Tuesday, September 6, 2016

Starting a New Game Store: Return on Investment (Part 10)

In part 9, we did a break even analysis. It showed we'll be spending the first 18 months losing money before we finally become profitable. In this section, we'll ask the question, how long will it take to pay back your initial investment? We will be calling this a Return on Investment (ROI), which has different meanings in business, but for us it's just getting our seed money back.

The starting investment was determined to be $140,958. Here's the table from that calculation:

We need to project how long it will take to make back this money, which will come to us in the form of net profit (ignoring taxes). There are several factors I'm using to calculate this estimate. First, we have a time period.

We want our money back in a reasonable amount of time. In this case, we're going to give ourselves five years. If this were a more professional investment, I would want a shorter period, like three years. Because this is something you really want to do and it somewhat defies conventional logic, we're giving you five years. That's my reasoning if I were one of your investors (you don't have investors in this model).

Second, we're going to calculate this number based on a reasonable net profit margin. There are many changes that will go into this business once it's off the ground. Over the first five years, expenses will rise as the needs of the business are recognized. Labor will definitely increase, rent will go up, and inflation will take its toll. I'm not going to calculate all those expenses, I'm just going to assume you work through them and absorb them as sales rise into the sky. So we'll use a percent of net profit as our driver.

An efficient hobby game store is going to have a net profit percentage in the 5-10% range. 10% is really high. My own store hit an 11% net profit last year and that's because it's under staffed; so like turn rates, it can be too high. You could also be working with high margin items that tweak this number, like used merchandise or cash events, but we'll assume you're running a conventional store for now.

Third, we're looking at turn rates, not as a driver of sales, but as an after the fact, reality check. Remember when we spent $70K on inventory? This is our economic engine that will allow our sales to perform. Like a net profit percentage, there's a range of what's reasonable for turn rates. Your inventory should be turning in the 3-6 range (gross sales divided by MSRP of inventory). If you're projecting significantly above this range, your projections are likely too high and you need to plan for more inventory investment. That's a vicious circle of calculations I don't wish on you.

Let's look at our five year return on investment:

The first thing to notice is we did it! We hit $141,000 in net profit after five years. We paid back our seed money. How we did this is a bit aggressive. Our first year we lost money, so that's ignored in the calculations, and year two is likewise kind of rough, since we lost money in the first half, eeking out a small profit at the end. Year three has us dialed in with an 8% net profit and a 3.3 turn rate. This is really strong, perhaps too strong. We quickly build off year three, becoming more efficient in years four and five, with a reasonably strong turn rate and a very strong net profit percentage. The model is sound. It could happen.

The question you have to ask is if this is reasonable or not. We've been conservative up until now. Are we ditching that to shoehorn in an ROI? Does your proposed store location have the potential to hit $600K in sales in five years?

If this is clearly not going to work, you have a few options. Consider putting your store somewhere else. You're going to invest $140K of hard cash into this thing, more than most people put down for a new house. Maybe you need to move. I can make this store work, but only in a high population area with the right demographic and a market that's not severely devalued. This isn't every store; it's now one type of store.

If you can't move or don't want to move, how can we make this situation more reasonable? The obvious answer is reduce your startup costs. Reduce your startup costs and you reduce your need to project a $600K five year ROI with a 10% net profit margin. Maybe play with these numbers and assume some slower net profit percentages. Or assume lower gross sales. Why not both?

What I really don't think you should do is ignore the ROI. It's easy to see this as your dream, rather than a business venture. You could just let it ride, right? You're still making money, just not as much as would be optimal. So what if we have a seven year or eight year ROI?  You say that now, but what does the eight year older you think of this brilliant plan? What's the value of three years of your income at your current job? Maybe take some time before doing this. Maybe take some community college classes to help you cut your startup costs (my next post).

By the way, if you pull this off, you're personally making $91,000 a year when you consider your salary and profit in year five. Don't act so incredulous, it could happen. What do you want to do now? Second store? Expansion? Save up for the next big idea?

1 comment:

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