Funeral industry

On a warm Chicago evening in August 2005, Regina Ryan leaned back in an overstuffed armchair in her brightly lit apartment above Ryan Funeral Home. Seventy-five years old and a widow, Regina smiled as she looked at the sons and daughters gathered before her: Maureen, Patrick, Sean, Brendan, Conner, and Siobhan.

Finally she spoke: "Your father was proud to own his own funeral home. He built this from nothing to what it is today. By serving local families so well, the name Ryan Funeral Home has come to mean compassion, integrity, and quality to those in this area. Reputation is everything in the funeral business.

"He's gone now, and I must decide what's to become of all this. I always thought it would be a simple decision: pass the business to the next generation."

"It's not so simple. The funeral industry has changed dramatically from what it was when we started out. It's much harder to make a living than it once was. Nonetheless, I know that the reason your father started this business was because he wanted something to pass on to his children. This was to be his legacy."

As her mother spoke, Maureen thought about how important the future of Ryan Funeral Home was to her personally. She was the only one of the six children who had become a funeral director, and she has worked alongside her father for eleven years. Maureen often met with families to make funeral arrangements when her father was busy elsewhere, and the local community had come to know her almost as well as they had known her father. Most of the families selecting Ryan Funeral Home did so because they knew they would be personally served by either Maureen or her father.

Maureen considered the fact that there were two parts to the business: the name Ryan Funeral Homes, and the tangible assets, chiefly the building and the land on which it stood. Her mother could decide to see her the business over time and rent her the building.

But, would her brothers and sister to agree to this? After her mother passed away, it was possible that Maureen's four brothers and sister would want their inheritance immediately. If this were the case, they would not look favorably on an arrangement which allowed Maureen to buy the business and assets over time.

Maureen wondered what the business might be worth. She knew that the value of any asset equaled the discounted present value of the expected cash flows. She also know that the greater the business risk, the higher the discount rate. What cash flows could be expected from Ryan Funeral Home? How risky was the funeral business?

There was also the question of the value of the building and the land on which it stood, which was much more valuable than it was when her parents went into business in 1980. She thought about the phone calls she had received recently from two area realtors who believed that the building could easily be sold to any of a number of their clients interested in converting the property to professional office space. The two realtors estimated it might sell for between $1.8 million and $2.0 million, given the location and buyer demand. How could she ever afford this?

BACKGROUND

In 1975, most funeral services were what are today referred to as traditional. A traditional funeral service is as follows: After transporting the deceased from the place of death to the funeral home, the funeral director or a member of his/her staff embalms, dresses, and applies cosmetics to the face and hands of the deceased before putting him/her in a wooden or metal container called a casket. The casket containing the body of the deceased is place in a room at the funeral home for one-two nights of viewing called the wake or visitation. The endpoint is the actually funeral service itself, which is typically conducted at a church or in the funeral home chapel, although sometimes it is done at graveside or in a room at the cemetery. Following the funeral, the casket is lowered into the grave for earth burial in a concrete box receptacle called a burial vault.

Until the 1970's, funeral directors used what was called all inclusive pricing, which meant that families paid one price for most elements of the funeral. The elements included: the casket, removal of the deceased from the place of death, embalming, dressing, application of cosmetics and place in the casket, arrangement conference with funeral director, two nights of visitation (also known as the wake) at the funeral home, directing the funeral, and the use of automotive fleet (including hearse and limousine) to transport family and the deceased to the church and/or the cemetery, and the register book, memorial folders, and acknowledgement cards. The elements of the funeral that were excluded from this all inclusive price were the grave, flowers, the opening and closing of the grave, the burial vault, the honorarium for the clergyman, and the grave maker.

There have been tremendous changes over the past few decades as a result of FTC mandated changes in funeral service pricing, changes in consumer preferences, and consolidation of funeral service providers. Beginning in 1984, the FTC required funeral homes to provide consumers with a general price list (See exhibit #1) which breaks down the prices of each element of the funeral. For example, instead of charging one price of say $9,000 for all the merchandise and services listed above, the funeral home must break the charge down into elements, such as $3,450 for the casket, $540 for embalming, $185 for cosmetology, hairdressing, and placement in the casket, and so on. Further, the FTC said that funeral homes may not require consumers to purchase most items, especially caskets or burial vaults, from the funeral home. Consumer may purchase either or both items from a vendor other than the funeral director and have the casket delivered to the funeral home and the vault delivered to the cemetery.

