I was having lunch with a client and he posed the question “Why don’t most small businesses make real money?” After talking for a while, we came up with some good ideas.
Before I tell you those ideas, let’s define what real money means. Real money is when the owner is paid the market rate for his or her services AND earns a healthy return on his or her investment. Assuming the owner of a particular company serves as CEO, the CEO/owner should earn a competitive salary for his or her service to the company. The actual salary depends on the company size, industry, etc. The CEO/owner should also receive some form of profit distribution relative to the performance of the company. Again, the actual profit distribution is contingent upon the specific characteristics of the business (e.g. industry, company size, etc.) If the CEO/owner does not receive both a competitive salary and an adequate return on investment, he or she may want to reconsider his or her employment and investment decisions.
Why don’t most small businesses make real money? Here are some thoughts:
1. Unwillingness to act like an investor: Just as an investor expects a certain return on investment (ROI), a business owner should also expect a return above and beyond what he or she receives as compensation. If this return is inadequate, the owner needs to evaluate whether or not the business is structured to earn an acceptable return on investment. If it is not structured properly, hard decisions may need to be made (layoffs, selling the business, etc.)
2. Failure to reinvest: Business owners need to continue investing in order to remain competitive (equipment, technology, training, etc.) Although this can be financially painful short term, reinvestment positions the business to continue making money in the future.
3. Not hiring key personnel: Not all management teams are created equal. Even though a marketing manager might do a great job at a $5 million company, that individual may not be capable of growing the business to a $50 million. Hiring the right key personnel is essential to achieving growth and profitability goals.
4. Lack of vision: A small business will always be a small business without a vision of being more. This requires management commitment, careful planning, and exceptional execution.
5.Lack of financial sophistication: Business planning without meaningful financial projections is a waste of time. In addition, it is critical to you subject to financial data to evaluate both company and employee performance. Without a certain level financial sophistication, management teams cannot be sure where they are at today or where they’re headed.
Addressing these issues early and often can help you avoid not making real money in your business.
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I agree with the reasons you have outlined. I have seen so many small businesses that failed or underperformed because the owner was prideful, which is really the source of the problems outlined above.
Many small businesses start out with an energetic entrepreneur who is a great salesman but a lousy businessperson. S/he needs to run the operation like a proper business and bring in the appropriate people at the right time including additional investors if needed.
Many business owners don’t only fail to hire the right people but often don’t listen to them and end up running the business into the ground needlessly.
IMHO
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Everyone always misses the most important reason: Because of the nature of what you sell you are unable to make sufficient margin on the product or services to grow to the next level. This might sound obvious but ask yourself this question: Why in the HISTORY of the world has no “Joe’s Garage” (You know..that place that fixes your car down the street) grown to be nationwide & franchise nationwide?I’m not talking about specialty shops like Midas or Q-lube or Meineke or a dealership. I’m talking about a general auto repair shops. Do you SERIOUSLY think that in the last 100 years there has been no “Joe” without the organizational smarts/willingness to reinvest, hire the right people, etc??? Sorry…but E-Myth is a Myth for certain types of businesses.
Yes. You need margin to have a sustainable business. As a former CFO I can only agree.
Of course the best way to have good margins is to have a valuable offer with unique attributes for your customers.
It is not that the owner of a small business always lack of vision, but rather that he is focus on day to day operations while its offer get banalized and while the market shifts…. I must also say that some small business owners are reluctant to share ideas, capital and power.
Nice Article, As a budding Entrepreneur, I can simply say that good ingredients for my recipe to become more Tasty.
It’s good to see that someone recognizes that small business owners have an opportunity cost when running a business.
You have done a good job of introducing small business owners to that concept without actually using that terminology. I think that most small business owners and managers don’t understand this (or most economic concepts) because they are good at a certain task, craft, service or selling but are not necessarily good business people.
Sometimes the best personnel decision can be to hire a manager who does understand business and economics and can run the business well. However, most owners are reluctant to do this for 2 reasons 1) the loss (or perceived loss) of control and 2) lack of funds to pay the salary necessary to secure such personnel.
