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"Intellectual Capital and Bootstrapping"

"Intellectual Capital and Bootstrapping"
Chapter 4 excerpt from

Thinking Like An Entrepreneur

  In this chapter, the term intellectual capital refers to not only intellectual capital but also creative capital or service capital—anything, in fact, that can be used to create wealth that does not involve plant, equipment, machinery, buildings, or other tangible assets. Today, intellectual capital is often the source of wealth created by companies. It is also the primary reason many companies can experience phenomenal growth rates. As mentioned previously, companies that must invest capital in plant and equipment will be limited in growth because of limits in available capital regardless of whether the capital comes from bootstrapping or from financing.

  When building a start-up company, I would always tend to favor non-capital-intensive businesses. Service businesses. Businesses that create intellectual property. Not too long ago, a new company started up in Minnesota to compete with Harley-Davidson. The brothers who started this company were able to raise a good level of financing due to favorable stock and business market conditions.

  The survival rate for manufacturing companies that start at such a size is quite good. The company was touted as being in an excellent growth area—high-end motorcycles. While this may be true for the present and for even the past decade, it is not fully true, in general. In fact, the company name they chose, Excelsior-Henderson, once belonged to another manufacturer of bikes that did not survive along with many other such companies. Sole survivor Harley-Davidson remained. In other words, the high-end motorcycle business is more appropriately described as a cyclical area rather than a growth area. A bull stock market and economy tends to blur these distinctions.

  Further, promoters of such stocks (of IPO's) tend to encourage the false label in order to generate more investors for the company. Now, I'm not knocking Excelsior-Henderson. They seem to know what they are doing and have hired excellent people in the areas of engineering and business to help them. In this way, even manufacturing companies benefit from intellectual capital and experience, as well as physical assets.

  But, if the stock market had not been so conducive, would the brothers have been able to raise the money to start-up from scratch? Certainly not as a public company. Would, on the other hand, a company, such as the dating service, It's Just Lunch, have been able to start? Yes. This is because the dating service is not a capital-intensive business. When you start a capital-intensive business, you are subjecting yourself far more to the vagaries of the general economy. While all types of businesses will suffer from a poorer economy, the ability to start a capital-intensive business might entirely depend upon the economy. Because of this, I strongly encourage entrepreneurs to give heavy preference to businesses that are not capital intensive.

  Many students of entrepreneurship tend to disagree with me on this one. They say choose the type of business you want, regardless of capital factors. Some businesses will, invariably, demand larger initial capital investments, and the entrepreneur must simply accept this. So, rather than choose another area or try to rescale a business that can't be rescaled, or effectively started at a smaller size, just seek external financing, i.e., equity investors.

  I can't help but feel this view is, at least partly, based upon the easy availability of capital due to the bull stock market of the late 1980's and 1990's. My response to them is always, "What if you can't raise the capital? Suppose you write up your business plan, and everything is feasible. But, what if you still can't raise the capital?" You could try for several years to fund your start-up. Ultimately, whether or not you start would be a decision dependent upon someone else, the investors who back you. I would much rather have a business, which I could begin bootstrapping to a larger size, than be sitting and waiting for someone else's approval. Remember, four years could easily take you from a start-up to a self-sustaining business entity. In fact, in four years, your company could be worth millions, or even tens of millions of dollars, without ever raising a dime in equity financing.

  You could respond, "Ah, but raising capital really is just selling a product (selling the idea of the company) like any other. And, if you have a good product, you should be able to find someone to sell it to." But, let's assume you don't really want external investors, i.e., equity capital. Or, like me, you are skeptical about being able to raise capital under all conditions. In this case, you must fund the venture yourself, and it seems obvious that you should avoid capital intensive businesses. This means that you should look to service companies or companies that create products that do not require large factories, machinery, etc..

