Lessons from cupcakesArticle added by Bob Seawright on January 15, 2010
Bob Seawright

Bob Seawright

Joined: December 18, 2008

My neighborhood shopping center here in San Diego now has a cupcake store. And many local caterers have even suggested that my daughter forgo the usual wedding cake for cupcakes when she's married early next year.


I'm not sure why, but it seems that this apparent trend is not limited to my locale. According to The New York Times, cupcakes are now hot nationwide.

It's still unclear if this trend will become an ongoing and viable business model. I have my doubts. But it's still instructive for us to take a look at how one Denver-area confectioner summarizes her business model and profitability:

For each cupcake she sells, Ms. Lovely figures she spends 60 cents on ingredients, 57 cents on mortgage payments and utilities, 48 cents on labor, 18 cents on packaging and merchant fees, 16 cents on loan repayment, 24 cents for marketing, 18 cents for miscellaneous expenses and 4 cents for insurance. That totals $2.45, leaving a potential profit of 55 cents on each $3 cupcake.

So far, the per-cupcake margin is going to pay down start-up expenses. She's been selling the 2,800 cupcakes a month she calculates she needs to sell to cover her costs -- she's taking only a small salary for now -- but she says it's too early to predict when the store will turn profitable, in part because of the economy and in part because she fears losing business to rival cupcake entrepreneurs.

Ms. Lovely is in the process of rebranding the shop to overcome what she calls "a typical rookie mistake" of underestimating "the power and importance of branding and marketing." She said she had to do more to tell customers that her cupcakes were made from organic, local and natural ingredients.

Ms. Lovely's overview of cupcake economics provides a fine illustration of three crucial points in the economics of competition, which apply to the financial services business, as well as to cupcakes.
    1. Costs matter. If you want to stay in business in a competitive market, you've got to keep a close eye on costs. Even though it should be obvious, a business owner absolutely must cover costs to stay in business -- and one of those costs needs to be a living wage to the entrepreneur for the business to be viable. Costs have a direct and lasting impact on the bottom line. On the other hand, costs can and need to be money well spent, too. Marketing is necessary for a business to grow. So is paying for and retaining competent staff. Prudent spending will more than pay for itself. Do you have an in-depth understanding of what your costs are and how those costs impact your bottom line? If you don't know the return on investment for every business line and for every business source within your business, you're flying blind and susceptible to a major crash.

    2. Competition matters. Rivals can and will eat into your profits. If cupcakes are a good idea, other bakers will follow. In the same way, competitors new and old will attack you and your business every single day. In the financial services business, since every competitor has access to most of the exact products and to all of the types of products that everyone else has, it is imperative that each professional stay current about the newest products and trends within the industry, as well as with what each specific competitor is doing. The idea that knowledge is power is a cliché, but it's a cliché that is absolutely true. The ethics of our business rightly require that we know our customers. The realities of business require that we know our competitors, as well.

    3. Differentiation matters. Differentiation can be difficult in a business that's largely fungible. But to have any chance of making a profit in the long run, producers must differentiate themselves. That said, different isn't necessarily better. The differentiation that really matters is a difference that separates you from the pack. Clients need clear reasons to come to you and to keep coming back to you. Build a brand based upon quality, service, and integrity, and clients will keep coming despite the best efforts of the competition.
If Ms. Lovely's cupcake business survives, she will learn another crucial aspect of business economics -- consistency matters. Each cupcake is a new audition. One bad cupcake may not lose an established customer, but a quick recovery and a return to consistent excellence is imperative nonetheless. In our business, each client interaction is both an opportunity to shine and a huge risk. Clients have many advisors from which to choose. We need to keep giving them reasons to come back and even to refer new clients to us. Every client interaction needs to be thought out and maximized.

Our futures depend upon it.

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