Coming from a generation built on broken economy, scared to death by the job market, spit on by our education system and even kick-assed by global warming, starting a business seems like the best choice we have. Lately I’ve been having a feeling everyone wants to be the next Elon Musk or the next Grant Cardone.
The question is, what to avoid when considering your first business? Or to put it simply, don’t choose Joffrey for your first marriage.
When starting a business you have two simple choices:
- Spend money
- Don’t spend money
The first option seems horrible. You have probably just graduated, still living with your parents and are eager to start utilising all the fresh knowledge, skills you’ve got. So you definitely don’t have enough money to buy expensive equipment or worse – rent a space to put this expensive equipment in.
Actually building something, whether it is the next generation of super-fast-furious-electric-beast cars or futuristic electronic gadgets is awesome, but getting in debt over it, not so much. That’s why the majority of fresh entrepreneurs start with something easy – a one man band. There’s one huge difference between starting a capital intensive and a capital non-intensive business.
In this segment I’ll primarily use two phrases: “service-based” and “capital intensive” business ideas. To put it simply, service-based companies are services, freelancing, and everything else where people are at the core of the execution.
When hearing “service-based” imagine a dog walking gig. Sure, starting the company is practically for free, but what about growing and decreasing costs. There’s only so many dogs a person can walk. On the other hand, capital intensive business idea is microbrewery. Here your growth is curbed only by how large your barrows are and how many ingredients for creating beer can you buy. It’s easy to grow your business just by purchasing more equipment, investing into capital.
A huge challenge when running a service-based company is the inability of reaching economies of scale.
Economies of scale is something every single manufacturing business is striving towards. To put it shortly, it is the advantage of lower costs per unit because of the increased output.
While this holds true for microbreweries – brewing 500 bottles of beer with the same equipment as brewing 1 bottle, it is not that simple with dog walking gig. Walking even 5 dogs is impossible, thus you are more limited from the beginning. You can pay your sister to help you out, but this will double the expenses.
Creating a service based business just to avoid spending money is a trap!
Remember, labor is expensive. And there’s only so much you can do in an hour.
Your costs per unit won’t see a steep decrease if you are building a service-based business. Especially in the early phases, when you are working alone or with a partner. It is reasonable to believe that the time of production can be decreased by half an hour or even an hour, everything above that is too optimistic.
Why? Because you are already working in a field in which you are comfortable, owning some expertise or you are at least passionate learner before plunging on the path of independence. Thus, it is questionable how much better you can become, even in a year.
Below is OECD’s (Organisation for Economic Co-operation and Development) statistic on earnings and wages by country:
The average wage in 2015 was 59.7k USD in the States (a country ranking third when it comes to labour prices).
The comment I always get when pointing this out is:”Well, I’m not going to pay myself much in the beginning or I’ll work for free”.
This is a nice strategy for your hobby, but it won’t get you far in business. Of course, feel free to not pay yourself and re-invest earnings. But I can bet you still want to get paid in the future.
Just like any input, labour must be priced into selling price. If not, your business will hit a dead end sooner or later.
When exactly? Once you decide that it’s time to start making some money. At this point you’ll crunch the numbers and figure out what’s the price of your work and it will impact your selling price significantly.
Let’s crunch those numbers!
Earning 60k per year (assuming you work for 50 weeks, 40 hours per week) is achievable if your hourly rate is 30 USD.
Now, if you start building a service based business, because you are trying to avoid investing in assets, major part of the selling price is labour. For example, if you decide to sew backpacks – you have the skills, and let’s say they are from recycled fabrics, one backpack will take you an hour at least. That’s 30 bucks right away. Without considering all the broken needles, buttons, zippers, package, marketing, electricity, profit for reinvesting in future designs, etc.
The end price easily jumps to 60 or even 70 USD. And entering a market with a selling price of 70 USD, puts you shoulder to shoulder with well known market players. Meaning, you’ve probably underestimated the price of marketing in the beginning.
My first business idea was exactly like the example above, and that’s why I call it Joffrey. It came around as a prince, maybe a king one day. I could almost imagine myself ruling the seven kingdoms,feeling the fresh breeze of financial independence, and finally becoming my own boss.
Then all of a sudden I realized, it’s a sadistic douchebag. No matter how much I’ve tried to trim the costs, use all the free marketing tools available, omit zippers, stop buying buttons and implementing plain-hipster package, the quality just couldn’t justify the price. The product was definitely innovative and cute, but not 70 USD cute.
This is the lesson I’ve learned the hard way. That no matter how many “Top 10 Low-Cost Business Ideas” you read, majority of them are recommending a service based business, which is usually not affordable. You’ll spent hours and hours developing a product, making a prototype, testing its functionalities but when it comes to calculating the price, please prepare some tissues.
Freelancing is underestimating the effort and marketing needed to succeed
Freelancing might save you from some of the issues above, but there are traps. Freelancing is awesome, but if you are not a designer or a coding god, it’s difficult to succeed. Even with those skills, more and more needs to be invested into personal branding and marketing since freelancing market has never been easier to reach and is saturated AF.
Let’s take Fiverr for an example. Fiverr is a marketplace where freelancers meet entrepreneurs. So if you are a business copywriter you just sign in, let the other know your work, pricing, and some savvy entrepreneur might hire you for the job.
While the idea of simply signing in to something seems perfect, the market is already so huge, you will need to climb a mountain in order to step out. While there’s no official statistics, I’ve tried to estimate the number of suppliers in the “Copywriting” category. I gave up on the 50th page, nowhere near the end. Below you can see an illustration of a current situation.
Not only is there too many people, because of it, suppliers are trying to stand out simply by lowering the price. Driving the revenues lower and marketing costs higher.
In short, the main disadvantage of starting a service-based company is the cost of labor. With markets getting more and more saturated, investment in good marketing is inevitable. Avoiding initial investments might sound appealing, but it will haunt you later on.
Purchasing equipment doesn’t put you in a dead end
Buying equipment sucks, I can’t argue that. It is also one of the main reasons people are turning to service based business ideas to start with. But with proper financing, it’s actually not that bad. Especially in the times of economic prosperity (low unemployment rate, no crisis, happy times), getting money is easy. Not free, but easy. Discussing financing opportunities deserves a post on its own and it shall have it.
When starting a business people don’t think about exit strategies. I didn’t. Who would plan on how to abandon their dreams? It does not make any sense at that point. But a day will come when you realize you’ve failed or underestimated the effort, market, and even product/service you are offering. What now? How do you make the most out of your failure?
It’s simple. Just sell everything you bought. You won’t get all the money you invested back, but at least you won’t lose everything.
This simple solution takes the sting out of investing money into your company. By going with capital intensive business idea, it will be easier to cut costs per unit of production and is not that risky after all. There’s an opportunity for exit and no one will blame you if you take it.
Simple steps that prevent your business idea from failing
- Don’t limit yourself when creating new business just because there’s an initial investment
- Always consider the amount of work needed and don’t neglect the cost of labor
- Pay yourself, or at least determine a point in time when you’ll start paying yourself
- Risk purchasing the equipment, because rewards are far greater in the end
Create a business plan, test the waters and buy the needed equipment to start the production. In the long run, it will pay off and if it is not meant to be, so be it. Sell everything, keep the experience, and start from the beginning.