Low prices are no guarantee of profits

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Whenever I ask first-time entrepreneurs what's going to make their businesses different from the competition, many of them say, “We're going to be cheaper.”

They think they can succeed with a strategy of undercutting their competition's prices for products or services. Low prices, they assume, will generate sufficient sales to more than make up for smaller profits. “What I lose in margins, I'll make up in volume.”

After all, they see tons of advertisements for big companies that only seem to emphasize low prices. And they know that they comparison shop before they make purchases. So they think that a strategy of low prices is the path to success.

But what's good strategy for a few giant retailers or airlines is extremely risky business for most small companies — and most big companies as well.

Competing on price is risky. Low prices mean narrow profit margins, and that means less cash. With a small financial cushion, you're vulnerable with every slight increase in costs. The landlord raises your rent 5 percent? That may be your entire year's profit.

That, in turn, means finding ways to reduce costs. The first thing you'll be tempted to do is reduce wages and benefits. Watch out! This means you won't be able to attract good employees. They're less likely to be productive or loyal. You'll be busy keeping an eye on them, and they'll be keeping an eye on the clock.

The next thing you'll do is cut marketing. And businesses that compete on the basis of price almost always depend on high levels of marketing to keep customers coming in the door.

And the customers who do come are fickle. Low-price shoppers are loyal to price. So if the competition decides to squeeze you with even lower prices, your hard-won customers will be gone in an instant.

But while price should never be the cornerstone of your strategy, it also can't be ignored. So how can a small company still maintain competitive pricing?

* Carve out a niche. If you ‘own' a market, you have more room to set prices. If there are 100 mechanics in your city, you'll face constant price competition. But if you're the only mechanic specializing in Volvos, you'll face much less price pressure.

* Work smarter, not cheaper. Improve your profits through innovative practices. Southwest Airlines saved money by using plastic, reusable boarding passes instead of paper passes, and it was the first carrier to use electronic ticketing. Southwest maximizes profits from its planes by getting them back in the air an average of 20 minutes after landing, instead of the two to three hours of other airlines. By being smarter, Southwest became the most consistently profitable airline in the industry.

* Focus on value, not price. Value is a term used to mean the combination of price and quality. When you shop for a winter coat, you may be willing to pay a higher price to get quality that will last many years. Likewise, a client may be willing to pay a higher price for your printing services if you can deliver the job faster with fewer errors than your competition. Excellence and service are competitive advantages that let you justify higher prices.

* Target the right customers. Not all customers are willing to pay more, even for better quality. So make certain you aim your marketing efforts at customers who will respond to the differences you offer and can pay a slightly higher price for that value.

* Build loyalty to you, not your price. Even if you use special pricing (discounts, introductory offers, sales) to initially attract customers, immediately go to work developing relationships that keep customers coming back when the price goes up.

Don't let yourself get caught in a continual battle to be the “low-price leader.” You may win that battle but lose the war — or worse, your business. Remember, you've got a lot more to offer than just a low price.

Rhonda Abrams is the author of “Six-Week Start-Up” and “What Business Should I Start?” You can register for her free newsletter at www.PlanningShop.com.

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About four years ago, Thomas Perlmutter and his wife took their friends the Lewises out for dinner to celebrate Robert Lewis's 45th birthday. The Perlmutters even gave the birthday boy a gift: a Montblanc fountain pen. But when Lewis tried to use the pen, he found that he was unable to pry it from the hard plastic case in which it was packaged.

It was an especially awkward moment: Perlmutter's business was designing inserts for those obnoxious "clamshells," the difficult-to-penetrate plastic packages that hold everything from MP3 players to, well, fountain pens. "You," his wife complained, "should invent something to open those things."