Either small business owners have to get the education and training necessary to perform this role themselves or they need to pony up now and hire someone to do it for them. I have always been a strong proponent of specialization. Focus on what you do best and hire others to do what they do best to supplement what you don’t do.
I realize that for small businesses this can be difficult due to lack of funds. My suggestion is for small business owners to hire sound and affordable coaches and/or consultants to either fill that roll on a part time basis or to show them how to attain key personnel on limited budgets. Make a deal with a solopreneur to trade out for their service in exchange for your goods or service if you don’t have the funds. Or hire someone who will work on a contingency fee.
Another option is to have a coach or consultant teach the business owner how to do it effectively and efficiently themselves. That is a tall order given the complexity of modern business but the survival of many small businesses depends on it. But very few small businesses will make “real money” until sound business/economic principles are applied and other peoples’ talents are leveraged.
I have just completed my MBA thesis focused around the SME sector.
https://publications.theseus.fi/bitstream/handle/10024/10966/Public%20Version%20thesis.PDF?sequence=1
Hope it helps to explain why SME’s can make real money and why they should feel the need to change what make them successful.
Hope it helps and look forward to your comments.
I think all parts of the world are starting to recognise that the SME sector, which is about 95% businesses in an economy, is where the jobs are going to come from.
I think angles are focused on SME because they business models are designed to deliver the ROI’s they need. They are different to the VC’s who tend not to consider any investments below a particular amounts.
Look forward to your comments.
Terrific conversations. As a small business owner how do the contributors feel about the administration’s claims that the economic success in America lies with small businesses? Also, why are angel investors so focused on investing in small businesses?
Not much left to add to this interesting discussion and great points. I think adequate capitalization, scalability, operations and growth management skill set and strategy, and of course vision (together with the desire to grow as maud pointed out) are the main ingredients for the commercialization of most types of SMEs.
It does’t matter whether you are small or big .. what is really matter the idea you are comng up with must be having the creativity and innovation in itself and must be very indifferent from the present system like the concept of the Three George by China …
all the big Biz today are started up with the small ideas but the main think why today they are big is their ideas were carrying the weight of creativity and innovation , start is always small but what matters is the end …
As I see it they go into business with a committment.
They never make a committment to the committment.
Which to me is only halfway step into business and lacks all the other necessities that successful business people have.
I agree with most of the comments above and would like to add another common problem I have encountered with many small businesses…CONTROL. I have met many small business owners whom want to leverage their businesses. Most are unwilling or not able to borrow to do so and thus look to equity partners however the stumbling block at the end of the day is loosing control, as we say letting go of the baby.
In their minds they really don’t want to take that step up AND loose effective control and this is very understandable especially for the less educated small business people.
REAL small businesses,
in the majority of cases,
are just NOT meant of making REAL money.
They are a replacement for being employed,
but while being your own boss.
Nothing more, nothing less.
It’s only in the hotheaded brains of financiers,
that this false idea exists.
Don’t push people into things,
they have NEVER intended……
There are several reasons I see as to why. First, is of course lack of capital and that comes from a poorly developed business plan and/or execution. Along the capital lines as well, they dont want to give up even a little control for equity capital, which for a new business is better than alot of debt. Alot of small businesses start out believing what they see their previous bosses and companies did were wrong and they know what is right and will not listen to any others. Those issues are generally for start ups, but they set the stage for what issues can come up later.
The best thing is for them is to read and study what others, similiar to their situations, did that was successful and what they did that was not and implement them. They must not look at paying a little tax on profits as bad. They are in there to make money and that goes along with it.
There were valid reason’s in Ren’s post as to why a lot of small businesses don’t make money.
But I happen to agree with Rock… even the large successful businesses started small and it has a lot to do with the business as well as your knowledge and experience. The CAPEX as well as REVENUE are key and one other thing… the team you build to help you reach your goals!
