Startups That Overlook the Cost of Sales … Fail! How much did that sale cost? What about the reorder? Until you know that you don't know if you're making money.
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You often see line items on business plans for the cost of goods sold, also known as COGS. Most startups are painfully aware of the cost of goods, but there is another cost that is even more painful if it's overlooked, and that is the cost of sales.
In today's "scale fast and fail fast" world of entrepreneurship, it's easy to scale fast and fail permanently when you don't appreciate the true cost of sales. Part of the problem of scaling fast is that you can scale so fast that you actually make sales you can't sustain.
Why? Because you inadvertently chose to make sales to a customer or in a territory with costs you can't afford. But you didn't know those costs when you made those sales. In fact, you were probably thrilled to make any sales and couldn't wait to get back to your investors with the news!
We serve as advisers to several startups throughout the country. They all have great products that have the potential to disrupt their industries. They typically want to raise the money to scale fast. We feel obligated to warn them about scaling too fast. We encourage them to start out slow, make their mistakes in a small place, and starting out, don't sell any further from their home than they can drive and apologize in one day.
Related: How to Calculate Gross Profit
When we started Barefoot Wine, we thought, "Ya know, Hawaii's a natural for this product. Everybody's running around barefoot. The beaches are covered with bare foot prints. And it seemed like half the bars are called "Barefoot.'" So we shipped our product off to Hawaii looking for the low hanging mangoes. And sure enough we found them! All of the retail accounts we presented it to took it. They said it was perfect for their recreational lifestyle. We were thrilled!
But a month went by, and then two, and then three …with no reorders! So we hopped on a plane back to Hawaii and visited the accounts we'd sold -- and couldn't find any Barefoot. When we asked the retailers why, they said, "Oh yeah, Barefoot. That was a hot mover! It sold through!" …as if to say they were through with it.
Then we got a big wake-up call on the true cost of sales. It turns out they didn't reorder because our own distributor in Hawaii had an incentive to sell another brand. So, they were glad Barefoot was sold out. It gave them a place to put the other brand and collect the incentive. The idea that we would have to police our sales, oversee our distributors and visit the stores on a regular basis in order to stay in those stores never crossed our mind -- and never entered our budget!
The cost of sales is something you find out by actually making the sale and then trying to sustain the sale. We found, for instance, that we had to pull out of Hawaii for two years until we could afford to put our own full-time rep in the islands.
As we began to grow we realized that our experience in Hawaii was the harbinger of things to come. We realized that we had to have a representative in every major metropolitan area where we sold our products - just to keep them in the stores, let alone make the first sale. This was an expensive proposition. We had to pay salaries, expenses, provide samples, do regular in-store demos, and promote our brand in the local communities to create the customers that would come in to those stores and buy our products.