You Decide: How Can a Business Stay Afloat?

Dr. Mike Walden

North Carolina Cooperative Extension

Operating a business is tough. Meeting payroll, hiring qualified workers, attracting buyers and complying with regulations are just a few of the challenges faced by business owners. Statistics show 44 percent of new businesses shut down within three years. Opening a business is no guarantee it will be a success.

This is why I was excited recently to run across a small paperback book titled The Roadside MBA. Although written by university professors, this isn’t a typical textbook. Instead, it’s a series of stories – 45 in total –  based on the authors’ travels around the country (including North Carolina) and their visits to successful businesses (most of them small). Each chapter illustrates a principle of profitably running a firm.

Of course, I don’t have the space to discuss all 45 ideas. But here is a sample of those I consider to be at the top of the list.

Factor in Your Fixed Costs: There are two important kinds of costs for a business: fixed costs and variable costs. Fixed costs are the costs of machinery, equipment or any other input a business has to have just to be open. For example, a restaurant needs a stove, refrigerator and other kitchen equipment, plus a space where customers eat. These costs are the same whether the restaurant serves one meal a day or 100 meals, hence the term fixed costs.

In contrast, variable costs increase as the business sells more and decline as the business sells less. Continuing with our restaurant example, food purchased for the meals is a prime example of variable costs: The more meals served, the more food has to be purchased.

An important business fact is that as sales increase, fixed costs per sale decline. Say our restaurant has monthly fixed costs of $5000. If 500 meals are sold during the month, fixed costs per meal are $10. But if 1000 meals are served, fixed costs per meal are only $5. One reason businesses like to sell more is that they lower their fixed costs per sale, meaning they can make more profit per sale or they can lower their price and be more competitive.

It’s typical for a beginning business that sales will be low, fixed costs per sale will be high, and profits will be low or non-existent. Not to panic; it may take time for customers to come around, and when they do, fixed costs per sale will drop. But if they don’t, it may be time to throw in the towel!

Build a Better Mousetrap:  In business, if often pays to be different. Many successful businesses have been built on finding shortcomings in the current market and developing ways to correct them. Uber, the personalized taxi service, is using smart-phone technology to better coordinate trips for travelers. Recently two entrepreneurs calculated the time and costs of installing misting services in supermarket vegetable sections. They developed a company providing less costly and portable misting systems that many supermarket chains are now using. There’s even an annual competition for developing an improved mousetrap!

Treat Customers Differently: Successful businesses know not all their customers are alike. Even though all customers may be purchasing the same general product or service, their costs of accessing the product or service can vary.

The authors of The Roadside MBA give an example of a gym in a small town. Many of the customers came to the gym because it was close to home or work. But to broaden the geographic scope of their customer base (and to reduce fixed costs per customer!), the gym operators put coupons in local newspapers in farther-away neighborhoods offering discounts on a membership. So members living nearby paid the full price, while members living farther away paid a lower price to compensate for their higher travel costs.

Go Around, not Straight Ahead: There are many advantages to being a big business: Fixed costs are less of an issue, input prices are often lower due to bulk buying, lenders and advertisers may be more likely to cut big businesses a deal, and it’s easier to establish a brand-name and command the loyalty of consumers.

With all these pluses of being big, how’s a small business to survive? One recommendation is, don’t compete head-to-head with the big guy, but go around him. Don’t try to offer customers what the big business has. Instead, a small business should provide to customers what the big business doesn’t have.

And what might this be? Personal service. A downside of being big is that the distance between the business decision-makers and customers can widen. This results in less attentiveness to customer needs and a slower response to solving problems. Larger bureaucracies and a tendency to do things “by the book” can be drawbacks of big companies.

In contrast, small companies can be fast, responsive and more adaptive to special circumstances. It’s these benefits that small businesses can push to allow them to successfully compete with the giants.

There are numerous other good tips for keeping a business alive, and you’ll find many of them in The Roadside MBA. If you are in business – or thinking of starting a business – I think you’ll decide it’s worth the trip!

Dr. Mike Walden is a William Neal Reynolds Distinguished Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of North Carolina State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The College of Agriculture and Life Sciences communications unit provides his You Decide column every two weeks.

Previous columns are available at http://www.cals.ncsu.edu/agcomm/news-center/tag/you-decide

Related audio files are at http://www.cals.ncsu.edu/agcomm/news-center/category/economic-perspective