PRINCIPLE 2

A Better Mousetrap Is Not Enough

The good news is that you have, or are convinced you can come up with, a product or service that can satisfy a big need in the marketplace, one that will solve a huge problem.

The bad news is that creating a better mousetrap isn’t the end of the journey; it’s just the beginning.

As we saw with Principle 1, even if you have the proverbial better mousetrap, the world may not beat a path to your door. The cliché is simply not true. You need to figure out a way to tell people what you have, and to position your product or service in a way that’ll keep the competition from eating you for lunch (and breakfast and dinner too).

The positioning and developing of your idea is as important as the idea itself.

This is another lesson I learned the hard way. Let me tell you about it.

We were convinced we had come up with a better mousetrap, specifically a better version of Red Bull, the high-energy drink. We had experience in the beverage business, and we understood how to get the product into stores where there was growing shelf space for this kind of product, so, if we gained even a small percentage of it, we could be very successful.

Red Bull is loaded with caffeine and promised it will keep you going. Our product, Mercury Energy Drink, also had caffeine, and it included ribose, which was another source of energy as well. We figured with ribose, and a formula designed to supply the body with carbohydrates and replace fluids and sodium lost during exertion, we could fuse two categories—sports drinks (Gatorade) with an energy drink (Red Bull)—into a new category that we would call “Sports Energy.”

As we thought about what it would take to make Mercury successful, we had the following pluses going for us:

1. We knew the beverage industry.

2. The timing was right for a sports energy drink, given the increasing awareness of the importance of working out and remaining hydrated.

3. We had the finances to launch and promote our product.

So why are people still drinking Red Bull and you have never heard of Mercury? It’s primarily because of something we did not anticipate. A successful entrenched competitor has the ability to match a new competitor’s price, eliminating the competitive advantage that comes with being less expensive. Red Bull began promoting its product with special deals like a buy one, get one (BOGO) free. They were willing to take a hit to their margins to keep from ceding an inch of shelf space to us.

Could we have come up with alternative marketing approaches?

Sure, we could have spent large sums of money:

Advertising

Getting celebrities to endorse the product

Paying to gain shelf space near checkout counters in supermarkets and convenience stores

Why didn’t we? Well, creating Mercury wasn’t our primary business and while it would have been something we would have been proud of, it wouldn’t be the end of the world if it never happened. And so we turned our attention to something else (details in a minute.)

The lessons from our Mercury project were clear to us:

1. You must be prepared for your competitor to change its market strategy and pricing in response to how you choose to market your product or service.

2. You must have financial staying power.

3. You must have the will to persevere. (We will talk more about this later as well.)

5-Hour ENERGY did these things, and they were able to compete with Red Bull.

We decided to abandon Mercury and concentrate our energies and financing in developing Blue Buffalo pet food. When Blue Buffalo had its IPO and became a public company on July 22, 2015, we knew we had made the right decision.

MORE PROOF

Let’s stay with this concept with an example of what you should do.

Two Babson students, Dinesh Wadhwani and his brother Danny, came up with a wonderful idea for a product: a longer-lasting light-bulb that saved energy and was specifically designed for warehouses and manufacturing plants. It really was superior to anything on the market, and they figured they could sell it for the same price as the competition.

They came to me looking for affirmation that they had a terrific concept and were on their way to success. I told them it was indeed a better mousetrap, but one, I felt, destined to fail in the marketplace.

“You’re never going to build a company given the way you have positioned the product,” I said. “For one thing, it’s going to be very difficult to get customers to switch lightbulb suppliers. They’re not going to accept on faith that yours lasts longer. They’re going to tell you they are too busy to test it out on their own and it will cost them money to try it.

“For another, the moment you do win a contract, someone may come out with a similar bulb. Yes, I know you have a patent, but I’m here to tell you the competition will find a way to differentiate their product from yours, or simply copy you and wait for you to sue—making money all the while. In either case, they’re going to undercut you on price and you won’t win another contract.”

