The Margin Manifesto, Part I

by Timothy Ferriss

The financial goal of a start-up should be simple: profit in the least time with the least effort. Not more customers, not more revenue, not more offices or more employees: more profit.

Based on my interviews with high-performing CEOs in more than 20 countries, and my guest lectures at Princeton University in high-tech entrepreneurship here are the basic tenets of the “Margin Manifesto” – a return-to-basics call that gives permission to do the uncommon in order to achieve the uncommon: consistent profitability in 3 months or less. (The best news is, these same principles can then be applied to double your profits in the same amount of time!)

Here, I present 5 of the 11 commandments in my Margin Manifesto:

I: Niche is the New Big – The Lavish Dwarf Entertainment Rule
Several years ago, an investment banker was jailed for trade violations. He was caught partly due to his lavish parties on yachts, often featuring hired dwarves. The owner of the dwarf rental company, Danny Black, was quoted in the Wall Street Journal as saying: “Some people are just into lavish dwarf entertainment.” Niche in the new big. But here’s the secret: it’s possible to niche market and mass sell. iPod commercials don’t feature dancing 50-year olds, they feature hip and fit 20-30-somethings, but everyone and his grandmother wants to feel youthful and hip, so they strap on Nanos and call themselves Apple converts. Who you portray in your marketing isn’t necessarily the only demographic who buys your product – it’s often the demographic that most people want to identify with or belong to. The target isn’t the market.

II: Revisit Drucker – What Gets Measured Gets Managed
Measure compulsively, for as Peter Drucker stated: what gets measured gets managed. (For more from Drucker click here.) Useful metrics to track, besides the usual operational stats, include CPO (“Cost-Per-Order,” which includes advertising, fulfillment and expected returns, chargebacks, and bad debt), ad allowable (the maximum you can spend on an advertisement and expect breakeven), MER (media efficiency ratio), and projected lifetime value given return rates and reorder %. Consider applying direct response advertising metrics to your business.

III: Pricing before Product – Plan Distribution First
Is your pricing scalable? Many companies will sell direct-to-consumer by necessity in early stages, only to realize that their margins can’t accommodate resellers and distributors when they come knocking. If you have a 40% profit margin and a distributor needs a 70% discount to sell into wholesale accounts, you’re forever limited to direct-to-consumer… unless you increase your pricing and margins. It’s best to do this beforehand if possible – otherwise, you’ll need to launch new or “premium” products – so plan distribution before setting pricing. Test assumptions and find hidden costs by interviewing those who have done it: will you need to pay for co-op advertising, offer rebates for bulk purchases, or pay for shelf space or featured placement? I know one former CEO of a national brand who had to sell his company to one of the world’s largest soft drink manufacturers before he could access front-of-store shelving in top retailers. Test your assumptions and do your homework before setting pricing.

IV: Less is More – Limiting Distribution to Increase Profit
Is more distribution automatically better? No. Uncontrolled distribution leads to all manner of head-ache and profit-bleeding, most often related to rogue discounters. Reseller A lowers pricing to compete with online discounter B, and the price cutting continues until neither is making sufficient profit on the product and both stop reordering. This requires you to launch a new product, as price erosion is almost always irreversible. Avoid this scenario and consider partnering with one or two key distributors instead, using that exclusivity to negotiate better terms: less discounting, prepayment, preferred placement and marketing support, etc. From iPods to Rolex and Estée Lauder, sustainable high-profit brands usually begin with controlled distribution. Remember, more customers isn’t the goal; more profit is.

V: Net-0 – Create Demand vs. Offering Terms
Focus on creating end-user demand so you can dictate terms. Often one trade publication advertisement, bought at discount remnant rates, will be enough to provide this leverage. Outside of science and law, most “rules” are just common practice. Just because everyone in your industry offers terms doesn’t mean you have to, and offering terms is the most consistent ingredient in start-up failure. Cite start-up economics and the ever-so-useful “company policy” as reasons for prepayment and apologize, but don’t make exceptions. Net-30 becomes net-60, which become net-120. Time is the most expensive asset a start-up has, and chasing delinquent accounts will prevent you from generating more sales. If customers are asking for your product, resellers and distributors will need to buy. It’s that simple. Put funds and time into strategic marketing and PR to tip the scales in your favor.

The next six commandments will appear tomorrow in The Margin Manifesto, Part II. Stay tuned for my explanations of how to “fire” customers, negotiate late, make advertising work in the real world (no more repetition), and much, much more…

Check out Tim’s best-selling book, The 4-Hour Workweek, which hit #1 on The Wall Street Journal’s list of best-selling business books last week. And see his original WebWorkerDaily essay published on Found|READ here.