Managing Costs is Crucial in a Startup

Some entrepreneurs think that high profit margins are the key to a successful startup. High profit margins are definitely an indisputable advantage. However there are reasons as to why certain products have high profit margins and why others do not command similar margins. Basically without going into details, products with high profit margins would probably require high advertising and promotion costs. However, there are businesses which make good profits on low margins while those with high margins make lesser profits. Whatever profit margins one may have, the key thing to note is that high costs could erode most of the gains the margins provide.

There are basically 2 types of costs a business encounters. They are fixed and variable costs. This post concentrates on fixed costs as one could make many significant changes to them. For fixed costs, there are 2 components ie capital costs and  non-capital costs. Capital costs generally refers to furniture & fixtures, and machinery & equipment costs as well as intangibles which are amortizable.

If one pays too much for capital costs, then the amount depreciated or amortized monthly could rise considerably so as to reduce the profits or even lead to losses. This could happen for several reasons. For instance, one could be lavish in renovating an office or other premises. Or one could be purchasing machinery and/or equipment whose capacities are far in excess to the sales that could be reasonably generated. The other possibility would be the unnecessary purchase of a vehicle or vehicles to do deliveries. As a result, there could be gross under-utilization of the vehicles or machinery/equipment. In the case of vehicles, it would probably be more economical to make use of courier services at the start. Once things reach a steady state, it would be easy to work out whether a vehicle or vehicles are needed for deliveries.

The other possibility is where one could be paying excessively for the rights to franchises or other licenses which translate into higher monthly amortization costs. The high costs of the intangibles could be way beyond the startup’s abilities to generate sufficient profits. Therefore it is important that one works out a viable business plan based on reasonable capital costs on the onset. While it is good to be generally optimistic about the success of a startup, it could be detrimental to be overly optimistic especially when capital costs are involved.

The non-capital fixed costs generally refers to components like rental and labor costs, and other overheads. Whether the business generates any revenue or not, these costs would still have to be paid. Similar to capital costs, one could end up with premises which are far beyond the needs of the startup at the point in time. For instance, one could locate an office in a prime area, thereby commanding premium rental rates. In fact, there could be no necessity for the prime location. Alternatively the size of the premises could be much more than what would be required for the startup. Of course, it would also be a mistake to lease too small the size of premises required and to outgrow it within a year. However, it is more likely that one overestimates the size of premises required than underestimating it. In the case of underestimating, it would be a much more pleasant problem to deal with than the other way around.

The same goes for labor costs. Hiring too many people from the start would be disastrous. The problem lies not only in the cost burden but also in terms of staff morale. Good employees worth retaining would be bored and would be among the first few to leave. The strategy should be to work everyone including yourself to the verge of exhaustion before taking in a new employee. It is also important to keep a tight lid on overheads. These costs include stationery, telecommunications, and utilities.

In conclusion, it is important to right size the scale of the startup in the beginning.

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