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Why we’re excited to make less money right now.

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Less Can Be More!

In 2006, we worked hard to become profitable within the first 18 months of building Crankset Group. And the profits went up each year until 2010. Then they started going down and that’s when we got excited. It was a very good sign.

In every business there are cycles of numbers that we should focus on. It’s never neat and tidy, but in general, we followed different numbers at different stages in our business.

The Cycle of Numbers:

Startup? Watch Revenue most.
Don’t bother going through a lot of profitability scenarios until you find out if you can actually sell your widget. Nothing else matters at startup except revenue. Everything else is voodoo and fortune telling. Go sell something. If it doesn’t sell, forget all the rest of the numbers. Our services started selling regularly, so we moved to a new focus:

Early Stage Business? Watch Profitability most.
As soon as you figure out you can sell something, figure out if you can actually be profitable selling it at that price. The polish sausage vendor buys them for $1.00 and sells them for $.95, but thinks he’ll make it up in volume. He’ll just lose more money. Get a good accountant at this stage who can tell you how many widgets you will have to sell per month to be profitable. Then focus on getting there.

Finding Break Even? Focus on Profit
Profitability is theoretical. You’re just making sure you aren’t wasting your time building a business that won’t make it. But Profit is “real”. Figure out your profitability, then focus on nothing but getting to real profit. A good accountant should be able to tell you how long it will take based on selling x widgets/mth at $x per month. Once you break even and start making a profit, the fun begins.

Growing a real business? Focus on Cashflow.
When you finally start making a regular profit, that is a very dangerous stage. Why? Because it is the first time you have something to protect – profit – and you will tend to hunker down and protect it.

Don’t.

If you stop at simple profit based on your own production, you will never grow a real business. Instead of siphoning off the profits and buying a hot tub, it’s time to reinvest them in growing the business to where it can make money while you’re regularly on vacation, or bigger if that is your preference. The problem is that when you decide to grow your business, the profits you worked so hard to realize, will go down or even disappear for a time.

Growth will kill your profit – for a short time
Even though our business has grown 392% in the last four years, our personal income has gone down every year for the last three years. But rather than be concerned, we’re very excited because we understand the principle of growth: growth decreases profit and cash flow. The faster you grow, the less profit you will have right now, but a lot more later.

If you are making less profit because your revenues are bad or your margins are too low, that’s a big problem. But if your profits are low because you are growing quickly, get happy about it. Just watch your cash flow – fast growth can put you out of business if you don’t have enough cash on hand to pay your bills.

Growth slowing down? Watch your expenses
The final cycle – If you decide to stop growing (we plan to keep growing internationally), your profit and your cash flow will return, and if you’ve done it right, you’ll have a lot more of both than when you first starting seeing profit. At this stage, tweaking your expenses will only make you more money.

Make decisions based on where you want to be, not on where you are
Too many business owners focus on expenses early in their business and say this to themselves, “I can’t afford to hire that sales person, buy that truck, install that software, etc.” The problem is that you are looking at an investment (money that comes back in spades) vs. an expense (money that never comes back). When you make decisions based on where you are, you shouldn’t be surprised that you’ll be there again next year.

One final thought – watch cash flow during every number cycle – it can put you out of business at any time.

So don’t be afraid of the growth stage! Give up the profit for a time and grow. You’ll have a lot more of it later.

What to Obsess About as You Grow

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(not profit)

Startup is all about proving you will make a profit someday soon. Once you prove it, you need to forget profit and focus on other things. If you don’t, you may stagnate or go out of business, ironically by focusing on profit.

Too often I see business owners who have worked hard to build a profitable business who never get off the treadmill. The problem is that when the business finally makes money, the founder too often hunkers down and protects their profit, when what they really need to do is move to a new stage – forget profit for a time and focus on growth.

At startup, if you don’t focus on proving your product or service can be profitable, you’re employing the Random Hope strategy of business. But once you’re there, if you want to grow, profit will shrink. It almost always does. Growth usually erodes profit significantly. If you’re focusing on profit, you’ll never want to grow, and you’ll never build a sustainable business.

When growing, here’s some things you should focus on instead of profit.

