More Discussion about the Lean Start-Up

Stephen DeAngelis

May 16, 2011

Last August I wrote a post that discussed some ideas offered by Eric Ries about how to begin a business without busting the bank [The Lean Start-Up]. A few months later, the Financial Times published an article about Ries and noted that his ideas had their origins in the lean management principles that made Toyota a global powerhouse in the automotive industry [“Lean start-up thinking that works for all,” by Philip Delves Broughton, 25 October 2010] Broughton writes:

“Not so long ago, management theorists and manufacturing scientists drooled over Toyota. Its production system represented scientific management at its best, the climax of a century that began with Frederick Taylor’s time-and-motion studies, passed through Henry Ford’s River Rouge plant, Alfred Sloan’s General Motors and finally reached perfection in Toyota City, the vast complex of manufacturing and assembly plants east of Nagoya. … At the core of Toyota’s philosophy is the idea of ‘lean’ processes. The term is often misunderstood to mean cheap. In fact, a lean production system is one in which every step of every process is transparent and considered ripe for improvement. Thinking lean is about constantly measuring all you do, and being able to change quickly as fresh evidence emerges. Apply this to starting a company or launching a new product within an existing company. The classic method is to look at the market for an opportunity, establish a business case, develop your product, test, validate and finally launch. At each stage, you gather resources, establish criteria for the next step and try to adjust as you go. The challenge these days, though, is that technology and customer tastes are moving so fast that the classic method is no longer adequate.”

With this introduction, Broughton continues his interview with “Eric Ries, a Silicon Valley entrepreneur who has coined the phrase ‘lean start-ups.'” Broughton writes:

“Mr Ries hit on the idea of lean start-ups after suffering one failed technology start-up and enjoying one success, the 3D instant messaging company IMVU, as well as observing the peculiar fortunes of many others as an investor and adviser. The classic start-up methods, built on linear management and innovation processes, he found, were not working for him or his peers. ‘They kept blowing up in my face,’ he says. Such methods offered too little flexibility to deal with changes in available technology and in customer needs. Imagine that today you decide to launch a new product. You size the opportunity, talk to potential customers, gather the resources and set to work. By the time you’re ready to launch, what are the chances your product is still relevant?”

One often hears the adage “better is the enemy of good enough.” An entrepreneur implementing lean start-up principles wouldn’t hesitate to launch with a good enough product so that it doesn’t become irrelevant. Broughton continues:

“Mr Ries and other new management thinkers – notably Steve Blank, a former entrepreneur who now teaches classes at Stanford and the Haas Business School at Berkeley – say the risks in any start-up can be reduced by constant interaction with potential customers during product development. Rather than waiting until you have all your ducks in a row, you iterate early and often by finding customers willing to help you refine your product and even buy it in its most primitive form. You don’t waste your money by investing in an unproven product, but rely on customer feedback to tell you where to spend. The ideas owe much to ‘agile software development’, an adaptive process that values customer collaboration, responsiveness and individual input over strict product road maps, tools and marketing plans. For the traditionalists, agile development may smack of ill- discipline, when in fact it is just a different kind of discipline.”

Ries told Broughton, “My own definition of a start-up is an institution asked to create something new under conditions of high uncertainty. … This has nothing to do with company size.” Broughton believes that most entrepreneurs cannot afford to take high risks and, thus, concludes that “lean is a far better way to go.” Colleen DeBaise, Sarah E. Needleman, and Emily Malty point out the obvious, “For many would-be entrepreneurs, money is the insurmountable hurdle.” [“Start-Ups on a Shoestring,” The Wall Street Journal, 16 August 2010]. In order to see if someone could start a business without a pile of cash, they went searching for entrepreneurs who had successfully started businesses with few resources. They were able to track down three entrepreneurs who started their companies with less than $150. They report:

“We set out to find bootstrapping business owners who started companies in recent years—without shelling out more than a couple of hundred dollars. The ground rules: The entrepreneurs had to be either paying themselves a salary or reinvesting substantial profits in the business, as well as planning to continue down the entrepreneurial path for some time to come. We also nixed people who opened consulting firms in fields where they had already built careers. While that’s certainly entrepreneurial, we wanted people who were truly starting from scratch. What did we discover? With creativity, commitment and resilience, an entrepreneur can turn even a small investment into an impressive business.”