That wasn't exactly a dumb idea. Manufacturers and retailers love clamshell packaging because it deters theft while showing off products in all their glory. But what consumer hasn't had to resort to scissors, keys, fingernails, or even teeth to get inside one? A friend of Perlmutter's once joked that clamshell makers probably own stock in kitchen-knife companies. The U.S. Consumer Product Safety Commission estimates that attempts to open plastic packaging led to 2,943 injuries in 2004.

So Perlmutter took his wife's anti-clamshell sentiment seriously—and began addressing it immediately. Before finishing their filets mignons, he and Lewis had drawn back-of-the-napkin sketches for a safe, easy-to-use tool. A few days later, they met in Perlmutter's office and began working on a prototype, which took two months to bang out. "The hardest thing was to get the blade at the proper angle so that people wouldn't cut themselves," Perlmutter recalls.

That wasn't the only obstacle, though. Perlmutter was at first convinced that he could manufacture the cutting device—he was already calling it OpenX because OpenExperts was too long to write on the handle—in the United States. But factories in Pennsylvania and California, where he initially farmed out the work, were too slow. "It took them a year to make a mold and forever to make some changes," he says. Finally, Perlmutter got in touch with a plant in Taiwan, which shipped back a finished product six weeks later. "They delivered exactly what they said they were going to deliver," he says.

In February 2003, Perlmutter and Lewis founded a company called Ranchmark to market OpenX. The tool sells for $9.95 at the company's website (myopenx.com) and at retailers including Amazon.com. Perlmutter, who is CEO and runs day-to-day operations, says Ranchmark was profitable on revenue of $250,000 last year, and demand shows no signs of flagging.

A big break came in May, when the popular gadget blog Gizmodo praised OpenX as "a great solution to an infuriating problem." The next day the company received 1,100 orders. Of course, such success pales in comparison with how OpenX has improved the Perlmutters' home life. The couple uses the cutter not only for plastic clamshells but also to open letters, boxes, FedEx envelopes, and plastic wraps around water bottles. "I was part of the problem, and now I have created the solution," Perlmutter muses. He's on the lookout for his next invention—and listening very carefully to his wife's complaints.
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When Commercial Space Is a Good Move

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I am contemplating moving my business from a home office to a commercial office space. What pros and cons should I weigh? Any tips on making the transition?

—D.B., Dallas

Once you've decided to take the plunge and move your home-based business to a commercial office space (see BusinessWeek.com, 1/22/07, "Home Office or Commercial Space?"), there are a number of decisions you'll have to make. First, where will you go and what facilities will you need?

Taking an office close to your home and your employees' homes is always a good bet, as it will cut down both on gas costs and on driving time. An office outside the home should provide a comfortable space—such as a conference room—where you can meet with customers and employees, particularly if one of your motivations for leaving home is to impress clients and appear more professional.

A real estate agent who works with business clients should be able to help you determine what square footage you will need. Space for a service business is usually easier to calculate than that needed for a company that produces a product, says Robin Lasher, a consultant with the Tarrant County College Small Business Development Center in Fort Worth.

An Eye Toward Growth

"A consultant may need no more than a small office with furnishings to create the desired image with clients, whereas a company that manufactures a product and has outgrown the garage may also outgrow commercial space sooner than expected," she notes. "However, even a service business that starts with 300 sq. ft. may find it a tight squeeze if an administrative assistant is hired."

So be cautious about the length of the lease you sign, Lasher advises, no matter how good a deal a landlord offers you on a long-term lease. "Try to negotiate a one-year lease with a one- or two-year option if you have any reservations about your move or whether the space will meet your future needs. If you're two years into a three-year lease with no immediate space available for expansion, you may have no choice but to stunt your growth until the lease expires, try to sublease your current location, or operate from two locations by leasing additional space elsewhere, which usually creates logistical problems," she says.

Jeffrey Landers, a serial entrepreneur and the owner of Offices2share.com, agrees. "The most common and often the most fatal mistake made by fledgling businesses is signing a multiyear lease which can require a financial obligation that may outlive the business itself," he says.