  But, what if you really want to build a motorcycle company? Bootstrap, but not fully within one type of business. Here is where many entrepreneurs tend to think in terms of projects, in terms of "What can I do now?" They know where they want to be in, say, ten years or what type of thing they want to be doing, sometimes. But, that is not always immediately possible. You choose a path that will get you where you want to go, a path that will better position you to do the thing you want to do. Most businesses do not continue to do only what they initially did. They evolve. They change. Opportunities will appear, and your company can change to pursue them. Change is good. Change is growth. New products will replace old products. Sometimes, there is a master plan. Other times there isn't.

  But, don't fall into the trap of accepting society's "career paths." People will tell you, "To succeed at this, you must to do this. And, then, you must do that. To get into this field, you must to do this." That's just bunk. You must give sincere thought to the path you will follow. You must have some knowledge of the general industry you wish to be in for this to work. I can't say, "Do this, and you will succeed." It depends upon the industry, which is one reason mentors are good. They can show you the nontraditional paths within a given industry. One area I do know is the computer programming field. Many people want to enter the field of programming or network administration, because it is an in-demand field, at least as I write this, and they want to earn good money. That's understandable. What are some good entry methods?

  Well, a degree in computer science is great. But, what if you don't want to spend that much time in college? No problem. Take a few classes in network administration at the local community college. That will give you some exposure. In particular, try to build some recommendations. Look into the various "certifications," such as Microsoft's Certified Systems Engineer. Basically, you take tests (and, give money to Microsoft. Would you expect them to have it any other way?) and, by passing those tests, you show that you know something about Microsoft's products, such as Windows NT. Best of all, look into what you can do for your present company. Could you help out the MIS staff? Would another smaller company, one that doesn't really want to pay the bucks to get a "real" network administrator, hire you to do simple stuff that could build your skills and give you experience in the field? This is all very common advice to a newbie network administrator and it is, by and large, valid.

  However, look at the real purpose of the above actions. This really falls into two parts: One, trying to learn new skills that are needed, but that you don't already possess; and, two, getting those skills somehow recognized or certified, in effect, showing others you have the skills. A computer science degree is probably the best way to say, "Hey, I know what I'm doing in computer science. They wouldn't have given me the degree if I didn't." With most universities, this is true. Despite all the bad press about college graduates who can't read or write, most graduates do tend to know more than people without degrees in the area.

  Occasionally, the university or the people selling the skill training will become so focused upon making money that an entire supporting industry will develop to teach people the minimum they need to know in order to obtain the "certification." This happened with Novell NetWare, a network operating system. Books, courses, CBT, etc…sprang up to allow people to pass the tests, never mind getting a real understanding of what was being done and why. But, let's just pass the test. Get the important certification. Get a good job and worry about being able to actually administrate a network later.

  Students considered the training a success if they passed the tests. What happened is that companies in the know tended to devalue the importance of Novell certification. Maybe, it meant you knew something. Then, again, maybe not. It was viewed with more skepticism. The real losers were the students who had the certification and really did know something, but who were classified with the other "paper CNEs" (Certified Network Engineers).

  Everything I've said is valid, if you want to be hired in the network administration field. The astute reader might even see why it would be more valuable to favor Microsoft's certification in preference to Novell's. But, what if you want to build a company in this field? How much of the above really applies? Well, learning skills needed is always good. It's pretty bad, if you run a company offering network consulting, and you know nothing about Windows NT. But, as pointed out in the chapter, "Men Are Cheaper Than Guns," you don't need to (and can't) know it all. So, while we can agree that Point One still has value, what about Point Two, getting our skills recognized by others? Is this important?

  As a consultant, you might say, "Yes, obviously, it's even more important than as an employee." But, let's neglect this. In many ways being a computer consultant sucks. When you send out a computer consultant, the company is interested in the experience of the person you are sending and in your company's reputation to always send out highly-skilled people. The hiring company doesn't give a rat's ass about what you personally know about Windows NT, unless, of course, you are the one going out on the job. Let's assume you have higher aspirations in building a larger company. How important is being validated by others?

