You’ve heard the adage, “Define Your Niche, and Work at It”? As businesses grow, I’ve noticed a clear tendency to stray from this strategy. While there are many legitimate reasons to do so, be careful that you don’t dynamite your cash flow as a result.
I have a client who has successfully cornered the market in a particular niche in a city with a great deal of that sort of work. The company has focused on customers who are resistant to deflation (downward price pressure) and stock market fluctuations, and who pay their invoices in 15 days. What a find!
In an attempt to expand their revenue base, this client took on a couple of contracts that were outside the deflation-resistant customer group, who take 10% in retention and hold it for six months or more, and who pay their invoices in an average of 50 days or more. Topping off the changes, the two contracts represented 16% of the client’s entire year’s revenue.
The client was excited to have landed what appeared to be very lucrative projects. However, within a couple of weeks it was clear that lack of cash would be a major issue. The entire operation was focused on these two projects, which meant that the work for which they were paid in two weeks slowed almost to a halt. Within two weeks, the cash that had once flowed so plentifully, dried up, and they almost went out of business.
Had the company prepared to ‘fund the ramp’ as I like to call it, they could have taken on this work without sucking the life out of their business. Banks are often hesitant to lend money to companies that have aggressive growth plans. This is because owners don’t understand the effects on cash flow as a result of rapid growth, especially growth in new niches. And most business owners don’t know how to measure the ramp, let alone fund it. (To learn more about the ‘ramp’ and how to manage the loan process to your advantage, look into my Profit Power Series.)
So, be very careful when attempting any departure from what you’re already VERY good at. And never stray with more than one thing to learn at a time. I had another client who ran a short-run production machine shop that had very good profits with some solid customers. He decided to go into production of a product that he would sell on the internet.
High-volume production and inventory would have been big enough issues for him to learn as he got into it. But the addition of trying to sell on the internet nearly did him in. He was not able to give either business the attention it needed, and after investing heavily in the new venture, he barely broke even that year.
Once he abandoned the new product, he found an outlet that would handle the marketing end (off the internet). He was able to begin again and build a small but lucrative new product line, requiring him to learn only one new aspect of business … higher volume production.
Now, let’s say you’re staying within your niche, but your customer group just grew to include Wal Mart or Home Depot. A prospect such as this tends to bring a flutter to the hearts of many small business owners. “I’ve finally arrived!” is what most owners in this situation conclude. I have seen owners celebrate for a week upon the news that they have been accepted as a ‘big box’ vendor. The problem is that, unless you are very well-funded … and I mean by a millionaire who doesn’t mind dropping a considerable amount your way, you may be signing a death warrant for your business.
First of all, this customer will overshadow all your other customers combined. Will you even be able to service your initial customers as you attempt to service the new big box contracts? So, you focus on this one customer and let your other customers fend for themselves. Next, their long payment terms will often cause a cash drain on your small business, on your retirement fund, on the education funds for the children, the swimming pool money that your wife has stashed, the equity in your home, and a handful of credit cards to boot!
Most owners, even if they have access to that much cash, don’t react quickly enough. Next, now that the big box is your main customer and they know it, they begin to beat you down on price. Then, when you don’t perform to their specifications, miss a delivery, or argue about price, they return your product and leave you to deal with it. By this time, your original customers have found other vendors, leaving you with no customers to fall back on.
My advice? Don’t celebrate. Plan. And don’t let adrenaline make your decisions for you. If it’s wrong for you … it’s wrong. Don’t go there.
There is a cash flow model that predicts how cash will flow for a given situation, and a method for measuring the ‘ramp factor’ in my Profit Power Series, in case you find yourself in one of these situations.
Good luck!