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The one thing each business has in common is that they all sell something, a product, or a service. But how important is what you sell to your long-term success? In some cases, people choose to sell a product or service or to become part of an industry because they have a passion for it. Think of all the geeks who create hi-tech products that they hope will change the way people work or play, or even help solve global issues. Others choose products or services based on what they themselves like to consume, things that excite them. Still, others find or think they have found, a gap in the market and aim to fill an unmet need or demand. (Excerpt is from “Built, Not Born” by Tom Golisano, an American billionaire businessman, philanthropist, and founder of Paychex).
Two Types of Business Formats
In addition to the actual product or service you sell, it’s important to take notice that there are two types of business formats: recurring and nonrecurring revenue businesses. Golisano is a fan of the former and here is the reason for that.
In the late 1960s and early ʼ70s, Golisano was working as a salesman for a payroll processing company, not because he had a passion for the industry, but to earn enough money to support his family. Payroll processing, on the face of it, is not a very exciting business, but he soon learned that it offered the ability to sell a service to a customer and then repeatedly deliver that same service week after week, month after month, year after year to that same customer. That proposition excited him. If you sell a sofa to a customer, it may be decades before they need another one, and by the time they do, they have probably forgotten you exist. Even if they do come back to you, you have to sell them all over again in the face of competition for their money.
Paychex was founded by Golisano in 1971. He started the company with $3,000 and a credit card. Golisano served as its President and Chief Executive Officer from 1971 to October 2004. As of June 2022, Paychex has a market cap of $45.18 Billion.
When Paychex starts handling a company’s payroll, it keeps providing the service until for some reason the customer no longer needs or wants the service. You can count on the revenue; it’s very predictable. Paychex has been handling payroll for some of its customers for several decades. That sort of stability is appreciated by banks and investors and, if you go public, Wall Street.
Locking in Customers
“Instead of focusing on the competition, focus on the customer.” – Scott Cook
Not only is the recurring revenue predictable, so is future growth. If you add a hundred new clients, you can easily calculate the revenue they will generate. That level of predictability and consistency is not available to many nonrecurring revenue businesses. Another example of a successful recurring revenue business is a sports franchise. When Golisano purchased the Buffalo Sabres in 2003, they had 5,800 season ticket holders. They grew that to over 15,000, and there was a waiting list. Having that predictable revenue helped enormously with stabilizing the franchise.
Recurring revenue businesses don’t have to be service-based. There are plenty of examples of businesses that sell products that manage to create recurring revenue streams. Have you ever had drinking water delivered to your house? That’s a recurring revenue business. Even companies selling software have, in recent years, strategically changed the way they do business to encourage recurring revenue by selling monthly subscriptions to their software rather than selling a single download program. Locking in customers is the genius of this type of business model. As long as your customers remain happy with what you are selling them, they will continue to pay you monthly, quarterly, or annually, and they are sheltered from the attention of your competitors.
Six Key Questions
Whatever the reason behind your choice of business, you must choose wisely if you expect your company to be successful. Here are six questions, that Golisano encourages you to ask yourself about the products or services you are either selling now or planning to sell in the future.
- Is there a large enough market?
- Can you make a decent profit margin?
- Can your company deliver?
- Does it have longevity?
- Do you have enough capital?
- Can you keep up with technological change?
Let’s break down each of these questions.
Is There a Large Enough Market?
Is there a large enough market for the product or service you are selling? Often, entrepreneurs assume there is a large market to create sufficient revenues and profit to cover a business’s overhead. This overconfidence can be dangerous. You might have even heard people say things like, “They’ll be lining up to buy this as soon as we open our doors.” Generally, it does not happen for a new business or a new product. Sure, if you are Apple and you’re launching a new iPhone or iPad there may well be lineups, but Apple has been around for a long time and has built a massively large and loyal consumer base.
Golisano’s initial goal when he launched Paychex was to sign up three hundred clients. This target was based on the personal revenue he required to maintain a decent lifestyle. He was confident he could achieve this fairly quickly. In reality, it took four years.
Overestimating the market is a perennial problem for entrepreneurs; optimism is built into their genes. This, of course, is a double-edged sword. In general terms, optimism is a good trait for an entrepreneur; otherwise, they would never consider starting a business. But overoptimism leads to inflated revenue expectations, which never materialize and subsequently endanger the entire business.
