Most of the entrepreneurs we interview in our consulting business have a very unrealistic conception of what excites and disappoints investors. The dream of many inexperienced inventors seeking to fund their opportunity is to build a substantial infrastructure. Their business plan identifies the need for factory space, equipment, staff, and many other fixed costs.
Investors want to see a plan that maximizes return on investment. High fixed costs are the enemy of a great profit margin. When business turns down, and it always does at some point, fixed cost assets become liabilities and must be continually fed, even as income declines.
Always present decision-makers with the most streamlined operations plan possible. Do not confuse grandiose staffing and equipment wants with actual needs. In today’s business climate, almost every possible service can be rented, leased, farmed out or performed by contract manufacture. A 25,000 square foot factory that is not running at 100% capacity is an under-performing fixed cost asset, especially if a private label manufacturer will provide the service at a competitive price. The cost to rent, power, insure maintain and staff the facility is ongoing and will be a drain on the bottom-line.
Investors want to see a lean operation with no fat or excess. They will always be open to adding costs as growth and sales traction begin to kick in. Initially, the entrepreneur needs to display that he or she will be a prudent shepherd of the investment required to startup the enterprise. Here are a few areas where fixed costs can be avoided and potential investors greatly impressed.
An opportunity killer is a funding request that includes money to buy a facility, office or plant. No startup can accurately pinpoint the growth (or failure) rate of a brand new business. Investors will want to see a plan reflecting realistic goals and space requirements. This almost always means renting facilities until need demands a purchase of facilities.
There are almost no good reasons for a startup to manufacture their own product. Possibly, if there is a very valuable trade secret involved, but not often even in that case. All contract manufacturing should include a Non-Disclosure Agreement (NDA) as part of negotiations. Contract manufacturing is available and utilized in almost every industry today. Estee Lauder manufactures almost none of the many cosmetic or fragrance products they market. Liz Claiborne and Calvin Klein make none of their apparel. Ikea sells only furniture made in third world facilities.
All of these companies, and many more, realized long ago that manufacturing was better left to factories located where labor, raw materials and government rules were not stifling. These companies concentrate their assets on research and development, design, sales and marketing. So should every entrepreneur seeking to succeed in obtaining investment.
Every entrepreneur should be able to aggressively market and sell their product. However, no single person, or small partnership, can be in front of every customer that will potentially be interested in purchasing the product on offer. The investor will want to know that there is a sales strategy that offers an excellent chance for success.
In the area of sales, there are industry specific sales representatives: manufacturer’s representatives and agencies available to sell an interesting, market ready product, on commission, within their industry. Commissions are typically standardized within each industry. The gift industry is 15%. Food products are 3% and up, depending on the volume a product can reasonably be projected to achieve. Industrial products are 2% to 5%. Historic profit margins dictate commission rates.
When using sales agents, the entrepreneur should manage the sales force as if they were salaried employees. Weekly calls to review goals, promotions and upcoming meetings. Write letters and e-mails pointing out other agent’s successful achievements. I have used commission sales agents for many years, and recommend them to most of my clients.
I make as many key- account sales calls as possible with my sales agents. If it is my product, I want to control big presentations, even though I will pay a commission on the sale I have principally generated. I attend as many sales meetings as possible. The more I can meet, learn and know about my sales teams activities the better I will be able to motivate, train and energize them.
When commission sales agents do not sell a product they are not paid. This obviously minimizes fixed costs. However, you will want to pay the largest amount of commission as possible. Healthy commission checks mean a very healthy sales base.
As a very young National Sales Manager for Vidal Sassoon Hair Care Products I was confronted with a problem. Our sales had exploded. Growth was so rapid and market acceptance of the Vidal Sassoon brand so overwhelming that our commission payments likewise accelerated to the point that my top management became upset when commissions exceeded their own salaries. “Don’t those guys work for us, why do they make more than the owners”, they asked?
I faced a difficult situation. I offered two options: cut commissions or fire the commission agents and hire a company employed sales force. I reckoned that if I could get sales coverage for 8% cost of sales (including salaries, benefits, travel, etc.), it would make sense to make the transition. Cutting the commission rate would displease the agents and I did not want to risk losing the excellent momentum we had developed.
Very surreptitiously and quietly I interviewed and hired a team of key regional sales managers and we quickly executed a plan of conversion that top management had signed off on. Vidal Sassoon was at the point in their business development that a company owned direct sales force was needed and justified. However, it was a concern as we were greatly increasing our fixed overhead.
Entrepreneurs should focus maniacally on sales growth. Sales are Job #1 in every company, especially a new venture! Be very careful in constructing sales coverage that will support the growth you project while not choking cash flow with a very high selling cost.
Hopefully the entrepreneur, or a member of the management team, has marketing experience. If not, the answer is often to hire a consultant. An experienced consultant will save time, money and mistakes. Be sure that the consultant being considered has current industry specific experience, strong references and a transparent history of success.
I never recommend for a new venture to handle their own logistics (warehousing, pick and pack, shipping, billing, etc.) Dealing with shipping, handling, conditions and the terms necessary to satisfy retailers is daunting. Big box stores such as Kroger, Lowes and Wal-Mart have exceedingly complicated inventory control systems. Special, very expensive software is needed to communicate and expedite receipt of goods.
On average, I can have my inventory warehoused, packed and shipped for about 4% of my selling price (depending on volume). If business is seasonal or slows down I do not have to pay high fixed costs, just a percent of the shipments total invoice amount. If business is booming, my contract fulfillment warehouse ramps up hiring. A good contract warehouse offers a complete menu of services that I can pick and choose from as needed. Their systems will be sophisticated enough to handle the most demanding purchaser of my product.
The first time reader of a business plan typically has a strong reaction, positive or negative, to the overall document. A negative result usually occurs when the Executive Summary contains references to high fixed costs. A positive verdict is more probable when the entrepreneur indicates in every way possible that they are solely interested in maximizing profit and return on investment, not building a colossal infrastructure that will bleed the enterprise dry if all does not proceed perfectly and assumptions are not realized.