Chapter 5 The Challenges of Starting a Business

The Nature of Entrepreneurship

If we look a little more closely at the definition of entrepreneurship, we can identify three characteristics of entrepreneurial activity:Adapted from Marc J. Dollinger, Entrepreneurship: Strategies and Resources, 3rd ed. (Upper Saddle River, NJ: Prentice Hall, 2003), 5–7.

1. Innovation. Entrepreneurship generally means offering a new product, applying a new technique or technology, opening a new market, or developing a new form of organization for the purpose of producing or enhancing a product.
2. Running a business. A business, as we saw in Chapter 1 "The Foundations of Business", combines resources to produce goods or services. Entrepreneurship means setting up a business to make a profit.
3. Risk taking. The term risk means that the outcome of the entrepreneurial venture can’t be known. Entrepreneurs, therefore, are always working under a certain degree of uncertainty, and they can’t know the outcomes of many of the decisions that they have to make. Consequently, many of the steps they take are motivated mainly by their confidence in the innovation and in their understanding of the business environment in which they’re operating.

It isn’t hard to recognize all three of these characteristics in the entrepreneurial experience of the Jurmains. They certainly had an innovative idea. But was it a good business idea? In a practical sense, a “good” business idea has to become something more than just an idea. If, like the Jurmains, you’re interested in generating income from your idea, you’ll probably need to turn it into a product—something that you can market because it satisfies a need. If—again, like the Jurmains—you want to develop a product, you’ll need some kind of organization to coordinate the resources necessary to make it a reality (in other words, a business). Risk enters the equation when, like the Jurmains, you make the decision to start up a business and when you commit yourself to managing it.

A Few Things to Know about Going into Business for Yourself

Figure 5.1

Do you think Chris DeWolfe knew what a huge success MySpace would be when he and Tom Anderson started their Web site?

Source: http://commons.wikimedia.org/wiki/File:Chris_DeWolfe.jpg accessed Feb. 2, 2009.

So what about you? Do you ever wonder what it would be like to start your own business? Maybe you want to try your hand at entrepreneurship. You could be the next Tom Anderson or Chris DeWolfe, founders of MySpace. Or the next David Marcks, a golf course manager who came up with the idea of Geese Police—training dogs to chase geese from golf courses, corporate parks, and municipal playgrounds.Isabel M. Isidro, “Geese Police: A Real-Life Home Business Success Story,” PowerHomeBiz.com (2008), http://www.powerhomebiz.com/OnlineSuccess/geesepolice.htm (accessed October 8, 2008). Or even the next Pierre Omidyar, the French-born software developer who built an online venue for person-to-person auctions, known as eBay.See American Academy of Achievement, “Pierre Omidyar,” Academy of Achievement (November 9, 2005), http://www.achievement.org/autodoc/page/omi0bio-1 (accessed October 8, 2008). You might even turn into a “serial entrepreneur,” like Dan Bricklin, whose résumé so far includes four software companies: Software Arts (founded to market his own invention, an electronic spreadsheet calculator), Software Garden (software for monitoring Web servers), Slate Corp. (software for pen computers), and Trellix Corp. (software for building and hosting Web sites).Dan Bricklin, Dan Bricklin’s Web site, http://www.bricklin.com (accessed October 8, 2008); Dan Bricklin, “Natural-Born Entrepreneur—Lessons of a Serial Entrepreneur,” Working Knowledge (October 22, 2001), http://hbswk.hbs.edu/archive/2569.html (accessed October 8, 2008).

For the sake of argument, let’s say that you would like to know a little more about going into business for yourself—in which case, you’ll want some answers to questions like the following:

• Should I start a business?
• What are the advantages and disadvantages of starting a business?
• How do I come up with a business idea?
• Should I build a business from scratch, buy an existing business, or invest in a franchise?
• How do I go about planning a business?
• What steps are involved in developing a business plan?
• Where would I find help in getting my business started and operating it through the start-up phase?
• How can I increase the likelihood that I’ll succeed?

In this chapter, we’ll provide some answers to questions like these.

Distinguishing Entrepreneurs from Small Business Owners

Figure 5.2

These bakers are not entrepreneurs. They run their small bakery for the sole purpose of providing an income for themselves and their families (a salary-substitute firm) or to earn a living while pursuing their hobby of baking (a lifestyle firm).

© 2010 Jupiterimages Corporation

Though most entrepreneurial ventures begin as small businesses, not all small business owners are entrepreneurs. Generally speaking, we can divide small businesses into three types:Adapted from Bruce R. Barringer and R. Duane Ireland, Entrepreneurship: Successfully Launching New Ventures, 2nd ed. (Upper Saddle River, NJ: Pearson Education, 2008), 16.

• Salary-substitute firms are started to provide owners with incomes similar to those that they’d be earning while working for an employer. Typically, they offer common products—retail merchandise, for example, or a service like accounting or hairstyling. Most small businesses are of this type.
• As the name suggests, people start lifestyle firms to earn a living while pursuing a particular lifestyle. These businesses often reflect owners’ hobbies or favorite pursuits—say, surf shops or rock-climbing excursions. As a rule, they don’t do anything innovative, and they don’t need to grow very fast.
• Like BTIO, entrepreneurial firms bring innovative products to market. Like the Jurmains, owners are people who recognized an opportunity and developed a product to satisfy the needs of certain customers. Their goal is to grow the business and eventually expand into other markets.

