January 26, 2015
Everyone knows what the formula for entrepreneurial success is supposed to look like. Come up with a great idea. Write a great business plan. And then raise a boatload of money to make it all a reality.
That final step is where so many entrepreneurs falter—either they can’t get the cash they want, or the very thought of getting it is so daunting they just drop their dream entirely.
But it doesn’t have to be that way.
Small-business people can find the cash they need to grow without going hat in hand to reluctant bankers, pleading with relatives or pandering to venture investors. They can, in fact, launch a business with almost nothing but salesmanship and the willingness to take a risk.
How? By financing the company with their customers’ cash.
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It isn’t a new idea—in fact, variations on the strategy have been used by many savvy businesses, from Microsoft to Banana Republic to eBay, as they grew from upstarts to household names. But many entrepreneurs who have gotten an earful of the conventional wisdom on financing may not realize that there are alternatives out there, and just how simple those alternatives can be to implement, especially when they can use the Internet to improve their reach and keep down overhead.
For instance, businesses can act as middlemen between buyers and sellers and avoid putting up cash themselves at the start. Or they might offer subscription models, where customers pay in advance and so provide the businesses with capital to make the products. Or they might offer deals for a limited time, so that customers snap up the merchandise before the business has to pay its suppliers.
Of course, entrepreneurs can’t finance every business with customers’ funds. Some, like brick-and-mortar stores, are just too capital-intensive. But for businesses that fit the model, this can be a perfect way to get under way without leaving the company staggering under debt or beholden to the demands of investors. And even if the companies end up needing lenders or investors later on to expand their reach, they can get deals on much better terms than they could at the start.
Here’s a closer look at these strategies, and how some entrepreneurs used them to build successful businesses.
Get the Money Up Front
Pay-in-advance models have been around practically forever and are the most straightforward of the five customer-funded models. Most service businesses run this way. Do you want to remodel your kitchen? You’ll pay at least part of the fees to your designer and builder in advance, to help them cover their costs for the project. Do you want to fly to Denver next Tuesday? You’ll pay for your airline ticket today.
Thus, implementing a pay-in-advance model is as simple as finding a good reason why a customer would be willing to pay in advance—at least in part—and having the courage to ask for the money.
who founded Via in 2006 and proceeded to build it into a giant in the Indian travel industry. How? By asking India’s mom-and-pop travel agents for a $5,000 deposit in return for real-time ticketing capability and better commissions than the airlines were giving them. Signing up 200 agents in the first few months gave Mr. Gupta $1 million in cash, his customers’ cash, with which to start and grow his business. Last year, Via generated a reported $500 million in revenue, serving travel agents in India, Indonesia and the Philippines.
Decades earlier, Mel and
got Banana Republic started by getting their customers’ money up front—$1 for the Banana Republic mail-order catalog, please—and setting up 30-day credit terms with suppliers. The business took off when media personalities, including WOR radio’s John Gambling, got intrigued enough by the merchandise, and Mel’s vivid and quirky prose, to talk about the new catalog on air.
Collect Cash Like Clockwork
In subscription models, which are as familiar and nearly as straightforward as pay-in-advance models, the customer pays up front for goods (say, a box of organic veggies) or services (think newspapers or cable TV), which are then delivered in serial fashion over some period.
Why are so many subscription models popping up these days, offering just about everything from the wine of the month to men’s underwear? Because of the ease with which nearly any Internet-based business can be started today.
Krishnan Ganesh started TutorVista in 2005 with three Indian teachers and a VOIP Internet connection reaching American teens who needed help with their homework. He quickly learned that $100-per-month subscriptions for “all you can learn”—paid monthly in advance—were just what the teens’ parents wanted. When renewal rates after the trial period quickly materialized at north of 50%, growing the business was simply a matter of adding more fuel. Venture-capital funds provided it, and the business took off.
Could TutorVista have continued to grow without the VC infusion? Of course. But not at the astonishing pace that Mr. Ganesh had in mind. Mr. Ganesh later sold the business, which had by then become the largest employer of teachers in India, to Pearson for more than $200 million.