I started my company in 2007/2008 and we have been blessed to grow!
A lot has to do with the solutions you provide (product or service), the markets you target, your exposure (advertising) and the FAITH you have!
You have to re-invest… someone said earlier… it takes money to make money… true, but is doesn’t always take a lot of money. I started my company with less than $2,000… the rest was fortitude and determination!
We consistantly make 6 figures and hope to reach 7.
Maybe we used some spit and duct tape as well… LOL!
In addition to Ren’s outline, Mark presents two of the most common funding deal-killers I see in points 1 (scalability) and 2 (lifestyle).
A great many small businesses are simply *not* scalable, either due to complexity, dependency, dying or transitioning market sector (like a physical record store). Another large chunk are represented by those “lifestyle” businesses, which work “well enough” for the founder(s) & family, but in truth, are sandwiched between that status quo position and upmarket competition (direct or indirect). Often founders are happy with running *that* small business, and not one 50x larger, and don’t perceive parallel competition as a threat until too late.
So, your choice of *which* business to start, and what products to offer (and to which customers) is critical to success, since your initial capital is more precious and offers the best compounded profit leverage.
Also, when starting out, you often don’t know what you don’t know unless you’ve come from a much larger organization!
I’ve read all of these comments and just wanted to add one item. Large markets are typically being addressed by large and sophisticated corporations ALREADY, which makes it difficult for small businesses to compete with them. Small businesses often remain small b/c their market size is limited to begin with.
Of course, there are plenty of exceptions to this, but large markets are usually being addressed already by sophisticated professional corporations. When an opening exists, or a paradigm shift / disruption occurs, openings occur that allow small businesses to break out and become huge businesses (Google overtaking adspend, Cisco powering the guts of the internet, Amazon taking advantage of unlimited shelf-space, etc).
Small businesses aren’t just small b/c of lack of capital or limited mgmt vision; lots of times they’re just small b/c their addressable market isnt big to begin with.
Peter
I can’t help but pipe in on this one. The premise of the whole question is wrong since small business makes up the entire market. Example: 2006 the US market had 26Million businesss, with 100K having revenues greater than $1Billion, and 1Million have more than 9 employees. That’s 25 Million businesses having employees of 1 to 9. That’s a huge segment of business, and ay way you look at it, small business is much larger, and contributes a much larger portion of business than larger business, thus the REAL money is made by small business. The ignorance is to assume that a small business is an island, adrift in some vast ocean waiting to die a slow death from lack of food and water. Statements like that just make one look and wonder what unemployment line are you in?
Another example, to those who would believe that small business is either small or unsuccessful, is in looking at the second largest sector, hospitality. Do you think that McDonalds, Subway, Wendy’s, etc., are large, sucessful corporations making REAL money. If so, you need to go and walk into one of their stores and ask for the owner. He’s probably in the back, or in the kitchen. Ace Hardware, True Value, OSH, do you think these are giant Home Depot businesses. If so you do not know retail, the number one business. Chevron, Mobile, Exon, how many of these sell product, and what is the retail market of thier business compared to production? Do you know how much money it costs to open a Denney’s, and what you must do to even be eligible to open one? Check it out. See if you could qualify. Doubtful.
Coke, is that a big corporation. CokaCola Bottlers made Coke what it is today. All Smal businesses, and many still. did you think that that bottle of Coke you bought came from Coke?
I have a customer, one of our 3000+, that owns five franchise locations in Nevada. If this guy is not making REAL money, I don’t know what it is. Smal business doens not lack vision or business knowledge. Definatly, not inexperience. Smal business fail, and so do big ones, just as much, just with a much bigger bang when they hit the ground. Is Exxon a safe haven? Was Enron? KMart came before Walmart, and Mervins is safe, Right? AIG, GM, and a long list, should be gone, just as the smaller risk taker whom knowbody bailed out. But if you don’t know that every economy, and every person is not deeply dependant on the success and the REAL money, which is small business, then it’s going to be government, and all of us with it that wil be to big, but failed anyway.
