Have you ever looked at a product and wondered whether the company just price it randomly or not? 

Prices should result from thorough studies, which rely on both people’s psychology and financial analysis.

While this might sound like a lot of work, it’s most certainly worth it. 

Why? 

Because pricing could be the main driver of success or failure when launching a new business. 

And that’s exactly what we are going to talk about here.

An insightful and comprehensive guidance on the art of setting the right price for maximum profits.

In this post, you’ll discover

• how Apple managed to overprice their iPhones and still make a fortune;
• why you shouldn’t price your products according to what consumers want to pay; and
• why understanding the value of your products is crucial.

The art of pricing is an essential element in today’s economy.

You might not have noticed, but pricing has become quite a hot topic over the last few years. 

Why? 

Well, as a result of the information revolution, we consumers have become more aware of and more sensitive to pricing.

These days, information on the products or services any company has to offer is at our fingertips. 

By now, many of us are seasoned online shoppers and are used to online product research until we find the one within our budget.

In light of this, many companies have placed pricing at the heart of their commercial strategy. 

Take the Apple iPhone, for instance. 

The iPhone was considered overpriced when it was first released.

However, Apple knew that early adopters and tech-obsessed people wouldn’t mind paying a premium for such a revolutionary product. 

They kept their high pricing and, in doing so, created a reference point for the market sector and their entire product range. 

When Apple slightly decreased their iPhone’s prices, people viewed this as a bargain, and sales increased once again.

Online retail giant Amazon also owes much of its success to clever pricing. 

Commodities like toilet paper or ketchup, are heavily discounted, ensuring that Amazon is the first place people will go to buy them.

Amazon avoids a price war because their competitors can’t afford to lose their profits on essential products like these.

And because so many people are buying their everyday items across Amazon now, the discounts aren’t likely to jeopardize their profits. 

Other items are then priced higher, which allows Amazon to recoup their losses.

Apple and Amazon teach us an important lesson about strategic pricing. 

It’s not about tweaking prices to perfection, nor is it about selling as much as possible; instead they focused their great pricing strategies on increasing profitability in innovative ways.

Unfortunately, many companies fail to grasp this and make plenty of pricing blunders. Next, we shall find out which pricing mistakes you should avoid.

Next, we shall find out which pricing mistakes you should avoid.

Strategic pricing isn’t simple, but it is effective.

Many companies that use pricing strategies might think they’ve picked the right approach and have got everything under control. 

Unfortunately, this is rarely the case; pricing is far more complex than simple strategies seem to indicate.

Take the cost-plus method, for instance. 

While it’s the most common pricing strategy among companies, it’s also the hardest to get right. 

This method involves calculating the costs of production and adding a markup to this cost to determine a retail price.

So, say your company makes towels. 

Between the rent for your production site at $100 and $100 worth of fabric you’ll need to purchase, your total cost is $200. 

Therefore, if you want to sell 100 towels, they’ll cost you $2 each to manufacture.

Through the cost-plus method, you can simply apply a 100% margin to your costs and you’ll end up with a selling price of $4. 

But here’s the catch: how do you know you’ll sell all 100 towels? 

This is something you can’t know for certain.

Other companies create their selling prices based on what their customers have said they’re willing to pay. 

This strategy seems foolproof at first – you’re giving your prospects the price they want, so they’ll simply have to buy!

But the problem is that most customers have no idea about a product’s actual value. 

When appliances, photocopiers and PCs first emerged on the market, most people thought they were expendable items, and would have priced these innovations at a price far lower than their real worth.

The final fatal mistake too many companies make is letting competition determine to price. 

Undercutting prices seems like a great aggressive tactic to fend off competitors. 

But it’s a recipe for disaster; competitors can easily match your price cuts, and though your discounts might boost sales, they’re unlikely to grow your profits.

Luxury car brands like Porsche could decrease their prices to sell more cars, but the increased sales simply wouldn’t cover the losses they would incur.

Value, proactivity and profits are at the core of a successful pricing policy.

Now that we’ve identified the methods we don’t want to mess with, let’s look at pricing strategies that work. 

There are 3 dimensions to successful strategic pricing: 

1. Value-based pricing
2. Proactive pricing
3. Profit-based pricing

Value-based Pricing

Value-based pricing requires that your prices change only when the value of your product as perceived by your customer’s changes. 

So, once the iPhone 10 is launched, for instance, other smartphones won’t be able to compete in terms of performance or features. 

Their value will shrink in the eyes of the customer, and their prices must be discounted accordingly.

Proactive Pricing

While value-based pricing is all about timely reactions, proactive pricing is based on anticipation. 

If you can foresee any major events that will impact prices, then you’ll need to develop and implement strategies that can help your company adapt and stay profitable.

You might need to get proactive when, say, new disruptive technology is about to launch. 

Anticipating that your customers will expect lower prices as the value of your product decreases, your company could introduce a new loyalty program that rewards returning customers. 

This adaptive strategy ensures your company has the means to maintain a stable customer base without having to resort to major price cuts.

Profit-based Pricing

This pricing strategy focuses on generating profits rather than boosting sales. 

Alan Mulally, former CEO of Ford Motor Company took profit-based pricing seriously. 

He was adamant that Ford remain profitable, even if this meant the company had to scale down. 

He gave up market shares and cut the 96 models offered down to 20.

Of course, Ford sold fewer cars as a result – but they also enjoyed great profits. 

What’s more, when the 2008 recession hit, Ford stayed afloat while many of their competitors, such as General Motors, were forced to file for bankruptcy.

Now that we’ve established the 3 dimensions of effective strategic pricing, let’s go through the 5 key steps to boost your pricing game.

Get to know what it offers to customers.

What makes someone willing to pay for your product? 

Well, it’s usually as simple as whether he/she thinks it’s any good or not! 

In developing your pricing strategy, your first task is to work out how the features of your product create value for your customers.

But before getting into that, let’s take a moment to define value. 

All too often, value is the satisfaction a customer receives through purchasing a product or service. 

This definition describes the use-value of a product or service, but it doesn’t tell the whole story.

On a hot day at the beach, a cold drink could easily have a value of $8. 

A drinks stand could capitalise on this and charge exorbitant prices for lemonade. 

But they won’t have any luck charging a price based on use value if a grocery store nearby is offering the same drinks for $2.99.

So if use-value won’t help us in our pricing strategy, what will? 

Clever pricing strategists use another indicator: economic value. 

Economic value describes the price of a purchaser’s best alternative. 

In the example above, the best alternative or reference value is $2.99. 

So, you’d need to price your offer at $2.99 and add a markup based on whatever differentiates your product from the competition.

You could differentiate yourself by lowering your price further, but there are other options too. 

Through great customer service or striking branding, you can add emotional value to your product to boost buyer satisfaction.

Jetstar differentiates itself from other airlines with its discounted prices. 

A Patek Philippe watch, on the other hand, is hardly a bargain; but it can offer great satisfaction and pride for conspicuous consumers out there.

Either way, differentiation is complex and can’t be calculated with a simple mathematical formula. 

For instance, a new drug to cure a disease that is 50% more effective does not need to be priced 50% more than its competitors – patients would be willing to pay for more!

Segment your pricing to ensure your customers all feel they’re getting great value.

By pricing your products according to their economic value and differentiating them, you’ll have completed the first step of the strategic pricing process. 

The next move is to define an appropriate range of prices.

All markets are made up of segments, where consumers are willing to pay varying amounts. 

Without creating prices tailored to each of these segments, your company will lose money.

Consider a market with 3 segments: 

1. One with a sales potential of 5,000 units where people are willing to pay $10 each;
2. Another segment with 20,000 units where people are willing to pay $15 each;
3. The third segment with 10,000 units and people willing to pay $20 each.

A supplier might look at these numbers and decide that by pricing in the middle of the range, at $15, he’d earn the most. 

But how true is this?

By setting the price at $15, people only willing to pay $10 will be disappointed and unwilling to buy, while those willing to pay $20 are saving $5 – money that could easily have gone into your profits. 

So what’s the solution?

Instead of offering a single price, you can segment the market by creating different packages suited to each target group.

Airlines give us a great example of segmentation in action. 

Rather than offering the same offer at a single price, airlines segment by charging more for extras for those who want them, such as more legroom, more attentive service and comfier seats. 

Those who are willing to pay more for first-class will do so, while those who can’t afford first-class or aren’t interested in the extras will buy economy tickets, rather than not flying at all.

In this way, segmenting is effective when certain features are valued by a target group and are unimportant for other customers. 

A vacation resort might capitalise on this by creating an all-inclusive package for golf players at a higher price for access to the golf course. 

Meanwhile, families who would rather just hang out at the pool can enjoy a cheaper family deal with only the features they’re interested in.

Give your customers the information they’re looking for.

How much effort do you put into researching products you want to buy? 

Sometimes customers simply have better things to do than read through a long list of specs. 

So, why not make it easier for them? 

The third step in the pricing process is all about how you can help clients understand why your product is a cut above the competition.

To do this, you’ll first need to assess your customer’s relative cost of the search. 

This is the effort they have to put in to find out about the pros and cons of your product. 

If your product is toilet paper, this cost is almost nothing, whereas a new car might take hours of online research.

The relative cost of the search is also affected by how much information is already out there about certain products. 

Information about search goods, such as PCs, mobile phones and appliances, is relatively easy to access, whereas information about experienced goods like services requires significantly more research.

Enter the marketer, whose job is to get customers interested in search of goods or experienced goods. 

When it comes to search for goods, a marketer will outline the product’s main features. 

These could be the type of camera on a smartphone or the staying power of a lipstick.

Experienced goods, on the other hand, require more involved in marketing. 

Free samples and free trials, such as a free first workout at a gym, allow people to assess the benefits and risks of an experienced good.

In both cases, the more information you put out there that demonstrates why your product stands out, the more people will get interested. 

Take Duracell, for example; central to their branding are the stats they use to demonstrate their products’ superiority, from how much longer it lasts, to how much money you save when you buy Duracell instead of Energizer.

Pricing strategies have a powerful psychological impact.

Did you know that 2 people who pay the same price for the same thing can have completely different perceptions of its value? 

For instance, there are 2 petrol stations:

• BP charges $1 per litre, plus a $0.20 fee for credit card payments. 
• United charges $1.20 per litre and offers a $0.20 discount per litre for cash payments. 

People paying cash will pay the same price at both stations – but a customer at United will feel like they’re winning because of the discount. 

Please do not underestimate this psychological dimension of purchasing.

Reference prices also have a psychological impact on customers, which price strategists can use to their advantage. 

For example, an expensive bottle of wine at Nobu restaurant will make all the other bottles look cheap in comparison. 

So, even if the pricey option may not sell especially well, it will indirectly boost sales of other bottles.

Similarly, smart salespeople always begin their presentations with the most expensive items, even if they aren’t in the customer’s price range, and then gradually introduces cheaper options. 

This is called a top-down selling technique and operates according to the same principle as reference pricing.

Even the way you discount products has psychological significance. 

Studies show that 68% of people would gladly leave a store where an item costs $20 and go to next door where it costs $15, thereby saving $5.

However, if an item costs $100 and $95 in another, less than 30% would switch, even though they could save the same $5. 

Why? 

It is because we think of price differences in relative terms (not absolute terms).

Most customers aren’t concerned with saving a few bucks if they’re already making a big purchase. 

Hotels take advantage of this when they market more expensive packages as including “free breakfast” or “free WiFi”, which is more enticing to people than offering $30 off.

With the psychology of pricing in mind, we’re now ready to take a look at the final two steps of strategic pricing.

Price sustainably to give your company legs.

As you get closer to pricing your offer, you’ll need a set of rules to guide you; in other words, you’ll need a pricing policy, the fourth step in this process. 

Your business is facing with uncertainty every day. 

Pricing policies are particularly useful when companies are facing changing situations that are likely to create a need for price adjustments.

Say you’re facing a sudden increase in the price of raw materials and are forced to increase your prices. 

Your clients aren’t convinced and refuse to pay more than usual. 

What would you do? 

You can’t risk alienating your clients, and your supplier simply won’t budge.

In tough times like these, honesty is the best policy. 

This is what airlines do, and while their no-refund policies might seem unfair, they’re up-front about it. 

Customers know what to expect and their rules are accepted.

With the first four steps complete, we’re onto the fifth and final stage of strategic pricing: setting the price sustainably. 

You accomplish this in three stages. 

Start by determining an initial price window with a ceiling and a floor. 

The floor (the minimum) will be the reference price described earlier.

Next, define the differential value that your price should capture, keeping in mind how long you’ll manage to stand out before your competitors follow suit. 

The higher this value, the higher you can set your initial price.

Finally, start talking to your target market about your prices and demonstrate just how reasonable they are. 

Though customers are sensitive to price shifts, they will react sensibly if they understand the reasons why. 

Don’t underestimate the power of an honest explanation!

The Key Takeaways

Pricing is so much more than setting one “right” price. 

With the 3 dimensions and 5 key steps of pricing in mind, you can ensure that your customers are paying the best price for your business and feel they’re getting the value they pay for.

Actionable advice: Price carefully.

Take care to ensure you price sensibly when launching a new product or service. 

You can encourage trials by offering it as a lower price, but you may well lose customers when you raise the price later on. 

So, look for incentives other than financial ones, such as gifts for signing up. 

This keeps people happy and maintains the integrity of your sustainable pricing.

When it comes to business, you might think there’s a starting line: a Master of Business Administration (MBA) degree, or stumbling on the right amount of money.

Wrong!

You don’t need an MBA or a winning lottery ticket to start a successful business or improve the one you’ve got.

You just need some common sense and a few basic guidelines. 

For example, every good business person knows how to negotiate, but you don’t need a whole semester to learn the key to good negotiation.

In this post, you’ll learn

• why an MBA is a big fat waste of time and money;
• how to confirm if your business idea is any good; and
• how borrowing money can increase your profits.

Business school: Not only expensive, but chances are, it won’t pay off.

Want to go into business, but have no idea where to start? 

Business school seems like a tempting prospect, a place where all the knowledge and contacts you need are simply handed to you – but is it really your ticket to success?

It has to be, right? 

Otherwise why else would people pay so much for their MBA? 

Average standard MBA school fees in Australia increased by about 2% from 2018 to 2019, with the average fee now costing about $58,384.

That’s not even including fees, loan interest or living expenses!

What if we factor those into the equation, plus the opportunity cost of lost wages too? 

Turns out the most expensive one would be the University of Melbourne’s MBA degree that costs $126,000 per year (as of 2019).

OK, so business degree costs a lot. 

So is an MBA degree worth it? 

Short answer: NO.

In the long term, an MBA does nothing for your career. 

If it did, an MBA degree should correlate with measures of success, like an increased salary, or promotions to higher-level positions. 

And it doesn’t.

Researchers from Stanford University and the University of Washington conducted an extensive study into the matter. 

Analyzing 40 years’ worth of data, they found that there is no correlation between long-term career success and possessing an MBA, whether you graduated with flying colours or just scraped a passing grade.

