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Start reading foundr magazine now for iOS Android. Issue March Owning the Market Jay Baer: Magazine Pricing. February January December November Once entrepreneurs have formulated clear strategies, they must determine whether those strategies will allow the ventures to be profitable and to grow to a desirable size.
The failure to earn satisfactory returns should prompt entrepreneurs to ask tough questions: If they are, does the premium we can charge justify the additional costs we incur, and can we move enough volume at higher prices to cover our fixed costs? Disappointing growth should also raise concerns: Is the market large enough? Do diseconomies of scale make profitable growth impossible?
No amount of hard work can turn a kitten into a lion. When a new venture is faltering, entrepreneurs must address basic economic issues. For instance, many people are attracted to personal service businesses, such as laundries and tax-preparation services, because they can start and operate those businesses just by working hard.
But the factors that make it easy for entrepreneurs to launch such businesses often prevent them from attaining their long-term goals. Furthermore, it is difficult to make such companies large enough to support employees and infrastructure.
Besides, if employees can do what the founder does, they have little incentive to stay with the venture.
Founders of such companies often cannot have the lifestyle they want, no matter how talented they are. With no way to leverage their skills, they can eat only what they kill. Entrepreneurs who are stuck in ventures that are unprofitable and cannot grow satisfactorily must take radical action.
They must find a new industry or develop innovative economies of scale or scope in their existing fields. Rebecca Matthias, for example, started Mothers Work in to sell maternity clothing to professional women by mail order. Both hopes are usually futile.
The next issue entrepreneurs must confront is whether their strategies can serve the enterprise over the long term. The issue of sustainability is especially significant for entrepreneurs who have been riding the wave of a new technology, a regulatory change, or any other change—exogenous to the business—that creates situations in which supply cannot keep up with demand.
Entrepreneurs who catch a wave can prosper at the outset just because the trend is on their side; they are competing not with one another but with outmoded players.
But what happens when the wave crests? As market imbalances disappear, so do many of the erstwhile high fliers who had never developed distinctive capabilities or established defensible competitive positions.
Wave riders must anticipate market saturation, intensifying competition, and the next wave. They have to abandon the me-too approach in favor of a new, more durable business model. Or they may be able to sell their high-growth businesses for handsome prices in spite of the dubious long-term prospects.
Consider Edward Rosen, who cofounded Vydec in But Rosen and his partner could see that the days of stand-alone word processors were numbered. Such forward thinking is an exception. Encouraged by short-term success, they continue to reinvest profits in unsustainable businesses until all they have left is memories of better days.
Entrepreneurs who start ventures not by catching a wave but by creating their own wave face a different set of challenges in crafting a sustainable strategy.
They must build on their initial strength by developing multiple strengths. Brand-new ventures usually cannot afford to innovate on every front. Few start-ups, for example, can expect to attract the resources needed to market a revolutionary product that requires radical advances in technology, a new manufacturing process, and new distribution channels. Cash-strapped entrepreneurs usually focus first on building and exploiting a few sources of uniqueness and use standard, readily available elements in the rest of the business.
Michael Dell, the founder of Dell Computer, for example, made low price an option for personal computer downloaders by assembling standard components in a college dormitory room and selling by mail order without frills or much sales support. A model based on one or two strengths becomes obsolete as success begets imitation.
But they will find it much more difficult to replicate systems that incorporate many distinct and complementary capabilities. A business with an attractive product line, well-integrated manufacturing and logistics, close relationships with distributors, a culture of responsiveness to customers, and the capability to produce a continuing stream of product innovations is not easy to copy.
Entrepreneurs who build desirable franchises must quickly find ways to broaden their competitive capabilities. Intuit realized, however, that competitors could also make their products easy to use, so the company took advantage of its early lead to invest in a variety of strengths.
Intuit enhanced its position with distributors by introducing a family of products for small businesses, including QuickBooks, an accounting program. It established a superior product-design process with multifunctional teams that included marketing and technical support.
And Intuit invested heavily to provide customers with outstanding technical support for free. After defining or redefining the business and verifying its basic soundness, an entrepreneur should determine whether plans for its growth are appropriate. Different enterprises can and should grow at different rates.
Setting the right pace is as important to a young business as it is to a novice bicyclist. For either one, too fast or too slow can lead to a fall. The optimal growth rate for a fledgling enterprise is a function of many interdependent factors. Finding the optimal growth rate for a new enterprise is a difficult and critical task.
