Fernando MonteiroI Believe in High Turnover Businesses
May 22nd 2010 13:29
Do you, dear reader, have a habit of looking into businesses as you travel around daily? When I go through Marrickville in my bus back from work I always observe the businesses around. Most of them seem to be quite profitable and well run. Interestingly enough, some rare ones don’t.
I am thinking of the second-hand furniture and electrical business in Victoria Road. If they sell a couple of items they probably make the day, but they don’t seem to be busy.
Now consider the two newsagents on Marrickville Road. They thrive, they’re always busy, they seem to be making lots of cash all the time. And the same goes for many other businesses there.
If you had a bag of money on hand and wanted to buy a business to explore, what sort of business would you go for? The run-down second-hand furniture, which should sell at a low price-to-earnings, or the newsagent, which should certainly be more expensive?
This is an old story: the paradigmatic new car dealership may make a few trades in good times and so the upmarket one as well. If one customer though, turns down a deal it hurts you. And if bad economic times ensue, you won’t make many trades and might even go under.
Compare this now with the thriving newsagent. He makes hundreds to thousands of small trades a day. His revenue comes from different items such as newspapers, which have small margins, to magazines which have high ones. He also sells the Lotto and Lotteries which might have low margins but very high turnover.
Now, if in an economic downturn, the newsagent can continue to sell their items, in part because they are low priced and in part because people just don’t go without them. The newsagent survives a recession.
The triumph of the newsagent is selling a lot, creating lots of cash-flow and, if necessary, being able to negotiate terms with suppliers. But generally, if you have a lot of money coming daily from sales, you are a lot more comfortable with your budget. You have money and so you can pay and because you can pay you can get credit. Money brings in more money.
Considering this you could think that the newsagent business is the kind of business that could expand. You could buy other such business and chain them, or buy vertically, who knows.
I’m convinced that great businesses must be high turnover, high cash flow type. Just think of Woolworths, perhaps the greatest Australian company. Their secret is to make many small trades every hour, which keeps their shelves being replenished all the time and their till ringing. Because they command large sales, suppliers elbow each other to win contracts with Woolworths and so this one can set the rules.
A low turnover business can never do this and, instead, has to accept the rules of the supplier. On the other hand, notice that Woolworths is constantly increasing its business, opening new stores, adding new business such as fuel and now hardware to their offering.
High turnover business might have low margins but just because they sell so much they also make greater profits. Henry Ford knew this when in the 1930s he priced his Ford T to the masses. The other thing this kind of businesses can do, which others can’t, is to pass on economies of scale to the customer, lowering prices and furthermore anchoring their loyalty.
As a matter of fact I’m convinced that not much is to be expected from a business through which little money runs. Instead, I think that you have to envisage your product, your customer and your business system with cash flow in mind. Because the fact is that cash flow brings a lot of power and profit.
I am thinking of the second-hand furniture and electrical business in Victoria Road. If they sell a couple of items they probably make the day, but they don’t seem to be busy.
Now consider the two newsagents on Marrickville Road. They thrive, they’re always busy, they seem to be making lots of cash all the time. And the same goes for many other businesses there.
If you had a bag of money on hand and wanted to buy a business to explore, what sort of business would you go for? The run-down second-hand furniture, which should sell at a low price-to-earnings, or the newsagent, which should certainly be more expensive?
This is an old story: the paradigmatic new car dealership may make a few trades in good times and so the upmarket one as well. If one customer though, turns down a deal it hurts you. And if bad economic times ensue, you won’t make many trades and might even go under.
Compare this now with the thriving newsagent. He makes hundreds to thousands of small trades a day. His revenue comes from different items such as newspapers, which have small margins, to magazines which have high ones. He also sells the Lotto and Lotteries which might have low margins but very high turnover.
Now, if in an economic downturn, the newsagent can continue to sell their items, in part because they are low priced and in part because people just don’t go without them. The newsagent survives a recession.
The triumph of the newsagent is selling a lot, creating lots of cash-flow and, if necessary, being able to negotiate terms with suppliers. But generally, if you have a lot of money coming daily from sales, you are a lot more comfortable with your budget. You have money and so you can pay and because you can pay you can get credit. Money brings in more money.
Considering this you could think that the newsagent business is the kind of business that could expand. You could buy other such business and chain them, or buy vertically, who knows.
I’m convinced that great businesses must be high turnover, high cash flow type. Just think of Woolworths, perhaps the greatest Australian company. Their secret is to make many small trades every hour, which keeps their shelves being replenished all the time and their till ringing. Because they command large sales, suppliers elbow each other to win contracts with Woolworths and so this one can set the rules.
A low turnover business can never do this and, instead, has to accept the rules of the supplier. On the other hand, notice that Woolworths is constantly increasing its business, opening new stores, adding new business such as fuel and now hardware to their offering.
High turnover business might have low margins but just because they sell so much they also make greater profits. Henry Ford knew this when in the 1930s he priced his Ford T to the masses. The other thing this kind of businesses can do, which others can’t, is to pass on economies of scale to the customer, lowering prices and furthermore anchoring their loyalty.
As a matter of fact I’m convinced that not much is to be expected from a business through which little money runs. Instead, I think that you have to envisage your product, your customer and your business system with cash flow in mind. Because the fact is that cash flow brings a lot of power and profit.
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