Business Structure

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Establishing Operations

learning objectives After studying this chapter, you will be able to: LO12- 1

Discuss the use of a critical path chart.

LO12- 2

Describe how location can be used as a competitive advantage.

LO12- 3

Discuss the important issues in the financing considerations of new firms

LO12- 4

Distinguish between the various methods with which a new firm establishes legitimacy in the market.

LO12- 5

Explain the importance of production management in start-up ventures.

LO12- 6

Explain how production charting is accomplished.

LO12- 7

Describe the importance of quality as a competitive tool.

LO12- 8

Discuss the type and condition of equipment needed at start-up.

LO12- 9

Explain how timing is a competitive advantage.

LO12- 10

Recognize the issues related to time management in the starting of a new business.

INDIGO IT

Indigo IT is the 2014 Small Business Administrations winner of the Procurement Award for services provided to the federal government. The firm is headed by Denise Van Wynsgaardt, who is a Mexican American native of Texas. Denise graduated from St. Mary’s University in San Antonio and received her master’s in public policy from Georgetown University in Washington, DC.

The firm was founded in 2001 to focus on IT support services with a focus on information assurance and security engineering, infrastructure analysis and planning, business continuity/disaster recovery, project management, enterprise integration and operations, and systems engineering. Today the firm employs approximately 70 people.

Denise is principally engaged in outreach activities with customers. Under her leadership the firm emphasizes a values-based philosophy with a strong ethical code of conduct and a commitment to Indigo IT’s core values of Responsibility, Initiative, Service, and

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Excellence. In addition to her overall CEO responsibilities, Denise provides management oversight of Indigo IT’s human resources and financial functions. As a female-headed firm, the company has been able to obtain a number of contracts that might not have been open to a new business. And the firm has had to deliver on its commitments.

The firm is organized as an LLC with Shane Van Wyngaardt and Rob Craig as the other principals in the firm. The growth of Indigo IT has faced its challenges. Specifically, in 2013, the firm had to restructure to ensure greater price competitiveness and alignment between the contracts they pursued and their competitive strengths.

Questions 1. What are the advantages of tying the business to federal government contracts? 2. Will winning the SBA award help future business with nongovernmental organizations?

Sources: M. Hoover, “Soul Searching for Success: Indigo IT Steps Back and Makes Changes to Fuel Growth,” Washington Technology, www.zoominfo.com/CachedPage/?archive_id=0&page_id=6647462554&page_url=//washington technology.com/articles/2013/05/06/indigo-it-story.aspx&page_last_updated=2013-05- 13T23:00:28&firstName=Shane&lastName=Van%20Wyngaardt; “Indigo IT Wins SBA Prime Contractor Award,” HispanicBusiness.com, May 15, 2014, HispanicBusiness.com Ms. Denise Van Wyngaardt, Zoominfo, www.zoominfo.com/p/Denise- Van%20Wyngaardt/648138143

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Planning is the first step in the entrepreneurial development process. A great many individuals do little more than this initial investigation. During this initial process, the individuals that stop may find a fatal flaw, decide that the business is not nearly as lucrative as they had originally thought, or simply determine that they do not want to take the risk. The decision to not pursue the business is completely legitimate, and it is better to make it early if you believe that the business does not present the right opportunity for success. The process provided in this book, in fact, is designed to encourage the student to fully examine the business opportunity prior to actually starting a business. Our expectation is that the specific plan you develop in this class may not be one you open, but you will learn a process that will allow you to keep examining potential businesses until there is one you do want to open.

However at some stage, if the business is one that is viable, the entrepreneur must decide that she has investigated the idea sufficiently and that it is time to actually begin operations. While we would advocate good research and examination of your idea, the critical point of difference between an entrepreneur and someone with an idea is action. This chapter examines the practical, process-based actions that must occur to actually begin operations.

The position reached by Friends’ Home Health discussed below is quite typical of most new business start-ups. During the initial start-up period, the expenses of the firm are often higher than expected, and the time to reach the break-even point takes longer than expected. A root cause of many of the problems for a new business can be traced to the lack of development of an operational plan.1 It is this lack of operational plans that can lead to a cash crunch in the organization as the new firm stumbles while trying to actually put its ideas into action. As a result, the firm may have a great idea and be on a clear path to breakeven but run out of cash before it has the opportunity to achieve that success. The firm should have a solid understanding of the specific operational issues related to that business prior to starting the new venture.

There are a number of distinct actions that must be taken in order for a new business to begin operations. Although there may be some crossover among these actions, we separate them into the following categories:

1. Critical path chart 2. Location 3. Financing considerations 4. Legitimacy 5. Production management 6. Production charting 7. Quality 8. Equipment 9. Timing 10. Time management

Each of these will be examined in turn.

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The time had arrived for the founders of Friends’ Home Health to put their plan into action and start the business or decide they would continue to work for other companies. Betty and Joan realized this need to make a choice during a time when the area’s economy appeared to be taking a nasty turn for the worse, with several major employers in the city announcing plans for layoffs. In addition, both of the potential founders had been informed by their employer that there would be no raises during the next year.

These economic conditions might look like a poor time to start a new firm, but our founders viewed the conditions as only limited barrier for starting their particular business. They knew from the analysis that their potential success depended on their customers. However, Friends’ Home Health was targeting an upper-income area of the city with a differentiation strategy (better product due to the specialized training of their employees). In addition, the service of home health care is not something where demand is elastic; that is, the demand does not change dramatically as price changes. If someone’s mother needs home health care then the adult children are not going to eliminate that care from their budget. The alternative is a nursing home, which many people will avoid at any cost. The issue that the founders next faced was to actually begin to set up the operations of the home health care business.

