Report to the Board of Dog Gourmet Supplies Limited

From: Oakley Dunstable Accountants

Date: 09/05/2023
Subject: Review of financial performance and strategic opportunities
Disclaimer: This report has been prepared for the Board and should not be distributed to any other
parties without prior written consent, no liability can be accepted in the event of such distribution.

1. Executive Summary
1.1.Review of 2021 performance
Reasonable revenue growth of 9.69%/£1490K was driven mainly by an increase in revenue from
Taylors, which saw a very strong increase of 42.89%. Specialist pet stores has seen an increase of
£1.5K average revenue per client which is the highest increase excluding Taylors. This is

Gross profit margin saw a very small increase of only 1%, this is due to the increase in cost of sales by
8.22%/£1009K which was slower than revenue growth.
The biggest change in cost of sales is attributed to production labour with an increase of
10.38%/£170k, but this was less than 1% more than production overheads which increased by
10.30%/£458K. Together these two costs make up 51% of total costs of sales.
Materials grew by 6.15%, which was disappointing considering the sector average costs only grew by
0.5% in the year, this indicates a need for an evaluation of supplier prices.

The resignation of Hugh Logan has led to the loss of VST as a client and may also result in the loss of
PAW if operational and business issues are not resolved. Staff feel pressure to meet KPI’s that High
Logan had called irrelevant, and this has put pressure on al production teams. This may be resolved
through stricter quality controls and an easement on KPI’s. Staff may also feel happier if their
concerns were formally responded to and documented.

1.2.Evaluation of the proposal to launch Cat food

The predicted ROI for the launch is 161%, this is 6.44 times higher than the target of 25% and DGS
should proceed with the launch.

The GPM over the two years is 37%, which is also higher than their existing 22% GPM. But DGS
should consider what other costs may be involved in the launch that were not included in the
calculation such as upfront costs and administrative expenses as these could impact the ROI of the
launch.

The new product is likely to put a strain on DGS’s production capacity and may negatively affect their
ability to produce dog food, which is what they are known and trusted for. This may have a negative
impact on their brand reputation and overall profitability. Consideration should also be given to the
price point at which cat food will be sold to ensure it is within keeping of DGS’s premium brand
image.

Sales volume is estimated to be 3 times higher in 2023 than 2023, which will need to be researched
further to sustain the feasibility of this. 2022 is also predicted to make a loss, and consideration will
need to be given as to whether DGS can sustain this loss until they start to make a profit without it
affecting their profit from dog food.
1.3.Evaluation of new sales channel and use of the digital marketing agency POM
Using POM to launch their DTC channel will create a gain off £34,040 per year, but only if not using
paid adds, as these make up 94% of the total costs and with paid adds the opportunity creates a loss
£831 a year. This would give a 26% GPM, which high higher than the 22% DGS currently achieves,
profits are also likely to continue increasing as DGS’s website becomes more popular.

DGS would recover the initial outlay of £115K in 3.38 years, this is based on the first year expected
figures and may occur quicker if sales increase in the following years.

DGS would need to ensure that they are selling at above the prices they sell to their business clients
as this may make existing clients feel like they are in direct competition with them. And while no
formal contract is in place to avoid this, it could affect their reputation and risk the loss of business
clients which are a proven source of revenue.

Selling directly to customers could put a lot of strain on production capacity, and with the lack of
storage space it may mean that DGS are unable to fulfil their business client’s orders. Consideration
should be given to purchasing or hiring warehouse or storage space nearby in order to be able to
efficiently use production runs to produce products in bulk. The extended shelf life of their products
means this is possible and will be a more efficient method of production.

Charlie is currently in a relationship with Mehul’s daughter. This could be seen as a bias towards
using POM for the DTC launch. If this is the case it could have negative effects for DGS’s reputation.
Charlie should be removed from the decision-making process, and an evaluation of other possible
marketing companies should be carried out to ensure that POM are the best option to go with.

