A crash course in managerial economics

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Common wisdom says that on any business venture, you set a stop limit. That is, pick a number and — if you can’t get profitable by the time you spend that amount of money — stop and move onto something else.

But suppose you hit that number and then see that you need only a small amount of money to turn the corner. Do you invest it and keep going, or look back at all you have spent and call it a day?

And then, suppose you spend that small amount and still need more. Now you’ve invested a huge amount, but it is sunk. Do you keep spending, or stop?

This is a key question for any web-based venture you may have, and happens to be one I am facing now with a venture.

My conclusion is to keep going, but to get very good at honing in on results.

Managerial economics is the field that asks these kinds of questions.

As I recall, a key principle in this field is that you start where you are, regardless of sunk costs. If you’ve spent lots of money already, that money is gone. So you need to look at additional costs from where you are, and determine what kind of return you can get by going forward. So if you’ve spent $50,000, and need $1,000 to make $5,000, you still spend the $1,000 (unless you can make more with another investment). You do this even if you can’t get back the $50K you’ve already blown.

The problem though is that you can lose your shirt with this kind of thinking, by continuously believing that only a little more will get you where you need to be. So, if you subscribe to this way of thinking, you have to be VERY good at knowing exactly how much more money you need to earn a return. Otherwise, you become like a drug addict looking for “just one more hit.”

In my venture, we are still at the point of spending money to learn about what works best. We keep honing in, which also means we have to keep spending. So for us, we are making a leap of faith that many might consider foolish.

Interesting stuff, no? I’d like to hear from you about how you decide when to call it a day, and when to keep going.

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  • Anonymous

    Mr. Neitlich,

    I’m an 18-year-old starting a Web development business.

    I’m having trouble deciding how much to charge for a Web site. While firms might charge $4,500, I don’t think that I could – maybe not even $1,000 due to my age.

    What would you recommend this young entrepreneur do to base his pricing?

    Thank you for your great advice and encouragement over the past year!

  • http://www.circle.co.nz nzgfxguru

    Interesting subject Andrew.

    I am a follower of the Demming Wheel: Plan, Do, Check, Action.

    Following my principles in your above example it would be difficult to know when to stop.

    I also employ one more aspect to the Demming Wheel, and that is to use mentoring to speed or help the entire process.

    To conclude, I would see that I am reaching breaking point, I have been taking action to remedy the problems, I have used mentoring…I then go to my last resort, which is knowledge of failing 9 times to succeed once.

  • http://www.eleytech.com beley

    I think each situation is different, but you have to weigh a lot of factors. First, if you put more money into the project will it cause a serious financial burden for your business or your familiy. If not, and the project is something you believe in, go for it. Losing a little money for something you believe in is well worth it – especially if it has potential to become something big.

    But, there are a lot of people who hang on to businesses when they should just give up. When you can’t pay the bills and you’re borrowing from Peter to pay Paul, just get out. I’ve been here before and it’s not a place you want to be. In this case, even if the business idea is viable you won’t make it. You’re in too deep.

    The best thing to do in a situation like this is to get out, get back on track and then take an objective look back at the project/business to see what went wrong. If you can’t pinpoint exactly what went wrong, don’t dare try again. However, if you can pinpoint the mistakes you made, and have an action plan for the future, you could give it another try.

    And remember, there are a lot of factors outside your control. Timing is everything in business and if a project doesn’t work now, that doesn’t mean it won’t work later.

  • mhdoc

    I think knowing when to call it quits is perhaps the most difficult business decision there is. Good things happen unexpectedly, you meet a deadline by hours etc. The temptation to hang on can be overwhelming. I called it quits when I filed the chapter 7; which was not the optimal way to do things :)

  • http://www.lopsica.com BerislavLopac

    To Anonymous: Your age should have nothing to do with what you charge. If you are good at what you do, feel free to charge as much as you can get by. If you suck at it, you’ll probably have to charge less or find another business.

    But if you suck because you are young, don’t go into your own business. Try to find a job with a similar firm to learn the tricks of the trade, and when you have more experience and confidence strike out on your own.

  • http://www.SitePoint.com Matt Mickiewicz

    For an interesting perspective of “stop limits”, read Bob Parsons story about his early struggles with GoDaddy on his blog – BobParsons.com …

  • http://www.interactwebsites.com kwallenbeck

    Right where I am at with our current venture. Only invested a small amount, but even with much research there sits the question. Will this thing really work? I tend to be more of a realist as I get older. Our ‘bench mark’ at this point has been to identify how the successful competition is getting customers online. Take that knowledge and put into practice what we’ve learned from others and our own experiences. Then put together the best kickin site we can. Will it be successful?

    Not sure yet. Do I realistically think it will be successful? We’ve got the ‘success factors’ identified and addressed. Time will tell.

  • drakke

    Following the last comment by ‘kwallenbeck’, why not research the track record of previous similar ventures and find their metrics. Compare yours to theirs and try to determine what about yours could be improved.

    Also I think building and launching projects is really a business process that is tuned on a running system. When you are continuously creating projects, put them in the ‘field’ and evaluating their performance, you should be tuning your whole project building process. So why not build projects that you can afford to walk away from and gradually progress to the more expensive ones.

  • pdxi

    I’m involved in a great number of projects, the most important of which I call “life” :)

    To me, my business is my life. I am doing what I’ve wanted to do since I can remember. There is no “giving in” for me – I work as hard as necessary to get what I need.

    This doesn’t really apply to corporations, but since I /am/ my own company (and vice versa), this is very important to me.