Month: May 2017

By Eli Schragenheim and Henry Camp

E-Commerce offers real added value to many different market segments. The value of the new technology has been analyzed in a previous post: “Applying the six questions of technology to digital stores.” This added value changes the whole business of retail.  But, it is not just a disruptive technology; there is a risk of being self-destructive, because digital stores face a huge threat to their own survival.

The main question every single digital stores faces is:

What added value can we offer relative to other digital stores?

The question targets a huge and sinister obstacle, which becomes more and more dangerous with time. From the point of view of potential customers, what is the difference between buying from one digital store and another? As long as delivery logistics are in place, location has no relevance, unlike traditional brick and mortar stores.

Dr. Goldratt coined the term “decisive competitive edge” (DCE), as being superior to any significant competitor in a given market segment. He also defined the conditions for gaining such a DCE.

• Answering a need that no other competitor is able or willing to.
• Competitors refuse or are slow to follow, usually because delivering equal value contradicts a common business paradigm, such as operating efficiently or containing costs.
• In other parameters important to the segment, the company is on par with the competition.

The direct consequence of lacking a strong DCE is that customers are left with no clear means to differentiate, except based on price. The reality of the internet has encouraged services that compare prices between different digital stores.  Thus, it is quick and easy for customers identify the cheapest digital store for any desired product.

Many on-line shoppers make spontaneous purchases once they see a product they fancy and its price. This is where the vast majority digital stores compete, but without truly gaining any advantage over each other.  They commonly offer a broad variety of products at very low prices and send emails in volume to past customers with the hope of capturing or keeping mindshare.  On top of that, artificial intelligence is deployed to speculate what any potential customer desires.  Could this be a DCE?  Yes, if you are far better than your rivals.  The problem is, since competition is so hot, any gaps close very fast.

When the only reliable competitive differentiator is price, then the Throughput percentage (Margin/Sales) drops, forcing the digital store to look for some combination of two alternatives:

One approach is cutting expenses, seeking profitability at current volumes. Unfortunately, the main expenses of digital stores support marketing as well as being quick and reliable in delivery.

If cutting expenses seems like an obviously bad idea, you will understand why most digital stores choose the opposite approach, spending more and slashing prices in the hope of driving sales growth. Driving OE up while cutting Throughput % typically results in current losses but maybe, just maybe, with enough more sales … someday the digital store will gain enough economies of scale to become profitable.  The required relentless increases in the quantities of items sold, becomes more and more difficult to accomplish, because the cost of entry for new competitors flush with investors’ cash is very low.  Should one digital store fail, then the remainder feel like there is no alternative to spending lavishly on marketing to attract the customers who used to buy from their now defunct competitor.  Furthermore, the survivors try to draw in ever more new clients by dropping prices some more.  This is the vicious cycle of the digital marketplace.

How can a digital store gain a Decisive Competitive Edge that is not price?

First let’s state the obvious: currently the only true DCE for digital-stores is being very big!  So, Amazon and AliBaba have already gained that position but how can others become that big?  There are three separate types of added value that big successful stores deliver to their customers:

1. Confidence that nothing will go wrong
2. A broad variety of products
3. The ability to succeed while delivering at low prices

Is there anything that a smaller digital store can do to gain a customer base that loyally buys from them? This is the most critical question for any digital store facing the grim reality of global and open competition on price.

There are several directions where breaking the vicious cycle is possible:

Building a strong loyalty program for customers

It has been proven by the airlines that loyalty programs work! It demonstrates not only the impact of getting things for free, but also that giving special VIP treatment to people makes an impact.  Translating the concept of a loyalty program to digital stores is far from being trivial but it also brings a new opportunity.  The common paradigm is stuck with investing money to give away value to customers who bought something without being certain of future purchases from those customers.  This paradigm makes such a loyalty program tough to imitate, especially in the current environment of lack of profits among digital stores.

The real challenge of pursuing this direction is not only the free gifts and price reductions but providing special VIP treatment to loyal customers. It could be a certain top product mix sold only to the members of the club, giving high priority in the shipping, free delivery – like Amazon Prime, free returns – like Zappos or any other generic idea for a DCE.