1) Product development – make it better!! Don’t settle for what worked to get you into business. Be relentless in developing an even better product or service. This could cost you some profit. It’s worth it.
2) Great people – great people are not an expense, they are an investment. Forget your profit, take a lower salary yourself, and get a couple great people. They will help you build a sustainable business, and you will grow much faster with a few key people doing things you’re not good at doing anyway. This will sacrifice short-term profits.
3) Logos, website, marketing materials. Too many businesses make the mistake of focusing on these things when they start (see last week’s post on why that’s a bad idea). But once you know you’ve got something, build a consistent face for your business.
4) Infrastructure (software, leased space, conveyor belts, computers, a bigger truck, etc.). When we cripple along and “make due” because we don’t want to hurt our profits, we are not thinking straight.

Focusing on profit, instead of growth, simply mortgages our future for short-term profit. We sacrifice much higher profits in the future because we’re not willing to take a break from profits to build the business.

The profits you were making early on need to be re-invested in the business in the form of a continually improved product, great people to build around, good messaging and marketing to expand the reach of your business, and infrastructure to support the growth.

Principle #1
Ask yourself this question: “Are you making decisions based on where you are, or where you want to be?” If you are making decisions based on where you are, where do you expect to be next year, or five years from now?

Principle #2
Don’t “go” into business, but “grow” into business.

Don’t spend money on the above things until you know you have a product or service that has proven it will be profitable. Don’t take loans out to build something early on that you haven’t proven has legs. But once you have proven it, then it’s time to make the investments that will take you from short-term profit, to a long-term sustainable business that makes money while you’re on vacation.

Prove profit. Then shift from profit to growth, and know that growth will cut the heart out of your short-term profit so you can build a long-term profitable business.

What to Obsess About at Startup

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And why

Most business owners obsess over the wrong things at the wrong time, costing time, money and even the business itself. What should you obsess over? When?

At startup we obsess over three things we shouldn’t:

1) The beauty and design of our product.
2) The beauty and design of our marketing (logo, business card, complex website, wrapping our van, etc.).
3) Focus groups, or other outside opinions that don’t involve someone’s wallet.

These are not things to obsess over at startup. They come later (in a future post we’ll discuss when these things become more important).

What should we obsess over at startup?
1) Sales – Are people buying right now, without fancy marketing, fancy packaging, or a fancy logo? Sales is NOT a focus group of people SAYING they would buy it, but cash actually exchanging hands. If this isn’t happening, don’t bother with a logo, website, focus groups or making the product prettier.

Nothing matters if people aren’t willing to buy the product long before it’s perfect. If the basic product isn’t enough to draw people in, then all you’ll be selling once you make it pretty is – “it’s pretty”. Google, Facebook, Basecamp, the automobile, cell phones, printers, TVs, radios, movies, cosmetics, you name it – none of them were very good when they came out, but sold anyway because the basic idea was really good. They got pretty later.

Focus first and foremost on selling a first generation product or service. If it doesn’t sell without the bells and whistles, the bells and whistles are very unlikely to make it sell more.

2) Close Ratios – How many Connections become Buying Conversations become Customers? Do I know the “close ratios” of Connections to Conversations to Customers? If I don’t know these numbers early on, I have no clue how to grow my business. After “Does it sell?”, nothing matters more than your close ratios. Knowing these defines all of your most important activity about how you will find customers in the early stages.

Example: I need 10 new Customers a month, which means I need 30 Buying Conversations (33% closing ratio), which means I need 90 Connections (33% ratio). If you don’t know how many people you need to reach to make a sale, you’re employing the Random Hope strategy of business. Good luck, because luck is all you’ve got.

3) Profitability – not “Am I profitable right now?”, but “Will this product/service be a profitable business?”

I worked with one client who I encouraged to make a few prototypes quickly, and take them out and see if they would sell. Instead they did focus groups, spent tens of thousands on product design, focused on product name, logos and branding, and put together a highly complex integrated marketing program with a great website, email campaigns, social media, etc. The product did not sell.

Marketing is what you do AFTER you have a viable product that sells on it’s own merits. Marketing will not make it sell, or will only make it sell nominally enough to fool you into staying in business.

When I started Crankset Group, for almost the first year I had no business card and a simple billboard website (1/2 page-no scrolling, almost no info, one email address), just to prove that most businesses don’t need marketing at first. They need to sell something.

Marketing is not the key to selling your product. Producing something that people want to buy before it’s beautiful is the key. If they will buy it when it’s slightly rough, they’ll love it when it’s refined.

At Startup, Profit Potential is Good
And don’t be fooled if your product or service sells like hotcakes right out of the gate without good marketing. Check your pricing and make sure this business will be profitable.

