Business Case Study - Cost Accounting I Implosion at Ecomom Ecomom.

Small startup internet retail company selling earth friendly mom and maternity products including food, toys, apparel, and other baby related items. Four years of history, 2011 revenue just over $1 million. Philip Prentiss. That's me. 42 year old single guy with a freshly minted CPA I had just received after 5 years of night school. I needed a job, and searching for a job sucks. After 6 rounds of interviews with every senior member of the Ecomom team, I got the nod for company controller, base salary $105,000 with another $100,000 of stock options. Reporting direct to CEO. Was I totally and completely thrilled? You bet. The CEO and founder, Jody Sherman, instructed me to show on my first day of work at the end of October 2012 at the Las Vegas headquarters. There was no previous controller or finance department; as with many small companies Ecomom had traditionally be run on the basis of the bank statements. Payroll and tax were handled by a third party bookkeeper who also received invoices and prepared all checks for Jody's signature. This system had worked relatively well when the company was small, but now with the enormous growth in size the number of invoices had reached well over one hundred a month, too many for a part time outside bookkeeper to handle. Things were starting to get out of control. Ecomom had received a large number of delinquent notices for missed payments and that was my first assignment: clean up Accounts Payable. In spite of the complete absence of established procedures, the financial processes of the company were actually in pretty good shape. All customers paid by credit card which was directly deposited into our bank accounts and so there were no accounts receivable. Payroll and tax were accurate and fairly efficient. No Balance Sheet or Statement of Cash flows had ever been prepared, but the Income Statement was quite presentable, and more importantly reconciled accurately to the bank account statements. The one big weakness was lack of matching between purchase orders, bills of lading, and invoices. In the past, either Jody or his co founder would initiate an order, and then since Jody signed all the checks, he would simply remember when the bill came in whether it had been received and whether to pay it. This worked well at $50,000 worth of cogs a month, but at triple the volume wasn't working anymore. Fortunately the solution to this problem has been known for centuries. I instructed purchasing to print each Purchase Order, staple it to the Bill of Lading when received, hand it to me, then I would staple that to the Invoice a cut the check. All payments paid on time and no double payments. The operations team was extremely excellent, and pointed out that my plan would kill a lot of trees in an eco antagonistic fashion, and that our computer system was more than capable of accomplishing this entire task electronically. Morale was high, the staff were treated well and many came from big companies with extensive operational experience. I had no more to say than "can you fix everything up?" while waving my hands vaguely and in less than two weeks the procedures were in place. The employees already knew how to handle inventory and non

On a strategic level. After a month on the job I knew I was going to look like a hero. Our infrastructure was built for size. vacations. A few notes on the financial and management structure might be in order at this point. I loved coming in to work and the staff buzzed happily about the upcoming holidays. the story was different. however. had offices in Guatemala and parts of our marketing fit naturally right next . The honeymoon lasted that whole month. for bloated travel and expense reports and questionable invoices. First class service. first class price. Next year's target was $10 million in sales and $30 million the year after that. and the VPs followed Jody's lead. one of our backers. The VP of Marketing approved all Selling expenses and the VP of Operations approved the Operations line item. black Friday was just around the corner. People Fund. Historically each of the 5 expense line items corresponded to each of the 5 major players in the company. While headquarters was in Vegas and San Francisco. The October Income Statement looked like this: ($000's) Revenue: 322 Cogs: 173 Gross Margin: 46% Selling: 288 G&A: 102 Operations: 169 IT: 87 Cust Service: 24 Net Profit (Loss): (548) A half million dollar loss wasn't great.inventory invoices and delivered tidy expense reports with collated receipts without prompting. We could easily have handled a million dollars of volume a month. but the company just received $4. a gamble that was invisible to me at the time. We anticipated sales of over $1 million for November and without the one time costs there seemed an outside chance we might actually reach the break even point. The company had another co founder plus four VPs who outranked me and were compensated proportionately. probably even ten million. Jody had taken an enormous gamble in a very critical way. but there were none. More importantly. and it was more efficient for them to set up a satellite office there. At the local level the structure was excellent.8 million in financing the previous month and a number of selling and operational expenses were due to one time website development fees. Everyone was honest. Jody left each manager with an enormous amount of freedom. Instantly I searched for abuse and waste. The IT and Operations group came from a blue chip background based in Virginia. Jody looked over G&A while IT and Customer Service were run by the final two managers. He seemed to review major spending initiatives quickly and efficiently and smaller expenses such as travel not at all. and the holiday party. our third party shipper operated out of Los Angeles at any volume within 24 hours.