So if the business school can’t make your entrepreneurial career blossom, what can? 

Well, you can learn a lot from experience, and from your research online – or from a blog post like this one.

The perfect business idea balances money and passion.

Now that you know not to waste your money on an MBA, let’s get down to business – your business. 

What kind of company should you start? 

You might think that since the fintech industry is booming right now, starting a fintech company would be a smart move. 

But what if you hate fintech as a field?

Here’s a fact that more people should know: your business won’t thrive if you do it for money alone. 

Even if it’ll run itself eventually, your business will still need hundreds of work hours and generous amounts of money to set up.

For example, you’ll have to work very hard for a few years to afford to outsource mundane tasks like bookkeeping and payroll. 

If you’re only in it for the money, can you see yourself persevering until your company reaches that point? 

Probably not!

But if you start a business in a field that you like, not only will you be more likely to stick with it, you’ll also be ahead on the decision-making front. 

If you know a certain amount about the specific market you’re entering, you’ll be able to make sound decisions, develop an attractive product and tackle the competition.

Say you’re into team sports. 

This may put you in a better position to judge which products meet the needs of sportsmen, making for a better line of business to focus on – even if there’s more demand for fintech products.

On the other hand, you might feel so passionate about an idea that it impedes your judgment.

Imagine a small city, where expressionist art exhibitions are understandably in no high demand. 

When you’re an expressionist art lover, you may be oblivious to this lack of interest and try to found a museum of Expressionism right there. 

Sure, this could be a highly rewarding experience, but by no stretch is it a promising business idea – a painful truth that an enthusiastic art lover might be reluctant to acknowledge.

But let’s say you’re not an oblivious expressionist art fan or a grudging IT entrepreneur. 

Let’s say you’ve found just the right mindset to start your own business. 

The next question is – how do you enter the market? 

Underneath that there’s another question: is there a shortcut to getting all the money you need? 

Leveraging your investments can be rewarding, but it’s also risky.

So you’ve found a great new business opportunity, but you’re short on the cash you need to pursue it. 

Should you just stop right there? 

No way. 

Instead, leverage your investment.

What is the leverage? 

Simply put, it’s any technique that amplifies investor profits or losses. 

Typically, it’s the strategy of using borrowed money to increase your profit potential. 

In this way, you can make enormous gains with very little of your capital.

Let’s say you want to make a big investment that you couldn’t afford without borrowing money: you want to buy four properties at $400,000 each, but only have $20,000 of your capital. 

If you borrow $380,000 and the properties double in value, you’ll have made $400,000 with just $20,000 of your capital. 

That’s a 20X return on your investment!

But if the idea that borrowing more always means earning more seems a little too good to be true, well, you’re right. 

Leverage can be risky because it also amplifies your losses.

Let’s return to our example: imagine that the properties you bought lost half their value – your losses would amount to $200,000. 

That’s right, you’d lose 10X your own capital resources.

For a real-life example of this, you need only look to the catastrophic recession of 2008, which was caused in part by the enormous amount of leverage used by investment banks, who were caught with catastrophic losses when the property bubble popped. 

The lesson? 

Leverage can be great, but you’ve got to watch out.

We’ve all got needs, and a product that satisfies them will sell.

Many think that for a product to sell, it just has to be good – not true. 

Consider this: People will only want something if it fulfils their needs. 

Let’s put it this way – a vampire won’t pay to use your state-of-the-art solarium (unless you’ve allowed him to use it to trap unsuspecting customers!)

All our decisions are influenced by our basic needs, including our buying decisions. 

Imagine selling a bottle of stale water to a hiker lost in a desert. 

He’d be willing to pay just about anything for that lousy bottle, just because it responds to his predominant need. 

The lesson here?

Find your thirsty people.

Any successful business fulfils one or more of its customers’ needs, and Harvard professors Nitin Nohria and Paul Lawrence asserted that there are 4 needs or drives that are common to all humans.

1. The desire to acquire and collect things, whether it’s bags, shares or social status (i.e. retailers and investment brokerages).
2. The drive to bond with other people, so we can feel valued and loved (i.e. dating services, perfumeries, beauty salons).
3. The want to learn and satisfy our curiosity. (i.e. online news media, magazines)
4. The need to defend ourselves, our loved ones and our property (i.e. security and alarm companies).

Consider your business idea in the light of each of these drives. 

Which of these 4 drives could your business cater to?

A great product deserves great marketing.

Say your product meets not just one, but three of your customers’ basic needs. 

It’s ready to deliver! 

Now, where are all those clients who should be drooling over it?

Well, you’ll need to get their attention first. 

But in this age of social media and information overload, this is no easy task. 

If you want customers to pay attention, you’ll need to offer something remarkable and memorable.

And if we want to do this, we’ve got to think about the way we deliver our message to clients – the medium matters. 

For example, if the form of your message makes a customer think it’s made just for her, you’re far more likely to get her attention.

Show your customer that you’ve made the extra effort, even if it’s just with a hand-addressed FedEx envelope. 

Sure, this can be expensive, but it’s worthwhile to inform selected prospective clients in a high-quality way – certainly better than spamming an entire town’s inboxes with irritating emails.

If you want to market your product effectively, there’s another crucial aspect you should consider: the product’s end result. 

Think about it: people don’t buy a product for its own sake. 

They buy it because of the result they’re hoping to attain. 

For example, a woman won’t pay $20 for a lipstick simply because the colour is nice. 

She buys it because she hopes it will make her more desirable.

A great way to highlight your product’s result is through testimonials, in a statement made by an ordinary person who overcame adversity, all thanks to your product. 

Say you’re selling an acne cream – your testimonial could be from a pimply teenager who thought he was doomed to be an outcast until your product cleared his skin right up. 

That’s the sort of story that’s going to draw your customers in.

Even when clients are reluctant, there are ways to make a sale.

Picture this: you’re visiting a pet store and see a puppy that you’re smitten with. 

But you’re unsure whether you want to buy it. 

The owner makes an offer to you to take the dog home for a week and guess what? 

It works its charms and you can’t imagine returning it once the week is over.

This is an example of how a sales expert can convince a reluctant prospect to become a customer. 

But how, exactly?

You can increase sales if you account for your clients’ fears. 

We all hate to make a bad choice, and this makes us cautious customers.

Instead of buying the wrong thing, we’d rather buy nothing at all – right? 

In sales theory, this is called a major barrier to purchase. 

Naturally, it’s something salespersons hate.

To encourage prospects to buy something, salespersons shoulder the risk of a bad transaction – by allowing the customer to return that cute puppy if things don’t work out. 

This strategy works for non-adorable items, too. 

For example, it’s often possible to try out a bed for an entire year and return it for a full refund. 

This makes people more likely to purchase a bed.

So if you can find out why your customers might say no, you’ll be able to talk them into a “yes.” 

In sales, reasons for saying no are called standard objections, and there are several of these. 

A customer might fear the product costs too much, or it won’t provide the promised benefits, or that he doesn’t need the product yet, and so on.

If you know why your client won’t buy, you can devise an argumentative strategy and convince him that he’s dead wrong. 

Say he thinks his old laptop will have to do for a while longer. 

You can convince him that his old laptop is incompatible with essential new software.

To strike a great deal, it helps to prepare.

How do you picture a negotiation? 

You might see yourself sitting at a conference table and discussing a deal, but don’t get ahead of yourself! 

This is just the last phase of a negotiation. 

A good negotiation occurs in several stages.

The first part of the negotiation is setting the stage. 

Long before you start exchanging offers with your business partners, you can optimise your outlook in the early decisions you make. 

You could make sure you’re negotiating with the right person, for example: did the company send someone with real decision-making authority? 

Or just someone who’s been assigned to collect information for those in power?

You can also create a conducive environment by choosing the setting you’re most convincing in. 

Will you present your offer in person, over the phone or should you organise an online meeting? 

An elegant office could make a great impression, but maybe your voice is a lot more confident over the phone. 

If you’re having trouble deciding, research data in your industry or market may prove very helpful.

Once you’ve prepared, decide on the terms of your proposal. 

Consider how attractive your offers will be to the other party, and in every case, search for ways to make the offer even more desirable. 

You could even try to find out the other party’s offers. 

Then you can work out a way to make yours seem superior.

You’ve always got to consider the worst-case scenario, so anticipate possible objections and create an argumentative strategy to defuse or counter them. 

And, in case they don’t work, decide on the concessions and compromises that you’re willing to accept.

The final stage of negotiation is the actual discussion. 

Because of the effort, you put in during the first two stages, you’ll be far better prepared. 

Most of the hard work at this point is already over!

A good leader is a good communicator.

Ever had a plan that seemed great until you tried to put it into action? 

Some bosses have great schemes they just can’t implement. 

Are they unlucky with their employees? 

Or is it possible they just don’t know how to communicate with them?

Here’s what they don’t know.

If you want others to do something, you should tell them why you want them to do it. 

Harvard psychologist Ellen Langer demonstrated this in a study where her students asked others queuing in front of a Xerox to let them go first. 

60% of the people agreed, but when a reason for the request was provided, an impressive 95% complied.

Moreover, if you tell people about your intentions, everyone can work in ways that support that plan, and know what to do if the situation changes. 

This way, you won’t have to micromanage every step.

Imagine a general telling his field commander to capture a hill, but the situation changes and capturing the hill becomes strategically futile – the field commander will know how to react if he knows the larger goal is to flank the enemy.

There’s another way to boost your communication, and it’s very simple: stop putting others down. 

Yet it’s surprising how often we find ourselves dismissing our coworkers’ comments. 

It might make you feel superior but it gets you nowhere, causing your partner to withdraw from the conversation, even if you don’t notice it.

People can also become defensive and try to save face rather than understand your comments. 

Think about it: how engaged and cooperative would you be in a conversation with your boss after he said: “This is the silliest idea I’ve ever heard of.”

By contrast, effective communication sees both partners actively and comfortably exchanging ideas in a dialogue that could strengthen the entire organisation.

Use your day more effectively by listening to your body.

Sure, it’s no fun to be unproductive, but being too busy can harm you and your work too. 

The best way to be productive is, in fact, through setting limits.

If you have several things to do at once, your performance can be reduced across all of them. 

Your brain can only handle so much. 

Think of it like juggling: the more balls you’re trying to juggle at once, the more likely you are to drop them all.

Moreover, with every task come unexpected demands that take extra time and effort to deal with. 

If your schedule doesn’t allow for extra time, you won’t be able to cope with those demands, especially if they’re coming from several tasks at once.

So how can we stay in tune with what we can handle? 

Your best bet is to listen to the natural fluctuations of your energy. 

We’re not talking about a far-fetched, new age concept here – it’s simply that your productivity isn’t distributed evenly throughout the day. 

Instead, your body has a natural rhythm. 

Sometimes you can feel highly alert and productive. 

At other times, you’re far too tired to get anything done at all.

Though it varies from person to person, most people are more productive in the morning than around noon. 

We also know that energy cycles in 90-minute-spans. 

So within that one-and-a-half-hour frame, your energy will both rise and fall.

If you’re aware of these natural fluctuations, you can take advantage of the times when you feel energized. 

And more importantly, you can recognize when you’re crashing and take a well-needed break.

The key takeaways

If you want a thriving business, your product should cater to the core needs of your customers. 

By communicating confidently and cleverly, you can convince your clients to buy, your employees to cooperate and your business partners to sign your deal.

Actionable advice:

Actions speak louder than words.

The next time you have to hire a new employee, don’t go for the applicants who performed best in an interview. 

Instead, do some extra research and find out how an applicant has performed in past months or years. 

Past performance is the best predictor of future performance.

Getting a new business off the ground is no easy feat, and those who do should get the kudos they deserve. 

Unfortunately for them, the tough times don’t end when the business opens its doors. 

From day one, entrepreneurs chase growth and sales, trying to get their businesses to eventually make more money than they spend. 

But an overwhelming number never even get close. 

50% of businesses close down in the first 5 years, and those that survive do so paycheck to paycheck, often racking up debt along the way.

Needless to say, this is not the way to become profitable. 

There’s a better, more instinctive approach to earning and growing profits.

You’ll learn

• why what you’ve been taught about profit is wrong; 
• why 5 bank accounts are better than one; and
• how UPS truck drivers drove right into $6 million.

Counter-intuitive works

The traditional approach to profit rarely works because it goes against our instincts.

There are millions of businesses around the world, from corner stores to huge tech companies. 

And there’s one thing their owners all want – to make a profit. 

Luckily, there’s an age-old formula to do just that. 

Sell as much as you can, subtract your expenses, and the rest is yours. 

A straightforward route to success, right? 

Not quite. 

A recent survey conducted by the Global Entrepreneurship Monitor showed 8 out of 10 businesses folding, with a lack of profits being the main reason. 

How does this happen when there’s a formula? 

The problem is the formula itself.

The key message here is: The traditional approach to profit rarely works because it goes against our instincts.

The formula sets businesses up to fail in several ways. 

First, it triggers our natural tendency to use up whatever is available.

This was discovered in the 1950s when historian and author Cyril Northcote Parkinson came up with Parkinson’s Law, which states that the amount of work required to complete a task increases in proportion to the amount of time available. 

For example, if someone has to complete a report in 2 days, they’ll spend 2 days doing it. 

Give them a week for the same report and that’s how long they’ll take.

Swap time for money and the same thing happens in business. 

Entrepreneurs will find ways to spend whatever money is available and eat into their profits as a result.

There’s another way the formula keeps profits out of reach, and it’s through something called the Primacy Effect. 

This is people’s inclination to focus on whatever they see first and ignore the rest. 

If you see a list of words, for example, you’re more likely to remember the words at the top. 

And since the formula starts with sales and ends with profit, entrepreneurs pump effort and resources into making more sales, believing this will automatically lead to profits.

But as you’ve just learned, profits are elusive. 

So, here’s the million-dollar question: how can entrepreneurs guarantee themselves a profit? 

The trick is to rework the formula. 

Instead of subtracting expenses from sales, determine what your profits should be and then subtract them from your sales. 

So, if your goal is a 5% profit, subtract this before you’ve had a chance to spend it. 

No matter how much or how little money remains, your natural ability to work with what you have will kick in. 

Rethinking the formula is a key step in making your business profitable, but it’s just that, a step. 

Is smaller better?

Working with smaller amounts of money makes managing your finances easier.

If you’ve ever tried to lose weight, you’ll be familiar with the idea of using smaller plates to consume fewer calories. 

Because we’re compelled to pile as much as we can onto a plate, using smaller plates makes it easier to eat less food. 

When the author first heard this, he had a eureka moment. 

He was piling all his money into one big account and subsequently spending everything. 

So, to spend less, he needed smaller portions of money.

The key message here is: Working with smaller amounts of money makes managing your finances easier.

So, how do you divide your money into smaller piles? 

By setting up different bank accounts for different purposes. 

You are recommended to have 5 different accounts for your business. 

• Main income account
• Profits
• Business owner’s salary
• Taxes
• Operating expenses

Once you have your accounts, here’s how to manage them. 