Try and open a JiffyLube without a business plan at least as good as Google’s was. I can hear the first investors in that one “Ya right, another search engine, like we need another one of those.” Heardd it, been there.
Thank you all for those good points you share. Getting into a business is facing competition in one or the other way. Hence, differentiation and value proposition becomes the key factor that make the business grow or not. Those for sue are the key growth inhibitors and the basis of a make or break.
On the other side the biggest prohibitor for growth is: access to capital – in particular in a business to business relation. Today, bad payment moral of clients is a given. On the other side, suppliers reduce their risk and often force startups into a position of paying cash in advance. On top, banks do not want to get engaged deeply when the business does not already run perfectly. There is a bridge to build: how to overcome a negative cash flow business that will drain all accounts with growth.
In business to consumer relations access to capital seems to be a less limiting factor. Consumer channels are used to cash in advance (ever walked out a retail store without paying for the goods in the baske?). If one runs an internet business with little to no inventory, has clients that pay immediately by credit card and so does the same with the suppliers, we are cash neutral to cash positive and the limitation to growth is back into a clear business concept, differentiation and providing value.
There sure is more to tell and share, but so much for tonight.
Greetings,
Thomas
Um, I hate to be the one to say the negative agin, but Internet business is not pay immediate, no inventory risk, risk and cash nuetral. Sorry to break the bad news, but Card not present on inventory is the highest risk business in retail. 60 to 90 day chargeback policy, and the credit card company does not represent the Merchant. Soft goods, like software, and SaaS ok, but send a 52″ LCD TV on a credit card for ecommerce, not me.
Additionally, Sate and federal laws that are anti business, especially credit card transactions with business that protect the bank, are on an expodential curve. Governements unpopularity makes them demonize business because they have no where else to go, and they can’t blame themselves and/or the consumer, what they don’t see is it hurts the consumer because someone has to pay it it won’t be government, and now not the bank either. It’s your job. People get that. Lawyers don’t. They never had to sell something or make something.
One more before I go, for the night; suppliers are doing much better than Internet right now. Sure AR is a bitch, but that’s the business, and tthe chain knows it. But Retail is hurt real bad and string can be lengthened if you need it. Adding Value in the supoply chain is good business and will improve.
TCO, ROI, low entry, and expect limited capital. Demand is there. Both Enterprise and SMB.
Richard – If you are having the control over the term called Value of Control while having your biz and at the same time you ae looking for the Equity or debt partner then there would not be any point on suh issue , but to maintain the value of Control one has to be very innovative and talenetd and all the ideas that he is putting in the mkt must realize the value of control …. , that is the only and best solution to prevent from the Control…
Peter – We are having the example of the one of the foremost Asian SWF called Chinese Investment Corporation (CIC ) of China with Just principally approved capital base of $ 200 Bn and started the operations in 2007 and in just 3 yrs , this SWF has dominated all the Deals accross the world and today just completed the deal of $ 40 BN with Australia LNG Player …
CIC is having the competitors like SWF from OPEC ( Dubai /Kuwait / …. ) but he is continously securing the deals and he is doing bez the vision of that entity even in the largest mkts of the world is very clear and clean and CIC is totally aware that what he is doing and with what vision ….
so what matters even if yu are in the big fishes but you are having the capability to think something concrete and innovative then there is no point of the demographic advantage your opponent is enjoying …
Excellent discussion. Each business is unique. Some small businesses are meant just a job for the owner. I created a job or two for myself through the years! To make real money, an owner would have to get beyond that mentality. More money is not the solution to small business problems. We have worked with small businesses for years and most try to get money when they are “out of runway” instead of when they are ready to fly. Most business owners panic too late.
The Buring question is why Most of the small Biz Houses are not be able to convert themselves like MS / Apple / Yahoo / Google / Wallmarts ? , though the fact is that all the said companiesare established by set of people and they lead it so well that today they are governing the Technology & Retailling of the world
Are they Really lacking Excellence /Fire of Success / Creativity and Innovation ?
