It's easy to get carried away with a great idea for a new business and overlook some of the biggest obstacles and pitfalls. This month we see an example of the kind of research you need to do and questions you need to ask. We also get tips on figuring out whether you can afford to add an employee and testing various ways of marketing a new product.
Hungry for Help
After a lot of soul-searching (and financial analysis), I have decided against opening up my dream business: a gourmet specialty-food store. I figure it would cost me $250,000 for the building, including renovations, and an additional $200,000 for equipment and inventory. That's more than I can afford.
Instead I am contemplating another idea. I believe that for less than $10,000 I could start a specialty-food distribution company. I wouldn't have to buy an FDA-approved warehouse, because a logistics company already has one near my home. In fact, the logistics company can also supply a truck and driver, as well as a state-of-the-art inventory-tracking system.
I have done my homework. There are no specialty-food distributors in northern Michigan above the 45th parallel, but there are hundreds of resorts and restaurants with chefs who would like to offer the best and can't find the high-quality, imported and domestic specialty ingredients that I could provide. Although I'm currently an army of one, I sincerely believe that I'm destined to launch something big. Is this it, or should I keep looking? --Emily
"You should probably keep looking, but first I'd do more research," says Ari Weinzweig, who has built seven food-related businesses in Ann Arbor, Mich., during the past 20 years, including the world-famous Zingerman's Delicatessen. "To begin with, I'd go talk to prospective clients and find out how they're getting their specialty foods now. I don't know that particular market, but specialty foods are pretty widely distributed these days. There's very little that can't be shipped by UPS. And don't assume you'll get sales just because people tell you they want such a service. They often change their minds when it comes time to pay for it. You have to go out and see for yourself if they have a real need or if there's an opportunity to create a need.
"You also have to figure out exactly what you'd be distributing. 'Specialty foods' is a huge category. Perishables may be in greater demand, but they take much more work than nonperishables. With perishables, you need to turn over your inventory faster, and you have refrigeration issues. Getting the stuff to your warehouse can be a problem as well if you're not on one of the major truck routes, and you may not be if you're that far north.
"Even if there is a market for you up there, you should be sure it's one you want to pursue. You'd be getting into a highly seasonal business and potentially a very labor-intensive one. The resorts and restaurants you mention aren't close together. My guess is that you'd wind up with a lot of small drops over a large area. I'm not a distributor, but we do sell wholesale, and I know how big a pain in the neck small orders can be. It takes just as much work to process one as it does to process a large order, and the return is much lower.
"But you should check all that out for yourself. Meanwhile, you might want to reconsider your dream business. Yes, you could fork over $250,000 for a building, but you wouldn't have to. Retail space is available for a lot less. Equipment would cost you next to nothing if you took over a place that was closing down. As for inventory, our deli carries $150,000 on a pretty high sales volume, and that's after 20 years. I doubt you'd need nearly as much starting out.
"I'm also skeptical that starting a distributorship would be less expensive than opening a specialty-food store. As a distributor, you'll have to deal with credit, collections, and accounts receivable. So you'll need a lot of working capital. A food store, on the other hand, is all cash, which makes things a lot simpler. If it's the store you really want, I'd give it a second look."
The First Employee
I have a small business that tutors people in writing. I've been running it out of my home as a sole proprietor, using independent contractors. One woman who has been editing for me wants to come on as a full-time employee doing marketing and sales. I need someone to work on those areas, and she has the right experience. Still, taking her on full-time would be a big financial commitment, requiring me to spend my savings. There's also a chance that she might generate more business than I could handle.
My revenues and profits are both modest but have been increasing slowly over the years. I know I'll have to invest to upgrade my Web site and do a few other things if I take this person on. I'm usually somewhat risk averse, but I feel I've reached a critical point and have to make some changes. So am I crazy to consider hiring her? --Sharon
"It's never crazy to hire an employee, provided you have the need and understand the financial consequences," says veteran entrepreneur and Street Smarts columnist Norm Brodsky. "In that regard, there's a handy rule of thumb you can use to determine the additional sales you'll have to generate in order to cover the new expenses you'll be taking on. You just add up those expenses over a period of time and divide by your average gross margin.
"Suppose, for example, that in the first year it's going to cost you $39,000 to bring on this employee, including salary, benefits, Web-site upgrade, whatever. Suppose also that you have an average gross margin of 30%. (That's the percentage of gross profit you make on a sale, taking into account all the direct costs required to provide your service but not your ongoing overhead expenses such as your own salary, your rent, your Web-hosting fees, and so on.) In that case, you'd need to increase your annual sales by $130,000 at the same gross margin to cover the new expenses and maintain your current profitability.
"So you need to make your best estimate of both the expenses associated with hiring the employee and the additional sales you think she can generate. Bear in mind that adding staff almost always costs more than you expect. To make sure you have enough cash to get through the first year, you should probably have a cash reserve that is 25% greater than your estimate of the new employee-related expenses -- that is, $48,750, if you think that the first year's expenses will be $39,000. It may also be a good idea to experiment a bit before bringing her on full-time. Maybe she would be willing to work part-time in sales at first and continue doing her editing until you both have a better sense of the new arrangement.
"And one other thing: if your Web-site upgrade is going to affect her productivity as a salesperson, I'd make sure you do it before she goes on the payroll, not afterward."
I own a small chemical company, and I've recently decided to focus all my energy and resources on one product: an all-purpose cleaner. I need some help in figuring out the most effective way of introducing it to the marketplace on an extremely limited budget. Should I go with independent sales reps? Distributors? Mail order? --Thomas
"There's no reason you can't try all three, as long as you're careful," says Chuck Sussman, who used reps, distributors, and mail order to build Pretty Neat Industries into the world's leading maker of cosmetics organizers. "Independent sales reps work only on commission, so they're cost-effective by definition. The trick is to find those who will represent you well -- calling frequently on your customers, ferreting out prospects you've never heard of, and stimulating sales with new ideas and promotions.
"For rep recommendations, I'd go to other people in your industry and to reps in other geographic areas. Once you have the reps you want, it will pay to work hard on developing good relationships with them. Aside from serving as your sales force, they can be a terrific source of information on competitors, industry trends, and market conditions.
"Distributors bring something else to the party because they tend to specialize both by region and type of customer. To avoid conflicts with your reps, you may have to create a separate package and label for the distributors. You'll have to decide for yourself whether the market potential justifies the cost.
"As for mail order, it's great for introducing an item to the market, creating retail demand, and generating cash flow -- provided you have the right kind of product. To do well in mail order, you need to come up with a dynamite ad that promises some kind of miracle. That's harder to do with some products than with others.
"Still, if you can afford the investment -- the cost of ads and maybe some professional help on the copy and layout -- mail order is definitely worth trying. Just be careful not to undercut the prices you're charging through your sales reps and distributors. And remember: there are many successful retail items that don't do well in mail order. So don't be discouraged if mail order doesn't work for you."
Having Trouble Sleeping Lately?
Could you use some advice from an experienced entrepreneur who's been where you are and figured out what works and what doesn't? Send your questions to IncQuery@inc.com. Editor-at-large Bo Burlingham, aided and abetted by Street Smarts columnist Norm Brodsky, will find the best people around to answer them. And if you don't like their answers -- well, you can tell us that, too.
The Whole New Business Catalog
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Strategies: Radical Sabbaticals
Search: It's 2010. Bring on the Designer Babies
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