This week’s featured article is from Daniel Murphy, Co-Founder and Managing Principal of Strategic Choice Partners. Dan has over 30 years of experience holding senior finance and operating roles at TJX, Pepsico, Panera Bread, Princess House and Immunotec. For the last 15 years Dan has served as both a CEO, CFO and COO for two party plans and network marketing company respectively. Currently Dan is a consultant specializing in the direct selling industry. Dan also served as the Treasurer of the Direct Selling Educational Foundation and previously served as the Treasurer for the US Direct Selling Association.
Guest Post by Dan Murphy
Common Pitfalls that Prevent Profitability in Direct Selling Start Ups
I would like to share a number of common pitfalls that prevent profitability in direct selling start ups. This comes from years of experience working with companies that have contacted me many times after making mistakes like these and then asking me to help them correct these issues.
Lack of Direct Selling Expertise
Many founders have started their ventures with only cursory experience in the industry. They have seen or heard of successes in this industry of companies started on a shoestring and quickly rising like a rocket with hundreds of millions in revenue. Although things like this have indeed happened, the much more common experience is modest success and many times failure.
Validate the Key Components of the Economic Model Before Launching
It’s obvious that one of the key components of any business is providing a product or serve that has a compelling selling proposition. This is a no-brainer, and yet this is where so many young direct selling companies stop. But you also must make sure that product or service can be sold with a times cost multiple that will support a competitive compensation plan while also contributing to the bottom line after commissions are paid. It’s seems very basic, and yet I’m always surprised how many companies launch with pricing models and compensation plans that don’t immediately or very quickly cover the projected overhead of the organization.
More than once I have met with executives who want to sell products that cost $10 and want to sell them for $40 MSRP, and then have a compensation plan that will pay out at close to 50%. The mathematics of this business case is a disaster. A comfortable, hard good cost multiple is between 6 and 7. The compensation plan in this situation could support a 40% to 45% pay out. Often in startup situations, since there are no sales, products are purchased at minimum order quantities, making the achievement of 6 to 7 times cost impossible. As the outset, it is critically important to create a plan which will quickly get to purchase quantities that support the needed margin. In the meantime, while the company is at this launch phase, it will burn cash.
Working Capital is Your Rocket Fuel
This brings me to my next point, which is the lack of working capital this has been a key factor in many companies I have seen fail. Working capital is like rocket fuel; without it getting off the ground is very difficult. In my practice, I have been contacted by several startups that have asked if I can assist them in a shoestring startup. I always say no. It’s not that it can’t happen, that a shoestring start up can’t be successful. However, invariably it will take much longer than planned and be more painful.
Achieve Profitability in Every Area of Your Business
Within every direct selling business, there are actually several businesses; of course the most important is the commissioned sales. This is the primary focus of a direct sales business. The other businesses are the shipping and delivery of products, printed material as sales aids, new consultant starter kits, and incentives and events—all of these ancillary businesses must be profitable or there is simply a hole in the bottom of the bucket.
I will focus on just one of these areas for the purpose of this article as an illustration. The shipping and handling of products, is an area where many startups immediately adopt a mindset that it will be a cost center. After all, this is the era of Amazon Prime and customers have come to expect either free or very low-cost shipping.
It takes great discipline and ingenuity to not fall into this mindset; I have worked with a company facing this issue where their field sales force voiced their biggest issue as the cost of shipping. Management, working with the field leaders, lowered shipping expense to end consumers by 60% but at the same time increased the retail price of each item by $3.00. This increase was non-commissionable which the field was fine with. This change made with the agreement of field sales leadership made a significant change in the trajectory of sales at the Company. At the end of the day, the margin on shipping actually improved year over year.
In summary gather experienced management in the industry, make sure the core economics of your company will work in the direct selling model, working capital availability is critical, and achieve profitability in all areas of the Company.