A few years ago in the TV series “The Office”, Michael Scott started his own paper company. He was able to pick up a lot of clients very quickly, seemingly proving he had a great business. Then his accountant told him that his pricing was too low and the more clients he landed, the more money he would lose.

Top line revenue is not profit. Profit is the number at the bottom after you pay for everything else. Because you may have startup expenses, you won’t actually see profit right away, but the profit potential must be very clear from the outset. Get outside eyes on this (i.e., accountant). Like Michael Scott, you almost certainly will be clouded, believing you see profit potential where there is none.

Sales, Close Ratios & Profitability Potential
People buy great marketing only once. If your product isn’t sellable without great marketing, it will die quickly. Word of mouth is the most powerful marketing you have. Make something people want, and serve them as they buy it. If it sells and it will make you profitable, then you can employ marketing to expand the reach of a product that is already viable.

Next week we discuss what to obsess over after you begin to grow.

Growth Can Kill Your Startup…

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And Profit Can Kill Your Growth

Huh? Aren’t profit and growth both good? Only in the right sequence. Focus on the wrong one at the wrong time and either one of them can drive you out of business.

At Startup, It’s All About Profit
Startups make the mistake of thinking what they need right away is growth. We measure growth in a number of ways, and all of them are largely unhelpful to an early stage business:
1) Revenue (is not profit!)
2) Market Share (lots of new customers)
3) Operational scalability (lots of new people, machines or square footage).
4) More investors (lots of cash being invested early on)

Problem: The ONLY thing that matters in the very early stages is finding something that can and will make us profitable for the life of the company. Why? Amar Bhide says 93% of all businesses leave their prime objective to become profitable. I think it’s even higher. If you focus on growth first, you’re almost certain to grow something that won’t be your long-term profit center, and backing out of it could be disastrous.

In 2006 we started Crankset Group believing our main profit center was something we stopped doing two and a half years later, and will never do again. It took us longer than normal to find our profit center, and I’m very thankful we didn’t invest a lot in making it go. Committing a lot of resources to it early on might have us mucking along trying to keep it alive just because we were too vested to move on.

An emphasis on growth before you’re 100% convinced you’ve found your long-term profit center will drain your resources and drive you out of business, by chasing an idea or a product that hasn’t been tested by your customer’s checkbooks (the only true focus group). Find your REAL prime objective, the one that will create long-term profitability, first. It almost certainly isn’t what you planned.

Found Your Profit Center? Forget Profit!
The game shifts radically once you’ve found what will make you profitable in the long run. Most business owners miss this one. I worked for a company that became profitable, decided to stop investing, and three years later, profited and saved their way right into bankruptcy.

Most small business owners do the same thing. As soon as they become profitable, they have something to protect (profit), and they’ll protect and defend that profit so fiercely that they either never hire anyone else to build the chair (I can do it cheaper myself) and never get off the treadmill, or their business becomes obsolete and just fades away. This is where Ray Kroc’s (founder of McDonalds) terse warning applies, “If you don’t want to take a risk, get the hell out of business.”

After finding your profit center, if you are worried about profit, you will likely never grow.

Growth means one of two things – you grow enough to build a true business that can make money while you’re on vacation. Or if you want to be Giant Corporation, Inc., then growth means figuring out how to capture the most market share. Most business owners will never want to be Giant Corporation, Inc., but all of us should grow our businesses to the point where we are no longer hostages, but can very regularly get away and enjoy the fruit of our business. To do that, focus on profit first, than be willing to take the risk to focus on growth, even at the risk of short-term profit.

It’s Worth the Risk
If you take the risk to grow, you’ll make a lot more money in a lot less time, for a lot longer than if you focus solely on profit.

Your Freedom Number is the Only Number That Matters.

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Your business has the same issues as those I visited in Kenya. In the final analysis, there’s only one number in business that really matters, you’re Freedom Number. While I was in Kenya, I had seminars and workshops with everyone from large international businesses to egg vendors in the slums. I wanted to impress on them the importance of net profit, the money that is “left over” after you pay all your expenses including your income.

I wanted them to know that it’s the only number that matters in the long run (others might be more important in the short run), so I asked an egg vendor:

“Would you like to get to a point where you could choose what to do with your time and your money?” She lit up.

I said, “Wealth is simply the ability to choose what to do with my time. We need to figure out how to become wealthy, not rich (riches=money).” She agreed and recognized instantly that having more money, if it didn’t create a better lifestyle for her, would not solve anything.