Not surprisingly, Dinesh and Danny were extremely dejected after I delivered my critique.

“However, there’s a way around this problem,” I said. “Go to all the plants and factories, explain what you have, and offer to replace their existing bulbs with yours, for free.

“You do the work. You physically swap out the bulbs they have with yours—and you don’t charge them a thing. How do you make money? Simply ask for a significant percentage of the energy savings! Most companies will go along with that because you’ll be lowering their electric bill, at no cost to them, so they’re not going to object to sharing the savings.”

Dinesh and Danny took my approach, and today Thinklite is a successful company. Dinesh and Danny were featured in 2015 in Inc. magazine’s 30 Under 30 (extremely successful entrepreneurs, that is).

And they are because they “dug a moat around their product.”

How to Build a Moat

The phrase in the subhead above is borrowed from the man who may be the greatest investor who ever lived, Warren Buffett. It’s his shorthand way of referring to a business’s ability to create and keep a competitive advantage in order to protect profits and market share over the long term.

Let me give you an example of how this works, courtesy of Investopedia. Suppose you have decided to make your fortune by running a lemonade stand. You realize that if you buy your lemons in bulk once a week, instead of every morning, you can reduce costs by 30%, making you able to undercut the prices of competing lemonade stands.

Your low prices lead to an increase in the number of customers buying lemonade from you (and not your competitors). As a result, you see an increase in profits.

It probably wouldn’t take very long for your competitors to notice your method and employ it themselves. Therefore, in a short period of time, your large profits would erode, and the local lemonade industry would return to normal (extremely competitive) conditions again.

However, suppose you develop and patent a juicing technology that allows you to get 30% more juice out of a lemon. This would have the same effect of reducing your average cost per glass of lemonade by 30%. This time, your competitors will have no way of duplicating your methods, at least not for the foreseeable future, as they scramble to come up with a juicing technology of their own.

This is the kind of protection—or moat—you want to have for your idea.

Moat Building 201

It’s typical in talking about competitive advantage to first define what it is. Many academics would say it is essentially any factor that allows you to make more money than your competitors who are offering a similar product or service—and only then do they discuss ways to protect your edge.

I think that’s wrong. If you aren’t thinking about how you’re going to create a moat around your competitive advantage from the very beginning, you run the very real risk of wasting a lot of time and effort.

If the students who had come up with the better industrial light-bulb hadn’t thought about their moat—installing the bulbs for free—they would’ve gone out in the marketplace and might very well have promptly been undercut on price (and eventually failed).

You need to be thinking about what kind of moat you’re going to have to protect your competitive advantage from day one.

You start by asking: How are you different?

It’s one of the most fundamental questions in business: How’re you going to position your product/service/idea so it’ll be successful? Everyone agrees how vitally important positioning is; then they promptly fall off the track. They instantly start rattling off ways they can position their product or service, assuming that the positioning is going to stay the same forever. That’s silly. Your positioning may, and probably will, change over the course of your product’s life cycle, as competition and economic conditions change.

How you position your product is up to you. That said, the following ideas, which are not meant to be all-inclusive, could help jolt your thinking:

Low-price provider. This positioning is self-explanatory and extremely dangerous in the long run, unless you plan to become the Walmart of your industry. The problem with taking this approach is that someone else—because she’s found how to do what you do only cheaper, or she really doesn’t know what her costs are so doesn’t charge enough—can always undercut your price.

High-price/high-quality provider. You are best in class. You can find examples everywhere you look. Gucci, Lamborghini, etc.

Fastest. Sure, car manufacturers talk about going from zero to sixty all the time, but that isn’t the only place where you position your product around speed. You could have the fastest search engine or seeds for the fastest-growing roses if you are selling to growers and home gardeners.

More convenient and user-friendly. You could provide one-stop shopping as the big-box stores do. The “doc-in-the-box” walk in medical centers or companies that offer twenty-four-hour access to their order takers and customer service providers are two other examples.

