Kalahari Bakery: A Chain Contract That Looks Like Growth
A Windhoek bakery bakes 8,000 loaves a month for retail sale at NAD 12.50 each, plus other lines, giving turnover of NAD 110,000 a month. Variable costs are 55% of selling price and fixed costs are NAD 48,000 a month, so the business is barely profitable. The oven can produce 15,000 loaves a month on a single shift. A supermarket chain offers a 12-month contract for 9,000 loaves a month at NAD 8.20 each, delivered to its depot, paid 60 days after invoice. Filling it needs a second shift (extra labour NAD 14,000 a month) and NAD 95,000 of equipment, repayable over 36 months at 12% a year, about NAD 3,155 a month. The business has NAD 12,000 cash and an overdraft of NAD 150,000, of which NAD 138,000 is used. The owner believes volume will solve her problems. The chain wants an answer in ten days.
1. Calculate the monthly financial effect of accepting the order at NAD 8.20 and decide whether to accept it.
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Step 1 - variable cost per loaf. 55% of NAD 12.50 = NAD 6.875 (NAD 6.88).
Step 2 - contribution per loaf on the contract. NAD 8.20 − NAD 6.88 = NAD 1.32. On 9,000 loaves that is NAD 11,880 a month.
Step 3 - extra fixed costs. Second shift NAD 14,000 + equipment instalment NAD 3,155 = NAD 17,155 a month.
Step 4 - net effect. NAD 11,880 − NAD 17,155 = −NAD 5,275 a month, or −NAD 63,300 over the year, before any interest on the extra working capital. The retail business, which currently survives on slim fixed-cost cover, would end up subsidising the chain.
Step 5 - the break-even price. NAD 17,155 ÷ 9,000 = NAD 1.906 per loaf, plus NAD 6.88 variable cost = NAD 8.79. At NAD 8.20 the owner is NAD 0.59 a loaf short of recovering the cost of serving the contract.
Decision: reject NAD 8.20 as it stands. The volume argument is exactly backwards: the contract adds 9,000 loaves of low-contribution work and NAD 17,155 of committed cost. A margin that is fixed by the buyer while costs are fixed by the bakery is a margin trap. Counter-offer, do not simply refuse.
2. Quantify the working capital effect of the 60-day terms and state what funding would be required.
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Receivables build-up. Contract revenue is 9,000 × NAD 8.20 = NAD 73,800 a month. At 60-day terms, the steady-state debtors balance is roughly two months of invoices: about NAD 147,600 locked up in the chain's account.
Available headroom. Overdraft limit NAD 150,000 less NAD 138,000 already used = NAD 12,000. The cash, NAD 12,000, is needed for wages and flour.
The gap. NAD 147,600 − NAD 12,000 = NAD 135,600 short, before the equipment deposit or any increase in flour and packaging stock. The bakery would be financing the supermarket's balance sheet with money it does not have.
The hidden cost. Assume 11% on NAD 147,600 for a year, about NAD 16,200, i.e. NAD 1,350 a month. Add that to the NAD 17,155 of extra fixed cost and the true cost of serving the contract rises to about NAD 18,505 - a break-even price of NAD 6.88 + (18,505 ÷ 9,000) = NAD 8.94.
Funding options, in order of preference: (1) 30-day terms, halving the debtors balance to about NAD 73,800; (2) invoice discounting or a debtor facility secured on the chain's invoices, priced at 2–3% of invoice value; (3) a NAD 180,000 term loan from the bank, only if the contract price has first been renegotiated above break-even. Accepting 60-day terms on a loss-making price would mean borrowing to fund losses - the classic route to insolvency for a small bakery.
3. Propose a counter-offer of at least three terms and justify each with numbers.
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Term 1 - price NAD 9.10 a loaf. Contribution becomes NAD 9.10 − NAD 6.88 = NAD 2.22 × 9,000 = NAD 19,980 against NAD 17,155 of extra fixed cost, a profit of NAD 2,825 a month. This is NAD 0.31 above break-even and leaves a cushion for flour inflation. If the chain insists on NAD 8.79 or less, the bakery is working for the bank.
Term 2 - 30-day payment, or a 3% settlement discount for 14 days. This halves receivables from NAD 147,600 to about NAD 73,800, cutting the funding gap from NAD 135,600 to roughly NAD 61,800 - within reach of an enlarged overdraft. A 3% discount costs NAD 2,214 a month at NAD 73,800, which is cheaper than NAD 1,350 a month of interest plus the risk of breaching the overdraft.
Term 3 - the chain contributes to the equipment. Ask for a NAD 30,000 up-front payment or a three-year volume commitment, and lease rather than buy the equipment so the asset is not stranded if the contract ends at month 13.
Term 4 - flour price escalation clause. Triggered if the miller's wholesale price moves more than 7%, with 30 days' notice. Bakery margins are destroyed by flour spikes, and a 12-month fixed price with no escalator transfers all commodity risk to the bakery.
Term 5 - minimum volume of 8,000 loaves a month, with the price rising to NAD 9.60 if volume falls below that, so the second shift is not paid for on a half-empty oven.
Framing: present this as a partnership proposal, not a rejection - the bakery can offer reliability, daily delivery and consistent weight, which is what the chain is really buying. If the chain will not move on price or terms, decline: the current retail trade is thin but survivable, and a 12-month contract signed at a loss is not.