Whenever the business earns revenue, you deposit it into the income account. 

Then you transfer money to the other accounts, always starting with – you guessed it – the profit account. 

Once you’ve taken your predetermined profit, you use the remaining money to fund the rest of your accounts.

You should only use each account for its specified purpose. 

For instance, you must pay any company bills from the operating expenses account, and when tax season comes around, you work with what’s in the tax account.

However, even the most disciplined people are tempted now and then. 

And so, just like some people try to avoid eating junk food and snacks by keeping them out of their homes, you can avoid dipping into two important accounts by keeping them out of sight. 

These accounts are your profit and tax accounts. 

Why? 

Well, profit is exactly what you’re trying to have more of, so depleting that account wouldn’t make sense. 

And tax? 

Just think of the trouble you can get into when you can’t pay your taxes.

To keep this money safe, these two accounts should be with a different bank. 

This is where your profit and taxes will be kept in the long term. 

After you’ve divided the money between the accounts at your main bank, transfer the profits and taxes to the corresponding accounts at the new bank. 

Not seeing this money every time you look at your bank balances means you’re less likely to spend it.

How to grow your profits

Taking small steps towards a defined target is the way to grow your profits. 

Now that you’ve got your different accounts, including one just for profits, you can start allocating the money as it hits your main income account. 

But do you immediately start taking as much profit as you think your business should be making? 

Well, like many things, good profits don’t happen overnight. Slow and steady wins the race, and this is also how you should approach your profits.

The key message here is: Taking small steps towards a defined target is the way to grow your profits. 

There is an ideal percentage that should be going towards profit, and hitting this magic number is your goal. 

So, you need to define that target percentage. 

One way of doing this is by looking at other companies in the same industry. 

Public companies have to share their financial reports, and by comparing their income to their total revenue, you can find out what their profit percentages are. 

Based on this, you’ll have a good idea of what your target should be. 

Include this in the name of your profit account so that you’re constantly aware of what your goal is. 

Now that you know where you’re going, how do you get there? 

By starting with one step or, more accurately, 1%. 

Start growing your profits by allocating just 1% of what your company makes to the profit account, and then reducing your operating expenses by 1%.

If you’re thinking that this isn’t much, remember this is a marathon to consistent profitability, not a sprint. 

Imagine overzealously taking 20% as profit, only to have your business struggle and be forced to use all those profits to rescue it. 

You’d be back at square one with zero profits, and probably a lot less enthusiasm for the process. 

Also, you might start at just 1%, but you won’t stay there for long. 

At the end of every quarter, increase your profit allocation to bring it closer to your target, and reduce your operating expenses by the same amount. 

It is suggested going up by at least 3% points each quarter. 

So, if you start with 1% going to profits, then you’ll move up to 4% in the next quarter. 

Over time, these small adjustments will pay off in a big way. 

The purpose of profits

Your profits are there to reward you and to serve as a safety net for the business.

Imagine that you’re baking a cake for yourself. 

You find the perfect recipe, gather the ingredients, and once it’s done, you cover it in icing and step back to admire your creation.

But admire is all you do. 

You don’t have a single piece or even a lick of icing. 

Now picture doing the same with your business, working hard on it and watching your profits grow, but never get to enjoy a cent. 

This is no way to treat your profits.

The key message is: Your profits are there to reward you and to serve as a safety net for the business.

This, however, doesn’t mean that you can reach into your profit account whenever you feel like splurging on something.

Instead, only take your profits at the end of every quarter, as the shareholders of large public companies do. 

This way, you’ll look forward to your profits and not misuse them or rely on them to support you.

And just as you wouldn’t – or at least shouldn’t – eat your entire cake in one go, don’t take everything that’s in the profits account at the end of each quarter and reinvest it in the company. 

Take 50% of your profits and enjoy it by spending it on yourself or your family, not the business. 

Remember, this is your reward! 

The remaining 50% should stay in the account as an emergency fund for the business and this is where you’ll keep depositing your profits.

After a while of putting money into your profit account and increasing your profit percentage, something great will happen. 

You’ll take your 50% at the end of the quarter, and realise that what’s left is enough to cover your business costs for more than 3 months! 

This is the only time you can take funds from the profit account and reinvest them in the business. 

Take the excess money, making sure to leave 3 months worth of funds, and decide how you can best use it to help grow your business. 

At this point, you should pat yourself on the back! 

You’ve got a business that’s consistently making a profit and you’ve got money in your pocket to prove it. 

But this isn’t the end of the road. 

You can free up more funds in your business and further increase your profits. 

How to do more with less

Learning how to do more with less will give your profits a boost.

Do you know that feeling of unexpectedly finding money in your coat pocket, or under the couch? 

It’s great, isn’t it? 

Guess what? You can get that same feeling from your business. 

You just need to know where to look and what to do. 

The key message here is: Learning how to do more with less will give your profits a boost.

The first place to look is at how efficient your business is. 

Is there anything you’re spending more money on than necessary? 

Which other tasks that could be done faster? 

Even seemingly small changes can have a big impact on your profits.

Just ask the people at United Parcel Service (UPS). 

In 2006, they decided to increase their efficiency and made some interesting and effective changes. 

For example, they realized that drivers spent more time waiting at traffic lights, and used more fuel when they took left turns. 

By instructing the drivers to avoid left-turn lanes as much as possible, UPS saved time and fuel to the tune of $6 million per year.

Once you’ve scoured your business for opportunities to reduce time-wasting and cut costs, it’s time to take a look at your customers and refine how you serve them. 

If all your customers have very different needs, then you spend time and money catering to the specific needs of each one. 

But if all your customers want the same thing, you can focus on how to do that one thing quickly, perfectly, and at a lower cost, until you’re serving more clients with fewer resources. 

That’s efficiency!

So, figure out what your company does best, and then get even better at it. Then, market yourself to the clients that need these services. 

The money you save will have you moving towards your profit target even faster.

It takes money to make money

Paying off your debt doesn’t have to get in the way of making your business profitable. 

You’ve heard the saying “it takes money to make money”, right? 

And as a business owner, you’re probably aware of just how true this is.

Building a company requires a lot of cash, and sometimes you just don’t have it. 

Whether it’s by borrowing money from friends and family, taking out a loan, or even maxing out a credit card or two, many entrepreneurs find themselves in debt. 

And when this happens, becoming debt-free can easily take precedence over everything else, including making a profit. 

But this doesn’t have to be the case. 

The key message here is: Paying off your debt doesn’t have to get in the way of making your business profitable. 

No matter how bad your debt is, you should continue putting a percentage of your company’s income into your profits account. 

Doing this while paying off what you owe will build your cash reserves and eventually ensure that you have enough to cover any expenses in the future.

If you’re wondering where the money to clear the debt will come from, just look in your bank account. 

Remember the profits that you’re pocketing every quarter? 

You’ll have to sacrifice some of them, 99% to be exact. 

Put 99% of your profit share towards debt payments, and keep the remaining 1% for yourself. 

Losing such a big chunk of money might sting, but this will get you debt-free much faster.

Now, having the money to pay off debts is not enough, you also have to be strategic with it. 

Here’s how.

Start by listing your debts from the smallest amount to the largest. 

If you have different debts of the same amounts, but the one with the higher interest rate first. 

Then, make the minimum payments on all the debts except the smallest one at the top of your list. 

Now, put the rest of your money towards this debt. 

Once you’ve paid it off completely, add the money you’ve freed up to payments for the next debt on your list.

Before you know it, there’ll be nothing left to pay off and you’ll have more of your profits to enjoy.

Profit comes first

Applying the profit first system to your personal life can help you gain financial freedom.

How great would it be to never have to worry about money again? 

Picture living in your dream home, and booking holidays whenever you feel like it. 

Or simply having the comfort of knowing that you can cover any expenses that life throws at you.

However you imagine a life free of financial stress, you can make it happen with the same profit-boosting tactics you’ve just learned. 

The key message here is: Applying the profit first system to your personal life can help you gain financial freedom.

Just as your business has different accounts for different purposes, you should split your finances across a few accounts. 

Have an income account where your salary is deposited, and then create accounts for your day-to-day expenses, recurring payments like rent or insurance, retirement funds, and any emergencies that might come up. 

Every time you get paid, immediately transfer a percentage into your retirement account. 

You’ll eventually have to live off this money, and so the account gets first dibs and the other accounts are filled after it.

If the debt is keeping you up at night, do exactly as you would in your business. 

Use 99% of the money allocated to your retirement for debt payments and keep the remaining 1% in the retirement fund. 

Do this until your debt is paid off and then turn your focus back on growing that nest egg.

As you watch it grow, you might be tempted to start living a bit larger. 

After all, the money’s in the bank so why not? 

But this is exactly the opposite of what you should do. 

To eventually become financially free, you need to consistently save as much money as you can. 

So, no matter how much money you see in your account, your lifestyle should remain the same. 

The author recommends maintaining it for 5 years. 

Keep your costs low by doing your research before buying anything. 

Find out if there are cheaper or free options, learn how to negotiate, and give yourself time to think about making big purchases. 

But if you’re thinking, “Wait a minute, there’s no fun in being this frugal,” don’t worry, you can enjoy a bit of your money and still save. 

Whenever your income increases through a raise or a tax refund, for example, invest only half of that money in your lifestyle and put the rest where it needs to be, in your retirement fund.

After enough years of adding to this fund, it will start earning enough interest to fully support any lifestyle you choose, making you completely financially free.

The Key Takeaways

• The best way to make sure your company makes a profit is to simply take it. 
• By immediately allocating a percentage of every bit of income to profits, you get into the habit of running your business on less money. 
• This will encourage you to take a closer look at your operations and become more innovative and efficient wherever possible, putting even more money in your pocket.

Actionable tip:

Get into a regular habit of managing your money.

Rather than waiting for the end of the month to distribute your money between accounts and make any necessary payments, start doing this every two weeks. 

Facing your finances this often allows you to keep close tabs on how your savings are faring and where your money is being spent, making you aware of exactly where you stand financially at any given point.

Ray Dalio is the founder of Bridgewater Associates (an investment firm).

He’s one of the world’s wealthiest people, so he must know one thing or two about business. 

But, as you know, running a successful business isn’t rocket science. 

Anyone can lead a great organisation by having a set of core principles that are always there to keep them on the right path.

Understanding what’s most important in your company is a personal matter that you have to figure out for yourself. 

But from a business standpoint, values like being honest with your staff to create an environment of trust and transparency.

It will keep problems from festering. 

You’ll learn:

• how running a business is like being a mechanic;
• why kindness isn’t always the best policy;
• how to build your business from the top down.

See the big picture

Look to nature and evolution to keep your eye on the big picture.

Sometimes life can be so overwhelming, with so many questions coming at you from every direction.

It feels like you’re trapped in a blizzard, unable to see more than a metre in front of your face. 

In such conditions, it’s impossible to tell which way you have to turn or what decisions you should make.

This is why you need a concrete set of guiding principles in your life.

Like having a compass in a blizzard, being equipped with such principles means you’ll always know exactly where you’re heading and which choices will keep you on that path, no matter the circumstances.

In short: having the right principles will provide you with fundamental truths that can be applied to any situation, allowing you to move toward your goals and the life you want to live.

When you’re figuring out what your guiding principles are it’s important to keep a realistic outlook on life.

Don’t fool yourself into thinking that life won’t be messy and uncomfortable from time to time. 

Ray is keenly aware that reality isn’t always pretty, and this understanding led to one of his principles: to let rational thinking be your guide, not emotions.

Sooner or later you’ll know for the fact that life isn’t always ideal, and it’s important to keep this in mind.

Think of nature. 

It’s sad to see a beautiful gazelle get eaten by a pack of vicious hyenas. 

But this is just a natural fact of life – part of the balanced ecosystem that has evolved.

If you were to deny this reality and try to intervene, it would have dangerous repercussions.

So remember that things do go wrong sometimes. 

And keep in mind that failure often provides a valuable chance to learn, adapt and evolve.

Any business that’s been around for a long time has had to adapt to change and bounce back from hard times.

Choose the right goal

It’s important to choose the right goal and to keep learning and improving.

You don’t have to be a professional athlete to put athletic training methods to work. 

Thinking of life as a game can help keep you focused on getting results and reaching your goals.

This perspective can also make it easier to get through the bad times. 

Even the best athletes have dry spells. 

So it’s wise to remember that life won’t be one long winning streak. 

When things aren’t going perfectly, it’s best to keep calm until things turn around.

But you can’t start playing without having an ultimate goal in mind.

The secret to good goal-setting is to prioritise and narrow things down.

Nearly anything is possible in life, but you can’t have it all. 

A common mistake is to reach for too many goals, all at once. 

But the truth is, whenever you choose one goal, you’re automatically ruling out some other goals in the process. 

So the smart thing is to choose wisely by looking within and identifying what you desire most.

Now, if there is something you feel passionate about but don’t feel skilled enough to master, that doesn’t mean you should push it aside. 

Remember, it’s never too late to continue your education, learn new skills and improve the ones you already have.

Once your goal is in place, the next step is to methodically examine the situation and identify any challenges or obstacles that are in your way. 

This is where being realistic is key. 

Don’t ignore problems because they’re too personal and don’t underestimate a potential issue by being overly optimistic.

If you have a personality trait like a tendency to be easily distracted, you shouldn’t avoid it. 

Acknowledging your weaknesses isn’t the same as letting them control you. 

Admitting they exist is the first step to improving yourself and learning how to control your shortcomings.

What is radical truth?

Radical truth and transparency are key to meaningful and long-lasting work relationships.

The other Dalio’s principles of doing business are: extreme truth and transparency.

Radical truth is about making sure that important issues don’t remain hidden.

It means creating an environment where employees feel free to speak their mind. 

This kind of transparency is a safeguard against poor decisions since coworkers will constantly be exchanging criticisms, making improvements and catching mistakes before they happen.

At Bridgewater Associates, radical truth applies to the executives as well.

When most companies are considering closing or selling one of their divisions, many executives usually decide to keep things quiet and only tell their employees at the last minute. 

But when this happened at Bridgewater, the senior managers held an employee meeting and were completely honest about the pending sale.

Here’s the thing: if managers aren’t upfront about an upcoming sale, it can cause a great deal of distrust and animosity among employees

It is because, in all likelihood, rumours about the sale will spread no matter what. 

So why not show respect by telling the truth?

What is Radical Transparency?

Radical transparency is similar to the radical truth. 

It means being open about the kind of behaviour and work that management expects from employees, and vice versa.

Managers and employees should treat one another as they would a partner in a long-term relationship. 

This means showing mutual respect, looking out for what’s in the other’s best interest and being crystal clear about who’s responsible for what.

You’ll find that a workplace is at its best when employees show more consideration for their colleagues than they expect to be shown. 

Yes, this is a radical approach since most people might be used to cutthroat workplaces where everyone is only looking out for him or herself. 