A better experience. Going to a minor league baseball game can be more entertaining than going to a major league one where you are cut off from the players, and very little happens between innings. At a minor league game, the players are accessible and readily sign autographs; fans often are allowed to run the bases after the game, and there are contests and other activities in between almost every inning. Other examples of this: Home Depot and Lowes may seemingly stock everything, but nothing beats the local hardware store for service and advice.

PROOF THIS WORKS

When John Gagliardi, a college All-American and All-World USA Team lacrosse player with the Long Island Lizards, decided to go into the lacrosse manufacturing business, he could have sold the same kind of equipment and clothing as his competitors.

Instead, based on being so personally involved in lacrosse, he realized improvements could be made in both equipment and clothing.

He also redesigned the shafts of the sticks, combining titanium and aluminum, to make a stronger, more affordable product for players of all ages.

In addition, he improved the women’s equipment based on their needs (not just smaller versions of the men’s equipment). On the marketing side, his company took an edgier approach and targeted players in the inner cities and emerging West Coast adoption of the sport instead of going after the traditional East Coast “Prep School” player. These became the building blocks of his very profitable and successful company, Maverick Lacrosse, which he eventually sold to Bauer Hockey.

Transport. Ideas that work in one place could very well work in another. This is what importing and exporting are all about. And you see this idea in television all the time when producers take a hit show in England and bring it to the United States.

One last point: although your positioning may change, you can only stress one significant attribute at a time. Of course, you would like to go after every potential market simultaneously, but the reality is that you can’t; you have limited resources. You need to stress one key attribute.

But can you subsegment that positioning to reach different groups? Sure. You see it all the time. The classic example is soft drinks.

Typically, companies will come out with the basic drink, say a cola. They quickly follow with a version with no sugar for the calorie conscious. And so you get diet cola. But some people who like diet colas don’t like caffeine so you get caffeine-free diet cola. And the company expands from there, offerings: cherry cola, vanilla cola, diet cherry cola, diet vanilla cola, and there are the caffeine-free versions on top of that.

FINANCING THE VENTURE

One of the things that surprised me when I began teaching entrepreneurship at Babson was that many students didn’t like numbers, or they didn’t want to talk about the numbers. They were more interested in marketing and the production aspects of their ideas.

That’s a mistake. As I said, I’m opposed to making them do a business plan where they are projecting out five years. The reason is simple: you don’t know what’s going to happen during those five years. Still, you need to have a good idea of how much money is going to be required to get you started.

My rule of thumb? Figure out how much money you’ll need to keep the company going for a year—without any revenues coming in—and then add 30%.

You can say I am being awfully conservative; but based on my experience, I’m not. It’s going to take you longer than you think to assemble a team, refine your idea, and get to market. On top of that, it will take more time than you could ever imagine to get paid for your product or service. For example, you’re going to send out invoices that say the customer can get a 2% discount if payment is received within thirty days. In many cases, they’re going to pay in sixty or ninety days, and still deduct that 2%.

DEBT OR EQUITY

While most people may not have thought about, or don’t want to discuss financing in detail, when it comes to the question of debt versus equity, they’ll talk your ears off. Everyone’s starting position is that they don’t want to give up equity, and if they have to, it should be nonvoting shares, so that they can control whatever happens to their company. They plan to use other people’s money for all the funds they need to get their startup under way (while they retain all the voting shares).

Theoretically it’s a lovely position to take. Now, let’s talk about the real world. Investors who’re willing to invest large sums in your idea are going to want to have a say. So, you can take the idea of two classes of stock—one that has voting rights, the other that doesn’t or has limited rights—off the table. They’ll never go for it.

CASE STUDY: CANYON RANCH

PROOF THIS WORKS

Because the website of Canyon Ranch, a health-and-wellness resort, gives such a wonderful description of how it came into being, let me quote pieces of it before I ask you some questions that could spur your thinking.