Call Your Lawyer

As long as you're looking for space, why not try to find an office location that has some prestige or local prominence? "Many prestigious office locations have some small spaces available as a result of dividing up larger spaces," notes Robert Donnelly, an entrepreneurial consultant and author.

"Negotiate for a reasonable rent," he adds. "You're doing the landlord a favor by taking a space that usually is not attractive to larger prospective tenants." It doesn't hurt to get your attorney involved in these negotiations. Commercial leases can be notoriously one-sided, and a savvy attorney should be able to help you get much better terms.

Once you've settled on a location, draw up a list of costs to include in your budget. You should include one-time costs associated with the move and the purchase of new furniture and equipment, as well as ongoing fixed costs, such as rent, insurance, and utilities. Will the building provide adequate parking for you and your employees? Make sure you include parking costs in your budget.

A final expense will be changing your business address to reflect your new location and revising all your marketing materials. Good luck!

Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.

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"I'm making a ton of money from Yelp, and it's freaking me out." Woe is Christopher Hall, the 34-year-old owner of Splitends, a hair salon in Orange County, Calif. Its chic decor is more architectural firm than beauty parlor. He has appeared on a reality show, in the L.A. Times, and on TV news segments. He's photogenic and has a quick wit. He serves beer to customers. So business, unsurprisingly, was decent as soon as he opened the place last December. Until March 6. That's when things got crazy.

Now he's literally in pain from all the coiffing. "I've been doing hair for 16 years, and I'm busier than I've ever been," he says. "Saturday I came in at 6:30 a.m., left at 8 p.m., and did 22 people. I woke up Sunday and my hands were all swollen. I had to put them in an ice bucket."

What happened March 6? That was the day Anita Lau wrote about Splitends at Yelp.com, an online platform for user reviews of everything from dive bars to funeral parlors. Lau has posted 2,036 reviews and 1,340 photos, has collected 790 compliments on her work from fellow Yelpers, and along the way has amassed the power to put bodies into barbershop chairs. She gave Splitends the maximum five stars, praising Hall and saying, "I absolutely love my haircut."

The review started a logroll of new clients for the stylist and a couple dozen subsequent five-star critiques. "I've taken out ten ads in OC Weekly this year and have gotten maybe one call," says Hall. "I get anywhere from five to 15 calls a day from Yelpers. They come in and then write reviews. Then other people see the reviews, think it must be great, and call. It's its own little biosphere. It feeds itself."

For those outside California, let's back up a bit. Yelp is part social network, part localized review site - think Facebook meets Zagat - and it's fast becoming the web's gift to small business. A platform for ratings of anything with a postal address, Yelp offers the service industry new insight into what the chattering masses are saying. The name "Yelp" comes from a friend of the founders who simply liked the word. But it also serves as a nifty contraction of "yellow pages," which reveals the company's ambitions: a land grab on the $100 billion that's spent every year on local advertising.

"There's an information shortage when it comes to local businesses," says co-founder and CEO Jeremy Stoppelman. "If you look at the yellow pages, what are you seeing? You're seeing how much money a business spent to buy a big ad. We're a place for a conversation between the prospective customer and the business owner."

Many well-funded companies have tried to tackle local search over the years, using a mix of strategies. There's the directory model, which involves a massive sales force upselling business owners to ever bigger, flashier ads. There's the Citysearch tactic of creating proprietary content and selling ads against it. And then there's the search-engine route of crawling everyone else's content and automating the ad sales. Yelp is taking a different road: crowd-sourcing. For years Zagat has been compiling anonymous user reviews, but Yelpers get to fully express their feelings and make names for themselves.

Employing the same user-generated content model that powers YouTube or Craigslist, Yelp can reach into a city's every nook to reveal hidden car washes, dentists, plumbers - the sorts of unsexy but necessary services that make up our daily lives. When we discover something wonderful (or horrible), we love to tell our friends about it. We also turn to people we trust when we need a good recommendation. Yelp is enabling those conversations to happen on a massive scale.

