First, spend a couple of sentences summarizing the Concepts in Article you read this week. Then, answer the following. In the Concepts in Action video you watched this week, what do you think the president of the bagel company mean when they called the Atkins diet unsystematic risk (note that ris

39333Concepts Article:

Laura Trust: So I was stationed in Hong Kong, where I was running a division of a large American public company, and we decided to leave corporate America, and do something on our own. And we chose bagels. We found Finagle to be an appealing opportunity for one primary reason, and that was, we thought it had a nice little brand. And we thought we could grow the brand here, and outside of New England eventually. So, that’s what attracted us to it initially.

From a financial perspective, the company had four stores, and they did very high volumes at the time, and the margins were quite good. And we saw that there was an opportunity to grow, both on the retail side, and, at the time, there was a small wholesale business, which allowed for additional revenue for the company and to maximize the equipment and the back of the house operations. So there was a lot of opportunities.

Hi, my name is Laura Trust, and I am the owner and co-president of Finagle a Bagel.

Alan Litchman: Hi I am Alan Litchman, and I am co-president and owner of Finagle a Bagel. And we like to take gigantic baby steps, which means we try and take, you know, strategic steps, but try and minimize your risk. Okay? And there are some things we’ve done incorrectly, that have cost us a little bit of money, so it’s not the biggest deal. But there are some things we’ve done incorrectly that have cost us a lot of money, and, yeah, sure I’d like to have those over.

Trust: When we were looking at growing the business, our strategy was to get it to be about 20 stores, which, we thought, was when you start to show up on the radar of some of the bigger companies. We were told that “the thing you want to be is a franchisor.” The reason why there are so many franchises out there is, for the franchise alone, the owner of the concept, it’s the quickest, and the most profitable, and the least risky way to grow.

And certainly, that requires the least amount of capital. Because for us to build a store was very expensive. For us to allow somebody else to build the store, and just take, you know, the money off of the top, is obviously, you know, a much more profitable way to go.

So we were—I don’t know—weeks away from signing a document, potentially, with this company, and when the economy fell apart and credit dried up, the deal fell apart because the franchisees, obviously didn’t have access to credit any longer. So we had a real problem on our hands. We had 21 stores in the worst retail economy that the country had seen in a century, and we really didn’t know what we were going to do. The differential in the revenue at the store level was, essentially, the profit. So if your revenues go back down by 10 or 20 percent, that’s all profit. So while the people were still coming into the stores, the hit that we took, and the retail world had taken, really affected the business, and the cash flows in the business.

Litchman: The CAPM is an effective way to calculate risk. I believe you have to come up with some assumptions on it, to try to understand what’s your risk/ return, and what’s your risk-free return, and, yes, it’s an immensely helpful tool to use. And it’s something that you need to sit back and really understand it. And not to simplify things, but no business is run by itself. You know, we have staff, which is necessary, controllers and accountants and we have outside advisors. Everyone needs to understand these terms and try your best to adequately use them when you’re making decisions.

Trust: So we said to ourselves, “Okay, wait a minute, we have a great product, we have a good brand in New England…how do we exploit that piece of the business?” Because we spent 10 years building this brand, we can’t obviously just, you know, give up on it. And we’ll go bankrupt if we don’t do something. So we decided to start a new business, an entirely new business—a wholesale business—and wholesale our branded bagels to the grocery stores. We had already moved into this facility, which we had actually bought, thinking that we were going to be supplying hundreds of franchisees, so it had tremendous capacity and a lot of flexibility. And we shifted gears and said we’re going to make the best grocery store bagel we can possibly make and see if we can sell it into the grocery store/wholesale market.

Litchman: Risk in the wholesale business is a wonderful question, and it takes a little bit of imagination in the sense that, what we tried to do in our stores is we make a unique product. We make, in essence, a hand-crafted unique product, and what we wanted to do was bring that to the masses, or bring that to the grocery stores. And to do that is difficult. How do you mass produce something that’s hand-crafted? And we took a lot of time and energy, and we researched a lot, and we decided the best way to do this was to come up with state-of-the-art, or apply state-of-the-art freezing technology, and let’s not change the essence of the bagel.

So to jump in the wholesale business was adding a few million dollars in hard assets to the company. But it also involved about a million and a half dollars’ worth of funding the company while we made the transfer. Because you end up with losses. When you’re trying to switch a company around, you’ve got to fund something that’s ongoing to switch it. So we have, you know, I don’t know if it’s three or four million dollar losses in totality on the new investment in the company. Hey, that’s a lot of money!

Trust: While we were starting up this new wholesale business, at the same time we really needed to pare down the retail stores. So we began getting out of, or closing stores where leases were coming up. The one good timing thing with the recession was it came after essentially 10 years of business. And many of our leases were up after 10 years. You sign a lot of 5-year, 5-year or 10-year leases, so we had the opportunity to close a lot of stores when the leases were up around that time and we began doing that.

Litchman: It’s, you know, the things like in the years we’ve rolled into this company, no one could have foreseen the Atkins issue, um…being an unsystematic risk, which would be, you know, “the carbs are bad for you”, and it was a very difficult six months or eight
months. You know, I remember seeing that. Systemic risk, we try and think it through. We try and understand what’s there, you know, leasing the space, coming up with new product lines. What’s it going to cost? I mean, the building we’re standing in had an electrical issue, and we had to add a $100,000 generator. Okay? I mean there are things that we think about.

To ask the question “if we’ve seen a fair return on original investment” is a complicated question. We bought the company, and the money we spent…we bought 60% of the company, and the money we spent on the 60% of the company has been a home run. Okay? While it was a fair amount of money at the time, in the scheme of what we have today, and what we’ve grown, and what we’ve taken out of the company, the profits we’ve made over the 14 years, that’s inconsequential. It’s an infinite return, and it’s wonderful.

If you ask the question about all the monies that we’ve invested since we’ve owned it, yeah, some of them would have negative returns. We try and look at it as a project by project basis, instead of its totality. And some of them, they’re wonderful, and some of them have been horrible. And I like to use baseball terms. And we try and hit doubles all the time, you know, it’s really hard to hit home runs, and you never want to strike out.

Trust: Today, after all of the work that we’ve done over the last two to three years, we are in a much better place than we were. And I think we’re where we hoped we would be when we came up with this strategy three years ago. I will say that the last two to three years was very difficult. And it was very risky in that we didn’t know if we would be successful in the wholesale business, or if we would get them…if we would get to the break-even that we needed to run the plant. A lot of that was a pure gamble. Closing 14 stores, which is essentially your only source of revenue, was very scary. We had to really take a leap that this was the right thing to do. And that, when we got rid of the stores, that the remaining stores would be able to support the infrastructure and the overhead that we had built up, planning on having 100 franchises. There was a fair amount of overhead. So it was very risky on both sides.

Litchman: You know, we’re 18 months or 24 months into it, and the run rate just looks like it’s going to really prove to be a good decision.

Requirements:

Your discussion board response should be approximately 200 words. APA format for all references is expected – at the very least, your textbook should be listed as a reference for your discussion board posting.

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