A Look At Other Businesses

August 2007

Let’s run through a few other businesses that we are all familiar with and get an understanding of how they apply the principles. Remember, most companies do not do all four principles well. They excel in one or two or do fair to middling in all.

If you are doing well in all four, congratulations. AND don’t expect it to last forever! Because if your business is kicking, making money hand over fist, someone else is always watching, and they may decide to go into your business also. As soon as that happens, you are in a competitive situation, which usually ruins principle #4, put a little in, get a lot out.

So to recap, first use other people’s money by collecting as soon as possible, holding a very small inventory (or no inventory) and stretching payables. Second, shave as many days as you can off the total number of days in the cash conversion cycle. Once you have this set up, then work to increase the volume of transactions running through your business. And lastly, cut costs and increase the selling price of your products and services. Consider creating high-margin products, services, or add-ons (“fries”) and enticing your customers to buy them.

There are very few industries that have maintained their dominance for more than a decade. A long time ago, railroads were the tops. Then it was steel, then cars, then aerospace, then computers…

So the big boys can do this, but can I?

Oh, yes. You don’t have to be big in order to be smart about how you manage your cash.

Remember the story of the florist who used credit cards to manage her payables.
Most graphic artists get 1/3 of their fee up front, 1/3 after acceptance of concept, and 1/3 at delivery of the work. They also get a commission from the printer. This is standard practice in the advertising and graphics industry, meaning that they are never using their own money to operate.

Several tax accountants I know demand payment for preparing a tax return up front. If they end up spending more time preparing the return than they expected, they charge the remainder before they will deliver the completed return.

Many of my colleagues, professional speakers, demand their fee for speaking when the “gig” is booked, not the date the gig is performed. This can mean that they have the cash in hand months before they have to perform.

It won't work in my industry!

I’m not buying that! Even if it is standard practice in your industry to do things one way, that doesn’t mean you have to. Back to the tax accountants, industry standard says that they get their money after billing the client after the return is prepared. Can you imagine how many of those “standard practice” accountants get stiffed every year?

And you can be niche-y and smarter than the average bear. Zara is in the retail clothing business, yet they do not operate like everyone else. Dell and Wal-Mart do not operate like the others in their industries, and thus are thriving.

Two different philosophies in the same industry

To a consumer, a hardware store is a hardware store is a hardware store when you need a hammer or a plunger, a key or a wrench.

But in Austin, we have several different kinds of hardware stores, each successful because of a unique implementation of the four principles. You are probably familiar with the huge hardware retailer, Home Depot. We have several of those in Austin. And we also have a specialty hardware store called Breed and Co. 

Breed and Co. is a fun place to shop. On one side of the store, you have a small hardware store with very attentive and experienced clerks who can answer just about any hardware or home repair question. Most of the clerks are over 50 years old. They know what they are doing.

On the other side of the store are a garden center, a gourmet chocolate shop, and an upscale kitchen goodies store. I registered for my wedding at Breed and Co. because they had such unique and beautiful things.

Breed and Co. is not known for its sales or its low prices on hardware. And because their hardware store is so small, they may not have just what you need.

Contrast this with Home Depot. Home Depot will likely have what you need, even if it is some odd sized nail, because they carry a whole aisle of nails. And Home Depot is going to provide the nail at a low cost. Home Depot has great products, but whatever you buy there, everyone may already have—they are on the tail end of home décor trends.

And the big thing you sometimes can’t get at Home Depot is experienced help, help that will spend the time with you to help you figure out a home repair problem.  
So, if you really need expert help, you would be wise to visit Breed and Co. and possibly pay a little more for your goodies. If you are concerned about cost and know what you are looking for and want to only go to one place to get it, Home Depot is your place.

Home Depot makes it by “pumping up the volume.” Breed and Co. makes it on “put a little in, get a lot out.”

A pizza franchiser

Please keep in mind that these principles only apply when looking at the sales phase of a business. The sales phase, in this case, is when you are cranking out the pizzas. Pizza! Pizza! Pizza! We don’t care, right now, about how much it cost to buy the franchise or the equipment.

So, do they apply principle number one? Do they use other people’s money?
YES, they do.  Customers pay for the pizza in cash the second it arrives at their door. Pizza Shack does not send you a statement every month with a big pig stamped on it telling you that you ate 5 cheese pizzas over the past three weeks. Thank goodness our gluttony is not documented that plainly.

And, they do pay for their supplies later. They pay for the sauce, dough, and other goodies after they receive the cash. Now in the restaurant business, they pay faster than the standard 30 days because food is perishable… but we can assume that they are doing fine with the first two principles.

Success with the third principle, pump up the volume, depends on how fabulous a neighborhood they are located in. If it is a neighborhood full of working parents, children, teenagers, and the occasional glutton (me!) they are going to do fine. Pizza! Pizza! Pizza!

But, principle number four is where they have their problem. Competition puts a cap on the amount they can charge for their pizzas—and making and delivering pizzas isn’t so cheap. As a matter of fact, pizza makers carefully weigh the amount of cheese they put on each pizza and count the number of pepperoni!

Now they have “fries” also. Think of those silly breadsticks. Those can’t cost much to make. And chicken wings or hot wings. Chicken processors used to pay to have the chicken wings taken away. Now they are all the rage. Drinks, beer, salads... I would imagine these are “fries”, and we do not, as consumers, require them to competitively price these things.

Sometimes, as in the case of Domino’s and those tasty Cinnasticks, they apply the drug dealer’s tactics.  Give the Cinnasticks to us free at first and when we are hooked, start charging! Cinnasticks, crack… same principle.

A tradeoff between the principles

As I mentioned in the first chapter, you can do well on some of these principles, but usually not all. And every business decision involves a tradeoff between the principles. You may have to sacrifice one to improve the other.