Today there are many non -funeral home vendors of these items. Consumers can go online to purchase caskets and vaults from the Funeral Depot of the American Casket Store with next day delivery guaranteed. Richard Lamb New Traditions Funerals has a "funeral resource center" showroom located in a Chicago suburb.

Consumer preferences have changed dramatically. Thirty years ago, 93% of families chose the traditional funeral followed by earth burial. Today, the percentage of burials has fallen to 71% while the percent of cremation has risen to 29% nationally.

Finally, there has been consolidation in the funeral industry. In 1975, most funeral homes were family-owned and many had been in the same family for two or more generations. About twenty years ago, large corporations began buying these small family-run businesses. The plan was to achieve economics of scale by purchasing caskets, vaults, and supplies in large quantities and better utilizing the professional staff of funeral directors and embalmers.

RYAN FUNERAL HOME

Don Ryan was born in 1932 in Chicago. His father, who had been one of the first licensed funeral directors/embalmers in the city, urged his son to also enter the profession. Shortly after high school graduation, Don enrolled at the Worsham College of Mortuary Since and was soon licensed as and Illinois funeral director. He married Regina Carey in 1953 and they had six children.

To support his growing family, Don started his own business as a trade embalmer. A trade embalmer travels amongst funeral homes doing just the embalming, cosmetizing, and casketing of remains. Don worked as a trade embalmer from 1952-1980, when he decided he wanted to start a funeral home that he could leave to his six children. Eh considered an area surrounding Chicago's Midway Airport on the city's southwest side.

In 1980, the area around Midway Airport was mostly blue collar residential. Midway is Chicago's second major airport, handling far less air traffic than the much larger O'Hare International Airport. At one time, there had been talk of closing Midway. Given the uncertain future of the neighborhood, Don was able to purchase a parcel of land near Midway for $30,000. He erected a structure consisting of a 4,100 square foot funeral home with a 1,100 square foot apartment above the funeral from for Don and Regina. Construction costs in 1980 totaled $240,000.

As soon as construction on the funeral home was complete, Don became active in the US Business Association of Midway. Neighborhood residents came to know Don & Regina, and the funeral business began to grow. At first, Don was able to do virtually all of the work himself, embalming, making arrangements, and directing funerals. The business grew, and in 1992 Don was able to hire his daughter Maureen (by that time a licensed funeral director).

In 2004, most families choosing a traditional funeral service were charged $4,495.00 for everything except merchandise. Referring to Exhibit 1, this includes basic services of funeral director and staff ($1,595) transfer or remains to funeral home ($425), embalming ($540), facilities and staff for funeral ceremony ($450), and use of hearse for transportation to place of disposition ($350). Illinois sales tax (7%) was only charged on the merchandise portion of the purchase, which included the casket (average sale $3,450.00), vault (average sale $900.00), and the register book, memorial folders, and acknowledgement cards (average sale $125.00). The average revenue/traditional funeral was $8,970.00 ($4,495 + $3,450 + $900 + $125).

Exhibit 2 shows financial results for the years 2002-2004. Don was the only corporate officer; his compensation (including fringe benefits) was the sum of Officer's wages plus Profit Sharing Expense.

For the last 3 years, Don had actually lowered his prices on merchandise (caskets, vaults, register books, etc.) by 3% per year. He did this because he was concerned that families might buy these items from other vendors. Don increased his prices by 4% per year for the non-merchandise portions of the funeral (basic services, facilities, etc.) For the time being, few families purchased caskets or vaults from an outside vendor. This could change overnight if a business such as Richard Lamb New Traditions Funerals opened a showroom nearby.

Starting the business from scratch in 1980, by 2000 Ryan Funeral Home was serving 87 families (also known as adult calls) per year. Table 1 shows the number of calls/year and the number of cremations and traditional services from 1990 through the year 2004.