Sound familiar? We struggle with the same issue, the decimal point is just in a different place. The key is Net Profit. If you have Net Profit, now you have the freedom to choose what to do with it – the seed money for Wealth. To drive this home I asked the Kenya business owners to switch out the term “Net Profit” with “Your Freedom Number”, and to report it to each other every month, along with how the were going to reinvest it to create more wealth. They got very excited about the idea and there was a lot of buzz about their “Freedom Numbers”. I also challenged them to have a long term Freedom Number – the accumulated Net Profits over time that would truly create Wealth – the ability to choose what to do with their time.

One of the big “ahas” from being with business owners in Kenya was that the Cycle of Poverty is identical here with seemingly successful business owners – we haven’t really broken out of the mental Cycle of Poverty. The decimal point is in a different place, but we’re mortgaged and leveraged to the hilt and Net Profit is something we use to go to the movies, not reinvest in our business. After all, how could $50 left over at the end of the month have any impact anyway? I might as well just use it to enjoy the moment.

The egg vendor had the same question. She figured she might have 200 shillings ($2.64) of Freedom Money at the end of a month. We did the math. If she reinvested it and bought 20 extra eggs the next month, and kept reinvesting her increasing Net Profit for 18 months, her personal income would go from 4800 shillings a month to 30,000 shillings a month, with 10,000 more shillings to still reinvest in her business! $2.64 is a great Freedom Number if you see it that way.

What is your Freedom Number (Net Profit) this month? What are you doing to create more of it? Are you reinvesting it to build Wealth or using it for short term comfort?

Net Profit is the most important number in your business – it’s your only Freedom Number. Focus on it and you’ll make more money in less time.

Simple Processes Create More Revenue

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Once in awhile Mom would tell me on the way out the door to school that we were having hamburgers that night. But when I came in from playing to eat dinner, I found chicken on the table. I was disappointed by the switch, which was completely irrational because I like chicken just as much as hamburgers. But she had set one expectation and fulfilled it with another. I was an irrationally unhappy customer, but unhappy just the same.

A realtor sold a house and sent a weekend voucher to a high-end hotel/spa to the new owners as a thanks. They recommended the realtor to friends, and after the friends sold their house, the realtor sent them a very nice, expensive house-warming gift. They were disappointed and never recommended her to others.

What happened? It’s simple. The realtor didn’t have a process in place for relating to clients and ensuring she got referrals. She was winging it. The first customer told the second about the weekend and when they got an equally expensive house-warming gift, they felt short-changed because the realtor had set an expectation for how they would be treated, then changed the rules of the game on them. The second seller thought they were getting hamburgers and they got chicken instead.

Simple, effective processes are a necessity for every small business. If businesses spent a few hours putting a few processes together instead of spending weeks on fancy business plans that never see the light of day again, they would be much more successful, much more quickly.

Creating processes to help us run our business is one of the keys to getting off the treadmill.

From Brian Phillips’ Third Secret of Small Business Success (of Four Secrets):
“Consistent results come from consistent actions. Too often we fall into crisis management mode and the wheels fall off the cart.”

Enter Edward Deming – 1950 – Japan.
What is a process? – “A system [process] is a network of interdependent components that work together to try to accomplish the aim of the system. A system must have an aim. Without an aim, there is no system.” Deming

Edward Deming, the father of modern quality and customer satisfaction had an 85/15 rule “85% of a worker’s effectiveness is determined by the process he works within, only 15% by his own skill.” One-person companies need processes as much as 500 person companies (more actually). If I’m operating without processes, I’m being as ineffective as possible, and my great chicken will not be well received.

Why we don’t create processes for ourselves.

  1. Only big businesses need processes – my company is small enough to not need all that “organization”. We couldn’t be more wrong. Operating without processes makes us reactive, but most importantly, when we’re “winging it”, we create inconsistent experiences for our customers, ourselves, our employees. Inconsistency is one of the keys to failure.
  2. Creating processes sounds too complicated. Keep it simple – a few bullet points for each process, not a 30 page detailed procedure manual. Just write down what you are already doing, and decide whether what you wrote is really what you want to see happen every time. If so, you have a process. If not, you have a piece of paper that will go in a drawer.
  3. I don’t have time – You don’t have time NOT to do this. A couple hours a week over a few weeks should get you most processes written down. If you have 3-6 processes in your business, and you dedicated four hours a week to this, you would be done in 1-4 weeks. You likely waste more time each month and lose more customers “winging it” than you would spend in one month completing your Processes.

