Making Money in Retail or Manufacturing During Tough Times

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Even when the economy is strong, it's hard to make a decent living running an independent retail business. The long-term trend that makes it tough for the little shop owner to survive began way back in the mid-19th century, when department stores began selling a wide variety of mass-produced consumer goods. It hugely accelerated in the decade after World War II with the advent of large discount chains, and went into hyper-drive in the last two decades with the marriage of computerized "just-in-time" inventory systems to low-cost but highly reliable foreign production.

Today there can be little doubt that if for no other reason than price, most Americans prefer to shop at the huge, low-cost megastores that have all but taken over the retail environment. The proof can be seen both in the empty storefronts that line the main streets of America's small cities and the crowded parking lots of the Walmart, Home Depot, Staples, and other big-box retailers. The main exceptions to the inexorable march of the megastore have been niche businesses that sell products not available from the big players: luxury goods or specialty items such as Balinese imports, fly fishing gear, or high-end bicycles.

Unfortunately, when times are tough, specialty goods retailers are extremely vulnerable to a devastating drop in sales even as their fixed costs, including rent and insurance, remain high. For example, stores that sell fancy kitchenware, lingerie, or wine all offer goods that newly frugal customers can do without or replace with less expensive alternatives. (When times are hard, lingerie is called underwear, and women wear last year's or shop at Target.)

In all but the most upscale neighborhoods, these businesses face the double whammy of many customers who can no longer afford boutique shopping and others who, even though they still have money to spend, find that it's suddenly cool to consume less and patronize consignment stores. And then there is the increasing competition from online niche retailers, who because of their nationwide reach can often offer a huge array of specialty goods at extremely attractive prices. The upshot is that many retailers, especially those that sell upscale items in areas hard hit by layoffs or a drop-off in the tourist business, have little chance of survival.

EXAMPLE: Frederika owned Fancy Food, a store that featured organic and other upscale food for dogs and cats. But with half a dozen local competitors, Fancy Food never made more than a modest profit. Then several large local employers cut workers and closed facilities, hurting her customer base. Almost immediately, Fancy Food's monthly sales dropped, first 25%, then 35%, and finally more than 40%.

To try to turn the situation around, Frederika, who by this time was almost out of cash, came up with a plan to increase her marketing for lower-priced brands. But after talking to her advisory board, she realized that even if sales fully recovered (unlikely given that Costco and Walmart were nearby), the far lower profit margins on budget food would still result in a substantial loss. Facing this truth, Frederika closed down.

On the other hand, retailers who have kept overhead low while providing convenient access to essential products may do just fine when times are hard. For example, people who do fix-it projects themselves rather than hiring a contractor might actually buy more from a local hardware, electrical supply, or paint store, especially one with deep community roots and the marketing savvy to compete with the discounters. True, some shoppers will be tempted to switch to the big-box retailer at the edge of town, but local providers who have lasted this long have learned how to emphasize service, convenience, and marketing to keep most customers loyal.

To get a good idea as to whether your store has a chance to survive until the economy improves, run a profit-and-loss statement and a cash flow analysis based on your new sales numbers. The results should give you a pretty accurate confirmation of whether or not your retail shop is savable. If, even given declining sales, you are still within shouting distance of breakeven, chances are you can cut costs and increase marketing to get back in the black. But if a huge sales drop has decimated your balance sheet, trying to keep going until business eventually improves may be as unwise as it is impossible. Here are some examples to illustrate these points.

EXAMPLE 1: John and Becky run a wine shop specializing in high-priced imported wines not available at mainstream retailers. Last year they made $50,000 on sales of $450,000 and hoped to improve significantly on this in the current year. Then, as America's financial system began to melt down, sales started dropping 5% to 10% per month, finally leveling off at an annual rate of $350,000. John and Becky do a detailed profit-and-loss statement and cash flow analysis based on this lower sales number and find that they are now losing $20,000 per year.

After checking with their advisers, John and Becky decide to take a number of steps to get the business back at least to breakeven. If they can, they have an assurance that Becky's dad will lend them money for their personal expenses for the next year, an amount that will be subtracted from Becky's eventual inheritance. Here are the steps Becky and John take:

  • They contact their landlord and show him their balance sheet. In part because he fears having an empty shop if they go under, he agrees to lower the rent 10%.
  • They lay off their one part-time employee and go to a five- instead of six-day schedule.
  • They increase the number of moderately priced but still unusual wines. This is not so much calculated to make money (lower priced wines are less profitable), but to bring customers into the store, where at least some of them would also buy a more upscale and profitable bottle.
  • They adopt a number of low-cost marketing techniques, the first and most successful of which is to write a forthright letter to everyone on their mailing list explaining that they are on the edge of insolvency and asking for help. They also include a 30%-off coupon good for any bottle over $20. Hundreds of people, concerned that their favorite little wine shop might close and wanting to help the nice couple who ran it, respond, with a surprising number purchasing a case or more. The result is that John and Becky have their best month of the year.