DeBaise, Needleman and Maltby report that the initial investment in capital may be small, but the investment in hard work and time can be enormous. Technology also helps to keep costs down without sacrificing quality. The authors note that “professional-looking websites and automated phone-answering systems can speed sales and make a start-up look more impressive to potential customers.” Even with all of the resources available to entrepreneurs — and in spite of the stories that DeBaise, Needleman, and Maltby are about to relate — they caution that starting a business on a shoestring isn’t easy nor is it the norm. They report:

“Babson College has estimated that on average it takes about $65,000 to start a business, a figure that can include everything from buying equipment and inventory to paying employees. Some industries come with even higher price tags, according to the Kauffman Foundation—$82,000 for construction, $98,000 for retail and $175,000 for manufacturing, to name just a few. And even if you get your business off the ground for pennies, there’s no guarantee that you’ll keep rising. About half of all start-ups close within five years, and most research indicates that’s usually due to lack of capital.”

In other words, even if you don’t need capital to kick off your business, you certainly need capital to keep it running. On that melancholy note, DeBaise and her cohorts introduce us to three entrepreneurs who did succeed: Kael Robinson, Jeff Swedarsky, and Marc Ringel.

 

Kael Robinson started her company, Live Worldly, LLC, with $40. She hadn’t intended on starting a business. She had a job in public-relations, but, as the British say, she was made redundant. She took advantage of her newly available free time to take her family on a vacation to Argentina where she discovered that “a flimsy cotton bracelet with Portuguese lettering on it,” like one she had received as a gift six months earlier, “was a hot item there.” That trip began her on her path “to a successful business venture.” DeBaise, Needleman, and Maltby continue the story:

“After she returned home she bought 100 of the bracelets for $40 from a wholesaler in South America. Wearing five of them herself, she offered them to [members of the lacrosse team she coached at a Denver high school] for $2.50 apiece and quickly sold out, prompting her to invest in another 100 units. … Ms. Robinson soon had more orders than she could fill—at a new retail price of $5 per bracelet—giving her enough confidence to purchase another 1,000. She then began cold-calling local businesses and several agreed to resell her product on a consignment basis. Gradually, retailers throughout the state and beyond began calling and emailing her to place orders. … By the summer of 2008, Ms. Robinson had earned enough to pay for a professional website and logo for the company, now known as Live Worldly LLC. She also hired a publicist friend who helped her write and distribute press releases. CosmoGirl became the first of several magazines to publish a blurb on her company. … These days, her products are for sale in more than 500 stores world-wide. The company has a more sophisticated website and two full-time employees who handle order fulfillment, new-business development and bookkeeping. Last year, Live Worldly racked up $60,000 in profits on revenue of $160,000, compared with $10,000 in earnings on revenue of $50,000 the year before.”

Jeff Swedarsky started his company, Food Tour Corp., with $110. He became an entrepreneur while still working a day job at the Department of Homeland Security. At night and on weekends, “he’s the director of Food Tour Corp., the company he created that offers culinary excursions of Washington, D.C., neighborhoods.” DeBaise and company continue the story:

“Mr. Swedarsky got his first taste of entrepreneurship during a post-college stint in Slovenia, when he helped to develop a now-defunct smoothie company. After finishing his M.B.A. in 2006, he was ready to start a business, inspired by a newspaper article about culinary tourism, but he lacked the dollars he needed. The solution, he soon realized, would be to take a 9-to-5 job to pay his bills and build Food Tour organically. In 2007, Mr. Swedarsky outlined the Food Tour concept in a brief written presentation, and used that to hook local restaurant owners’ interest. The plan: He would bring in small groups for special tastings, during the slow period between lunch and dinner, and restaurants would make them smaller, customized dishes that weren’t on their usual menu and that reflected local history, such as Virginia ham. … Mr. Swedarsky then paid $100 in filing fees to register his business with the Commonwealth of Virginia and $10 to buy his online domain name through GoDaddy.com; he created a website himself. … Mr. Swedarsky gave his first official tour in May 2008 with just two people along for the ride. … After about six months, Mr. Swedarsky hired his first part-time employees to lend a hand. … These days, Mr. Swedarsky employs 23 part-time staffers, primarily tour guides, and he rarely gives tours himself. Instead, he focuses on expanding the company, which now offers several tours, lunches and pub crawls in Washington and Baltimore, and is preparing to acquire a competitor in Annapolis, Md. Generally, tours are limited to about 12 to 14 people, and tickets cost about $50 to $60.”