There's any number of reasons the site could fail. But so far the enthusiasm Yelp has generated indicates otherwise - usage is up nearly 400% to 1.8 million users a month, according to Nielsen/NetRatings. In San Francisco the dining and nightlife scene has been all but completely trolled, analyzed, and pontificated upon (or "Yelped," for short), and the site has recently caught fire in Chicago, New York, and L.A. In those cities it has begun changing the way local businesses do their marketing.

The word most often used to describe Yelp - other than some variation on the ever-flexible brand itself, which can be intoned positively, as in "I Yelped that awesome crepe wagon," or negatively, "That bitchy waiter totally got Yelped!" - is "addictive." Anita Lau drives around Southern California in an SUV with a vanity plate that reads I YELP. The plate is unique. The sentiment isn't.

A charismatic 29-year-old with a boyish smile and a self-deprecating streak, Stoppelman started the company in 2004 with longtime friend and CTO Russel Simmons, 28. (No, not the hip-hop impresario. This Russel has only one "L.") After their last employer, PayPal, was sold to eBay (Charts, Fortune 500), the co-founders cashed out and began kicking around startup ideas with a former colleague, PayPal co-founder Max Levchin. One day Stoppelman was looking for a doctor but had no clue how to find a good one. That gave him and Simmons an idea for a convoluted automated system in which people could e-mail friends asking for recommendations on, say, local doctors, and the answers would be logged at a communal site for everyone to see. Levchin floated the duo $1 million to build out the plan. It went nowhere. But the co-founders noticed an interesting tendency among the early users. People were writing unsolicited reviews of their favorite businesses just for fun. So Yelp switched tack. "I remember the moment that Russ said, 'There should be a way for you to write your own reviews without asking questions,'" Stoppelman recalls.

Actually, Stoppelman and Simmons weren't just looking for a new doctor. A pair of unrepentant party boys - they did tequila shots during the Fortune photo shoot - they were in a perpetual search for the greatest restaurants and clubs in San Francisco. To get Yelp off the ground, they decided to mix business and pleasure, and started hosting Yelp parties at local establishments. The parties got people talking. (Flickr is littered with raucous snapshots from Yelp events featuring bar dancing and an endless train of women hanging all over the co-founders.) More important, the revelry got people writing reviews, building up the site's content.

Today Yelpers seem to live on the site, messaging one another about their social lives, reacting to reviews, and planning get-togethers. That's the social-networking part. As is the case on most social networks, Yelp is rife with self-conscious patter. But there's a point to all the yammering: finding cool stuff that's not too far away. It's a mission everyone seems to take seriously.

"One of the first surprises was the length of reviews and the attention to detail," says Simmons. "People think they have to write reviews of a certain quality or there's no point. A lot of them are funny. Some are poetry. I saw one review in the form of an IM conversation with Skeletor" (the latter, of course, being the superevil, skull-faced archnemesis of He-Man, Master of the Universe).

In 2005, Stoppelman and Simmons raised $5 million from Bessemer Ventures, the VC firm behind Verisign and Skype, among others, and then last November another $10 million from Benchmark Capital, whose hits include eBay and Red Hat. The company's strategy is to build a rabid following in any given market. Once an establishment has a good number of reviews, a Yelp salesperson calls to make sure the establishment's owner is aware of all the chatter going on, offers a Yelp window sticker, and, of course, tries to sell an ad. Ads and sponsorship packages range from $200 to $2,000 a month.

Stoppelman is coy about how well Yelp is doing on the business side. The company is generating revenue, though he won't say how much. He does acknowledge that profits are a ways off. "Someday we'll make money," he says, smiling, adding only that Yelp has all the funding it needs.

