A Paper-Bag Unit Behind a Plastic Ban
A final-year commerce student in a tier-3 town plans a paper-carry-bag unit after the municipal plastic ban. His survey of a 40 km radius found six existing units running at about 55% of capacity, roughly 220 kirana and medical retailers, and one 180-bed hospital that buys 40,000 bags a month but pays at 45 days and rejects any consignment with more than 2% defective bags. Retailers currently pay ₹1.55 per bag; the hospital pays ₹1.95 but insists on a food-grade certificate. Variable cost works out to ₹1.32 a bag and fixed costs ₹26,000 a month. An investment of ₹12 lakh (₹9 lakh machinery, ₹3 lakh working capital) can produce 5 lakh bags a month. He expects to capture 1.2 lakh bags a month from retailers in year one. His father wants him to join the family hardware shop, or take a bank job paying ₹22,000 a month.
1. Compute the break-even quantity and the expected monthly profit, and judge whether the plan is viable.
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Contribution per bag: ₹1.55 − ₹1.32 = ₹0.23
Break-even quantity: ₹26,000 ÷ ₹0.23 = 1,13,043 bags a month
At his expected 1.2 lakh bags: contribution = 1,20,000 × 0.23 = ₹27,600; less fixed costs ₹26,000 = ₹1,600 profit a month.
Judgement - the plan fails as designed, for four reasons:
- Margin of safety is 3%. He must sell 94% of his projected volume just to break even. One lost retailer wipes out the profit.
- No cushion for price competition. Six units are idling at 45% spare capacity; the obvious competitive response is a price cut. At ₹1.50, contribution falls to ₹0.18 and the break-even jumps to 1.44 lakh bags - more than he expects to sell. At ₹1.45 he loses money on every bag sold at full projected volume.
- Payback is absurd. ₹12 lakh invested against ₹1,600 a month takes roughly 75 years; even ignoring interest and depreciation, the return is below a savings account.
- Opportunity cost is ignored. The ₹22,000 bank job is worth more than thirteen times the projected profit, and the hardware shop earns something real today.
What would change the verdict: a much higher contribution (differentiation, not commodity bags), a much larger volume with the same fixed cost, or added revenue streams from the same machinery (carry bags plus bakery and grocery pouches), which spread the ₹26,000 fixed cost over more units.
2. Should he pursue the hospital contract? Quantify it and identify the hidden costs.
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Direct arithmetic: 40,000 bags × (₹1.95 − ₹1.32) = ₹25,200 contribution a month - sixteen times the retail-only profit. Even after the certification and rejection costs it is the better segment.
But price it properly:
- Receivable financing. 40,000 × ₹1.95 = ₹78,000 of monthly billing on 45-day terms, so about ₹1.17 lakh is permanently locked in receivables. At 12% cost of funds that is roughly ₹1,170 a month of interest - small, but it must be funded, and his ₹3 lakh working capital will be consumed quickly if he adds retail debtors on top.
- Rejection risk. A 2% rejection limit on 40,000 bags is 800 bags; at ₹1.32 variable cost, a rejected lot costs ₹1,056 to produce and nothing to recover. Repeated rejections above the limit can lead to termination.
- Certification and consistency. A food-grade certificate costs money and time, and the hospital will audit consistency, not just the certificate. Cheap recycled paper that tears or bleeds is a rejection waiting to happen.
- Concentration risk. One buyer taking a third of output can dictate terms, delay payments and demand price cuts.
Verdict: pursue the hospital, but negotiate a purchase order with defined specifications, a sample-approval stage, payment within 45 days, and a written rejection procedure. Use the hospital's ₹25,200 contribution to cover the ₹26,000 fixed cost, then treat every retail bag as almost pure contribution. On a combined mix of 40,000 hospital plus 1.2 lakh retail bags, profit becomes about ₹25,200 + ₹27,600 − ₹26,000 ≈ ₹26,800 a month - viable, but only with the institutional anchor.
3. What feasibility checks must he complete before spending the ₹12 lakh, and what would make him walk away?
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Checks that convert a survey into a decision:
- Demand validation, not estimation. Get written or documented interest - purchase orders, letters of intent, or at minimum a signed list of 30 retailers who will switch at a stated price. "220 retailers exist" is not demand.
- Competitor reality check. Visit two of the six units. Ask why they are at 55% - machine downtime, labour, paper price, or lack of buyers. If it is lack of buyers, his capacity plan is fiction.
- Price test. Quote ₹1.55 and see who actually buys; if the market clears at ₹1.45, the project is dead on arrival.
- Machine and paper economics. Confirm rated output per hour, wastage, power load, and the current price and availability of kraft paper locally; a paper price rise of ₹0.05 a bag erases a fifth of his contribution.
- Working-capital stress test. Model the worst month: 45-day hospital payment, retail cash sales, a rejected consignment, and a paper bill due. If the ₹3 lakh does not survive it, the project is undercapitalised.
- Break-even sanity check at a lower price. Run the numbers at ₹1.45, ₹1.50 and ₹1.55 and see how narrow the viable band is.
Walk-away triggers: confirmed market clearing price at or below ₹1.45; inability to get even one institutional buyer; machinery quotation that leaves no working capital; and any requirement to borrow at more than about 12% for a business earning ₹1,600 a month on the base case. If those triggers appear, the ₹22,000 job is not a fallback - it is the rational choice, and he can revisit the unit after a year of saving and market observation.