Why we should create processes for ourselves.

  1. Effectiveness/Profitability – Natural talent is not a good way to run a business. All of us would make more money if we systemize what we’re doing.
  2. Consistency – If each customer (or vendor or employee) has a different experience, I’m creating issues. Why not ensure everyone has the same good quality experience every time? McDonald’s is successful not because they have the best food, but because you know exactly what you’re going to get at every location, everywhere in the U.S. Consistency builds loyalty. Inconsistency builds confusion and disappointment.
  3. Transferability – which is a key to consistency. When Tom goes on vacation or takes a day off, or worse yet, leaves the company, the “procedures” in his head no longer exist. A good, simple, WRITTEN process can be carried out by the next person without dropping a beat, especially if you have done cross-training on each process to ensure more than one person already knows how to do it.
  4. Profitability/YPH – all this leads to making more money in less time!

Next week we’ll talk over specifically about how to write a good process – I’m betting that what we describe won’t be what you imagine as “processes”, but something more practical and easier to implement.

Revenue is Not Your Friend – Pricing For Profit

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The Sausage Vendor said he bought his sausages for a buck, and sells them for $.95. When challenged as to how he would make money, he said, “No problem, I’ll make it up in volume.”

Business owners focus on Revenue when they should be focused on Profit. If they focused on Profit, they would raise their prices more often.

(This is Part One – The Mind Games of Pricing. Next week we’ll do Part Two – The Mechanics of Pricing)

The old saw is wrong – “If you worrying about sales, profits will take care of themselves”.
Neither Revenue nor Sales are a good place to focus financially – we need to focus on profit (actually cash flow, but that’s another blog.)

What barriers do you encounter in communicating your pricing to potential clients?
Competition, market conditions, aging industry, complex service, fear, not understanding how to price? Probably a little of most of the above.

When we aren’t sold on our pricing, what does that communicate to the potential client? It communicates that all of the above (competition, market, fear, etc.) are all good reasons not to buy my product or service from me. The best way to create pricing problems is to not believe in our own pricing.

A caterer friend gave his “best, lowest” price to a potential client, skimmed of any “excess” profit, and the client’s response was “Is there any way you can go lower?”. When we aren’t confident in our prices, we mentally set up shop in a place that attracts bottom-feeders like the guy above. Getting a lot of pushback on your prices? It’s possible its because your prices are too low!

Joel Spolsky is the co-founder and CEO of Fog Creek Software, said “I often meet people at parties and conferences who are starting companies, and they will invariably ask me, “Say, Joel, do you have any advice for start-ups? Since I know next to nothing about these people or their businesses, or even their industries, I usually just say, “Yes! You should raise all your prices!”

And we both have a good laugh, bwa ha ha, then the founder ignores me. But my advice was most likely right. That’s because almost every start-up I have ever seen has set its prices too low.

Of the three business owner Profiles – Market Focused, Systems Focused, and Product Focused, the Market Focused entrepreneur is most likely to have good pricing, and the Product Focused craftsperson will have the worst. The problem – the overwhelming number of businesses are started by Product Focused craftspeople. (The Systems Focused manager loves accounting-driven pricing that ignores all market conditions; they also start the fewest businesses.)

What makes for the most profitable company? One that focuses on providing VALUE, not COST! Lower prices is not value, it is simply lower prices (and may communicate less value).

FIND VALUE OUTSIDE OF PRICE!

If relationships are equal, there are only two other buying questions – 1) How much does it cost? (price question), or 2) Can you do it? (value question). If you’re getting the “How uch does it cost?” question too often, you’re not focused on adding value or you’re not confident in the extra value you’re delivering. Either one will lose you clients much more than your pricing itself.

What does having slightly higher prices communicate to the customer? We are confident in how our product performs.

How do we get confidence?

  1. Understand the value to your clients. Ask them – why do you buy from me? What are you buying that you don’t think I even know I’m selling? It’s the best question you’ll ever ask them.
  2. Stop thinking about how YOU think you perform (internal/craftsmen view), start pricing based on how you benefit them (see #1 above.)
  3. Get some support – have somebody hold your feet to the fire on WHEN you will raise your prices.

Raising your prices is usually the fastest way to create new PROFIT. If you’re already covering all your costs, then every penny of higher prices falls directly to the bottom line. Want to make more money in less time? This is one of the best ways to do it.

Next week we’ll cover the actual mechanics of how to set and stick with a good price.