  A hint. No doubt the best entry-level certification is a full computer science degree. How many founders of companies in the computer industry have computer science degrees? Hmm. Well, Bill Gates dropped out of Harvard. Steve Jobs and Steve Wozniak, the cofounders of Apple Computer, dropped out of several colleges. Larry Ellison, founder of the leading database company, Oracle, dropped out of college. Rick Born, founder of Born Informational Services, has a few technical college classes under his belt. That's all. Michael Dell dropped. The list could go on and on. How can all these founders of information-programming-based companies not have computer science degrees? And, yet they succeed!

  The crucial factor is these entrepreneurs were thinking in terms of "What product can I create to sell to others?" rather than in terms of "How can I show others what I know, so they will hire me?" Traditional career path advice is heavily slanted toward showing others what you can do without actually doing it. Traditional paths are concerned with winning acceptance from others. "Yeah, he knows what he's doing. He got straight A's and great recommendations. Let's hire him." Traditional career path advice is slanted to the belief that you need to convince someone else to "give you a chance" to succeed.

  Yet, when you buy a product, do you really ask which individual produced it? Usually not. You go by reviews of others, reviews of the product, not reviews of the creators, not, usually, even reviews of the company creating the product—although the company's reputation might influence your decision.

  A person only has so much energy to expend in life, and you must decide where to expend it. It's fun and reassuring to have multiple projects in the hopper, various ideas you contemplate pursuing, different things you are working on or learning. But, once you start down a particular path, you can only split your time in so many ways before you wind up sabotaging yourself. Have you ever tried to do too much at one time, and, as a result, you didn't do well at any of the things you were trying to do?

  In a college computer science program, you will learn dozens of different aspects of computer programming, most of which won't be applicable to what you will do in the "real" world. Taking a dozen classes and using what you learned from only two is not a good return on your investment of personal time. Once you start creating a product, chances are you will need to learn many things that weren't covered in any class, anyway. You may as well spend your time learning the things, as needed, to create your product.

  Entrepreneurs tend to focus upon creating the best product they can at the time and, then, marketing it. That is the priority, not impressing others with their qualifications to enter the field. It's really a question of knowing what is really important. Is doing it important, or is showing off important? Show off by doing! While most people tend to think in terms of "If I work hard enough and do a good enough job, then, I'll be recommended for a promotion," as the best career path, entrepreneurs think, "How do I get where I want to go? How can I bootstrap myself up?"

  For those unfamiliar with the term "bootstrapping," I should probably define it. It refers to "pulling yourself up by your bootstraps," starting with whatever you have to work with and building from it. Compounding it and shaping it, so that you work toward your goal.

  Maybe, a better, visual way of thinking of this is trying to elevate yourself higher and higher. Imagine trying to get a whiffle ball out of a tree. You can't reach it. You tossed another ball up there to knock it down. But, now, the second ball is trapped up there also. You look around to see what you could stand on. What you see is a picnic table and benches. You bring one of the benches over. But, it's not high enough. So you bring over the table. It's not high enough, either. But, then, you stack the bench on top of the table, and, Walla, you can reach the balls. That's bootstrapping in a nutshell.

  Our visual example is bad in that it gives the impression that bootstrapping is inherently unstable. If we were to put the second bench on top of the first, which was on top of the table, we might not feel comfortable standing on it. We don't want our creation to come toppling down. Especially if we are standing on top of it! But, the stability with which you build the base is totally unrelated to the concept of bootstrapping. Some entrepreneurs bootstrap rapidly, giving little thought to the stability of the base. They expand their business as rapidly as they can. They keep little in reserve. Others tend to be more cautions. They are sure the base is secure before they start adding to it. Some are so conservative, they fear the base is never stable enough, so despite having made it solid, they continue working upon the base and never get to the second platform of the pyramid.

  Bootstrapping means using whatever resources are at hand to go in the correct direction, to make what progress you can. Many non-entrepreneurs don't really see how bootstrapping can help them. They say, "Yeah, I see I could do that. But, so what? What I really want is just so far away I'll never get there by bootstrapping." Then they never exert the effort to make progress at all. That's not unreasonable from their perspective. It is fundamental risk/return analysis! Why do something, if you don't see any gain from it?

