Last summer a local entrepreneur contacted me. He had been reading my blog for years, not realizing we lived in the same town. We had coffee and talked business and he told me his latest business was a furniture store. While I don't remember the exact conversation, I do remember that it went something like this.
Me: Furniture? Why furniture? That doesn't sound too exciting.
Him: Do you know what the margins are on furniture?
Me: Yes, they are pretty good. But still…
Him: Good? They are ridiculous. I can sell way below retail and still make a nice profit.
Me: Awesome. But do you know anything about the business?
Him: I've talked to some guys that do the same thing in other cities.
It was an eye opener for me because I tend to fall into this trap of always wanting to do some new cool thing for a venture. I forget that there is good money to be made in areas that have known business models and high margins.
Since then, the previously mentioned entrepreneur has learned that mattresses in particular are easy and profitable to sell, and has focused in on those. I've always wondered how there could be so many mattress stores around. Now it makes sense.
This startup strategy is more common that you might think for two reasons. First, in some industries, costs fall quickly and production gains go primarily to the seller, not the end consumer. Secondly, the businesses have limited geographic scope, so there is ample opportunity to open one up in a new and growing area. By starting something with high margins, you leave room for errors in cost estimation and pricing, which means a mistake on one of those won't kill your business. Also, by embracing a known business model you can learn from the mistakes of others and predict your revenues must more accurately than you can when launching something brand new.
Coffee houses are another popular business that has high margins and a known business model. Even high quality coffee is just pennies a cup. Add a little sugar and flavored syrup and sell it for $2 and you have a nice profit margin.
What do you look for in a high margin business?
1. Something that can take advantage of production gains. Many items used to be labor intensive but are now performed by machines, or are outsourced.
2. The materials of production are cheap. Coffee is mostly water. Mattresses are mostly metal coils and some padding. Sunglasses and toys are mostly plastic.
3. Easy sell. Don't try to sell some strange new thing. Sell something people are already comfortable buying.
Entrepreneurs often look for things like huge market potential, first mover advantage, network effects, etc. But don't ignore the success potential of business ideas that are simple to run and make a lot of money. It is a great first step on the ladder of entrepreneurship.