The 10 Most Common Mistakes in Direct Selling
by Dan Jensen
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Direct selling is the essence of free enterprise. Thousands of direct selling companies have sprouted during the last few decades. Sadly, many are no longer in business. I have been entrenched in the direct selling industry for over twenty five years and have seen hundreds of companies come and go. As the years have passed, I have discovered patterns of success and tragic mistakes that weaken direct selling businesses often to the point of failure. While there are many reasons for failure, it is my hope that by understanding ten of the more common mistakes, an aspiring direct selling business owner might have a better chance at success than those that failed to see the picture clearly. These ten common mistakes include:
- Inadequate planning
- The wrong business model
- Poorly designed compensation plan
- Lack of a good field training system
- Lack of an effective selling system
- Inexperienced management team
- Computer software that doesn’t work
- Listening to the wrong people
- Poor customer service
- Growing too fast
While these mistakes are not in any particular order, they carry with them differing levels of severity if committed. For example, while a poorly designed compensation plan can become a major obstacle to the success of the organization, it isn’t too difficult to correct the problem by changing to a good one. Lack of funding, however, can quickly force a company out of business within a few weeks when they fail to meet payroll or their commission obligations. Both problems can be fatal, but one is easier to correct than the other. Let’s review these problems in more detail.
#1 Inadequate Planning
Let’s suppose you want to build a house and have borrowed $350,000 to complete the project – the most your bank will lend you. You have $50,000 of your own money to add to the mortgage and expect the house to cost no more than $400,000. During the construction, you found a few unforeseen problems. While digging the basement, a water spring was found that had to be routed to a different part of the property. Cost: $8,000. Lumber prices rose 30% from the time you started the project. Cost: $12,000. You upgraded the carpeting hoping to make up the difference in other areas. Cost: $9,000. As you near the end of the project, try as hard as you might, you can’t get the house complete without another $40,000. You’ve already borrowed as much as you can to get the $350,000. You have no more money of your own. What will you do?
So it is with starting a business. Many well intentioned entrepreneurs embark on a long to prosperity full of hopes and dreams. As they journey along the road, they hit a few “water springs”, and find many things costing far more than expected. They make a few mistakes which are expensive to fix, and soon find they didn’t budget enough money to get the business off the ground. These people always come away from the experience learning a golden rule of business: Know how much money you need beforehand and secure the funds before you start.
How does a person find enough capital to start a direct selling business, and how much does he need? Finding the necessary funding will take a well-prepared business plan which is not only reviewed by potential investors and financial institutions, but will also determine the amount of financing needed. No investor will be willing to risk their money without a plan. You shouldn’t either!
Common sources for funding include:
- Home Equity financing through banks, savings and loans, etc..
- Venture capital organizations that specialize in helping new businesses. This type of investor or investor group will expect a significant ownership position for taking the risk. Venture capital groups are found by networking with financial planners, accountants, bankers, and merger/acquisition specialists. You may find a few that know the direct selling industry by going to www.dsa.org and looking through the supplier members list (search for “Finance”). Be prepared to give up a healthy chunk of your equity if you ask them to take on a big part of the risk.
- Private or ‘angel’ investors, including friends, business associates, friends of friends, etc. Find them by networking with everyone you know. Talk to financial planners, accountants, business owners, etc.
- Small Business Administration or other federal and state agencies. These agencies will either loan the money, or guarantee a loan through a bank. In either case, you’ll need to be able to pay back the loan on a set schedule. See www.sba.gov for more information.
- Local community bond funding. Some communities, especially those with high unemployment, work aggressively with businesses to acquire funding for starting or expanding, especially in areas of high unemployment. Contact local county and state agencies to see if programs are available in your area.
- General bank financing. Banks will often lend based on credit history and assets with a personal guarantee of the business owner or another credit worthy third party.
Don’t become impatient and launch the business without the necessary funding! How much funding is necessary will depend on your business plan. Some companies start for as little as $50,000, while others find they require several million dollars. Your business plan will tell you how much you need.
Lack of an effective Business Plan
A business plan is a “first creation” of the business, just like an architect’s blue print is the first creation of a beautiful home. A good architect will plan out every detail of a home long before the first shovel of earth is moved. So it must be with any business. You must become a business architect before you can build the business. Companies that are successful without a plan gain their success more by accident and luck than by design and thought.
A key benefit of the business plan is that it is often used to attract potential investors, lenders, and vendors. No investor will be willing to risk their capital on a business venture without a well-designed business plan. You shouldn’t either!
Investors have plenty of other candidates to consider who have prepared a compelling business plan. You compete with those other candidates so consider your business plan much like a resume – you want to give them a compelling reason to pick you rather than the others they are considering.