The founders raised their initial investment from themselves, friends, and family. The funds they hoped would be able to pay for a number of things including the rent on the office they would establish, initial supplies, and some basic training of employees. The founders had sought out a relatively cheap location because they did not believe that they needed a place that was highly visible; no one would drive by and decide to hire a home health care worker for a loved one after seeing their sign. Unfortunately, they realized they did not have enough capital for the business to reach the six months they estimated it would take to reach breakeven. Therefore, they took their business plan to their local bank and worked out an initial working line of credit from which they could draw to pay expenses and then pay back as accounts payable were paid to them. Armed with this initial financing, they proceeded to complete the next steps critical to starting the business over a three-week period of time. The steps they took included the following:

Betty and Joan employed a stationery store to design a simple logo for the operation. The cost was only $400, and the service would be free if they purchased all their business cards, letterhead, and envelopes from the store. The founders realized that visual items such as letterhead and cards would help to legitimize their appearance (a concept discussed in more depth later in this chapter). They agreed to this immediately.

Betty and Joan started advertising to recruit staff. They wanted all of their staff certified to some degree. Although they wanted to hire people with their certification in hand, they knew for the largest segment of their potential workers\u2014those who most often worked with individuals in their homes, delivering very basic services\u2014that this would not be readily available. Therefore, they reached out to the local community college, which had a two-week program offering such training. If the firm could hire a set of 25 part-time workers who would deliver these services, then the local community college would offer the two-week intensive class just for Friends’ Home Health Care employees.

The class would cost Friends’ Home Health only a fraction of the total cost as the population of students would be considered low skill and there were subsidy programs for technical training. In the economic setting of the city, this course was seen as a valuable service to provide this group of jobs. However, Friends’ knew that the potential employees might not go to the class if they were not paid for their time. Therefore, Friends’ also had to have in place a means to pay them. To make such an investment pay for itself, Friends’ would need to have a number of customers already in place to generate the needed revenue as soon as the employees were trained.

Betty and Joan contacted the phone company, electric company, water department of the city, and gas company to establish service at the facility.

The two owners realized they were in a delicate position, that is, by needing to recruit and train employees and also having the accounts waiting in place for these employees to start to work almost immediately after the training. Thus, the two owners agreed to take no salaries for themselves until cash flow was positive.

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The partners had begun the operations of their entrepreneurial business. They had a plan for when they should reach breakeven, but unexpected expenses also started almost immediately.

Friends’ Home Health hoped to offer a rich range of services in addition to the direct care of patients, including occupational (OT) and physical therapy (PT). The founders quickly recognized as they started looking, however, that such employees were very expensive and they needed guarantees of hours worked. The two entrepreneurs also realized that they could not financially make that work at the outset of the business. Therefore, they decided to create a contract relationship with local OT and PT firms. However, these contracts required that Friends’ guarantee minimum revenues for the OT and PT firms. Therefore, as the firm started there was an immediate cash flow out that was not matched by a cash flow in.

Betty and Joan also soon found that whereas they were willing to pay the new employees even while they were in training, that these individuals had little loyalty to the business, and the resulting turnover rate was very high: Approximately 15 percent of potential employees dropped out during the two-week class. The typical employee was female with a high school education. The work was not seen as appealing to most individuals since they are frequently just sitting with a person who is often bedridden or in a wheelchair. The activities that must be done as a part of the position included helping to feed the client and helping him or her with their bodily functions. Although Friends’ had planned to pay above-city averages for such work consistent with their differentiation strategy, as a start-up, their reputation for such efforts was not well established. The outcome was that they found they were paying for people’s education, although some of those who received the education would never work for the firm, and this extra service was yet to be appreciated by the firm’s potential customers.

Betty and Joan immediately recognized that their plans for the operations of the business were not leading to the break- even point (the point where revenue equals expenses) that they had projected. Instead, the company was faced with a negative situation well beyond their expectations.

QUESTIONS 1. What steps would you take now to start this business if you were in the Friends’ Home Health founders’ position? 2. In what order would you suggest they proceed with these steps? 3. What are your suggestions for Friends’ to overcome the negative cash flow setting they now face?

LO12-1 Discuss the use of a critical path chart.

The Use of a Critical Path Chart The first operations-related concept we want to introduce in this section is also one of the most popular for organizing a wide range of activities in a firm. An absolute imperative for any organization, but most especially for a new business, is the efficient use of time. Many tasks can be handled concurrently, but others must be performed sequentially. Identifying the actions that must occur, in what order they should occur, and what order will be most efficient is one of the first operational steps for a new business. Although it is often not possible to identify every action item that will be required prior to the start of a new business, the effort to develop a complete list will allow the new business to have a faster, more thorough, less expensive start-up. Failing to plan may leave the new business waiting weeks for some small step that could have been completed earlier, concurrently with other actions taken by the firm. For example, items such as obtaining a state tax ID or a city license are not difficult but may take some time, depending on the requirements. However, the firm may not be able to buy equipment for the business or rent facilities until these licenses are obtained.

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Table 12.1 Critical Path Table

Although there are a number of methods and formats for completing a critical path analysis, we present a relatively common, easily understood format that we have used with a number of new start-ups.2 Initially, the entrepreneur must identify the most likely amount of time it will take for each of the key tasks to be completed, the actual time one of the owners will be involved, any prerequisite tasks, and who is responsible for the task. The chart of critical activities might look something like the one in Table 12.1 for a small manufacturer. This process could be the same for many different types of manufacturing. However, it should be noted that the initial efforts of the entrepreneur, concern so much more than the actual manufacturing. It should also be noted that while we have specified the tasks for a manufacturer, the tasks will be different for different types of businesses.

Note that the assigning of responsibilities and estimated times is more than an intellectual activity. When you specify who will do a task and how long it will take to be completed, you set for yourself a control mechanism to ensure that you are going to be ready when you intend to open. If you do not set timetables and responsibilities, it is possible for the founding of the business to drag on, using up precious financial and emotional resources. The founders setting the schedule allows them to get a solid handle on how soon they can begin operations. The owners understand that while they must wait on some tasks, they can complete other tasks so that their time is used efficiently. The owners also can set some priorities on where their time should be focused. For example, it would be difficult to acquire raw materials and have them delivered prior to the leasing of the facility. Thus, if the leasing of the facility took more time than estimated, then the entire process would be delayed.

