or delivery problems during the transition, risking existing customers.
Risk reduction without abandoning growth:
- Negotiate a lease with a break clause or a 12-month term with an option to renew, so commitment matches uncertainty.
- Confirm the café chain's intentions in writing before committing; seek a minimum-order agreement.
- Lease rather than buy the second roaster, or buy refurbished, converting a capital cost into a variable one.
- Secure one or two new wholesale customers before expanding, so added capacity is matched by contracted demand.
- Phase the move: stay in the current unit, add a smaller roaster if feasible, and relocate only when volume passes roughly 1,600 kg.
This preserves the growth path while ensuring fixed costs do not outrun confirmed demand.