it dies all at once.to them. Sales rang the fire bell at every hundred orders and everyone clapped. Sales are great. it was downright harmful. The normal financial presentation format. but simultaneously I would guess that the possibility of spectacular failure first entered Jody's mind. Let's recast the Income Statement into a Cost Volume Profit format. there must have been some mistake. consulting fees for October were $156k. How was that even possible? Surely. but infinitely superior for business management purposes: . Perhaps October was a fluke? No. when a dream dies. And there were an army of web design and computer consultants. Marketing revved the engine for Black Friday. In fact. Black Friday was indeed the best sales day in the history of the company. Each decision made sense for its own reason. the biggest sales day of the year. Sometimes. Consulting fees turned out to be constant and stable as salary and wages. but the sum total of individually optimized decisions spawned a behemoth . as each of the chances for success slip away. it was worse than useless. If the sales volume caught up to the size of the infrastructure. this gamble would make everyone at Ecomom very wealthy indeed. November started out well and sales tracked towards the million dollar mark. Payroll for October was $115k.. was not so useful for an online business.. almost always along the lines of: Jody: What are you doing? Where is the money? VP Marketing: We're on track to hit a million dollars. Jody had several heated discussions with the head of marketing. VP Marketing: Marketing is on track to over deliver. But there was no mistake. a very expensive behemoth. so useful for a traditional manufacturing business. not so good for our management incentive structure. killed in an instant by a meteor from outer space. and usually the dream dies bit by bit. Jody: But where's the money? I'm not seeing the money in our bank. November's Income Statement looked like this: ($000's) Revenue: 1089 Cogs: 548 Gross Margin: 50% Selling: 849 G&A: 126 Operations: 334 IT: 65 Cust Service: 30 Net Profit (Loss): (864) Our revenue had indeed surpassed a million dollars. but instead of breaking even we had lost $860. piece by piece.000. But in business that rarely happens. and we watched sales numbers by the hour.

Not a single minute was spent discussing any of these statements. our best product. The Ecomom brand existed only at the website level and did not extend to the product level. and here Ecomom was failing miserably. but here too we faced intense competition. Said another way. Customers could easily buy the exact same item at Whole Foods or any of the other dozen or so internet retailers targeting the exact same market. Said another way.($000's) Revenue: Variable Costs Cogs: Discounts: Warehousing: Freight Out: Fixed Costs Employees: Consultants: Advertising: Overhead: Net Profit (Loss): 1089 548 751 152 134 141 111 44 41 (864) Contribution Margin: -48% Holy guacamole Batman. contribution margin was almost zero. I had prepared the Income Statement in both the standard and CVP format showing our severe losses. But once you get your brand you have to protect it. and one that incurred double freight. if we cut all our sales to zero and sat around and played ping pong all day we could continue to pay ourselves handsomely for two more years while at the current sales rate we'll be out of cash in three months. Said another way. Also joining us were two more marketing managers. and the warehouse manager who had been there from day one. A classic business school question for any new business is: what is your competitive advantage? It's a good question. For toys. and also a statement of Cash Flows showing us declaring bankruptcy in March. do you mean to tell me our Contribution Margin is really negative 48%? Yes Robin that's correct. the more we sell. . Our discounts are meant to be one time only. we became slaves to the lowest price. but we can't limit them by customer so every order ends up sold 50% off. And with comparison shopping as easy as clicking the mouse button. Our own suppliers would list the exact same items on their own website. For diapers and baby food our contribution margin was close to negative 100%. What value. the more we lose. The co-founder and four VP's flew in from their respective cities. and after Jody I was the number seven guy at the table. was Ecomom providing to our customers? We became simply a middleman. for every additional $60 average order shipped our variable cost is $89 and we lose of $29. Not a bad idea at all. Jody called an offsite meeting for the management team to discuss our condition. Ecomom sought to establish itself as a niche player catering to eco conscious moms. now would be a very good time to pull the fire alarm. the customer service manager who was brother to Jody's wife. a gross margin by line item report. then. Said another way.