Underestimating the amount of time it will take to begin operations is a mistake that harms many new businesses. You should estimate the times very generously, since many critical steps may take significantly longer than originally planned. New businesspeople often do not recognize a given step they will need to accomplish in order to successfully develop their business. It is for this reason that you will hear many new entrepreneurs say getting the business to the state it could generate revenue often takes 2 or 3 times what they first thought. The listing of critical tasks and the resulting critical path chart can help to overcome this problem.

From the lists of critical tasks identified in Table 12.1, the new business can then develop a chart that demonstrates how the activities fit together. The chart of how your actions fit together is your critical path chart that shows the set of activities that are dependent on each other (i.e., the longest path) and which take the longest time. The chart listing the critical tasks provided in Table 12.1 will produce the critical path chart shown in Figure 12.1.

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Figure 12.1 The Critical Path Chart

As you can see from the critical path in Figure 12.1, it will take a minimum of 12 weeks to open the business in this case. There are some things the firm can do at the same time, such as setting up the firm’s bank accounts and starting to work on bank loans. However, the new business will likely not be able to start to lease a facility until it has its financing in place. Potential landlords will initially screen out those individuals they do not think are serious as they seek to lease a property.

The businessperson can make the critical path as detailed as is necessary. The chart for the small manufacturing firm in Figure 12.1 is actually quite simple. The new businessperson should be guided by developing a chart that provides the most assistance and information. The purpose of the chart is not to be a formal document to place solely in a business plan. Instead, it is designed to help focus the founders’ efforts so they are not slowed down by some simple activity that was not visualized. Therefore, it may be useful for the founders to create a more complex form of a critical path chart that can be developed by estimating three different time needs for each task: minimum, most likely, and maximum. For complex start-up operations, there are several project management software packages that will assist you in developing a task chart and producing a critical path chart. They are available at most office supply stores. The new businessperson must judge the level of detail that he desires in a critical path chart and whether purchasing such a program will aid him or not. The process for an Internet-based business is somewhat simpler than for a manufacturing business. However, there are critical steps that can delay the start of any business such as obtaining the required licenses.

To further illustrate the importance of such planning, consider one of the entrepreneurial businesses that students in one of our classes wished to start. The students wanted to start a Study Caf\u00E9 that would be open from 4 P.M. to 8 A.M., seven days a week. The business design was simple but elegant and potentially quite lucrative. The café would provide a well-lit, open- forum, safe space to study individually or meet with groups. It would make a majority of its money by selling basic food and drinks, and leasing out the conference rooms in the facility. There was cheap space available close to the campus where a restaurant had gone out of business. (The prior restaurant had appealed to students, but closed every night at 9 P.M. and strongly discouraged students from “hanging out.”) The students’ original intent was to open just prior to the start of classes in the fall semester. However, after completing the critical path chart, they realized that they would complete everything necessary to open their doors in April. This would mean the business would open for operation at the end of the spring semester. The city in which the Study Café wanted to open was a college town where only the resident college students would be interested in staying up until the early hours of the morning. As a result, the business would have to suffer through the summer months of limited business while the expenses just piled up.

critical path chart Chart that demonstrates how the activities necessary to start the firm fit together and build on each other. This chart allows you to understand which activities can occur concurrently and which must already be in place before the next activity can occur.

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As a result of their critical path analysis, they approached their opening from a completely different perspective. Rather than starting the process immediately and seeing when they could open, they went to the end of the chart and set the opening date as August 1. They then calculated the critical path chart in reverse, with the date they were to open being the starting (and therefore missing) element. Estimating the longest path for opening the Study Café, they were able to establish a date to begin the process of putting together the operations of the business so as to minimize wasted effort and money while still opening for operations by August 1.

Entrepreneurs should constantly update their critical path analysis as they develop the plan for a business. Entrepreneurs should also share that critical path analysis with potential suppliers, friends, and industry experts\u2014with anyone who will look it over for you and add, modify, or delete activities. The critical path analysis is a living document that should be modified during the process of actually accomplishing the tasks. We have worked with a number of new businesspeople who take large flip chart sheets of paper and post a critical path chart on the wall of their home, office, or wherever it can be easily viewed. As tasks are accomplished, delayed, added, or changed, the chart is continually updated.

Is the Study Café a lucrative business idea? Why or why not?

EXERCISE 1 1. Develop a list of all activities necessary to start your business. 2. Develop a critical path table of activities. Think very carefully about what activities can be completed concurrently.

How Location Can Be Used as a Competitive Advantage LO12-2

Describe how location can be used as a competitive advantage.

One of the most important steps in the critical path chart will be the identification and purchase or lease of a location for the new business. The old axiom from marketing is that the three keys to business success are location, location, and location. Although this might be a bit overblown, we certainly agree that location is a critical factor in the successful operation of a new non-Internet business.3 How do you decide upon the best location for the money? The method that we use involves breaking the business down into the critical design features of the business. You may recall from Chapter 5 that you should develop a list consisting of all of the resources or capabilities of the organization.

It is very easy to simply fall into the trap of trying to locate a business based on the capital available or some convenience factor that has little to do with the actual strategy of the business. This is a mistake that can, by itself, send all of the other planning down the drain. For example, one of the authors met a young couple for dinner several years back, both of whom had been students in his classes. They were very excited because they had decided to open a restaurant and wanted us to come by once it was open. It was a reasonable restaurant idea, but its location constituted a fatal flaw. They were opening the business near their home because they knew the area “so very well.” This decision also allowed them to return to the area where they had both grown up.

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However, the area the couple wanted to locate to was more than 60 miles from any major city and, worse than that, they had selected as their location a strip shopping center with very cheap rent. A strip center is a small, one-story retail center typically located parallel to a well-traveled road. This type of center is referred to as a strip center since it is often developed on a strip of land irrespective of the development in the area; a strip center generally has no major anchor stores to draw in customers. The fact that the entrepreneurial couple were locating in the strip center itself was not the problem. Instead, it was the specific strip center that they had selected. The reason the rent was so cheap was that the shopping center was virtually empty. It was empty not because the center was too new to have tenants; instead, the customer base in the area was too small and poor to support any of the businesses that had previously operated there. Their proposed location was more than two miles from the interstate. Therefore, they would not be getting the interstate travel traffic that would be passing through this isolated location. Despite our warnings and suggestions, they went ahead with the business with their father’s seed money (almost $50,000) only to see the small restaurant collapse within six months. Even the best idea can be killed by a bad location.

