Profitability often requires better rules and speed, not more time. (Photo: Jetta Girl)
I wrote this “margin manifesto” several months ago and somehow neglected to post it. Your requests for more content on start-up economics and processes reminded me.
These are the principles I review whenever facing operational overwhelm or declining/stagnating profits. Hope you find them useful.
The financial goal of a start-up should be simple: profit in the least time with the least effort. Not more customers, not more revenue, not more offices or more employees: more profit.
Based on my interviews with high-performing (using profit-per-employee metrics) CEOs in more than a dozen countries, here are the 11 basic tenets of the “Margin Manifesto”… a return-to-basics call that gives permission to do the uncommon to achieve the uncommon: consistent profitability (or doubling of it) in 3 months or less.
1. Niche is the New Big — The Lavish Dwarf Entertainment Rule:
Several years ago, an investment banker was jailed for trade violations. He was caught partly due to his lavish parties on yachts, often featuring hired dwarves. The owner of the dwarf rental company, Danny Black, was quoted in the Wall Street Journal as saying: “Some people are just into lavish dwarf entertainment.” Niche in the new big. But here’s the secret: it’s possible to niche market and mass sell. iPod commercials don’t feature dancing 50-year olds, they feature hip and fit 20-30-somethings, but everyone and his grandmother wants to feel youthful and hip, so they strap on Nanos and call themselves Apple converts. Who you portray in your marketing isn’t necessarily the only demographic who buys your product — it’s often the demographic that most people want to identify with or belong to. The target isn’t the market. No one aspires to be the bland average, so don’t water down messaging to appeal to everyone–it will end up appealing to no one.
2. Revisit Drucker — What Gets Measured Gets Managed:
Measure compulsively, for as Peter Drucker stated: what gets measured gets managed. Useful metrics to track, besides the usual operational stats, include CPO (“Cost-Per-Order,” which includes advertising, fulfillment and expected returns, chargebacks, and bad debt), ad allowable (the maximum you can spend on an advertisement and expect breakeven), MER (media efficiency ratio), and projected lifetime value (LV) given return rates and reorder %. Consider applying direct response advertising metrics to your business.
3. Pricing before Product – Plan Distribution First:
Is your pricing scalable? Many companies will sell direct-to-consumer by necessity in early stages, only to realize that their margins can’t accommodate resellers and distributors when they come knocking. If you have a 40% profit margin and a distributor needs a 70% discount to sell into wholesale accounts, you’re forever limited to direct-to-consumer… unless you increase your pricing and margins. It’s best to do this beforehand if possible – otherwise, you’ll need to launch new or “premium” products — so plan distribution before setting pricing. Test assumptions and find hidden costs by interviewing those who have done it: will you need to pay for co-op advertising, offer rebates for bulk purchases, or pay for shelfspace or featured placement? I know one former CEO of a national brand who had to sell his company to one of the world’s largest soft drink manufacturers before he could access front-of-store shelving in top retailers. Test your assumptions and do your homework before setting pricing.
4. Less is More – Limiting Distribution to Increase Profit:
Is more distribution automatically better? No. Uncontrolled distribution leads to all manner of head-ache and profit-bleeding, most often related to rogue discounters. Reseller A lowers pricing to compete with online discounter B, and the price cutting continues until neither is making sufficient profit on the product and both stop reordering. This requires you to launch a new product, as price erosion is almost always irreversible. Avoid this scenario and consider partnering with one or two key distributors instead, using that exclusivity to negotiate better terms: less discounting, prepayment, preferred placement and marketing support, etc. From iPods to Rolex and Estee Lauder, sustainable high-profit brands usually begin with controlled distribution. Remember, more customers isn’t the goal; more profit is.
5. Net-0 — Create Demand vs. Offering Terms:
Focus on creating end-user demand so you can dictate terms. Often one trade publication advertisment, bought at discount remnant rates, will be enough to provide this leverage. Outside of science and law, most “rules” are just common practice. Just because everyone in your industry offers terms doesn’t mean you have to, and offering terms is the most consistent ingredient in start-up failure. Cite start-up economics and the ever-so-useful “company policy” as reasons for prepayment and apologize, but don’t make exceptions. Net-30 becomes net-60, which become net-120. Time is the most expensive asset a start-up has, and chasing delinquent accounts will prevent you from generating more sales. If customers are asking for your product, resellers and distributors will need to buy. It’s that simple. Put funds and time into strategic marketing and PR to tip the scales in your favor.