Key Takeaways

• An entrepreneur is someone who identifies a business opportunity and assumes the risk of creating and running a business to take advantage of it.

• There are three characteristics of entrepreneurial activity:

  1. Innovating. An entrepreneur offers a new product, applies a new technique or technology, opens a new market, or develops a new form of organization for the purpose of producing or enhancing a product.
  2. Running a business. Entrepreneurship means setting up a business to make a profit from an innovative product or process.
  3. Risk taking. Risk means that an outcome is unknown. Entrepreneurs, therefore, are always working under a certain degree of uncertainty, and they can’t know the outcomes of many of the decisions that they have to make.

• According to the SBA, a government agency that provides assistance to small businesses, there are five advantages to starting a business—“for the right person”:

  1. Be your own boss.
  2. Accommodate a desired lifestyle.
  3. Achieve financial independence.
  4. Enjoy creative freedom.
  5. Use your skills and knowledge.

• To determine whether you’re one of the “right people” to exploit the advantages of starting your own business, the SBA suggests that you assess your strengths and weaknesses by asking yourself the following questions:

  1. Am I a self-starter?
  2. How well do I get along with different personalities?
  3. How good am I at making decisions?
  4. Do I have the physical and emotional stamina?
  5. How well do I plan and organize?
  6. Is my drive strong enough?
  7. How will my business affect my family?

• Though most entrepreneurial ventures begin as small businesses, not all small business owners are entrepreneurs. Generally speaking, we can divide small businesses into three types:

  1. Salary-substitute firms are started to provide owners with incomes similar to those that they’d be earning while working for employers.
  2. People start lifestyle firms to earn a living while pursuing a particular lifestyle; they often reflect owners’ hobbies or favorite pursuits.
  3. Entrepreneurial firms bring innovative products to market; owners are people who recognized an opportunity and developed a product to satisfy the needs of certain customers.

Exercise

(AACSB) Analysis

Do you have what it takes to be an entrepreneur? To find out, start by reviewing the following list of characteristics commonly attributed to entrepreneurs:

• They are creative people who sometimes accomplish extraordinary things because they’re passionate about what they’re doing.
• They are risk-taking optimists who commit themselves to working long hours to reach desired goals.
• They take pride in what they’re doing and get satisfaction from doing something they enjoy.
• They have the flexibility to adjust to changing situations to achieve their goals.

We’ll also add that entrepreneurs usually start small. They begin with limited resources and build their businesses through personal effort. At the end of the day, their success depends on their ability to manage and grow the organization that they created to implement their vision.

Now use the following three-point scale to indicate the extent to which each of these attributes characterizes you:

1. It doesn’t sound like me.
2. It sounds like me to a certain extent.
3. It sounds a lot like me.

Based on your responses, do you think that you have the attributes of an entrepreneur? Do you think you could be a successful entrepreneur? Why, or why not?

What Is a “Small Business”?

To assess the value of small businesses to the U.S. economy, we first need to know what constitutes a small business. Let’s start by looking at the criteria used by the Small Business Administration. According to the SBA, a small businessAccording to the SBA, a business that is independently operated, exerts little influence in its industry, and employs fewer than five hundred people. is one that is independently owned and operated, exerts little influence in its industry, and (with a few exceptions) has fewer than five hundred employees.U.S. Small Business Administration, “What Is Small Business?” (2008), http://www.sba.gov/services/contractingopportunities/sizestandardstopics/size/index.html (accessed October 9, 2008).

Why Are Small Businesses Important?

Small business constitutes a major force in the U.S. economy. There are nearly twenty-seven million small businesses in this country, and they generate about 50 percent of our gross domestic product (GDP).Office of Advocacy, U.S. Small Business Administration, The Small Business Economy for Data Year 2006: A Report to the President (December 2007), http://www.sba.gov/advo/research/sb_econ2007.pdf (accessed October 9, 2008). Indeed, if all the small businesses in the United States seceded and formed their own economy, it would be the third-largest economy in the world (behind the United States itself and China).Thomas W. Zimmerer and Norman M. Scarborough, Essentials of Entrepreneurship and Small Business Management, 5th ed. (Upper Saddle River, NJ: Pearson Education, 2008), 27. The millions of individuals who have started businesses in the United States have shaped the business world as we know it today. Some small business founders like Henry Ford and Thomas Edison have even gained places in history. Others, including Bill Gates (Microsoft), Sam Walton (Wal-Mart), Steve Jobs (Apple Computer), Michael Dell (Dell, Inc.), Steve Case (AOL), Pierre Omidyar (eBay), and Larry Page and Sergey Brin (Google), have changed the way business is done today. Still millions of others have collectively contributed to our standard of living.

Aside from contributions to our general economic well-being, founders of small businesses also contribute to growth and vitality in specific areas of economic and socioeconomic development. In particular, small businesses do the following:

• Create jobs
• Spark innovation
• Provide opportunities for many people, including women and minorities, to achieve financial success and independence

In addition, they complement the economic activity of large organizations by providing them with components, services, and distribution of their products.

Let’s take a closer look at each of these contributions.

