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Should Startups Place Bulk Orders?

Getting discounts often means you have to place a large order with a supplier. Is this a wise move for a new business?
December 6, 2004
URL: http://www.entrepreneur.com/article/74896

Many new business owners face the following dilemma: In order to charge a competitive and reasonable price for products, they have to order in great volume to get a discount. Since they're just beginning their business, how is it possible to buy in such bulk if they're just testing out the market and have limited resources?

For entrepreneurs that sell physical products, the decisions you make on pricing strategy and supplier strategy are critical. Even if your business sells services rather than products, you'll regularly face the dilemma of when to buy in bulk, how to manage your cost structure and how this will impact the price of your service.

Deciding whether your business should buy in bulk isn't as straightforward as deciding whether to shop at Costco for your household. Your business has clients and competitors, while your household does not. If your price isn't competitive, or if product quality isn't satisfactory, your clients can take their business elsewhere-while it's unlikely your kids will pack up and move out if the quality of paper towels doesn't meet their standards.

Startups in unproven markets face an additional complexity when deciding to order in bulk. Established businesses in proven markets are more likely to make supplier decisions based solely on maximizing quality and minimizing cost; whereas if demand for your product is unproven, it's a leap of faith to throw down the cash for a bulk order.

When your startup is faced with the decision of whether to order in bulk, there are several issues to consider:

1. How do you differentiate your product from competitors? If you've decided to position your product as a low-cost alternative to competitors, you have little choice but to reduce your production costs by ordering in bulk. However, startups typically aren't able to enter a market as a low-cost alternative. For example, California-based POM Wonderful recently released bottled pomegranate juice through retail channels and decided to set a $4 to $5 retail price point for their large-size juice bottles. This price point is significantly higher than alternative juice bottles, but they've opted to differentiate their product based primarily on health benefits rather than cost. (Pomegranate juice is good for your heart.) Very few startup companies are able to release products with a cost advantage over established competitors; therefore, ordering in bulk usually doesn't make sense for young companies.

However, if your product is more like orange juice than pomegranate juice, ordering in bulk will often be necessary to compete. If it's difficult to differentiate your product from competitors, and if price is the main driver of consumer purchases in your market, you'll be faced with the dilemma of buying in bulk. Assuming there are hundreds of suppliers of orange juice in retail aisles, a juice maker will need to order oranges in bulk even when starting out.

2. Can you do market research rather than an in-market test? Many entrepreneurs assume that in-market product launches are the only way to test a product. This isn't true. You can sidestep the dilemma of ordering in bulk for an unproven market by focusing on how to prove the market-that is, how to prove to yourself that the size of the market for your product will justify a bulk order. You can cost-effectively gather intelligence on how likely your product is to sell at different price points by speaking to clients and asking them. Armed with good market research, you should feel more confident in placing bulk orders even at the startup stage. For example, if your market research shows that twice as many consumers will buy pomegranate juice if it's priced at $3 per bottle rather than $4 per bottle, then you may decide that you need to order pomegranates in bulk to make the business thrive.

3. How much do you believe in your product? For some entrepreneurs, ordering in bulk is a testament to how much they believe in their product. Andrew Carnegie once famously declared that the way to make money is to put all your eggs in one basket and guard that basket with your life. If you genuinely believe that your product will sell, and that keeping costs and prices down is necessary to make this happen, then ask yourself if you're willing to live dangerously and take the risk of placing a bulk order. I would recommend (and I'm sure Carnegie would agree with me) that you should take this plunge only after some degree of market research validates your belief.

4. Can you find alternatives to buying in bulk? There are some creative ways to realize the cost benefits of buying in bulk without making a substantial financial commitment. Try negotiating with your bulk supplier to extend the duration of your order-with termination provisions added to the contract that allow you to cancel the order the future. Since your supplier's salespeople may be paid with quarterly volume bonuses, they may agree to termination clauses more readily than they would lower volume orders. For example, try ordering three years' worth of supply rather than a one-year supply, but be sure to spread out the payments over the life of the contract and add in an enforceable termination clause. If you believe in your product and your enthusiasm is contagious, your suppliers will be more likely to agree to such terms and share in the risk of your product's success. I'm always amazed how much easier it is to negotiate termination clauses than cost discounts for small orders.

Some bulk suppliers also have excess inventory that they'll sell in partial shipments for bulk-level prices. Try calling suppliers at the end of the month and at the end of the season to capitalize on these deals. It never hurts to ask!

Finally, it's worth investigating whether your industry offers a buying club. Much like Costco does for households, buying clubs aggregate the spending power of several small-business buyers in the form of an association, co-op or membership-based club. For example, in some states, startups can purchase employee health insurance for corporate-level rates by joining small-business cooperatives. Self-employed independent contractors can purchase health insurance and other services by joining organizations like Working Today . Buying clubs and industry associations have historically been more common in manufacturing industries rather than services industries, but they've recently grown in popularity due to the internet and e-mail user groups.