  But, they are making a major error. They miss the fact that bootstrapping often involves the compounding property. By this, I mean, that as you make each incremental gain, that gain becomes the base from which you can make newer gains. This is the same principle as compounding money through reinvestment. It's not always easy to see just how far you can go. You see the limits, but you miss the compounding nature inherent to business and bootstrapping. And, yet, this compounding nature of bootstrapping is exactly how most businesses are built to a substantial size. Once you understand the compounding property, you will understand how businesses grow. I cover compounding in detail in Chapter 16.

  Regarding business, whiffle balls aside, bootstrapping means using current earnings to reinvest in producing more products, either more of the same product or entirely new products.1 You sell your products and generate some profits. This all occurs over some time period we will call the interval cycle, or compounding cycle, or cash flow cycle. What exactly you choose to call this cycle is unimportant. What is important is to know that it exists. There is some time period over which products are produced, marketed, sold, and the sales revenue is collected for that set of products. Then, the process can start all over with slightly more money to produce more products to sell.

FOOTNOTE: 1 Some people will see that, maybe, I should more properly use the term cash flow rather than current earnings. I donít want to make any distinction between which term is more proper or best at present, nor even to distinguish between the two. I think for most nonbusiness people, the term, current earnings, will most clearly convey the idea I want to express. Getting into cash flow is counterproductive at present.

  Let's suppose you have invented a new board game called, "Lifer." Producing Lifers is easy. You outsource manufacturing of the board and the player pieces to a fictitious company called, "We Do Games." You will market the games yourself via direct mail, the Internet, and various advertisements. Suppose that We Do Games tells you it can produce 1,000 Lifers for $5,000. That sounds high, but Lifers are really complex with lots of special pieces, and you can't find a better manufacturing price from another source. Further, you know that to set up a plant to actually build Lifers is too high a cost for you. Even if you could fund the manufacturing shop yourself, you are not sure you can sell Lifers, and, so, you decide it is safer, at the onset, at least, to outsource manufacturing.

  So, your cost to manufacture a Lifer is $5. This is referred to as your cost of goods sold (cogs). Other costs that are properly allocated to the individual game units could also be included in cogs, such as any shipping charges We Do Games charges you when they ship you your 1,000 Lifers. We will assume the cogs of a Lifer is $5 which is just the total production cost divided by the number of units (Lifers) produced. You can only afford to make 1,000 Lifers.

  You decide you will price your Lifers at $20 retail. Maybe, that's a bit high. But, it is a high-quality game. You might do some price testing to see what people are willing to pay for your game and set your price accordingly, later, but, for now, you need a price, and you've chosen $20.

  The big day comes, and your Lifers arrive. You have 1,000 Lifers in your garage and starry-eyed dreams of competing with Hasbro, Mattel, and the other big toy and game manufacturers. You try to market your Lifers, and, immediately, you discover the following: 1) Internet sales just aren't happening. No one wants to send you his credit card number over the Internet just to buy a Lifer. They don't know you. They don't know your company. They pass; 2) Your direct mail plans, also, just aren't working. You are not generating enough sales to recoup your promotional costs. So you nix both the Internet and direct mail as marketing channels. And, they both seemed like such good ideas!

  However, there is some good news on the Lifer front. A couple of the chain stores have agreed to try selling your game, and the few units they put on the shelves sold out. They want to order more. Now, they only pay you $10 per Lifer. The other $10 of the Lifer's retail selling price is the retailer's mark-up. The retailers have a 50 percent cogs ($10) for Lifers relative to their selling price of $20. You have a cogs of $5 which is only 25 percent of the retail selling price of $20.

  But, as you only collect $10 per Lifer sold, your cogs ($5) is also 50 percent when compared to the actual revenue a Lifer sale generates to you ($10). We will ignore all the other costs associated with selling Lifers. In particular, there is no order fulfillment cost allocated to shipping the Lifers to the retail seller. Nor is there any allowance for overhead, etc. We want to keep the example simple.