It is also important to keep in mind that numbers have been provided by POM, and seem to be
substantially higher than when POM worked with X Ltd. There is a concern that these numbers have
been inflated by POM.

2. Review of DGS’s management account for 2021 in comparison to 2020

Appendix 1
£'000 Sales Mix
%
2021 2020 £ Change Change 2021 2020
Revenue
Veterinary practices 3866 3913 -47 -1.20% 23% 25%
Specialist pet stores 6502 6105 397 6.50% 39% 40%
Other 2285 2411 -126 -5.23% 14% 16%
Taylors 4218 2952 1266 42.89% 25% 19%
Total 16871 15381 1490 1 1

Cost of sales as a % of total COS

Materials 6574 6193 381 6.15% 49% 50%
Production labour 1807 1637 170 10.38% 14% 13%
Production overheads 4903 4445 458 10.30% 37% 36%
Total 13284 12275 1009 1 1

Gross Profit 3587 3106 481 15.49%

Gross profit margin 21% 20% 1%
Avg. Discounts per
channel
No of clients per channel 2021 2020
Veterinary practices 450 448 -2 -0.44% 30% 30%
Specialist pet stores 129 125 -4 -3.10% 30% 30%
Other 111 108 -3 -2.70% 40% 23%
Taylors 1 1 0 0.00% 40% 40%
Total 691 682 -9

Average revenue per

client exc. Taylors 18.338 18.251

revenue per client per channel

Veterinary practices 8.59 8.73
Specialist pet stores 50.40 48.84
Other 20.59 22.32
Taylors 4218 2952

Revenue
Total revenue increased by a surprising 9.69%/£1490K, which is higher than the 5% average rate the
global pet food market is increasing by. A substantial 42% of this growth came from Taylors.

Vet practices saw a small decrease in revenue of 1.2%/£47k, this is in line with expectations as many
vet practices are merging and forming collectives with other larger organisations. This is further
supported by the fact that vet practices made up the smallest number of increases in clients with
only 2 new clients in the year. Vet practices tend to have the smallest revenue per client overall too,
with the average revenue per client being £8.5K, this is almost £12k less than the next highest
average which is ‘Other’.
Specialist pet stores saw the highest number of increase in clients (4 new clients), and this is
reflected in the 6.5%/£397K increase in revenue seen, the highest when excluding Taylors. This is in
line with expectations due to the increase in demand for specialist pet food and the fact that DGS
specialise in specialist pet food that targets that market. There was an increase of £1.5k in the
average revenue per client in this channel, and the average discounts offered to these clients
remained the same at 30%.

The other category saw an alarming decrease in revenue of 5.23%/£126k. This is likely led by the
increase in average discounts offered from 23% to 405%, almost doubling. This partnered with the
fact that there were only 3 new clients in the year contribute to the decrease in revenue. Others
make up 14% of the total revenue for DGS so further decreases in average revenue per client may
have a large impact on overall revenue.

Taylors saw the largest increase in revenue of 42.89%/£1266k, they also make up 25% of the total
revenue of the company. This increase is maintained by the fact that the average discount for
Taylors remained the same. As Taylors is a very large client, with customers who pay high prices, this
may help DGS continue to increase their revenue over the coming years.

Cost of sales and gross profit

Total cost of sales increased by 8.22%/£1009K, slower than revenue growth, indicating good cost
control. As a result, gross profit margin grew by 1% from 20% to 21% in the year.

The biggest change in cost of sales is attributed to production labour with an increase of
10.38%/£170k, although this was less than 1% more than the next highest increase from production
overheads. Considering that there was an 8.5% increase in production hours, as well as a 1.8%
increase in salaries for production staff, this is in line with expectations.

Production overheads increased from 2020 by 10.30%/£458K. The changing client base and demand
from pet owners means that there were more complexities in the business which impacted
production, increasing costs. Total number of production runs only increased by 5%, so new
technology, or better scheduled maintenance may assist in reducing these costs.

