Better to Analyze Cash Requirements than to “Launch and Hope”

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Starting a new business has its own special risk.   In the last few weeks I blogged about two ways that founders of start-ups can lower their risk: 1) making good business decisions based on industry knowledge, and 2) executing well.

 

A third way is by having knowledge of how much initial funding is likely needed to carry the business from the time it is launched until it reaches a point where it is cash flow positive, especially as new businesses don’t typically have much access to outside funding sources.

 

It is typically not possible to make an exact estimate of how much this initial funding needs to be, because the nature of a new product or service launch is that the founder has to invest in marketing to “get the word out,” and it’s hard to tell: 1) how effective that marketing will be in terms of stimulating initial trial purchase and 2) how many consumers who try it once will come back and purchase again.

 

Based on the start-up business owners I’ve met over the years, about half will nonetheless attempt to estimate the funding needed and whether they have the needed funds, before they commit to the venture, fiscally and emotionally. But then there is the other half who get quite a way into things without doing that calculation, either because they are daunted by the uncertainty, they don’t know how to do the math, or perhaps because they are scared by what it might tell them.

 

What we do in our work with clients is estimate a low side, mid-case and a high side scenario, in order to show how the various marketplace responses translate to cash requirements.   Further, there are typically many expenditures of opening up shop which are very predictable, and we are able to project these with a greater degree of certainty, which is all the more reason for doing the exercise.   It is always better to model the cash requirements, then to “launch and hope” that the cash on hand will be sufficient.

Hiring Great People Reduces New Biz Risk

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New businesses owners need to execute exceptionally well, otherwise they are increasing their risk of failure. Exceptional execution is usually the outcome of hiring exceptional people. As Dan Geller, founder of Gate Guru described it at a Wharton Entrepreneurship panel discussion I recently attended: “10% of start-ups are successful; those are the ones that hire really great people.” Savvy entrepreneurs who lack the funds to hire top people can at least identify their intended team members to potential investors, to reassure them that a strong team will coalesce once they invest.

 

For certain businesses, securing the right people talent is a case of hiring the right service provider.   The most outstanding example of this I ever witnessed was when helping Richard Ellenson with the financial model and competitor analysis for the launch of Blink Twice: he engaged Frog Design, Flextronics and some of the leading linguists in the U.S. for the design and development of the Yakk, a ground breaking alternative augmentative communications device.

 

Strong execution also is the outcome of sequencing the business growth wisely. A second Wharton panelist mentioned the approach at HopStop, where the founder decided he was going to prove the business “in one market, and one use case, before going broad.”   Starting in a single market is the best way to prove that the demand for your product or service is at the level you believe, and that you will have the capacity to meet it at a service level your customers expect and at a cost where you can make a profit as you expand. With those kinds of in-market results to point to, you will have a better chance to raise outside capital for your new business.

When Farm-to-Table Was Too Risky

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All businesses have risk, especially new businesses. There are things that new business owners can and should do to mitigate the risk, but often don’t.   At the top of the list: make good business decisions based on industry knowledge.

 

It is much easier for a new business owner to make well-informed decisions if he or she has a deep knowledge of the industry they are entering.   And this is why many business advisers will suggest if you are thinking of starting a business in an industry with which you are unfamiliar, you first should spend some time working in that industry, even in an entry-level job.   Failing that, other ways to gain additional industry knowledge are to attend trade shows, or talk to a business adviser who has worked in that industry. If you don’t have the budget to hire a consultant, try speaking to a SCORE counselor.

 

If you have a choice between launching two different new businesses, and you have prior industry experience in one, give that choice first consideration. I had a conversation some years ago once with an individual who wanted to raise investor funds to start both an organic vegetable farm and a nightclub simultaneously. The big idea: the organic vegetable farm would supply the nightclub with organic vegetables to serve to patrons. The individual had some prior exposure to farming, but everything about owning and operating a nightclub would be new.  Either business would be a lot to learn, so it was better to choose just one, in his case, probably the farm.