A few weeks ago I was doing a consulting engagement with a small business to help them understand why their growth had stagnated.
In talking to the principles, it became clear that they had not captured any performance metrics and didn’t really understand how to benchmark their business.
While I’ve seen this a bunch of times, it’s been fairly rare as I usually work with VC-backed business, where metrics are required in order to even get funding. I suspect, and my experience in several non-investor backed businesses bears this out, that most small businesses are not tracking performance and don’t understand how to do this.
Most (all?) the people on this thread seem to be fairly well versed in business financials, metrics, performance analysis and using spreadsheets, but I think that most small business owners are not. Sure, they can probably do an adequate job of maintaining books and accounts, but they lack the understanding and tools to analyze their performance. This, in turn, leads to poor decisions on using business resources (whether cash or people), a general lack of focus on what makes the most money and no understanding of where to invest for growth.
Probably the single most significant thing that could be done to improve small business performance is to teach owners how to instrument and analyze their businesses performance from quarter to quarter.
As an aside, channel Five in the UK has a great series on improving business performance: http://www.five.tv/programmes/documentaries/the-business-inspector – the problems highlighted are pretty much what I have found in helping over 60 small businesses….
Chris.
Chris – Do you think any one needs a benchmark to get success in his life . The only Benchmark one needs is the Excellence and the talent to Create and Innvoate . Won’t you think Benchmarks are created not followed
I think a lot of the discrepancy is that in small businesses people often get involved because of personal reasons, for example; they like to cook.
Being a great pizza artist has nothing to do with managing customers, clients, employees, competition, etc…a lot of business owners that I have met are drowning in quickbooks and everything else involved in operation.
Undercapitalization is horrible and very common these days, but I genuinely believe that small businesses don’t make as much money because the owners have no idea how to actually “run a business”…let’s get together and open a school for them! =D Academy of Small Business Owners…ASBO! Yay!
@rahul
I don’t think we are talking about the same things. Personal success is not business success. They may be related for some people, but they certainly don’t need to be. Whether or not you choose to judge your personal success using metrics is a very personal choice…
In businesses, however, you need metrics and benchmarks in order to measure performance over time. They are also essential in figuring out opportunities, improving performance and diagnosing problems. As Michael Sherrill once said in a business meeting we were both in: “If you can’t measure it, it doesn’t count”.
I would note that, in the context above, the term benchmark refers to an internal reference point – a baseline if you prefer – rather than against comparable peers.
Besides, I’m not sure how you measure ‘Excellence’ – I’m wondering how you propose doing that?
On a side note – I’m not a worshiper of metrics, but I have come to understand that numbers tell stories and that listening to these stories can guide you to a better understanding of business fundamentals. However, if you don’t have the numbers, they can’t tell their story….
Chris.
About three quarters of all U.S. business firms have no payroll. The number is around 20 million. Most are self-employed persons operating unincorporated businesses, and may or may not be the owner’s principal source of income. Those nonemployers account for only about 3.4% of business receipts. That’s statistical explanation why MOST cannot make REAL money.
There are also market rules that play against small businesses. The laws of highly competitive (efficient) market work such way that the median margins are always close to zero. Small business environment is fiercely competitive market due to easy entry. The only time business with low margins can make REAL MONEY is when it has many workers. In that case it wouldn’t be a small business.
So there are only two ways to make real money, grow your business large (the more people you employ the more income they will generate for you,) or find inefficient market with low competition that would allow increasing your margins. Again, there can be several reasons why there is low or no competition in a particular market segment. It can be because too few people care about what business has to offer, and that is a dead end some small businesses find themselves in. For example, if you open a convenience store on the top of Mount McKinley, you will have no competition and … no customers. The market may also be inefficient because there are barriers for entry, e.g. high cost, security clearance, licensing, government restrictions, etc. Another possibility is that market doesn’t exist yet and business has to create it first. Most hi-tech startups are in this high risk category, and therefore most of them must fail.