The Qormi Bakery's Automation Decision
A family bakery in Qormi employs four production workers, each costing about €1,300 a month including social security contributions. With them it produces and sells 20,000 loaves a month at €1.20 each, which is its full capacity. Materials and energy cost €0.45 a loaf. Rent, insurance and administration come to €3,000 a month and do not vary with output. The owners are offered an automated line for €180,000 that would raise capacity to 26,000 loaves and cut the workforce to one production worker; maintenance would add €1,500 a month. A bank will lend the full amount at 5% a year over ten years. The owners know they cannot sell more than about 22,000 loaves at the current price without starting a price war with two larger competitors, and that they could at best sell 26,000 only by cutting the price to €1.00. They must decide whether to buy the machine.
1. Calculate the bakery's monthly profit now and the profit it would make with the machine selling 22,000 loaves at €1.20. What does the comparison suggest?
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Now (20,000 loaves):
- Revenue = 20,000 × €1.20 = €24,000
- Materials and energy = 20,000 × €0.45 = €9,000
- Labour = 4 × €1,300 = €5,200
- Overheads = €3,000
- Profit = 24,000 - 9,000 - 5,200 - 3,000 = €6,800
With the machine (22,000 loaves):
- Revenue = 22,000 × €1.20 = €26,400
- Materials and energy = 22,000 × €0.45 = €9,900
- Labour = €1,300
- Maintenance = €1,500
- Interest = €180,000 × 5% = €9,000 a year = €750 a month
- Overheads = €3,000
- Profit = 26,400 - 9,900 - 1,300 - 1,500 - 750 - 3,000 = €9,950
Profit rises by €3,150 a month, or €37,800 a year. Against a €180,000 outlay that is a payback of about 4.8 years - inside the ten-year loan and, presumably, the machine's working life. The investment also lowers the break-even volume: fixed costs fall from €8,200 to €6,550 a month (interest included), so break-even falls from about 10,933 loaves to about 8,733 at a €0.75 contribution per loaf. That margin of safety is worth as much as the profit figure.
2. The owners are also tempted to use the new capacity to sell 26,000 loaves at €1.00. Evaluate this.
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Run the numbers rather than the instinct that more output must be better.
26,000 loaves at €1.00:
- Revenue = €26,000
- Materials and energy = 26,000 × €0.45 = €11,700
- Labour €1,300 + maintenance €1,500 + interest €750 + overheads €3,000 = €6,550
- Profit = 26,000 - 11,700 - 6,550 = €7,750
That is €2,200 a month worse than selling 22,000 at €1.20, despite 4,000 more loaves and a fully used machine.
The reason is that the price cut destroys contribution faster than volume creates it. Contribution per loaf falls from €0.75 to €0.55, a 27% fall, while volume rises 18%. Each extra loaf contributes €0.55 but the existing 22,000 each give up €0.20 - a loss of €4,400 that the extra 2,200 contribution cannot cover.
The same logic warns about the price war itself. Two larger competitors can match a €1.00 price, and if they do, the bakery ends up with the low price and its old volume. Cutting price to fill capacity is only rational where demand is elastic and the extra volume is genuinely additional, not taken from existing customers.
3. Beyond these numbers, what should the owners weigh before committing?
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Several things the profit calculation does not capture.
Demand risk. The €9,950 assumes 22,000 loaves actually sell. The machine's advantage over the current set-up is that fixed costs are lower but the €180,000 is sunk - if sales fall to 18,000, the machine still has to be paid for. The current labour-heavy structure is flexible: workers can be reduced in a bad month; a loan cannot.
Redundancy and reputation. Three workers lose their jobs in a family business in a village where everyone knows everyone. There may be statutory redundancy costs, and the loss of craft knowledge matters if customers value the current product.
Technology risk. A first-generation automated line can be superseded; the loan runs ten years and the machine may not.
Alternative uses of €180,000. A second delivery van, longer opening hours or a wholesale contract with a supermarket might raise profit with lower fixed commitment.
The numbers support the investment at 22,000 loaves. The judgement is whether that demand is secure enough to justify converting flexible labour costs into an inflexible capital commitment - and that is a question about risk, not arithmetic.