6 ways start-ups reduce their profit margins

Every start-up begins with a bright idea. But even with a steady stream of clients, some start-ups might still flop. Sounds like a head scratcher? Here is how that happens.

For most start-ups and small businesses, every coin counts. Sometimes, businesses spend money on unnecessary things or overspend on the things that don’t give back value. And over a long period of time, overspending will cost the business significant profits, and in extreme cases, the business will be forced to close. So what are common pitfalls that tank otherwise great businesses?

1. Expansion and capital expenses without a plan

“In business, there is planned expansion and visionless expansion,” says Peter Macharia, the CEO of Jijenge Credit Limited. “Start-ups can be overzealous. I have seen start-ups that invest in state-of-the-art machines and software which they do not need at that point in the growth of their business,” he says.

Buying improved technology, tools or even infrastructure is part of a business’s growth. But it should be measured and guided by a need for it.

 “When Jijenge opened its doors we used excel sheets to capture and process loan facilities for our clients. It took five years to get to where we felt a software update was necessary,” Macharia explains.

The few clients they initially had could be served with the simplest tools at the credit firm’s disposal.

“Would we have wanted to use a sophisticated banking software? Sure! Because apart from reducing loan processing from 24 hours to just one hour, the software would run through a customer’s credit score numbers under two minutes. But it wouldn’t have been prudent to purchase the software at the time.”

“The software was expensive when we bought it. But at the time, it added value to the business. This time we had thousands of clients to attend to. It was time to buy the software and improve efficiency.”

According to Macharia, one ought to wait until the business demands for the expensive tool.

 “When demand is still low, use old tools at your disposal. Buying state of the art technology will cost you a lot of money at a time the technology won’t be able to give back in true value.”

2. A bloated and unnecessary staff team

While fully functional and autonomous departments such as IT, customer service, human resources and legal are good for any business, the financial muscle needed to power all of them would be too much for a start-up.  At the onset, Jijenge had one staff.

 “I was the only staff. I did everything by myself. I could comfortably handle the workload. You have to hire on a need- to basis. Even when you do, hire staff with multiple skills. Avoid hiring prematurely and hire labour you can afford to pay,” Macharia says.

 Another way of reducing the number of people on your payroll, is to hire consultants periodically.

“For instance, I do not have an IT team. If I was to hire an IT manager, I would have to pay them at least Sh100,000 per month. Instead, I bring in a consultant once every quota and I pay them Sh20,000 to do maintenance and upgrades. Thus, the business saves a lot in capital costs,” Macharia says.

Winnie Ngumi, CEO of Space and Style Roofing Tiles, says that a start-up owner should avoid paying yourselves too much.

“There is always the risk that founders of a business may start off paying themselves hefty salaries and disregard business’ growth. Also, hire affordable staff then bring in an experienced consultant to train them for the business.”

3. Expensive office spaces and utilities

Sheila Birgen is the CEO of The Cord; an organisation that works with companies to keep them competitive and successful.

 “I have seen start-ups get excited and open offices in upmarket places where rent is exorbitantly high. Accompanying utility costs for these upmarket offices are equally high. I guess the intention is to stand out as a formidable, credible and legitimate business…but this can backfire,” she says.

Birgen recommends starting simple; then slowly, one can upgrade. And in these times when businesses can operate remotely, one can be spared of these costs.

“If you study the most successful start-ups in the Silicon Valley, most, if not all, started from garages or a backyard somewhere. A start-up cannot afford expensive leases. This is a bad decision however promising the business is,” Birgen says.

4. Unnecessary infrastructure

You do not need the leather seats, glass tables and an embroidered carpet for the office reception. Extravagant purchases will only eat into crucial capital that could be used to grow your business.

According to Ngumi, when a start-up opens office, they should stick to equipment and tools that they need to run the business.

“Spend as little as possible on setting up,” she says. “Do not be extravagant in purchasing ambitious infrastructure. Office desks, machines, furniture, décor and equipment should be good enough to get the job done but not extravagant.”

5. Bad marketing strategies

Marketing and advertising are necessary in raising brand awareness. Marketing is crucial in selling a product or even a service.

It is precisely because of the value marketing has on a business’ prospects that Ngumi argues it can easily become a channel for excessive spending.

The challenge is that there aren’t any scientific tools to determine ‘enough marketing’. Therefore, a business can end up spending more money unnecessarily.

The best way to mitigate this is to start looking at marketing in terms of its return on investment (ROI) probability.  A few questions to ask yourself would be; What is the marketing bringing in compared to what you’re spending on it?

“Another common mistake start-ups make is being quick to go to market before the full product is available on the shelves. The downside of this kind of early marketing is that the product might miss the mark and attract bad reviews at launch; precipitating into a public relations nightmare. Only do marketing when the product is ready to launch,” Ngumi says.

6. Technology subscriptions

Your business might need telecom services such as phone service and internet. The business may also need to tap onto data storage and management services.

Today, we have apps and software that can improve aspects of your business – from HR management to staff co-ordination.

Each of them will likely attract a monthly subscription. Though their rates might seem small individually, they can add up to a lot.

So, what do you do?

“Research. Find a provider that’s both less expensive and more reliable. Or you can negotiate streamlined options to save you money.”

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