Vending may be the last truly viable business opportunity for someone with entrepreneurial skills to earn a good income. As much as the industry has consolidated and it has become more expensive for a business to play in the "big leagues," there is still room for the small guys. I don't expect this will change in the foreseeable future.
The story of yesteryear
Back in the mid-1950s, I was attending Boston University as an undergraduate. I had a lucrative summer job with a carnival that enabled me to earn my full tuition, purchase an Italian motor scooter, and even have enough money left over for personal spending and saving. I was living at home at the time, and tuition was $300 per semester. As an accounting and finance major, I had a consuming interest in business and investment, and I was actively looking for a place to invest my limited savings.
As a summer manager of 19 games of chance on the carnival lot, I was amazed at how fast coins added up to real money. And, in an attempt to learn all that I could about my job, I was an avid reader of The Billboard, which was the major trade magazine for the carnival industry. Interestingly enough, The Billboard was the first trade paper to address vending as an industry. I contacted some of the vending advertisers and started to investigate vending as a business.
Before long, I was routed to a local Boston distributor, and I purchased four Acorn bulk vending machines, with 8-pound glass globes. The machines cost approximately $15 each, and the "arithmetic" for the business was fairly simple.
Low purchasing costs
Using gumballs sized at 240 count per pound, each globe would hold approximately 2,000 gumballs. At the time, ball gum could be bought for approximately 30 cents per pound, so a globe full of gum cost approximately $2.50. At a selling price of a penny, the machine would gross $20 when empty, which produced a gross profit of $17.50, or 87.5 percent before any other expenses. And, I had few other expenses.
Gasoline cost less than 25 cents per gallon in those days, and my little motor scooter could deliver 125 miles per gallon. Even after the business grew, and I attached a home-made trailer to the scooter, I still got better than 80 miles to the gallon.
The only other serious expense I encountered was location commissions. However, in those days, I was my own "charitable affiliation." I was able to sell most of my locations on the proposition that I was working my way through college, and I needed all the help I could get. Many of the customers charitably allowed me to place machines on a no-commission basis.
ROI was a new concept to this operator
I started the business at the beginning of my freshman year, and I hadn't yet reached the chapter in my Introduction to Accounting textbook that dealt with Return on Investment (ROI). But I had good instincts. I knew that any business that allowed you to recover your full investment in equipment and inventory, with only one inventory turn, couldn't be bad.
Remember, this all took place long before strip malls, discount department stores, convenience store chains and supermarkets dominated the retail landscape. My typical location was a mom and pop variety store, small grocery store or a family restaurant. They were not high-volume locations. My average machine grossed 80 cents per week, so it required more than 24 weeks for the average machine to go empty.
However, the good news was I was earning better than a 200 percent return on my investment per year, based upon my simplistic ROI calculation. Needless to say I was excited, and I couldn't wait to grow the business.
Two machine placements a day
Every day, I would load two new filled machines into the trailer, and after classes, I would cold call on potential locations. I refused to come home until I found a home for the two new machines. By the end of my sophomore year, I had more than 800 penny gum machines located in every ethnic neighborhood in the city. I owned a small business that was producing more than $500 per week in "profits," I was my own boss, and I truly felt like I was in tall clover. My original capital investment had to be less than $2,000; however, I reinvested almost every dollar the business produced during this period.
An outstanding business for its time
Just to give you some perspective, at the time my dad owned a successful, small meat and grocery market. My penny gumball business was earning twice as much as his market. And when I passed the CPA exam a couple of years later, Price Waterhouse offered me a job as a junior accountant at the then magnificent salary of $67.50 per week. I had an easy choice to make. I couldn't afford to become an accountant. I was hooked on vending.
I tell this story not just because I'm proud of it, but to illustrate how a vending neophyte approaches this business from an investment point of view. As my education continued, I realized my 200 percent ROI calculation was a little optimistic.