Marc Ringel started his company, Floor Works New York, with $145. Armed with computer science degree but unable to find suitable work, Mr. Ringel became “a math teacher in New York City.” You have to admit that a flooring company sounds like an unlikely enterprise to be started by a math teacher with a computer science degree. As we all know, however, public school teachers aren’t paid exorbitant salaries and Ringel found himself struggling to make ends meet. “So, he jumped at the opportunity to work for a colleague who ran a flooring company on the side.” DeBaise, Needleman, and Maltby continue the story:

“The job, which entailed finding new clients and marketing for the company, wasn’t terribly lucrative. Mr. Ringel made only $2,000 in commissions his first year. Still, he was so discouraged at his teaching job that he moved to the flooring company full-time in 2005—and took the chance to learn everything he could about the business. He observed how a small enterprise operated and watched the contractors to better understand the trade, even helping them occasionally. At the time, sales were booming, and Mr. Ringel thought the company had the potential to soar even higher, if it implemented systems and processes that would better organize and dispatch the contractors. But the owner didn’t have the same vision. … Against the advice of friends and family, he decided to start his own flooring business in the summer of 2007. It was a risky time; many contractors were feeling the impact of the housing-market bust. Mr. Ringel had to act fast to get his own firm up and running while it was still a busy season for repairs and renovations. The problem: He didn’t have the licenses or insurance that contracting companies require—nor could he afford them—and he had only a cursory knowledge of how to lay a floor. He did, however, have a solid network of contractors and he knew how to attract new clients. So, Mr. Ringel says, he approached a licensed and insured freelance contractor and asked to solicit work for him, in exchange for a cut of the profits. The contractor agreed. Mr. Ringel set up a phone line, with a voicemail system that left callers thinking that they had dialed a fully staffed company, he says. It cost about $20 a month. He also bought new business cards for $25. Finally, he spent $100 for the hosting and domain name of a new website, which he designed himself. … By August 2007, the Astoria, N.Y., start-up had $7,000 in reserves. … By the middle of last year, Mr. Ringel had started paying himself a regular salary. And when winter rolled around, he was ready for the slump, adding painting to his services to supplement the flooring work.”

As noted earlier, hard work is one thread that weaves its way through all of these stories. Another thread is that each entrepreneur had to deal with the legalities of starting a business. Sarah Needleman reports, “Deciding what kind of legal structure to form for your new business — and when to do it — may require more research and consideration than other tasks.” [“Setting Up a Business Structure,” The Wall Street Journal, 26 September 2010] Of course, setting up a legal structure costs money. Still, it’s important. Needleman continues:

“Rules regarding eligibility to collect unemployment benefits vary by state, as do the costs associated with setting up the various types of entities. And each option has distinct tax, liability and administrative implications. … In general, most small businesses are structured into one of five basic forms: a sole proprietorship, partnership, C corporation, S corporation or limited liability company. You don’t need to file paperwork to establish a sole proprietorship, which is a business that’s owned by one person or a husband-and-wife team. The same goes for partnerships, defined as enterprises with two or more nonmarried owners. For this reason, these options are typically the least expensive — though most states and cities do require entrepreneurs to obtain a license or permit to operate and will charge various fees. C corporations, S corporations and LLCs, which differ by their tax structure, require filing paperwork. C corporations typically pay taxes twice — first on all income that’s left after business expenses are paid and again on that income when it’s distributed as dividends to shareholders. S corporations allow profits to pass through to the owners’ personal tax returns. For tax purposes, LLCs must elect to file their tax returns as a C corporation, S corporation, partnership or sole proprietorship.”

Needleman points out that “a major downside to sole proprietorships and partnerships is that they lack liability protection. So owners’ personal assets could be at risk should their companies get sued.” She provides more good information in her article and, if you are thinking of starting your own company, it’s worth a read. By now you should understand that starting a company on a limited budget is possible but difficult. It won’t take long before an infusion of capital is needed. In order to keep costs in check, Ries’ principles for a lean start-up are worth looking into and implementing.