Owning your own business can appear glamorous: You are your own boss, your income potential seems unlimited, you can work “or not” when you want, and get tax write-offs for many everyday expenditures. The list goes on and on. If you have a really great idea, you may even be able to franchise it or hit the big time and go public.
But have you got what it takes? Previous research suggests that degree of schooling,[1] amount of financing,[2] previous entrepreneurial experience,[3] and characteristics of the owner(s)[4][5] all factor into the ultimate success or failure of a new business. Based on lessons learned from starting two companies, a summer tour business, and an automatic garage door closer business, the author lends support to some of these findings, but also identifies additional factors that provide valuable input. These are especially applicable in difficult economic circumstances.
Lesson No. 1: Do your research.
Do not re-invent the wheel if there is already something useable out there.[6] The entrepreneurial spirit wants to invent, to create, or to establish something where nothing existed before. However, such efforts can lead to wasted time, money, and effort if the marketplace already offers some variation of your product or service. With the automatic garage door closer business, a careful search revealed a product that potentially “and eventually did” fit the bill, and also showed why other similar products did not. In the words of GE’s former CEO, Jack Welch, “If you don’t have a competitive advantage, don’t compete.”
Lesson No. 2: It is difficult to predict good/great employees in the interview process.
While a company’s employees are likely its greatest asset, finding and hiring them is problematic.[7] Since the interview process is often very different from the workplace, initial impressions can be far off the mark. In the words of Malcolm Gladwell, author of best-selling books Tipping Point and Blink, at the 2008 New Yorker conference, “So many industries today have a mismatch between the criteria set out during the hiring process and the demands of a role.” Sital Ruparelia, founder of Career & Talent Management Solutions, states that in such situations, “Judgment and subjective indicators become far better indicators for a successful hire than many of the objective measures.” For example, in the summer tour business, one of the first interviews was with a scruffy-looking individual complete with a well-worn beanie cap. In the author’s judgment, the applicant did not communicate well nor would likely interact successfully with customers. However, he seemed sincere and teachable, and the fledgling business needed employees. Not only did he end up relating well with customers, he had great mechanical skills that he failed to mention in the interview and perfectly fit an unexpected need of the business. Moreover, he became one of the businesses’ most conscientious and trustworthy employees.
Lesson No. 3: The daily relevance of contribution margin.
This is such a fundamental concept yet is absolutely critical to making sound financial decisions, especially in the early days of a new business and during difficult economic times. Simply stated, contribution margin equals sales revenue minus variable costs, normally calculated on a per unit basis. Multiplied by the number of units sold, total contribution margin must be large enough to cover all fixed expenses or else the business will lose money. Going back to Lesson No. 1, part of the research process should include both a careful estimate of likely unit sales and solid estimates of unit costs. If this does not yield sufficient contribution margin to eventually exceed estimated fixed costs, the business is a “no-go.” In difficult economic times or in a highly competitive industry, these calculations are even more important. No matter how good the idea, if it does not have a reasonable chance to make money, it is a waste of time and money.
Once a business is running, contribution margin has another practical benefit. Every major spending decision should be evaluated against this metric. Taken to its extreme, the amount of expenditure does not matter if the potential revenue exceeds the expenditure. Yes, you should still attempt to get the best deal, but ultimately, if your incremental revenue projections are fairly reliable, the amount of the expenditure just does not matter. If a new, expensive piece of equipment is going to reduce unit variable costs sufficiently over its useful life, the added contribution margin will justify the expenditure. If increased sales projections outweigh the cost of advertising, even a $2+ million ad for 30 seconds during the Super Bowl can make good financial sense.
One caution: In difficult economic times, it is easy to focus too much on controlling and minimizing expenses. Yet, that can be exactly the wrong response. Product lines and even whole divisions that are producing losses from a bottom line measurement can instead be generating positive contribution margin and, if eliminated, will actually make things worse because allocated fixed costs rarely disappear and must now be spread over fewer products or divisions. Give careful attention to contribution margin with every major expenditure or cost-cutting initiative.
Lesson No. 4: It can take much longer to establish market presence than you think.
No matter how great you believe your product or service is, your potential market does not always agree, at least not right away. A classic example is the highly unusual-looking but extremely successful Aeron office chair manufactured by Herman Miller, Inc. Its odd-ball design violated nearly every standard office chair style at the time. Aesthetic appeal was questioned in market study after market study, and resistance was intense in its early years. However, the company knew it had a winner, and the chair ultimately became a best-seller spawning numerous imitations. No matter how great your product or service may be, market recognition takes time.
Lesson No. 5: Your time will not be your own.
