The hardest part of starting a business is not coming up with the idea. Despite the pain many feel during the process, it is not preparing a good business plan (particularly if one has a SCORE mentor). The hardest part is getting the scratch. Everyone who has tackled that process can tell you that people are not tripping over themselves to drop briefcases of banknotes on your business’ doorstep. The Wall Street Journal recently suggested that you can start up with a lot of salesmanship, a little risk and very little cash. How, you ask? Dr. John Mullins of the London School of Economics says you should consider financing with your customers’ money.
Not every business can do so. Some are simply too capital-intensive. But for many, the model works. Dr. Mullins provides five pay-in-advance models businesses could investigate.
The first, oldest, and most common is the pay-in-advance model, used by many service industries. Remodelers and landscapers require at least part of their fee upfront. Airlines always charge in advance for tickets. Give a customer a good reason to pay in advance (and have the courage to ask him to), and you could be off to a good start.
The prescription model is also popular. Everyone willingly pays their cell phone and internet charges in advance. Many other services could be handled in such a manner. Those who use this approach, however, should take a lesson from the cell phone firms and be very clear upfront about the level of services available with the subscription and what happens when that cap is passed. Also keep in mind that subscriptions work better for expendables (fruit and vegetable deliveries) than for durables (refrigerators and furniture).
Third, consider putting yourself in the middle of the deal. Act as a matchmaker, bringing together buyers and sellers. Consider how eBay and Amazon keep their cash registers churning with small percentages of the sales of second-party products they never even touch. There are cautions one must observe. First, don’t enter a market which is saturated. Secondly, develop buyers and sellers at the same rate so that neither has cause to be discouraged with you.
The fourth approach is quick inventory turns. Price inventory to move so quickly that it is sold before you have to pay suppliers. This can be a risky approach, so it is dependent on selling inventory you have already acquired. A similar approach could be created by taking customer credit card payment at the time of order, and then only buying what customers have already ordered. This approach requires that you have committed suppliers who will meet your delivery needs at close to 100%.
There is a limit to the sales volume that can be generated with customer financing, so it is worthwhile with any pay-in-advance venture to consider how the product can be transformed in the future. Microsoft is an excellent illustration. Bill Gates and Paul Allen started by writing custom software for PC manufacturers. While profitable, that effort could not be expanded exponentially. While retaining their relations with manufacturers, Microsoft by transitioning from a pure service model into a retail model, packaging key user programs (and operating system upgrades) for direct sale to end consumers.
Most businesses will find that none of these models work for them. However, many businesses will be happily surprised to find that they can adapt some of these methods to at least partially use “customer financing” to accelerate their cash flow.