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Small Business Failure… thoughts

Sunday, August 3rd, 2008

Today I am heading down to Alpharetta because a tile business I know of is giving away the last of their inventory.  It’s always sad to see someone’s dreams wind down to it’s untimely end.  This is especially painful for me because we had a small business fail.

Closing a small business is very hard for two reasons:

1.  It’s hard to fail.  Failure is a real bummer.

2.  Most small businesses help the local community in many ways.  Small businesses often hire people with problems (people that can’t work at a normal job).  It’s always hard to tell someone that’s living on the edge that they have lost their income.  Small businesses usually support tiny local groups the ones that you don’t get a tax write off for.  Small businesses usually have people that like to hang out and connect at them (the people that hang out at your shop and then buy at Walmart… ok I am a little bitter).  The point is that when you close a small business you say goodbye to a lot of people.

So what makes running a small business so hard?  The cards are stacked against small businesses in the following ways:

1.  Credit Cards – For the first two weeks we were open our business did not accept credit cards, after we started accepting credit cards our business increased four times. Sadly credit cards are necessary.

I can illustrate my point through a story… when I was in HS I ran track.  My events were the 1500M and the 3000M.  I was the third fastest on the team, but to be honest the first and second fastest were MUCH faster.  A few times throughout the season my coach put five pound vests on the first and second fastest guys and we raced a mile.  If you have ever worn a five pound vest you know that it’s hardly noticeable at first.  Before the first race they didn’t think the vests would make a difference.  I ended up beating both of them.  The thing that was interesting about it was that all of the non-distance athletes thought I had just gotten faster.  They were all cheering and clapping when I came in first place.  They did not know that the other two athletes were wearing five pound vests.  We all learned two important things.  First, it doesn’t take much of a disadvantage to pull the better athlete down.  Second, they really weren’t that much better than me, but being a little bit better makes a HUGE difference.

So now I can make my point.  The percentage of a business’ sales that has to be payed to credit cards is like a weighted vest on an athlete.  As a business’ volume increases the percentage the business has to pay goes down.  So the weighted vest gets lighter as it gets busier.  So the way the current system works would be the equivalent to my coaches in HS making the slowest runners wear the heaviest weight in a race.

2. Rent, if you go to a strip mall and ask how much the rent is you will probably be quoted a price per square foot that’s 2 or 3 times what a national account would be charged.  I know this because one time we asked for a price quote on a location and the rate was $21.00 a square foot.  A few weeks later I found out that the property manager was one of my co-worker’s sister.  He was a very talkative fellow and he told me that the rate they charge for national accounts was $7.00 a square foot.  So from a head to head perspective a small business is at a huge disadvantage.

3. Rent again.  If you open a small business you will likely be competing against giant superstores.  If that is the case then those superstores typically pay less than $1.00 a square foot.

4. Taxes.  Most giant corporations work out deals for tax breaks.  So they may collect 6% in sales tax, but then the state or city returns some or all of that back. Many times these companies report profits of 3% so basically every cent of profit they made was made off of the tax payer.  It’s like the tax payers is footing the bill to put small businesses out of business.

5. Volume.  So lets say you sell shoes and you can buy at whole sale prices as the big guys (unlikely) then this is the situation.  I took an intro to business class and I remember they described the way a business owner should see selling inventory.  Let’s say the big corp buys 10,000 units for $10.00 each this is a possible scenario:

Month 1: Sells 3000 units for $30.00 each (earns $90,000)

Month 2: Sells 3000 units for $20.00 each (earns $60,000)

Month 3: Sells 3000 units for $10.00 each (earns $30,000)

Month 4: Sells 1000 units for $5.00 each (earns $5,000)

Total Sales: $185,000

Total Cost: $100,000

Total Profit: $85,000

As a small business you may look a catalog and see that you can buy 1000 pairs of shoes for $10,000 and those shoes at $30.00 a pair at the mall.  You think… awesome I can sell these shoes for $20.00 a pair and undercut the mall.  The problem is that by the time you get the shoes the mall is in month two or maybe worse month three and they are selling them at your cost.  Then the small business is in a world of pain when the mall is selling the shoes for half the small business’ cost.

6. Debt: One business I just loved was Steve and Berry’s.  They sold leather jackets and nice shoes for around $10.00.  Everything in their store was one price that was around $10.00.  Whenever we visit out daughter in NJ we load up.  I remember wondering how they make any money at those prices.  The answer is they don’t, they lose money.  They use(d) loans.  A lot of these giant corporations have access to billions in debt.  They can lose money for decades before anyone can tell that they have lost any money.  I’ve seen companies report profits for decades and then suddenly one year they go bankrupt with hundreds of millions of dollars in debt.  A company reports 50 million a year in profit for 10 years and then suddenly go bankrupt in year 11 with 800 million in debt.  So instead of 500 million in profit over ten years they actually had 300 million in losses over 11 years.  Then the banks collapse and the tax power bails them out and I am left to wonder how many small businesses did that giant corporation run out of business over the last 11 years.

I am sure there are a lot more disadvantages, but I can’t of any more right now.

So why do some small business succeed?

1. I think most small businesses aren’t in it for the profits.  I’ve noticed that many small businesses are owned by individuals that are married to sales professionals.  If you own a thriving small business you may not be making any money, but you know a lot of people and you know what’s happening in the community.  If your spouse sells real estate, mortgages, insurance, or is a lawyer, or something else like that then a small business can be a great way to get customers to the spouse.

2. Many small businesses are owned by politicians.  To reiterate the previous point when we owned Melissa’s Boutique Melissa had 600 consigners and 2000 people on her email list.  She could with a push of a button contact 2600 people and the vast majority of them lived in Marietta.  Marietta is a city of about 100,000 people.  If you think about it Melissa was probably one node away from every citizen in Marietta.  Almost every mom in Marietta knew Melissa or knew someone that knew Melissa.  Small businesses are perfect for most politicians and as long as they break even or don’t lose too much money it’s the cheapest way to communicate and earn the trust of massive numbers of people.

3. Many small businesses are a different identity.  You can do business as a small business, but if things go bad you can start a new small business and have a fresh start.  Many people in the roofing, construction, mechanic… business pretty much just practice their trade.  Then if they get sued or make a huge mistake they can close the small business down and get a fresh start.

4. Many small businesses are vanity businesses.  A lot of people respect business owners (as they should IMHO) and people keep the business open for pride and because it’s good for the community.

5. Special side effects.  I met a guy that owned a bed and breakfast once.  He was working in a gas station in a tiny town in the mountains.  He worked the graveyard shift and I think he would drum up business by selling rooms to travelers that looked really tired at the gas station.  He told me about the awesome B&B that he owned and how it was 6000 SF and they had animals and they served a great breakfast and… and… and… The place sounded awesome, but I remember feeling sorry for the guy working all night at a gas station to keep the B&B afloat.  Then about a week ago I remember thinking Whoa, how many gas station attendants live in a 6000 SF house, with horses and stables, and mountain bike trails?  I know plenty of people that work 80 hours a week that don’t live that kind of lifestyle.  My guess is that the B&B loses money, but it’s probably worth it because he gets to live in an awesome environment.  He owns a business.  He gets to write everything (including his food, housing, probably clothing…) off as losses.  That’s an awesome side effect.

Small businesses have lots of advantages as well as disadvantages.  The point is if you think you are going to take on the big guys by running a traditional business for profit you IMHO are in for a long and painful journey.  But if you are clever and create a useful small business to drive business to a more profitable and difficult sale or if you use a small business as a way to improve your lifestyle then it makes a lot of sense.