Part 1 of our cash strategist series defined what a business model is and how essential cash is for the survival of any business. Here we look at how different business models in the Food & Drink industry will generate very different revenue streams.
Attracting your Customers
One of the first things a food business will consider is its brand. A brand can create an emotional connection between a product and customer. In cold, hard cash terms, brands are beneficial because:
- You may be able to sell more volumes or
- You may be able to sell at a higher unit price or
Your brand offers you the potential to bring in more cash from sales than if you did not have a brand.
However, the value of a brand extends beyond the generation of regular cash sales. If you are looking to sell your business, your brand may be your biggest and most valuable asset.
For instance, innocent drinks was sold for around £400m in 2013. Looking at the financials in the run up to the sale, this price was not justified by the underlying numbers. Innocent’s value was increased by its extremely strong brand, which pumped up the price tag (and the cash return).
Irrespective of your branding, you are likely to need to undertake Marketing throughout the life cycle of your product. Marketing supports the sales volumes, the price point, or both. Grocers, for example, demand a high Rate of Sale (RoS) in order to keep your product listed, and marketing will be key to keeping the customers buying and achieving the required RoS levels.
With both Branding and Marketing you will pay out cash up front, and only reap the benefit later, possibly over months or even years to come. It is a cash investment to bring in higher levels of future income: but there is also an element of gambling. There is no guarantee that your campaigns will work.
Significant cash is often required to fund marketing. If you are launching a new product, marketing budgets of 20-40% of target revenue are not unusual. If you outsourced the creation of your brand and all the brand collateral, you could easily pay over £100k.
Branding and Marketing are enormously important in the busy, vibrant food sector, but they are a cash temptation that must be closely monitored. A stand out brand may get you recognised and on shelf, but investing all your cash upfront in your marketing means you risk jeopardising your business through a lack of funds for other vital areas, such as production.
If you are facing a cash shortage, consider reining in marketing spend instead of, say, alienating your supply chain through lack of payment. Keep your business model up to date with your marketing plans and remember that marketing spend, both value and timing, is entirely at your discretion.
It will always be a balancing act and there will be many options to choose from.
Which Route to Market (RTM) you choose to sell to your customers through will have a direct impact on your cash balance.
Online selling is a very attractive channel from a cash perspective.
You are paid upfront, before sending your product out to the customer, getting cash in your pocket at the earliest possible moment. You have no risk of bad debts.
As you are selling direct to your customer, your sales price is the full market price which maximises your profitability.
You also do not need much up-front investment to get a trading website up and running.
Depending on how long a production run takes, you may even be able to manufacture to demand: an order is placed and paid for, which triggers your production run. Not only does this give you full control over your demand pipeline, but the production run has been funded in advance by the customer’s order – you have no working capital needs at all, an incredibly rare and desirable position to be in.
Other benefits from an online business model include direction interaction with your consumers which can provide vital feedback from and information about your consumers’ needs.
It’s not all straightforward though. The online market place is extremely crowded so different types of marketing are needed to make you stand out and to drive consumers to your online shop. This requires cash payments in advance as described above.
Getting your product to customers may be a challenge, expensive or impractical. Is it physically possible to deliver ice-cream across the country, and what’s the cost impact on your margins? You need to consider your logistics operation carefully, examining the fragility of your product and its shelf life as well as the packaging and the impression received at the delivery point by the final consumer. Returns can be costly, so you need to minimise damages and delays.
Overall, Online businesses can expect to have more ready cash than those businesses selling through 3rd party retailers, and have an element of freedom in flexing their production to satisfy demand.
Is your vision to have your own store or restaurant?
This model has a regular cash flow benefit as you receive cash payment for your goods immediately, at the same time as you make the sale. You also get the full market price as you sell directly to your consumer.
Having a physical presence means you can get direct feedback from your consumers and can build relationships to encourage repeat purchases. The physical space also provides advertising to potential consumers passing your shop window and is potentially a platform to trial new ideas.