Job Creation

The majority of Americans first entered the business world by working for small businesses, and today, more than half of all U.S. adults either are self-employed or work for businesses with fewer than five hundred employees.Terry Bibbens, “A New View of Government, University, and Industry Partnerships” (U.S. Small Business Administration, Office of Advocacy, February 2000), 2, http://www.sba.gov/advo/laws/test99_0804.pdf (accessed October 10, 2008). These enterprises are constantly creating jobs and providing opportunities for a vast number of workers. Figure 5.3 "Net New Jobs by Firm Size, 1992–1996" shows just how many jobs were created by small (and very small) firms between 1992 and 1996, the last year for which there are data on the actual number of jobs created by small firms. In the decade between 1995 and 2005, small businesses also created 60 percent to 80 percent of net new jobs annually, including 40 percent of high-tech workers (scientists, engineers, computer workers). Their share of total employment remains steady at about 51 percent, because many small firms, as they add employees, naturally grow into large firms.Terry Bibbens, “A New View of Government, University, and Industry Partnerships” (U.S. Small Business Administration, Office of Advocacy, February 2000), 2, http://www.sba.gov/advo/laws/test99_0804.pdf (accessed October 10, 2008), 3.

Figure 5.3 Net New Jobs by Firm Size, 1992–1996

Opportunities for Women and Minorities

Small business is the portal through which many people enter the economic mainstream. Business ownership allows individuals, including women and minorities, to achieve financial success, as well as pride in their accomplishments. While the majority of small businesses are still owned by white males, the past two decades have seen a substantial increase in the number of businesses owned by women and minorities. Figure 5.4 "Businesses Owned by Women and Minorities" gives you an idea of how many American businesses are owned by women and minorities, and indicates how much the numbers grew between 1982 and 2002, the last year for which there are reliable data.Ying Lowrey, “Women in Business, 2006: A Demographic Review of Women’s Business Ownership” (U.S. Small Business Administration, Office of Advocacy, August 2006), http://www.sba.gov/advo/research/rs280tot.pdf (accessed October 10, 2008); Ying Lowrey, “Minorities in Business” (U.S. Small Business Administration, Office of Advocacy, April 2007), http://www.sba.gov/advo/research/rs298tot.pdf (accessed October 10, 2008).

Figure 5.4 Businesses Owned by Women and Minorities

Industries by Sector

We’ll have more to say about industries and how to analyze them in later chapters. Here, we’ll simply define an industry as a group of companies that compete with one another to sell similar products, and we’ll focus on the relationship between a small business and the industry in which it operates. First, we’ll discuss the industries in which small businesses tend to be concentrated. To do this, we’ll divide businesses into two broad types of industries, or sectors: the goods-producing sector and the service-producing sector.

• The goods-producing sectorAll businesses whose primary purpose is to produce tangible goods. includes all businesses that produce tangible goods. Generally speaking, companies in this sector are involved in manufacturing, construction, and agriculture.
• The service-producing sectorAll businesses whose primary purpose is to provide a service rather than make tangible goods. includes all businesses that provide services but don’t make tangible goods. They may be involved in retail and wholesale trade, transportation, communications, finance, insurance, real estate, and such professional activities as health care, advertising, accounting, and personal services.

About 80 percent of small businesses in the United States are concentrated in the service-producing sector. Of these, about 25 percent are in retailing, 10 percent in wholesaling, and 35 percent in professional and business services. Of the 20 percent of all small businesses in the goods-producing sector, nearly two thirds are in construction and the other one third in manufacturing.John Case, “What Businesses Are Small Companies Really In—And Where Are They Scarce,” Inc.com (May 2001), http://www.inc.com/magazine/20010515/22612.html (accessed October 11, 2008) (October 11, 2008).

Figure 5.5

A high percentage of small businesses are in the retail sector.

© 2010 Jupiterimages Corporation

The high concentration of small businesses in the service-producing sector reflects the makeup of the overall U.S. economy. Over the past forty years, the service-producing sector has been growing at an impressive rate. In 1960, for example, the goods-producing sector accounted for 38 percent of GDP, the service-producing sector for 62 percent. By 2000, the balance had shifted dramatically, with the goods-producing sector accounting for only 23 percent of GDP, while the service-producing sector had grown to 77 percent.Laura Baughman, “Why Congress Should Fund Better Services Data,” Sitrends.org (May 6, 2002), http://www.sitrends.org/ideas/expert.asp?EXPERT_ID=49 (accessed October 11, 2008) (October 11, 2008).

Service-Producing Sector

Many small businesses in this sector are retailers—they buy goods from other firms and sell them to consumers, in stores, by phone, through direct mailings, or over the Internet. In fact, entrepreneurs are turning increasingly to the Internet as a venue for start-up ventures. Take Tony Roeder, for example, who had a fascination with the red Radio Flyer wagons that many of today’s adults had owned as children. In 1998, he started an online store through Yahoo! to sell red wagons from his home. In three years, he turned his online store into a million-dollar business. Internet entrepreneurship was also attractive to Sean Lundgren and Todd Livdahl—two computer engineers who gave up successful careers at Disney to turn their fascination with video games and DVDs into an online business. To their delight, their small start-up venture, a CD and DVD retailer that they call Sneetch.com, generated sales of $1.2 million during its first year of operation.Isabel Isidro, “What Works on the Web: 12 Lessons from Successful Home-Based Online Entrepreneurs,” PowerHomeBiz.com (2008), http://www.powerhomebiz.com/vol63/whatworks.htm (accessed October 12, 2008) (October 12, 2008).

Other small business owners in this sector are wholesalers—they sell products to businesses that buy them for resale or for company use. A local bakery, for example, is acting as a wholesaler when it sells desserts to a restaurant, which then resells them to its customers. A small business that buys flowers from a local grower (the manufacturer) and resells them to a retail store is another example of a wholesaler.