Although there are many very sophisticated methods for performing a location analysis, in simple terms, locations can be graded by the type and amount of traffic that the particular location draws. If you are setting up a warehouse, then you neither need nor want an “A” location in a mall, on a busy street, or in a tourist-heavy downtown area. Match the type of business and the amount of money that you wish to invest in the first years of operation. Take the time to analyze the long term as well. If you will need to move within a short period of time because you achieve all of your targets and outgrow your space, then you may want to consider a location that includes an option to allow for expansion.

To illustrate the rich options that a firm can pursue, we helped a small group of founders of a real estate firm that started out as three people renting space from a travel agency (literally, three desks in the back of the building). As luck would have it (for the new business at least), the travel agency was struggling, which allowed the new business owners to rent more and more of the building as their business expanded. Within 18 months the team was renting 80 percent of the building and approached the travel agency owner about taking over the entire building and setting up a lease-purchase agreement. The travel agency finally closed and the entrepreneurial team was able to acquire the building location. Having established a client base, they really wanted to hold onto their location. As will be discussed later in this chapter, location is one of the things that provide a business with legitimacy. If you have a location and maintain it for some period of time, then you are more accepted and acceptable with potential clients and suppliers, because your business appears to be more stable.

strip shopping center A small retail center located typically along a major road. The center has only small businesses and the center itself occupies only a small strip of land along the major street.

anchor stores Major retail stores, such as department stores in a mall. They serve as the anchor for the retail establishment.

What businesses are best suited for a strip shopping center? What businesses might not work in such a space?

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ETHICAL CHALLENGE Entrepreneurs often face serious ethical challenges in their operations. For example, in obtaining supplies for products such as shoes, balls, clothing, and agricultural products, the cheapest supplier may be able to provide that price by cutting corners in worker safety or by polluting the environment. For major corporations it is often not the law but the potential of bad publicity that pushes them to take certain operational actions. In 2012 more than 100 people were killed at a factory fire in Bangladesh. The supplier who employed the people had violated many laws such as locking all doors with chains so no one would skip out from work. However, it was not only the local Bangladeshi factory owner who suffered, it was also their large U.S. and European retailing customers who suffered as the bad publicity did major damage to their reputations. The result is that some large corporations now have an entire staff, or hire consultants, to ensure that they are not using a supplier who keeps costs low by using methods that most of the world would condemn.

New entrepreneurial firms will not have the staff or the slack resources to send individuals to check out how well potential suppliers treat their employees or their environment. In addition it is far less likely that adverse publicity will negatively impact a relatively small entrepreneurial firm. However, the ethical challenge remains for the entrepreneurial firm. How is the entrepreneur responsible for ensuring that its suppliers are meeting its own ethical standards? If the entrepreneurial firm sells sporting goods and buys a container load of soccer balls from Pakistan, do they have the responsibility to make sure children were not used in this process? (It is a shame that in some places children work long days to make soccer balls because their small hands are flexible enough to perform the stitching work inside the ball.)

QUESTIONS 1. What would you do to get something that you deemed to be critical for your new business? 2. At what point do you have a responsibility to find out the nature of the supplier of a product?

Commercial real estate firms are a source of unparalleled information for the new business owners trying to locate their business. Building owners pay agents in a leasing agreement that is usually based on a percentage of the first year’s lease and the signing of a two-year lease. Although commercial real estate agent income can be quite substantial, the commercial real estate market is relatively small and an individual’s reputation is critical to future bookings. Therefore, agents focus extensively on ensuring that the new business signing the lease is successful. The fact is that the cost for all this expertise is paid by the building owner, and a successful business that pays its bills is very desirable. Thus, commercial agents can be a valuable asset to new business owners as they seek to locate properties that match their needs.

The Important Issues in the Financing Considerations of New Firms

LO12-3 Discuss the important issues in the financing considerations of new firms.

While not addressing the details of financing operations here (we have covered those issues in depth earlier), we nonetheless want to acknowledge the gamut of financial issues related to the operational start-up of a new business. Financing the initial operations begins with the variety of initial payments and the process of setting up the business and ends with the first completed sale. The new organization has to be in a position to make initial payments for

1. Security deposits. 2. Utility setup fees.

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3. Purchase or lease of initial equipment and installation. 4. All licenses and inspections. 5. All initial supplies (this is a significant and often overlooked expense). 6. Hiring and training of initial staff. 7. Initial advertising expenses. 8. Bank set-up fees. These costs can be substantial, and the new business must ensure that it has the proper resources to conduct these activities.

(For an interesting discussion of start-up costs in the artesian cheese industry, see the 2014 article by Bouma, Durham, and Meunier-Goddik).4 Recalling our critical path analysis, if one element, such as purchasing of some key inputs, must be delayed because of a lack of resources, the impact can be to place the entire development of the new business’s operations behind schedule.

It was highlighted earlier that the issue of establishing a bank relationship is critical. The new business is well served to establish a variety of financial relationships with its bank. Some of these key issues include establishing a revolving line of credit (working capital), acquiring a business credit card account, and setting up a basic business checking account. These accounts should have a primary signatory and a confirmation signatory as an audit safety condition. No one individual should be able to write checks for the business in excess of a specified amount (usually $500) without a countersignature. Using confirmatory signatures ensures both parties know where major expenses occur and that the bill is accurate.

Picking which bank to work with is more than a choice of which branch is closest to you. Working with small businesses is a specialized skill that all banks will say they possess, but which, in fact, may be very limited at a given institution. Some banks develop expertise in large commercial accounts such as Fortune 500 customers. Other banks have an expertise in retail banking, primarily serving individuals. Still other banks have their principal focus on small and medium-sized businesses. A bank may have a range of customers, but you want to ensure that it has an expertise in your type of business and understands issues such as timing of payments from customers. If you have a small retail firm, you may need large draws on your lines of credit to get the Christmas merchandise onto your shelves. If you are a small oil and gas exploration firm, you will have other specialized needs, such as determining the value of given leases that you include in your assets. Whether your bank can work with such issues is an important question for a new business owner. The expertise of other successful entrepreneurs in your area provides valuable insight into these issues.