This lesson directly contradicts one of the supposed justifications for having your own business. The never-ending tasks required to get a small business up and running can easily take 16 to 20 or more hours per day: Laying the groundwork, hiring employees, training those employees, doing the marketing, managing operations, and dealing with minor or major crises, etc.[8] Until the business is established and you can afford to hire managers, learn to take naps. Through the long days, eating regularly, and getting sufficient exercise may be difficult, but it is almost impossible to think clearly or make good decisions without sufficient rest and nourishment.
Lesson No. 6: The critical importance of marketing.
If the new business has entrenched competition, both suppliers and customers need to be made aware and educated about your product or service and how it is different and/or better than the competition. Recall Jack Welch’s admonition that “If you don’t have a competitive advantage, don’t compete.”
New product failure rates run as high as 90 percent.[9] Your buyers may be concerned about your “staying power,” and be waiting until you establish a successful track record. This is especially relevant if they have long-standing relationships with the competition. They may be hesitant to break those ties, even if their product or service is of lesser quality.
One of the examples used for this article, a summer tour business, was the new kid on the block and management naively thought that the cruise lines that brought 50+ percent of the tourists to the area would be anxious to add another option to their excursion menu. Wrong! Three of the four companies had exclusive contracts with the competition. The cruise line customers either booked their tours with the competitor before arriving in the area or did so at their hotel’s activities desk. During its first season, the business was forced to maximize tours from “walk-through” traffic composed primarily of independent travelers and cruise customers willing to explore alternative tours. The business also had to devise a plan to convince the cruise companies to take a chance on it in the future.
To make the transient population aware of the new business and the distinctive elements of its tours, management utilized every advertising medium possible: travel brochures and magazines, banners, posters, coupons, special promotions, handouts, a picture board, equipment displays, and continuous communication with all of the accommodation facilities. In essence, the company drastically out-marketed its competition.
To make the cruise companies aware of the business’ existence and persuade them to consider using the company, both a “back-door” and “front-door” approach were utilized. The back-door approach involved talking to and offering complimentary tours to the cruise line bus drivers and guides. Once they went on one of the tours, they became some of the company’s best salespeople with their passengers and their superiors.
The front-door approach was a bit trickier. It was necessary to acknowledge that there was value to both long-standing relationships and contractual arrangements. Management developed a completely new tour in a different area and pitched the benefits of offering another excursion option to cruise line passengers. Since cruise line managements were now aware of the company’s existence due to the successful back-door approach, they were willing to listen. After a major company booked this tour, it became the most successful one in the next season. Over time, the company’s reputation for offering better tours allowed the business to get bookings from more cruise lines. Although the successful strategy for new businesses will differ, the lesson is to never give up and to keep trying to find what works most effectively to sell your product or service.
Lesson No. 7: Never disregard or discount serendipity.
Serendipity is defined in Webster’s dictionary as “the phenomenon of finding valuable or agreeable things not sought for.” In the weekly podcast on WCVE Public Radio, Talking Business, the February 11, 2010 edition discussed serendipity and numerous events that have occurred by chance and have had a life-changing impact on a person or business. Glenn Llopis in his book, Four Skills for Creating and Sustaining Good Fortune in Your Work[10], claims that serendipity is not always governed by chance alone, but can be “earned” by following four principles that he identifies.
In the author’s experience, there have been numerous serendipitous events that either saved the business from disaster or opened up unbelievable opportunities. Serendipitous events cannot be directly factored into a business plan, but they will occur and, if recognized, will likely have a tremendous impact. Be on the lookout for them.
Lesson No. 8: Initial projections are virtually useless.
The future, whether for a new business venture, an acquisition, or the rollout of a new product, is fraught with unknowns. However, business plans and product-success projections utilize large amounts of estimated data to justify the expenditure. Coca Cola used extensive market studies to launch New Coke in reaction to increasing competition from Pepsi, yet it turned out to be a colossal failure. Initial market projections for sales of the book, The Shack, by first-time author William P. Young, were modest at best, as it was initially self-published. As of January 2010, it had sold over 7 million copies and had been No. 1 on the New York Times best-seller list for 70 weeks.
In the summer tour business, initial projections (really just guesses) suggested revenues of $400,000 to $600,000 and, of course, profitable operations. They were not even close. The first year garnered about one-fourth of those revenues and recorded a modest loss. Maybe this is not bad for a first year in business, but it was a real letdown. On the positive side, with all of the marketing efforts during that first season, the groundwork was laid for a successful second season. A thorough business plan is essential[11] to convince yourself and your financial backers that the venture is ultimately destined for success, but in the early stages of a business, it serves more as a valuable organizing tool than a predictor of first-year results.
Lesson No. 9: Finding the capital to keep a potentially successful business going and growing is tough slogging.