A high proportion of small businesses in this sector provide professional, business, or personal services. Doctors and dentists are part of the service industry, as are insurance agents, accountants, and lawyers. So are businesses that provide personal services, such as dry cleaning and hairdressing.

David Marcks, for example, entered the service industry about fourteen years ago when he learned that his border collie enjoyed chasing geese at the golf course where he worked. Anyone who’s been on a golf course recently knows exactly what the goose problem is. While they are lovely to look at, they answer the call of nature on tees, fairways, and greens. That’s where Marcks’s company, Geese Police, comes in: Marcks employs specially trained dogs to chase the geese away. He now has twenty-seven trucks, thirty-two border collies, and five offices. Golf courses account for only about 5 percent of his business, as his dogs now patrol corporate parks and playgrounds as well.Isabel M. Isidro, “Geese Police: A Real-Life Home Business Success Story,” PowerHomeBiz.com (2008), http://www.powerhomebiz.com/OnlineSuccess/geesepolice.htm (accessed October 8, 2008).

Figure 5.6 "Small Business by Industry" provides a more detailed breakdown of small businesses by industry.

Figure 5.6 Small Business by Industry

Key Takeaways

• An industry is a group of companies that compete with one another to sell similar products. There are two broad types of industries, or sectors:

  1. The goods-producing sector includes all businesses that produce tangible goods.
  2. The service-producing sector includes all businesses that provide services but don’t make tangible goods.
• The largest areas of the goods-producing sector are construction and manufacturing. Construction businesses are often started by skilled workers, such as electricians, painters, plumbers, and home builders. These businesses tend to be small and generally focused on local projects. Though manufacturing is primarily the domain of large businesses, there are exceptions.
• Many small businesses in the service-producing sector are retailers—they buy goods from other firms and resell them to consumers, in stores, by phone, through direct mailings, or over the Internet. Other small business owners in this sector are wholesalers—they sell products to businesses that buy them for resale or for company use. A high proportion of small businesses in this sector provide professional, business, or personal services.

Exercise

Why are most small businesses found in the service-producing sector? Identify five small service-producing businesses that you patronize frequently. What kinds of small businesses are found in the goods-producing sector? What small goods-producing firms do you do business with regularly?

Advantages of Small Business Ownership

Being a business owner can be extremely rewarding. Having the courage to take a risk and start a venture is part of the American dream. Success brings with it many advantages:

• Independence. As a business owner, you’re your own boss. You can’t get fired. More importantly, you have the freedom to make the decisions that are crucial to your own business success.
• Lifestyle. Owning a small business gives you certain lifestyle advantages. Because you’re in charge, you decide when and where you want to work. If you want to spend more time on nonwork activities or with your family, you don’t have to ask for the time off. If it’s important that you be with your family all day, you might decide to run your business from your home. Given today’s technology, it’s relatively easy to do. Moreover, it eliminates commuting time.
• Financial rewards. In spite of high financial risk, running your own business gives you a chance to make more money than if you were employed by someone else. You benefit from your own hard work.
• Learning opportunities. As a business owner, you’ll be involved in all aspects of your business. This situation creates numerous opportunities to gain a thorough understanding of the various business functions.
• Creative freedom and personal satisfaction. As a business owner, you’ll be able to work in a field that you really enjoy. You’ll be able to put your skills and knowledge to use, and you’ll gain personal satisfaction from implementing your ideas, working directly with customers, and watching your business succeed.

Disadvantages of Small Business Ownership

As the little boy said when he got off his first roller-coaster ride, “I like the ups but not the downs!” Here are some of the risks you run if you want to start a small business:

• Financial risk. The financial resources needed to start and grow a business can be extensive. You may need to commit most of your savings or even go into debt to get started. If things don’t go well, you may face substantial financial loss. In addition, there’s no guaranteed income. There might be times, especially in the first few years, when the business isn’t generating enough cash for you to live on.
• Stress. As a business owner, you are the business. There’s a bewildering array of things to worry about—competition, employees, bills, equipment breakdowns, customer problems. As the owner, you’re also responsible for the well-being of your employees.
• Time commitment. People often start businesses so that they’ll have more time to spend with their families. Unfortunately, running a business is extremely time-consuming. In theory, you have the freedom to take time off, but in reality, you may not be able to get away. In fact, you’ll probably have less free time than you’d have working for someone else. For many entrepreneurs and small business owners, a forty-hour workweek is a myth; see Figure 5.7 "The Entrepreneur’s Workweek". Vacations will be difficult to take and will often be interrupted. In recent years, the difficulty of getting away from the job has been compounded by cell phones, WiFi laptops, and personal digital assistants (PDAs), and many small business owners have come to regret that they’re always reachable.
• Undesirable duties. When you start up, you’ll undoubtedly be responsible for either doing or overseeing just about everything that needs to be done. You can get bogged down in detail work that you don’t enjoy. As a business owner, you’ll probably have to perform some unpleasant tasks, like firing people.

In spite of these and other disadvantages, most small business owners are pleased with their decision to start a business. A survey conducted by the Wall Street Journal and Cicco and Associates indicates that small business owners and top-level corporate executives agree overwhelmingly that small business owners have a more satisfying business experience. Interestingly, the researchers had fully expected to find that small business owners were happy with their choices; they were, however, surprised at the number of corporate executives who believed that the grass was greener in the world of small business ownership.Cicco and Associates Inc., “Type E Personality—Happy Days—Entrepreneurs Top Satisfaction Survey,” Entrepreneur.com, http://entrepreneur-online.com/mag/article/0,1539,226838–-3-,00.html (accessed April 21, 2006).