Depending on which report or study you read, approximately 80 percent of consumer products fail. It convinces you not to believe your own press and to carry out sufficient market research. You need to accurately estimate the size of your potential market and the cost of getting a high enough percentage of that market through your door.
Can You Make a Decent Profit Margin?
Whatever product or service you provide, you have to ensure you can make a profit every time you sell a unit. That sounds obvious, but there are business people who say they understand this but then can’t tell what their gross profit margin is on the items or services they sell. In its simplest form, your gross profit margin is what you can sell something for minus what it costs you to produce the item. The gross profit on everything you sell has to be sufficient to cover your corporate overhead.
You need to not only make a profit on each item or service you sell but that profit when multiplied by the total number of units you sell needs to generate enough revenue to cover all your overhead (i.e., fixed costs). Making a suitable gross profit margin can be a balancing act between the price you can charge and the cost of delivering the product or service. To obtain a higher profit margin, you have two options: raise your price or reduce your costs. If you find yourself in a position where, because of competitive pressure, you cannot charge more and there is no way to reduce your variable costs, your product or service may not be a viable proposition. Making that discovery before you launch your company will save you a lot of money.
One area some entrepreneurs fail to take full advantage of is negotiating lower prices on raw materials and finding creative ways to reduce manufacturing and production costs. Being resourceful when sourcing raw materials or other variable costs is a key way to increase the profit on each item.
Can Your Company Deliver?
How complicated is it to manufacture your product or deliver your service? Before you commit, ensure you have looked at every step of the production process. Not only do you need to have vendors and key employees lined up, but you also need a backup strategy should a supplier let you down. Carry out a risk analysis by considering everything that could go wrong. What, for instance, will you do if there is a shortage of your primary raw material and not only does it become difficult to obtain but the market price rises to a point where it seriously affects your profit margin? Do you have room to raise your price without it affecting sales? How vulnerable is your profit margin? How can you minimize that vulnerability?
Does It Have Longevity?
Over three-quarters of the products that were around just five years ago no longer exist. Certainly, over the years we have seen technology make obsolete a large number of once-popular products and services. But it’s not only new science that changes what consumers want to buy; new generations have different expectations, and trends such as environmental awareness and an increasing reliance on cellular communication affect what and how people buy. Gluten-free products were all but unheard of a few years ago but today are big sellers. The question is whether this is a fad or a range of products that are here to stay. This applies to a wide range of products and services.
When you look at introducing a new product or service to the market, think ten years into the future and try to figure out whether it could be prone to extinction. For instance, is this a good time to start a newspaper, open a camera retail store, or manufacture e-readers? Probably not. Consumer products and services have a shelf life, some longer than others. Choose one with a longer shelf life.
Do You Have Enough Capital?
Many businesses start out undercapitalized. Golisano started Paychex with only $3,000 and a credit card, which was soon cut in half by a restaurant owner under the instruction of American Express. You can bootstrap a business, but you are reducing your chances of success significantly.
So it’s better for you to carry out the homework. Get a decent calculator, or these days a decent app on your phone, and do the math. Get help to ensure you have thought of every dime you will need to get you through the first year or more. Figure how much you need to sell and be honest; put your optimism aside for this exercise and keep it real. Then you will need to figure out how you are going to raise the necessary capital.
Can You Keep Up with Technological Change?
The speed of technological change is astounding and accelerating every year. If your product or service is in any way reliant on technology, you need to be aware of the capital costs involved in constantly updating what you sell or what you use to manufacture what you sell. And it’s not only the cost of reinventing the wheel regularly; consider the time, effort, and money required to continually promote and sell new versions of products. Finally, when products become outdated, they clog your warehouse with unsold and potentially unsellable inventory that can be a significant drain on your bottom line.
Takeaways
- Recurring revenue businesses offer better opportunities for sustainable sales than nonrecurring revenue businesses.
- Never assume there is a market large enough to create sufficient revenues and profit to cover your business’s overhead.
- Always be aware of your gross profit margin and understand what revenues you need to cover costs and also make a profit.
- Overconfidence in your product or service can be dangerous.
- It’s not good enough to simply have a good product or service; you need to be able to deliver what you sell consistently and reliably.
- Over 75 percent of products that were around five years ago no longer exist. Ensure your product can stand the test of time.
- Technological change can sometimes be like an incoming tsunami.