But you’ll find that productivity and quality will improve when employees drop the selfish behaviour and start developing strong relationships based on generosity, cooperation and honest transparency.

How to evaluate performance

Radical truth extends to performance evaluations.

Being dishonest isn’t always a malicious act. 

Indeed, people are often the most dishonest when attempting to be kind.

Once, Ray was considering promoting an employee to the Department Head. 

He knew that many of this employee’s coworkers felt he deserved the job.

However, when Ray looked at the company’s performance tracking system, which contained hundreds of pieces of data on every employee, the evidence told a different story.

The employee considered for promotion simply didn’t have the right qualities for the job.

You may think the nice thing to do in this situation would be to give the employee the position based on the praise of his colleagues.

But the secret to success isn’t radical kindness, it’s radical truth. 

You’ll be doing everyone a disservice by ignoring the evidence that the employee isn’t ready for the promotion.

As most people overestimate their capabilities and the amount of work they do, performing accurate evaluations is essential to preventing problems.

When Bridgewater Associates polled their employees and asked them to estimate what % of the company’s achievements they were personally accountable for, the combined percentages added up to 301%. 

Clearly, managers must have an accurate understanding of how much work each person is doing, because employees usually don’t.

But accuracy and honesty are not only good for the overall business; they’re also good for each employee.

Psychologists believe the biggest motivator for personal improvement is the pain you feel after making a mistake. 

When you feel so terrible about having done something wrong that you never want to feel that way again.

It’s called “hitting bottom” and it’s often what a person needs to finally change his or her ways.

It’s also important to remember that sorting out an employee’s shortcomings is time-consuming.

So it should be given priority over celebrating success.

When dealing with strengths, it’s a relatively simple matter of encouraging an employee to keep up the good work. 

For problems, you need to identify the cause and work out the solutions

All of which can take much more time and resources.

How to enhance your team’s performance

Flowcharts and metrics are great tools for enhanced performance.

When you have a goal in place for your business, you can start to think of your employees as parts within an engine

An engine that’s powering your company, or machine, down the path toward its goal.

For Ray Dalio, his goal was to provide clients with the best possible ROIs.

He often felt like a mechanic, popping open the hood to improve the engine of his company’s machine.

This analogy, of the manager as a mechanic and the company as a machine, is a great way to keep your mind focused on the responsibilities of the job and what needs to be repaired.

Every machine should have a process flowchart that clearly shows how work enters and travels from one employee to the next until completion. 

With this tool in hand, you’ll always be able to spot the exact place where problems are occurring and what you, the mechanic, need to do.

No one likes to reprimand or fire an employee, but remember that one of the fundamental principles of success is to be realistic. 

This means you can’t fool yourself into thinking there’s a way to avoid unpleasant business.

Other great tools to check your machine for possible maintenance needs are metrics / performance measurements.

When you have a system in place to accurately measure performance, it’s like having a dashboard for your machine, complete with flashing lights to alert you the moment something goes wrong.

Metrics can provide a considerable boost to productivity.

Since metrics are unbiased, accurate and reliable, they’re perfectly suited to an environment that practices radical truth and transparency. 

With an accurate view of exactly what employees are doing, and how well they’re doing it, you’ll find that the job of supervision almost takes care of itself!

Now that you know how to keep your engine running smoothly, let’s look at how to build a solid machine.

Why problems are good for you

Build organisations from the top down and keep an eye on manager-to-employee ratios.

As you move toward your goals, it’s only a matter of time before problems arise. 

But you don’t need to panic and don’t let these road bumps deter you.

Developing solutions for problems is how many companies improve. 

In other words, most problems will end up providing fuel for your machine.

However, if you hope to turn problems into advantages, you need to design your business so that you notice any problems and implement solutions straightaway.

One of the best ways to build your organisation is from the top down.

You can think of a good business structure as being the opposite of a building.

Your foundation is located at the top, which means that, first and foremost, you need to make sure you have great managers.

Every manager should be trustworthy and have high standards. 

If this isn’t the case, their weaknesses and poor performance will eventually spread to their staff. 

On the other hand, managers who show their appreciation for excellent work, and have strong oversight and strict quality control, will lead teams of employees who rise to their level of great performance.

So that they can deal with problems swiftly, each department should be given a certain amount of self-sufficiency and control over the resources they require. 

If bureaucracy is keeping departments from acting fast, your teams simply won’t be able to do their job.

The good balance ratio of managers to staff

A good rule of thumb is not to exceed a ratio of ten to one.

The ideal ratio is closer to 5 employees for every manager.

This will give your managers the best chance of having meaningful relationships and mutual understanding with each employee. 

But rather than setting strict rules on team sizes, you’ll get the best results by assessing each manager’s capabilities and proceeding accordingly.

So now you have a basic idea of the principles Ray Dalio has used to find amazing success. 

It’s up to you to start putting them to use and turning your organisation into a constantly evolving and constantly winning enterprise.

The Key Takeaways

A collection of firm principles will help you make decisions, even during the most chaotic and confusing times. 

These principles depend on you, but it’s always a good idea to build radically truthful and transparent relationships with all your colleagues. 

As a manager, you are like a mechanic, and your company is like a machine. 

You can use flowcharts and metrics to keep things running smoothly and ensure that your company is solid by building it from the top-down and keeping manager-to-employee ratios relatively small.

Actionable tip:

• Identify your blind spots.
• Everyone has areas where they’re closed-minded – that is, where they have blind spots. 
• Unfortunately, it’s very difficult to see where your blind spots are. 
• So to identify them, keep a list of the circumstances surrounding bad decisions you’ve made in the past. 
• You could ask other people – especially people who spotted what you missed – to help you in this endeavour. 

Put this list up on the wall and look at it every time you’re making a decision in your blind-spot area. 

And don’t be afraid to consult others before moving forward.

How to escape from your competitors and move into new markets

If you’re building a typical business, you’re probably operating in a “red ocean” of overcrowded, fierce competition. 

But have you ever thought there could be a way to escape and move into a “blue ocean,” that is, away from your competitors?

This post will teach you how to venture out into new waters by making a blue ocean shift.

That is, a shift from a competitive industry environment to new markets full of opportunities.

Start by learning a step-by-step framework and find out about a series of practical tools that can be used on any kind of organisation to navigate into a brand-new, wide-open market.

You’ll learn:

• how the market of french fry makers was revolutionized through a blue ocean shift;
• how a red clown nose shaped the charity industry; and
• how the luxury hotel chain citizenM made a blue ocean shift by eliminating the front desk.

How to surpass competition with blue ocean

When choosing a business strategy, it’s important to decide which direction you want it to take.

You usually think that your choices are limited to either: 

• The value-driven path: your business expands through outstanding quality and service
• The low-cost strategy: your business tries to offer the best price among all your competitors

Did you know that there is third strategy that can do much more?

It’s called the blue ocean shift. 

The blue ocean shift is about taking your business beyond competition into markets that are entirely untouched.

Just take the example of Groupe SEB, a well-established French maker of small appliances like those that make french fries. 

One of the basic assumptions in this industry was that making french fries involved deep frying and using a great deal of oil. 

Nobody ever thought to challenge this idea, even though cooking in liters of oil is expensive, dangerous, messy and, of course, unhealthy.

But in 2006, Groupe SEB came out with the ActiFry, introducing a whole new way of making french fries that requires no frying and employs just a tablespoon of oil. 

ActiFry brought in new customers, opened up a brand-new market and positioned Groupe SEB as a global leader.

In other words, the essence of a blue ocean shift is moving from a market that’s pervaded by fierce competition (a.k.a. red ocean) into a blue ocean (a market that’s wide open and full of opportunity). 

Such a move might seem like a magic trick, but there’s a straightforward method behind it that abides by three key components.

• A new blue ocean perspective that expands the horizon of your thinking
• Humanness along the way to motivate people into helping you make the shift of perspective
• Market-creating tools to transform that perspective into an attractive product.

How to create new markets

So, a blue ocean strategy can transform your business. 

Before we dive into the new perspective, humanness, and market-creating tools of applying one, though, it’s useful to learn a bit of market creation theory. 

This way, you’ll understand why making such a shift works.

For instance, you might assume that markets are established when new ideas arise that are fundamentally better or new. 

But there are actually three more specific market-creating strategies.

The majority of business leaders and entrepreneurs are familiar with the first one, you know it as disruptive innovation. 

This tactic is what the 20th century Austrian economist Joseph Schumpeter dubbed creative destruction, and it occurs when a new innovation overcomes earlier technology, thereby disrupting the industry.

Just think of the Kodak company and the photographic film industry over which it reigned. 

The invention of digital photography fundamentally disrupted both of them.

Then there’s non-disruptive creation, in which markets are neither destroyed or replaced. 

A new market is simply created without any change to existing ones.

A good example here is Pfizer’s creation of Viagra. 

This new drug didn’t disrupt the existing drug market. 

Instead, it forged a whole new market by solving a previously unaddressed problem among men – erectile dysfunction.

And finally, in between these 2 strategies is a third, often-overlooked middle way. 

This strategy comes into play when an existing problem is redefined, and Groupe SEB’s ActiFry, the french fry maker mentioned earlier, falls into this category. 

In this example, they involved both non-disruptive and disruptive forces. 

The existing industry wasn’t displaced, but it was certainly turned on its head.

In simple terms, you can either create a breakthrough product that replaces existing ones, identify and solve a brand-new problem or redefine your approach to an existing one.

Four traits of a blue ocean strategist

Alright, now that you know the basics of how you create markets, you’re ready to find your own blue ocean. 

Trait #1: Adopt a mind-set with seriously broad horizons

For instance, consider the UK charity, Comic Relief. 

The charity industry is a prime example of a red ocean: there are 600 cancer charities in London alone. 

Nonetheless, Comic Relief instituted a blue ocean shift by fundamentally reconceptualizing the industry.

Every other year since the 1980s, the charity has held a Red Nose Day, in which people do all manner of funny things to solicit donations. 

For example, a CEO might hold a business meeting with a red ball stuck on his nose, like a clown would wear. 

These Red Nose Days have been a massive success and in 2017 they raised £73 million.

But this invites the question: did they create Comic Relief with a blue ocean perspective? 

Absolutely, and there are a few ways you can tell.

For starters, blue ocean strategists think of industry conditions as malleable, and that’s precisely what Comic Relief did. 

Instead of accepting the conventional modes of fundraising, like fancy galas, the charity implemented a brand-new concept.

Trait #2: Don’t set out to beat competitors, but try to make them obsolete

In other words, Comic Relief didn’t try to copy other charities and win the donor race. 

In fact, the Red Nose Days had no competition from any other charity and effectively eliminated competition altogether.

Trait #3: Create a new demand

Rather than pitching wealthy donors, the organisation made charity attractive to everybody, no matter how tiny their contributions would be.

Trait #4: Aim for low-cost and distinct at the same time

With its fund-raising approach, the group clearly sets itself apart from other charities, but it’s also a low-cost organisation that doesn’t pour donations into year-round marketing or grant writing.

So, a change in perspective is the first step. 

A human element is central to the blue ocean process.

Before explaining the tools that make a blue ocean shift possible, it’s important to examine a fundamental concept of the process as a whole: humanness. 

Humanness is essential, as it acknowledges the fears, insecurities and desire for dignity and purpose that people inevitably bring with them.

Humanness will provide your employees with a sense of trust in the blue ocean strategy as a tool for taking them and your organisation to new and exciting places.

Three humanness key elements

Element #1: Break it down

After all, from the starting line, a blue ocean shift can seem like a daunting task. 

It requires entirely rethinking your industry.

Your team might wonder, “can we even do this?”

The answer, of course, is that you can.

But you also need to be able to break down the overwhelming task into bite-sized pieces, focusing on one at a time.

Element #2: First-hand discovery 

This piece is important since a blue ocean shift demands new ways of thinking and it’s important that every person on your team find new ways to think for themselves, through their own experience.

In other words, each and every one of them needs to feel the need for change as a result of his own thinking, not as a preordained decision.

Element #3: Fair process

In this case, a fair process abides by 3 principles: 

• Engagement: bringing all the stakeholders into the decision-making process.
• Explanation: giving a clear breakdown of decisions and ideas that are rejected.
• Clear expectations: openly stating what people will experience and what their responsibilities will entail.

Assess your situation before embarking on your blue ocean journey.

Now, with the other 2 components – a perspective shift and humanness – set in your mind, your real journey to a big blue ocean begins.

Five practical blue ocean tools

Tool #1: Pioneer-migrator-settler map

This tool lets you assess your organisation’s current products or services in a simple chart so that you know where you stand in your market.

Best of all, it’s easy to set up.

Your ultimate aim in developing this tool is to get an objective sense of your products and their value to a buyer.

To do so, you simply need to divide them into three categories.

Category 1: Pioneers

They are products with clear innovative value.

Your customers don’t just purchase them, they love them.

Your pioneers are the key to your company’s distinctive touch and future profits.

Category 2: Settlers

These are products that are based on what your competitors have to offer; in other words, they’re the result of imitating the competition and only marginally improve on what others have to offer.

Category 3: Migrators

They are somewhere in between.

These products provide greater value than the competition, but aren’t truly innovative.

To actually draw your pioneer-migrator-settler map, simply divide a square horizontally into three sections.

In the bottom section, draw your settlers as circles, in the middle do the same with your migrators and at the top put your pioneers.

Draw the circles in different sizes to reflect the revenue that each product generates – the bigger the circle, the greater the revenue.

Once you’ve drawn it all out, take a look at the breakdown.

The more your business depends on settlers, the more vulnerable it will be in the future, which is why your blue ocean initiative will endeavor to create larger pioneer circles and move your migrators up a row.

Plot your competitive value against that of your rival to get a clear picture of where you stand.

Tool #2: Strategy canvas

This is a method designed to generate an overview of your current business strategy and the competitive drivers of your industry.

To do so, the strategy canvas maps the competitive factors in your industry and how much value buyers derive from each of them.

More concretely, it’s a graph on which the horizontal axis indicates the main competitive factors within your industry, and whose vertical axis indicates the offering level of each factor from low to high.

For an illustration of this, think back to the charity from earlier.

The factors of competition in that scenario could include the percentage of each dollar that goes to the cause and the costs incurred in fundraising.

To draw your own canvas, begin by identifying key competitive factors like these, selecting between five and 12 of them.

From there, chose a key player from your industry to whom you can compare yourself.

If possible, choose the industry leader so that you know what the benchmark for your field is.

If that happens to be you, just use your closest rival.

Finally, on a scale of one to five, one being very low and five being very high, rate your offerings as well as those of your competitor for each factor, plotting your graphs as you do so.

Once you’ve drawn it, your strategy canvas has much to reveal.

For instance, if there’s a strong resemblance between your curve and your competitor’s, you’re in a red ocean of competition.

If your curve is consistently lower, your offerings are generally inferior.

In this way, the strategy canvas is a powerful tool that highlights the need for a blue ocean shift.

It will put your whole team on the same page and reveal potential ways that your organisation can break away from industry conventions.