The Various Methods with Which a New Firm Establishes Legitimacy in the Market A topic rarely discussed in the establishment of a new business is the issue of legitimacy. Legitimacy is the term we use to discuss acceptance by key stakeholders, such as customers and suppliers, who believe in the firm as a genuine business that will still be in operation next year. Developing the perception of legitimacy for both customers and suppliers can be difficult, although it is critical to the long-term survival of the business.5

LO12-4 Distinguish between the various methods with which a new firm establishes legitimacy in the market.

legitimacy The acceptance by key stakeholders such as customers and suppliers that you are a genuine business that will still be in operation next year.

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The new business will need to look like and act as an operation that will be in business for the long run in order to achieve some level of legitimacy. If a customer buys a product and the company is then no longer in business, who does she turn to when she has a problem? When a supplier sells goods on terms of 90 days, where will that firm get its payment if the firm that bought the goods goes out of business before the 90 days? Thus, both customers and suppliers want to ensure your business will be operating for the long term before they do business with you.

You will recall from our discussion of community supports in Chapter 2 that business incubators were discussed. These institutions are a potential setting for new businesses (especially non\u2013food service businesses) to locate their initial operations. They offer new businesses office space at reduced rates, as well as providing services such as a receptionist who answers the phone with the business name, conference room facilities, and basic office equipment (copying, fax, Internet, telephones). The effect of these supports is that it helps to build the perceived legitimacy of the business with the look of a more professional presentation as well as the endorsement provided by the incubator operator. Incubators are usually swamped with new businesses that would like to be considered. The incubator operators try to pick those businesses that have the best chance for success.

Regardless of the business location, the entrepreneur needs to consider the potential means with which to establish the legitimacy of the business in the eyes of the customers and suppliers. Below is a list of classic items that may help establish more legitimacy for your new business:

1. A business checking account with the firm’s name printed on the checks; start the check numbering higher than 001 or even 101.

2. A business credit card. 3. A bank line of credit. 4. Professional business cards. 5. Professional letterhead, billing slips, envelopes, and so on. 6. Professional advertising material. 7. The prestige of the business address 8. Job titles\u2014titles cost you very little, use them liberally. 9. Telephone answering support. 10. A high-quality Web page. 11. A board of advisors and/or directors with excellent community visibility. 12. Endorsements from well-recognized and respected individuals. You may have noticed that some items in the list above are quite inexpensive, whereas others are both time consuming and

expensive. We suggest that all new businesses develop a plan to establish and continually enhance their legitimacy. While you may not choose to do them all, and appearances are not everything, the business’s legitimacy is critical at the outset of the business.6 Thus, every reasonable way to improve the firm’s legitimacy should be taken.

EXERCISE 2 1. What do you look for in a business before you patronize it? 2. If you were going to sell equipment and supplies to a new entrepreneurial business on credit, what would you want to see from the new

business before selling to them? 3. What small items might aid to your legitimacy as a new business with little cost?

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LO12-5 Explain the importance of production management in start-up ventures.

The Importance of Production Management in Start-Up Ventures Another important element in the success of a new business is the establishment of a production management system.7 A production management system defines the steps that are involved in moving from your product or service offering to the point where you actually receive money. This importance is exaggerated in the early stages of a new business, as the firm has only limited resources, as well as strong time pressures to perform well at the outset. To illustrate, many years ago when inkjet printers were fairly new, we worked with a small group of individuals’ rather simple but interesting plan to refurbish printer cartridges. This was targeted at college students. Their original plan had them handling the vast variety of cartridges on an individual basis. They would simply deal with each cartridge as it came in and depend upon their individual knowledge and experience to punch the hole in the cartridge, refill the ink, plug the hole, and finally seal up the cartridge for resale. They accepted the fact that they would develop procedures for each type of cartridge but thought that this would develop over time. The process of discovery would allow them to handle a wide variety of cartridges early in the life of the company.

We pointed out to the entrepreneurs that their projections depended upon their handling more than 10,000 cartridges a month by the sixth month of operation, and that an ad hoc system being handled directly by the owners would likely not lead to success. The time wasted as each cartridge was treated as a unique order would simply be unwieldy in a very short time period. As a result, they employed a mechanical engineer who developed a very simple set of procedures with fixed equipment to handle the most common types of cartridges. For these stations with fixed equipment, they employed individuals to process the most common cartridges. For all other cartridges they maintained a job shop section to develop procedures and process those cartridges. Over the next eight months, they developed a production management system and methodology that allowed them to dramatically cut costs. On more than one occasion the entrepreneurs have commented to us that more time spent prior to startup in developing a process would have resulted in enormous financial dividends to the owners. The production system developed post-hoc was expensive and resulted in many lost opportunities.

It is important to emphasize that all businesses have production systems, whether or not they are codified. All service and Internet businesses have preferred ways of dealing with items such as customers, paperwork, orders, and services. These constitute the foundation of a production system. Putting together a production management system to handle the most common and expected routines will ensure consistent handling and enable the employees to focus their energy on the other, unusual aspects of the job.

While this topic is quite complex and is its own field of study, we discuss the two most important elements to production management as they relate to entrepreneurial business. These are production charting and quality.

How Production Charting Is Accomplished There are many established software programs available for new business owners to help them establish the production processes they will use in their firms. To emphasize the importance of such methods, entrepreneurs need only look to franchises. The text will discuss franchises in greater detail in Chapter 14. Here we simply point out that one of the reasons that franchises are so successful is that they have well-established methods of operation. The franchisors have prepared these methods for the franchisees in a plan detailing each step that occurs in the production process and when each step is to occur. This type of exercise is enormously helpful for all new entrepreneurial businesses.

LO12-6 Explain how production charting is accomplished.

