In our previous post we described how a profitable business could still run out of cash and fail. Here we discuss how choosing the wrong business model can lead to dire consequences. In particular, how one decision can dictate your company’s cash flow.
Let’s take the cellular service industry. While most people receive mobile service through one of the four major carriers (AT&T, Sprint, T-Mobile, Verizon), some go through a Mobile Virtual Network Operators (MVNO). An MVNO, like Cricket Wireless or Project Fi, operates their mobile phone service on the major carrier’s infrastructure. Without the need to invest in infrastructure development, MVNOs are free to focus on developing innovative business models and novel marketing strategies.
In 2005, Amp’d Mobile did just this. They launched a mobile phone service targeted at consumers between the ages of 18 and 35. YouTube launched that very same year and Amp’d hoped to attract the young and tech-savvy demographic by bundling phone service with streaming on-demand video. After raising $360 million in funding, Amp’d Mobile filed for bankruptcy in 2007. Many people wondered how after having raised so much money, the company would need to file for bankruptcy.
The answer lies in Amp’d Mobile’s business model. At the end of 2006, the MVNO had amassed close to 100,000 customers, of which 89% were on a unique post-paid wireless contract. This type of contract is offered by the big four carriers as well, allowing the customer to pay for wireless service fees in arrears, but usually every 30 days. This means that a customer receives service for the month of January and their bill is due at the end of February. Most often, these contracts are for customers with a steady income and allows the provider to charge overages more easily. In order to manage missed or late payments, the carriers perform a customer credit check to ensure that they have the ability to pay their bills within 30 days. In an effort to grow their customer base rapidly, Amp’d chose to extend this requirement to 90 days.
That turned out to be a fatal mistake. While Amp’d customers now had 3x the time to pay their cell phone bill, Amp’d itself still owed monthly rent on the Verizon network. This meant Amp’d was paying to provide a service to a customer who wasn’t going to pay until much, much later — or, as it turned out, ever.
Amp’d Mobile’s relaxed credit constraints were a boon for new customer sign ups, but proved to be ultimately disastrous for cash flow.
Almost half of Amp’d customers were in default on the 90-day contract terms, making it very difficult to close the company’s revenue cycle or manage rent payments to Verizon for access to its mobile network. At its worst point, Amp’d was losing $370,000 dollars a day and had racked up over $100 million dollars in debt.
Consider another MVNO and its business model, Virgin Mobile. Like Amp’d, they targeted a similar demographic and the service comes bundled with unlimited access to a music streaming service. Unlike Amp’d however, Virgin is a pre-pay, per-minute service. So while Virgin serves high credit risk customers, their business model decision to go against the grain of post-pay, monthly contracts enables the business to have much better cash position. Virgin Mobile was eventually sold to Sprint in 2009.
Although business models can be innovative, it’s important to understand the cash flow constraints of your business and work within those parameters to your advantage. Next in our cash flow series, the Fluid team will share a framework for considering financing products specially designed for thriving businesses.