STREET SMARTS

Barriers to Entry

Why barriers to entry are good.

Norm Brodsky is a veteran entrepreneur.

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You often hear these days that the barriers to entry are dropping in industry after industry. It's easier, we're told, to get into pretty much any business today than it ever has been, thanks largely to technology.

That may be true. But it's also true that some businesses are harder to get into than others, no matter what happens technologically. Given a choice, moreover, I'd always go for a hard-access business over an easy-access one.

Why? Because in an easy-access business, the product or service you're selling will eventually become a commodity, if it isn't one already. Not that there's anything wrong with commodities. You're just severely restricted in what you can charge for them, so you're forced to operate with much thinner gross margins than those you'd enjoy in a business that is more difficult for competitors to enter.

When you're starting your first venture, however, you may not have any alternative but to go into an easy-access business, especially if you don't have much capital to work with. That's one reason I began my entrepreneurial career in the messenger business, which has virtually no barriers to entry. By the time I went into records storage, which requires a big investment in fixed assets, I had another company I could use to cover a lot of my start-up costs.

In fact, it's often possible to go from having an easy-access business to having a hard-access one. Sometimes you can do it without even changing industries. The document-destruction business that I started with my friend Bob and his son, Trace, is a good example.

We launched the business, called U.S. Document Security (USDS), about a year and a half ago, after doing enough market research to determine that secure document destruction was an industry still in its infancy. (See " The View From Brooklyn," Inc, State of Small Business special issue, 2000.) I'm talking here about the business of destroying sensitive documents using a system that guarantees they won't fall into the wrong hands.

That type of service has been around for only a decade or so, which was a negative in my view. While the market potential was huge, most prospective customers didn't even know that the service existed, let alone that they really needed it. We were therefore going to have to educate the market while we educated ourselves -- always an expensive and time-consuming proposition.

But I'd been working with Bob and Trace for more than a year to find a business they'd be happy with, and document destruction was by far the most promising one we'd seen. So we worked out a deal whereby they'd put up capital and operate the business, while I'd guarantee their investment, serve as their adviser, and give them access to the resources of my company, CitiStorage. Then Bob and Trace headed out into the market.

It was very slow going at first. As I expected, most people had no idea what Bob and Trace were talking about when they said they were offering secure document destruction. We soon discovered, moreover, that secure document destruction is actually two businesses rather than one. It took time to explain the concept, determine which companies to approach and which people to speak with, perfect the sales pitch, and so on.

One business involves so-called clean-outs, wherein you destroy a large volume of sensitive documents that a customer has accumulated over a long period of time. For example, a company might want to get rid of old personnel files it no longer needs to hold on to. The other kind of document-destruction business is based on the premise that most companies routinely produce and discard sensitive documents. Correspondence, internal reports, and records of various sorts all wind up in the trash. Even if they're being sent to a recycler, there's no guarantee that they're actually being shredded.

Document-destruction companies bring certainty to the process, first by placing locked bins around the offices of a customer, whose employees dispose of sensitive material by sliding it through a slot in the bin. On a schedule worked out with the customer, the destruction company sends in a service person to empty the bins and destroy the documents. The customer then receives a certificate attesting to the fact that its material has been shredded.

The two businesses may sound similar, but they're actually quite different. For example, most customers do a clean-out only once every year or two, and they pay according to the volume of the documents being destroyed. A typical sale runs between $2,000 and $10,000. That's not necessarily recurring revenue -- who can predict that the customer will come back the next year? -- but clean-outs can generate a large amount of cash fairly quickly.

In the bin business, the revenue is recurring, and you measure it by the week or month. The amount per customer will vary, depending on how many bins you place and how frequently you empty them, but a typical sale would be about $100 a week. At that rate, you'd have to empty bins for almost six months to generate the same revenue that you'd get from even a small clean-out.

There's another important difference between the businesses as well. The clean-out business is relatively easy-access. You can lease a shredding truck or work out a deal with a secure shredding facility, and have a viable business within a short period of time. Yes, you need to figure out how to sell the service, but once you learn the ropes it's not all that hard to find customers. Just go to your prospects' payroll people. They understand the concept of periodically destroying large numbers of sensitive documents in a secure fashion. If prospective customers know what you do and why it's important, pretty soon you'll start making sales.

The bin business is another story. For one thing, it's much harder to locate the companies most in need of your service and to identify the appropriate decision makers. Even then, you're only at the starting line. You still have to explain your service to the decision makers and convince them that they need it -- a slow, difficult task that can consume a lot of start-up capital.

And what do you get if you're successful? A drop in the bucket compared with all the sales needed to cover your investment.

But that's exactly the kind of business I want to be in. Provided you can hang on long enough to survive, you wind up with a large base of small customers and a lot of recurring revenue. To be sure, you have to take care of those customers and make sure you don't lose them, but it's always easier -- and cheaper -- to keep an old customer than it is to find a new one.

Then again, if you're someone who's trying to build that type of business, you have a challenge. Unless you're careful, your start-up capital could disappear while you're out there building that base of small customers. So it's important to finds ways of making your capital last. For example, you can come up with another revenue stream to carry the company for a while, or you can work in partnership with a company that's already established.

Bob and Trace have done both. They do clean-outs to generate cash, but they always remember that the real goal is to build the bin business. In addition, they've had the advantage of operating out of CitiStorage, which has allowed them to obtain numerous services at a much lower cost than what they would have paid if they were out on their own. As a result, USDS is already close to being viable -- that is, capable of surviving on its own internally generated cash flow. I had expected that Bob and Trace would need about $250,000 in capital to reach that stage. As it turns out, they've spent barely 40% of that amount.

But viability is only the first step. The biggest mistake Bob and Trace could make right now would be to remain dependent on clean-outs. That's similar to the trap of building a business on the basis of sales to one or two large customers and then failing to diversify. You're not independent or secure until you have recurring revenue from a broad and diverse customer base.

I feel confident that Bob and Trace will get there, although they face obstacles. There's still much work to be done in educating the market. What USDS could really use is some additional competition. Four or five tough new competitors would make the education process a lot easier.

So, are there any takers?

Norm Brodsky is a veteran entrepreneur whose six businesses include an Inc 100 company and a three-time Inc 500 company. This column was coauthored by Bo Burlingham. Previous Street Smarts columns are available online at www.inc.com/incmagazine/columns/streetsmarts.


Please e-mail your comments to editors@inc.com.

Last updated: Oct 1, 2001

NORM BRODSKY | Columnist

Street Smarts columnist and senior contributing editor Norm Brodsky is a veteran entrepreneur who has founded and expanded six businesses.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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