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This level of detailed understanding about a firm’s production typically comes from a production chart. You will recall that at the beginning of this chapter, we discussed a critical path chart. A production chart is similar; however, rather than focusing on the founding of the business, this chart details each step that must occur within the production process. It takes the reader step by step through the processes necessary to provide the customer with the finished product. It starts with the order being received and finishes with the final delivery to the customer. The production chart is similar to the critical path chart in that some steps in the production process can occur simultaneously while others must occur concurrently. In presenting this chart, we have chosen a slightly different format from the traditional one used in most textbooks. Most textbooks focus on established company production processes and have many items occurring concurrently; however, we have found that new firms have limited personnel and the processes are more sequential. The process detailed in the production chart in Figure 12.2 is very simple: production of a plaque from a trophy shop.

Even for early-stage ventures, the production chart can become complex quite quickly. Imagine the difficulty in producing meals from a menu that may have 25 different entrées with different vegetable selections. How does the restaurant assure that all of the items are produced so that those that take longer are started sooner, those that take less time are started later, and all items are finalized at approximately the same time and are delivered to the table when they are at their peak? Now add in complexities such as appearance, appetizers, salads, and drinks. The production chart for a business that appears quite simple can, in fact, be quite complex.

As noted, all businesses have a production process. It is easy to recognize such a process in a manufacturing setting. To illustrate, even a retail firm has a production process. Goods come into the store and then are counted, tagged, stocked, sold, detagged, and bagged, or if not sold moved to the discount area. If firms do not have a detailed understanding of the methods needed for these basic processes, it is quite easy to end up creating bottlenecks and procedures that negatively impact both customers and employees. One business that we got to know was in a tourist area and it catered to the tourist trade. To save money the owner decided to use a dial-up telephone line for credit card transactions. As compared to a dedicated high-speed line, this choice meant an additional 45 seconds per transaction, and dialing delays and busy signals were a common problem. Complaints continued to rise, and the owner noticed more and more people either walking out of the store or deciding, upon looking at the checkout line, to go elsewhere. As a result, the entrepreneur chose to move to a dedicated line for credit card transactions. At the same time, he changed his required procedure that each item purchased be recorded in a ledger by the cash register, as that process was slow and cumbersome. At some expense he moved to a bar code system to improve the throughput of customers. The dedicated high-speed Internet line and the bar code system were both more expensive, but once the owner realized the negative impact on his production process of not having them, the rationale for each became quite obvious. If the entrepreneur had thought through their retailing business as a production process, they likely could have avoided the problems. They would have been able to put in place the changes as they built the stores, since they would have seen the impact on time and sales more clearly early.

production chart

A chart that provides a detailed understanding of a firm’s production process.

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Figure 12.2 Production Chart

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In a similar vein, we once dealt with a clothing retailer who did not have a clear understanding of the store’s current process, nor what processes should be in place. The owner would bring all goods in at cost and continue to carry all unsold items in inventory at their original cost. The predictable result was an ever-growing percentage of the store being consumed by obsolete stock, and this eventually led to failure, as the firm ended up with a storeroom and retail space full of goods that appeared on paper to be quite valuable, but were in fact items that had little or no market value. The firm’s bank eventually figured out the ever growing stock of valueless materials and employed the clauses in the line of credit that allowed the bank to cut the credit line of the firm to virtually nothing. This cash crunch resulted in an inability to place orders for goods the store needed in the upcoming year, and the store eventually closed. There is no universally “correct” way to deal with the issue of obsolete stock; however, it is necessary to establish a procedure for handling such stock. The procedure should be aggressive and recognize that there is little to no value in holding onto obsolete inventory, even if its cost was significant.

There are many established production management systems that operate on any computer available to new business owners. If you are starting a business that is part of an established industry, then you should talk to others in the industry regarding the popular packages for the management of your business processes. Starting one from scratch is a waste of time and money. A little effort investigating the industry should provide tremendous positives for the organization.

The Importance of Quality as a Competitive Tool Another important consideration in all aspects of a business venture is the investment in quality. In the recent past, designing quality into your product or service was a means to differentiate an entrepreneurial business from the larger mass-market businesses. Increasingly, however, quality is an assumed standard whether the entrepreneurial business is in manufacturing or is a service business. Individuals have to look no farther than fast-food restaurants. For illustration purposes, look at a franchise such as McDonald’s. It sells a number of products for $1.00, has playgrounds for kids, maintains clean tables and restrooms, and even puts a toy in a meal for children. The playgrounds are expansive and expensive, while the food quality is guaranteed across the spectrum of all McDonald’s restaurants. It is a tremendous value for a very small price, and each store opens with the full complement of offerings. If a new business is to compete against McDonald’s, it will have to have a similar quality and quantity of offerings to be successful. Therefore, new businesses need to be clear about the expectations for quality in whatever business they pursue.

One of the keys to successfully delivering quality is the monitoring and measuring systems put into place by the founders. Dr. W. Edwards Deming is considered the father of the quality movement in the United States. One of his arguments is that quality needs to be constantly and consistently improved. Thus, there needs to be a continuous set of measures for each of the various processes of the organization. Without recorded data, it is impossible to judge the performance of the processes that have been put in place by the owners.

LO12-7 Describe the importance of quality as a competitive tool.

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Deming went much further and argued that while the organization should set goals for quality in the organization, these goals are not to drive every action. If a firm focuses only on those goals, the firm might make short-term decisions that were detrimental to the overall direction of the company. To illustrate, a firm may have a target for on-time delivery that it is striving to improve upon. Although this is an admirable goal, and perhaps even a point of differentiation in the industry, if the firm gets so wrapped up in on-time delivery that this becomes the only focus of the organization, the firm can easily miss other critical issues, such as delivering the correct item. Delivering the wrong item on time would result in great statistical success (concerning timing, at least) but would destroy value in the firm.8

Deming strongly suggests that the firm be guided by what he calls the “scientific method.” In this method, rather than changing lots of things at the same time, the firm should change only one thing at a time, measuring the impact of that change. It is through this systematic method that a firm knows if it is moving in the right direction and also knows the true impact of each change.