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Tool #3: Customer experience chart

This tool enables you to uncover hidden pain points, areas in your industry that hamper the popularity of your product or scare away potential customers.

Chart customer experience to make your product more accessible.

For instance, in the United States, wine makes up just 15% of alcohol sales.

Why is that number so low?

Well, think of the last time you bought a bottle of wine for yourself.

Wasn’t it frustrating to choose between so many options?

And how many people struggle to open a bottle of wine with ease?

Pain points like these can limit the size of your industry, but not if you uncover them.

To do so, draw a buyer utility map.

Basically, this map is just a table with 6 rows and 6 columns.

The columns represent the six stages of the buyer experience cycle, namely purchase, delivery, use, supplements, maintenance and disposal. 

And the rows are for the so-called six utility levers: customer productivity, simplicity, convenience, risk reduction, fun and image and environmental friendliness.

For a wine buyer, the experience cycle would begin with searching for the right bottle, purchasing it, opening and sharing it, drinking the wine and finally disposing of the empty bottle.

During each step, the utility rows can be filled in by asking the following questions:

• What impedes customer productivity?
• What prevents simplicity?
• How is convenience hampered?
• What prevents us from reducing risk?
• What inhibits fun?
• And what hampers environmental friendliness?

When asking each of these questions, also consider why the answer has that effect.

After filling out all 36 cells in the table, consider how many of them your industry addresses.

Which pain points can you eliminate?

By understanding the pain points specific to your field, you’ll be able to make changes that’ll draw in people who are not yet buying the products you offer.

Just think back to the charity, Comic Relief.

Their Red Nose Day eliminated the pain point of making a small donation.

As a result, people who wouldn’t normally participate in a charitable drive, like children and low-income families, could play their part for a good cause as well.

Use a simple framework to uncover vast opportunities.

Tool #4: Six paths framework

This is great for producing blue ocean opportunities.

Path 1: Look over alternative industries

Your goal in doing so is to determine why customers choose one industry over another.

For instance, why do some people hire plumbers while others go to the hardware store?

Path 2: Examine strategic groups within your industry.

Your intention here is to figure out why buyers would choose one product group, say high-value, over another group, like low-cost.

Path 3: An assessment of the chain of buyers.

This refers to users who pay for your product and, in turn, influence the purchasing decisions of others. Just consider a pre-teen girl.

She has plenty of clothing, but her parents pay for it and her favourite pop star likely influenced her fashion tastes.

By identifying such a chain of buyers, you can focus on the ones your industry currently ignores.

Path 4: Consider the greater solution that buyers are seeking

To do so, assess the context your product operates in and identify what occurs before, during and after its use.

Just take the electric kettle industry in Britain, a quintessential red ocean.

British people love their afternoon tea, but before they can brew it, they have to clean the limescale out of their kettles.

Recognising this issue, the company Phillips produced a filter that removes the scale automatically.

Path 5: Rethink the balance of functionality and emotion within your industry

This will vary as some industries are purely functional, such as the legal world; lawyers don’t aim to elicit positive emotions, but are simply concerned with accomplishing their task.

Thus, you can potentially redefine such orientations to open new possibilities.

Path 6: Shape external trends that impact your industry

Begin by identifying those that affect you.

In the case of, say, agriculture, this could be climate change.

Once you’ve done so, consider ways to either adapt to, or better yet, shape these trends.

Develop your blue ocean option by challenging assumptions through a series of questions.

So, the six paths framework helps you identify potential changes you can make.

But to utilise these observations, you’ll need to distill them into clear options for blue ocean shifts.

Tool #5: Four actions framework

The basis of this framework rests on four questions and the actions that correspond to them.

Question 1: Which factors does your industry take for granted that could just as easily be eliminated?

Just take the example of citizenM, a hotel chain that forged a blue ocean shift in the highly competitive hospitality industry by offering affordable luxury stays.

How?

By cutting, among other things, the front desk and concierge services.

These basic services have long been considered a necessity for luxury hotels, but it turns out they’re not so crucial.

In citizenM hotels, visitors use a self-check-in kiosk and don’t wait in line.

Question 2: Which factors should be reduced well below the industry standard?

Here again, citizenM offers a good example.

They reduced room sizes by a considerable margin, hypothesizing that visitors wouldn’t spend much time in their rooms anyway, except when lying in bed.

But if you’re going to make cuts, you should have something else to offer.

Question 3: Which factor should be raised well above the industry standard?

For citizenM, the answer was an increase in the luxury surrounding the sleeping environment for guests.

This meant extra large beds, fine linens and utter peace and quiet.

Question 4: Which amenities or features have never been offered before and should be created?

For instance, since citizenM got rid of the front desk, the company introduced multitasking “ambassadors” whose job it is to answer the questions of visitors and solve little problems that come up.

By asking the above questions of your own business context, you can quickly formulate a blue ocean strategy that works for you.

Final step: Put your blue ocean shift into practice

Bring in your top people, select your best blue ocean option and make your move.

By following the previous step, you’ll have developed several well-formulated options for a blue ocean shift.

In this fifth and final step, your task is to pick the best one and put it into practice.

To do so, hold a blue ocean fair and invite the cream of the crop, bringing together a number of leaders from departments across your company.

You should at a minimum invite the head of your primary unit as well as her top team, the heads of marketing, manufacturing, HR, finance, IT and logistics.

You can even invite customers, partners and suppliers if you like.

At the event itself, begin with an overview of your industry, including all its red oceans, and an explanation of why you need a blue ocean shift.

Once that has been made clear, make a presentation on the different blue ocean options you have to choose from.

For each one, lead with the new product’s tagline.

Present the strategy you developed in step two with your strategy canvas and guide your audience through the four actions framework you developed in step four.

Remember, it’s vital that everyone understands the rationale behind your different options.

Once all the presentations have been made, give people some time to reflect.

You could even set up little stations with posters describing all the options for attendees to consider.

And finally, ask everyone to vote on which to go with.

This can be as simple as handing out post-it notes that people can stick on the posters they found most compelling.

You can also use the opportunity to collect feedback on why people gravitate toward a particular option.

From there, you’ll have your blue ocean option in mind and will be ready to implement your new concept.

With a little dedication and luck, you’ll be swimming in clear blue waters in no time!

The Key Takeaways

Most companies operate in red oceans, marked by intense and “bloody” competition. But it doesn’t have to be this way.

By following a systematic process, you can make a blue ocean shift that moves you beyond competition and opens up brand-new, untapped market opportunities.

Actionable tip: Create a powerful blue ocean team.

To make your blue ocean shift happen, you’ll need a multi-talented team.

Your blue ocean team should be small enough to be flexible and fast-moving, and big enough to have sufficient creativity, expertise, and experience.

Aim for 10 to 15 people representing HR, IT, marketing, finance, manufacturing, R&D and sales.

How to turn your great idea into a successful business

Do you have a business already, but want to optimise it according to the needs of your customers?

Well, then it’s probably time to develop a business model.

A sound business model is vital for any business.

It nails down:

• who your customers are, in which market you operate
• who your partners are
• which costs you have
• where your revenues come from, in which activities you engage
• how you create and deliver value to your customers

In this post, you’ll learn about the pillars of developing a business model.

You’ll learn:

• which questions you have to address when you build a new business
• how to empathise with your customers to come up with innovative ideas
• why you need to know what your customers think to themselves
• how writing short stories helps you come up with business ideas
• why Skype is free

A business model starts with your customer groups, value propositions and market channels.

There’s a business for just about everything these days: Nestlé snacks, Nike apparel, the brand of underwear you’ve got on right now.

And though these businesses seem very different, they’ve all got one thing in common – they create and deliver value for customers.

It all starts with a business model that defines a market of customers for whom a product creates value.

Element 1: Customer Groups

Customers are at the heart of any good business model – after all, a business can’t survive without them.

There are 2 main categories:

1. Mass market
2. Niche market

Category #1: Mass market

Mass market businesses cater to a very large market of customers with similar needs (i.e. toilet paper or milk).

Category #2: Niche market

Niche market businesses reach out to a smaller group of customers with specific interests (i.e. a Christian book store).

Element 2: Value Proposition

This outlines the problem that your product solves, or, in other words, the need it fulfills for your customer.

Your value proposition should also demonstrate why your product is worth choosing over others.

The value of your product can derive from one of many factors.

Stunning design might imbue your product with aesthetic appeal that beats out the competition (i.e. Apple).

Or customers might be drawn to the risk reduction that your product offers, which is often the case with IT services.

Or perhaps your product’s performance holds all the appeal – a computer that’s faster and more powerful, for instance, offers considerable value to customers.

Element 3: Market Channels

Next your business model needs an outline of the channels that you’ll use to reach out to and engage with your customers.

There are a wide range of options.

You can establish your own channels:

• a storefront
• a website
• a sales team

Or you can create channels through business partners, like a shop that stocks your product (i.e. a wholesaler).

Element 4: Customer Relationships

When reaching out to your customers, there’s more to consider than just the channels you use.

The tone and style of your outreach is equally important.

And this is why your business model should take customer relationships into account.

The relationships you build with your clients is crucial, as it’ll determine how they perceive the value of your company.

Will you give your communication with customers a personalised touch?

Or will you automate all your emails?

Or you could do a mix of the two.

Say you’re an IT company.

Customers with a particular problem might need personal assistance, while regular customers could receive automated emails with upcoming deals.

Self-service, an approach incorporated by Ikea, is another option.

Other companies even use a co-creation model, where they create value by joining forces with their customers.

Just think of Amazon, where customers write book reviews, creating value for other customers selling books online.

Element 5: Revenue Streams

If your customers are the heart of your business, revenue streams will be the veins and arteries that keep things running.

There are 3 ways to create revenue:

• Transaction revenues
  One-time payments, like when you pay for a cup of coffee.
• Recurring revenues
  Repeating payments, like the monthly subscriptions (i.e. Netflix, Spotify, Disney+).
• Usage fees
  These fees depend on how much a customer actually uses your service (i.e. your phone plan).

Element 6: Key Resources

Your business model should also set out how your company will access the resources it needs.

Think of these resources as the nutrients that’ll help your company grow and thrive.

There are 3 kinds of resources you’ll need to gain access to:

Resource #1: Physical resources

They include the materials, equipment or buildings you’ll need to run your business.

Small boutiques require a shopfront and cash registers, while consumer giants like Costco and Ikea count massive warehouses among their physical resources.

Resource #2: Human resources

Human resources are your staff – that is, the people you’ve selected because of the skills, experience and qualities they have that’ll make your business succeed.

Marketing agencies, for example, depend on the creative people in their staff.

Resource #3: Intellectual resources

These include copyrights and patents – things that companies like Microsoft and Adobe rely on.

Element 7: Key Activities

Key activities, partnerships and a cost structure are vital aspects of a business model.

Just as we need to eat, breathe and sleep to survive, your business needs to perform a set of critical activities to succeed.

These key activities can be considered in terms of 3 broad categories:

1. Production,
2. Problem-solving
3. Network or platform hosting

Manufacturing a smartphone or cooking a pizza are examples of production activities.

Consultancy is an example of a problem-solving activity, where ideas and recommendations are developed.

Network or platform hosting are the key activities of internet companies like eBay and AirBnB.

Alongside key activities, partnerships are another indispensable aspect of your business model.

Element 8: Key Partners

To run your business, you’ll need to team up with others.

Partnerships are essential to some of the world’s biggest brands (i.e. Apple partners with Foxconn to produce their iPhones).

Partnerships are also a great way to reduce risk.

Take the Blu-Ray data-storage format, for instance.

Several electronics companies decided to develop a standard format together.

This provided each company with a relative level of security.

If each company had developed their own format, they would have run the risk of being outperformed by the competition, and having their format displaced.

Element 9: Cost Structure

A business model must include a cost structure, too.

A cost structure defines where and what costs arise in your business.

Some businesses are cost-driven, while others are value-driven.

Cost-driven business models are based on the principle that costs should be kept as low as possible.

This can be achieved by reducing the amount of service provided to your customers by using automated systems.

Jetstar is an example of a cost-driven business.

Private airlines, on the other hand, represent a value-driven business model.

This approach focuses less on keeping costs low and more on offering customers a high-value product that justifies the higher prices.

Empathize with your customers to discover what they really need.

Being an entrepreneur is all about taking risks and diving into the unknown.

Just as a designer might anticipate a new trend in fashion by creating something that hasn’t been done before, it’s your job to dream up something that doesn’t yet exist.

This is no small feat, but there’s one tool you can use to get those creative juices flowing – customer insights.

By learning about what your customers really value, you can discover niches with untapped business potential.

Take Jetstar, for instance.

They recognised that lower-income customers yearned to travel by plane.

So they created a business model that took advantage of the potential in the lower-price segment.

Flexicar is another business that used customer insights to find a new niche.

They put themselves into their customers’ shoes and discovered that there was a huge demand for rental cars in metropolitan areas, if only they came without the maintenance and insurance costs.

So Flexicar created a yearly membership for their customers, allowing them to rent cars at an hourly rate.

So how can you get inside your customers’ heads like Jetstar and Flexicar did?

Empathy-map method

Try using the empathy-map method.

Start by drawing a big X on a flip chart.

1. Top: write what your potential customers might think and feel when they use your product.
2. Right: write what they see.
3. Left: what they hear.
4. Bottom: what they say and do.

This way, you’ll have mapped out every aspect of your customer’s experience.

Now, combine this map with customer personas.

This is a fictional profile of your ideal customers outlining their demographic details, including their age, marital status, income and state of employment.

With your map and your ideal personas ready, it’s time to ask some key questions about what they think, feel, see, hear, say and do.

• What emotions do your customers experience?
• What do they think or feel that they don’t share with anyone else?
• How does their environment look like?
• What kind of people are they surrounded by?
• How do those people influence them?
• What do they hear from their wives, husbands, friends and colleagues?
• What do they tell other people?
• And, finally, how do they act in public?

This comprehensive set of questions will allow you to uncover wishes and needs that your customers might not even realise they have.

And these latent wishes and needs may become the key ingredients to your business’s success.

Get inspiration for your business by writing scenarios with your customer as the good guy.

Just as a scriptwriter dreams up a compelling story filled with complex characters, you can bring your business model to life by writing out business scenarios.

There are 2 main writing approaches you can use to create these scenarios.

Approach #1: Come up with straightforward scenarios that your customers might face

Take your empathy-map and use it as your inspiration to write a short text about each of your customer personas, detailing their needs, aspirations, goals and worries.

These scenarios should be about 300 words each.

Okay, now what?

Well, let’s say you’re a telecom operator keen on taking your GPS technology to the next level.

You might want to create the following scenarios featuring your customers as characters: Tourists visiting Rome without planning their day and having to rely on guidance from their GPS.

Or a young entrepreneur running a small home-delivery service using her GPS to navigate shipments to her clients.

Approach #2: Imagine the world your customers might face in the future

For example, if you’re a tech company, why not write a scenario about the future of public transport?

