I’ve been saying for years, that there are only three things any company must do to succeed. And as simple as that sounds, I was wrong. The revised three things are:

1. Create Value that people want to pay for.
2. Find those people and sell to them.
3. Build an organization that does the first two, over and over again at a cost below what your customers want to pay.

I used to say the first thing was “Make something people want to buy.” That’s subtly but significantly different from the way I say it now. What made the change? Three reasons.

Reason #1:  COSTCO. Costco doesn’t make anything but they are one of the most successful companies around. They do create value that people are willing to pay for by finding stuff, bringing it to an accessible location and pricing / packaging it in a way that is appealing to their market. So from that perspective it makes sense to think of creating value rather than making something.

Reason #2:  Passion-blinded entrepreneurs. These are folks that get so fixated on the thing they’ve invented that they don’t listen to the market. Either they believe that because they love it everyone else should too; or they refuse to listen to how the market wants to buy it or use it. So I thought changing the emphasis from “making something” to “creating value” would get those people to consider engaging the customer more. Maybe.

Reason #3 – For a business to succeed, you don’t do these thing independently from one another. It’s not like you create value. THEN go out and sell it. THEN build an organization. The best companies create value that is easy to sell and take their organizational strengths and weaknesses into account when doing so. It’s all of a piece. I thought saying “create value” makes it seem slightly less distinct that “make something”.

As I said – a subtle difference, but a significant one.

Takeaways:

1. Create Value that people want to pay for.
2. Find those people and sell to them.
3. Build an organization that does the first two, over and over again at a cost below what your customers want to pay.

And why that’s a good thing!

Just like a bicycle built for one doesn’t usually grow into a bicycle built for two, there is not a linear continuum from small company to big company like there is from little kid to big adult. It doesn’t work that way.

Why? Because the business model has an external component: customers. And if you hadn’t noticed, they have a mind of their own. It’s been said, the things you can’t change include the weather and other people. The things you can change include yourself and the oil in your truck.

But the truth is, if your burrito sales max out at lunch time because there just aren’t enough people in driving distance who want your burritos, then making more of them faster, or adding more chairs or a bigger sign won’t conjure up any more sales. Now if the bottle neck is chairs, or how fast you can roll a burrito, then that’s an internal problem and you can fix it.

But if you’ve maxed out the external aspect of your business model, you just can’t grow it any bigger without changing the model. Opening another store to become a chain or selling online would change your model and allow for more growth. But without changing your model, the company won’t grow in size – but it can grow in profit.

Why is this a good thing?

The silver lining is that most really big business models REQUIRE size. They can’t survive at all when they’re tiny. They need life support (in the form of outside investment). And they need to grow really fast. Because of that, competition can often do a lot more harm to a company with a business model that requires growth.

As Ridgely Evers said “A Silicon Valley start-up is completely focused on getting big, and naturally risks failure to get there. A true small business, on the other hand, is focused on becoming profitable, feeding a family, and staying in business. That’s a fundamental psychographic and cultural difference.”

I’ve often said you need to do three things to have your company succeed.

1. Make something people want to buy.
2. Find those people and sell to them.
3. Build an organization that does the first two, over and over again at a cost below what your customers want to pay.

As I was thinking about Evers’ quote, it occurred to me that people who run small companies focus more on number one and two than they do on number three. While big companies put a lot of focus on number three.

The problem is not that small companies don’t grow into large ones – the problem is that if you ignore point number three, your company is not as successful as it could be regardless of its size.

The better you build your organization the more profitable and less frustrating it will become. Building an organization is the true job of a CEO.

It’s a statistical fact that people with bigger feet are better at spelling than people with smaller feet. Why? … They tend to be older!

Sorry for the bad joke, but ask yourself what’s the difference between big companies and small ones?

Did you answer things like: more customers, greater revenue, larger staff production capacity or sales force? Then you made the same mistake as the joke. Not understanding that size is the consequence not the cause.

What do we mean by “Scale”?

Scale has to be understood in context. If you’re a surgeon, or a personal trainer or a voice coach, then your business is a “practice”; and the maximum size you can get is going to be smaller than the maximum size for a company that makes computer hard drives. (It’s also true that the minimum size you can survive at is likely to be smaller as well.)

