In the beginning, the majority of startup founders are extremely ambitious and motivated. But, with the passage of time, their energy dwindles, and they eventually give up on their dreams. Why does this happen? The simple answer is that they are unable to handle startup costs.
Startup costs are the non-recurring expenditures that incur during the process of establishing a new business. All startups are different from each other. Hence, their costs also vary from one another. These costs include costs like startup insurance fees, legal fees, registration charges, accountant’s fees, etc.. Startup costs are also referred to as startup expenses, preliminary expenses, or pre-opening expenses.
Failure in setting realistic goals is also a culprit here. Another aspect is being over-excited about the product launch. With so much excitement, several important things are either missed or miscalculated, putting the reputation of the product and the startup at stake.
In fact, almost 29% of startups fail during the initial years because they lack a clear vision or are unable to fulfill the costs required.
The good news is that this issue can easily be solved by evaluating the costs that are associated with the production and scaling of the product.
Startup founders should realize that coming up with practical estimates of startup costs that are required for building an MVP is essential for success but they can’t solely depend on it. This is because the inventory turnover ratio also plays a major role in keeping the startup afloat.
Let’s learn how to estimate business startup costs of an MVP.
1. Calculate Cost of Minimum Viable Product (MVP).
First, let’s learn how startups can produce a prototype after they have finalized an idea.
What is a Minimum Viable Product (MVP)?
Every startup team needs to build a basic product that they can take to the market. This first working product/prototype is called an MVP, and it is crucial for the life and future of all startup businesses, if messed up, it can be catastrophic, leading towards overall production cost failures.
Building an MVP entails costs. The challenge here is to realize that cost is not a single consolidated number. It actually comprises several sub-costs that could impact the overall development process of the MVP.
Recurring Costs vs One-time Costs
A ‘recurring cost,’ is the cost component that repeats regularly. A good example would be web-based tools for which you pay either monthly or yearly until you unsubscribe.
A ‘one-time cost’ is a cost component that is paid only once. Two good examples would be software lifetime licenses and hardware platforms. It is, therefore, better to divide the startup’s cost further into a direct and indirect cost.
Direct Costs vs Indirect Costs
Costs that are associated with discrete areas of the project are known as direct costs. Examples include the cost of hardware components, fuel, and profits distributed among team members.
On the other hand, indirect costs are costs that couldn’t be associated with a specific expense head. Consider the scenario; If you are building the product out of your garage, the power bill of the garage would be an indirect cost of your startup.
Cost(s) of Human Capital
Unless you are skilled and experienced enough to build the entire product by yourself, you will need help which comes at a price. Entrepreneurs often overlook such costs, giving rise to unpredictable outcomes. The founders need to calculate the cost of human capital for the entire duration of the MVP product development cycle. For example, if you require a web developer, find hourly rates and the estimated time for project completion. You will then have a fair idea of the cost of the human capital required for the project.
While building your prototype, it is wise to opt for contractual employees. In this scenario, you only pay the team when they complete the contractual obligations or achieve the pre-agreed milestones. This is an advantage for startups because salaried employees will need to be paid every month, regardless of their performance.
Moira Vetter, a columnist for Entrepreneur, says that it is better to get people from incubators or universities because they are available to work for a much lower cost.
“Not every startup has access to scientists and engineers to help them noodle on a concept at no charge. It’s important to take advantage of what you can, while you can, but don’t push your luck for a long-term operating model.”
Time vs Cost Penalty
Startup trainers say three months is the optimum time to build a startup product or an MVP. If the product fails, you have wasted only three months which is not that bad considering starting a venture of your own. If it works, however, you can focus on the next iteration with renewed motivation. Three months is the right amount of time to keep you on track, and understand costs, and help roll out MVP faster.
Remember that as you exceed the three-month mark, you run the risk of increasing the total cost that will continue to mount up in the future.
According to CB Insights, 48% of startups fail because the products they were making had no value in the market.
So, your goal with an MVP should be to build a product that you can roll out to the public while keeping a check on the startup production cost. Don’t just build an MVP with the intention that it is NOT the final product. This decision is best left to the customers. In almost all cases, you will have to go back to the drawing board to make necessary changes to the MVP.
Yevgeniy (Jim) Brikman puts it best:
“In a trial-and-error world, the one who can find errors the fastest wins. Some people call this philosophy “fail fast.” At TripAdvisor, we called it “Speed Wins.” Eric Ries called it Lean. Kent Beck and other programmers called it Agile. Whatever you call it, the point is to find out which of your assumptions are wrong by getting feedback on your product from real users as quickly as possible.”
