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Gel Factors – Part 3: Long Life
Does Your Business Have Staying Power?
50% of small businesses fail in the first year and 95% fail within five years, according to the U.S. Small Business Administration. Does your business have staying power? In this article we will talk about what contributes to staying power and how to incorporate that into your own business.
If you know what to look for, it is not too hard to spot whether or not your business has a chance of staying in the game. Many businesses to go under because of unexpected expenses, like lawsuits, an aggressive new competitor, new government regulations or any number of things. These can and will bankrupt a business that is barely running a profit, or isn’t running a profit at all. The businesses with lasting power are making enough to cover these unexpected expenses while still turning a profit.
Many businesses go under just because they aren’t set up right. Any number of things can cause their demise and sometimes another company can come out just a few years later and be a huge success only because of minor changes in the business plan.
One great example of this is Webvan, based in San Francisco, and SimonDelivers, based in Minneapolis-St. Paul of Minnesota. They were both founded in 1999, but Webvan was bankrupt by 2001 while SimonDelivers continues to succeed. Both companies are online grocery stores that took orders online and delivered the groceries to homes. What made SimonDelivers succeed while Webvan failed? That is what we will discuss in this article.
There are five important factors for staying power:
- how much investment is needed to start up
- how much money is needed to stay in business
- how much money is made from each sale or profit margins
- up-selling/cross-selling
- ongoing product costs
The third factor, profit margins, is the most important as high profit margins can make up for a lot of problems in a business model, but if the cost of keeping up with market trends or protecting market share is too high, no matter how high your profit margins are, you can easily loose money.
Investment Needed
Businesses should recoup their investment within the first few years of operation. This is because investors will expect this and they will not invest any more you if can’t recoup the initial investment. Also, you need to quickly recoup the investment so you can start investing back into the company. Within a few years, if all is going well, you will probably need new equipment or a bigger facility and you need to use your profits for this, but if you are still recouping your initial investment, you will have no extra money for this.
You can cut back on initial investments with partnerships and outsourcing, especially outsourcing manufacturing, but also anything that requires you building up infrastructure. This strategy may cost you more in the long run, but if your initial investment is too large, you are better off using partnerships and outsourcing.
Cost of Staying in Business
The costs of staying in business that often hurt small businesses, which are rarely planned for by entrepreneurs, are the cost of keeping your market share – or fighting off competitors – and the cost of keeping up to date – or better yet, on the cutting edge – which includes updating products and the technology you use.
These costs vary widely by market, for instance a business that deals with technology has to be constantly updating their equipment and improving their products – a very costly process. Also, if your competitors are large established companies, you will need to spend lots of money to gain and keep a market share. Your business must be prepared for these costs or you will quickly go out of business.
There are a few ways to keep the costs of keeping your market share down.
The first way to keep your cost down of keeping your market share is to greatly differentiate your product from the competition. This can be done by gearing your product towards a specific group of target customers or a specific use of a product that may have many uses. The more differentiated your product is, the less direct competition you will have and therefore, the less money needed to keep your market share. Your group of target customers may become smaller, but as long as that group remains large enough to support a business, you will probably make more money (by not needing to spend so much money on marketing) than selling more products (and using that money to fight off competitors).
The second way to keep your costs down in related to the first: competing only in market segments where your product has the most advantages. Instead of changing your product, just target market segments that most value your product or service and where you will have easy sales. This will save you significant sales dollars because the easier the sales are, the less money you will need convincing customers to buy your product. Many entrepreneurs only think about the number of sales they will make, but not about how much it will cost to make those sales. Drop the sales that are expensive to make, and focus on the easy ones.
The third way of keeping costs down is to target a smaller market. For instance, target your local city, state or whatever is within driving range from your house. This again allows your marketing dollars go further and many media outlets like to reprint local stories, which translates into free marketing for your company. You can also do promotional events that are easy to do yourself locally, but are a nightmare to do at a national level.
The final way to lower your costs is by using truly innovative marketing. This is the least reliable method because it is so hard to determine what marketing will be memorable (and favorable) and what will not. If you do create truly innovative marketing, you will need to spend less money on marketing because potential customers will remember you more easily.
Profit Margins – the most important factor for long life
Your margin is the percentage of your selling price that is profit. High profit margins can make up for all sorts of deficiencies in your distribution or capability to sell your product. With high margins you can afford to distribute through an additional broker or use a highly professional sales staff working on commission.
Most low margin products just don’t have the capability to absorb unexpected costs that every business inevitably faces. The truth is that you need high margins to give your company a cushion to adjust to market changes, fight back competition and otherwise try new tactics or introduce new products.