Figure 5.7 The Entrepreneur’s Workweek

Questions to Ask Before You Start a Business

If you’re interested in starting a business, you need to make decisions even before you bring your talent, determination, hard work, and persistence to bear on your project. Here are the basic questions you’ll need to address:

• What, exactly, is my business idea? Is it feasible?
• What type of business is right for me? What industry do I want to get into? Do I want to be a manufacturer, a retailer, or a wholesaler? Do I want to provide professional or personal services? Do I want to start a business that I can operate out of my home?
• Do I want to run a business that’s similar to many existing businesses? Do I want to innovate—to create a new product or a new approach to doing business?
• Do I want to start a new business, buy an existing one, or buy a franchise?
• Do I want to start the business by myself or with others?
• What form of business organization do I want? Do I want to own the business myself, or do I want to work with other owners—say, as a partnership or a corporation?

After making these decisions, you’ll be ready to take the most important step in the entire process of starting a business: you must describe your future business in the form of a business planFormal document describing a proposed business concept, description of the proposed business, industry analysis, mission statement and core values, a management plan, a description of goods or services, a description of production processes, and marketing and financial plans.—a document that identifies the goals of your proposed business and explains how these goals will be achieved. Think of a business plan as a blueprint for a proposed company: it shows how you intend to build the company and how you intend to make sure that it’s sturdy. You must also take a second crucial step before you actually start up your business: You need to get financing—the money from individuals, banks, or both, that you’ll need to get your business off the ground. (Obviously, if you already have the necessary funds, you’re one of the fortunate few who can skip this step.)

The Business Idea

For some people, coming up with a great business idea is a gratifying adventure. For most, however, it’s a daunting task. The key to coming up with a business idea is identifying something that customers want—or, perhaps more importantly, filling an unmet need. Your business will probably survive only if its purpose is to satisfy its customers—the ultimate users of its goods or services. In coming up with a business idea, don’t ask, “What do we want to sell?” but rather, “What does the customer want to buy?”Scott Thurm and Joann S. Lublin, “Peter Drucker’s Legacy Includes Simple Advice: It’s All about the People,” Wall Street Journal (November 14, 2005, B1), http://online.wsj.com/public/article/SB113192826302796041.html?mod=2_1194_3 (accessed April 21, 2006).

To come up with an innovative business idea, you need to be creative. The idea itself can come from various sources. Prior experience accounts for the bulk of new business ideas. Many people generate ideas for industries they’re already working in. Past experience in an industry also increases your chances of success. Take Sam Walton, the late founder of Wal-Mart. He began his retailing career at JCPenney and then became a successful franchiser of a Ben Franklin five-and-dime store. In 1962, he came up with the idea of opening large stores in rural areas, with low costs and heavy discounts. He founded his first Wal-Mart store in 1962, and when he died thirty years later, his family’s net worth was $25 billion.Peter Krass, “Sam Walton: 10 Rules for Building a Successful Business,” http://www.powerhomebiz.com/vol76/walton.htm (accessed April 21, 2006).

Industry experience also gave Howard Schultz, a New York executive for a housewares company, his breakthrough idea. In 1981, Schultz noticed that a small customer in Seattle—Starbucks Coffee, Tea and Spice—ordered more coffeemaker cone filters than Macy’s and many other large customers. So he flew across the country to find out why. His meeting with the owner-operators of the original Starbucks Coffee Co. resulted in his becoming part-owner of the company, and changed his life and the life of coffee lovers forever. Schultz’s vision for the company far surpassed that of its other owners. While they wanted Starbucks to remain small and local, Schultz saw potential for a national business that not only sold world-class-quality coffee beans but also offered customers a European coffee-bar experience. After attempting unsuccessfully to convince his partners to try his experiment, Schultz left Starbucks and started his own chain of coffee bars, which he called Il Giornale (after an Italian newspaper). Two years later, he bought out the original owners and reclaimed the name Starbucks.Howard Schultz and Dori Jones Yang, Pour Your Heart into It (New York: Hyperion, 1997), 24–109.

Other people come up with business ideas because of hobbies or personal interests. This was the case with Nike founder Phil Knight, who was an avid runner. He was convinced that it was possible to make high-quality track shoes that cost less than the European shoes dominating the market at the time. His track experience, coupled with his knowledge of business (Knight holds an MBA from Stanford and worked as an accountant), inspired him to start Nike. Michael Dell also turned a personal interest into a business. From a young age, he was obsessed with taking computers apart and putting them back together again, and it was this personal interest that led to his great business idea. At college, instead of attending classes, he spent his time assembling computers and, eventually, founded Dell Computers.

We will expand on this important topic of idea generation and creativity in other chapters.

Ownership Options

As we’ve already seen, you can become a small business owner in one of three ways—by starting a new business, buying an existing one, or obtaining a franchise. Let’s look more closely at the advantages and disadvantages of each option.

Starting from Scratch

Figure 5.8

Segways have made getting around large cities quicker and easier—many now offer Segway Tours.