Additionally, Deming suggests that rather than focusing strictly on obtaining the lowest prices for supplies, firms should focus on the quality of the inputs. He argues that without quality inputs, the output has no chance to be high quality. To illustrate, there was a large privately held, relatively large bakery in Oklahoma that used 12 different types of flour. The owners shopped by price, so there were actually as many as 15 different suppliers they used at different points in time. The result was that the firm would use inputs that met the formal requirements for the flour, but each had slight differences in their characteristics, such as moisture content. These differences were very small, but they still led inexorably to differences in the baking processes. Thus, each time a new supplier’s product was employed, the owner of the firm found that her workers had to test and adjust the production process. After years of handling this situation, the owner followed the advice of a close friend who simply recommended that the bakery employ one supplier who would guarantee the quality standard. Saving the constant testing and product waste would more than make up for any additional expense. It is this type of realization that has moved firms to focus on forming strategic alliances, where firms join together to form long-term, mutually beneficial relationships. Firms, both large and small, now seek to establish a reasonable price for their inputs and then seek out a long-term relationship with a supplier that can meet that price and supply a consistent, high-quality product. A consistent input helps the firm produce a consistent output.

The Type and Condition of Equipment Needed at Start-Up Acquiring the initial equipment for a business can be a daunting task. The basic equipment can easily be one of the most expensive elements for a new business. Clearly, a small manufacturer that needs to purchase specialized equipment will have a higher initial outlay when compared to a service business. Yet even an entrepreneurial business such as an Internet business can incur significant expenses for equipment as computers and related items are purchased. Businesses with even greater equipment needs, such as a restaurant, need to accurately evaluate the equipment needs while at the same time recognize that there is a wide flexibility in the types, ages, methods of acquisition, and availability of all equipment obtained for the new organization. Purchasing new equipment may guarantee that it is the most current available and that it will be delivered directly to the new business; however, it is usually the most expensive method, and delays may be significant if the items are not in stock. Purchasing older equipment has its own risks with quality and availability but should always be investigated. It is relatively common for new equipment to depreciate 50 percent or more in the first year. Similarly, it is possible to lease equipment. The ability to lease the equipment is particularly attractive to new firms as it has the lowest initial costs. However, over the long run, such leasing can prove expensive.

strategic alliances

The joining together of firms to form long-term, mutually beneficial relationships.

LO12-8 Discuss the type and condition of equipment needed at start-up.

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Therefore, the new business owner needs to clearly understand what equipment is needed, how long it will be before it will need to be replaced, and what are the long-term impacts of the decision. This understanding should also include both what equipment is needed to begin operations and how quickly the company might need more or even bigger equipment. The new business owner should then prepare a chart comparing the price and the positives and negatives of buying new, buying used, or leasing that equipment. The positives and negatives should include not only the immediate cost and the ability to overcome the cash flow crunch that impacts all new businesses, but also the impact on the firm’s quality, and the long-term impact if the entrepreneurial business grows.

In the early days of the business development, Chris wanted to show his potential customers and suppliers that he was serious about the business and that he expected to be there for a long period of time\u2014to establish his legitimacy. He knew from his conversations with other bar and restaurant owners that the first six months were critical to his success. However, he also knew that since that first six months would decide if he would survive, many suppliers would not provide goods at favorable terms, and would not trust him until they were sure he would be in business for a long period of time.

Chris was well established with the local home brewers, but he had virtually no relationships with the suppliers in the industry. This situation was even more critical because he was going into a location in which previous restaurants had regularly failed. Thus, his suppliers might fear he would follow the same path. Chris knew he would still need to buy several hundred thousand dollars’ worth of equipment if he bought it new. He had the benefit of having some used equipment, which he could buy cheaply, but there was still the issue of beer brewing equipment, supplies, and food suppliers. Chris estimated he would need more than $100,000 to obtain the necessary equipment and supplies for the first month of operation. If he could get favorable terms rather than pay cash up front on the equipment, then his initial capital requirements would be significantly different and help him with his cash flow.

Chris decided to seek out his personal and family friends that could perhaps help him build relationships with his key suppliers. He found in his home brewing club that one of his friend’s brother was a senior executive in a U.S.-based brewing equipment company that he had hoped to use. He could have sought out far cheaper Chinese-made brewing equipment, but he wanted the higher-quality equipment. The introduction of the brother to the firm was just what Chris needed. Interestingly, the brewing equipment company was looking to expand more aggressively; knowing that Chris was a serious prospect led them to make him a great deal on the equipment. Chris then tried the same approach with his food suppliers. This time he found a family friend who worked for a large regional food supplier. The food supplier was not as willing to arrange as much credit as the brewing company had been, but Chris thought it was manageable. Thus, Chris’s effort to build legitimacy with the key suppliers was largely successful.

1. If Chris had not been able to connect to the supplier, what else could he have done to cut his costs of operation start- up?

2. Chris had equipment in the kitchen from the prior business. Should he have tried to replace that? 3. In your business can you think of ways to cut your start-up operational costs?

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How Timing Is a Competitive Advantage It is interesting to note that choosing when to start a business is an important operational element. The temptation for most new businesses is to start their operations as soon as possible. This is rarely an effective strategy. Instead, the potential entrepreneur should select the time to enter the market based on when it provides the greatest competitive advantage.9 The timing of your start is a function of several factors: (1) the general environment, (2) competitor moves, (3) cycles in purchasing/supply patterns, and (4) lifestyle issues.

The general economy moves in cycles of boom, slowdown, recession (or the many other terms that are used as euphemisms for this term), growth, and boom. Although the general rule might be that you should open your business during or at the beginning of a boom, the reality is that different businesses depend on different conditions. A foreclosure business depends on poor economic times, and storage facilities do best when the economy is heading downward, among others.

Competitor moves may also dictate the opening of a new business. If your business plan is dependent on having no direct competitors within a specified radius of your operation, a move by another business may accelerate or dramatically alter your plans. Alternatively, the failure of several similar businesses may suggest an alteration of your opening or strategic positioning prior to your actually opening the business.