“Canyon Ranch . . . began with an aha moment. On New Year’s Day 1978, Mel Zuckerman, overweight, sedentary, stressed-out, with high blood pressure and a galaxy of other health problems, resolved to lose forty pounds. By March 4, he had gained four.

“Desperate, he fled to a ‘fat farm’ in California, planning to spend ten days. He ended up staying a month and changing his life forever. There, he met an inspiring fitness expert who had him running a mile and a half within ten days. As a result, Mel realized that he had, within himself, the power to dramatically improve his health and happiness and that he needed to arrange his life so that he could continue along the healthy track he’d found.”

That last sentence is key. Where other “fat farms” just concentrated on providing a weight-reducing menu and exercise, Zuckerman added a psychology component—so that people could truly understand why they were overeating and find new ways to think about food. Extremely pleasant surroundings also helped people actually enjoy the experience.

I tell you this in the interest of full disclosure: my wife, Lois, and I are frequent visitors to Canyon Ranch.

I interviewed Mel Zuckerman because I wanted to do a case study on Canyon Ranch for my Babson College class. Mel emphasized that although there are now a number of competitors who have the same concept, he has added new classes in motivation, stress control, and conflict management. Canyon Ranch offers dozens of different exercise classes and many different types of massage. It has expanded its medical and health services, and its food menus are continually updated and improved.

There are now Canyon Ranches in Tucson, Miami Beach, Lennox (Massachusetts), Las Vegas, and Turkey.

I understand his approach. My question for you is: Do you agree with it? After all, the world is full of companies that had a wonderful product but couldn’t turn it into a successful business. (Burger Chef, with its flame-broiled hamburgers, was once the second largest hamburger chain, trailing only McDonald’s. And what about the DeLorean car, Lionel Trains, and all those millions of radios and televisions made by RCA?) Will Canyon Ranch join that list, or will it stand the test of time?

As for outsiders putting up all the money, potential investors are going to want to see that you have invested your own money—even if it’s “only” money that you borrowed from your family and friends—to get under way. Outside investors are not going to risk their money on someone who is treating the startup like a theoretical exercise. They will want to make sure that you have “skin in the game.”

I understand completely the desire to hold on to as much equity in your company as possible, but owning 100% of a very small business may not be as valuable as owning 10% of something huge. What that means is that it’s more than okay. In fact, it may be a good idea to dilute your position (selling your stock to others to help the company become dramatically bigger).

One last point if you want to eat your cake and have it, too. Build into your personal compensation package the right to earn a stock bonus if your sales and profits exceed projections. This will help you increase your equity position as you go. Your investors won’t mind because if you earn the bonus, it’ll mean you made them a lot of money and a smaller percentage of a larger company is a win-win situation for the investor also.

WHERE DO YOU FIND THE FUNDING?

In class, I use the header “family, friends, and fools” to introduce the subject of where to find the money you need to get under way. Clearly, of the three, friends are the easiest to approach. They like you. So they’re most likely to listen to your pitch.

If both you and they make sure they don’t invest more than they can afford to lose, the process of raising money from them should go smoothly, whether or not your company is ultimately successful. No, you never want to lose money, especially not your friends’ money; but if you explain the potential risk up front in detail and the amount of money invested is relatively small for your friends, you probably still will be friends should the venture not work out.

Raising money from family is far more complicated, regardless of the quality of your idea. It’s so difficult because of the emotions involved. In fact, I am convinced that the number-one reason people don’t become entrepreneurs is because they are scared they’re going to fail, and they certainly don’t want to fail in front of people they care about.

Failure can be devastating if your family is involved in the financing. If you borrow $100,000 from your parents to get under way and the venture bombs, you might hear something like this at the Thanksgiving table: “Son, could you pass me the mashed potatoes? While you’re at it, can you pass me back the $100,000 I loaned you?”

So, how do you ask your family for money?

Very carefully.