Adequate financing is one of the well-documented success factors for a new business.[12][13] In the current economic climate it has become a “make-or-break” outcome for just about any business. It is often said, “When you really need the money, the banks won’t loan it to you; when you don’t need it, they’ll come banging on your door.” In growing your idea, you may run into this same obstacle. You can try borrowing from friends or family, but this is rarely a realistic option. You can max out your credit cards and pay their exorbitant interest, or, if you have retirement accounts and are willing to literally bet with your retirement future, there are several options, one fairly new. First, your plan may allow you to borrow against it at a reasonable rate. Second, you may be able to cash them out. However, if you are less than 59-½, you will not only have to pay income taxes on them but will also incur a 10 percent penalty, significantly reducing the investable proceeds. The recently developed method involves setting up a “C corporation,” creating a profit-sharing retirement plan within that corporation and then rolling over proceeds from a 401(k), 403(b) or IRA into the profit-sharing plan, which can then be used to fund the business.[14] One of the big benefits of this new approach is that you will avoid the 10 percent early withdrawal penalty if you are less than 59-½. If this option is of interest, make sure to seek professional guidance.
It is not uncommon in the early years to be faced with the decision of how much you really believe in your idea. About 50 percent of businesses fail in the first five years. A major cause is not having enough capital to get through the tough initial years.
Lesson No. 10: Whenever possible, celebrate and memorialize successes.
Whether or not your venture succeeds, you will want to have some good memories. The summer tour business celebrated its first $1,000 revenue day with a fabulous dinner in one of the local hotel restaurants. As part of that celebration, the most productive employee was honored. To celebrate its first $3,000 revenue day, the employees had a wonderful time at the best pizza joint, playing cards and enjoying beer all around. This is all part of keeping employees happy and productive.
Summary
It should be noted that there has been very little mention of accounting. Although important, with all the activity involved in getting a new business off the ground and doing everything possible to generate sales, accounting initially fell far down the list of priorities for both of the author’s businesses, and during the busy selling season only revenues were tracked. Since all fixed costs were incurred prior to the start of the season and the unit sales price exceeded variable costs, all that really mattered was maximizing sales, thereby creating sufficient amounts of contribution margin to cover those fixed costs and generate a profit or minimize the loss. As far as controlling costs, if the business is still small with few or no employees, an owner is likely paying the bills and should have a general sense of how expenses are running. In other words, in the early going, there may be little or no time to do the formal accounting unless the business has the resources to hire an accountant or can farm out this process. While it has to be done at some point, a detailed accounting system may have to wait until time allows.
[1] Wagner, J. and Sternberg, R., “Start-up Activities, Individual Characteristics, and the Regional Milieu: Lessons for Entrepreneurship Support Policies from German Micro Data,” The Annals of Regional Science (June 2004): 219-240.
[2] Headd, Brian, “Redefining Business Success: Distinguishing Between Closure and Failure,” Small Business Economics (August 2003): 51-61.
[3] Rotefoss, B. and L. Kolyereid, “Aspiring, Nascent and Fledgling Entrepreneurs: An Investigation of the Business Start-Up Process,” Entrepreneurship & Regional Development (March 2005): 109-127.
[4] van Gelderen, M., Thurik, R., and Bosma, N., “Success and Risk Factors in the Pre-Startup Phase,” Small Business Economics (May 2006): 319-335.
[5] Gartner, W.B., J.A. Starr, and S. Bhat, “Predicting New Venture Survival: An Analysis of ‘Anatomy of a Start-Up’ Cases from Inc. Magazine,” Journal of Business Venturing (March 1999):215-232.
[6] Kraus, S. and E. Schwarz, “The Role of Pre-Start-Up Planning in New Small Business,” International Journal of Management and Enterprise Development 4, No. 1 (2007): 1-17.
[7] Bakker, Shawn, “Taking the Guesswork out of Hiring,” Psychometrics Direct (August 2007).
[8] Gartner, W.B., J.A. Starr, and S. Bhat, “Predicting New Venture Survival: An Analysis of ‘Anatomy of a Start-Up’ Cases from Inc. Magazine,” Journal of Business Venturing (March 1999): 215-232.
[9] Stevens, G.A. and J. Burley, “3,000 Raw Ideas = 1 Commercial Success!” Research Technology Management, (May/June 1997): 16-27.
[10] Llopis, Glen, Earning Serendipity: Four Skills for Creating and Sustaining Good Fortune in Your Work, (Greenleaf Book Group Press, 2009).
[11] Kraus, S. and E. Schwarz, “The Role of Pre-Start-Up Planning in New Small Business,” International Journal of Management and Enterprise Development 4, No. 1 (2007): 1-17.
[12] Ãstebro, T. and I. Bernhardt, “Start-Up Financing, Owner Characteristics, and Survival,” Journal of Economics and Business, (July-August 2003): 303-319.
[13] Dassar, Gavin, “The Financing of Business Start-Ups,” Journal of Business Venturing (March 2004): 261-283.
[14] Joachim, D.S., “Betting Your Retirement on Your Start-Up,” The New York Times, October 1, 2008.