Some (we might suggest most) businesses have cycles for their purchasing. Some suppliers have production runs that are scheduled a year or more in advance. Your ability to obtain critical supplies may dictate your lead time and opening time. It can be difficult, for example, to obtain significant Christmas inventory in September. The shipping time for these goods and other factors typically requires that a retailer make decisions much earlier.

An entrepreneur that we advised some years ago had a significant issue with the supply of wooden tubes that were needed for its production. The sole supplier of this particular size and quality of wooden tubes had a production run of eight weeks in March/April of each year for that particular product. All orders had to be in place by January. This new business reoriented its entire opening and operation around the acquisition of these wooden tubes. The owners placed an order in January, took delivery in three batches between April and June (storing all of the tubes in a warehouse that they leased), and began production of their product in November. Their first sale was in February of the following year, by which time they had placed yet another order for the following year. The ability of the new business to understand these timing issues required extensive planning and forecasting, without which it would have failed.

The Issues Related to Time Management in the Starting of a New Business The last item is one that is meant to help the new business owners as they seek to manage this wide variety of operations. It is clear from the discussion provided here that the business owners will need to manage their own time efficiently if they are to be successful.10 There are several steps that are helpful in this process.

LO12-9 Explain how timing is a competitive advantage.

LO12-10 Recognize the issues related to time management in the starting of a new business.

1. Write down what has to be accomplished in all parts of the business formation.

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2. Prioritize which tasks are critical and which would be helpful. Those that are critical must be done and should be the priority.

3. Segment items in terms of the time frame they need to be accomplished\u2014short term and long term. The short-term items that are critical have to take priority. The fires that are burning have to be put out before the longer-term issues approach.

4. Allocate time that is strictly for dealing with operational issues. The more you become involved in establishing the business and its operations, the more individuals will wish to visit with you about the business. Even though some of these individuals will be helpful, many simply wish to sell you something you do not need or to find out what you are doing. As your agenda becomes filled you must ensure that your attention is not diverted to nonproductive activities. This does not mean you should not be flexible when opportunities arise, but it does mean that you must have a clear vision of your work goals.

5. Write tasks down and mark them off when you accomplish them. As your agenda becomes more complex, you will gain satisfaction from seeing things being removed from it. However, this method also ensures that you will not forget key items (there should be a strong tie back to your critical path chart). In writing these things down, it is best if you can do this in a systematic, organized manner. Keep a notebook or use a PDA every day to see what you must accomplish and take notes about it. This approach can also be a valuable resource for keeping notes about meetings, issues that hit you as you think about the business, and issues that others raise with you. From these items and other information, you can keep track of issues to do today, this week, this month, and so forth.

SUMMARY There is a wide variety of operational issues that must be considered as the new business begins operations. These include (1) developing a critical path chart; (2) establishing a location; (3) financing considerations; (4) legitimacy; (5) production management; (6) production charting; (7) quality; (8) equipment; (9) timing; and finally, (10) time management. Each is important to the start-up of a new business, and with proper planning and implementation, these various activities can substantially improve the opportunity for success.

KEY TERMS anchor stores critical path chart legitimacy production chart strategic alliances strip shopping center

REVIEW QUESTIONS 1. Why is a critical path chart useful to potential investors? 2. Are all locations equal? 3. What elements should be considered when leasing a new business location? 4. What would you recommend that a new business do to improve its acceptance and legitimacy in the market? 5. Why is a detailed chart of how business operations are conducted important to the new business? 6. How can quality be built into any product or service? 7. Should all new companies open as soon as they are physically ready? Why or why not? 8. Explain some key time management techniques that will benefit any new entrepreneur.

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BUSINESS PLAN DEVELOPMENT QUESTIONS 1. What elements would you include in a critical path chart for your proposed business? How would you

ensure that your estimates were accurate? 2. What is the potential locations for your business? Evaluate the different locations and pick one that is the most

attractive. 3. What criteria are critical for the location decision of your new business? 4. What are the specific ways you plan to build legitimacy for your business?

INDIVIDUAL EXERCISES 1. What are the “lease or buy” equipment issues you will face in your business? 2. Can you employ used, or will you need new equipment in your business? 3. What is the difference in price of new and used equipment in your proposed business? 4. What are the critical timing issues involved in your business?

GROUP EXERCISES 1. Establish a plan to address each of the critical issues related to the starting of operations for a new organization. 2. Imagine that your team has decided to franchise the business idea. Develop a set of processes/procedures that would

allow a third party to become a franchise of your operation. 3. Present your operational plan to the class and ask for feedback.

ENDNOTES 1. A. Gunasekaran, L. Forker, and B. Kobu, “Improving Operations Performance in a Small Company: A Case Study,”

International Journal of Operations & Production Management 20, no. 3/4 (2000), pp. 316–36. 2. F. Levy, G. Thompson, and J. Weist, “The ABCs of the Critical Path Method,” Harvard Business Review 41, no. 5

(1963) pp. 98–109. 3. K. Jensen and G. Pompelli, “Manufacturing Site Location Preference of Small Agribusiness Firms,” Journal of Small

Business Management 40 (2002), pp. 204–19. 4. A. Bouma, C. Durham, and L. Meunier-Goddik, “Start-Up and Operating Costs for Artisan Cheese Companies,”

Journal of Dairy Science 97 (2014), pp. 3964–72. 5. D. Shepard and A. Zacharakis, “A New Venture’s Cognitive Legitimacy: An Assessment by Customers,” Journal of

Small Business Management 41 (2003), pp. 148–68. 6. B. Nagy, J. Pollack, M. Rutherford, and F. Lohrke, “The Influence of Entrepreneurs Credentials and Impression

Management Behaviors on Perceptions of New Venture Legitimacy,” Entrepreneurship Theory & Practice 36 (2012), pp. 941–55.

7. K. Papke-Shields, M. Malhotra, and V. Grover, “Strategic Manufacturing Planning Systems and Their Linkage to Planning System Success,” Decision Sciences 33 (2002), pp. 1–30.

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