Materials cost grew by 6.15%/£381k, which is disappointing considering that average sector annual
price increase was only 0.5%. This signals that renegotiation with suppliers may be needed.
Materials make up almost half of total costs, which is to be expected as DGS focus on high quality
materials as their USP. Material wastage decreased from 9.7% in 2020 to 3.6% in 2021, so it is
surprising to not see better cost controls here.

Request for advice

Operational, Ethics and Business Trust
Hugh Logan had stated in the past that there are increasing pressures on all of the operational teams
due to what he considered increasingly irrelevant KPI’s and the impact in terms of profitability being
ignored. This may have been the reason he had not been meeting his targets and ultimately led him
to resign.
He had also mentioned that he had brought up his concerns multiple times and may have felt that
managements responses to this had not been have been how he had hoped.
There were also statements made regarding Charlie managing the larger clients, given that he was a
less experienced member of the team, and that clients felt that they were not being heard. Hugh
had concerns that clients may leave if this continued.

VST has since left and there is a real threat that PAW, which Hugh had also brought with him when
he joined DGS may go the same way.

Advice
It may be beneficial to restructure how KPI’s are measured and how they are reflected in the bonus
system. It may also be beneficial to have a formalised way of responding to staff concerns, to ensure
that staff feel heard.

In terms of operational improvements, stricter application of quality controls may ease the pressure
off operational staff and enable an efficient way of work for everyone.

Conclusions
Reasonable revenue growth of 9.69%/£1490K was driven mainly by an increase in revenue from
Taylors, which saw a very strong increase of 42.89%.

Cost of sales grew less than revenue, showing some cost control, with an increase of only 8.22%
overall. This increase was mainly led by both production labour and overheads, which in total make
up 51% of total cost of sales.

Due to the increase in costs, gross profit saw a very small increase of only 1% in the year.

There is a potential of losing more clients if operational issues are not fixed with the
recommendations and advice provided. This has already been seen with the loss of VST.

Recommendations

Review average discounts offered to clients and consider the impact it may have on future profits if
discounts continue to decrease.

Improve staff’s knowledge on production processes and ensure that all staff are up to date on their
training to ensure quality control is done correctly.

Staff concerns and responses to those concerns should be documented formally and efficiently.

Review prices with suppliers to ensure that DGS are getting the most competitive prices and making
use of economies of scale.

Get more information on what products are most popular using Taylor’s insights to be able to
increase production of more popular and profitable products.

3. Evaluation of proposal to launch cat food range

 Appendix 2

2022 2023 Total

Volume in Kg 140 420 560
£'000 £'000 £'000
Revenue *4 / *4.4 560 1848 2408
(avg.32.8%
less discount ) -183.68 -606.144 789.824
Cost of materials -240 -380 -620
cost of labour -36 -40 -76
Production costs -140 -180 -320
Gross profit -39.68 641.856 602.176

Gross profit margin (on

rev. less discount) -11% 52% 37%

ROI £'000
Expected GP 301
Dev and marketing
costs 187
Expected ROI 161%

Accuracy and reliability of predictions

The calculations have been based on assumptions which if changed, may also affect the outcomes of
the calculations.

The calculation predicts a very high gross profit margin of 52% in 2023. The average GPM with Nu
God Fit is roughly 22%, as the cat food production will require new suppliers and materials, it is
unlikely that GPM in 2023 will be this high.

The research for this was done based on shoppers and so is therefore probably not representative of
a bigger sample or what more people in the market would think.

There have been no upfront costs included in the in the research around smaller packet sizes, this
will likely decrease ROI, especially if advertisements campaigns will be done, which mean marketing
costs will likely be much higher.

The assumption that cat food will be almost sold almost 3 times, more in 2023 than 2022 does not
seem to be based on any evidence, and so this may be a large overestimation that affects the overall
ROI of this project greatly.