The same is true for a restaurant or a knitting shop.  You can only get so big before you’re serving all the customers who want what you sell and are within a reasonable distance from your shop. You’ve saturated the “addressable market” in business jargon.

Of course, a restaurant can open other locations and become a chain, and the knitting shop can start selling stuff on line. But think how different your day would be as the owner of a knitting shop compared to the owner of an online knitting shop. In the latter case you’d be analyzing your page views and conversion rates. You’d have a shipping department and your business would be open 24/7. You might even need to conduct business in multiple languages.

The difference is not one of size or quantity but a difference of kind or quality.  You’re not really in the same business at all. You are (to use jargon again) operating in a different business model.

And that brings us to the difference between a big company and a small one. A big company is one that understands it’s business model and exploits it for maximum size; and a small company doesn’t.

What is a Business Model?

A business model is how you transform the customer’s desires into profit. It happens at the intersection of the following:

• Your goals, passion and financial targets. (Otherwise why on earth would you be running your own company if you didn’t have goals and passion for it?)
• Your customer’s desires. (They have to want what you sell more than they want their money or they won’t buy.)
• Your internal processes. (To make a profit, you have to make something  customers want, find those who want it, sell it to them, then build an organization that can do that repeatedly and less than the cost they’re willing to pay).

Two Kinds of Small Companies

Let me mention that there are two kinds of (small) companies that don’t understand or exploit their business models.

The first is what most companies are like. 50% of American workers work for small companies and most are like this. They actually have a business model, and they operate within that model. They just don’t consciously analyze the model so they don’t know how to incorporate it into their business decisions.

The Devil in the Details

To understand and exploit your business model, you have to know what really drives your customers to buy. Is it price? quality? features – and which ones? convenience? That’s why Ray Kroc (McDonald’s founder) used to say that they weren’t in the hamburger business they were in the real estate business. Their customers bought for convenience and consistency (not quality). So the key to their success was picking the right locations to give their customers the most convenient access to their consistent products.

You have to understand all your internal costs and how to maximize the impact of every dollar you spend. Do you know the cost of lead? The cost to convert each lead to a customer? Whether spending an extra 10K to improve production capacity will improve or hurt your bottom line and by how much?

Scalable companies know these things. And they’re always working to improve their execution of the model in which they operate.

Companies without a business Model
The second group of small companies is exemplified by the newest internet start-up. I’d name one but by the time you read this they’ll be supplanted by another.

But it’s true of any novel invention. Novocaine was invented to be a local anesthetic for military use – but found it’s market in dentistry. Early telephones were wired in pairs. You needed a separate line to the phone of each person you wanted to talk to because the business model was predicated on sending only urgent messages (faster than a telegraph). PayPal started selling cryptography on hand held devices. No one bought it. They tried several other business models before they found that people would pay to transfer cash electronically and that required security which they were good at.
These companies don’t have a business model or rather they haven’t found it yet. So what they should be doing is NOT growing. They should be learning. They should be learning what customers want, how much they’ll pay, how to find and sell to them, and how to do this in a way that makes money. Once they’ve figured that out, then they should grow.

Worst Place #1 – Investors! Why? it’s the most expensive money and it takes more of your time and energy to secure it. Plus they almost never tell you no so you waste a lot of energy pursuing deals that are never going to happen.
Worst Place #2 – Lenders. It’s cheaper than investor money but it’s still hard to get (almost impossible for start-ups). Not only do you have to pay it back with interest but often at the most inconvenient times that don’t account for dips and fits that all businesses (especially young ones) go through.
Worst Place #3 – Friends and Family. Why? It can be easy to get, and if you’re a success you probably won’t mind paying it back. But if you aren’t a success you can mess up some important relationships. Seriously.

THE BEST PLACE? Customers.

Not only are they the best place, customers are actually the only place to get money. Here’s why. Your business is like a car. It has to get a lot of power. Power to go, of course, but also for the power steering, power brakes (did you forget cars didn’t use to power those things?) And you need power for the windows, the AC, the audio system, even the GPS and the DVD player for the kids. All that power has to come from the engine. All of it. There are no solar panels (not yet) no gerbils or even rubber bands under the hood. Every single bit has to come from the engine.

