Is Your Business Strong?

Entrepreneurs spend their days focusing on a wide variety of issues. It seems endless and overwhelming. They must figure out how to raise money, sell their products, what software to use for their online store, how to hire people, do payroll, and design packages. It is amazing they ever get any rest!

And yet, none of that determines whether a company is strong and will succeed. Just like the driver in the picture, he could have done a great job of painting his cart, registering for the race, hiring a publicist, and so on, but it won’t matter. He probably won’t win the race unless he is the only entrant.

The two things that truly matter are:

1. Strong Demand: For a company to succeed, there must be a strong demand for the product. Most entrepreneurs believe they have come up with a unique product. Maybe they think they have even created a whole new category! However, most products differ only slightly from existing products on the market. Although there might be a small number of customers who appreciate your unique selling point (USP), for a company to be strong, there must be a large demand for the product versus the competitors at the price you are offering it.

   Your product will be sold in the market next to your larger competitor, who most likely can produce at a lower price than you. For the customer to prefer your product, it needs to be significantly better or different than the competitor’s product.

   This is called product-market fit. Half of all companies who fail do so because of lack of product-market fit. Before you launch your product, talk to retailers who will sell the product and ask them if they see a market for your product, and what they think the price should be.

   Let’s say you have had the brilliant idea to sell cold-brew organic, fair-trade coffee from Chile, where you grew up. You know someone in Chile who will air-freight bags of coffee beans, where you will brew it and bottle it in your Portland factory. You feel certain that customers won’t mind paying three times as much for your coffee because it is fair-trade, organic, gluten-free, non-alcoholic and comes from Chile.

   You need to validate this by talking to grocery store and cafe owners. Ask if they feel that their customers will pay more for these unique selling points. Perhaps you are overestimating the value to the customer of these unique selling points. A good rule of thumb is that you value your USP three times as much as your competitor does. And your competitor thinks your USP is three times as important as the customer does. Most customers don’t value what you think is so valuable. This would be an example of a lack of product-market fit.

   When you launch the product, you will find that the demand is much weaker than what you thought. You have a donkey pulling your cart, in other words. The company has limited potential and will never be strong.

2. A high profit margin: Strong companies generate cash. This is a combination of the strong demand and a large profit per item sold. Weak companies have a product with weak demand, and they are losing money on each sale. They valiantly convince investors to keep pouring money into the company. The company will never succeed because they will never be able to produce their product cheaply enough to energize customers about their product, which is practically indistinguishable from the competition.

   Strong companies have at least a 40% gross profit margin. Large, successful companies like Apple, Intel, or Coca-Cola are closer to 65%. The profit margin is proof of the desirability of the product.

These two factors — demand and profitability — are linked. If customers value your novel product, they will pay a premium for it, and you will generate profit on it. If you are trying to compete against a much larger brand on price, you likely will be operating on thin or negative margins, and it will be a slow death for your company. Many companies hope that they can lower their prices as volumes increase, but in practice this does not happen.

It is about the product

Once you have decided on a product to sell, the trajectory of the brand is basically set (barring execution blunders). A talented, well-funded, or experienced staff cannot compensate for a bad product. Likewise, good products will often generate so much demand that the company will be able to attract talent and capital.

What doesn’t matter

In the past year that I have been a Fractional CFO, I have had the pleasure of interacting with many companies, both successful and unsuccessful. The leaders of these companies have varied in talent. Some companies have founders with previous successful exits. Some have raised millions of dollars. Some have stellar advisory boards. Some are LLCs, S-Corps, or C-Corps. Some have no marketing team. Some have no computer systems in place. Others are using state-of-the-art computers.

None of that matters. The two things that characterize strong companies are a large untapped demand for their product and that the company can produce the product profitably. Even if they are writing the orders down with a pencil and mailing the invoices by U.S. mail¹.

Here are some things that don’t matter, but that entrepreneurs spend a lot of time thinking about:

Should the company be a C-Corp or an S-Corp or an LLC If you are successful, you won’t have to take in any money at all. Since you won’t have to issue stock, your corporate form will not matter at all. Yes, this does happen. I have clients like this. Anyway, corporate forms can be changed if necessary.

What type of inventory system should I use I have seen successful companies who keep track of their inventory in spreadsheets and don’t truly know how profitable the company is. All they know is that they haven’t run out of money, sales are going up 10% per month, and their inventory is getting larger.

Should I have an advisory board If your sales are exploding and you are not running out of money, you probably know more about your business than any advisory board would. Instead, continue innovating and offering the products your customers love.

Should I use distributors? If you have a strong product, you will be able to overcome the fees that large distributors charge. You will also have a choice of channels where you can sell your product. Sell it in all channels, making sure you are making a large profit on every sale. Weak companies are scared to death of using large distributors because of the fees involved. This is a sign that the real problem is the product, or at a minimum the channel that the distributor sells into is not the best channel for that product.

Should I raise money from Venture Capital? I have been on calls where VCs were begging the company to take their money. Strong companies do not have to dilute founder ownership by taking VC money, unless it is is software product that needs development funds to get to a minimum viable product. Strong companies with some sales history often can borrow funds. Venture Capital itself is a relatively new concept. Before that, companies generated profit on their products immediately from strong demand. For instance, read Phil Knight’s memoir Shoe Dog.

Where can I find a lawyer to trademark my IP Although it is important to protect the name of your product, your ability to out-innovate the competition will determine success. Trademarking a brand is not difficult to do yourself.

What gross margin do I need? Although I said that a 40% gross margin is desirable, I have seen successful companies with 25% gross margins. (Although they thought their margin was 60%). The key thing is that you are making enough to pay your staff and that you are experiencing strong demand for your products.

Final Thoughts

If you are spending time trying to finely craft a marketing message or your investor deck, you may be trying to compensate for a weak product. Instead, offer a compelling product. If you make a better mousetrap, the world will beat a path to your door. And you won’t need a lawyer or a VC.