Impact of commercial and operational issues

A new product launch of cat food would be a rebrand for DGS and may have many commercial and
operational issues. The rebrand itself may cause confusion for DGS’s customers, partnered with the
fact that the cat food will be priced competitively, assumed on the lower end of the scale, this may
hard DGS’s reputation of being a high end, high quality brand. This could affect their revenue on
product lines that currently do very well.
Another issue is the need for new suppliers. Stephanie Bailey has always been insistent on being
able to personally guarantee the integrity of the ingredients DGS get from their suppliers. With new
suppliers there is a risk that the quality will not be of DGS standard and may negatively impact their
brand reputation and ultimately how successful not just the cat food, but lower sales on their dog
food too.

Packaging may cause some concerns too, cats enjoy their food in plastic trays, which is different to
how DGS package their food now and how they plan to for cat food. This may mean that the cat food
is not as popular with cats and their owners. Changing this packaging would be costly and tine
consuming for DGS and may out strain on their ability to produce dog food, which is a proven
product line that brings them revenue.

The cat food market has grown by 20% in 2 years, so this may be an attractive market to enter. This
could increase DGS’s revenue and overall market share within the pet food industry. As they are
already an established brand that dog owners love, it may make it easier for them to market their
new product range as they are a trusted brand.

Appropriateness of using ROI

While ROI has been an affective measure for DGS with their other product launches, it does not take
into account operating profit, which may make a large difference in the real ROI of the launch.

Assessing ROI over only a 2-year period is quite short term and may not mean profitability in the
long run.

ROI also does not consider other positive externalities of launching a new product line. It does
consider benefits such as increased market share, better brand awareness and visibility to new
customers. It also does not consider the possible economies of scale DGS could achieve producing
cat food, which would lower their costs and increase profitability.

Overall, the ROI does have the benefit of being much higher than the target 25%, which shows that
the product launch may be very successful and profitable for DGS.

Conclusion and Recommendation on proceeding with cat food launch

When using the calculations done based on the research, the project looks to be profitable for DGS
starting from 2023, with a total ROI of 161%, which is much higher than the target of 25%.

But in 2022 the launch would make a loss, and it is important to consider if DGS could support this
loss in the first year to see profit thereafter.

Costs are also likely to be much higher than predicted due to the need for new suppliers and
increased distributions costs.

This launch may also put stress on DGSs production facilities and teams, which may cause
operational issues in the future and affect their dog food products.

Overall, the ROI predicted is 6.44 times higher than the target, so the launch should go ahead, with
consideration that the ROI is based on assumptions that may not be 100% accurate.

Recommendations

Further research should be done on the possible costs as well as savings that DGS may achieve.

Consideration should be given to the price point food, to be in keeping with DGS’s premium brand.
More research should be done on packaging options to ensure that the packaging options meet cat’s
needs.

New suppliers’ due diligence should be done to ensure they meet the standard and quality that DGS
currently has.
 4. Evaluation to sell Direct-To-Customer and whether Pro-Online Marketing (POM) should be
hired

Appendix 3

CTR Revenue @£45 per cost as % of

Visitors 5.5% order Cost rev
organic search 12500 687.5 30937.5 -2500 8%
paid adds 1500 82.5 3712.5 -3500 94%
-
affiliate referrals 1250 68.75 3093.75 108.281 4%
-
Total 15250 838.75 37743.75 6108.28 16%

Gross profit (26%) 9813.38

Agency costs -6108.28
distribution costs -3774.38
Loss from using DTC and
POM -69.28
Per year -831.38

without loss making Paid adds

CTR Revenue @£45 per cost as % of
Visitors 5.5% order Cost rev
organic search 12500 687.5 30937.5 -2500 8%
-
affiliate referrals 1250 68.75 3093.75 108.281 4%
-
Total 13750 756.25 34031.25 2608.28 8%

Gross profit (26%) 8848.13

Agency costs -2608.28
distribution costs -3403.13
Gain from using DTC and
POM 2836.72
Per year 34040.63

Financial

Using POM to launch their DTC channel creates a loss of £831 a year. However, this is due to the fact
that paid adds cost more to run than they bring in revenue and make up 94% of the total costs.
When excluding paid adds, DGS could see a £34,040 increase in profit per year. This is only a
prediction for year 1, and even with paid adds, this may be different in future years as DGS see a
growth in the amount of people who use their website.