2. Calculate Startup Inventory Cost
An MVP is not the end. Rather, it is the beginning, an iterative process that you might end up repeating time after time to reach closer to what the public actually wants. And, once you have reached that phase, it is time you start focusing on the startup’s inventory cost.
What is Startup Inventory Cost?
Startup inventory cost is the amount of inventory you have manufactured to help take the project further. It is important to calculate the inventory cost in the start because most of the startups fail only because they have overstocked themselves without realizing the actual amount of orders they are going to get.
For instance, a startup aims to sell 1000 units in a month. It orders 1000 units. But due to certain reasons, it is only able to sell 100 units of the product. So, 900 units are now left. This stock will, therefore, keep piling up and might end up leaving the startup cash drained. There is a simple solution to that as well.
Estimating Cost of Inventory
The best way to avoid losses due to inventory stockpiling is to start small and keep a track of the overall inventory. You can achieve this by starting small and calculating the inventory turnover ratio on a regular basis.
To begin with, startups that have an MVP and are now moving towards the production phase, if they aim towards 1000 sales in the beginning month, they should order 100 units only. This may increase the initial manufacturing cost, but it will still help them keep assets liquid. Once the first batch is sold, they can order more products from the manufacturer. Here is a simple formula to calculate the startup inventory leftover ratio.
First, find the Cost of Goods Sold (COGS) and Average Inventory.
COGS = Beginning Inventory + Purchases – Ending Inventory
Your purchases include necessary costs related to inventory management such as handling, shipping, and packaging during the period under calculation.
Second, find the average inventory.
Average Inventory = Beginning Inventory + Ending Inventory / 2
Third, calculate inventory turnover.
Inventory Turnover = COGS / Average Inventory
Now you can calculate the days of inventory held.
Days Inventory Held = Days in Accounting Period / Inventory Turnover Ratio
Usually, the accounting period is of 90 days.
Also note, an inventory holding period of fewer than 30 days is considered as a high turnover ratio.
Factors that affect Inventory Turnover
There are certain factors that can lead to a change in the inventory turnover ratio. Read what they are.
As most startups have a small budget, it is difficult for them to market their products properly. This often leads to lower inventory turnover.
The good thing is that finances are only a problem at the start. With time, your brick and mortar or online business startup costs will become stable, and you will be better able to manage a financial crunch.
The time it takes for a product to reach from the manufacturer to the customer is known as the lead time. Though this time varies from one manufacturing process to the next, it can reduce the overall turnover rate if the delay is longer than usual.
Successful businesses require reliable suppliers. An unreliable supplier can destroy the whole business. That’s why in an ideal situation, it is better to have a backup supplier that could help in case of product delays.
One major factor that influences the turnover ratio is management problems. Management problems occur when people managing the inventory don’t have a major stake in the business. For startups, apart from the founders, no other person has a real stake in the business. This problem can be solved by monitoring the inventory and getting updates from managers from time to time.
Remember Your Goal
So, keep yourself focused on your goal and be prepared to rework the startup production costs if needed in order to bring them down.
3. Building an Effective Team
Building the right team is one of the most important aspects of any startup. Entrepreneurs need to bring together the best individuals for their startup in order to accomplish their business goals. Failure to do so may result in operational inefficiency, shipping delays, growing debt or organizational dysfunctions at different levels.
Not very long ago, recruiters would just post a job opening and candidates would flock in for interviews. Later, whenever they could afford it, they would hire expert expats and relocate them to build an effective in-house team.
However, in the wake of current barriers to immigration that major “talent importing” countries are facing, there is a need for identifying new strategies for building an effective team that delivers promising results. So how can startups come up with a viable solution?
a. In-House Team
An in-house team works like a charm. The entire team works on the startup premises. An in-house team is capable of overcoming challenges and delivering results effectively.
However, an in-house team comes at a high price. Where the cost of living is expensive and the battle for talent acquisition is fierce, the in-house model can prove to be costly. Nonetheless, if budget is not an issue, an in-house team will always ensure effective workflows and will save time that can be productively utilized elsewhere.
b. Outsourced Team
Whenever a startup lacks resources to build an in-house team, they engage with an outsourced team. It is mainly because an outsourced team is comparatively cheaper. Although outsourcing a workforce may be budget-friendly, many a time, numerous business processes do not remain efficient anymore.
In certain cases, an outsourced team will fail to deliver the desired results, primarily due to the communication gap and management awkwardness. Bad project management may result in huge differences in the pace on both sides of the aisle. Communication gap remains a massive issue and is typically tackled by hiring more resources to the management layer. It may cause even more slack rather than solve what’s wrong.
c. Hybrid Team
A hybrid team is a group of individuals who work on interdependent tasks. They share responsibility for different projects. Some team members work in-house, whereas others are outsourced who work remotely from a different location.
