Friday, July 6, 2012

Budgeting Under Uncertainty

imageThis article was written by Mike Capsuto, SCORE Orange County Management Counselor

Budgets are an important business planning tool. They manage costs and help foresee problems. Developing a budget is a time consuming tasks filled with risks from uncertainties especially when predicting future sales and costs. However, forsaking such a task has one making important business decisions based on little quantitative knowledge of the risks involved.

Assessing the risk requires using a simple statistical function and basic math. The function, known as the BETA distribution, has been used by engineers and planners to evaluate the risks based on uncertain predictions. This distribution gives a statistical estimate of the expected value and the range of possible high and low values. Its simplicity derives from requiring only three thought out numbers – the most likely, the most optimistic and the most pessimistic values. The formulas are simple:

Expected value = (most pessimistic value + 4*most likely value + most optimistic value)/6.

Standard deviation = +/- (most optimistic value – most pessimistic value)/6

Before we apply the function some definitions are in order:

Inputs

Most likely value: This is what you would expect the sales or cost would be.

Most optimistic value: In terms of cost this is the minimum expected cost. In terms of sales this represents the maximum expected sales given a good economy and minimum competition.

Most pessimistic value: This is the opposite of most optimistic. Cost will be based on the highest expected cost. Sales will be based on a poor economy and maximum competition.

Note: The difference in cost or sales between the most pessimistic and most likely should be greater than the difference between the most optimistic and most likely since it is easier that things go wrong than go right.

Outputs

Expected value: The expected value is a calculation that serves as the best prediction of the most likely outcome.

Standard deviation: It is not sufficient to know just the “expected value”. It is also important to know how much spread exists plus or minus from the expected value. The standard deviation is a measure of this spread. One standard deviation indicates that there is a 68 % probability that the high and low values are within the extremes of the spread. Alternatively there is a 32% probability that the high and low values are greater than the extremes. Two standard deviations indicate a 95% probability the high and low values are within the extremes of the spread. A low value for the standard deviation indicates that the extreme values tends to be very close to the mean, whereas high standard deviation indicates that the values are spread over a large range of values.

Now that we have an understanding of the definitions, let us look at an example.

Jan H. owns a small local gourmet bakery. Her products range from cookies to custom made cakes. To satisfy the current health craze she developed a gluten-free, lactose-free chocolate cake. Taste tests by her customers were very favorable and many indicated they would buy it and are willing to pay $7.00.

Jan is uncertain as to the number of these cakes that can be sold. She expects that sales would be 30 per month. But it can go as high as 40 or as low as 10. Another uncertainty is the cost of ingredients and labor. Presently the cost is $3.50 and can drop to $3.00 as more ingredients become available or can increase to $4.50 if the external market demand for the ingredients becomes greater. For competitive reasons she is afraid to change the selling price from $7.00. How should she plan?

First, let’s look at sales. Using the BETA distribution the expected, highest and lowest sales can be determined.

Expected sales = (10+4*30+40)/6

Expected sales = 28.3 cakes.

The standard deviation = +/- (40-10)/6

The standard deviation =+/- 5.0

The standard deviation indicates that there is a 68% probability that the sales of her new cake will be between 23.3 (28.3-5.0) and 33.3 (28.3+5.0) with expected sales at 28.3. "At two standard deviations" means that the sales would be 18.3 (28.3-10) and 38.3 (28.3+10). Jan decides to use the one standard deviation for her analysis.

Now the ingredient cost.

Expected cost = ($4.50+4*$3.50+$3.00)/6

Expected cost = $3.58

The standard deviation = ($4.50-$3.00)/6

The standard deviation = +/- $0.25

The ingredients will have a 68% probability of costing between $3.28 ($3.58-$0.25) and $3.78 ($3.58+$0.25).

How can Jan H. use these numbers to establish her budget?

Jan should develop at three budgets to determine her gross profit from the new product– the expected (expected sales times the expected ingredient cost), the most optimistic case (the expected highest sales times the lowest cost), and the most pessimistic case (the lowest sales times the highest ingredient cost) as shown below:

    Expected   Optimistic   Pessimistic
       Case       Case      Case
Sales            
Number of Cakes Sold:    28.3     33.3     23.3 
Selling Price:   $7.00   $7.00   $7.00
Gross Sales:   $198.10   $233.10   $163.30
             
Cost            
Number of Cakes Sold:    28.3     33.3     23.3 
Cost to produce:   $3.58   $3.28   $3.78
Total Cost:   $92.83   $109.23   $88.05
             
Profit            
Gross Sales:   $198.10   $233.10   $163.30
Total Cost to Produce;    92.83     109.23     88.05 
             
Gross Profit   $105.27   $123.87   $75.25

By not using the BETA distribution Jan H. might decide to produce the cakes based on her original estimate of 30 cakes per month. She now knows that there is a good chance that only 23.3 cakes could be sold with a profit of $75.25. Jan H. must decide if this is sufficient profit. If Jan decides to proceed she now knows that sales need to increase. This can be accomplished by advertising, giving samples to customers or notifying local doctors and allergist of her new healthy product.