personable. funny." Critically. We closed November with $2. enthusiastic. Outgoing." He did not understand. but before I tell you how our remaining cash reserves were pitched into the furnace. Surreptitiously." We discussed market strategies for selling the Ecomom lifestyle. No financial numbers were ever presented. I want to play armchair psychoanalyst and tell you my experience with Jody himself. Perhaps we might discontinue all low margin items and focus exclusively on items with margins of zero or better. Perhaps our customer service and shipping department might one day become so good that customers would pay more for the convenience and satisfaction of doing business with us. At the end of December when things were getting truly desperate. Perhaps with another $30 million or so we could hit our 2014 P&L forecast and reach the size necessary to make all these things happen. To pay for this Jody indicated he would bring in additional financing. that increased sales resulted in increased losses. Jody was upset and let everyone know it. Perhaps we might acquire a small manufacturer that could make use of our A+ customer service and distribution system. On the other hand.2 million in the bank and the real hope of "getting unfucked" as Jody would colorfully say. we might one day demand exclusive distribution rights for some products. Jody never said no to a vacation request and bent over backwards to make sure every member of Ecomom got health insurance. First of all. Business wise he was full of ideas and excelled as a pitch man. he had some serious weaknesses too. He had built his house by raising money and when times got tough he went with what he knew. he said to me "Phil. he did not understand margin. but I can tell you for sure the word "margin" and the word "profit" were never mentioned. Perhaps we might arrange for private label products sold at a premium under the Ecomom name. None of these ideas were discussed in any serious way. possibly from People Fund. He was not a numbers guy. after three years of negative margin. We discussed the possibility of expanding our email and customer base and "driving more traffic into the funnel. . I never heard him insult or say a bad word to or about anyone.Perhaps. just bring me a forecast that shows how much we need to sell to break even. but he never came right out and said "we are losing money. Jody was a master marketer and led a management meeting that focused on an awesome feel good marketing plan. with enough market power. I would bring the financial statements to Jody who would glance at them so cursorily and wave me away with "no one can understand this without extensive analysis." We discussed moving the warehouse operations in house to Vegas. he was a great guy. We discussed the advantages of expanding our Guatemala marketing team. which of course looked fantastically good. in retrospect. except year over year sales growth. was surreal. I called my recruiter and let him know I might be looking for another job soon. in the amount of $2 million. It's been nearly half a year and I can't remember exactly what else was discussed. The management meeting.