This model allows startups to hire core team members who work within the premises to ensure the desired results and smoother workflows. The in-house team comprises of specialized, experienced individuals who offer a relevant and broader skill set. They strive to meet the targets on time without compromising on the quality of the project. Furthermore, the environment within the startup fosters continuous learning and growth.
Any additional resources that the project demands can be outsourced at a cheaper price. The outsourced team members fulfill petty tasks so that the in-house team can focus on tasks that are more important to accomplish the business goals. With that being said, the total cost of a hybrid team may vary greatly based on the size of the team and the business. Also, on how much the startup is looking forward to accomplishing.
A hybrid approach allows startups to take advantage of onboarding lower-cost creative help full-time, while also attaining flexibility and skill diversification from outsourced help when needed.
PRO TIP: Despite the team model you choose, always make sure you hire T-Managers. They are a jack-of-all-trades who will ensure promising results in a timely manner.
4. Sales and Marketing
Promoting your newly launched venture is a non-stop task. You must keep aside a realistic budget for sales and marketing. In order to attract and retain new customers, you should focus on digital marketing, as it forms the basis of many startups.
Paid advertisement allows you to be more vocal. It further allows you to be more visible when it comes to related keyword terms within search engines for a set budget. Organic marketing, on the other hand, is a mixture of your online PR and your content. Make sure your content strategy is solid enough to create an impact. Bear in mind that online business costs will vary from a brick and mortar startup. So choose your strategies and tactics carefully.
If you have a database of your potential customers or existing leads, you must invest in email marketing. It is one of the best methods to convert potential customers. It will allow you to distribute highly targeted emails and gain more exposure. However, email marketing also comes at a cost if you wish to distribute emails in high volume.
Also, in the digital landscape that you are living today, you must have a website. There are hardly any businesses that do not have a website today. It doesn’t matter whether you design your own website or outsource a professional to design one for you, you’ll need to factor time and money in order to establish your online presence.
Lastly, there are a few things you must take care of during the startup ideation process. Obviously, there are a few costs involved initially such as refurbishing your front or purchasing equipment and supplies for your MVP. These are known as deductible startup costs however, you cannot deduct all of them at once.
The IRS (Internal Revenue Service) considers deductible costs as capital expenses. Simply because the expenses that incur before the startup starts will benefit them for years. Hence, you must deduct and depreciate the expenses over time that get the business going.
Taxes are a necessary evil that comes around every year. When you’re developing a budget, it’s almost impossible to assign an amount or a percentage to allocate for taxes. They depend totally on the amount of revenue your startup generates, which is also something that you can’t really predict.
But know that you can often save money by working with a Certified Public Accountant (CPA). He can help you figure out what exactly you need to deduct in order to pay as little as possible. Hiring the services of a professional accountant can save you some time too, which indeed is money in itself.
More Startup Costs to Avoid
To sum up, there are a few startup costs that you should avoid as much as possible. They are:
1. Subscription-based services
There are numerous cheap if not free alternatives available in the market. There is no need for you to subscribe to an expensive service. Use the free ones until you’re sure that you need advanced features that only a paid solution can offer.
2. A huge office
Everyone desires a fancy office. But everything comes at its right time. There is no need for you to purchase or rent a huge workplace. Focus on the success of your business first – your dreamy office can wait until you establish yourself.
3. Expensive Assets
Although new technology seems to be tempting, it doesn’t mean that it will be a useful business expense. Initially, you need to purchase only what you truly need. Also, try to do so as economically as possible.
4. Non-measurable outreach efforts
It doesn’t matter whether it’s public relations, marketing or branding, if you are unable to measure the results of your efforts, you shouldn’t be spending that money. When you’re on a budget, focus your spendings on things that can provide you a better return on investment.
5. Spending money before you make it
Be cautious of spending money on irrelevant things before you’re making enough to cover it. Just as humans should live within their boundaries, so should your startup.
Expect a Loss
It is okay to fail. But it’s not okay to not learn from your mistakes and repeat them.
All best startups have experienced failures, and none of them regret them at all. When you fail, you learn and that’s how you build better products.
If for some reason, your MVP fails to delight customers or you have a lower turnover ratio in the start, don’t worry. Just take a deep breath, think of all the things that went wrong, and have an expert roundup or talk to the experts about how you can improve things further and come up with viable solutions.
I hope this article will help you in coming up with realistic estimates of different startup costs. If you need to add to the discussion, or need more information on the topic, let me know in the comments below.