Still, loyalty programs have been copied. What airline doesn’t have one?  The “D” in DCE stands for decisive.  This means others won’t copy the edge, at least for long enough for the developer to gain enough of an advantage, like accumulated profits, to make another leap ahead of the competition that they can’t or won’t afford – again, at least for many years.  For a digital store’s loyalty program to remain exclusive, it must either address a problem caused by digital stores by their very design or an issue that is unresolved by all stores.

One comment about a neglected market segment: the high socioeconomic sector is not actively sought by digital stores who speak the language of low price. While relatively rich people still hate to pay more just because they can afford to, those people are willing to pay more for higher value.  A loyalty program that treats the members specially is something they look for.  If digital stores are able to find its way into this sector – they’ll become antifragile, and that is worth a lot.

Choosing the right product mix

Regular stores carry and display physical items. Virtual stores can only display a picture of an item.  This allows the digital stores to display and sell very wide variety of similar items, without the need to choose the preferred product mix.  On the other hand, even if offering more is virtually free, studies have confirmed what shoppers already feel – having to sort through the haystack to find the desired needle makes what could be easy and fun a boring chore.

What does it mean that a store shows a picture of a certain product? Actually, it only means that the product is for sale.  There is no implied formal recommendation by the store.  “Some people buy it.  So, we have it.”

What if the store took a stand on what it considers good and worthy products? Consumers are rightfully suspicious that stores recommend those items that bring the store the most margin.  If that expectation for self-serving behavior can be overcome, then truly assisting individual buyers choose well for themselves specifically is a significant added value.  Big retail already relinquished all the responsibility of choice to the customer.  The need for help making the right choice is still real for many buyers of many products.  So, being able to identify the right product mix and then directing the consumer to what truly fits his or her needs while clearly projecting pure intentions is a Decisive Competitive Edge.

Assisting customers can be partially by virtual means, displaying relevant information that helps them realize which needs the product meets or by means of real-time texting or even speaking with a shopper live. Such services add complexity and costs to operations, which is seen as problematic, but could also establish a unique value that makes the specific digital store unique and it attracts high level customers.

Making the delivery a special experience

It is true that customers of digital stores have a somewhat elastic tolerance to the time of the delivery. If they didn’t, they would be forced to buy from a local store that holds stock of those products for which they prefer not to wait.  This does not mean they don’t care how the item finds its way to their home or workplace.  Most digital stores partner with delivery companies to handle shipments.  This means the delivery company treats the item(s) that are delivered just like all other items.  It is enough that they get there reliably.

What if, for the upscale segment, the carrier truly represents the digital store? When this is feasible, the delivery could easily answer a need: allowing the customer to physically check the product and only then decide whether to keep or return it.  It could solve the problem of fitting clothing, by including in the delivery two or three sizes out of which the customer would choose the best fit.  The buyer could decide by actual inspection which of two competing brands is preferred.

Is this too expensive to do?

This is the wrong question, even though this is the most common one managers of digital stores probably ask themselves. The real question is whether some customers are ready to pay for such a service?  If there are customers for whom this service is what they desire, then the price is not the only issue.  What a relief!

The internet created a sea change, the ramifications of which we are still struggling to understand. There are some destructive aspects to the internet economy.  The belief that the number of customers and detailed information about them are enough for making a successful exit are probably over but the damage from making customers expect to getting value for free still exists.  It is time for deep cause-and-effect analysis to outline a way to draw true value, value that answers our needs from the internet.  E-commerce in general and individual digital stores in particular are ripe areas in which to start such an analysis.  Those who do it well and soon will deploy their DCE to earn not just sales but disproportionate profits.

By Ravi Gilani and Eli Schragenheim

Money is a critical resource as demonstrated by every company that has gone through bankruptcy or has been on the verge of bankruptcy.

Generally speaking cash is also the ultimate constraint of the public sector, as the budget dictates the maximum value that the public-sector organization, a non-profit organization by definition, is able to draw. Limiting the working capital of an organization to the extent that lack of cash limits the throughput happens also to some profit organizations.

This article focuses on companies for which the cash limitation is a direct threat on their survival. This kind of cash constraint is unique because it is imperative to find the immediate way to go out of the situation.

