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Self-Funded, Vertically Integrated-Part 2

Self-Funded, Vertically Integrated-Part 2

Hello and good day!

For the second day in a row, I'll be going full blown finance nerd.

My goal is to show that food supply chains tend to use the most expensive financing and distribution model available.

The result of this is lower quality food for customers and a lower standard of living for farmers. So much profit is eaten up by financing that manufacturers must cut corners in production and farmers must receive low prices for their crops.

I am going to do my best to explain this in a simple and straightforward way, as I realize that not everybody is as enamored with business numbers as I am.

Albert Einstein called compound interest the eighth wonder of the world.

If you start with a dollar and you earn 20% on it, you will end up with $1.20. If you earn 20% on $1.20, you will end up with $1.44. Do this seven times and you'll have $3.58.

This is why it makes sense to start saving young and let your investment returns compound. Seven times 20% is 140%. But through the power of compounding, instead of 140%, you get a 358% return.

Compounding like this happens in food supply chains. I've written about this many times in the past, so I will summarize here.

There are generally 7 or 8 middlemen between a cacao farmer and a chocolate lover. Each takes a profit along the way and the profit they take is on top of the price they paid to the previous player in the supply chain.

This means that if the average markup of each middleman is 20%, there will be a 350% increase in the price of the raw material by the time it gets from a farm to a chocolate lover.

But unlike interest in the example above, in which the interest is annual, and it takes 7 years to make 350% on the original investment, a cacao supply chain takes about 7 months. At least, that's how long it takes us.

To put this in perspective, the interest rate for business borrowing is generally somewhere between 5% and 15% annually.

Without even thinking this thing through very much further, you can see how borrowing money, even at very high interest rates, say 15% annually, and eliminating middlemen creates huge savings in the supply chain.

In our case, we pay essentially zero percent interest and we've cut out everybody.

We buy cacao off the tree. We sell chocolate products direct to customers. We own the raw material the entire time. The supply chain savings allow us to pay roughly ten times FairTrade premiums to our cacao farm partners.

We've freed up enough money to centralize post-harvest processing which leads to a much higher quality product.

And while our prices are not the cheapest, they are by far not the most expensive.

If you go out and look at other products that cost the same price per ounce as our products and turn them around to look at the ingredient list, you'll be surprised at what you find. In general, you'll find a lot of filler, namely oils and sugar. This is the result of the common method of financing and distribution.

Most people buy chocolate in a grocery store. The beautiful part of shopping in a grocery store is variety and convenience and the ability to price comparison shop.

The downside is that better products don't get to make a good case for why they cost a little bit more. All they have is their packaging and the price is on a tag down below.

For better or worse, most shoppers tend to go for the low-cost item. This tendency towards low prices works its way back through the supply chain, forces the manufacture to choose cheaper, less delicious ingredients, and sets a low starting price for farmers.

But if you do what we do, which is cut out middlemen and self-finance, you can square the circle.

High prices for cacao farmers.

High quality, delicious ingredients.

Fair, affordable prices for customers.

Now here is the problem and the opportunity.

Self-funding a supply chain with personal savings means that your footprint is going to be pretty small in the beginning, and the enterprise is going to grow relatively slowly.

Ditto if you only make chocolate with a single  rare variety of cacao that grows in a remote zone, far off the beaten path, in northern Peru.

Here at Fortunato Chocolate, we may be a billion dollar a year company someday, but it will take us 50 to 60 years from now at a minimum.We'd have to be a multi-generational family business for this to happen and that is fine by us, because that is what we want to be.

We're happy being who we are.

We don't have to answer to outside investors. We don't have to send our financial statements to a bank to justify our loans.

We're free.

However, this also limits the amount of cacao farmers we can help and the amount of chocolate lovers we can serve.

If a famous influencer were to mention us online, we'd sell all of our chocolate in a day and our regular customers would be out of luck.

Bank loans and equity investments are vastly, vastly superior and cheaper ways of financing chocolate and many other food supply chains.

The middleman model that is prevalent is by far the most expensive way to go and it causes suffering for customers and farmers, who frankly make the whole thing possible in the first place. The two players who should benefit most get a raw deal.

Collapsing and integrating supply chains through better financing and distribution would change this. And of course, as I have shown, there are huge profit opportunities available.

Somebody gets to keep the difference between the eliminated 350% markup and the cost of borrowing money which is 5% - 15%.

If you or anybody you know can raise a lot of equity or borrow big sums of money from the bank, disrupting food supply chains on a massive scale could be a great business. They can buy raw materials direct, make great products, and then only sell online or through company owned retail stores.

Our model writ large.

Thank you so much for your time today.

I hope that you have a truly blessed day!