As seen from the bakery example, the BETA distribution is a very simplistic yet a powerful tool. It can be used in many business situations to asses risk when there is uncertainty. If the business is viable under the most pessimistic situation, it has a good chance of future success. If not, as Jan did, one now knows what steps need to be taken.

How to Stand Out Among Bigger Brands on Google

This article was written by AJ Kumar, in Entrepreneur Magazine, July 3, 2012, reprinted by permission

Google loves big brand names, and for good reason. But that doesn't mean smaller companies don't stand a chance when it comes to search engine optimization (SEO).

In regard to natural search results, the better the results Google can deliver, the more people will use its service. To provide the best possible results, Google tries to identify website elements that provide quantifiable proof that users find a given site valuable, as well as to refine its ranking algorithms to ensure that these factors are prioritized. Website branding falls into this category because users tend to trust and engage more with website brands they know than with lesser-known competitors.

Spend time on any SEO news website and you'll likely find dozens of articles about how difficult the world's largest search engine is making it for small-time webmasters to compete with the big brand boys. But instead of bemoaning the fact that bigger brands seem to receive advantageous treatment in natural search results, follow these three tips to harness the power of branding for your own site:

1. Develop your visual brand.
Just because your website only has a handful of pages doesn't mean you can't create a strong brand. Not only will developing your own distinctive brand pay off when it comes to SEO, it can also be an effective way to generate business. Consumers are still wary of handing out personal and financial information to potentially unscrupulous sites, but recognizable brands tend to put them at ease, making them more likely to convert into buyers or subscribers for your business.

Think about the elements that you associate with well-known brands, such as discount retailer Target. The company has:

·An easily recognizable logo

·A consistent color scheme across its web and offline properties

·Consistent marketing messages, taglines and slogans

Related: Google's 10-Minute Guide to SEO Basics

None of these factors is out of your reach, no matter how small your business. Setting up a consistent color scheme, for example, can be as simple as choosing a couple of colors that you feel reflect your company's personality and then splashing them across your website.

Once you've chosen colors, find a qualified designer to create a distinctive logo. While traditional graphic designers typically charge $500 or more for logo creation, a number of freelance designers might do the job for $100 or less.

Creating compelling marketing messages may take some time, but once you settle on some, you can easily incorporate them into different areas of your website. Encompass your brand's primary features and benefits in as few words as possible. That can help increase the chances that your audience will remember the message and associate your brand with it.

2. Add branded keywords to your site's SEO.
Because search engines rely on your site's SEO to determine what it's about, make sure your branded keywords are incorporated into your website's content alongside your target keyword phrases. Branded keywords include words that are unique to your company ("Zappos shoe sale," for example), while traditional SEO keywords target phrases consumers enter into search engines ("women's sandals, size 9," for example).

One effective place to include your branded keywords is your title tag, using the following structure:

<head><title>Traditional SEO Target Keyword Used Naturally | Brand Name </title></head>

Related: 5 Tips for Making Your Website More Social

Keep your title tags to a maximum of 62 characters to ensure that your branded keywords aren't cut off by the search engine spiders. Don't "keyword stuff" your title tag with a series of unconnected traditional keywords. Instead, make sure your title tag reads naturally and provides valuable information to your readers. Then, add your branded keywords after a pipe symbol (|) to begin to build search engine recognition for the brand name you've created.

3. Behave more like bigger brands.
Try to think like a bigger company and make your branding as pervasive as possible. For example, do you think that Target would send out an email newsletter without formatting that mimics the branding elements on its website?

In general, the more places you can incorporate your brand signals, the better. As you integrate these symbols across your web properties, you should see better visitor engagement and increased trust with your consumers.

Additionally, Google will likely continue to roll out algorithm updates that reward well-branded websites over their unbranded competitors. Implementing these techniques now could lower your risk of being affected by future search algorithm penalties.

Health Insurance for Small Business Employees

WASHINGTON (AP), Reprinted by Permission

Many small businesses struggle to afford health insurance for their workers, but a new tax credit meant to help them seems to be turning into a disappointment.

Although opinion polls show the credit is one of the most popular ideas in President Barack Obama's health care law, only 170,300 businesses out of a pool of as many as 4 million potentially eligible claimed it in 2010, about 4 percent.

A recent government report found the tax credit time-consuming to apply for and not rewarding enough to be financially attractive.

That's put the Obama administration in the awkward position of asking Congress to help fix the problems by allowing more businesses to qualify and making it simpler to apply. But Republicans who run the House say they want to repeal what they deride as "Obamacare," not fix its flaws.