But the engine can’t start itself. In the olden days it was started by muscle power with a crank. In my younger days I had a car that had to be started with a push down a hill. Modern cars get started with power from the battery. But that battery needs to be recharged, and the charge comes from guess where? The engine.

Your business is like that. The customers are the engine. All the money has to come from the customers. Sure you may need a jump start, and you may look to some of those worst case sources I mentioned for that jump start. But if you haven’t built a business model that shows how your customers will ultimately pay your cost of goods, plus all the costs of selling to them, plus the cost of keeping the lights on PLUS paying back the lenders, investors or friends and family your company will sputter and die. In many cases you won’t even get the jump start.

I say this as an ex-entrepreneur who is currently an angel investor. I love it when my investment can jump-start a successful company. But I don’t get to do it enough. Why? Too many entrepreneurs think getting my money is closer to the end not the beginning.

Too often I see pitches from entrepreneurs who don’t really get that my money is just a jump start – and an expensive one at that. So expensive in fact, that there are a lot of good companies who will never get going fast enough to pay me back enough to make me take the risk. Too often they waste so much time trying to pitch to people like me when they could be selling stuff to customers and actually making money.

Many would be much better off to start with a little push, and grow slower but more profitably, with customer’s money.

photo credit http://www.flickr.com/photos/neubie/2273635564/

[tags] start-up, entrepreneur, financing, investors, VC, angel investor [/tags]

I’m sure you’ve heard that when you ASSUME it makes an ASS out of U and ME. Here’s a way to make assumptions that work.

Investors all know that business plans are fiction, or rather fairy tales (fiction sometimes has an unhappy ending business plans never do.) And many successful companies thrive without business plans. Even those who promote business plans as a management tool usually say it’s the planning not the plan that’s of value. So what’s better?

A business Model
As I’ve long said, a model is better than a plan. The key difference is that a plan is based on time – what you’ll do in this month, that quarter, the next year. Hint: the vast majority of business plans have a huge sales jump in year three. Why year three? it’s so far in the future that it doesn’t have to be based on reality, yet it gives you the numbers you need to make your return look good. A model, on the other hand, has all the parts of the business based on each other (and ultimately sales) not based on time. So as reality happens differently than you’d like, you can adjust. Quickly.
How to Assume
This article gives a good example of the kind of assumptions that underly a business model. The two key points are Dollars per … and Levels of demand.
Dollars per …
You only spend money in a business because you want to gain something. Usually it’s to gain capacity. Every single one of your costs should have an assumption tied to it that links dollars to some non-financial thing. And no cheating. You can’t assume rent by saying dollars per square feet. That’s the same thing. You need to say dollars per employee (if you’re renting office space) dollars per SKU (if you’re renting retail space) or dollars per widget produced (if you’re renting manufacturing space).

You must tie each dollar you spend to something else – it makes you think long and hard about why you’re spending it. In some cases you need to break down a single line item on your P&L into multiple assumptions. Take the example of rent I gave above. Suppose you rent a building that you use as an office, a warehouse, and a manufacturing space. Your P&L probably just says RENT. But to build a good model, your assumptions have to state why you need so much of each type of space. That way the parts of your model are tied together. If you double your business, you won’t just double your rent because the ratio of office to warehouse to manufacturing won’t stay the same. Likewise if your business falters and you have to downsize.

So having an assumption of Dollars per for each reason you spend money gives you a model you can use.

Levels of Demand
Hidden in this paragraph of the article I linked to is a gem. (emphasis mine)

Admit that revenues are a mystery. If you don’t have any revenues yet, you can’t say what they’ll be. The point of a model is to prove you can make money if people buy your product, not to insist that they will. By developing different scenarios based on different levels of demand, you can later calibrate hiring and spending according to which scenario fits reality best.

This was written for a start-up but it applies to any business that is growing (or shrinking) or attempting a new initiative. Since you don’t know how the customers will react, or how fast, you need to develop scenarios based on different levels of demand. This is possible to do if you’ve made your assumptions with dollars per. Because what you’re buying with those dollars is capacity – the capacity to support a certain level of sales. (And by support I mean everything in the whole company life cycle – market, sell, produce, deliver, invoice, collect etc. Everything.)