Cremation is either direct cremation of cremation following visitation and funeral. With direct cremation, the body is typically not embalmed and no casket is used. Instead, the unembalmed remains are placed in an inexpensive cardboard or this wooden tray and taken to the crematory. About half of cremations are direct cremations, meaning that there is no visitation. Referring to the partial General Price List in Exhibit 1, the price for direct cremation is $1,820. The price would rise if the family wanted a memorial service at the funeral home ($450) or at a church ($375).

With cremation following visitation and perhaps a funeral, the remains are prepared as they would be for a traditional funeral. Often, a reusable casket is rented. Excluding charges for the casket and optional funeral, the price charged for this cremation alternative is $3,995 ($1,595 + $540 + $185 + $950 + $425 + $100 + $200). Again, the price would rise if the family wanted a memorial service at the funeral home ($450) or at a church ($375).

Give his advancing age and declining physical abilities, Don was grateful that Maureen was working at Ryan Funeral Home. By 2002, he was 70 years old and working just a few hours each week. Don was diagnosed with cancer in 2003 and died in March 2005.

After her father's death Maureen continued to operate the business much as before, working an average of 60 hrs/week. She hired a licensed funeral director at the same salary and benefits she had received. Maureen continues to draw an annual salary of $60,000.

TABLE 1

Ryan Funeral Home, Ltd.
Year Total Adult Calls Traditional Cremations
1990 59 53 6
1991 64 56 8
1992 66 58 8
1993 70 60 10
1994 69 60 9
1995 65 57 8
1996 71 60 11
1997 69 56 13
1998 73 58 15
1999 77 63 14
2000 79 63 16
2001 81 62 19
2002 83 68 15
2003 89 67 22
2004 87 66 21

EXHIBIT #1

Ryan Funeral Home, Ltd.

General Price List (partial)

A. BASIC SERVICES OF FUNERAL DIRECTOR AND STAFF $1,595
Our fee for the service of funeral director and staff includes, but is not limited to, staff to respond to initial request of service 24 hrs daily; consultation with the family or responsible party; coordinating service plans with cemetery, crematory, and/or other parties involved in the final disposition of the deceased; securing official documents and necessary registrations and sheltering of the deceased. This fee for our basic services and overhead will be added to the total cost of the funeral arrangements you select. (This fee is already included in our charge for direct cremations, immediate burials, and forwarding or receiving remains.)
B. EMBALMING $540
C. OTHER PREPARATION OF THE BODY $185
Cosmetology, hairdressing, and placement in casket.

Facilities
A. Continuous use of Stateroom for Public Visitation between 8:30am-9:00 pm $950

B. Use of facilities and staff for funeral ceremony $450

C. Use of faculties and staff for church service $375

DIRECT CREMATION SERVICE

A. Basic Services of Funeral Director and Staff $1095
Our fee for services of funeral director and staff includes, but is not limited to: staff response to initial request for service on a daily, 24 hour basis; coordinating service plans with cemetery, crematory, and or other parties involved in final disposition; securing official documents and necessary registrations and sheltering of deceased; bathing, feature setting, and dressing (if desired) before being taken to crematory. This fee for our basic services and overhead will be added to the total cost of cremation arrangements you select.
B. Transfer of Body from place of death to funeral home $425
C. Transfer of Body to crematory $100
D. Cost of cremation as charged by crematory service $200
E. Alternative container (cardboard container) $n/c

If you want to arrange a direct cremation, you can use an alternative container. The minimal alternative container stated here is required by the crematory, if no other container is provided by the family.
Total: $1,820

TRANSPORTATION

A. Transfer of remains to funeral home $425
B. Use of hearse for transportation to place of disposition $350

Casket Price (partial)

A. Parliament Solid Mahogany - velvet interior $8200
B. Mansfield Siler Rose Stainless Steel - velvet interior $3450
C. Neapolitan Blue 18 gauge steel - crepe interior $3055
D. Spencer 20 gauge steel - crepe interior $1510
E. Cremation rental casket oak - crepe interior $1095

Outer burial containers
In most areas of the country, state law or local law does not require that you buy a container to surround the casket in the grave. However, many cemeteries require that you have such a container so the grave will not sink in. Either a grave liner or a burial vault will satisfy these requirements.