"They completely missed the target on this thing," Rep. Sam Graves, R-Mo., said of the tax credit. "I don't think expanding it is going to make any difference whatsoever." Graves chairs the House Small Business Committee.

It doesn't help the administration's plea that the biggest small-business lobbying group is a lead plaintiff asking the Supreme Court to overturn the Affordable Care Act. The National Federation of Independent Business isn't likely to spend much time tinkering with the tax credit or promoting it to members.

Small businesses represent the crumbling edge of the nation's system of employer-based health care. Only about 30 percent of companies with fewer than 10 workers offer health coverage and they often pay more for insurance than large businesses. The credit, which once had support from lawmakers of both parties, was supposed to help businesses already providing coverage afford the premiums. Maybe it would even entice some to start.

"We agree it is not a panacea for all costs," said John Arensmeyer, founder of Small Business Majority, an advocacy group that supports the health care law and disagrees with the much larger independent business federation. The problem is all the negative publicity around the health care law has discouraged business owners from applying for the credit, he says.

"There has been more heat than light shone on this," Arensmeyer said. "There is no reason why small businesses shouldn't be taking advantage of this credit." About 770,000 workers were covered by the businesses claiming the credit in 2010.

The administration says word is finally getting out, and it expects the number of companies claiming the credit for 2011 to more than double, reaching 360,000 businesses.

A recent report by Congress' nonpartisan Government Accountability Office identified several problems with the program.

To begin with, the GAO said, the tax credit is structured so its biggest benefits go to very small companies paying low wages. About 4 out of 5 such businesses don't offer coverage, and the tax credit is not sufficient to encourage them to start doing so.

"Small employers do not likely view the credit as a big enough incentive to begin offering health insurance," the report said.

The average credit claimed in 2010 was about $2,700, although some companies qualified for much more.

Many small firms did not qualify because they paid fairly decent wages. The GAO report quoted an unidentified tax preparer who explained that "people get excited that they're eligible and then they do the calculations and it's like the bottom just falls out of it and it's not really there." It's almost a bait and switch.

Stand Out in a Saturated Market

Goldstar.com's Jim McCarthy has the ticket to e-commerce success, from Success Magazine, June, 2012, reprinted by permission

Anything you can think of is already being sold online,” says Jim McCarthy, CEO of Goldstar.com. But that didn’t stop him and his partners, Robert Graff and Rich Webster, from launching the online discount site for event tickets in 2002. What’s the secret to profitability in a vast world of discount online dealers?
“You have to make sure you understand that what you’re bringing to the marketplace is special,” McCarthy says. “And you should never underestimate the difficulty of everything you’re doing as an entrepreneur,” he adds, noting that he and his partners burned lots of shoe leather visiting the human resources departments of large corporations, asking them to send mass e-mails to employees offering half-price event tickets to concerts, comedy clubs, cultural performances and more. Doing so sometimes earned the fledgling company 1,000 new customers a day.
Today Goldstar.com has 2 million members. McCarthy thinks the company owes that success in large part to the fact that they stuck it out. “If you just keep at it, you’ll win out over all the people who don’t,” he says.
Planning and testing go a long way, too, especially when it comes to the highly competitive world of e-commerce. McCarthy says it’s critical to make sure your concept works before you invest loads of cash in it. For Goldstar.com, that meant the three partners did most of the work themselves the first years they were in business. (They started out with only $1,000 in cash.) And they garnered help from friends with the realistic approach of “Hey, this might not work out, but if it does, we’ll share the benefits.”
McCarthy says to be careful of spending loads of money on marketing or hiring employees until you really can afford it. And realize that even if it’s an online business, you may still have to hit the streets to get the word out, targeting corporations that might benefit from your offerings.
And while Goldstar.com predates the concept of the “daily deal” site, McCarthy realizes it’s easy to get thrown on that heap as a discount retailer. As a result, Goldstar.com has distinguished itself not just as a site where members can buy half-price event tickets but as a genuine source of finding something to do. He also says it’s important when running an online business to make the experience hassle-free, to provide superior customer support (and that means responding to customer inquiries in a matter of minutes, not days), and making sure you deliver your product promptly.

Goldstar.com CEO Jim McCarthy’s Tips for Daily Dealing

  • Think promotion, not profit. The reality is you’re using the daily deal site for the sake of promotion, not to make money, because you’ll have to offer your product or service at a deeply discounted rate. The question you must ask yourself is, Will that promotion garner you enough new business to pay for the money you lose offering the daily deal?
  • Control the number of products you offer and the timing of the sales. McCarthy says it’s critical to offer as few products as possible. If you can promote your business selling 400 watches at discount instead of 2,000, then do it. And if you can make the sales during your business’s slow season, do that, too.
  • Negotiate revenue share. Despite what you might have heard about daily deal sites requiring 50 percent revenue share, McCarthy says, “It’s really hard to make a case for 50 percent these days.” He advises negotiating that rate down to 20 percent if you can.