So pick three levels of demand and work your model of what your costs need to be to fully support each level. That way as your initiative goes forward, you know what you should be spending.

If you’re a start-up one of those levels needs to be break-even: the level sales need to be so pay for all the support in a self-sustaining manner.

Takeaways:

• A model is better than a plan.
• You spend money to gain capacity – your assumptions should reflect this.
• Develop scenarios for different levels of demand.
• Building a business model is a CEO skill

[tags] business model, small business, entrepreneur, start-up business plan[/tags]

In most industries probably not. But music is different (like art and a few others where commitment and commerce are closely linked). SELLABAND has developed an interesting business model to exploit this combination of passion and partnership. Details HERE.

The idea is “believers” aka investors invest $10 in a share of a new band. When the band has raised $50,000 (5,000 investors) SellABand helps them produce and promote a CD – the investors get one copy of the CD for “free”. Money is split between the band, the investors and the company. Any time before the band raises 50K an investor can get their money back or switch it to another band.

Seems to me that $10 is a really cheap way to “own” part of a band for people who like to be early adopters of new music and a way for a band to raise money but more importantly get 5,000 folks promoting their music from the get go. For the investors, it’s like paying $10 to be a promoter of an idea virus. And you get a CD for the price.

UPDATE: Slice The Pie has a similar concept.

Takeaway:

• The real power of any technology is not to do the same old stuff quicker, better, or more accurately, but to allow you to do things that could not be done before. The web is no different in that it’s real power lies in the uncharted.

[tags] entrepreneur,record label, Music Business, business model [/tags]

You wouldn’t ever spend a penny of your company’s money without expecting some benefit. You spend advertising to get sales, you spend on inventory to have something to sell. You spend on sales people because they put money in your pocket.

A business model is a tool to help you figure out when to spend how much, what results you should be getting when, and to know in advance when you’ll have to raise more money from investors.

How, you ask, can you predict all those things with enough accuracy to bother? Well, you can’t. Certainly not at first. But the fact that you can’t predict the future doesn’t mean you shouldn’t develop a tool that helps you understand it – especially as the future becomes the present. That tool is the business model. Probably the most important thing you’ll do as CEO is develop, refine and then USE the business model when decisions are being made in the company.

What is a Business Model? It’s an understanding of how these three things intersect:

1. What the customers want to buy (and why).

2. How the company will make and sell those things.

3. How the company will make money from doing so.

As you can imagine, there is a bit of guesswork involved. We call them assumptions. And it’s important to write them down and test them against reality, then revise them as you learn more. Pretty soon they’ll actually be dependable.

The other thing you’ll need assumptions about (at least at first) is the capacity of parts of your business. Production capacity is pretty easy to come by – how many widgets can a machine make in a day. But Sales capacity (how much can you sell before you need to hire an additional sales person) and administrative support are things you’ll have to guess and refine.

The parts of your model that you can get exactly are your costs.

Many people don’t build a model because so much of it involves guesses (I mean assumptions) so they don’t think it’s valuable. They are wrong.

I build mine based on cash flow. On the dollars page I put all the sources of cash in on top of the reasons to spend cash out. I group the cash in by product line and the cash out by reasons to spend: COGS, Cost of Sales & Marketing, Overhead, Paying back lenders & investors and PROFIT. Profit can be money taken out of the company or money kept in and used for growth.

On the assumptions page, I make all kinds of assumptions about how long it will take for customers to buy, what the average sale size will be, how interest rates will affect my business, how long it will take to raise more money etc. Make sure the numbers on the dollars page accurately reflect these.

I make a third page for capacity. This is a specialized form of assumptions that relates how much it costs to accomplish or produce a certain number of results. Things like how many people can each administrative assistant support, to how big can you grow before you have to rent larger facilities.

When you first start this, the number of details can seem overwhelming. Don’t worry. Start at the highest level and add details as you need them.

Takeaways:

• A complete business model will help you make every business decisions.
• It will help you adapt quickly when things don’t go as planned (and they won’t).
• It’s not a trivial task to build and use a business model. But I know of no better way to grow a company that has a functioning CEO. Without it, you’ll always be just the CCB – chief cook and bottle washer.

