Overcoming the #1 reason of why retail fails
There are many articles that list the top reasons of why retail companies fail. Most articles are consistent and some highlight different reasons. I looked at the ten most searched articles, summarized their top reasons and identified the consistent themes. In conclusion, every single list includes some money related issue as one of the top reasons of why retail companies fail. Whether is pricing, or lack of financial know-how, or running out of cash. They all include some finance element as one of the reasons for failure.
The three most common reasons are:
Lack of capital: not planning for at least 6 months of fixed expenses during the first 2 years, can be catastrophic. Even the best financial plans could be off in terms of lower than expected sales or higher than expected expenses (or both).
Unprofitable business model: examples of this include, retail locations with high rent expenses and niche products that don’t generate sufficient volume/traffic. For example, a Hallmark Greeting card store in a high-end mall. In this case, the high-end mall demands a higher rent, while the type of business is a niche (not a lot of people need or even believe in greeting cards these days).
Poor Financial Management: this category includes, not having the proper inventory level, not managing costs and pricing, not properly managing expenses, etc.
Most articles just list the reasons, but how do we avoid these situations?
Cash reserves should be treated in a similar manner as the lease security deposit. In other words, the landlord would typically request 1 or 2 months of rent as a security deposit. You should add up all of the expenses and multiply by 6 and put that money aside and consider it as another “security” deposit.
Business Model: it goes without saying that the business model needs to be profitable in a short period of time. After all, you only have 6 months in your cash reserve “security” deposit. It is a good idea to “test” your business model before signing the lease. A typical lease is 5 years and most likely it will become your largest expense. You should consider a pilot (if possible) to test pricing, target market, advertising effectiveness, etc. At a minimum, you should address these aspects of your business model:
1. Product and merchandising.
2. Pricing in relation to value proposition,
3. Overall customer experience in relation to competition (especially online competition)
Product and merchandising ar
e your ticket to the dance. In other words having the right product mix/inventory and merchandising is the number one reason why new customers will walk into your store. A new customer may not know about your pricing, they probably don’t know what to expect as far as customer experience, etc. But if you have the product that they are looking for, they may consider going in. I owned a custom wedding invitation store and as such, customers came into the store because they were looking for something different and unique. The products were hand-crafted and materials were sourced from all over the world in order to make each piece different. After customers came into the store and glanced at a particular invitation, they evaluated the price relative to the value. In the case of my stationery store, prices were 4x higher than regular invitations; however, in most cases the value of a custom invitation was quickly perceived by the customer.
Value proposition in relation to price: the business model must address how are you going to provide sufficient value to your customers in order to attrack them to your store over and over. This may sound obvious, but it is often missed by many entrepreneurs. For example, a clothing boutique may consider having the latest fashion as their value add or differentiator from the competition. The reality is that this may not be enough of a differentiator for people to go shopping to this store. Customers in the target market may be price sensitive or they may be location sensitive or they may want other perks such as free tailoring, etc.
For most companies the cost of keeping a customer (or making him/her return) is far cheaper than acquiring a customer. For example, you may run an ad in facebook that costs $5,000 out of which you get 10 new customers, the cost of acquisition is $500 each. Assuming that you provide excellent service and that the customer perceived value in their purchases some of these 10 customers may return. The cost of making these customers return, is probably far less than $500.
Financial Management: One of the most important things you can do to overcome this challenge is to measure and act upon your key performance indicators (KPI). In the case of retail the top five KPI’s are:
Traffic: how many potential customers actually come through the door. This helps you measure the effectiveness of your advertising campaign. It doesn’t matter how many people click on your facebook ad or see your billboard, it boils down to how many people came to your store because of the ad.
Conversion: how many potential customers actually bought something. At least 10%-15% should be the target. That means that at least 1 out of 10 people that came through the door bought something
Average ticket: the average size of the transaction. This depends very much on the type of retail, if you are selling candy, the average is going to be much less than if you are selling shoes.
Gross margin: in simple terms is the price less the cost of the product. A gross margin above 50% in retail is consider good.
Inventory turns: how much inventory do you have and how well are you turning the inventory over. The last thing you want is to have a lot of inventory that is slow moving, this will tie up capital and restrict your ability to grow profitably.
In summary, having cash reserves equivalent to at least 6 months of operating expenses is a must-have before you sign the lease. A profitable business model is designed with 3 main characteristics; superb product; value-based pricing and excellent customer experience. Last but not least, you need to measure the business. What you don’t measure you don’t manage.
Ricardo Lowe, CPA
About RLowe Consulting: We help companies improve their bottom line by assisting them solve their business challenges and by taking their business to the next level. For a complimentary consultation call 954 632 3939 or via email at: email@example.com