Why I Overinvest

In every company I have owned, I have made the same mistake: I over invested.

For most businesses, generally in the first few years, there is a period when you have to spend a significant amount of time and/or money to get it off the ground. You are trying to figure out what does - and does not - work. Seth Godin calls this the ‘throw spaghetti at the wall and see what sticks’ phase.

Problem is, some business owners (including me at times), just keep throwing spaghetti at the wall forgetting that one day their arm will become tired and also - noodles may be cheap but they’re not free.

Truth is, after a few years, most companies have a core product and a clear cost structure. Meaning: they know how much they have to invest to make the product, market it and deliver to customers. (If you don’t know this number after being in business for several years, stop reading this now and spend the afternoon figuring out how to read a P&L).

Like a speed boat planing on top of the sea, getting up to speed requires a lot more energy than cruising. And, with most companies, you will probably spend money that doesn’t produce an efficient return on investment in the beginning. This is OK. However, once the hull of the boat starts to glide on top of the water, you can actually give it less throttle. The boat becomes more efficient because it’s found an equilibrium. Same goes with marketing dollars, product development, production costs, etc in most small businesses.

This is because companies are machines too, with varying degrees of efficiency. A lot of times, when you give them more throttle, as in the case of a boat, or more time and money, they simply do not go faster, or produce a better return, once they have reached a certain size.

So, how do you know when enough is enough?

If it isn’t being tracked, it can’t be measured. Many companies lump all of their new product development, new marketing strategies, new brands, etc in with the costs of their core business (or the product that is profitable). This makes it almost impossible to analyze and track progress.

Easiest solution: Start documenting all of your crack-pot ideas in proper categories.

Marketing person spending 50% of her time on a new brand? Keep track. New product development caused you to hire two new developers? Write it down.

Next, come up with an acceptable net margin: We came up with this around year 3 or 4. Think of the number that you want to make year over year. For us, in our physical product business, this was 20%. It meant we could chase any, and every, crazy new product idea or marketing strategy on condition that, at the end of the year, we were left with 20%. Sure, some years it was 18%, but I am seeing some companies bet as much as 90% of their net margins on unproven investments. I think many will agree, this is suicide unless you are a funded company.

A helpful way to view it is: think about your investments in the company as your personal money: Because depending on your corporate structure, it probably is your money. For years we kept personal money in the corporate bank account. At the end of the year, that 20% we had earned was never transferred to our private accounts. It becomes a much harder investment decision to make if you have to physically transfer the money back into the corporation in order to spend it. Side note, this is why I suck at gambling in a casino. Once my dollars are converted to chips, they don’t represent money to me any longer and I’m much more free with them.

Have realistic goals: ‘I want a company that makes 50 million dollars in revenue’ if you have flat-lined at 5 million dollars in year 4 it's probably not a realistic goal anymore. And that is OK! If you are making 20% net margins with a 5 million dollar company you are bringing home a million dollars a year. Congratulations, you are currently making more than 99% of the population.

Until recently I had always thought I could ‘do better’ in every business. But, getting back to the idea of the speed boat, sometimes it never planes out, it just keeps trying to accelerate with the bow up in the air fighting the water. And that makes for an uncomfortable ride. Sometimes it makes sense to stop paying for all that gas and buy a better boat.

Maybe there is a metaphor for sailboats being powered by the endless supply of wind but I’m not smart, or green, enough to see it :)