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And Things Keep Getting Worse for this New Business

January 31, 2012

Cases

Big Box of Disappointment!

And worse and worse . . .

I have previously chronicled some big problems for a start-up business being launched by a very good friend of mine.  Here are the “get you started” posts on this saga:

Big Problems for New Business (Part 1)

Big Problems for New Business – So What? (Part 2)

Big Problems for New Business – Give a Result (Part 3)

The hardest part of the story is the email I had to send to my great friend about the problems in his business plan.

Sending that email when he was so excited about the new business, had his money and sweat invested in it and looking toward “big money” with an impending layoff, was tough.  But it had to be done.  Those guys were going to receive nothing in the mail but a big box of disappointment going with what they had

In that email I sent I discussed:

HUGE mistakes launching a new business.

They were a classic crew – one guy with a “break through” idea.  Another guy, my friend, who was good at statistics (Excel) and brought in to build a sexy financial model and some “marketing” guys they had hired who guaranteed moving 25,000 units in 2 months.  Nobody on the team had actually ever sold hard-goods (“stuff”) before.

So you may guess, there’s more to the story.  And more to that fateful email.

More Problems with this New Business Plan

Strategic Issues

“Go To Market”

I couldn’t figure out how these guys were actually going to sell product.  Their business plan had an annual Sales and Marketing budget of $35,500.

OK, maybe you think this isn’t so bad, but they included direct selling, trade-show marketing, and their web activities.  If you’ve ever done hard-goods selling then you know that one trade-show could take the whole budget.  And those Marketing guys they hired, that expense would be taken out tool.  And who’s going to sell this thing directly to the retail outlets, fitness clubs, etc.  Both of the principals had full-time jobs.  So they’d have to hire someone to sell.

They had not done any research to really understand the costs involved in their strategy.  And they were not capitalized for more investment.

Pricing

So, with questionable Sales and Marketing plans, you might guess that the price assumptions had problems.

You are correct!

In various parts of the business plan and financial statement, I found different assumptions for distribution.  And, then, looking at the financials, it became clear that had full retail price in their model.  Holy moly!  They are going to sell a product, a retail product, through some kind of distribution network and assume they’ll get retail price?  Ugh.

Market and Competition

They had no competition.

Really.

This product was so innovative, there was no competition.  And they were comparing market share ‘gains’ against results for other fitness products.  As discussed, the benefit of this product isn’t clear yet they were making share forecasts similar to products like body fat analyzers, heart rate monitors, and pedometers.  But these products have tangible benefits like measuring body fat loss or training level.  Overconfident.

Distribution/Warehousing

As noted above, it’s not clear which distribution model will be use.

  • Are most sales expected to move through distributors at the wholesale price or direct at retail?
  • Or will it be a mix?
  • Warehousing/shipping looked like garage storage for these guys (or basement). No clear plan for logistics.

Financial Problems

So, given all the issues above, we might expect some serious financial concerns, right?

Again, Correct!

Gross Profit- Slip Sliding Away!

Just as a quick analysis, I recalculated their Net Price for them using the following assumptions: Retail mark-up = 100%, Wholesaler Margin = 10%. That gives a net price of 45% of what they had in their model.  Eeek.

The distribution channel is critical it seems if this is a wholesaler to retail model that is predicted. The direct model is, obviously, more attractive.  They only need to sell 1/8th units sold direct vs. through wholesaler for the same Net Income.  They needed to pick an objective – volume or price strategy?

Expenses – Just Can’t Get Enough!

I was very concerned about the marketing and sales estimates.  How much impact can be made for $20,000, including the cost of website management?  Advertising in one magazine could blow most of that money. One trade-show booth could eat most of that.

And $15,000 for sales expenses?  I asked if they were planning to hire a college student.  Who will do all the face-to-face selling and demonstrating? That’s a lot of travel and expense.

I could not find the warehousing and distribution costs (transportation costs). Booked into another line item? COGS? I think this depends on the distribution strategy, mostly for direct sales items. Who will store and ship?

Bottom Line – Somebody Get Me a Doctor!

So, without even making major changes in expenses (except for adding in some distribution expenses pre-wholesaler), just focusing on the average selling price assumptions through a wholesaler+retail channel, their Net Income dropped to 6% of their forecast.  6%!

Now maybe the analysis was conservative, but this is a big difference to a small business, wouldn’t you say?

Well, you know the note was sent.  But, tough love is sometimes the best love.

So, what can you learn from this piece of the case?

  • Before getting too far into the business launch (like ordering 25,000 units), find a way to sanity check your business plan and, especially, the key assumptions that will drive your business success or failure.  Find someone that can help if you don’t have the expertise.  A simple request for help could save you a lot of trouble.
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