[tags]Business Model, Small Business, Entrepreneur, Management, How to be CEO,CEO Skills[/tags]

I said last time that to function as a CEO, you need a team that doesn’t depend on you for day to day successes. It’s hard to build a team like that. Impossible if you don’t understand today’s topic.

Bigger is different – not just more
Companies don’t grow in linear fashion. The characteristics change along with the size. My friend Nick at The Black Sheep started out as a professional baker. He told me you can’t just take a recipe for 3 dozen cookies and multiply everything by ten. At that size you have to change the mix for it to work right. You know the same thing if you’ve raised a family. Going from a couple to having a child is not just 1/2 again as much. It’s completely different. And the quality changes again with your second child and your third. When you only have one kid at least there’s some quite when the little one is taking a nap. When the kids start to out number the adults it’s a whole new world.

Plumbing Plateaus
The best example of this in business is to consider a plumber. The one we’re imagining works from home, has a truck and a helper and is doing well. The two of them are busy 40-50 hours a week, making a nice living. The company grosses 200K per year (at $125 an hour you do the math), the helper makes 45K and the take home pay is decent for the owner.

The company is at what I call a plateau of profitability. So she (or he) decides to grow the business. You can’t grow a company like that by 20%. The boss and her helper can’t do 20% more work – there just aren’t enough hours in the week. And 20% isn’t enough to afford another truck, another plumber and a helper. If they expanded and only grossed $240K they’d loose money. So as the company grows it falls off the plateau of profitability and enters the canyon of negative cash flow.

So what to do? As the saying goes “You can’t leap a canyon in two jumps” The solution, as you’ve probably intuited, is to figure out how much growth is required to make it profitable to run a company of two crews, trucks, helpers and all. Let’s say with increased marketing, a bit of inefficiency due to communication between 4 people, and such it would take 75% growth to be profitable at grossing $350K. That defines the next plateau of profitability.

So now the choice is this: Keep the company small (one crew) or commit to grow it by 75%, and realize it will go through a time of bleeding till it gets to the next plateau. Don’t start on that journey till you have the resources to make it all the way to the next plateau.

Tired of working at Home
Let’s say our plumber makes that leap successfully. After all it’s not rocket surgery. Lot’s of people dumber than you have done it. One day she gets tired of working at home. Doesn’t want to do paperwork at night. Hates taking calls on her cell phone when she’s on a job. She want’s to grow large enough to afford an office with a receptionist/bookkeeper. Can she afford it with just two trucks on the road? Will it take three? Five? Undoubtedly she’ll enter another canyon before she reaches that plateau. How deep is that canyon?

Build a Model not a Business Plan
To answer those questions you need a business model. By now you’ve realized that I’ve been pulling these numbers out of my butt – for illustrative purposes of course. But if you used real numbers – actual cost of vans, labor, advertising, rent, salaries plus realistic sales figures you’d have a model of how money flows through our plumbing company. The most critical feature to put in your model is capacity – the amount of work each person can reasonably be expected to do. The model shows the interrelationship between sales and the various costs required to sell and service that much business. Your model will show you how deep the canyons of negative cash flow are, what level sales have to be to reach the next plateau of profitability and by including capacity your model will show you how many crews it will take to reach that level.

A model is different from a business plan in two ways: 1. It explicitly includes capacity. 2. It’s not time based. Everyone knows that the monthly numbers for most business plans are fiction. What a model allows you to do is state your assumptions (It will take 6 months to increase sales by 50%) and then adjust as reality hits the fan.

What a model does is take the experience, wisdom and gut feel that most entrepreneurs live by and quantify them in a way that you can monitor the progress of your team. That way the changes and tweaks needed to make any vision a reality don’t depend on your immediate involvement. This gives you the space to be the CEO and do the strategic directing of the company.

Takeaways:

• If you expect to build a team that can handle the day to day without you, and allow you to be the CEO – a detailed model is a must.
• This is harder than it looks because it requires you to make guesses and assumptions before hand rather than just make decisions when stuff comes up.
• A well-built model has a place to note your guesses and adjust them as they get tempered by actual accomplishments.
• The model is always a work in progress – but it allows you to see on a daily basis if you need to, how changes will affect your most critical resources: Cash, and staff capacity.