but it was too little and too late. It was a step in the right direction. Each of them lived in a different city. None of the VPs were privy to the financial statements and losses were not discussed in public. On the other hand. We closed December with less than $1 million in the bank. Our GM quit towards the beginning of December to pursue other opportunities . No substantive changes were made to the business strategy and starting from a $4. I received only copies at the end of each month. the business silo managers were separated by great distances. There was no mechanism to identify this problem. Immediately following November's results Jody made some big changes . and certainly none to talk about it. I did shake her hand once a the Christmas party. and by that time inventory had built up to $1. not according to margin or profit. The company had never had a profitable month in its entire history so turning the ship around would not be easy. It took our $860k loss for Jody to notice. but for the VP of sales the strategy optimized his bonus. and pursing the relationship would require me to leave Las Vegas.There were some big problems with the management structure too. Over the course of January the consequences of the great failed gamble became apparent. this was in many ways the best job I ever had and I was 30% Jody would raise additional funds and keep the business alive.2 million to support that same strategy in the months going forward. Laying off half the staff at the beginning of December and freezing sales might have given Jody another few months of breathing room. I dared not call the bank.he dropped the discount strategy and the VP of sales left the company. At the end of the day I turned in my resignation on Jan 14. and neither did our outside accountant who had worked for the company for three years. spent $1. . I did not want to ask Jody. Secondly. 2013. but the final bills for our huge inventory accumulation still needed to be paid and enough old discount coupons were still floating around that they would dog us for several more months. I had a front row seat to the painful disintegration of the company which.7 million more on overhead.2 million in inventory.. Our bank credit line happened to be exactly $1 million was there a bank covenant? I did not know. and the lack of management cohesiveness allowed a poisonous discount strategy to grow for 8 months without anyone noticing.1 million after variable cost. and locked up another $1. First and foremost. my last day of work would be Jan 31st.. I was the ostensible controller. Our discount strategy resulted in enormous losses. In a long and complicated story that has nothing to do with Ecomom I was a dating a nice girl I had met out of town. but nobody came. Taken together. and yet I did not have check signing authority or even access to the bank statements. the VP of Sales was compensated according to sales before discounts. We had built it. What kind of controller doesn't even know if his own company has a bank covenant? At this point I was debating with myself every day whether to fish or cut bait. did she know? She lived in San Francisco and I never actually spoke with her. the compensation structure. the lack of financial information. Thirdly. Sales dropped off precipitously without discounts to only a few hundred thousand per month and we could not move a large portion of our inventory at all. Jody held financial information and control very close to the vest.8 million capital raise in Aug for the 5 months through Dec 31st we lost $1.

That was a painful assignment for me. 2013. Some were 2013 P&L forecasts at different levels of revenue. if you guys want to fire me that's ok. I discontinued all payments except for payroll. 2013. and some were detailed expense forecasts with spending cut to an absolute minimum. On my very last weekend. The failure of the business would be a bitter pill to swallow . and now his baby was dead. Ecomom entered into Assignment for Benefit of Creditors. The last few staff meetings were very depressed." and "I'm too old to start over. many of whom had followed him from Los Angeles to Vegas. Jody asked me to draw up a forecast assuming half of the staff were let go and we used the empty space to transfer all our remaining inventory from Los Angeles. January 26-27. Even at this drastically reduced spending.it was Jody's baby for four years and he had hoped to reward all of his friends. but I do know that Ecomom was his dream and his baby. Philip Prentiss 22 April 2013 . Would he have to give up the big new house he had purchased not just a few months earlier? Would his gorgeous wife have to quit medical school and become a waitress to support him? I don't know anything about Jody's personal life. benefits. and I didn't even have to face anyone. Jody looked haggard. He was personally extremely pessimistic that he would ever be able to raise money again. A week before the end. I speculate Jody was either trying one final time to raise capital or preparing for severe downsizing otherwise. I remember him quite clearly ending one with "well. Jody committed suicide by shooting himself on Jan 28. I drew up multiple different forecasts at Jody's request.as far as disintegrations go. and utilities." For many calls he would end up leaving the office to speak in private. and employees handsomely. and assuming the bank did not seize our assets." One week before the end he drew up his will and handed it to his secretary. was a relatively calm and orderly. Instead he would be faced with humiliating explanations for lost money and painful layoffs of his loyal employees. I never had a close relationship with Jody but I did sit right across from him in the office and overheard a large number of unsuccessful fund raising calls. On Feb 15. our forecast showed us out of cash by March. angel investors. and made a number of very morose comments such as "I feel terrible about this. I'm not really in love with this conversation either.

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