The research uses a gross profit margin of 26%, this is higher than what DGS currently achieve by
selling to businesses (which is only 22%). This may be because DGS would not be offering the type of
discounts they offer when selling B-2-B. If selling at full RRP this GPM may be even higher than
predicted.

The initial outlay of £115k has not been included in the calculations, but from DGS’s balance sheet
we can see they have cash to cover this. If taking it into consideration, it would take DGS 3.38 years
to break even (if paid adds are not used).

The figures have been provided by POM and are an estimate, it should be noted that the final figures
may look very differently, and if figures change so would the estimate of gain or loss from selling DTC
and POM’s services.

Operational and strategic

While DGS has no contractual restrictions with any of its clients preventing it from using a DTC
approach, it would need to apply caution so as not to jeopardise its relationships with clients by
being seen to be competing directly with them. They could do this be ensuring that they sell at RRP
or above what the discounted price for their clients are.

Selling directly to customers is likely to put a lot of pressures on production and scheduling. DGS do
not currently have the ability to expand their warehouse or storing facilities, meaning that small
production runs will have to likely occur to fulfil customer’s orders. This may impact their ability to
fulfil their business client’s orders and put undue pressures on staff too.

On the other hand, over half of new pet owners are young people who are more likely to shop
online, so this opportunity may allow DGS to reach new customers and increase its market share,
ultimately allowing it to purchase more storage space in order to bulk produce and store popular
orders. An online selling system may also allow DGS to keep better track for what product lines are
popular, enabling it to better schedule production in the long run.

Ethical and business trust

Charlie is in a relationship with Mehul’s daughter, there could be an aspect of bias around his
decision making when choosing POM to work with.

Charlie is confident that Mehul could ‘ensure we will get lots of supportive comments. This is a
concern due to the media coverage on fake comments, as it may make it seem like Mehul is
suggesting that DGS could pay for supportive comments. If this is true it could have negative effects
on DGS’s public image and reputation.

IT is also important to keep in mind that numbers have been provided by POM, and seem to be
substantially higher than when POM worked with X Ltd. There is a concern that these numbers have
been inflated by POM.

Lastly, affiliate marketing comes with its own risks. If affiliates present themselves in a way that
damages their image, this may negatively impact DGS who will likely be viewed in association with
the affiliates.

Conclusion

When including paid adds this is not an attractive opportunity as it makes a loss of £831 a year.
Without paid adds this could be a beneficial option for DGS as it will increase their profit by £34,040
a year, in the first year, with the likelihood of this growing each year as their website becomes more
popular.
Charlie is currently in a relationship with Mehul’s daughter, which may be seen as a conflict of
interest and raise questions about possible bias towards choosing POM for this contract.

Selling DTC may have an impact on business client relations if they feel that DGS are now in direct
competition with, so pricing needs to be carefully thought out as not to be lower than the prices
currently offered to business customers.

Overall DGS should take on this opportunity as it will increase their revenue, especially in future
years as the benefit of the website increases with popularity. Selling directly to customers also has a
higher GPM at 26% and so is therefore going to increase DGS’s profit overall.

Recommendation

Affiliates should be chosen carefully to avoid a negative impact on reputation.

It may be wise to exclude Charlie from the decision-making process when hiring POM due to his
possible conflict of interest.

Ensure that prices are kept above the discounted price for clients as not to be in competition with
clients and risk upsetting them.

More research should be done on the GPM figure, to calculate what it would be if products were
sold at RRP.

Consider tendering for this contract and evaluating other marketing agencies to be able to compare
costs and assumptions.