Now, let’s say you are a successful little Pizza Shack. You have a loyal client base and life is good. But, unfortunately, a competitor—Cheesy’s Maximum Pizza—has moved in down the block. You are losing customers fast. Everyone wants to try Cheesy’s and Cheesy’s pizzas are good - just as good as yours. 

EECK! What do you do? Your volume has slowed considerably. To speed volume, you could send out a coupon to bring your customers back. Of course, this messes with the fourth principle, put a little in, get a lot out, because you are cutting your selling price and reducing your margins.

After a few months, you notice that you are not bringing in the cash or the profits that you were. So you decide to cut costs. You put less cheese on the pizza, you hire cheaper (and more snarly) delivery kids, you put fewer wings in the hot wing bucket. OOOOH NO—not a good idea.

The loyal customers you did hold onto initially quit you.

What is an alternative to this ugly scenario? Differentiation. Somehow your customers have to believe that your product is better than Cheesy’s. That you are worth the extra cost.  You could use higher quality ingredients, appeal to children somehow, make yourself “cool” by marketing to teens, get involved more in your community, or, like Pizza Hut, offer a dazzling array of products—cheese stuffed crust, NY crust, thin and crispy crust… etc.

It is going to be a long, but worthwhile, battle. Welcome to capitalism.

A service model—a contingency lawyer

Let’s go to the other extreme, a service not a product model. Let’s say you are a lawyer working on contingency. You don’t get your money unless you win your case.
This is a very precarious cash flow situation indeed. I once met a banker whose primary clients were lawyers working on contingency who needed loans until their case was won.

Consider the lawyers who argued the tobacco cases. Do they use other people’s money? Definitely not. They must invest their own time and effort, the time and effort of their staff, and their office expenses to be able to finance the battle. 

I have a friend whose son suffers from brain damage, likely caused by the obstetrician during birth. She went to many lawyers asking them to take her case. Because it was not a cut-and-dried, for-sure win, no one would take her case. One lawyer offered to take it on if she had $50,000 to contribute first. Since her son was taking so much extra care and cash, in no way could she come up with that money.

She was so angry, but it was unrealistic of her to expect that these lawyers should take her case out of the goodness of their hearts. They also have families to support.
The lawyer is a bit of a high stakes gambler. They can’t take on possible loser cases because they don’t have extra time or extra resources. 

They don’t have volume and their cash conversion cycle takes forever. It can sometimes take years to win the case.

But, oh, the last principle. Yes it appears that lawyers make mucho bucks. But given this crazy cash flow situation, they have to have it to survive.

How do lawyers get around this? Sometimes they ask for retainers. Sometimes they get their money up front. Sometimes they save money from the last case to last them a while, get interim financing, or their favorite cash flow management tactic… band together in packs. Excuse me, I mean firms. (Hey, I couldn’t resist). This way someone’s money is coming in sometime. It is how they pump up the volume. The corporate lawyer, the tax lawyer, the personal injury lawyer… all together with different timings on their cash conversion cycle—that is one reason why law firms are so big.

The multi-level marketer

Multi-level marketers make a profit in two ways—from selling a product and from taking a percentage of what their affiliates sell further down the line.

For example, when the front-line salesperson sells a bottle of vitamins to a customer—they collect 100% of the retail price from the customer. The front-line salesperson keeps 25%, pays 50% for the product, and pays another 25% to the person that brought them into the program. The person that brought them into the program turns around and pays the person that brought them into the program 25% of their cut and so on and so on up the chain. Someone who has several levels of salespeople and supervisors—or affiliates—underneath them could, conceptually, never sell a product directly to a customer, but still be bringing in income.

If a multi-level marketer works things just right, she can apply all Four Principles of Happy Cash Flow™.

If she asks customers to pay her before she calls her distributor to order the product, she doesn’t use her own money or get stuck with excess inventory.  So she is doing well on Principle #1—Use other people’s money—and Principle #2—Cut the number of days.

If she has a large clientele, she can keep the volume flowing. If she can elicit someone to sell on her behalf—if she becomes a supervisor—then she can benefit from the volume created by others’ efforts. So, she is doing well on Principle #3—Pump up the volume.

And the margins on these products are generous. Generous enough for her to share a cut with her supervisor and several people up the chain of command. So the potential is there to make it on Principle #4—Put a little in—get a lot out. And I say POTENTIAL because the product is not the only cost of doing business. She must also advertise, pay for office supplies, telephone, gas, Internet access, possibly rent… and the list goes on and is unique to each salesperson’s approach to her business. If too much money is spent “running” the business, then the profit made on each product evaporates.  As with any business, the danger of turning into one of those hobbies I mentioned in the first chapter is there.

A not-for-profit model

A not-for-profit also has to worry about cash flow. They need cash to support their operations and pay their staff and provide services.

What often messes up their cash flow is grants—grants that fund on the reimbursement basis. Many federal grants require that a grantor spend the money first, accumulate the costs, and then seek reimbursement monthly. Then the federal government takes a month to reimburse the grantee.

This is a cash flow mess. If the not-for-profit wants the money, they have to put up with this? Well, maybe not. The feds can be reasonable.

They may be willing to reimburse on a weekly or even daily basis. They may give you some costs up front and ask you to justify the rest. It doesn’t have to be this way.
Of course, billing on a daily basis takes time, but can help ensure you don’t run out of cash as often.

Instead of DSI—Days Supply of Inventory—the metric you would be concerned with is Days Between Billings. The longer you wait, the longer your cash conversion cycle will take.

Some not-for-profits choose to reject grants that have such bad cash flow effects and are paper work intensive. They prefer direct gifts and donations, if they can get them. You can also renegotiate with a grantor to change the sequence of events.