To set the right pace, entrepreneurs must consider many factors, including the following:. Economies of scale, scope, or customer network. When scale causes profitability to increase considerably, growth soon pays for itself. And in industries in which economies of scale or scope limit the number of viable competitors, establishing a favorable economic position first can help deter rivals.
The ability to lock in customers or scarce resources. Rapid growth also makes sense if consumers are inclined to stick with the companies with which they initially do business, either because of an aversion to change or because of the expense of switching to another company.
Similarly, in retail, growing rapidly can allow a company to secure the most favorable locations or dominate a geographic area that can support only one large store, even if national economies of scale are limited. If rivals are expanding quickly, a company may be forced to do the same. Resource constraints. A new venture will not be able to grow rapidly if there is a shortage of skilled employees or if investors and lenders are unwilling to fund an expansion that they consider reckless.
A venture that is growing quickly, however, will be able to attract capital as well as the employees and customers who want to go with a winner. Internal financing capability.
When a new venture is not able to attract investors or borrow at reasonable terms, its internal financing capability will determine the pace at which it can grow.
Businesses that have high profit margins and low assets-to-sales ratios can fund high growth rates. A self-funded business, according to the well-known sustainable growth formula, cannot expand its revenues at a rate faster than its return on equity.
Tolerant customers. When a company is young and growing rapidly, its products and services often contain some flaws.
In some markets, such as certain segments of the high-tech industry, customers are accustomed to imperfect offerings and may even derive some pleasure from complaining about them.
Companies in such markets can expand quickly. But in markets in which downloaders will not stand for breakdowns and bugs, such as the market for luxury goods and mission-critical process-control systems, growth should be much more cautious.
Personal temperament and goals. Some entrepreneurs thrive on rapid growth; others are uncomfortable with the crises and fire fighting that usually accompany it.
The third question entrepreneurs must ask themselves may be the hardest to answer because it requires the most candid self-examination: Can I execute the strategy?
Entrepreneurs must examine three areas—resources, organizational capabilities, and their personal roles—to evaluate their ability to carry out their strategies.
The lack of talented employees is often the first obstacle to the successful implementation of a strategy. During the start-up phase, many ventures cannot attract top-notch employees, so the founders perform most of the crucial tasks themselves and recruit whomever they can to help out. After that initial period, entrepreneurs can and should be ambitious in seeking new talent, especially if they want their businesses to grow quickly.
Entrepreneurs who hope to turn underqualified employees into star performers are almost always disappointed. In determining how to upgrade the workforce, entrepreneurs must address many complex and sensitive issues: Should I recruit individuals for specific slots or, as is commonly the case in talent-starved organizations, should I create positions for promising candidates? Are the recruits going to manage or replace existing employees?
How extensive should the replacements be? Should the replacement process be gradual or quick? Should I, with my personal attachment to the business, make termination decisions myself or should I bring in outsiders? A young venture needs more than internal resources.
Entrepreneurs must also consider their customers and sources of capital. Ventures often start with the customers they can attract the most quickly, which may not be the customers the company eventually needs. Similarly, entrepreneurs who begin by bootstrapping, using money from friends and family or loans from local banks, must often find richer sources of capital to build sustainable businesses. For a new venture to survive, some resources that initially are external may have to become internal.
Many start-ups operate at first as virtual enterprises because the founders cannot afford to produce in-house and hire employees, and because they value flexibility. But the flexibility that comes from owning few resources is a double-edged sword. Just as a young company is free to stop placing orders, suppliers can stop filling them.
Furthermore, a company with no assets signals to customers and potential investors that the entrepreneur may not be committed for the long haul.
A business with no employees and hard assets may also be difficult to sell, because potential downloaders will probably worry that the company will vanish when the founder departs. To build a durable company, an entrepreneur may have to consider integrating vertically or replacing subcontractors with full-time employees.
The hard infrastructure an entrepreneurial company needs depends on its goals and strategies. They must invest more in organizational infrastructure than their counterparts who want to build simple, single-location businesses at a cautious pace. Few entrepreneurs start out with both a well-defined strategy and a plan for developing an organization that can achieve that strategy. The founders of such ventures improvise. They perform most of the important functions themselves and make decisions as they go along.
Once that becomes their goal, however, they must start developing formal systems and processes. Such organizational infrastructure allows a venture to grow, but at the same time, it increases overhead and may slow down decision making.