© 2010 Jupiterimages Corporation

The most common—and the riskiest—option is starting from scratch. This approach lets you start with a clean slate and allows you to build the business the way you want. You select the goods or services that you’re going to offer, secure your location, and hire your employees, and then it’s up to you to develop your customer base and build your reputation. This is the path taken by Dean Kamen when he formed a company to design and market the Segway, and also by Tom Anderson and Chris DeWolfe when they started MySpace. Of course, for every Kamen, Anderson, and DeWolfe, there are hundreds of individuals whose venture into business was unsuccessful.

Getting a Franchise

Lastly, you can buy a franchiseForm of business ownership in which a franchiser (a seller) grants a franchisee (a buyer) the right to use a brand name and to sell its products or services.. Under this setup, a franchiser (the company that sells the franchise) grants the franchisee (the buyer—you) the right to use a brand name and to sell its goods or services. Franchises market products in a variety of industries, including food, retail, hotels, travel, real estate, business services, cleaning services, and even weight-loss centers and wedding services. There are thousands of franchises, many of which are quite familiar—SUBWAY, McDonald’s, 7-Eleven, Holiday Inn, Budget Car Rental, RadioShack, and Jiffy Lube.

As you can see from Figure 5.9 "The Growth of Franchising, 1980–2004", franchising has become an extremely popular way to do business. A new franchise outlet opens once every eight minutes in the United States, where one in twelve businesses is now a franchise. Franchises employ eight million people and account for 40 percent of all retail sales in this country.“Franchise 500,” Entrepreneur.com—Franchise, http://www.entrepreneur.com/franchises/rankings/franchise500-115608/2005,-1.html (accessed April 21, 2006).

Figure 5.9 The Growth of Franchising, 1980–2004

In addition to the right to use a company’s brand name and sell its products, the franchisee gets help in picking a location, starting and operating the business, and advertising. In effect, you’ve bought a prepackaged, ready-to-go business that’s proven successful elsewhere. You also get ongoing support from the franchiser, which has a vested interest in your success.

Not surprisingly, these advantages don’t come cheaply. Franchises can be very expensive, usually depending on the amount of business that a franchisee is expected to do. KFC franchises, for example, require a total investment of $1.1 million to $1.7 million each. This fee includes the cost of the property, equipment, training, start-up costs, and the franchise fee—a one-time charge for the right to operate as a KFC outlet. McDonald’s is in the same price range ($950,000 to $1.8 million). SUBWAY sandwich shops are more affordable, with expected total investment ranging from $80,000 to $310,000. If you’d prefer teaching dance and exercise classes, you could get a Jazzercise franchise for anywhere from $3,000 to $33,000. If you don’t want to deal in food or dance, you might want to buy a dating service. The Right One® franchises go for an initial investment of $100,000 to $250,000, depending on location.“2008 Franchise 500,” Entrepreneur.com (2008), http://www.entrepreneur.com/franchise500 (accessed October 18, 2008).

In addition to your initial investment, you’ll have to pay two other fees on a monthly basis—a royalty fee (typically from 3 to 12 percent of sales) for continued support from the franchiser and the right to keep using the company’s trade name, plus an advertising fee to cover your share of national and regional advertising. You’ll also be expected to buy your products from the franchiser.Michael Seid and Kay Marie Ainsley, “Franchise Fee—Made Simple,” Entrepreneur.com, http://www.entrepreneur.com/article/0,4621,299085,00.html (accessed April 21, 2006).

Why do would-be business owners like franchises? For one thing, buying a franchise lets you start up under fairly safe conditions, with a proven model for running a company and a permanent support team. You can profit from name recognition without having to develop your own image in the marketplace, and you can be your own boss (as long as you comply with the standards set by the franchiser).

But there are disadvantages. The cost of obtaining and running a franchise can be high, and you have to play by the franchiser’s rules, even when you disagree with them. The franchiser maintains a great deal of control over its franchisees. For example, if you own a fast-food franchise, the franchise agreement will likely dictate the food and beverages you can sell; the methods used to store, prepare, and serve the food; and the prices you’ll charge. In addition, the agreement will dictate what the premises will look like and how they’ll be maintained.

Finally, franchisers don’t always keep their promises. What do you do if the promised advertising or employee training doesn’t materialize? What do you do if you’re forced to make unnecessary and costly alterations to your premises, or the franchising company sets up a competing establishment nearby? What if the franchising company gets bad press, which, in turn, hurts your sales? You always have the option of suing the franchiser, but this is time-consuming and costly. As with any business venture, you need to do your homework before investing in a franchise.

Key Takeaways

• Before starting a business, you need to ask yourself a few basic questions:

  1. What, exactly, is my business idea? Is it feasible?
  2. What type of business is right for me? What industry do I want to get into?
  3. Do I want to run a business that’s similar to many existing businesses, or do I want to innovate?
  4. Do I want to start a new business, take over an existing one, or buy a franchise?
  5. Do I want to start the business by myself, or do I want company?
  6. What form of business organization do I want?
• After you’ve addressed these basic questions, you’ll be ready to describe your future business in the form of a business plan—a document that identifies the goals of your proposed business and explains how it will achieve them. Before you actually start up your business, you must also get financing.
• The key to coming up with a business idea is identifying something that customers want. Your business will probably survive only if its “purpose” is to satisfy its customers—the ultimate users of its goods or services.