People who are knowledgeable in TOC are aware that any specific constraint of the organization should dictate policies and norms of behavior that could be different than with another constraint. This dependency on the constraint is even more noted when the constraint lies with cash, which prevents purchasing the required materials and the use of capacity and by that disrupts the life line of the organization. The immediate result is that revenues are blocked.  These revenues could have been used to generate more revenues and reduce the pressure on cash.  In such a case money is both the goal and the absolutely required capacity to continue the business. This is a unique situation with very critical ramifications, which should lead the management to behave differently than in any other state. When lack of cash threatens the existence of the organization all the attention of the top management is consumed in fighting one payment crisis after another.

The seemingly complicating factor of money being the goal, the constraint and the direct threat to the organization makes the TOC insights regarding exploiting the constraint and subordinating everything else to it, especially strong. The good news are that the right behavior accelerates the regaining of cash in a non-linear way. The objective of this article is to point to ways to elevate the cash constraint. It is not a constraint a company can live with for too long.  We believe that it is possible, many times, to get out of the cash constraint situation in 15-20 weeks.

The important generic insight for a survival cash-constraint situation is to understand the meaning of cash-to-cash cycle time and cash-velocity. This leads to being able to accelerate the cash-velocity and go out of the current state, even on the expense of the amount of revenues.

Cash to cash cycle time is the total time it takes from cash going out to cash coming in. In other words the time from the actual payment to a supplier until the client pays. We can measure the time by days or weeks as reasonable periods of time.

Cash Velocity (CV) is defined as the contribution-ratio of one unit of cash in one period of time.  For any business every dollar invested in materials, or for providing the capacity required for a sale, is expected to yield, on average, more than one dollar. In other words, the ratio of the cash in to cash going-out should be higher than 1. The idea here is to get the ratio for one period of time, like a day or a week.

Suppose one dollar is the cost to buy materials and the finished item is sold for $2 dollars three weeks later. So, the going out cash is doubled in three weeks and should yield 4$ in another three weeks.

How much did the invested dollar yielded after just one week? The answer is NOT 33%, because if after one week we get $1.33, then we immediately invest the $1.33 to generate more sales and then after the second week we have 1.33*1.33 = $1.7689, and after the third week we should have: 1.33*1.33*1.33 = 2.35, not 2.  In order to get the cash velocity (CV) of the situation where $1 would yield revenue after three weeks of $2 the CV = the 3^rd root of 2 = 1.259, or 25.9% contribution rate in one week.

A company that is in the state of struggling with a cash constraint has operational lines working, but it needs to invest its limited cash to buy materials and then turn them into sales. These are the main body of the truly-variable-costs (TVC), the cost saved when one unit of output is not produced and sold.  The quicker these dollars, used for TVC, are turned into Sales the amount of cash would grow until the state where the constraint moves to something else.  The ratio of S/TVC, S stands for sales, representing the contribution of $1 invested in materials to cash coming from sales.  This ratio is called: contribution-ratio.

The overhanging threat on the company is its ability to cover all the other operating expenses (OE). These are all the expenses the company has to carry to sustain the operational line alive.  Without the OE there is no basic ability to survive.  So, it is absolutely critical to have the amount of necessary OE in order to stay alive.  The rest of the limited cash is to make more cash as fast as possible, until the company reaches the state where there is enough cash to support the full market demand.  At that state the constraint might move to the market or to another resource.

The formal mathematical formula for cash velocity is: CV = ((S/TVC)^(1/n) -1).

The cash-to-cash cycle time is represented as n in the above definition.

Table 1 details the calculations for two different products P & Q.

Table 1

Parameter	P	Q
Selling price per unit (s) in $	100	80
Totally Variable Cost per unit (TVC) in $	50	50
Contribution ratio s/tvc	2	1.6
Manufacturing lead-time in weeks	2	2
Clients credit period in weeks	4	1
Total cash to cash time (n)	6	3
CV/Week =[{(S/TVC)^(1/n)}-1]*100	12.25%	16.9%

It seems that given a choice, due to the lack of cash, between selling P and selling Q, that selling Q would generate cash faster, bringing the company to go out of the cash constraint situation earlier than focusing on selling P. This is not the intuitive answer, just to hint how far are most managers from the right answer when cash appears as a constraint.

The cash the company holds at every point in time when it is in a cash constraint situation is used for two critical objectives:

1. Covering the critical operating expenses: the must-have expenses to keep going – OE.
2. Purchasing the absolutely required materials to enables sales. This is the TVC.

