What is a cash cow?
- A product or a service that generates a lot of profit with small expenses for a business.
- Companies aim to have a cash cow, and some companies base their business on cash cows alone.
- Businesses and investors alike love cash cows. They give stable returns because they exist in low growth industries where they dominate the market.
Cash cows – milking lucrative products properly
Profitable businesses need time and resources to grow. Have you seen the long lines when Apple announces their new lineup of iPhones and iPads? How about people buying tickets for the latest superhero movie by Marvel Studios? Or the long line of princesses, and a few queens, for the latest Disney flick? These are all examples of profitable cash cows for big companies.
Before they produce milk, real live cows consume tons of nutritious grass, just like how cash cows need a sizable amount of funds for marketing, research and production before they give profits to companies and investors. The risk of losing the business increases the longer the project is still in its growing phase, and some investors can get scared of the uncertainty and pull out their investments. The risks are high when the business operations are still in the growing phase.
On the other hand, once the market and the operations mature, then a project has to opportunity to become a cash cow. While not a monopoly, a cash cow has a significant share in the market with high-profit margins. Profit margins and dominance are not the only benefits of having a cash cow. Difficulty in gaining entry to the market is another reason why companies would want their business operations to have higher returns at a lower cost. Due to the extensive time, human resources and funds needed, competitors may have second thoughts in entering the competitive market, which gives the cash cow more staying power.
What makes a profitable business a cash cow?
The term cash cow came into existence when the Boston Consulting Group made the BCG growth-share matrix. The BCG growth-share matrix offers excellent insight into where your business projects are in comparison to competitors and industries. It has four categories in two areas, cash usage, and cash flow or generation. They are then further categorized on how low or high they score.
There are four categories:
- Question mark – Products or services that use a lot of cash to operate but offers little to no cash flow or revenue. Businesses and investors hate these businesses since they provide little to no value.
- Dogs – Business projects that do not require a lot of capital to set up and operate but produces a minimal return to investors. Dogs have potential and offer stable returns for people who are cautious and are looking for low-risk business models.
- Stars – Companies who operate in industries that require a lot of capital that offers tremendous returns usually have businesses categorized as stars. The movie industry needs quite a lot of money to hire actors and actresses, shoot in a reserved location and other expensive but necessary operations like marketing and tv advertising. However, even after the premiere which can bring profits, producers can still get royalties through merchandise related to the films and reruns.
- Cash cows – Businesses that have entered a market that is capital intensive to start but is cheap to maintain is more likely to have a cash cow. Telecommunications companies invest millions, even billions of dollars, to erect signal towers to provide mobile coverage. Once the towers are set up though, maintaining them are a lot cheaper. These companies can just let the money roll in, with profit margins getting bigger the older the cash cows get.
With knowledge of how a cash cow operates, it can be a great idea to invest in a company that has one. Always do your research, since some cash cows become “dogs” or “question marks” when new products or services are invented.