The Australian Small Business Blog

Monday, February 27, 2006

False Economies

by Dr Greg Chapman

Today I was discussing with a business manager the future of a business which has an innovative product but low sales. The owner had invested over a million dollars in the business developing this product, but had spent nothing on marketing. The manager told me how he believed that their product was superior to others on the market, but because of their size, other businesses were not taking them seriously.

Now, because of poor sales, the owner wants to sell the business. But guess what? No-one wants to buy it as there is no demonstrated market for the business. It is perceived as just another product in a crowded marketplace. Consultants that were advising the owner on the sale advised him that this was the issue, but he has taken the view that he does not want to spend anymore money on the business.

To obtain a sales price of $1,000,000 just to recover his costs, the owner would have to demonstrate that a buyer would receive a return of 25-30%. But at the moment he can't even cover the modest running costs of the business through sales.

So the owner has three choices. He can hang out for a fire sale price while his operating costs continue to bleed. He can write off his investment and walk away. Or if he really believes that there is a need for this product, he could put together a short term marketing plan to demonstrate the viability of his product.

If he invested $30,000 in marketing, or 3% of his outlay, and 10% of his projected sales turnover to justify his $1,000,000 business valuation, it is likely that he would not only start to see such returns, that he may even decide to hang onto what has become a very attractive business.

In business, the concept of sunk capital is crucial for an owner to make unemotional business decisions. But if you have invested the capital for product development, not investing in a marketing launch is just crazy. If the owner had created a business plan at the start, he would have probably been quite happy to add in 10% for marketing, but refusing to spend on marketing at this stage is just false economy.

Dr Greg Chapman is the Director of Empower Business Solutions

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