"Remind people that profit is the difference between revenue and expense... this makes you look smart... "
~ Scott Adams - Dilbert Creator
Several years ago, my son Ben asked me to be a guest speaker in his 5th grade class during career month at his school.
I thought the idea of talking about what I actually do to a bunch of impressionable 10-year old boys and girls would be fun. But as the date approached, I began to panic as I thought more about it.
These young kids didn’t want to know what the unique features and benefits were for products that we sell... how marketing works... who is our target customer... what our cash-flow projections were... how much competition did we have... or what our corporate structure and governance looked like...
Although these are exactly the type of important questions a possible investor or a banker might ask... to the average 5th grader... these are absolutely meaningless topics...
I thought to myself, "why couldn’t you have been a fireman or an astronaut?... that would have made this presentation so much easier".
Unfortunately for me... I am not a fireman or astronaut... but rather an entrepreneur... I start, operate, and build businesses.
It’s a profession I love and over the past 25 years I’ve become fairly proficient at it... albeit after many years of tuition payments to the "school of hard-knocks"...
I decided then to use what I had and try my best to relate it to the world of a 10-year old. They don’t quite understand the business of electronic components... but they do understand the business of lemonade stands.
So with that in mind, I developed a model of business that is simple enough that it is easily understood by a class of 5th graders. Yet complex enough to accurately describe any business enterprise.
This might seem like a stretch but a lemonade stand business is not all that different from any other business... once you break it down into the 6 basic components.
All businesses consist of these 6 basic core competencies:
- You make something and/or provide some type of service
- You locate potential customers (or help potential customers to find you)
- You sell whatever it is you make or do to those potential customers
- You hire and train other people to help you
- You measure things and keep records
- You acquire access to capital to help you get started and to grow the business
Each of the above items are essential to the overall health, well-being, and success of any company be it large or small.
This includes Apple (the world’s most valuable company) or our lemonade stand.
Any person wanting to be an entrepreneur, now or in the future, needs to fully understand these basic business components, and if they do not possess the skills to be competent in each area, they should then seriously think about having partners or trusted advisers who do.
Starting or running a business shouldn’t be that complicated and it isn’t if you understand the fundamental concepts.
Over the course of the next 3 weeks, I hope to discuss each of the 6 basic core components of business listed above in great detail.
Make something and/or provide a service
Every business has a product and/or service that they must be able to sell for more money than it costs. This is the very essence of any business.
Price - Cost = Profit
There are two sides to this equation: The price and the cost.
The price of the product or service is typically determined by the marketplace.
If your product or service is unique, you will create a higher market demand due to limited availability which means that you can subsequently demand a higher price from your customers. Typically, this higher demand is short-lived as competition, seeing the limited supply, will eventually enter your market and attempt to convert your customers to become their customers.
If your product or service is simply a commodity, then you might have lower market demand for your particular product or service meaning you must charge a lower price unless you can somehow create a benefit offering higher value to your customer.
Just because your product or service is widely available, doesn’t necessarily mean that it is a true commodity.
For example, restaurants sell prepared food to people. There are tens of millions of restaurants throughout the world. Some of these restaurants are very successful selling meals at a relatively low price, such as fast-food restaurants or take-away food stands/trucks while other restaurants are very successful selling food at extremely high prices such as those operated by celebrity chefs in Manhattan and Las Vegas.
At their core, all restaurants are essentially offering the same service, prepared food for sale. But within that broad definition, there are thousands of differentiators that create uniqueness to a particular restaurant (or perhaps consistency in the case of fast-food). These differentiators might include location, quality of the ingredients, type of cuisine, ambiance and decor, reputation of the chef, and/or customer service. The price of the food is determined by those differentiating factors.
The other side of the equation is the cost. If you have a unique product or service, then you may be tempted to not worry about the product or service costs. People will pay whatever price you ask so why does costs matter?
The difference between your price and your cost is your profit (or loss if the number is negative). All companies should be in the business of maximizing profits whenever possible (in the case of non-profit companies... its goals should be to maximize benefits by delivering the highest value to it constituents... )
In most cases, the market is efficient and will set the pricing of your product or service. Therefore the only thing that you can control is the cost it takes to produce this product or service. Driving cost out of your product or service is absolutely essential in most businesses regardless of what your prices might be.
The 3 fundamental goals of any business providing products and/or services should be:
- Better - more innovative, higher quality, more customer benefits - allowing for higher prices.
- Faster - more convenient, better response, better delivery
- Less expensive (not cheaper) - more value to the customer and higher profits to the company
At our lemonade stand, we sell lemonade. We use a recipe consisting of water, lemons, and sugar. We prepare the lemonade in an insulated dispenser filled with ice and give the customer disposable plastic cups that they can keep.
We are constantly testing new recipes to add to or replace our current product offering.
Our future plans include opening new stands close to schools, parks, and golf courses making it more convenient for thirsty people.
As we grow, we hope to be able to purchase our raw materials in bulk, helping to lower our production costs.
Better - Faster - Less Expensive
The person typically in charge of this core competency in most businesses is the Chief Operating Officer.
Next week, I’ll discuss two areas that are related but still very different. For many people, sales and marketing are one in the same, but as we will soon discover, they are two completely separate concepts each needing a different set of talents and skills.
Thank you for your support of OptiFuse where we hope to encourage and foster entrepreneurship around the world...
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