There is no pithier summation of the right startup philosophy than this quotation by Professor Amar Bhide of Columbia University. One means of gambling as few resources as possible is via use of the virtual corporation strategy early on and for as long as it makes economic sense to do so.
The Virtual Corporation Strategy
Veteran entrepreneurs aim for as few “moving parts” as possible during the start-up phase. This means that they frequently outsource most business functions to outside parties in order to focus their attention and limited resources on their core strength. The objective is to free yourself to do what you do best and let others do what they do best on your behalf. It’s also a means of reducing or eliminating altogether the need for investment in inventory and fixed overhead. This is called the “Virtual Corporation” strategy.
For example, let’s look at an entrepreneur whose personal forte is marketing. She is looking at introducing a new and unproven product into the market-place. In order to keep both start-up and fixed costs down to a minimum, as well as to enable herself to focus her time and energy on what she does best (aka, her “core” activity, marketing), she decides to subcontract as follows:
-product design work to an engineering firm
-production to a manufacturer
-order taking and shipping to a fulfillment house.
Doing so not only allows her to keep her start-up costs to an absolute minimum because she avoids investing in her own equipment, facilities, and staff, but she turns what would normally be fixed costs into variable costs. While outside talent and rented assets may cost more by the hour they can be utilized more flexibly. If demand for the entrepreneur’s product stops so does her demand for her contractors’ services.
For these reasons this approach is known as the “virtual corporation”. To the outside world it has the “look and feel” of a fully-integrated company, but in reality it may be no more than a single-owner-operated home business working with a number of third-parties.
The key to successfully using the virtual corporation strategy is to always retain responsibility for the core function which gives your company its competitive advantage. In our example, another entrepreneur whose strength is engineering would subcontract out the sales and marketing functions and retain responsibility for design work.
As with everything, there is a trade-off. The main trade-off for the virtual corporation is a lower profit margin because independent contractors will factor a profit margin into their prices which then has to come out of the entrepreneur’s profit if she cannot pass it along to her customers via a higher price.
Once an entrepreneur has proven the viability of his venture he should consider moving towards a more traditional structure by bringing back functions in-house whenever it’s economically viable to do so. Although his required capital investment will then increase, so will his profit margins.
More information can be found on the virtual corporation here.
Know your breakeven point and strive to keep it as low as possible. Breakeven analysis is a key tool in business planning.