The obvious question: If the content costs nothing and the marketing is word-of-mouth, where is Yelp spending its $16 million? Well, salespeople are expensive. The company is always adding servers to handle growth and is in a desperate search for more engineers in San Francisco. Given the reputations of Stoppelman and Simmons, it'd be easy to accuse the co-founders of spending their funding on bar tabs. Except that lately an awful lot of their drinks seem to be on the house.

Not all Yelping is good for business. It's plausible, for example, that national chains may find a new set of rules in a Yelped market. Why do you frequent Starbucks when you're traveling? Do you really love the coffee, or do you go because you know what you'll get when you walk through the front door? As Simmons puts it, "A brand is a proxy for knowledge." What if you found out there was a wonderful little cafй down the street? Would you still go to Starbucks? Maybe, maybe not. But by providing local knowledge, Yelp may diminish the power of a brand - or at least a franchise's ability to coast on that brand.

Yelp can be even more dangerous to a mom-and-pop coffee shop or fledgling restaurant. While professional reviewers typically grant a new restaurant a grace period to work out the kinks, Yelpers flock to new places to earn a coveted "first to review" notation and often expect the place to be operating as though it were mature. Then there are some people who are just plain ornery - and there's always the possibility of one restaurant owner sabotaging another.

Craig Stoll is the owner of one of San Francisco's most reputable restaurants, Delfina. The eight-year-old trattoria has collected 333 reviews and a four-star rating. But Stoll is miffed at Yelp. "We recently had a post where someone fabricated an incident," he says. One Yelper, John S., a new member with zero Yelp friends, no photo, and only nine reviews, claims he captured a cockroach on his table at Delfina and showed it to his server, who laughed. Stoll says the event never happened, but John S.'s telling of the incident lives on. (John S. never returned two Yelp messages from Fortune.)

Stoll says he contacted Yelp and unsuccessfully requested that the review be taken down. "They said, 'This doesn't violate any of our rules. It stays.' But it didn't happen. A lot of people pay attention to Yelp. But there are no checks and balances. As a business owner, you have no recourse."

Stoppelman and Simmons empathize. Even Yelp has been Yelped. But they stand behind Yelpers' right to say what they want, as long as it's true. (Authors are solely responsible for their reviews. That should help the company avoid run-ins with angry restaurateurs, but one messy lawsuit would surely curb Yelpers' enthusiasm.) Most reviews are positive - 85% are three stars or more. Stoppelman thinks that's because people would rather write about great experiences. As for the harsh critiques, Stoppelman considers them an opportunity for a business owner to start a conversation. "Your customers are out there saying things about you, whether it's on Yelp or on some blog," he says. "The faster you can fix problems, the better you're going to do. Customer service is the new marketing."

Where does Yelp go from here? Stoppelman and Simmons plan to reach 25 markets in the next 18 months. Not that Yelpers are waiting for that to happen - they're busily Yelping suburbs and vacation spots all over the country. Clearly there's a desire for this service outside the major cities. And if the enthusiasm over the launch of the iPhone last month can be attributed to anything other than insane product lust, it's that we all really want the web while on the go. Once we have that, the growth potential for a site like Yelp seems unlimited.

Of course, turning long-term potential into short-term dollars remains a challenge. But if Christopher Hall's experience is any indication, that's already happening. Yelp doesn't make Splitends a better business. It provides a better soapbox, and that's something any smart business owner is willing to pay for. "I'm a rad hairdresser," says Hall. "Yelp is just validating my business and letting the public know."

After Yau's review of Splitends, a Yelp salesperson called Hall to see if he'd be willing to spend some money. "She asked if I wanted to sign up for a sponsorship. I told her that if she sent me a Yelp sticker for my window, I'd give her my credit card." He didn't kill his old ad campaign with OC Weekly. But he did change the creative. Now the ad simply reads "Splitends. Read our reviews on Yelp."

