Robert Ochtel’s Blog

An Experienced Approach to Venture Funding

Entrepreneurs, Business Plans Often Do Not Reflect Reality

The development of a business plan should be only viewed as a “plan” as it is really out of date the day you put your pencil down.  On the other hand, the business plan is a useful tool for the entrepreneur to create a map of the opportunities they will be addressing in the market.  As such, it provides a baseline of the path forward in the market, a time frame as to when your product will be available, and a blueprint of your financial model, and how you are planning to provide your investors a substantial return for their investment.  That being said, after you secure funding and start development, is when reality sets in.  Many of the scenarios outlined in your business plan from the cost assumptions, to operations, to the target markets may require a dose of reality when you begin development and execution of your original business plan.   In what follows is a short discussion on some of the things that need to be addressed forge through these realities. 

Ferret Out Your Unforeseen Product Costs

Many entrepreneurs do not have a good handle on their product costs and associated margins as presented in their business plan.  The numbers they present are often marred with faulty assumptions and inaccuracies that will hurt their bottom line when they finally bring their product to market.  This is not unusual as “reality” often has a way of creeping in and changing your actual costs.  These realities can often affect your product costs, operating margins, etc.  As an entrepreneur you need to get a handle on anything that significantly affects your original planned costs.  As an example, in operating an on-line eStore there are costs associated with allowing customers to use their credit cards on line to purchase products and services (e.g. merchant and gateway costs). Your business plan may have originally assumed your credit card merchants will only charge you a set service charge of 1.6% of each purchase price plus a fixed fee for each transaction.  But, when you finally get your bill you see that the average charge for each purchase is 2.6% plus the same fixed fee.  This is a big reality for a couple of reasons.  The 1.0% affects your gross margins and your bottom line. In addition, if you have a micropayment based business, this slight change can affect your business model, and also cost your company thousands of dollars every year in unanticipated costs. What happened here? The business plan assumed that the merchant charged a fixed percentage for each online purchase.  The truth is that depending on the consumers credit card, their credit rating, and any rewards programs they participate in, these same merchants have over 490 different costs levels associated with the percentage they charge and the number initial provided is usually a low ball number and does not reflect the realities of the real credit card customer base.  So in the end, the start-up company will be hit with additional costs that will affect their margins and bottom line.

Understand Your Real Operations

Many start-up companies do not really understand the total costs of doing business. They assume they can produce their end products based on a set of assumptions that do not always take into consideration the total cost of production, including marketing and overhead.  They just look at the product cost and not all of the infrastructure costs associated with producing their product and getting it to market. Recently, I was involved with a start-up company creating electronic content from published books. They claimed that their costs were only $1.00 to create a single piece of electronic content. What they did not tell me is that much of upfront costs associated with converting the original content into electronic form were not taken into consideration with this presented cost number.  These conversion costs included extracting the text, properly formatting the files, and sizing the associated images that were to be used in the final product.  The costs they claimed were only associated with the cost of taking the electronic content, once it had been created, and putting it into a spreadsheet that was ultimately extracted automatically into the online database. As it turns out if you take into consideration all of the preparation steps this probably added $3.00 to $4.00 to the cost of producing this same electronic content. So again, when the reality hits the road, the associated operating costs were significantly higher than outline within the business plan. As it turns out, I worked with them to develop a standard format as well as a couple of text/image extraction and verification programs and they were able to get the total costs of creating this same electronic content to about $0.25 single piece of electronic content.  So, again the operational costs of the business plan did not reflect the realities of the real world.

Be Open to New Market Opportunities

Entrepreneurs and their business plans tend to be fairly myopic.  That is, they generally focus on a limited target market or small defined set of target markets in which to sell their product offering.  This is generally considered a good thing, since it provides your start-up company with focus.  On the other hand, often many of the technologies, products or services being developed by this same start-up company could be used in other, non-related markets which may drive new, larger near term and long term revenue opportunities for your start-up company.  As a recent example, I was working with a start-up company that was developing a product for a consumer application.  After talking to an expert in the industry, it turned out that they believed that this same product offering, with minor modifications, could be used for commercial applications. Here, the start-up company was aware of this, but did not focus on this as a near term revenue opportunity for the company.  After a limited number of discussions, what was presented to this same start-up company was a strategic partnership that allowed for immediate nationwide penetration into the targeted commercial market with the strategic partner’s nationwide sales force.  This commercial opportunity, although not originally a near term focus of the start-up company made sense both strategically and helped with their near term marketing tactics.  So, again the business plan did not outline this opportunity for the start-up company, but the realities of the market, drove this start-up company to be open to new opportunities in the market.

A business plan should be considered a useful jumping off point for start-up companies to provide an initial path forward in addressing the market.  In reality, a business plan is out of date the day it is completed and often many of the underlying assumptions of the business plan are either incorrect or change substantially once the realities of the market hits.  Entrepreneurs need to be cognizant of this and appropriately adjust to these same market realities by ferreting out unforeseen product costs, understanding their real operations, and being open to new market opportunities.  By doing this you will be able to navigate through the realities of the market on your road to success.

This information was taken from Robert’s new book: “Business Planning, Business Plans and Venture Funding – A Definitive Reference Guide for Start-up Companies”.  Available at www.amazon.com.

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August 2, 2010 - Posted by | Venture Capital | , , , , , ,

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