This physical presence comes at the price of an upfront cash investment. Buying or leasing and fitting out a store costs money in advance of making any sales. The size of the cash investment will depend on the location of the store and also the fitting requirements. You will also need to recruit and train staff to sell from the store. All these costs need funding before you sell anything.
Before choosing a store location consider what type of consumers you are targeting.
Are you reliant on passing trade (people walking past your shop)? If so, you should aim to get the best location that you can afford. The rent will be more, but the higher footfall, and therefore higher sales, should make up for this additional cost. If not, then you can choose a cheaper location, but will need to drive people to find and visit your store via other means – e.g. marketing- and become a ‘destination’ store.
With this model you are using another business’ retail and online infrastructure to sell your products. Getting a listing gives you immediate exposure to potential customers. These can range from a small independent store to the nationwide grocers such as Tesco, or businesses with large traffic websites such as Amazon Fresh, Uber or Just Eat.
In each case, from a cash perspective, you are going to be paid significantly later than in the two models above. Stores typically pay 30 to 90 days after the sale has been made. Assuming payment is on 60 day terms, you need to fund 2 months’ worth of sales before you receive any cash payments. You need a pretty healthy bank balance before the listing starts.
Selling through a 3rd party retailer does not only delay your cash, it also reduces it. You receive a lower price for your goods than what the end consumer pays at the till. The retailer needs to make money from selling your product and will take a percentage of the consumer retail price. This can range from 20% to over 35%. E.g. if the retailer takes 30% and your product sells for £1 to the end consumer, you will receive 70p for each unit sold. If you were selling the same product direct from your own store or online, you would have received the full £1. If you are planning to use a 3rd party retailer for your sales, you must make sure you have sufficient margin to still cover your costs.
The amount of money a 3rd party retailers earns on your product is calculated by multiplying their % cut by the number of units sold in a given period: the ‘Rate of Sale’ (RoS). If your ROS is deemed too low by the retailer, you are at risk of have your range reduced or being completely delisted. i.e. you will no longer be able to sell your products via that retailer. Hence the need for an ongoing marketing campaign to support your RoS.
The 3rd party retail model sounds doom & gloom from a cash perspective as it ties up cash through delayed payment terms and demands more upfront cash to be spent on marketing.
However, there is a huge benefit from being listed in the big retailers – there must be, or no one would do it. So what is it?
3rd party retailers give your product tremendous exposure. It is physically in front of millions of people across the country, hitting all geographies and demographics in a way that a website or localised store cannot achieve. If you go on promotion on a gondola end or by the checkout, your exposure rises even further (note, you will be funding this as another chunk of marketing spend). And if your product, marketing and branding is right, you will hit the sales jackpot, with product flying off the shelf.
We must reiterate that success in 3rd party retailers relies on you having deep pockets, at least when starting out, and if your volumes increase rapidly. The delay in cash receipts means you have to fund 2-3 months’ worth of stock and production, as well as marketing, which is not viable for the cash poor.
A number of the big grocers offer a sop to their suppliers, by offering their own invoice factoring facility. This effectively allows you to be paid for your goods early or on demand, instead of waiting 60 or 90 days for payment. It comes at a price though, as the grocer keeps a small % of the final payment in return for early cash settlement, so your margins shrink further. It can be a useful funding method to bridge a cash shortfall.
In reality, very few businesses fit neatly into one of the above categories. The simplicity of the internet means that many businesses have their own website, offering direct sales to consumer.
Having a hybrid model can be great for your cash flow and ultimately, your business’ health. Prompt cash payments from online sales (and at a higher price too) help fill the 2-3 month cash vacuum left by the 3rd party retailers, providing an income source to fund your production, payroll and overhead costs.
Understanding your business model and being able to flex it gives you control over your business’ future. Making a sale is hard enough; but the work’s not done until the cash is in the bank. Predicting and protecting your cash inflows is critical to your long term survival.
In Part 3 of our Cash Strategist series, we look at production and overheads, examining how your business model impacts your cash payment profile. Read part 3 here…