 

The current issue of Inc. magazine has a cover article “The art of the pivot.”  It is one thing for Howard Schultz to come back on board at Starbucks and manage a “pivot”, but as a new business owner, hope you won’t have to do any pivoting your first few years, you may not have the needed financial resources. And with the right initial decision-making, it hopefully won’t be necessary to do a pivot.

Budgeting for Profit Improvement

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Budgeting can be an effective tool for profit improvement if done properly.  I learned that lesson when I started my career in Finance with General Foods, makers of Maxwell House Coffee and Jell-O Desserts.

We didn’t even call the annual budget a “budget,” we called it the “Operating Plan” and that tells you something about the whole improvement mentality, and the emphasis on planning for improvement.  This is especially so as this Operating Plan was required to be the first year of a five-year Strategic Plan, furthering the emphasis on improved results over time.

The Operating Plan was the outcome of some very spirited negotiations between each Divisional General Manager and the heads of Marketing, Sales, Operations and Engineering.    The financial function facilitated this whole process, which included pulling together an objective estimate of how the current fiscal year was likely to end up, since the Operating Plan was created in October, before the December year-end.   If the Operating Plan called for improved year-over-year results, it was grounded in real actions that were needed to make it happen.

As a consultant to small and mid-sized clients, I find I am having a chance to help them implement some of these best practices.  What I am often seeing is the budget is something that is mechanically put together by the controller or bookkeeper in January, by taking the past year actual results, and applying an across-the-board percentage increase.  Creating the budget this way is missing a big opportunity to engage all of the managers in a dialogue that can establish a shared vision for improved results as well as greater accountability for making it happen.

 

 

 

 

 

 

 

 

 

 

Pricing Strategy Made Easy for Fast Trac Students

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Last week, I was a guest speaker again at the Kauffman Fast Trac program, speaking on Pricing Strategy. As I told the twenty or so Growth Ventures students, the costs for your products or services typically are the basis for establishing a floor you don’t want to price your product or service below. It pays to know the gross margin which is typical for your industry, so you can set your pricing at a level sufficient to achieve the gross profit needed to make your business sustainable. How to have an accurate understanding of your costs is a big topic unto itself.   If you are including some allowance for material losses (for product manufacturers) and for unabsorbed labor during low sales periods (for both product manufacturers and service providers) these are good indicators that your cost analysis is fairly complete.

It also is important to have a feel for the ceiling which you should not price above. To some extent this is determined by the existing players in the marketplace for your product and service.   That said, if you have a clear edge in perceived quality, delivery, service or some specific product features, this will provide opportunity to price above competition. (For example, Terra Chips was first launched at a price of $8 for an 8 oz. bag, but it was a totally unique product.) But if you have a “me-too” product, and price much above the going rate,  consumers may feel your pricing is unfair and shun your brand.

So suppose you have determined your pricing floor, and your pricing ceiling, as discussed above, how then to decide on the exact pricing point for your product or service?  This was the balance of what I discussed with the Fast Trac class.

For businesses where there is a fair amount of uniformity in pricing, it is important to consider what is the gross margin being realized under the current pricing.   As two extreme examples, consider a business realizing 50% gross margin and a second one realizing 20% gross margin under their current pricing.   In most cases the 50% gross margin business should look to sales increases to drive profits, since any attempt at further pricing increases may be counter-productive, as customers leaving the franchise could offset any profit gains on those who stay and accept a further increase.   Conversely, the 20% gross margin business should typically look to increase prices; as it is rare for a business with such low gross margin to be sustainable.   In between these two extremes, the key is for business owners to know or determine the price elasticity of demand for their product or service, to make an informed decision on when and how much pricing to consider.

Finally, for businesses where there is little uniformity in pricing,  differentiation is a key to improving results.   This can be based on consumer demographics, location, time of purchase, purchase quantity, or many other attributes.

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If you are interested in receiving a PDF version of the Pricing presentation, send me an email at David@RudofskyAssociates.com, with a brief description of your business.