Example 2: Phyllis runs an upmarket women's clothing boutique called Festoon, out of a hole-in-the-wall shop near a large university. After making money 20 years in a row, Festoon suffers six consecutive losing months. When a larger boutique goes out of business around the corner, Phyllis considers moving and turning half of the new shop into an upmarket vintage clothing store.

But after talking extensively with her advisers, she decides that with her house paid for, some money in the bank, and Festoon's lease running out in three months, her best bet is to have a three-month going-out-of-business sale, put her store fixtures in storage, and consider reopening at a lower-rent location when the recession finally exhausts itself. Fortunately, when her long-term customers hear Festoon is closing down, they flood the store and all but demand Phyllis stay open through the holidays. The resulting profit from the going-out-of-business sale is much larger than Phyllis's previous losses, meaning that she has a nice nest egg to cushion her temporary retirement.

You should be able to demonstrate that you understand how to return your business to profitability by using your profit-and-loss statement. Unfortunately, most shop owners and small manufacturers are not sure what it will take to make their enterprises sufficiently profitable. This helps explain why so many seemingly popular small retailers and manufacturers come and go, especially in tough economic times. Their owners, it turns out, never quite understood business basics, such as how much they needed to mark up their goods at a given sales volume and inventory level to cover their expenses (rent, salaries, the cost of carrying inventory, and marketing expenditures to mention a few) and still make a decent profit. When the economy turns sour, they simply don't know what to do to survive.

Here's one business owner who has a good handle on what's needed to do to make a reasonable profit: Felice, who publishes regional guidebooks. Here's is Felice's simple proft and loss statement.

My goal is to gross $1 million a year and net a 9% profit, or $90,000. To do this, I need to develop and maintain a list of 20 core titles that annually sell 5,000 or more copies each at an average cover price of at least $20. If I meet that sales goal, my gross is $1 million after wholesalers and retailers take their 50% cut. The cost to manufacture each book is about $2, or $200,000 per year, all told. I pay my authors a royalty of 10% of net receipts (10% of $1 million, or $100,000). This leaves $700,000.

Doing the Numbers

Revenue
Gross sales at retail $2,000,000
Net receipts 1,000,000
Cost of Goods
Manufacturing ($2 per book) $200,000
Author royalties (10% of net) 100,000
Total cost of goods 300,000
Gross profit 700,000
Expenses
Rent and utilities $30,000
Equipment (lease and purchase) 40,000
Book storage and shipping 50,000
Salaries and benefits for 6½ employees 350,000
Payments to freelancers 130,000
Miscellaneous 10,000
Total Expenses $610,000
Profit $90,000


Special Problems for Businesses With Inventory

If something goes wrong with one part of your retail or manufacturing business—for example, sales of new products are disappointing—you'll have a tougher job reducing expenditures than would a service provider. Of all business expenses, the substantial cost of keeping an inventory of merchandise is usually the least well understood and accounted for. For instance, if you typically carry $200,000 in inventory, your profits must be large enough to cover the cost of tying up this investment, as well as all the other expenditures necessary to keep the doors open. If you use a bank line of credit to cover some or all of your inventory investment, the cost just to finance the inventory might be $10,000 to $20,000 per year, depending on how fast things sell.

EXAMPLE: Tamara opened a shop specializing in handmade Southwestern furniture. She located in a large, bright space near the affluent residential area that she expected to produce the bulk of her customers. Business was good, and for a few months she believed she was going to be a big success. But then, just about the time the economy began to turn sour, she looked more closely at her profit-and-loss statement and found that the cost of buying and maintaining a large display floor of furniture was gobbling up most of her cash. She was going into the red for several months of the year. Scared and disappointed, Tamara considered closing the store.

But then one of her advisers had a suggestion. If the cost of keeping a big inventory was the problem, why not sublease two-thirds of the store and embrace a different sales model? This time, Tamara would work with just a few high-end furniture makers who were willing to supply her with floor samples of their tables, chests, chairs, and other items. Customers would then place orders and pay in advance. Free of the need to pay rent on a large retail space and to tie up cash in inventory, Tamara began to have continuous, positive cash flow.

 Tip: Add a service component to your retail business. A struggling low-profit retail enterprise might be able to save itself by adding a higher-margin services component. For example, a bookstore specializing in building and design books could make referrals to highly regarded local architects, contractors, and builders, for which it would receive commissions. In this business model, the low-margin retail business would be reinvented to provide a steady stream of customers to the much higher-profit service business. 

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