Reality Check

When you come up with an idea for your business, how do you go about assessing whether it is a good idea? How do you convince yourself (and others) that you can make money exploiting the idea? A written business plan is one way to evaluate an idea before you commit to pursuing it. The process of creating the plan can reveal factors that you might otherwise not consider. And that can save you big money.

Some years back, before there were a dozen gourmet coffee shops in every town, most people bought coffee in the grocery store. There were a few specialty stores that roasted and sold their own beans, and a couple of mail order firms that sold rather expensive whole bean coffee. Customers paid a tremendous premium in exchange for the freshness that comes from grinding the beans just before brewing the coffee. But people were willing to indulge themselves for a few extra dollars a pound. The cost per cup just wasn't that high.

An entrepreneur friend of ours saw an opportunity to bridge the gap between the specialty shops, which purchased the beans green and roasted them, and the supermarkets, which mostly carried canned coffee. He took a chance, borrowed some money, and opened a coffee store. He found a mail order source that would sell to him cheaply enough so that he could compete against the few local specialty shops that existed. As time went on, he found a local roaster that didn't operate a competing retail outlet, and he was able to reduce his cost while maintaining or increasing the quality of the product.

Even though sales volume slowly increased and his profit margin rose as he reduced costs, it seemed like he could never make ends meet. He restocked coffee only as his bins were depleted, added teas, spices, and brewing equipment, but never really hit big, as he had hoped. Sales growth slowly declined as more competitors arose. When the bigger chains entered his Midwestern market, the game was over. He couldn't hope to compete with Gloria Jean's or Starbuck's. The business slowly ground to a halt, superseded by the larger mass marketers.

What went wrong? It would be easy to say that he failed because of the unanticipated entry of new competitors into the market. But that was really just a symptom of the failure to plan. When he opened his first store, he knew what coffee cost, he knew what his fixed expenses were, and he set prices that let him cover expenses plus generate a small living wage. But he didn't go any farther. He had no plan that tied advertising to specific sales targets. When business was slow, his creditors and suppliers were paid late. And the big chains were already swiftly expanding across the country, even though they hadn't reached his market yet. A little research, a little planning, and he would have realized that it wouldn't be long until the big chains were a force in his market. He also would have seen the nature of the market shift, with customers expecting to purchase fresh-brewed coffee in addition to whole beans. He had correctly identified a niche, but failed to follow through with the planning that would have revealed the strengths and weaknesses of his plan.

In retrospect, this entrepreneur often bemoaned the fact that he could have positioned the business in such a way that the big chains, rather than ignoring him, would have bought him out. Perhaps he could have. Had he kept closer tabs on trends in the industry, he would have realized that the competition wasn't just selling beans anymore. They were opening early to offer commuters fresh morning coffee and bakery goods. What is certain is that his decision to fly by the seat of his pants, without benefit of a plan, cost him dearly. It was easy to dismiss the existing competition, and he overlooked the new competitors who were already making inroads into "his" market. The failure to anticipate new entrants into the market, the failure to consider what kind of sales volume levels were required to grow the business, and the failure to establish realistic measures by which to judge his success were fatal to the business. He operated his business reactively: adjusting as best he could to the changing market.

Moral of the story: if he had taken the time to create a formal business plan, he would have had the opportunity to more closely examine some of the assumptions he made when he started out.