Starting a company in an economic drought(DARE)

With so many people around the world focusing on holding onto their jobs, what would you think if a friend told you that he or she is thinking of starting a business now?

Around the world, economies are contracting, demand is falling, companies are cutting back their purchases, bank credit is increasingly difficult to obtain, and risky projects are being canceled. Perhaps India—one of the few economies in the world that still registered healthy growth in the past six months—is less hard-hit than others, but still, starting a new business during the economic equivalent of drought season seems like a mad idea. Or is it?

Our case in this month’s issue of DARE seems perhaps to tell a cautionary tale. Manish Sharma started his first company right after graduating in 1995. It was a web solutions provider that entered the market at the perfect time. Attempting to build on this success, he started a second venture just as the dotcom bust took hold, and this company was unable to survive that lean season. It took several years before he was ready to start his third venture, Printo, with his wife, and this venture has prospered in part by riding the rising tide of India’s remarkable recent economic growth. So is the lesson here “Wait until the business cycle is rising before you start a new enterprise?”

Such a dictum is far too general to be useful. Sharma’s second venture failed because it was the wrong kind of business to start at the time: an innovative product company. In contrast, rigorous academic studies show that many successful companies are started during down periods in the business cycle, and often they are more robust in the long run than those which were founded during good times. However, the kinds of businesses that survive in challenging times are not the same as those that thrive in more prosperous eras.

Businesses that typically do well in a downturn solve pressing problems (usually saving their clients money) without requiring much up-front investment or cash. This is not a great time to start a product company that requires a lot of investment and a long runway before it breaks even. It is also not a great time to start a company whose offering would make your customers’ lives better if they bought it, but which would not be missed if they did not. Companies that thrive in harsh economic environments usually save their clients money right away. Most businesses and consumers are looking for ways to conserve cash, decrease investment outlays, and lower their total cost of ownership. Firms that can help them achieve such goals often perform especially well during a recession.

If you have an idea that fits these times, there are still a few pitfalls to avoid. First, ensure you can reach prospective customers at low cost. If you have a product or service that will save people money, but you can’t make them aware of the opportunity until you spend a lot of money on marketing, you may run out of cash before you build up enough revenues to sustain your enterprise. Startups who grow via word of mouth or inexpensive search engine optimization are much more attractive than those requiring heavy marketing communications investments.

Another pitfall is paying insufficient attention to collecting your accounts receivable. Making money isn’t the only thing that matters in tough times—getting cash as early as you can is at least as important. Many an entrepreneur has grown impressively on paper, only to run out of cash because customers made late or partial payments for work that cost money up front. The more your business can be structured in pay-as-you-go fashion for customers, the brighter its prospects.

A third pitfall is relying too much on credit, especially for investments in equipment or inventory. Entrepreneurs often fall into a growth trap when expanding their business requires them to borrow in order to sustain a growing stock of working capital. Even if your top line is growing, you may find yourself in a squeeze when you hit a credit limit and find that sources of debt financing have dried up. Work up a spreadsheet showing how your credit needs will grow as your business expands, then ensure your growth does not outpace the amount you need to borrow in order to sustain it. Then, build in a safety buffer and stage your growth accordingly.

Businesses with the right configuration—saving their customers money visibly and swiftly with low marketing costs, a short sales-to-cash cycle, and manageable investment outlays—enjoy a number of advantages when they are launched in tough times. Costs are lower and vendors may be more willing to help out an enterprise that has promising growth prospects. Talent
is more readily available and key employees will become more loyal if treated well and given opportunities. Niches are less crowded with rivals, and it is harder for competitors
to overwhelm you by spending lavishly on marketing, channel coverage, or direct sales.

Challenging times also present another opportunity: rejuvenating sound businesses that have run into trouble because they were configured for growth. In 1965, the US sociologist Arthur Stinchcombe introduced one of the most influential ideas in modern management thought: “organizational imprinting.” Just as a duck is imprinted at birth, attaching itself to the first object it sees and treating it like a mother, so organizations are imprinted by the conditions in which they were founded. For example, Stinchcombe studied college fraternities in the US, and found that in the 1950s, those started in the mid-18th century continued to be much different than those founded decades later. The environment at the time an organization was launched shaped it in ways that were still visible a century later.

The Printo case in this month’s issue of DARE is an interesting case in point. Any digital printing business founded by professionals in 2005 would almost certainly be configured around a fast-growth strategy, as Printo was. The kind of people one hires; the pricing strategy one pursues; the amount of attention that any one location gets before the founders open another, and dozens of other factors reflect the growth pressures that typically drive firms in eras of economic expansion. They are built for growth, and expanding rapidly is in their DNA. Printo is unusual because its founders recognized in 2008 that they had to rethink the fundamental nature of their business. Most entrepreneurs do not—they operate “bicycle” businesses that move forward smartly as long as they have momentum, but that tip over when their forward motion slows to a crawl.

If you start a business in 2009, you will have opportunities to take customers away from businesses that were started several years ago and have not yet gone through the painful change management required to shift gears and run lean. You will also have opportunities to partner with such ventures in cases where they have access to customers but are not configured to save them money right away. You will also have opportunities to buy cheap assets from businesses that are fundamentally sound but that have overextended themselves because they were built to succeed in a different era.

2009 is a great time to start a business for entrepreneurs whose ideas, abilities, and connections fit the spirit of the times. If you can get your first couple of customers very quickly, save them money in the short run, and soon generate more cash than you consume, then you will seldom find more fertile ground to till. If, however, your passions take you in a different direction—for example, toward wanting to invest in breakthrough innovations that temporarily raise your customers’ spending—then bide your time. In both good times and bad, it is important to understand what you love to do and do well, then pick the right moment to start the kind of business that feeds off your passions.