The minimal cash required for survival is n*OE, because whatever is purchased now will turn to revenues only in n periods. However, this amount does not leave any room for investing cash in order to get more cash. This means that once the company is left only with that amount of cash it is doomed.  Question is what is the amount of cash that still provides a valid option to survive? We like to find out what cash leaves an option that after n periods the company would still have the same amount of cash. Let’s call it adequate survival cash. So, we look for X cash that after n periods would yield exactly X cash. In the beginning we need first to put aside n*OE from the cash in order to cover the OE payments for all the periods, including the current one, until the new cash appears.  The remaining cash of X-(n*OE) is used to purchase materials to sell end items after n periods getting X in revenues, allowing us to repeat the process. The invested cash in materials would yield c*(X-(n*OE)), where c is the contribution rate, S/TVC, and we like it to be equal to X.

X = c*(X – (n*OE)) = c*X – c*n*OE

X*(c-1) = c*n*OE

X=n*OE*{c/(c-1)}

Sufficient cash means the cash at hand is enough to cover the n*OE plus having enough to purchase whatever is needed to exploit the capacity and/or the maximum market demand. If the cost of materials that fully answer all the demand or the full capacity of the most loaded resource, then it is enough cash to be considered beyond the urgent need pull the company from its cash constraint situation.

Table 2 provides sample calculations for above parameters.

Table 2

Parameter	P	Q
Contribution ratio (c) ~ S/TVC	2	1.6
Total cash to cash time (n)	6	3
OE / week in $	500	500
Cash available in $	2000	2000
Survival time in weeks	4	4
Survival cash requirement:   n*O.E.	3000	1500
Adequate cash requirement: n*OE*{c/(c-1)}	6000	4000
Cash required / week for full capacity	1000	1000
Sufficient cash requirement: n*(OE+1000)	9000	4500

What the table shows is that having on hand cash between $4,001 and $4,500 and focusing on the Q product provides a much better way to bring the organization out of the cash constraint than by concentrating on the P product. If the market for the Q product is limited, and this is what constraining the company from investing more than $1,000 per period in purchasing materials, the organization has more cash than 4,500, and the internal constraint provides enough capacity also for the P product, then the organization can improve even more.

The above example is a simplified reality.  Usually, while having on-hand only $2,000 there are already orders and materials in the pipeline.  That means the cash-flow situation needs to be clearly specified week-by-week.  But the principles are the same.

The process of going out of the cash constraint situation

In cash constraint situation, the focus on generating as much cash and as fast as is possible through effective utilization of existing cash. A small increase or reduction in cash can make or break the organization. This unique property of cash impacting throughput non-linearly could help organizations to overcome cash constraint in a very short period of time.  In most cases it may be possible to come out of cash constraint in less than three months by reducing cash to cash time, and by that accelerating the cash velocity.

Cash to cash cycle time (n) reduction has huge non-linear impact on throughput, cash availability, survival time, adequate cash requirement etc. Often just shrinking cash to cash cycle time is good enough to come out of the cash constraint situation provided the right measurements are in place.

The common TOC techniques of accelerating the flow of value to customers, through chocking the release of orders and the use of buffer management, are already good means to shorten the cash-to-cash cycle and increase cash-velocity.

Additional ways to reduce the cash-to-cash cycle time are:

Reducing the customer paying time. Giving the customer price reduction in exchange of significant faster payment is of paramount importance for achieving faster CV. It can be shown that even after providing 20% price discount to shrink customer payment time from 4 weeks to one week could exploit better the cash constraint. Of course, this might not be the right move when cash is not an active constraint.

Reducing the manufacturing lead-time is also of critical impact. While it is always good to reduce manufacturing lead-time, its impact on exploiting the cash constraint is even more critical.  Even here, when possible, on top of all the known TOC techniques, to use overtime, for extra cash, to vastly reduce the lead-time and by that accelerate the revenues, then it has to be carefully checked.

This thinking on the special devastating impact of a cash constraint, and its practical meaning for exploiting the cash constraint, is a major contribution of the five focusing steps of TOC.  Just remember the purpose here is to get rid of the cash constraint situation.  Cash is not a resource to keep as a system constraint!