• You can become a small business owner in one of three ways, each of which has advantages and disadvantages:

  1. Starting from scratch. This is the most common—and riskiest—option. Advantage: You start with a clean slate and build the business the way you want. Disadvantage: It’s up to you to develop your customer base and build your reputation.
  2. Buying an existing business. This option is not as risky as starting a business from scratch, but it has some drawbacks. Advantages: You’ll already have a proven product, current customers, active suppliers, a known location, and trained employees. Disadvantages: It’s hard to determine how much to pay for a business; perhaps the current owners have disappointed customers; maybe the location isn’t as good as it used to be.
  3. Buying a franchise. Under a franchise setup, a franchiser (the company that sells the franchise) grants the franchisee (the buyer) the right to use a brand name and to sell its goods or services. Advantages: You’ve bought a prepackaged, ready-to-go business that’s proven successful elsewhere; you also get ongoing support from the franchiser. Disadvantages: The cost can be high; you have to play by the franchiser’s rules; and franchisers don’t always keep their promises.

Exercises

1. (AACSB) Analysis

   If business ownership interests you, you can start a new business, buy an existing one, or obtain a franchise. Evaluate the advantages and disadvantages of each option. Which option do you find most appealing, and why? Describe the business you would probably start.

2. (AACSB) Analysis

   How would you like to spend your summer collecting trash in a used pickup? Doesn’t sound very appealing, does it? Would you quit college to do it full time? Probably not. But that’s exactly what Brian Scudamore did. And he got very rich doing it. His summer job turned into the company known as 1-800-GOT-JUNK, one of the fastest-growing franchises in the United States and Canada. Go to http://www.1800gotjunk.com to link to the Web site and learn more about the company. After looking at the Web site, answer the following questions:

   1. What is the company’s business model? What does it do? Where does it do it?
   2. Are you the kind of person the company wants to attract as a franchise partner?
   3. How much would it cost you to buy a franchise? How much total capital would you need?
   4. What kinds of support and services would you receive from the company?
   5. Assuming that you had enough money, would you buy a franchise? Why, or why not?

   As a reward for working hard, take a break and click on the Junk Genie icon on the bottom of the company’s home page (http://www.1800gotjunk.com). Can you figure out the trick? Pass it along to your friends.

Purpose of a Business Plan

The business plan is a plan or blueprint for the company, and it’s an indispensable tool in attracting investors, obtaining loans, or both. Remember, too, that the value of your business plan isn’t limited to the planning stages of your business and the process of finding start-up money. Once you’ve acquired start-up capital, don’t just stuff your plan in a drawer. Treat it as an ongoing guide to your business and its operations, as well as a yardstick by which you can measure your performance. Keep it handy, update it periodically, and use it to assess your progress.

In developing and writing your business plan, you must make strategic decisions in the areas of management, operations, marketing, accounting, and finance—in short, in all the functional areas of business that we described in Chapter 1 "The Foundations of Business". Granted, preparing a business plan takes a lot of time and work, but it’s well worth the effort. A business plan forces you to think critically about your proposed business and reduces your risk of failure. It forces you to analyze your business concept and the industry in which you’ll be operating, and it helps you determine how you can grab a percentage of sales in that industry.

The most common use of a business plan is persuading investors, lenders, or both, to provide financing. These two groups look for different things. Investors are particularly interested in the quality of your business concept and the ability of management to make your venture successful. Bankers and other lenders are primarily concerned with your company’s ability to generate cash to repay loans. To persuade investors and lenders to support your business, you need a professional, well-written business plan that paints a clear picture of your proposed business.

Sections of the Business Plan

Though formats can vary, a business plan generally includes the following sections: executive summary, description of proposed business, industry analysis, mission statement and core values, management plan, goods or services and (if applicable) production processes, marketing, global issues, and financial plan. Let’s explore each of these sections in more detail. (Note: More detailed documents and an Excel template are available for those classes in which the optional business plan project is assigned.)

Why Do Businesses Succeed?

Being successful as a business owner requires more than coming up with a brilliant idea and working hard. You need to learn how to manage and grow your business. In the process, you’ll face numerous challenges, and your ability to meet them will be a major factor in your success (or failure).“D&B—The Challenges of Managing a Small Business,” http://www.dnbexpress.ca/ChallengesSmallBusiness.html (accessed October 30, 2008). To give yourself a fighting chance in making a success of your business, you should do the following:

• Know your business. It seems obvious, but it’s worth mentioning: successful businesspeople know what they’re doing. They’re knowledgeable about the industry in which they operate (both as it stands today and where it’s headed), and they know who their competitors are. They know how to attract customers and who the best suppliers and distributors are, and they understand the impact of technology on their business.
• Know the basics of business management. You might be able to start a business on the basis of a great idea, but to manage it you need to understand the functional areas of business—accounting, finance, management, marketing, and production. You need to be a salesperson, as well as a decision maker and a planner.
• Have the proper attitude. When you own a business, you are the business. If you’re going to devote the time and energy needed to transform an idea into a successful venture, you need to have a passion for your work. You should believe in what you’re doing and make a strong personal commitment to your business.
• Get adequate funding. It takes a lot of money to start a business and guide it through the start-up phase (which can last for over a year). You can have the most brilliant idea in the world, the best marketing approach, and a talented management team, yet if you run out of cash, your career as a business owner could be brief. Plan for the long term and work with lenders and investors to ensure that you’ll have sufficient funds to get open, stay open during the start-up phase, and, ultimately, expand.
• Manage your money effectively. You’ll be under constant pressure to come up with the money to meet payroll and pay your other bills. That’s why you need to keep an eye on cash flow—money coming in and money going out. You need to control costs and collect money that’s owed you, and, generally, you need to know how to gather the financial information that you require to run your business.
• Manage your time efficiently. A new business owner can expect to work sixty hours a week. If you want to grow a business and have some type of nonwork life at the same time, you’ll have to give up some control—to let others take over some of the work. Thus, you must develop time-management skills and learn how to delegate responsibility.
• Know how to manage people. Hiring, keeping, and managing good people are crucial to business success. As your business grows, you’ll depend more on your employees. You need to develop a positive working relationship with them, train them properly, and motivate them to provide quality goods or services.
• Satisfy your customers. You might attract customers through impressive advertising campaigns, but you’ll keep them only by providing quality goods or services. Commit yourself to satisfying—or even exceeding—customer needs.
• Know how to compete. Find your niche in the marketplace, keep an eye on your competitors, and be prepared to react to changes in the marketplace. The history of business (and much of life) can be summed up in three words: “Adapt or perish.”