Treat it (as much as you can) as an arm’s-length business transaction. Invite your parents’ accountant or lawyer to the meeting when you’re going to ask them for money. The meeting will go much better if you can also bring along people who have already invested with you. It’ll be far better if your folks are not the first people you’re asking for funding.

This is one of the rare cases where you may actually want to do a business plan, so that your parents and their advisers feel more comfortable.

As part of the condition of the loan or investment, don’t be surprised if your parents say something like, “We hope this works out, but if it doesn’t, we expect you to do X,” with X being joining the family business or “getting a real job.”

DON’T FORGET

Now, let me run through—briefly—three areas that people invariably don’t pay enough attention to in getting under way.

Product Distribution

I’m not going to go into this in any detail, other than to say that you need to have your plan for distribution completely in place before you open your doors for business. Retailers and wholesalers are only going to stock and support so many products. You must be able to explain, with certainty, why they’ll need to carry yours. For example, with some of our businesses, we’ve used the concept of having the retailer take the product on consignment. They only pay us if the product sells. We also have offered the retailer a higher gross profit than what our competitors offered, as an inducement to give us a try.

Getting Paid

It sounds like the simplest thing in the world. You make a sale, you get paid.

But it’s far from simple. What is your plan to collect? If you can’t collect as projected, what is your backup plan if you run short of money?

1. Credit line?

2. Factoring? (A factor is an alternative funding source. The factoring firm agrees to pay you the value of your invoices, minus a discount to cover its commission and fees. The factor gives you most of the invoiced amount immediately and the rest when it receives the money from your customers.)

3. Stretching out the payments you are making to your suppliers?

4. Reducing your cash outlays?

When it comes to this, here are two ideas you may not have thought of:

1. Triple-check that you’re being as (legally) aggressive as you can with the tax deductions you’re taking. This will reduce the taxes you might otherwise pay, which is another way of saying you’ll be reducing your expenses and retaining more cash.

2. Bartering: As our story in Principle 3 about how Bob Reiss started the TV Guide Trivia Game makes clear, this can be a very effective way to gain funding.

Advertising

There have been thousands of books written on this topic. I just want to raise the subject here to make sure you consider it in detail.

For what it’s worth, I’m big on promotion instead of general advertising. I think television, radio, and newspaper advertising—even the Internet—is far too broad and, as a result, in many cases not cost justified.

Promotion, where you’re dealing directly with the consumer you want to reach, by handing out samples, lets you reach your audience with far less waste.

Two other points about advertising:

1. Everyone always immediately jumps to advertising to the end user, which doesn’t have to be the case. Working with the wholesalers and distributors for promotion of your products could be more effective. They can decide if they want to promote your products through the use of “specials” or “coupons” or combining your product promotion with “like-kind products.”

2. Involve your customers in your product. Have them tell you how they use it on your website. Make it easy for them to make comments and suggestions on how you can improve, and what products you should add. It’s the best form of market research there is.

SWEAT THE SMALL STUFF

Everything we just talked about could strike some people as “details.” More than one person has said to me that “the details will take care of themselves” if they get their idea right.

I could not disagree more.

My educated guess is that if you did a postmortem on 100 companies who had a better mousetrap but failed, you would find that 75% did not pay sufficient attention to the details.

I began the chapter by saying a better mousetrap is not enough. Let me end the same way: a better mousetrap is not enough.

FOUR TAKEAWAYS FROM PRINCIPLE 2

1. Remember, everything is possible. Armed with your better mousetrap, consider each and every possibility to both protect and expand it.

2. The kings of yore got it right: Build a moat. You need to know how you are going to protect your better mousetrap from the inevitable competition you are going to face.

3. Involve your customers in developing your company’s future. What products would they like to see? What features? Ask them about the problems they would like you to solve for them.

4. Have (a lot) more money than you think you are going to need. Starting a business is tough. You don’t want to make it tougher on yourself by running out of money.