  The net result is that you sell your 1,000 lifers. The retail store pays you $10,000. You paid your manufacturer, We Do Games, $5,000 so you made $5,000. Not bad at all. That's a 100% return on your initial investment of $5,000. Not even a bull stock market would ever give you such a rate of return on your investment within a year. You should be pleased.

  But things are even better than this. For the retail stores are clamoring for more Lifers. And, a crucial neglected fact is, "What exactly was the period over which my business investment compounded to a 100% return?" Now, if we are in time-lapse photography, and it is ten years later, before you have sold your 1,000 Lifers, I have bad news for you. Your Lifers suck as an investment. Sure, you got a 100% rate of return, but it took you a decade to do it. That amounts to only a seven percent annual rate of return. But, that isn't what's happened. It didn't take a decade to sell your 1,000 Lifers. It only took 6 months. So you really don't have a 100% annual rate of return. You have a 100% rate of return within 6 months. Your compounding interval is 6 months or half a year, not one year. You might want to give this some real thought. This is a crucial aspect of business and is discussed more on the chapter on compounding.

  Now, even the most basic analysis shows you that you are compounding your money at a rate of at least 200% annually. For you could use your initial investment sum of $5,000 to buy 1,000 Lifers and sell them over 6 months (which you already did), then turn around and buy 1,000 more Lifers 6 months later (the present actually, as you have been selling Lifers for 6 months now) and sell them over the next 6 months. That's 2,000 Lifers sold in one year, and you have made $10,000 on your initial investment of $5,000 in exactly one year ($10,000 return on $5,000 is 200%). This shows that the compounding interval is just as important as the rate of return. Compounding intervals for small and start-up companies vary, obviously, but usually are much shorter than one year. Compounding intervals tend to be shortest for non-capital intensive businesses and businesses which have high gross and net margins.

  But things are even better! For our simple analysis above actually neglects compounding entirely. This is because it makes no use of the money made on the initial $5,000 investment as reinvestment funds to produce even more Lifers. Remember, 6 months down the road, you not only have your initial investment of $5,000 returned to you (which you can turn around and spend to invest in another 1,000 Lifers), but you also have the profits made on the first set of 1,000 sales. That amount was $5,000 if you recall. What this means is that you can order not 1,000 Lifers on your second production run, but rather, you can order 2,000. This is because you have your initial investment of $5,000 and, now, you also have the profits on the first set of sales which is also $5,000. You have $10,000 to reinvest in more Lifers. A Lifer costs $5 per unit to produce, so you can produce 2,000 of the little buggers.

  So, assuming the Lifer market demand is there, within the year you could have sold a total of 3,000 Lifers—1,000 from the first production run and 2,000 from the second production run. You made $15,000 which is a 300% return on your initial investment within one year. Your initial investment of $5,000 was enough to produce not just 1,000 Lifers in your first year, but it was enough to produce a total of 3,000 Lifers, which had a total production cost of $15,000. This is the power of compounding as applied to business activity. It is an immense force. As long as the market demand for your product is sufficient, you can keep reinvesting the money made on previous sales to produce more units to sell. Never was more money put into the company. There was no new so-called equity financing or borrowing in addition to the initial $5,000. The growth was the result of bootstrapping. More correctly, the growth was really the result of being able to sell more and more Lifers, but the capital to produce the Lifers came from reinvestment of earnings.

  Notice, at the end of the year, you have $20,000 which is just the sum of your initial $5,000 and the $15,000 profit you made throughout the year. Because your money doubles every six months and there are two such periods within one year, at the end of the year, you have four times your initial amount. So, as long as the Lifer demand remains, you will multiply whatever capital you start a year with by a factor of four to determine how much capital you end the year with. So, you could calculate that at the end of your second year, you will have four times $20,000 or $80,000 in equity.

