Online NewsHour: Internet Cash Flow -- July 7, 1999



	THE INTERNET STOREFRONT

July 7, 1999

The Amazon.com model is an example of how Internet commerce principles simplify the business cash flow cycle by reducing inventory and warehousing costs. Professor James Angel of the McDonough School of Business at Georgetown University explains how the e-model compares to stores down the road.

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August 18, 1997: A report on the rise of Internet bookstores.

Browse the NewsHour's coverage of Cyberspace and the Internet Stocks index

Professor Angel's working papers

One of the biggest investments that most retailers make is in the inventory that they carry on their shelf or in a warehouse. For example, inventory makes up about 40 percent of Wal-Mart's total assets.

The money tied up in inventory to a retailer is very costly; either the retailer has to pay interest on money borrowed to pay for the inventory, or the retailer could be earning interest on that tied-up money. Furthermore, the retailer has to pay storage costs for inventory that is stored in warehouses, and the inventory may become damaged or obsolete. Thus, retailers are always looking for ways to reduce the amount of money tied up in inventory without losing sales.

Often retailers have to pay for merchandise long before they are able to sell it to customers and get paid for it. The length of time that the retailer is out of pocket is sometimes called the cash cycle, or the cash conversion cycle.

For example, if a merchant pays cash for some inventory on day 1 and sells the item for cash on day 40, the cash cycle is 39 days.

Often, both the purchase of the inventory and the ultimate sale to the consumer involve credit transactions. In order to calculate the cash cycle when credit is involved, what matters is when the retailer and the final customer actually pay rather than when they take delivery of the merchandise.

Brick and mortar cycle.

Consider this sequence of events:

Day 1: Retailer buys merchandise for $75 and agrees to pay for it in 30 days.

Day 30: Merchant pays for merchandise

Day 45: Merchant sells merchandise to customer on credit for $100

Day 75: Customer pays $100 to merchant.

In this example, the cash conversion cycle is 45 days: The customer pays the merchant 45 days after the merchant paid for the merchandise.

Some advantages.

One of the advantages that some e-commerce companies, or "e-tailers," have is that they can reduce the holding of inventory by relying on the inventory of their suppliers. For example, when a customer places an order via the Web, the e-tailer transmits the order to the supplier who ships directly to the customer. This vastly reduces the inventory that the e-tailer needs to carry. However, there is no free lunch involved. The e-tailer's supplier still has all the costs of holding inventory, and presumably passes those costs along in the price charged to the e-tailer. Furthermore, reliance on vendors to hold inventory reduces the control that the e-tailer has over the availability of goods as well as the quality and timeliness of the delivery service. Furthermore, relying on the vendors to hold the inventory makes it much easier for e-commerce competitors to duplicate the same strategy.

Professor Angel also provides an Internet stock value
calculator on his Web site.