[tags]Business Model, Small Business, Entrepreneur, Management, How to be CEO,CEO Skills, Profitability[/tags]

• What does a CEO do all day?
• What do you do all day?
• Is it good or bad if the answers are not the same?

Most business of our size get started because a person can make something or sell something. As the market responds, they need to build a company to meet the market demand. In the early stages they can juggle it all. But at some point the company needs a CEO. What does that mean?

The two things about being a CEO are:
1. Produce Results
2. Choose the Right Results to produce

How to Produce Results. By definition, the CEO is an executive. That means you don’t produce results yourself. You did that before the company needed a CEO. As CEO you produce results by organizing others to be productive. That means you devise, implement, monitor, and adapt systems within the company to help the group produce more than any one of you could on your own. To see all the systems I’ve identified so far click here. But think about that last phrase for a minute. It’s your job to help the group produce more than any one of you could on your own. It can be a noble calling when you think about it.

How to Choose the Right Results. This is a dance between your vision of the company and external forces. The primary force is your customer’s desire – what they value. But there are others whose desires you must accommodate: investors if you have them, employee’s needs and skill sets (and the pool of potential employees if yours is a growing company) the technology “space”, regulatory agencies, etc. Your job in this capacity is to see the big picture of where the company can go, then fall back to #1 to devise a way to get there. In short, you’re monitoring trends outside the company, and interactions of the company with the outside world.

This leads to the following observations.

CEO Time.
A company of any size needs some CEO time. But most small companies don’t need a full-time CEO. That means you’ll be spending some of your time selling and doing the technical aspect of producing or managing. It’s important for your sanity and that of your employees that everyone – especially you – knows when you have the CEO hat on and when you’re functioning in some other capacity.

CEO Skills.
I think it was Peter Drucker who said the tools of an executive are meetings and reports. You need to develop skills in using these tools. You have to develop the right reports for your company and the stage it’s currently at. And you have to understand your business model or you won’t be able to see ramifications of the trends shown by the data in those reports. Meetings include every one-on-one conversation as well as when groups get together. There are different kinds of meetings for different purposes and they need to be run differently.

CEO Priorities.
A CEO must work on what’s important not just what’s urgent. That means you have to plan space in your calendar for CEO time. Time to work on the important stuff. Don’t let that time get crowded out by the emergency-du-jour. Your company will need more CEO time as it gets larger. And if you compare two companies the same size, the one which is growing faster or changing more needs more CEO time.

CEO Instinct.
You must know when to go with your gut and when to go with analysis. It generally works like this. You can analyze the past. That analysis only helps plot the future when the future is an extension of the past; when you’re doing “more of the same.” When you need to make a revolutionary jump you need to go with your gut. Apple computer did this when it launched the Macintosh – a product that analysis showed was going to put their cash cow (The Apple II) out of business. They did it again when they launched the iPod which didn’t bankrupt any existing products but did take them into a whole new business.

But as soon as you make a gutsy move and launch a revolution, the future is now past. So analyze the hell out of what you’re doing and change, adapt, revise as necessary. Two more examples from Apple. They launched the Mac thinking it would be used for spreadsheets, database and word processing. Instead desktop publishing became it’s killer app. They did enough analysis to recognize this early on and exploit it well. Likewise with the iPod. Launching it was a gut move, but the frequency and timing of improvement (different sizes) and enhancements (selling songs and now video) requires analysis.

Takeaways:

• Plan time in your calendar to function as a CEO.
• If you don’t love that job, if you’re better at production or sales, perhaps you should stay there and hire a CEO. You can be the owner but not the CEO.
• The better you are at CEO skills and priorities the better your CEO gut instincts will be.

[tags]Small Business, Entrepreneur, Management, How to be CEO,CEO Skills,Leadership[/tags]

There’s a real gulf between an entrepreneurial business where you can do anything through harder work and an ongoing sustainable business that is run through good management technique.
- Bob Jones, owner The Chef’s Garden

I think that says it all.