  As a preview to compounding: If there are n compounding periods within one year, and you compound your money at a rate of return given by R (expressed not as a percentage, but as a decimal) for each of these sub-year periods, then, within one year, your money grows to become the initial amount times (1+ R)n. Here R=100% or expressed as a decimal just 1, and n is 2. The factor (1+ R)n is 4. This is equivalent to a one-year 300% rate of return whose multiplying factor is calculated as (1+ 3)1.

  Reinvestment of earnings is how real growth businesses get most of their financing. It's not by selling more and more stock to investors. It's not by borrowing more and more money from lenders. Yes, those are ways to increase your working capital, but to really grow involves generating more and more sales. With those sales come profits to be reinvested which are used to…generate more sales.

  Now, neglecting the effect of taxes, you can see how businesses can grow rapidly. In particular, we have shown that our business creating Lifers is generating a 300% annual return on the initial investment. Suppose the company could continue growing like this for five years, i.e., there is no market limit to growth for this time. The initial $5,000 investment would grow to $5,120,000. In eight years, the amount would become $327 million dollars! That's not a typo. That's $327,000,000. In ten years, the amount would compound to $5,243,000,000. Five billion two hundred and forty three million and change neglected. In twelve years, the amount would be $83,886,000,000 or eighty-three billion eight hundred and eighty-six million and change neglected.

  The above should serve to convince you of the importance of compounding and bootstrapping in building a business. If you ever really want to build large levels of wealth, this is worth understanding. If there are aspects you don't understand, reread it. Read the chapter on compounding. Maybe look at a mathematics book on investing or seek out a college class that covers this.

  Now, obviously, our hypothetical company could not continue growing like this forever. Probably not even for five years, in fact. After all, only so many people will buy the Lifer game. Further, as the company grows, it will find itself taking on overhead expenses. Are you going to pack and ship all those Lifer games yourself when sales are in the millions? Where will you store all the inventory before it is shipped to the retailers? In practice, there will be constraints on a company's growth. Often, it will be the level of sales you can generate with a given product. You will be market limited. If Lifer sales started floundering, it would be smart to start trying to come up with other games to market. You would already have the retail channels lined up. The retailers would know you are a serious business person they have worked with before.

  Now suppose that in our idealized example, Lifer sales do continue unlimited, and the costs and the profits are as above. At some point, your success would be noticed by other entrepreneurs and business people. They would think to themselves, "Lifers really are profitable. Maybe, we should be in the Lifer business."

  Suddenly, there is another company producing Lifers. The games they make are exactly like yours, but rather than charging retail stores $10 per Lifer, your new competitor is only charging $9. Where will the retailers buy Lifers from? The other company, of course! The only way for you to get back the lost sales is to charge less, say $8 per Lifer. But this means you are only making $3 per Lifer profit now. Your growth rate will be lower. But, your situation is even worse. Your competitor drops their Lifer price to $7. You drop your price to $6. You are only making $1 profit per Lifer now, only one-fifth of what you were originally making. The Lifer business is getting really tough. "But, at least, it won't get any worse," you think.

  Your competitor drops their price to $5 per Lifer. "They can't do that! That's insane. They won't make any money." But your competitor has found a way to manufacture Lifers for $4 apiece rather than $5. To be competitive, you now need to lower your Lifer production costs. If you can't do this, you're out of the Lifer business. Lifers have become a commodity. They are available from several sources, and the only factor that really distinguishes your Lifers from your competitors' is price. You don't want to be in a business where the low cost competitor wins. It's tough to survive, let alone make money and grow. What you want is a monopoly on the Lifer game market. And, you could have gotten it. You could have copyrighted your game. Then, you alone would have control over how Lifers were sold. No other company could just move in and start selling Lifers exactly like yours.