The real ROI was much different
I neglected to include the depreciation expense for approximately $12,000 worth of equipment, and the depreciation, insurance and operating expenses for the Volkswagen van I had to buy to replace the scooter, (which lacked the power to haul all the pennies I was collecting), or the coin counter I had to buy. And, I didn't impute a rental cost for the family garage I was using or the cost of family members who fielded telephone calls for me from customers and suppliers, or any of the other costs that "real" businesses face. But most important of all, I didn't impute a cost for my own time and effort.
In addition to carrying a full load of classes for the better part of two years, I was working at least 10 hours a day, six or seven days a week, for no salary. I was the salesman, installer, route man, mechanic, cashier, bookkeeper, buyer and general manager. How do you place a value on that level of passionate dedication and energy? The fact is, you can't. I would have had to hire at least two people to do the work I was doing, and then, because it was a cash business, a third person to keep the first two honest.
Most ventures begin part-time
What I'm suggesting is that most people who start a vending operation do so in an effort to earn extra money. Most start on a part-time basis, and hope to build it into a full-time job. Vending is both an "easy-entry" business and a very forgiving business. It can be started working out of the home, and the operator can decide how fast to grow it.
Because of these qualities, it is very attractive as a small business. The entrepreneur who decides to proceed rarely does an ROI analysis. He usually does so based upon the same kind of simple arithmetic I used to quantify the bulk vending business. Based upon the cash flows, how long will it take to build the business to the point where it will support me?
Costs have changed, not principles
Picture an administrator who earns $50,000 per year working for a large company. He is concerned that his job may disappear, or that there is little potential for advancement. He investigates vending and learns that he can buy new or slightly used glassfront snack machines and can and bottle cold drink machines at an average cost of $2,500. (Some equipment may be more expensive, but he has learned that he can beg, borrow or rent some equipment at little or no cost from bottlers.) He has enough equity in his home so that he can finance the purchase of equipment at a 6 percent rate. For a fee, equipment distributors are happy to arrange delivery of equipment to his locations.
Beginning start-up costs are low
He owns an SUV that has enough space to haul product, enough space in his garage to store some product or the occasional idle machine, and he is content to use the local vend product distributor as his warehouse. Although he has never sold anything for a living, he is outgoing, gregarious and very active in the church and the community. He has lots of friendly contacts.
Through trial and error, he has learned to solicit only locations that will produce average, minimum sales of $100 per week, per machine, and keep his commission costs below 10 percent of sales. He prices his products so that he derives a 50 percent gross profit. With this kind of profile, each machine should produce something in excess of $40 per week, less the cost of gasoline, minimal repair parts costs, and the interest he has to pay on his home equity loan. A $40 per week contribution will retire a $2,500 loan, at 6 percent interest, in approximately 15 months, including the cost of the interest.
25 machines can put him in business
The bottom line is that it will only require approximately 25 paid off machines to replace his $50,000 per year salary. Properly scheduled, he will have to devote less than two days per week to service these machines, and many of them can be done on the weekend. At some point in time, he gives up his full-time job to devote full time to vending.
If he continues to operate as a one-man business, it is entirely conceivable that he can easily earn more than $100,000 per year. However, if he attempts to grow the business beyond that point, his operating costs, profit, and his ROI will change dramatically.
The next stage takes more investment
The day he outgrows his garage and has to rent an outside facility is the day his costs start to resemble the real costs of running a business. In addition to rent, the new facility will require heat, light, power, insurance and telephone costs, and somebody will have to be hired to answer the phone and receive merchandise.
In order to provide the additional revenues to pay for all of this, he will have to add more customers and machines. In order to do that, he will have to hire and train a route person to replace himself so that he can spend more time on sales.
He will also need another vehicle since the new route person will be using his truck. And, he will have to pay competitive wages and benefits to retain his newly hired staff. In short, it is entirely conceivable that even if he doubles the size of the business, he may not be able to pull any more out of it than he could as a one-man operator.
ROI varies by size of business
The point I'm attempting to make is that the ROI in a vending business will vary considerably depending upon the size of the entity. In a one-man business, operating out of a home, it may be possible to earn a realistic 40 to 50 percent ROI.
