Top Ten Reasons Small Businesses Fail articles are designed to help the solopreneur avoid these traps! This article will cover what risks to avoid when you finally hit that tipping point of demand and your product or service goes viral.
The J. Peterman Company is a perfect example of what happens to a company when its revenues grow quickly. First, you’re constrained by inventory levels. Lots of people want your product, but you don’t have enough inventory on hand to fill all the orders. You increase your cost of goods from suppliers to buy more raw materials and get a bigger credit line to create that inventory for resale.
If you’re like most businesses, you have to pay your suppliers before your customers pay you. That means you have to borrow money or finance your inventory until you get paid. Usually that time lag is at least three months. In a recession, expect the time lag to be longer.
In the case of Peterman, he not only built much larger inventories of his existing items, he expanded his product line like crazy. He went from four items to over two thousand items in his line in three years! One of the top ten reasons small businesses fail is because they have too much cash wrapped up in inventory because their product line is too broad.
Peterman thought if he expanded his product line a lot, he’d give his customers more reasons to buy from him. In theory, that sounded like a good idea. The problem was, most of those two thousand items had low demand so revenues for them were relatively low.
The other problem was that he invested lots of cash in building infrastructure to support a large product line with so many items. He needed more warehouse space, more buyers (salary and administrative costs), more marketing expense, more insurance and bigger offices.
This top ten reason small businesses fail, uncontrolled growth, is all about taking on expenses before the revenues and cash catch up. Peterman increased expenses dramatically expecting demand for all its products to be strong. It didn’t work out that way. The bank and investors pulled out and Peterman went bankrupt.
So what’s the answer? Learn from Peterman. In the Harvard Business School case, J. Peterman said he should have focused on his core business and product line. Instead, he expanded in anticipation of demand. When demand dropped off for most of his products, he was saddled with all those extra fixed costs and few revenues to cover them. In hindsight, he should have slashed his product line sooner and not taken on all that additional expense.
You always want your costs to closely align with revenues. When you expand your office space, for example, that cost becomes fixed. It doesn’t go away in the near term. Your revenues, however, can fluctuate a lot. If demand softens, you’re still stuck with the added expenses. That’s the problem many solopreneurs are dealing with in a recessionary economy.
Most solopreneurs have some products or services that are very profitable and some that are not. Don’t ever ask an unprofitable portion of your business to subsidize a profitable portion of your business for more than three months. If after that time, the unprofitable products or services don’t pay for themselves, you must drop them or restructure how you’re producing and delivering them to reduce costs and protect gross margins.
Remember, as we say in our Learn videos, your gross margin on each item or service must be at least 30% for you to cover costs and stay in business. If a product or service doesn’t meet that test, drop it. Take no prisoners in a recession. Protect your bottom line and it will sustain your household.
You’ll have a smaller, but much more profitable business with you working half the amount of time.
Build a loyal customer base and grow at a rate you can manage even if you have to turn a few customers away in the short run. Take on fixed expenses (larger space or more employees) when you already have the revenue in hand and you’re sure the revenue will be recurring.
Top ten reasons small businesses fail gives us important insight into the drivers of profits. Uncontrolled growth sounds great, but it can destroy your business.
Don’t despise the day of small beginnings. Start small. Build a loyal client base. Protect your gross margins. Limit your product or service to the most profitable and easiest to deliver first. Build word of mouth marketing to drive down customer acquisition costs.
Build your cash position. Creating a cash buffer means you can weather the ebbs and flows in seasonal demand. This is very sophisticated business strategy most solopreneurs and small business don’t think about. However, this is the way you avoid the top ten reasons small businesses fail- uncontrolled growth.