The science of entrepreneurship Featured

8:00pm EDT March 26, 2008

Statistics have long confirmed that nearly 80 percent of all start-up ventures never make it to their fifth anniversary. The upside to these failures is the plethora of case studies available for review; information that holds the key to pumping a new venture’s success rate up closer to 50 percent. For instance, a long-term review conducted by Ph.D. students of 200 successful start-ups revealed that not one of them had gross margins lower than the average of their industries.

“In a start-up venture, you presumably have something that nobody else has,” says Dr. Charles Hofer, Regents Professor, Coles College of Business, Kennesaw State University. “Now, if you can figure out who your customer really is, they’ll pay the premium prices required to sustain a successful start-up.”

Smart Business asked Hofer about how to avoid the most common start-up traps.

What are the top three marketing and financial mistakes for new ventures?

There are several mistakes made by prospective entrepreneurs regardless of industry. The most significant of these include charging too little for the products and services, failing to create ‘just noticeable differences’ in your products and services that differentiate them from the products and services offered by your competitors, and failing to limit the credit extended to customers and monitor accounts receivable closely. A sale does not occur when you ship products to your customers; it occurs when they pay you. Since the gross margins on most products are less than their full costs, this means that it may take two or three ‘good’ customers to make up for just one ‘deadbeat.’ Large companies operating well above their breakeven points may be able to afford to take such risks. Most new ventures that are working hard to reach breakeven cannot.

How are proper and sustainable prices determined?

There are three factors that must be considered in setting your prices. The first is costs. Except for overstocks of seasonal items, you must charge enough to cover the full costs, both variable and fixed, of the items you sell, which means that you must have an accounting system that provides reasonably accurate estimates of these costs. Second, you need to know what your competitors are charging for their products and services. This does not mean that you should match them. In most cases, you should not. But their prices may set an upper limit on how much more you can charge than they do. Most customers will be willing to pay a premium for products and services that better serve their specific needs — up to a point. That point will be determined by your competitors’ prices and the magnitude of the benefits that you provide. The third factor is the specific benefits that you provide that your competitors do not.

Won’t high prices limit sales?

Yes. But not as much as one might think if the new venture is pursuing the appropriate set of initial target customers. Having lower than average margins for your industry may be the ‘kiss of death.’ New ventures will do many things exceptionally well, but they will also make many mistakes, and high margins provide the resources needed to pay for these errors. Second, and more importantly, you should be providing benefits other than low prices to your initial target customers.

Where should new ventures first focus their marketing budgets?

Most new ventures should use variable and/or no cost marketing methods whenever possible since the lower you can make your breakeven point, the greater your chances for a successful launch. It is crucial that you identify and focus on those customers who currently have an absolutely compelling need for your product as well as the ability to pay for it. Seldom is this the largest segment of the market. The best way to do this is to talk with as many different potential customer groups as possible. Surveys will seldom, if ever, do the job. Once you have identified this initial target customer group, you need to develop a set of unique selling propositions built on the ‘just noticeable differences’ of your products. Wendy’s original ‘Where’s the Beef?’ advertising campaign was one such unique selling proposition that was built on the fact that Wendy’s had square burgers that could be seen hanging over the edge of the bun.

Can a new venture grow too fast?

Absolutely. In fact, one of the most significant problems for companies that survive start-up is growing too rapidly, which frequently leads to exceptionally poor customer service followed too often by bankruptcy. One of the best ways to control growth is to increase prices. Not only will this limit the growth in sales, the increased margins generated by such higher prices will flow directly to the bottom line and help pay for the additional resources needed to supply and service the additional new customers who are willing to pay the increased prices. Another way is to cut back on the various sales and marketing activities that generated the growth in sales. This is more difficult to do, however, and does not help identify those customers for whom your products have the greatest value and those who will pay higher prices to get them.

DR. CHARLES HOFER is a Regents Professor in the Department of Management and Entrepreneurship, Coles College of Business, Kennesaw State University. Reach him at (770) 423-6000 or chofer@kennesaw.edu.