Consider how today’s emerging technology – from big data to AI to the internet of things – will change the way we get to work or drop our children off at school in 50 years time.

• Will we still need train drivers? Or will intelligent systems take their place?
• Will WiFi on underground trains become the norm?
• What about new tools that allow us to track our children’s paths as they head home from school?

While building these forward-looking business scenarios around your customer personas, you’ll find the inspiration you need to create business models that don’t just solve today’s problems, but are flexible enough to solve tomorrow’s, too.

Writing business scenarios isn’t the only way you can get inspired.

Successful brands are another great source of inspiration.

Freemium and open-source models are disrupting business today.

Imagine you’re living in Melbourne and your sister has just moved to Gold Coast.

How do you keep in touch with her?

Expensive long-distance phone calls?

The occasional email? Nope.

Chances are, you use Skype.

Ever wondered why this service, which provides so much value, is free?

Freemium model

Well, Skype’s founders put themselves in your shoes, learned what you needed and wanted, and then built their business model: freemium.

The freemium model means customers can use a service for free, with the option to pay for more advanced or comfortable services.

Essentially, these premium customers cover the costs of free users.

This is the case at Skype, where a large user base can take advantage of the basic product for free.

Customers who opt to pay more get more value, such as the ability to call landlines.

The freemium model works particularly well for web companies, but could be applied to any business as long as the pricing is viable.

So how do you make sure freemium will work for you?

Well, you’ll need to determine the average costs that free users will generate, as well as the rate at which they convert to paying customers.

These numbers will help you decide how much you need to charge for premium options to make your business profitable.

Open-source model

A clever variation on the freemium model is the open-source model.

Let’s look at software company Red Hat.

They knew that they could build a strong business around free, open-source software if they offered customer support and malware testing alongside it.

Today, Red Hat provides free software created by their community of passionate open-source developers.

You can get this software for free as a self-service product.

But customers also have the option to pay a yearly fee to Red Hat for their support, maintenance and upgrades.

The key difference between this and Skype’s freemium model is that Red Hat’s software is provided by developers who work for free.

There’s one more business model to consider.

It’s called the long-tail model, and we can learn a lot from it.

Long-tail models use strong platforms to create a community of customers that double as creators.

Who hasn’t heard their older family members complain that, back in the good old days, life was simply better?

It’s true that things were simpler.

Back then, there’re a few standard products for everybody.

Today, on the other hand, there’s a huge variety of brands offering just about every product.

That’s why you can consider selling a small variety of products to a large number of people.

This is the basis of the long-tail model, which helps businesses take a market lead in particular industries.

Take the book-publishing industry, for example.

Typically, a small variety of hit manuscripts are published and then distributed to a large number of people in large quantities.

But in recent years, platforms like Lulu.com have disrupted this model by publishing a wide variety of niche literature – but on a small scale.

Inventory costs are kept low by printing books on demand, which, in turn, keeps revenue up.

Long-tail businesses can succeed if they have a strong platform for customer outreach.

In Lulu’s case, people who submitted their works also became customers, as they also read books offered on the platform.

Lulu created a tight-knit online community where authors could publish, distribute and sell their books, as well as find and buy others’ work themselves.

Another example is Lego.

The company gives customers the chance to design their own figures, buildings and vehicles – they can even design the packaging.

For this to succeed, Lego built up an online platform and community where customers could design their products and place orders for existing products.

By opening up the means of production and distribution to the individual user, these long-tail businesses show that, today, anybody can be a designer, writer and creator.

The Key Takeaways

So the key is that successful companies are built on business models that take just about everything into consideration, from your customers to your pricing to your communication and resources.

By stepping into your customers’ shoes and exploring innovative variations on different business models, you can find the inspiration you need to create a blueprint for a business that adds value to your customers’ lives.

You probably already know that restaurants such as McDonald’s and Subway or the convenience store 7-Eleven are franchise businesses.

But do you know what exactly this entails?

More importantly, would a franchise be the right option for you if you were to expand your business?

After all, franchising is only one of many options.

This post will help you to figure out if franchising is the right step for your business pursuits.

They’ll outline the key advantages of franchising, while also offering some insights as to why not all companies will work as franchises.

You’ll also discover

• why franchisees tend to be very committed managers
• why most businesses usually aren’t franchises
• three possible ways to structure your franchise business

Franchises are built on mutually beneficial relationships between business owners and their franchisees.

When it comes to modern business, franchise structures are everywhere.

Many companies today increase their market share and expand across new areas by creating a franchise.

So what is a franchise exactly?

A franchise is a partnership between a franchisor and a franchisee.

A franchisor is typically someone who already owns a thriving business.

Franchisors create a contract that allows another party, the franchisee, to copy and use the existing business model. And with that, a franchise is born!

Hold on; you might be thinking – why would any aspiring business owner want to join a franchise?

After all, wouldn’t it be more exciting to create a unique business of one’s own?

Sure!

But starting your own business, as we all know, is tough.

Becoming a franchisee, on the other hand, has a lot of perks that make those difficult first stages easier.

Franchisees can take advantage of the franchisor’s brand, trademark and customer base, rather than having to build up their own from scratch.

Franchisees also benefit from the training provided by the franchisor, helping them set up and run the business as smoothly as possible.

Plus, franchisors provide ongoing support in challenging areas, including finance and operations.

This way, franchisees can hit the ground running and get their branch off to a great start.

Of course, franchisors don’t take care of everything for the franchisee. Franchisees invest their own money and are responsible for all loans made to open up the new branch.

They’re also expected to pay a certain percentage of their sales to the franchisor and buy supplies, from ingredients to branded equipment, from them as well.

The advantages

Expanding through franchising has several advantages over just opening new company-run units.

If you’ve got a great business on your hands and are ready to take the next step, what are your options?

Business owners looking to expand might think about opening another business unit operating under their management but this can be expensive and time-consuming.

Franchising offers a more cost-effective alternative to growing your business. Let’s take a closer look at three key advantages.

Advantage #1: Franchises require less money to get started

You’ll need capital to set up another company-owned business unit,.

To get the funds you need, you’ll find yourself grappling with banks to set up increasingly expensive loans or struggling to win the attention of investors in equity markets.

You as business owners can create franchises to avoid all this hassle.

As we learned in the previous section, franchisees invest their own money and carry the risk of the business themselves.

This means that franchisors don’t have to raise anywhere near as much capital to open a new branch.

Advantage #2: Franchisees make great managers

No matter how you expand your business, you’ll have to delegate control to others.

But managers hired to run new company-owned businesses are likely to act rather selfishly since their livelihood doesn’t directly depend on the survival of your brand and business.

Managers of franchise branches, on the other hand, carry the risk of the operation; they’re personally invested in the business and will want to see it succeed. As a result, franchisees tend to be responsible and reliable managers.

Advantage #3: You can expand much faster with franchising

Taking the latter path means a lot of managerial work ends up on your plate, from finding a new location to hiring staff, whereas franchisees will take on this managerial work themselves.

Then you find the individuals willing to become your franchisees.

Businesses must have a reproducible model to become a franchise.

We now know that franchising has a whole host of benefits. But when deciding to start a franchise, there are a few more factors to consider.

The conditions

The truth is that not all businesses make good franchises, so how can you tell whether it’s worth becoming a franchisor or not?

There are two essential conditions that any company hoping to jump into franchising needs to have covered.

Condition #1: Your business must look promising to franchisees

You want potential franchisees to jump at the chance to put your name on their shop front, so your business needs to have the edge over competitors.

So HOW can you differentiate yourself?

Start out by working out your unique selling points.

Unique selling points can be anything from a viral marketing strategy to eco-friendly company values to a just plain brilliant product.

Even the pizza franchise Domino’s has unique selling points that help it stand out from the competition, such as its strong focus on delivery service.

If there are just too many competitors with similar products out there, your business can still win over franchisees with promises of significant benefits.

Many lawn-care companies are part of a franchise, has signed up because of the great marketing and support networks offered by the franchisors.

Condition #2: The business must be easy to reproduce

Once you’ve sealed the deal with franchisees, they’ll have to build up a replica of your business, which means learning everything about its operation and they’ve got about 3 months to do it.

If your business model is too complicated to be taught and reproduced within three months, then franchising may not be your best option.

Be mindful that not all products can be a hit in every region. Different cities come with various customers, who in turn have different tastes.

After investigating whether your business is suitable for franchising, it’s time to think about whether a franchise model suits you personally.

Some caveats

Before starting your franchise, consider whether it suits your future and personality.

Doing your business into a franchise is no easy task.

It takes a lot of effort to build up a winning franchise system, and this should fit into your plans for the future, both professionally and personally.

Start by asking yourself where you want to be with your business five years down the line.

Do you still plan on running it, or do you hope to have sold it by that time?

If you’re planning to sell, you’ll want to maximise the value of your business so you can get a good price.

In this case, franchising is a sensible option: you can expand quickly, which means you can attain a higher valuation for your business sooner.

Next, ask where you are with your business now.

Consult your finances, and consider some of the challenges your business faces.

Is your business concept a valuable one?

If it is, then there’s just one last question to ask: are you the right person to start a franchise?

Franchisees are business owners themselves, often with experience and, sometimes, strong opinions.

To build a successful relationship with them, you’ll need to have some leadership skills up your sleeve.

In the best-case scenario, you and your franchisees should be able to work together on new ideas and strategies to keep your brand moving forward.

As well as being a good leader, you need to be a great salesperson.

As the franchisor, you call the shots when it comes to the direction of your business.

You must be able to sell your ideas to your franchisees, helping them see things from your perspective.

Explain your choices, and make it clear how the whole franchise will benefit from them.

If you’ve gotten this far and have decided to enter the franchise business, it’s time to start your preparations!

Great franchises are built on solid plans & fitting structures.

There are over 1,160 franchise companies active in the Australian market according to Franchising Australian survey in 2016.

So what does this mean for you?

Well, put it this way: the days when a bright idea was enough to make a load of money through franchising are gone.

Nowadays, a clear franchise plan is what will ensure your business’s survival.

A franchise plan should outline how you envision working with your franchisees.

It’s vital that you have a fixed set of rules to follow.

This will help you stay on the right track and keep your franchise relationships healthy.

Like any good plan, your franchise plan must include goals, as well as the steps you need to take to achieve them.

Start by deciding on the kind of franchise structure you’re aiming for.

You could take the single-unit approach, which allows each franchisee to open one business unit each.

This strategy was behind the successful expansion of McDonald’s to just about every city in the world.

Area development franchising

Another option is area development franchising.

This means creating a contract with an area developer, who then retains the exclusive right to open up a certain number of business units in an agreed-upon area.

Pizza Hut and KFC are known for their use of this franchising strategy.

A third alternative is sub-franchising, most often seen in international markets.

This entails giving another individual the rights to act as a franchisor in a particular region.

This company will take care of negotiations with new franchisees and provide support for them, in exchange for a fee paid to you, the franchisor.

Each of these options has its benefits and disadvantages.

The single-unit franchise requires that you give your franchisees a lot of support, which could lead to high costs in training and management.

If this doesn’t sound feasible, then area development franchising could be a better bet.

That way, you’re able to rely on qualified franchisees to take care of support and management.

After setting up your franchise according to your plan, the job isn’t done!

You need to maintain your franchise so that it continually generates profit and grows.

The quality control

Quality control is essential to upholding your brand values across branches.

Franchisees are a little different from your garden-variety managers.

You can’t fire them easily, and you can’t control how they run their business as much as you’d hope.

Because of this, you need to ensure your brand gets the protection it needs.

How?

By creating a quality control system.

An efficient quality control system starts with hiring professional and reliable franchisees.

The right candidates need not only business chops but a strong work ethic too.

This way, you can be sure that they’ll provide your customers with top-notch service.

If a franchisee is a good businessperson but hurts your brand image by disrespecting customers, your brand will run into serious complications sooner than you think.

What is franchise operations manual?

It’s a good idea to create and maintain a franchise operations manual.

This is a guidebook for your franchisees that details how each aspect of you should run your business.

A franchise operations manual also serves as a legally binding document that you can write into your franchisee’s contract.

This way, you can ensure that every franchisee is committed to maintaining the standards of your brand.

In fact, one legal case illustrates just how great operations manuals are.

In Ketterling vs. Burger King, a customer took the fast food chain to court because she slipped on snow in the parking area of one of its branches.

But because Burger King had specified in their operations manual that day-to-day maintenance was the task of the franchisee and not the franchisor, they couldn’t be held responsible for not removing the snow.

Finally, you can ensure that your brand upholds the quality standards of your brand by providing adequate training and support to your franchisees.

You shouldn’t underestimate the importance of these two aspects of franchising!

Training doesn’t mean just one introductory crash course in your business with a new franchisee.

Instead, ongoing training is required to ensure branches are consistently performing well.

You can make ongoing training cost effective by going digital.

Online videos and training programs allow franchisees to brush up on their skills anywhere, anytime.

Regional meetings and annual conventions are also great fixtures in a franchise’s calendar, enabling teams to come together and get to know each other.

Ensure long-term success for your franchise through honesty, feedback & communication with franchisees.

With all this talk of business standards and quality control behind us, it’s time we take a closer look at the human side of franchises.

A great relationship with franchisees is essential to your business’s success and growth – and it all starts with healthy communication.

When establishing relationships with franchisees, roles should be defined.

They should know where they stand and feel comfortable with the fact that you’re there to protect the brand and supervise your network of franchisees.

While certain sanctions may be necessary to communicate to franchisees that they’ve overstepped their roles, be careful not to slip into the role of a dictator; franchisees have the right to receive explanations for your business decisions, so let their voices be heard too!

Be open and honest

By being open and honest with your franchisees, you can secure their trust and loyalty.

Get in touch with them on a regular basis and be sure to respond to their e-mails and calls as quickly as possible.

They’ll appreciate it and will know that they have your support.

Give feedback

Finally, give your franchisees the opportunity to provide feedback.

Unfortunately, many franchisors forget that their franchisees need a space where they can express their concerns.

These constructive conversations are essential to successful long-term relationships, so be sure to make them part of your franchise operations.

From open discussions with outspoken employees to anonymous surveys to help more private team members express their opinions, feedback is a cornerstone of thriving franchises.

The Key Takeaways

From winning over franchisees to creating a franchise business plan to establishing routines of quality control, setting up a franchise requires preparation and dedication.

But with a strong brand, clear communication channels and an appropriately tailored model, you can ensure your business enjoys the many perks of a franchise strategy.

Actionable tip:

Never stop supporting your best-performing franchisees.

Next time you think those franchisees whose numbers are always outstanding don’t need that monthly meeting with you, think again!

Though it’s tempting to shift your time, money and support to branches that need the extra help, it’s essential that you never stop caring about any of your franchisees.

Rather than creating an imbalance in your attention and resources across branches, tailor different kinds of support to each franchisee’s needs.

Even successful branches have the potential to do better!

You own a small business, and things seem to be going well.

You’ve managed to survive the first few turbulent months and have even started to grow the business a little.

What should you do next?