6. Repetition is Usually Redundant — Good Advertising Works the First Time:
Use direct response advertising (call-to-action to a phone number or website) that is uniquely trackable – fully accountable advertising — instead of image advertising, unless others are prepurchasing to offset the cost (e.g. “If you prepurchase 288 units, we’ll feature your store/URL/phone exclusively in a full-page ad in….”). Don’t listen to advertising salespeople who tell you that 3, 7, or 27 exposures are needed before someone will act on an advertisement. Well-designed and well-targeted advertising works the first time. If something works partially well (e.g., high response with low percentage conversion to sales, low response with high conversion, etc.), indicating that a strong ROI might be possible with small changes, tweak one controlled variable and micro-test once more. Cancel anything that cannot be justified with a trackable ROI.
7. Limit Downside to Ensure Upside — Sacrifice Margin for Safety:
Don’t manufacture product in large quantities to increase margin unless your product and marketing are tested and ready for roll-out without changes. If a limited number of prototypes cost $10 per piece to manufacture and sell for $11 each, that’s fine for the initial testing period, and essential for limiting downside. Sacrifice margin temporarily for the testing phase, if need be, and avoid potentially fatal upfront overcommitments.
8. Negotiate Late — Make Others Negotiate Against Themselves:
Never make a first offer when purchasing. Flinch after the first offer (“$3,000!” followed by pure silence, which uncomfortable salespeople fill by dropping the price once), let people negotiate against themselves (“Is that really the best you can offer?” elicits at least one additional drop in price), then “bracket”. If they end up at $2,000 and you want to pay $1,500, offer $1,250. They’ll counter with approximately $1,750, to which you respond: “I’ll tell you what — let’s just split the difference. I’ll overnight FedEx you a check, and we can call it a day.” The end result? Exactly what you wanted: $1,500.
9. Hyperactivity vs. Productivity — 80/20 and Pareto’s Law:
Being busy is not the same as being productive. Forget about the start-up overwork ethic that people wear as a badge of honor–get analytical. The 80/20 principle, also known as Pareto’s Law, dictates that 80% of your desired outcomes are the result of 20% of your activities or inputs. Once per week, stop putting out fires for an afternoon and run the numbers to ensure you’re placing effort in high-yield areas: What 20% of customers/products/regions are producing 80% of the profit? What are the factors that could account for this? Invest in duplicating your few strong areas instead of fixing all of your weaknesses.
10. The Customer is Not Always Right — “Fire” High-Maintenance Customers:
Not all customers are created equal. Apply the 80/20 principle to time consumption: What 20% of people are consuming 80% of your time? Put high-maintenance, low-profit customers on auto-pilot–process orders but don’t pursue them or check up on them–and “fire” high-maintenance, high-profit customers by sending a memo detailing how a change in business model requires a few new policies: how often and how to communicate, standardized pricing and order process, etc. Indicate that, for those clients whose needs are incompatible with these new policies, you are happy to introduce other providers. “But what if my largest customer consumes all of my time?” Recognize that 1) without time, you cannot scale your company (and, oftentimes, life) beyond that customer, and 2) people, even good people, will unknowingly abuse your time to the extent that you let them. Set good rules for all involved to minimize back-and-forth and meaningless communication.
11. Deadlines over Details – Test Reliability Before Capability:
Skills are overrated. Perfect products delivered past deadline kill companies faster than decent products delivered on-time. Test someone’s ability to deliver on a specific and tight deadline before hiring them based on a dazzling portfolio. Products can be fixed as long as you have cash-flow, and bugs are forgiven, but missing deadlines is often fatal. Calvin Coolidge once said that nothing is more common than unsuccessful men with talent; I would add that the second most common is smart people who think their IQ or resume justifies delivering late.
Did you enjoy this post? If you’d like more like it, please click on the Digg or Buzz buttons below to let me know.
The Tim Ferriss Show is one of the most popular podcasts in the world with more than 800 million downloads. It has been selected for "Best of Apple Podcasts" three times, it is often the #1 interview podcast across all of Apple Podcasts, and it's been ranked #1 out of 400,000+ podcasts on many occasions. To listen to any of the past episodes for free, check out this page.