It’s no secret I love the Fourth of July. Independence Day is my favorite holiday. From the food to just blowing stuff up, I love it all.
In recent years I’ve taken a big interest in operating my own fireworks store. Fireworks provide exceptional gross margins of up to 80% (a $100 retail price costs the store $20), which should allow for excess profits.
In the last few weeks, I’ve been doing some light research in my free time to discover just how much profit potential there is in my local area. So now I’ll lay out my back of the envelope analysis just for the record.
Local fireworks market
4 local competing stores
$900,000+ of annual retail sales
$40,000 in total marketing spend
Following a state-wide ban of fireworks stands (roadside vendors selling in a tent, not a building) competition has dwindled. Only two incumbents own substantially all the fireworks business in my local area.
Competitor number one primarily serves a state border, grabbing sales from travelers who cross state lines to purchase what they couldn’t in their home state. Seeing as this location is a good 20 minute drive from my city, it isn’t really a strong competitor for local, in-state business (people who don’t need to cross state lines to get the good stuff).
Competitor number two is actually a multi-location mattress store that makes the switch every June and July to capitalize on fireworks sales. He owns virtually 100% of the market inside the city, as the ban on roadside vendors cracked down on fly-by-night competitors. Three locations service my city.
Using state revenue data from 2008, I estimate that the average person in my state spent an average of $7.80 per person on retail fireworks in 2011. Assuming an even distribution of wealth and firework sales, my city is worth upwards of $900,000 in annual retail sales. This is a fair assumption given that my city is above the state average household wealth measures.
Cost of customer acquisition
Competitor number 2 ran advertising campaigns worth $5,000 combined on the two leading television stations in my area. Given that these two networks are the highest-rated, one can assume total TV spend of $10,000. Assuming another $10,000 on radio/billboard and other print media, we come to total spend of $20,000 for four locations.
Total spend by all competitors comes to $40,000 on the high end to capture $900,000 in total retail sales. Incumbents have little competition, so naturally they cut out the marketing spend.
Is it profitable?
High gross margins are one of the most tempting, but least important metrics in all of business. Jewelry stores, pizza restaurants, and lawyers all have high gross margins. However, the costs of customer acquisition drive net margins into the ground. In the case of jewelry stores, low inventory turnover reduces returns on capital.
Fireworks, however, are different in that a “right-sized” store should sell substantially all of its inventory in less than two months. Therefore, returns on capital are much higher. And, as evidenced by my estimation of $40,000 of advertising spend vs. $900,000 in retail sales, cost of customer acquisition is decidedly low at roughly 4.4% of sales.
I think there are substantial excess profits to be made in my city with one or two locations and the right marketing budget.
Going in deep, but moderating risk
There are two big risks to opening a fireworks store:
- Weather prohibits the use of fireworks as drought conditions create a “burn ban” that outlaws the use of fireworks on the fourth. Local authorities generally do not care about the proper use of fireworks on and around the fourth. However, if it is too dry, you can expect full enforcement and numerous tickets. Sales plummet.
- Inventory does not sell out. Carrying inventory over to the next year is costly. It’s especially costly when you consider that the only way to liquidate it is to sell it at a big discount, or reopen another store the following year. Exiting the business is difficult.
I can minimize weather risk with insurance. A combination of rain and drought insurance should cost me no more than 1-2% of sales or about 6% of inventory. (This is a common insurance item for golf scrambles, believe it or not.)
Inventory risk can be minimized by selling fireworks on consignment. However, my research indicates that mitigating this risk is not worth the lost profit potential.
Finally, liability is covered with a simple insurance policy that costs no more than $500. Most wholesalers have a contact for cheap liability coverage in case someone loses an arm to a mortar, or something.
Running the numbers
Using very conservative estimates, I believe I could capture a relatively sizeable share of the addressable market and make substantial amount of money.
- Inventory investment – $80,000 which should equate to $200,000+ equivalent in retail sales.
- Marketing spend – A mailer (to collect household/zip-level data on firework purchases) plus TV campaign should cost right around $15,000. This budget would allow me to reach every household within a 3 mile radius and blast a majority of high-income homes in the area to reach a frequency of 5+ (each viewer sees a 30 second ad 5 times). Also, it allows for TV ads after the fourth to push inventory at a “discount” (firework “sales” still aren’t bargains) to move inventory.
- Insurance costs – Insurance comes in at $3,000 for poor weather, and $500 for a liability policy. Both rates have been shopped.
This leaves with an initial investment of $98,500, and potential retail sales of $220,000 (based on my bulging shopping cart at a wholesaler ;)).
First, location. $5,000 for two months should be easy enough. I’m going super conservative. Includes tables, etc.
Next, merchant fees. 3% of sales is more than conservative, so $6,000.
Finally, labor. Various fly-by-night operators pay their contractors 20% of sales to maintain the operation. I suspect that I can drive this lower, in part because it will be backed by significant advertising spend, and because I know quite a few poor college students. If I assume 12 hour days for 30 days, I get 360 hours. Averaging 2 employees, we get 720 hours, or $7,200 at $10/hr. Round up to $8,000 for taxes/payroll management and we’ll call it $8,500.
Potential retail sales = $220,000
All-in COGS + SGA = $118,000
Pre-tax profit = $102,000
Excess profits abound
There are definitely excess profits to be had in my local area for a new fireworks store. Given the market size, limited competition, low COCA, and high gross margins, I think there’s every reason to believe a new competitor could generate a substantial profit in year one.
Still, more research needs to be done:
- Espionage – I need to determine the exact product mix of competing stores, or stores in similar markets. This shouldn’t be a problem. Low-level employees tend to know WAY too much about their employer.
- Location hunt – It isn’t easy to secure a building for one or two months for a firework store, which creates difficulty for seasonal stores, which is what I would want to run. This is pain point numero uno.
- Inventory management – I think there’s potential to reduce my inventory risk by purchasing a smaller amount of inventory and securing a contract on consignment sales to replace my inventory once it sells through. Wholesalers don’t want to hold excess inventory. I believe I can get a favorable contract that will allow me to operate with a smaller inventory investment yet keep shelves stocked if I sell through. Profits would dip at the margin, but this acts as another form of insurance. I still need to build out a model for a consignment-based store, or one with a repurchase agreement on unsold inventory. Perhaps I could work out a deal whereby I can resell unsold merchandise at…say, 60% of my cost, back to the wholesaler. That would definitely appeal to me.
Bottom line: With six-figure profit potential and a whole lot of fun to be had, I’m definitely giving this a deeper look.