Why Do Businesses Fail?

If you’ve paid attention to the occupancy of shopping malls over a few years, you’ve noticed that retailers come and go with surprising frequency. The same thing happens with restaurants—indeed, with all kinds of businesses. By definition, starting a business—small or large—is risky, and though many businesses succeed, a large proportion of them don’t. One-third of small businesses that have employees go out of business within the first two years. Some 55 percent never celebrate a fourth anniversary.Amy E. Knaup, “Survival and Longevity in the Business Employment Dynamics Data,” Monthly Labor Review (May 2005): 50–56, http://www.bls.gov/opub/mlr/2005/05/ressum.pdf (accessed October 20, 2008).

Businesses fail for any number of reasons, but many experts agree that the vast majority of failures result from some combination of the following problems:

• Bad business idea. Like any idea, a business idea can be flawed, either in the conception or in the execution. If you tried selling snowblowers in Hawaii, you could count on little competition, but you’d still be doomed to failure.
• Cash problems. Too many new businesses are underfunded. The owner borrows enough money to set up the business but doesn’t have enough extra cash to operate during the start-up phase, when very little money is coming in but a lot is going out.
• Managerial inexperience or incompetence. Many new business owners have no experience in running a business; many have limited management skills. Maybe an owner knows how to make or market a product but doesn’t know how to manage people. Maybe an owner can’t attract and keep talented employees. Maybe an owner has poor leadership skills and isn’t willing to plan ahead.
• Lack of customer focus. A major advantage of a small business is the ability to provide special attention to customers. But some small businesses fail to seize this advantage. Perhaps the owner doesn’t anticipate customers’ needs or keep up with changing markets or the customer-focused practices of competitors.
• Inability to handle growth. You’d think that a sales increase would be a good thing. Often it is, of course, but sometimes it can be a major problem. When a company grows, the owner’s role changes. He or she needs to delegate work to others and build a business structure that can handle the increase in volume. Some owners don’t make the transition and find themselves overwhelmed. Things don’t get done, customers become unhappy, and expansion actually damages the company.

Help from the SBA

The Small Business Administration offers an array of programs to help current and prospective small business owners. Services include assistance in developing a business plan, starting a business, obtaining financing, and managing an organization.U.S. Small Business Administration, “Expand Your Business with Programs and Services,” Services, http://www.sba.gov/services/index.html (accessed October 20, 2008).

Through various programs, for example, the SBA is responsible for seeing that small business owners get more than $60 billion a year in financing from lenders and investors. Each year, the SBA 7(a) Loan Guarantee Program helps some forty-three thousand small businesspeople receive loans from private lenders. As you can see from Figure 5.10 "SBA Loan Guarantees, 1976–2004", the amount of money guaranteed by the program has risen considerably in the last thirty years.See Norman M. Scarborough and Thomas W. Zimmerman, Effective Small Business Management, 9th ed. (Upper Saddle River, NJ: Pearson Prentice Hall, 2006), 485–87; U.S. Small Business Administration, “Basic 7(a) Loan Program,” Services, http://www.sba.gov/services/financialassistance/sbaloantopics/7a/index.html (accessed October 20, 2008).

Figure 5.10 SBA Loan Guarantees, 1976–2004

The SBA also offers management and technical-services training. This assistance is available through a number of channels, including the SBA’s extensive Web site, online courses, and training programs. A full array of individualized services is also available. The Small Business Development Center (SBDC), a program of the SBASBA program in which centers housed at colleges and other locations provide free training and technical information to current and prospective small business owners., assists current and prospective small business owners with business problems and provides free training and technical information on all aspects of small business management. These services are available at approximately one thousand locations around the country, many housed at colleges and universities.U.S. Small Business Administration, “Office of Small Business Development Centers: Entrepreneurial Development,” Services, http://www.sba.gov/aboutsba/sbaprograms/sbdc/index.html (accessed October 20, 2008).

If you need individualized advice from experienced executives, you can get it through the Service Corps of Retired Executives (SCORE)SBA program in which a businessperson needing advice is matched with a member of a team of retired executives working as volunteers.. Under the SCORE program, a businessperson needing advice is matched with someone on a team of retired executives who work as volunteers. Together, the SBDC and SCORE help more than nine hundred thousand small businesspersons every year.U.S. Small Business Administration, SCORE—Counselors to America’s Small Businesses, http://www.score.org/index.html (accessed October 20, 2008).