Common wisdom would advise that you focus on revenue and maximising sales.

You borrow, you hire more staff and take all the orders you can, anything to keep the money coming in.

That’s not the right path.

We’ll show you how sticking to this simple yet flawed strategy will lead you toward ruin.

Far from the money you think you want to come in, it’s the money going out that matters.

Revenue means nothing if you are spending more than you earn.

Profit is king, and we’ll show you how to go about securing it.

Here you’ll discover:

• why every business leader should pay themselves what they deserve;
• why you should never, ever go into debt; and
• why you should pay your staff as a winning AFL coach would.

Pay the correct market salary

Business owners or entrepreneurs should always pay themselves the correct market salary.

Here’s a surprising figure: 90% of small business owners pay themselves less than a fair market salary.

And in many ways, this is a rational choice: After all, by lowering their salary costs, business owners can make pre-tax earnings look much stronger.

But despite this, many should always pay them the correct market salary.

There could be two reasons.

Reason #1: By not paying yourself (or your staff) a market-based wage undermines your business

Pre-tax profits and labour expenses are key figures which affect substantial financial measures such as labour productivity, or the portion of pre-tax profits to revenue.

By artificially altering them could affect your ability to grow your company.

You should also know that ATO has included this tactic – that is, underpaying wages – in a list of “dirty dozen” tax frauds used by closely held corporations.

Accordingly, ATO is increasingly choosing to audit companies suspected of employing this practice.

Reason #2: Paying yourself a market-based wage is crucial when it comes to selling your business or making an exit.

That’s because your company’s profitability is a key factor in determining its fair market value.

So when an outside party looks at your books before purchasing your business, artificially lowered salaries could project doubt on your company’s value in the eyes of a potential investor.

Alternately, paying yourself a market-based wage from the outset will save your business cash flow problems (and the nasty surprise of diminished earnings) if you choose to exit and replace yourself with an external CEO who’s expecting to earn a market salary.

Focusing on healthy profits will guide your business through its critical adolescent years.

At some point, every company risks falling into a black hole.

We aren’t talking about space travel.

A black hole is when your revenue first surpasses $1 million, and there’s an increased demand for staff, but not enough capital to pay for new employees.

At this point, many business leaders will focus on balancing the budget, but that’s not sufficient.

If you want to dodge the black hole, you must aim for 10% to 15% pre-tax profitability.

In other words, getting through a black hole is like a pioneer making a road trip from Melbourne to Sydney.

Even if you stock provisions from the outset, if you deplete your resources too soon without adding more as you go (or if you incur losses but don’t build gains as you grow), you’ll never make it to Sydney!

That’s exactly why your goal should be to accrue strong earnings while you grow.

By reinvesting profits and building your capital reserves, you’ll make it through that black hole.

What’s more, the benefits of being profitable while you’re in a black hole don’t end when you get out of it.

Because if you choose to sell your business, historical profitability will have a vital impression on your company’s value.

Prospective investors will want to see your last three years of pre-tax profits and equity – a broad measure used to gauge your company’s value.

Thus, a company that has achieved 10% to 15% pre-tax profitability will have a considerably higher market value than another company with smaller profits or none.

Do you want to position your business to achieve an optimal market value? Of course!

Keep labour costs down and have a salary cap

Keep labour costs down and protect 10% of your profits by implementing a salary cap.

As we discussed in the previously, 10-15% profitability should be your company objective.

But how can you accomplish it during that black hole period, when you’ll need to hire new staff to fulfil growing demand?

Firstly you have to understand the relationship between labour expenses and profitability.

You already know that labour is a significant cost in running a business.

But unlike rent and supplies, labour is a cost you can control.

And that’s exactly why you should introduce a salary cap to protect at least 10% of your profits.

Imagine you’re earning $1 million in revenue.

In that case, you should aim for profits of at least $100k.

Simply combine all your non-labour costs and subtract them from your $900k operating budget.

Whatever is left is your firm’s total salary cap, and should include all labour costs (including your market-based wage).

But then to keep growing, use the salary cap as support to shift between 10% and 15% profitability.

Once you have a salary cap based on 10% profits, you can set your sights on growing profits to 15% by recalculating your salary cap accordingly.

Then, you should concentrate on enhancing productivity, rather than increasing revenue.

Once you’re at 15% profitability, and it’s time for you to hire new staff.

Increase productivity

Productivity increase is essential to meet your salary cap and reach profitability.

We’ve learned that often you’ll need to focus instead on enhancing the productivity of your existing employees instead of just hiring new staff.

But what does it take to build and sustain productivity?

Start by measuring productivity at your company by using the following equation: productivity equals gross profits divided by dollars spent on labour.

(And to calculate gross profits: gross profits equal revenue minus the cost of goods sold.)

While it may seem simple, this is a powerful tool as it provides evidence for your intuition and allows you to spot and respond to negative trends quickly.

And once you’ve calculated this metric, you can start implementing new practices to enhance productivity at your company.

Start by ensuring you compensate employees appropriately.

This is important, as paying too little leads to high turnover, which is not only costly but also disruptive to the workplace and detrimental to productivity.

Overpaying is also a problem as it eats into gross profits and thus negatively affects productivity.

You might be overpaying someone if their job requires fewer skills than it did in the past, due to the emergence of new technology, for example.

So instead of overpaying or underpaying, strive to pay your employees a reasonable market-based wage.

And once you’ve calibrated your compensation structure accordingly, you can implement an evaluation system to increase productivity.

The benefits of doing so include instituting a better way to manage employee expectations; a way to highlight areas for improvement; and especially, turns your focus toward career planning.

This last point is especially beneficial for productivity, in that it encourages employees to develop their skills and stay motivated.

It will also improve employee retention, which saves time and money.

And to get the most out of employee evaluations, it helps to identify three to five skills that could improve productivity for each role.

Additionally, it’s good practice to ask each employee to describe how their role contributes to the firm’s targeted profitability level.

The four forces of cash flow

Pay attention to the four forces of cash flow: tax, debt, core capital target and distributions.

Labour costs aren’t the only thing involved in running a healthy business.

If you want to stay solvent, understanding the four forces of cash flow is crucial.

So here they are – the four forces:

Force #1: Tax

Put money aside to pay taxes. Failure to do this can create liquidity problems, even if your business is profitable.

Force #2: Debt

You run the risk of default and foreclosure when you fail to meet debt payments.

Force #3: Core Capital Target (CCT)

A buffer to cover normal fluctuations in cash flow. We’ll discuss this in further detail below.

Force #4: Distributions

Once you’ve covered the first three forces, you can safely start distributing some of the company’s profits to yourself.

This is crucial, so we’ll say it again: you shouldn’t pay distributions until you’ve built up enough cash reserves to handle the first three forces.

And this gets us back to our 10% to 15% profitability goal.

This principle is also crucial for cash-flow management, as profit reinvestment will help your business reach your CCT.

It’s important that you keep these forces in mind and follow them, as unquestionably, there are always highs and lows in the business cycle.

You will experience periods when money is tight – just think about tax time when all that cash flows out of your bank account!

The Core Capital Target (CCT) is there to cover these cyclical swings.

And you can calculate the CCT simply by reviewing your company’s history.

As a rule of thumb, it’s recommended that you build up two months of operating expenses.

For example, if your start-up deals with long waits on account receivables, the CCT might need to exceed two months of operating expenses.

As we mentioned earlier, you can invest your profits to build this buffer.

This should be a top priority before you even think about taking distributions from the company.

If you need to raise capital, it’s better to live off your savings than going into debt.

As we’ve learned, maintaining 10% to 15% profitability is the best way of raising capital.

Don’t borrow to raise money

Debt is dangerous, so it should only be your last resort.

That’s because when you borrow other people’s money, you’re more likely to take risks with it.

When you start a business with your money, in contrast, it does feel more precious; therefore you will be more cautious.

You should treat borrowed money the same way.

Remember: debt is dangerous!

This also applies to start-up capital from venture capitalists.

These people tend to be cautious investors who expect growth and a high return on investment.

And all too often, after a company’s growth plateaus, investors decide to wind up their interests and sell business assets.

But what should you do if you don’t have that much money to invest upfront?

It’s called sweat equity.

As we’ve discussed, when you’re running a business, it’s important to pay yourself a market-based wage.

But temporarily paying yourself a below-market wage is way better than taking on debt.

Just make sure you’re living on your savings and not your firm’s after-tax profits!

Let’s say your market-based wage would be $75,000 annually.

And if you don’t pay yourself a salary the first year and only pay yourself $25,000 the second year, you’ve just added $100,000 to your company’s equity.

Plus, having this kind of blood-sweat-and-tears work ethic will allow you to focus on productivity and profitability.

It’s the safest path to rapid wealth creation!

Spot trends and quickly take action

Regularly monitoring key measures will allow you to spot trends and quickly take action.

The secrets to your company’s success are already there; they’re just buried in the data.

And that’s why regularly monitoring key measures will help your business thrive.

Don’t overwhelm yourself with too many numbers.

Find just a few, ones that are essential to your company’s survival and positive development and growth.

Crucially, you have to pay attention to your cash balance every day.

Especially if you’re new, as younger companies are at risk of falling into cash deficit in the first few months.

For new companies, being vigilant about the cash balance is an existential matter.

Knowing what’s happening daily will allow you to focus on getting your bills paid.

And then on a weekly basis, you should mind three metrics: sales, labour productivity and the cash-flow forecast for the next fortnight.

This is where you need to be watching for trends.

For example, if you notice a decline in labour productivity over the course of two weeks, you can work on turning things around before any serious harm is done.

Creating a meaningful profit-and-loss (P&L) statement will also help you spot trends and give you time to make necessary adjustments.

And that’s why you should look specifically at “rolling” profit-and-loss statements.

Ordinary P&L shows revenue, costs and expenses, along with the primary performance measures like labour productivity or any salary caps.

Separately, a “rolling” P&L focuses on just the last 12 months, revealing many trends.

For example, if you aren’t meeting your 10% to 15% profitability goals, you can see what your salary cap should have been to reach the target.

Carefully monitor metrics to forecast your cash flow and identify problems before they pop up.

Once you’re in the habit of regularly monitoring key metrics and looking for trends, you can also implement forecasting to maintain your business growth dynamically.

Cash-flow forecasting might sound daunting, but it’s easy to master.

Here’s how it works:

When you take your profit-and-loss (P&L) statement, you’ll note several future key costs that you can predict with some certainty, like rent.

And you’ll see other fees, like labour, over which you have significant control.

And then, looking at your performance over the last few months, you can make solid educated guesses for things like operating expenses and projected revenue.

Since we’re forecasting cash flow, your P&L history will also reveal payments that haven’t yet come through.

This information will allow you to predict future cash flow and also spot any discrepancies.

And that gets to the power of forecasting – going back periodically and checking the accuracy of forecasts will give you insight into potential problems before they do too much damage.

To do this effectively, you have to predict all your key metrics (like labour, productivity and accounts receivable) concerning your profit target.

By working backwards from your profit goals and Core Capital Target (CCT) targets, you’ll be able to identify desirable productivity rates, labour costs and other factors.

And once you’ve done that, you can then ask yourself: Have I reached my goals?

Am I moving in a positive or negative direction?

The answer to the second question is especially crucial because it provides a warning sign if things are going south.

That way, you can check your metrics, figure out the problem and fix it.

Don’t forget that companies can’t be moved or turned on a dime!

Understanding the relationship between the various metrics buys you time and gives you the opportunity to steer your business true before you crash and burn!

The Key Takeaways

Sustaining profitability, avoiding debt and improving productivity are some of the sound business practices that can help you boost profits and raise your company’s market valuation in the longer term.

Tip: Don’t focus on revenue too much when it comes to maximising your profits.

Many business owners focus on revenue to the exclusion of all other metrics.

And although it’s tempting to do so too, remember that concentrating on the size and growth of income instead of more insightful metrics, such as profitability and productivity, can be misleading and potentially damaging to your company.

Click below link to see if we can help with your unique situation…

Learn the secrets for small business success.

Did you ever realise that the vast majority of small businesses fail without ever becoming successful?

Did you ever wonder what’s so special about businesses that survive past the five-year mark and then run smoothly ever after?

Here you’ll find an easy-to-follow guide to making sure your business is a success and not just a sad statistic.

You’ll also find out:

• why 80% of small businesses fail in the first five years,
• how founder Ray Kroc’s strategy for McDonald’s is one you should follow, and
• why your business will be better off without you.

1. The entrepreneurial myth.

A heroic entrepreneur with a great idea and technical know-how succeeding in business quickly? That’s a myth.

Did you know that there were 629,000 such small businesses in Australia in June 2019, up from 572,000 two years earlier. But 40% of them fail in the first year and 80% in the first 5 years? Most of these failures are due to the entrepreneurial myth.

The entrepreneurial myth is a fundamental misunderstanding in Australian business.

It’s the notion that skilled technical work and a good idea form a sufficient basis for business success.

People often start their own business merely because they excel at work in a certain field, such as a machinist, barber or computer programmer.

Then one day the entrepreneurial seizure strikes.

They realise they don’t want to do technical work for someone else. They want to work for themselves as per their ideas for their own business.

Let’s say you work as a barista. You’ve mastered coffee roasting, brewing and latte art and you have lots of ideas of how to run a cafe. Suddenly, you realise you’d rather open your cafe.

Such a realisation is the reason behind the one million new businesses each year.

But if you start a business from the basis that you have technical expertise and new ideas, you’ve already begun on the wrong foot.

Your business will probably fail.

You’ve made the fatal assumption, the mistaken belief that knowing how to do technical work means you know how to run a business.

In fact, technical work and the work required to run a business are two entirely different things.

Here’s an example. Jane, a barista opens his cafe and soon realises that his coffee skills are not enough to make his business successful.

He has to know how to hire more employees, organise tasks and grow his business.

This is why so many small businesses fail!

2. Usually, an entrepreneur’s business won’t survive past adolescence.

Have you ever thought about the stages of a business like those of a person?

Interestingly enough, businesses go through infant, adolescent and mature stages, just like we do.

The difference is that most businesses won’t survive adolescence.

In the first stage, infancy, the owner and the business are the same.

At first, infancy is romantic.

The business owner finally gets to do all the work himself!

For example, the barista opens his cafe and is now roasting and brewing his coffee – great!

But success at this stage means more customers and more production.

Eventually, the work becomes too much to handle.

At the barista’s cafe, customers notice space isn’t as orderly anymore because the owner doesn’t have time to clean every day.

Suddenly, by starting his own business, the owner too finds himself buried under technical tasks.

He’s become the boss he wanted to avoid!

When he hires someone to help him, the business enters its adolescence phase.

Adolescence also starts out great, as the owner doesn’t have to do everything himself anymore.

But most young business owners enjoy freedom too much and manage by abdication instead of managing by delegation.

They leave their tasks to others and assume they’re taken care of, instead of ensuring everything is done properly.

Back at the cafe, customers start to complain about the lacklustre lattes the new employees make.

