Cash is King: How bargaining power can influence your business model, profitability and ultimately cash flow
September 29, 2014
Personeelnuus
November 13, 2014

Cash is King: How strategic placement affects your cash flow position

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In our previous newsletter article on the topic of cash flow, we made the point that cash flow is a factor of profit. The relationship between profit and cash flow is sometimes complicated, however: In many instances a business might be reporting reasonable profits while still experiencing severe cash flow constraints, while a business reporting mild profits might be in a very healthy cash flow position.

Although there are various factors that will have an impact on the relationship between profit and cash flow, such as creditor and debtor terms, rate of organic (internal) growth, capital requirements, research and development requirements and average time horizon of projects, in this article we will focus on two of the less mentioned components, namely the product mix and product life cycle.

The business philosopher, Michael Porter, suggested in his product life cycle model that all products move through a series of development stages, namely the introduction, growth, maturity and finally the decline stage.

In the introduction stage, development and initial marketing cost will cause negative cash flow, while profits would likely not yet have been realised. During the growth stage, the product’s contribution to profit will likely grow, generating positive cash flow, although initial cost in terms of placement of the product as well as initial marketing cost will likely counter positive cash flows. In the maturity stage, however, as the product becomes established in the market, it can be expected that the product will start realising positive cash flow exceeding investment requirements, until demand starts declining, leading to the ultimate death of the product.

The Boston Consulting Group developed the BSG matrix, which attempts to explain the placement of products within the product mix. According to the BSG matrix, products are grouped in relation to market growth and market share, as shown below:

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Cash cows are well-established products, positioned in well-established markets, while stars are well-established products in growing markets. At the other end of the market share continuum, question marks are those products that are not yet well established, but are placed in a growing market, while dogs are products that are not well established, but placed in a mature market.

Understanding your product mix, the positioning of products in their development cycles, and also the placement of products in terms of market share and market growth, can contribute greatly to your understanding of cash flow requirements for different products.

The capital outlay required to gain market share in an established market, for instance, will often outweigh the potential benefits, especially if there are no guarantees that such a strategy will be successful. This makes dogs unattractive prospects in terms of potential cash flow generation.

Question marks might provide the opportunity for investment to gain market share (while the market is still growing), although care should be taken to prioritise products, since it is likely that these products will take time to start generating positive cash flow, placing strain on cash flow requirements. Stars are those products that promise to provide healthy cash flow in the medium to long term, although investment will be required in order to maintain market share, as competitors invest in the question marks in their portfolios. Finally, cash cows are those established products earning positive cash flows, with relatively low investment requirements, since the investment required by competitors to develop dogs, will likely outweigh the benefits to them.

While an understanding of these models can provide great insight into product placement, it is our view that it can also provide great insight in terms of business placement. By understanding the placement of your business (and its products) in terms of its development cycle, but also in terms of the environment in which it operates, it is possible to better equip yourself for understanding your cash flow requirements, managing your competitive environment, and also your product or business portfolio.

Should you require our assistance in regard to the above, or with any other issues relating to your cash flow situation, please contact Malan Botha (malan@asl.co.za) or Arnold Scholtz (arnold@asl.co.za).