A. Wilbert Bronze Concrete/ 3,000 lbs $10,000
B. Wilbert Monticello Concrete /Sterner plastic reinforcing/2000 lbs $900
C. Concrete Box (non-sealing) Concrete grave liner $575

CHOICE OF ADDITIONAL GOODS

Register Books $40-$198

Memorial Folders $35-$60/per 100

Acknowledgement Cards $10/box

(See below for questions)

QUESTIONS:

1. How is the funeral industry changing?

2. Assume that in mid-September 2005, Maureen phoned you to say she is considering the following options. She would like your opinion of each.

a. Should she purchase Ryan Funeral Home and asked her mother to rent her the existing building for $2000/month? Given the low rent, Maureeen would have to pay all real estate taxes, utilities, and repairs, and maintenance on the building.
b. Suppose Regina requires at least 11% cash flow return on her investment in the building. Should Maureen purchase Ryan Funeral Home and operate it at its present location?

Prepare a pro-forma cash flow statement for this scenario. Ignore payroll taxes. You may assume: 1) repairs and maintenance and utilities expenses will remain the same; 2) depreciation equals capital acquisitions; 3) there is not interest expense; 4) a 3% Illinois income tax rate; 4) the following corporate tax rate schedule:

If taxable income is: The tax is:

Not over $50,000 15% of taxable income
Over $50,000 $7,500 plus 25% of the amount over $50,000
Over $75,000 $13,750 plus 34% of the amount over $75,000
Over $100,000 $22,250 plus 39% of the amount over $100,000
Over $335,000 $113,900 plus 34% of the amount over $335,000

c. Is it a good idea for her to purchase Ryan Funeral Home and operate it at a nearby location? With this scenario, Regina Ryan would sell the existing building, which would become professional office space.

Maureen would find an investor willing to build a new funeral home further away from Midway Airport where land values were lower. To have adequate parking, she would have to purchase at least 10 residential lots, which currently sell for $30,000 each. Building costs would be an additional $900,000 and real estate tax would be about $25,000/year. The investor would rent the building to Maureen and require a 10% cash flow return on investment. Maureeen would be the full time director/manager.

Prepare a pro-forma cash flow statement for this scenario. Assume the same Illinois and corporate tax rate info from part b. above.

d. Should Maureen approach Modelski Funeral Home and suggest that she merge the Ryan Funeral Home business into the Modelski location? Modelski has enough excess capacity to absorb an additional 100 adult calls/year. Regina Ryan would sell the existing building, which would become professional office space.

Under this arrangement, Modelski would have a small sign that says "Ryan Funeral Home" beneath their much larger "Modelski Funeral Home" sign. Maureen would notify all the families served by Ryan home sine 1980 that she was not a Modelski. She would also advertise the same in formation in the Southtown Economist, the local newspaper. Families wanting Maureen Ryan to serve them would call Modelski staff and facilities. For this privilege, she would pay Modelski one half of Ryan Funeral Home Revenues. Prepare a pro-forma cash flow statement to demonstrate to Modelski the benefits of combing the two businesses.

e. Suppose that Regina decides that she will sell Ryan Funeral Home (the
business, not the building) to Maureen for five times the debt free cash
flow calculated in 2c. Maureen could purchase the business interest-free
over five years. Regina Ryan would see the existing building, which
would become professional office space. Should she buy Ryan Funeral?
Home from her mother at that price and merge the business into the
Modelski location as described in d. above?

f. Maureen is considering approaching Modelski Funeral Home with the following offer: she would work as a funeral director at Modelski's and they would hang a small sign "Maureen Ryan Funeral Director" beneath their much larger Modelski Funeral Home sign. All other details would be the same as stated in part d. above.

Maureen informs you that under this plan, she would not purchase Ryan Funeral Home from her mother. Maureen says "I am Ryan Funeral Home; I would be the only be purchasing my own good reputation." What is your advice?

g. Suppose that Maureen is considering getting out of the funeral business.
Regina would sell Ryan Funeral Home to Modelski and merge the Ryan
business into the Modelski location. The selling price for Ryan Funeral
Home would be five times the cash flow calculated in d. above. What is
your advice?

Business risk is the uncertainty regarding a company's ability to earn a satisfactory return on its investments in light of cost & revenue factors, including factors of competition, product mix, and management ability. Prepare a 2 column table to assess the business risk associated with Ryan Funeral Home. Label one column "Increases business risk" and the other column "Decreases business risk"