  Copyrights and patents give you proprietary products. Proprietary products are products that for whatever reason are exclusively controlled by one company (technically, several companies could share patent rights, but that's a nit-picky detail that doesn't concern us). If the market demand exists for a product, and the product is not proprietary, you will have great difficulty bootstrapping to a much higher level of sales. You could only produce 3,000 Lifers in your first year without external financing. This doesn't change if the demand for Lifers is 300,000 per year.2

  If the product is not proprietary, your competitors and the market will not simply wait as you bootstrap yourself to riches! Someone with more capital will fulfill the 300,000 orders, and they will become the dominant player in the Lifer industry. Never mind that you were the one who showed that the Lifer market existed in the first place! With a proprietary product and huge demand, you will be in control. You will probably be able to raise the working capital to immediately fulfill all the orders. Even if you cannot raise enough money to fulfill all the orders, at least, you would be able to raise your selling price. Some retailers would be willing to pay more to get the much in-demand Lifers! They will charge the end buyer more.

  FOOTNOTE: 2Notice, I'm not saying why you can only produce 3,000 Lifers in one year. This is just our assumption. Saying that you can only produce 3,000 Lifers in one year is equivalent to saying that your compounding cycle is six months. It might be that the retailers only pay you every six months, or it might be that you can only schedule two production runs per year. The possible limitations upon how many compounding cycles will fit into one year is discussed in detail in Chapter 16.

  Each Christmas, there is at least one hot, hard-to-get toy everyone seems to want. And, some parents pay ungodly amounts for one. If the market demand for Lifers remained strong, you could bootstrap yourself to riches if you had proprietary control. Or, maybe, you could just sell your proprietary rights to another company that could produce all the little 300,000 Lifers. You might collect a royalty for each sale, or maybe a significant one-time payment, or maybe some combination of the two. Controlling an in-demand proprietary product gives you options, and it allows you to keep your prices and, hence, profit margins high.

  Notice, I said a proprietary product is one that is exclusively controlled by one company for whatever reason. It could be legal copyright or patent protection that gives the company exclusive control, but the product could essentially be proprietary due to other factors.

  The common example is the trade secret product. No one else has the secret decoder ring or the secret recipe to make the product. You guard that information with your life! If no one else can do what your company can do, you have a monopoly on the market. You have a proprietary product.

  Some companies like Coke-a-Cola really play this up. However, there is no product, that once on the market, cannot be reverse engineered, understood, and reproduced. In fact, even with full legal patent protection, there are few products that cannot be analyzed by your competitors who then turn around and replicate the underlying idea of your product. Pure trade secret protection isn't all it's cracked up to be. It is usually only naive companies who believe that they have a stranglehold on some body of knowledge. In fact, it usually works in the reverse direction. The best entrepreneurs, upon seeing a good opportunity, know that they must act fast or else someone else will beat them to the market with their own version of the product or idea.

  Some entrepreneurs realize the above, but they figure, "Maybe we can't prevent others from copying us, but we sure can be the front runner, the pacesetter, or the leading company in our industry. We will innovate so rapidly that no one can keep up." This is a tough, tough road. Innovation alone will not lead to success. However, it can lead to a reputation. One form of proprietary product that does tend to work is proprietary ownership based upon reputation. Clients or consumers buy your product due to the company's strong reputation or name brand recognition. This is especially true for companies which provide services, and it is the reason you should try to build a great reputation for your business. Clients will pay more for a service, if they feel that the company providing the service is one of the best.

  There is one case where you can effectively get the benefit of a proprietary product, protection from competition, for, at least, a period of time, despite having no actual proprietary control. This is the case where the demand for the product is so immense that demand exceeds the total capacity of all the companies capable of producing the product. In time, the business will become competitive and difficult, but for awhile, there will be no competitor limiting your growth or profit margins.

  The Lifer example chosen is a difficult product to classify in that even though it is a manufactured product, its manufacture is being outsourced. How would you classify such a product? Is it a manufactured product, or is it more of an intellectually-created-informational product? Is it a bit of both? You might think I'm dwelling on a trifle of a point. But it's not a trifle. It's important. Where is the value of this product? Where was the value created? Why was this product such a good choice for bootstrapping? For use in our example? What are good characteristics of a product for a company that wishes rapid growth via bootstrap financing? What difficulties might the product run into? Give some thought to these questions before moving on to the next chapter.

Copyright ã 1999 Peter Hupalo


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