[This article is a piece of part 8 of our Smart and Simple Guide to Starting a Business - scroll to the end to see the other parts]
For any business, it’s important to accurately estimate supply and production costs. If cost estimates are inaccurate, you can’t price your product correctly, which will lead to a faulty prediction of your potential profit. Don’t let this chain reaction be the kiss of death for your new company.
Understanding the fixed and variable costs of your business
When building a financial model for your business, you’ll have fixed and variable costs to consider. Make sure to list out both types of expenses, doing your best to predict them accurately right from the start. As you adjust this list, you’ll need to modify your financial model and price point.
Fixed costs, or operating costs, don’t fluctuate much as they don’t depend on daily sales figures. Some examples of fixed costs might be:
- Lease of office or warehouse space
- Rental of equipment and vehicles
- Loan payments
- Salaries of permanent employees
While fixed expenses don’t fluctuate like variable expenses do, keep in mind that they can change. If you expand your business, adding more employees or vehicles, or if you have an unfortunate decline, leading to lay-offs, your fixed expenses will go up or down.
On the other hand, variable costs fluctuate as a direct result of your production. If your sales figures increase, so will your supply turnover rate, leading to increased supply costs.
Some examples of variable costs might be:
- Raw materials
- Commissions for your sales force
- Part-time employees
- Temporary employees
Of course, your variable costs will increase as you sell more product, but keep in mind that if you can purchase supplies in greater volume, you can usually receive a better per unit price from your wholesaler.
The operating or fixed costs are usually pretty easy to list out, but sometimes people get tripped up calculating the variable costs properly. Problems can quickly snowball for an entrepreneur if expenses aren’t estimated correctly.
I’ve seen many self-published authors struggle over the price point of their book. Authors are usually passionate about their message, so they sometimes pay a high price to see their names in print. Printing a small quantity can be expensive. So, in order to make a profit, they increase the retail price of their book, making it unattractive to readers.
Last year one friend of mine poured a lot of time and money into creating a board game, which turned out to be more expensive to manufacture than he realized. In the end, he had to price the game too high. Had he done the research ahead of time, he would have saved himself thousands of dollars. Instead, he now has a storage unit filled with boxes of games he can’t move.
Don’t allow your enthusiasm for your product to override your common sense. Remember, it’s business. Your hard earned money is on the line, so make sure to calculate all of your expenses before you invest.
In general, products flow from a manufacturer through a number of middle men before they get to you, the retailer. However, some merchandise can be purchased directly from the manufacturer at dramatic savings.
If the item you need is coming from overseas, there might be an importer/exporter involved, who works with a smaller local wholesaler. Sometimes, the importer/exporter will work directly with retailers.
Regional wholesalers often take delivery of large containers and break them down for their clients, creating smaller units, which are easier to sell.
In some industries, wholesalers are further broken down into a smaller classification, called jobbers. They deliver on a daily basis to local shops, like grocers.
The first step for anyone selling a product is to learn the precise distribution channel for their particular industry. Remember, with proper research you may be able to bypass a few of the middle men, and perhaps find a manufacturer who is willing to give you a good price.
How do you find a wholesaler?
Finding a good wholesaler is a crucial part of any retailer’s business. The first step is to find a few potentials, so that you can choose the best one to fit your needs. Here are some suggestions on places to start looking:
Trade Shows: If you have the money and the time, trade shows can be excellent for your business. TSNN (Trade Show News Network) and biztradeshows.com can help you find the right trade shows for your location and industry.
Surf the net: You can do online searches for your area and industry. Look for wholesale directories like Wholesale Central or Wholesale Network. Ebay and Craigslist are also possibilities, as is yellowpages.com.
Trade Magazines: Check out the ads and classifieds of wholesalers in the professional magazines of your industry.
Network: Talking to others in your industry can sometimes give you good tips. Some people may refuse to give out information on their wholesalers, guarding them as they would treasure, but others are more open, not fearing healthy competition.
Chamber of Commerce: Network with other businesses at your local Chamber of Commerce. Ask around to find out who the most reputable wholesalers are.
Form solid relationships with wholesalers
Bob Reiss, author of Bootstrapping 101: Tips to Build your Business with Limited Cash and Free Outside Help, states, “Let’s get this right – you need good reliable suppliers. When you find them, treat them like gold.”
One of your first goals will be to develop a good relationship with wholesalers in your industry. They can make or break your business. After all, you need to get the best quality materials at the lowest price you can.
Typically, the higher the quantity of your purchase, the lower your wholesale price will be. This means more profit for you. However, when you’re first starting out, you probably will not be able to negotiate low rates, because your production volume will still be small. Still, some wholesalers may be eager to work with you, seeing a potential future relationship.
Once you find the perfect supplier, they’ll probably request that you enter into a contract with them. Remember to make notes on any terms that aren’t favorable (price, minimum orders, delivery schedules, etc.) and work toward negotiating with them. It doesn’t hurt to ask.
Remember, if the modified agreement isn’t in writing, it probably won’t be honored. Oral agreements aren’t worth the paper they weren’t written on. Make sure the exact deal is written down and put in as a proper addendum and run the contract by your attorney before you sign.
As with any business venture, you must do proper research on the suppliers you choose in order to prevent potential financial headaches. Get plenty of references and do your due diligence before you enter into a long term commitment with them.
Once you find a good, reliable wholesaler and can build a relationship with them, you will be able to lower your variable costs, increasing your profits.
Accurately predicting all your costs and setting your product’s price point at a competitive level will set you and your business up for success.
Part eight of a series - The Yahoo Smart and Simple Guide to Starting a Business.
- Part one: Is it time to start up that startup business? and Part 1- Goals, Values and Ideas and Resources for Goals, Values and Ideas
- Part two: Build a winning business right from the start and Part 2: Defining your business concept and Resources for defining your business concept.
- Part three: Funding, Fraternity and Family and Part 3: Ownership, Funding and Family and Resources for funding and ownership
- Part four: The Name Game and Part 4: Naming Your Business and Resources for naming
- Part five: How to Brand your Business on a Budget and Branding: First Impressions Matter and Resources for Branding .
- Part six: Keep Your Friends close and your Competitors Closer and Competitive Research and Resources for Competitive Research
- Part seven:Find Profit in Pricing Your Product Or Service For Your Target Market and Customer and Market Research – Necessary but Overlooked steps for the Entrepreneur and Resources for market research, customer research and competitive research