As you establish credit with vendors, they will be more willing to grant credit if they can review a well-prepared business plan. Remember, that any credit granted by vendors reduces your starting capital requirements; if your manufacturer is willing to extend 90 days terms for $100,000 of product, you will need $100,000 less to start.
A business plan should include:
- An Overview: One or two pages describing the business will help a potential investor become interested in learning more of the opportunity. If an overview is missing, few investors will be interested enough to take the time to read the entire plan. The overview should describe the products or services being sold, the principals involved, funds required to launch, and estimated return on investment, both conservative and potential. It should also include an exit strategy for initial investors.
- Background of Management Team: A summary resume of the owners and executives of the company is a critical part of a business plan that will be read by investors, banks, and other trade creditors. A common expression among investors is ‘bet on the jockey, not on the horse’. In other words, the strength of the management team is often considered as being more important than the company, product, or compensation plan being offered.
- A mission statement that clearly identifies what the company is all about should be included. It’s been said that distributors will work for money, but kill for a cause. Your mission statement should be something you can proudly display in literature or on a wall plaque. A corporate motto might be taken from the mission statement. Most mission statements are expressed in one or two paragraphs. Find samples of mission statements in annual stockholder reports of many public companies. There are a number of books available that also teach how to write and use a mission statement.1
- A product description section describes your products and what makes them unique. This is called your ‘Unique Selling Proposition’ or “USP”.
- Goals and objectives should be identified and each should spring from the mission statement. Goals might reflect the level of customer satisfaction, order turnaround, staff efficiency, but most certainly sales and profits.
- A market analysis must be done to determine the potential of the product or service, priced as it is to be priced (based on end user pricing rather than wholesale pricing to your sales force). The analysis should address market demand, similar products and how they have been accepted and marketed, competition, etc. This information might be found on the Internet, in libraries, universities, and other business consulting groups. The Small Business Administration has access to large amounts of information and people who can get the information for you. Many universities have business students who would love to do market research for businesses, often at no charge, for their MBA requirements.
- Your recruiting & marketing plan explains how you will build your sales force and promote your products. What sales support materials are required? Who is your target audience? How will you reach them? This is not your compensation plan.
- Operational plans: How much office space will you need? How many employees will be needed to handle the expected business volumes? Warehouse space, telephone equipment, initial product orders, printing, distributor kits, videos, and scores of other issues must be addressed in as much detail as possible. This section may be the most important section of all and is usually the one people try to gloss over. It’s more fun to make sales projections than to figure out how much office space is needed. Yet, one major mistake in this area can cost tens (or hundreds) of thousands of dollars. This part of the plan takes time, often several months. Time spent here will pay huge dividends in the future.
- Projections: Profit/Loss and cash flow projections are critical to every business plan. A competent consultant or accountant can assist in this effort by identifying common areas of expenses for new start-up businesses. With computer spreadsheet programs like Microsoft Excel, many different scenarios can be created once an initial spreadsheet format is built. Always prepare a pessimistic “worst case” scenario, a middle of the road scenario, and an optimistic (but realistic) best case version. As you develop your business plan, always plan on the conservative side, but be ready to scale up into the more optimistic version should the need arise. Remember that if your investor has read the overview, the next thing he’ll want to know is how much money is needed. These projections are critical to a prospective investor.
- Return on Investment Analysis is important for those investing into the business. This is why they would want to take the risk. Attractive charts and graphs are essential. This section answers the investor’s question of what’s in it for me? Remember that you are competing for their money against other options they will evaluate like yours. Investors are quickly turned off by hype so be conservative in your estimates.
- Risk Analysis: Careful study of the each known risk and the assumptions involved should be explained in this section. While not intended to “turn off” a potential investor, most investors will do their own risk analysis but with only the bits and pieces of information available. This is an opportunity for you to address the potential concerns of an investor in a positive and controlled fashion. If you don’t need an investor, this section will make your business plan more bulletproof. No plan is viable that hasn’t addressed the potential points of failure and risk. If an investor finds that you have overlooked some key areas of risk, they will assume you are headed for failure.
Once the plan is complete, bind it so it can make an attractive presentation. Do not include your proposed compensation plan as it would only confuse the reader in most cases. Include a table of contents, index tabs, and an impressive cover. Don’t put the plan on the shelf! Use it in each manager’s meeting, refer to it like the corporate bible. Change it when needed, but follow it carefully.
Part of the business plan, of course, is to plan to be a profitable company. It’s amazing how many companies fail to plan to be profitable. Here’s a general breakdown of how income is used in direct selling companies:
- 40% of income for commissions to the field
- 20% of income for cost of goods or products
- 20% of income for administrative expense such as payroll, facilities, utilities, etc.
- 20% of income for profit
While the above numbers are very rough, they have proven to be a target that many successful companies have set. Your numbers may vary considerably from these. The profit you make on each sale will be a primary factor in determining how much you should allocate to each major category, especially commissions (discussed in Part 2).