Even low priced products often have high margins. For instance Wal-Mart has high margins for a mass merchandiser because instead of just charging as little as possible, they save money in other areas, like production and distribution. Their low prices with their high margins have made them the dominant mass merchandiser. Wal-Mart is often involved at least one lawsuit, proving that their margin is high enough to cover unexpected expenses.
Luckily there are ways to adjust and create higher margins for your product or company.
First, you can add value. Provide a better service, a more complete solution, create an up-scale image and countless other things can provide added value. The trick is you need to create added value, which then increases your retail price, but the cost to add the value needs to be less than the increase in price. That way, you are making more profit per sale.
Second, you can find a new target customer group. When you target a new customer you just need to find someone who is willing to pay more for your service and then just target them. You may make fewer sales, but your profit per sale will be much higher, giving longer life to your company.
Third, you can cut costs. These costs can come from production, distribution, overhead or all sorts of other areas. This is how Wal-Mart makes its money.
Up-Selling or Cross-Selling
Up-selling or cross-selling refers to selling different products to the same customer and usually only applies to either stores or service providers. Many industries estimate that the cost to acquire a new customer is four to five times what it costs to keep a repeat customer. So by selling to the same customers, you will save yourself a lot of money, which allows you to make more money per sale and stay in business longer.
This can be a problem with many businesses. For instance, how often do you go appliance shopping? Not very often, but this is exactly why stores like Best Buy have been successful. Stores like Best Buy have mastered the art of cross-selling. Let’s say you like music or own a computer, you will need to go shopping to purchase all sorts of things like CDs or printer ink. Then while you are buying computer paper you see that there is a sale on dishwashers and you think, I need a new dishwasher, and you start shopping. And just the opposite is true too. If you are looking for a new dishwasher you might go into Best Buy and buy blank CDs for recording music onto. The idea is to establish a customer base that will keep on coming back to you and buy different products.
So you might say: how can a one-product company create cross-selling? This is usually done by either selling private-label products or just by carrying other products. This can help you in two ways. First, you will make some money of the other products you are selling and second, you will find customers that are not looking for your product, but for one of the other products you carry and then they might buy your product. For instance, if you sell a mandolin related product on a website and you also sell mandolin strings, you might get customers coming for mandolin strings but then also see and buy your product.
Another option is to add a consumable component to your product. If your customers need to make periodic purchases to keep your product working, then you can always introduce them to other products or improvements in your original product whenever they come to replace the consumable parts.
Ongoing Product Costs
Ongoing product costs can either be in follow up sales support, like helping a company implement a new technology, or the cost of keeping a customer informed about your product or service, like when your contact within a company keeps on changing and you need to educate the new person on your product.
Ongoing product costs will drive down your profits and make it harder for you to stay in business.
There are a few ways to drive down these costs. First, you can prepare answers to common questions in advance and either post them on a website or give them to customers when they purchase your product. Second, you can plan upgrades when your product integrates with other products that change. Finally, you can plan training meetings for either whole corporations or multiple organizations to train many people at once.
Case Study
So let’s now discuss why Webvan failed while SimonDelivers continues to succeed. We will use our five factors to show what SimonDelivers did right and what Webvan did wrong.
Factor One: Investment needed to start-up. Webvan was quickly launched in many major cities which required a huge investment. Since the business didn’t start making money right away (or ever) there was no chance to pay back the investment. The company had to close as quickly as it opened because of that huge investment.
SimonDelivers, on the other hand, started small, just in a few neighborhoods in the Twin Cities of Minnesota. They honed their business model and grew as they were successful. Now their business covers the Twin Cities and is planning on moving into Wisconsin as well.
Factor Two: the cost of staying in business. Webvan had some competitors in some of the cities they operated in. This of course creates a higher cost of staying in business by needing more advertising and to create more sales and deals to attract customers.
SimonDelivers, by focusing on a small market with no competitors, has had a much lower cost of staying in business. Also their slow market growth has allowed a lot of word-of-mouth advertising and local media coverage that has also cut back on the costs to stay in business.
Factor Three: profit margins. This was Webvan’s biggest mistake. They charged grocery store prices for a better service. That better service was also more expensive to operate and so their profit margins were even lower than grocery stores. Grocery stores do not generally have high margins, so Webvan set itself up for disaster.
SimonDelivers on the other hand, charges higher prices because they realize people will pay for the convenience of having groceries delivered. Of course, not all people will pay more, but people who are short on time, who often tend to be wealthy as well, are willing to pay a higher price to save them the time of going grocery shopping. They targeted a smaller group (wealthier people who are short on time) while Webvan targeted everyone.
Factors Four and Five did not really play a major role in Webvan’s failure or SimonDelivers’ success.
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