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Brothers of invention turn cobs into potential gold

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Nebraska City, Neb. — For the past 10 years, harvesting corn and selling the cobs has been a humble little business for Ty and Jay Stukenholtz, 34-year-old twin brothers.

By trial and error, computer designing, tinkering and banging away, the Stukenholtz brothers, who farm the 350-acre family farm near Nebraska City, came up with a way to harvest corn cobs and kernels at the same time and keep the materials separate.

Until now, the brothers’ invention has had limited appeal because of the small market for corn cobs, save as cattle feed or in some limited industrial uses.

But that might be about to change as ethanol makers look into producing ethanol from crop residue and other biomass, including the cobs, leaves and stalks from corn plants.

The potential use of corn cobs and other plant material as an ethanol feedstock has the brothers Stukenholtz and their business partner, Beth Pihlblad of Waukee, thinking that they might be sitting on the hottest new product in the farm equipment business.

“Our goal was to build a cleaner that can attach to the back of a combine with a tank on top for the cobs,” Ty said.

“It’s universal, so it fits on any combine,” said Jay, finishing Ty’s thought.

Ty and Jay are identical twins except for the fact that Ty is right-handed and Jay is left-handed. Their thinking is as complementary as their dexterity, they say, so they form two halves of an inventing whole.

“What one of them doesn’t think of, the other does,” said Pihlblad, whose family has farming interests near the Stukenholtz brothers’ farm.

In January, Pihlblad and the Stukenholtz twins formed a limited liability company called Ceres Agriculture Consultants, based in Waukee.

The company intends to produce or license the twins’ biomass collection system to a farm equipment manufacturer and provide other renewable fuel services.

“We want the attachment to fit on older and new combines so that a farm equipment maker can offer it as a kit for their customers,” Jay said. “We’ll license the technology to a farm equipment company.”

The brothers have made about a dozen different versions of their cob collector. Their 10th version is attached to a 2388 Case IH combine.

As the combine moves through the field, it pulls whole corn plants into the corn head mounted on the front of the combine.
Corn kernels are separated from the cobs and other parts of the corn plant and the kernels are routed into the combine’s conventional grain storage tank.

The Stukenholtz brothers’ innovation fits on the back of a combine, where the leaves, cobs and other shredded corn plant residue is normally flung out and onto the ground.

Instead, the brothers have come up with a device that consists of a series of sieves and fans that separate the different parts of the corn residue as it moves to the back of the combine.

The cobs, once separated from the other parts of the corn plant, are sent to a tank that sits atop the combine.

The tank is designed to slide to one side so it can discharge the cobs into a wagon.

Other plant residues like soybean pods also can be gleaned by setting the sieves and fans in a different configuration.
It’s been 10 years since the Stukenholtz brothers started tinkering around with a corn cob collector.

They’ve made about a dozen versions, including one that is being used by Dan Allen of Allendan Seed Co. in Winterset.
Allen grows and sells 300 species of native grasses and wildflowers. Separating the tiny grass and flower seeds from the rest of the plant materials is a challenge.

“We tried for 10 years to get someone to help us with harvesting seeds,” Allen said. “I don’t know where we’d be without their help.”

But it’s in the emerging field of cellulosic ethanol that the Stukenholtz brothers and Pihl-blad think their machine will really take off.

Poet, the ethanol producer formerly known as Broin Cos., plans to use corn cobs to make ethanol at its Emmetsburg plant. Poet has said the plant will need 450 to 500 tons of cobs a day to make cellulosic ethanol.

Nathan Schock, director of public relations, said Poet has been working with several developers, including the Stukenholtz brothers.

Stuart Birrell, who leads Iowa State University’s research on biomass collection, said the problem of harvesting, collecting and transporting biomass material must be solved before the new technology can be adapted.

Although Birrell said he hasn’t seen the Stukenholtzes’ attachment at work, cellulosic ethanol production will need innovations like theirs to solve roadblocks to produce ethanol from biomass.

DesMoinesRegister.com

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