During this part of the adolescent stage, the owner must get past his comfort zone, where he controlled everything in the business himself.

The business will fail unless it can grow beyond the owner’s ability to do and control everything himself.

What can the former barista, now business owner, do?

He could get small again, fire his employees and return to his comfort zone, where work instead overwhelmed him.

Alternatively, he could risk and let the growth of his business accelerate until it got out of control, hiring more employees and accepting an inevitable decline in quality.

3. To nurture your business beyond the adolescent stage, you have to plan from the start.

Even if you’re prepared to get out of your comfort zone and relinquish some control to grow your business, where do you start?

You have to start from the very beginning, back before you even opened your business.

That’s because businesses that make it past adolescence and into maturity are founded on a broader perspective than most, and have planned their structures accordingly.

Successful businesses consider the future, focusing on building a business that works without being dependent on the owner always being there.

That way, when it’s time to grow past adolescence, they’ll be able to handle the growth.

To launch a business that will make it to maturity, you need entrepreneurial perspective.

This means that you plan from the very beginning how your business will look, feel and work toward its goals.

Instead of asking “What work is necessary for the business?” ask “How will the business work as a whole?”

For example, the barista knows the technical work his cafe requires.

He’ll roast Guatemalan beans and serve lattes.

• What will set his business apart from competitors?
• How will he attract customers?
• What sort of customer does he want?

The answers to these questions demand entrepreneurial perspective.

Then, to implement your entrepreneurial perspective, you’ll need an entrepreneurial model.

The entrepreneurial model is a plan for your business that satisfies potential customers’ needs in an innovative way.

Your entrepreneurial model will include your business’s market opportunities, a clear idea of your ideal customer and exactly how you’re going to deliver your product.

To save his business, the barista might have to close the cafe for a few days to ponder his entrepreneurial perspective and entrepreneurial model.

He could decide, then, that his target customers are eco-conscious students and he’ll satisfy their needs by being the first cafe to offer locally sourced milk and reading cubicles.

4. Inside, everyone has many different business personalities.

Do you think of yourself as just one single, predictable personality?

Then your business is probably going to struggle.

The truth is that we’re made up of some battling personalities.

Specifically, we’re each some part:

• entrepreneur
• manager
• technician

One moment we’re entrepreneurs creating a new product, and the next we’re a technician, frustrated with the new idea we just came up with a moment ago!

Of our battling personalities, the entrepreneur is the innovator, looking around and seeing a world of opportunity.

He’s a high-energy dreamer and visionary.

He sees all the angles, all the possibilities toward success and is intently focused on the future.

Sometimes that energy and constant opportunity-chasing create havoc and chaos.

He tries to pull people along and gets frustrated when things slow down or lag behind.

Without the entrepreneur, there’d be no innovation.

The manager in you is pragmatic and craves order.

More than opportunities, he sees problems to fix.

As the entrepreneur innovates and creates new things, the manager arranges things into rows, organised and orderly.

Without the manager, the business could never function.

Lastly, there’s the technician, the doer and the tinkerer.

The technician in you loves controlling the work flow and getting things done.

The entrepreneur’s flakiness and needs to constantly change ideas frustrates him.

But he’s happy when the entrepreneur and the manager create more work for him to do.

Without the technician, nothing in the business would ever get done.

Although the three personalities inside us seem to be totally at odds with each other, we must utilise the strengths of each to run a successful business.

That’s why the average small business owner is approximately 10% entrepreneur, 20% manager and 70% technician.

So now you know the daunting odds stacked against you if you decide to start a company.

But how can you avoid becoming one of the 800,000 failed businesses? Well, there’s a revolution going on in small business, and within lies the secret of success.

5. There’s an ongoing revolution in small business that provides a path to success.

Did you realise that we’re in the middle of a historic revolution that will change business forever?

It’s called the turn-key revolution, because more and more, businesses are being built so that an owner could in principle give the key to their business to anyone, and that person would be able to run the business successfully.

Businesses in the turn-key revolution create a model that works perfectly, provides a predictable product to the customer with every purchase and can be replicated without the owner’s presence.

In other words, they’re franchises.

For your business to be a turn-key business, you need to have a business format franchise: the model you give to the franchisee, the person who will run your franchise.

It contains your company’s processes, organisations and systems.

The success rate for franchises is incredible.

Whereas 80% of small businesses fail in the first 5 years, 75% of business format franchises succeed.

The turn-key revolution is so successful because it focuses on building businesses that anyone would want to buy.

For example, if someone wanted to buy your business, their first question would probably be, “Does it work?”

If you design your company’s systems to operate most naturally and efficiently, anyone can run the business, and thus it is appealing to buy.

In the turn-key revolution, you’re not just selling the products you make to customers.

You’re working to sell the whole business, including its processes and systems, to franchisees.

Ray Kroc started the turn-key revolution in 1952 when he became obsessed with creating a hamburger stand that would produce a precisely replicable hamburger to each customer.

He re-engineered the way hamburger stands worked, making everything so exact that every hamburger was flipped at the same time.

Ray Kroc defined processes that anybody could follow because he saw the eventual franchisee, the person who would run the stand, as his real customer.

Ray Kroc then sold the system of McDonald’s businesses as a franchise, thousands of times over.

6. Imagine your small business will one day be a national chain; now, build the very first store.

Companies franchise? The first thing you have to do is build a franchise prototype, the original model of your business that will be replicated.

Your franchise prototype has to give people value and be so simple that it can operate by anyone.

The value your prototype offers customers is whatever they perceive it to be.

Sound confusing?

What it means is that the value can be anywhere: in your reasonable prices, in your fantastic customer service, in a gift, your customers receive in the mail, and so on.

For example, the barista’s cafe value could be his perfect lattes that come with free cookies.

Next, the way the value is delivered has to be designed in a way that is systems-dependent, NOT expert-dependent.

This means that you should design your systems to be so straightforward and efficient that your business will no longer rely on you or technical experts.

For example, if the barista designs a perfect training program that ensures every barista in his cafe makes perfect lattes, he or other latte experts will not have to do it themselves.

Also, the franchise prototype should document everything in an operations manual.

Why?

If you don’t document how your business works, how will someone be able to run it without you?

Therefore, you must write down every single process as part of your company’s how-to guide.

The barista’s cafe, then, should have manuals not just on how to make a latte, but on how to train people to make lattes.

Lastly, the franchise prototype also should provide predictable service, 100% of the time.

If people don’t know what kind of product or service they’re going to receive, they probably won’t become regular customers.

For example, people who come to the barista’s cafe shouldn’t get a delicious latte one day and a bad one the next, or they’ll never come back again.

And of course, a franchisee won’t want to run a business with unpredictable results.

7. Start a business to satisfy your aim in life.

Why did you want to start a business in the first place?

Hopefully, it’s at least partially because you wanted something more than a 9-to-5 job in your life.

So as you set up your franchise prototype, your top priority is to ensure that your business will give you what you want!

The most important step in building your business is knowing your primary aim, or what kind of life you want to live.

After all, how can you tell what kind of business to build if you don’t know what it’ll help you achieve?

To know your primary aim, ask yourself questions such as: 

• “How do I want to live?”
• “What do I care about most?”
• “How much money do I want?”
• “How much do I want to travel?”

After you know your primary aim, you have to make a strategic objective.

That’s a list of goals that your business will have to fulfil to help you reach your primary objective.

A strategic goal is also a tool for measuring progress, implementing plans and franchising your business.

It’s a list of standards that anyone should be able to understand.

It should include financial projections, including how much money you expect to make in gross revenue and profit.

It should also define why your business is an opportunity worth pursuing, meaning that it involves a big enough market opportunity to fulfil your financial goals and satisfy your primary aim.

And it should define what kind of business you’re in, including a description of your ideal customer.

Let’s say the barista’s primary aim is to make $500,000 a year and travel for one month every year.

That means that his strategic objective should explain how his three cafes will each make his $167,000 a year, as well as a plan on how he can close the cafes and wind down operations for one month each year.

8. Organisational charts are crucial for your business’s growth and establishing accountability.

If you’re like most people, you hate drafting organisational charts.

Boring, right?

But without a clear way for everyone to know their responsibilities, how will your business succeed?

You need an organisational strategy to lay out exactly who in your company will do what work.

Even if you’re still a one-person business, you have to plan your organisational strategy to know how your business will grow.

So start out by considering how many employees you’ll need, and what work each one will do.

Then, for each position, write out a position contract explaining who the employee reports to, what work has to be done and by what standards the employee’s work will be judged.

For example, the barista knows that his cafes will need 3 baristas and 1 baker in each, a manager to oversee them, a marketing manager, an accountant and a general manager to oversee everyone.

In the beginning, the Barista will fulfil all those jobs.

He’ll make coffee, bake cookies, design ads for local newspapers and keep the books.

But as the business grows, he’ll need to know exactly how many people and for which positions he has to hire for his business to run successfully.

Plus, the barista will learn the best approaches as he works in each position.

He should document them in a specific manual for each position so that he can pass it down to future employees.

Another advantage of a clear organisational strategy is establishing accountability.

Each employee will be responsible for the work his position requires, which will be laid out in each position’s manual and position contract.

Each employee also must sign his position contract, which shows he agrees to accept responsibility in accomplishing his assigned work.

In the end, when each position is filled, with employees fulfilling the standards for their positions, your business will be on its way toward satisfying its strategic objective and your primary aim.

9. To manage your employees, don’t rely on great people – rely on a great people-management system.

Do you think the secret to a successful management strategy is finding as many incredibly talented people as possible?

Wrong!

The secret to a great management strategy is implementing a management system that approaches your management of people as a marketing tool.

Why a marketing tool?

Well, the way you treat your employees and the way you push them to do satisfactory work will end up having the biggest impact on the product your customer receives.

For example, one way the barista could manage his baker would be by telling him that he must stay in the kitchen and bake a certain amount of cookies and cakes every day.

Or, alternatively, he could put him on display in the shop, front and centre, and even let him choose his ingredients.

The latter option would probably result in the Baker being more enthusiastic about his job and customers consequently enjoying better cookies.

But the most important part of your management system is a people strategy, where you ensure your people understand the idea behind the work they’re doing.

If your employees understand the meaning of the work they’re doing, they’re more likely to want to work to help the business reach its goals.

A third important component is that you should test your employees against the standards you set for each position.

Let’s say that one of the barista’s business objectives is to prioritise creativity.

When the barista hires a baker, he makes sure to connect the objective of creativity with his work.

He tells him that personal creativity is a cornerstone of his cafes, so he has to push his creative limits by designing each week’s cake schedule.

He will be held up to the standard of creativity: no two weeks’ cake schedules should be the same.

The result?

The Baker will be pushed to reach his baking potential, while your customers will have more choice of cakes!

10. Next, forget everything and think only about the customer.

What about marketing?

What’s the best way to approach your marketing strategy?

It’s simple.

Focusing on the customer is so vital that you should forget about everything else and only think about the customer.

First, consider your customer demographics.

• How old are your customers?
• Where do they live?
• Why do your customer buy from you?

These are your psycho-graphics.

Why should your demographic group buy from you and not from somebody else?

For example, while the barista might not have enough money to compile a huge customer research report, he could ask each of his customers to fill out a small survey, rewarded with a free cookie at the cafe.

To know his customer better, he could ask demographic questions such as age and address, and psycho-graphic questions, such as which leisure-time activities a customer enjoys.

With this information, the barista can present his products according to his customers’ profiles, and they’ll be more likely to buy.

Once you understand your customers as best as you can, make your marketing as appealing as possible to them.

For your franchise prototype to be predictable to a potential franchisee, you have to consistently market to your customers as scientifically as possible.

Scientifically, in this case, means according to data and tests that you run.

That means that once your research shows your customers have become younger, or that your marketing approach by advertising in newspapers isn’t as effective anymore, you must change it.

For example, you can consider buying online ads to reach younger customers.

11. In the end, you’ll have a business made up of fully functional systems.

What will your business look like after plotting out your entire franchise prototype?

It will be a complex, yet easy to run, interdependent series of all the systems and processes that make up the business, from marketing to management to organisational structure, all the way back to your primary aim.

That’s because you’ll have a systems strategy in which everything interacts with each other, and through those interactions, everything will develop and change.

Your systems strategy will fall into a few categories:

• Hard systems, the inanimate objects that make up your business, such as computers and colours.
• Soft systems, the ideas and the living things in your business, like yourself!
• Information systems, which will tell you all the data on your business, so you know what’s working, what’s not and when it’s time to change.

For example, in the barista’s cafe, hard systems will include his espresso machine; soft systems will include employee attitudes, and information systems will include data on what exactly customers purchase.

To succeed, all these systems have to work together.

You can’t work on any one part of the business without considering all the other parts.

At the barista’s cafe, he might want to exchange the espresso machine for a newer model, a change to the hard system.

To make that decision, he’ll have to consider how the other systems will be affected.

The soft system could be compromised if employees adore the current machine and don’t want to learn how to operate a new one.

Then the information system will have to monitor customer behaviour to ensure the new machine isn’t making subpar lattes and hurting sales.

If the systems can’t run smoothly together, the business doesn’t have a chance!

12. This process of planning and implementing never stops.

If you want to ensure your business is successful, you can never rest on your laurels.

You have to constantly be working on your prototype, tweaking its systems and confirming that it’s running as best as it can.

That continual tweaking, testing and energy are called the business development process.

The first step in the business development process is innovation.

Innovation is simply doing new things.

The key to successful business innovation, though, isn’t innovating your product so much as it is innovating your business.

Ask yourself the question, “What’s the best way to do this?”

Remember, Ray Kroc didn’t innovate hamburgers – he innovated how McDonald’s made and sold hamburgers.

The second step in the business development process is quantification.

Quantification is simply measuring everything.

How can you know what’s working or what’s not without measuring your innovation’s impact?

For example, how will the barista know that his management system of fostering creativity in the Baker is working unless he tracks how many pieces of cake he sells?

The final step of the business development process is orchestration.

The orchestration is putting innovation into practice.

It’s taking your idea of how your business should work and having it play out between employees and customers, then watching what happens.

It’s a constant process, based on your efforts of innovation and quantification.

That means, if wearing a blue suit increases your sales, keep wearing a blue suit!

But if quantification finds that losing the suit and wearing shirtsleeves helps performance, then switch to shirtsleeves.

The key point is that innovation, quantification, and orchestration aren’t necessarily chronological.

They don’t happen one after the other, but rather all together, all the time.

The business development process never ends, because your business will constantly be creating innovations, orchestrating them into real life and measuring the results.

It’s a process that will drive your small business to success.

Final thoughts

Most small businesses fail, but if from day one you build your business as a franchise prototype so that anybody can take the reins, your chances of success increase dramatically.

The key is to go to work on your business, NOT in your business.

Actionable tip:

Define your primary aim.

Before starting your business, ask yourself:

• What kind of life do I want to live?
• How much money do you want, and how much do you want to work?

These are fundamental questions for which you need the answers before you start, as you should set up your business in a way to help you attain your goals.

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