Spending months writing a business plan can make you feel like you’re being productive, but what you really need is market data and some experience.
Walk into any bank in the country and ask for a loan to start a business and the knee jerk reaction of the banker behind the desk will be to ask you to write a business plan—even though they themselves have likely never written one and will not base their lending decision on its content.
The problem with writing a business plan as a start-up is that it will be based on one assumption on top of another. If your first assumption is flawed, then the whole thing is useless.
Way back in 1996, I wrote a business plan for an audiotape magazine. My idea was, each month, to give subscribers a new audio recording of an interview I had conducted with a well-known entrepreneur (sort of like today’s model of podcasting). I decided to charge $99 for an annual subscription.
My business plan called for 10,000 subscribers in the first year, which amounted to a run rate of a cool $1 million in annual revenue. I had no idea what it would cost to acquire a new subscriber but figured $10, or about 10 percent of what I was charging them, seemed about right, so I calculated that it would cost $100,000 to get to my 10,000-subscriber base. With only $17,000 saved up to start the business, I assumed I would finance the acquisition of subscribers through the $99 prepayments of my new customers. I calculated the cost of mass producing 10,000 cassettes (this was long before iPods) and the cost of mailing the cassettes to my 10,000 subscribers each month.
I invested months in writing my business plan, and when it was complete, I felt ready to start running my million-dollar business.
My first step was to put together a top-notch first edition befitting of a million-dollar company. I rented studio time at a professional facility and hired an announcer from a popular morning show in Toronto and a producer from a local radio station. By the time I had my first edition finished, I had invested roughly $5,000 of the $17,000 I had saved up to start the business.
Next, I went to a printing company and had a four-color logo and package designed for my tape series. Each color added a little bit more to the cost of the tapes, but I justified the fancy graphics to myself because, spread across the 10,000 subscribers my business plan called for, the cost of each extra color was negligible.
I then created a fax-back subscription form (yes, this is well before ecommerce-enabled websites) and set up a fax machine in my parents’ basement.
To get my 10,000 subscribers, I printed brochures and started handing them out anywhere entrepreneurial people gathered: trade shows, small-business development centers and so on.
The first morning after handing out the brochures at a small-business trade show, I rushed downstairs to see how many orders I had received.
I checked the paper cartridge—it was full. I picked up the receiver to ensure there was a dial tone, and sure enough, the fax machine was working. I tried to remain optimistic, figuring people were still returning to their offices from the trade show, and told myself I’d have orders the next day.
The next morning I went downstairs again in anticipation of the floodgates opening. Still no orders.
The next day, again, I was shut out. I became increasingly depressed with each passing day of not selling a single subscription.
By the time I ran out of money and had to shut the business down, I had sold just 82 subscriptions in three months.
As I think back on the experience, the business plan I had spent months on was useless. It didn’t matter how much time I spent modeling out a million-dollar company because the house of cards was all based on one wobbly assumption: my guess that it would cost $10 to acquire a subscriber.
I had no basis for this assumption. I just made it up—which, of course, is the problem with the business plan of most start-ups: it’s all fiction until you get into the market and start selling. While it is true you can find comparable data from some sources, oftentimes start-ups are bringing a new concept to market making it impossible to find an apples-to-apples comparison.
What you really need to plan your business is some market data, which only comes from—you guessed it—the market. My advice for starting a business is to develop your product or service as cheaply as you can (or even develop just a description of what you plan to offer) and try to start selling it.
Skip wasting time on writing a traditional plan, and instead invest that energy in establishing a benchmark for what it costs in time, money and prospects to close a sale. Once you have a baseline, try to improve your efficiency over time.
Let’s say, for example, it costs you $16.60 to get a prospect (or a website visitor, person to visit your booth or shopper to come into your store). If you have to pitch 15 prospects before one says yes, your cost per customer acquired is $249 (15 x $16.60).
Now let’s imagine you charge only $200 for your product. With a marketing cost of $249, you’re underwater and need either to raise your price or to get more efficient at selling.
Start by getting more efficient. Let’s say you tweak your pitch and, over time, get your cost per customer down to $135.
Now start nudging up the price and see if you can keep acquiring customers at $135 each. Imagine you’re able to get your price to $250 without compromising your ability to get a customer.
You’re now clearing $115 per sale, and assuming you’re making your product for less than that, you’re in business.
Spending months writing a business plan can make you feel like you’re being productive, but it’s really just busywork. No bank in the country is going to lend you money based on your business plan (they only lend to start-ups based on your personal creditworthiness). Hiding behind a spreadsheet won’t help you get a business off the ground. What you need first is some real-world data, and you won’t get that from sitting in front of Excel. It comes when someone says “yes” to what you’re selling.
With some real data, you can start to write a business plan for scaling up your company. I think too many of us make the mistake—often encouraged by well-meaning bankers and advisers—of writing a business plan before you start. The problem is, until you have some real-world data, your business plan will be pure fiction.
John Warrillow is the author of Built To Sell: Creating a Business That Can Thrive Without You, which will be released by Portfolio/Penguin on April 28, 2011.