One warning: Subscription models work best when what they’re offering is perishable in some sense—today’s news, or the veggies—or regularly used or consumed, like Salesforce.com software or household electricity. For durables, such as underwear or shoes, delivered monthly, customer fatigue often sets in, or the shoe rack or underwear drawer gets full.
Put Yourself in The Middle of the Deal
Another common approach for customer funding these days is to act as matchmaker, bringing together buyers and sellers. Think eBay, Expedia and many more, who don’t own or even touch what is bought and sold, and make money by taking a share of the transactions.
With the cost of creating websites at all-time lows, matchmakers’ principal costs are those of getting suppliers on board and getting buyers to show up. Happily, neither of these is likely to require much cash, at least at the outset. Getting buyers is a matter of optimizing one’s website so that the search engines find it, or using paid adwords on Google and other search engines. (And, with luck, customers will click on the matchmaker’s site—and start spending money—before the matchmaker has to pay for the ad.) Ramping up suppliers can be as straightforward as knocking on their doors.
Today’s matchmaker poster child is Airbnb.
and his co-founders put the site together in 2007 as a way to pay their rent, by offering up space in their own San Francisco apartment for local conference-goers. By narrowly focusing on events that were too big for the local hotel inventory, they built their business one step at a time until they landed a CNN interview at the Democratic National Convention in Denver in 2008. They won a spot in Y Combinator, and landed venture capital, allowing the fledgling business to ramp up its growth, and the rest is history: over 1 million listings in over 190 countries.
But beware. One key to profitable growth using matchmaker models is to build both supply and demand in balanced fashion, with neither racing far ahead of the other. Too much or too little of either won’t only waste the money you spent getting them on board, but you’ll also run into trouble: unhappy suppliers who sign on but get few added sales, or disappointed buyers who come to your site but don’t find what they want.
Give Them a Deadline for Buying
In scarcity models, instead of attempting to sell as much as they can as often as they can, for the highest price they can (as most sellers do), sellers sell a limited amount for a limited time, and typically at bargain prices. “Buy it now,” they tell their customers, “because when it’s gone, it’s gone, and there won’t be any more.”
Doing so enables them to turn their inventory so quickly that they’ve been paid by their customers long before they have to pay their suppliers. The customers’ cash is then used to fund the operation and growth of the business.
Consider vente-privee.com’s Jacques-Antoine Granjon and his partners, who created the flash-sales phenomenon in 1985, and then moved online in 2001. The company offered a limited quantity of goods—unwanted or overstocked inventory from Parisian designer-apparel makers—at discounted prices in three-to-five-day sales.
The business collected immediate credit-card payment from “members” but didn’t buy stock until it had already been purchased by members. That meant Mr. Granjon didn’t need any additional capital to grow what became France’s most popular fashion brand.
There’s a downside here, though, that many of today’s flash-sales merchants didn’t anticipate. Because it’s so easy to get into selling closeout merchandise online, these days there are so many merchants in most categories that they have to compete to get their hands on their suppliers’ unwanted goods. So, what do the suppliers do? They raise the prices, of course, and sometimes they simply make more of the stuff to satisfy the merchants’ voracious appetites.
Transform What You Offer
As we’ve seen, most service businesses are able to operate using pay-in-advance models. But pure service businesses can be tough to scale past a certain point. So some canny entrepreneurs use the money they make from selling services to create products that are even more profitable.
got started by writing customized software for most of the early PC makers, which I would call a service business. Then they made the transition to a product business when they started selling Windows, Word, Excel and the rest in shrink-wrapped boxes. That’s when Microsoft’s value really took off, as selling millions of copies of software-in-a-box is far more scalable than writing operating systems one at a time. The cash earned from the original service business largely funded the development of the application software.
launched GoViral, a viral-video production company, in 2003. They funded their company’s startup and growth with the proceeds of one successful campaign after another. Two years later, a new partner, Jimmy Maymann, helped steer the company out of video creation and turned its attention to building the necessary technology platform to host such content and to effectively measure the reach each virally distributed video achieved. In 2011, GoViral was sold for $97 million.
Dr. Mullins, an associate professor at London Business School, is the author of “The Customer-Funded Business: Start, Finance, or Grow Your Company with Your Customers’ Cash.” He can be reached at firstname.lastname@example.org.
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