However, as the business outgrows the home office and garage, and requires realistic staffing, the ROI starts to approach more realistic levels. The question often asked is what is a realistic level of ROI for a mature business? I recently read that one economist estimated the average ROI of all of the companies listed on the New York Stock Exchange is 15 percent.
ROI is one of the better measurements of the health of an enterprise. It is calculated by dividing the income earned by the capital investment required to earn that income. Generally speaking, investors are willing to accept lower returns for safer investments, and they demand higher returns as the risk of loss increases.
Low risk, low ROI
If, for example, you invested $100,000 in a government bond, and it paid $4,000 per year in interest, your ROI would be 4 percent (4,000/100,000 = .04). One reason the ROI is so low is the fact that the bond is backed by the full faith and credit of the U.S. government. A corporate bond issued by a well rated corporation carries more credit risk, and may have to offer 7 or 8 percent to attract investors. And if you choose to buy stock in a publicly traded company, you may be well advised to choose a company that delivers a 15 percent ROI if you expect the value of your stock to go up.
How about investing in a small, closely held, vending company? What kind of return would you be looking for? It certainly carries more risk than buying a government bond, or investing in a well rated corporation. Furthermore, it wouldn't be a "passive" investment where you simply wait for the mailman to deliver your interest check.
Reasonable ROI: 20 to 25 percent
In addition to putting your capital at risk, you have to assume the burden and responsibility of management. I personally feel that 20 to 25percent is a reasonable ROI target range for smaller, closely held businesses, where the owner's compensation is handled as an expense in calculating the ROI.
Having said that, I should point out that comparing ROI numbers in the vending industry is a difficult exercise. Privately held companies still do the lion's share of the volume in our industry, and accounting standards and business practices vary considerably in smaller, closely held companies.
How costs are capitalized can vary
For example, the tax code suggests that the total cost of improvements made to a piece of equipment that materially extends the useful life of the equipment should be capitalized; i.e., the total cost for labor, freight and parts should be added to the value of the asset on the balance sheet, and the expense should be recognized as depreciation over the extended years of useful life added.
If you simply repair a machine and the repair will not extend the useful life of the asset, the total cost should be "expensed"; i.e., the total cost should be charged against the current year's income.
With this in mind, if you normally depreciate vending equipment over an eight-year cycle, how would you handle the cost of replacing a compressor in a 2-year-old drink machine? Would your answer change if the machine was 7 years old? It's a judgment call.
Expense and profit calculations
If you choose to capitalize these costs, you reduce the current year's expenses, and therefore increase the reported profits and ROI. If you expense these costs, you increase current expenses and therefore decrease reported profits and ROI.
Most smaller, privately held companies make this decision based upon the tax consequences, and expense these costs whenever possible. Larger, publicly held companies tend to want to inflate current profits, (which drives their stock price), and capitalize these costs whenever possible.
Compensation vs. reinvestment
Another common point of difference is the amount of salary paid to the owner/manager. In two companies that are exactly the same size with the same operating costs, one owner may feel entitled to a $100,000 salary. The other one may choose to live less opulently, on a salary of $50,000 and leave the remaining $50,000 on the balance sheet for growth. Obviously, the owner that only draws $50,000 will report higher profits and show a higher ROI. So, if you are comparing your ROI with a friendly competitor, make certain you are accounting for expenses on the same basis.
If you use ROI as a basis for monitoring change in your own company, year to year, or in bidding a new piece of business, I applaud you. It is one of the more valid measures of your management skills.
In a one- or two-person operation, ROI is not the most appropriate measure of success since the owner wears many hats. The only relevant challenge is cash flow: Is it sufficient to support the owner/manager? This being the case, vending will continue to attract entrepreneurs who are satisfied with a comfortable income
Today's start-up financials Start-up costs Loan to cover average soda machine cost $2,500 Borrowing cost 6% $40 per week contribution Pay off (including interest) in 15 months
Allan Z. Gilbert is founder and managing partner of Merrimac Consulting Group, Billerica, Mass. He provides equipment financing, consulting and business brokerage services to the OCS and vending industries.
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