How much infrastructure is enough and how much is too much? Delegating tasks. As a young venture grows, its founders will probably need to delegate many of the tasks that they used to perform. To get employees to perform those tasks competently and diligently, the founders may need to establish mechanisms to monitor employees and standard operating procedures and policies. Consider an extreme example. Randy and Debbi Fields pass along their skills and knowledge through software that tells employees in every Mrs.
Fields Cookies shop exactly how to make cookies and operate the business. The software analyzes data such as local weather conditions and the day of the week to generate hourly instructions about such matters as which cookies to bake, when to offer free samples, and when to reorder chocolate chips.
Telling employees how to do their jobs, however, can stifle initiative. Companies that require frontline employees to act quickly and resourcefully might decide to focus more on outcomes than on behavior, using control systems that set performance targets for employees, compare results against objectives, and provide appropriate incentives.
Specializing tasks. In a small-scale start-up, everyone does a little bit of everything, but as a business grows and tries to achieve economies of scale and scope, employees must be assigned clearly defined roles and grouped into appropriate organizational units. An all-purpose workshop employee, for example, might become a machine tool operator, who is part of a manufacturing unit. Specialized activities need to be integrated by, for example, creating the position of a general manager, who coordinates the manufacturing and marketing functions, or through systems that are designed to measure and reward employees for cross-functional cooperation.
Poor integrative mechanisms are why geographic expansion, vertical integration, broadening of product lines, and other strategies to achieve economies of scale and scope often fail. Mobilizing funds for growth. Cash-strapped businesses that are trying to grow need good systems to forecast and monitor the availability of funds. Outside sources of capital such as banks often refuse to advance funds to companies with weak controls and organizational infrastructure.
Creating a track record. If entrepreneurs hope to build a company that they can sell, they must start preparing early. Public markets and potential acquirers like to see an extended history of well-kept financial records and controls to reassure them of the soundness of the business.
If performance is sluggish—if, for example, growth lags behind expectations and new products are late—excessive rules and controls may be stifling employees. If, in contrast, the business is growing rapidly and gaining share, inadequate reporting mechanisms and controls are a more likely concern.
When a new venture is growing at a fast pace, entrepreneurs must simultaneously give new employees considerable responsibility and monitor their finances very closely. Companies like Block-buster Video cope by giving frontline employees all the operating autonomy they can handle while maintaining tight, centralized financial controls. Culture determines the personalities and temperaments of the workforce; lone wolves are unlikely to want to work in a consensual organization, whereas shy introverts may avoid rowdy outfits.
Culture determines the degree to which individual employees and organizational units compete and cooperate, and how they treat customers.
More than any other factor, culture determines whether an organization can cope with the crises and discontinuities of growth. Unlike organizational structures and systems, which entrepreneurs often copy from other companies, culture must be custom built.
The rambunctiousness of a start-up trading operation may scare away the conservative clients the venture wants to attract. Like other rapidly growing companies, PSS has tight financial controls. PSS employees are motivated by the culture to provide unmatched customer service.
When entrepreneurs neglect to articulate organizational norms and instead hire employees mainly for their technical skills and credentials, their organizations develop a culture by chance rather than by design. Once a culture is established, it is difficult to change. Entrepreneurs who aspire to operate small enterprises in which they perform all crucial tasks never have to change their roles. In personal service companies, for instance, the founding partners often perform client work from the time they start the company until they retire.
Transforming a fledgling enterprise into an entity capable of an independent existence, however, requires founders to undertake new roles. If the business model is not sustainable, they must create a new one.
To secure the resources demanded by an ambitious strategy, they must manage the perceptions of the resource providers: While they are sketching out an expansive view of the future, entrepreneurs also have to manage as if the company were on the verge of going under, keeping a firm grip on expenses and monitoring performance.
They have to inspire and coach employees while dealing with the unpleasantness of firing those who will not be able to grow with the company. Few successful entrepreneurs ever come to play a purely visionary role in their organizations.
Bill Gates, co-founder and CEO of multibillion-dollar software powerhouse Microsoft, reportedly still reviews the code that programmers write.
Gates no longer writes programs. One entrepreneur speaks of changing from quarterback to coach. Whatever the metaphor, the idea is that leaders seek ever increasing impact from what they do. They achieve this by, for example, focusing more on formulating marketing strategies than on selling; negotiating and reviewing budgets rather than directly supervising work; designing incentive plans rather than setting the compensation of individual employees; negotiating the acquisitions of companies instead of the cost of office supplies; and developing a common purpose and organizational norms rather than moving a product out the door.
In evaluating their personal roles, therefore, entrepreneurs should ask themselves whether they continually experiment with new jobs and responsibilities.