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The Kozmo Trap

What small businesses can learn from a dot-com debacle.

A Kozmo.com messenger makes his rounds February 11, 2000 in downtown New York City.
A Kozmo.com messenger makes his rounds Feb. 11, 2000, in downtown New York City.

Photograph by Chris Hondros/Newsmakers.

It was an Internet start-up with a million-dollar idea: delivery of nearly any product you could want, sent to your home in one hour or less. Between the time it began operations in March 1998 and the time it filed SEC papers for an initial public offering two years later, the company raised $232.3 million, opened operations in six markets, and built partnerships with Starbucks and Amazon.com. The company even considered opening in Hong Kong.

If you recall the story of Kozmo.com, you know the IPO never happened. By 2001, Kozmo had closed up shop in nine American cities and laid off all of its 1,100 employees without notice. One of the most notorious flameouts of the dot-com bubble, the company is remembered mainly as a cautionary tale about investing in companies that have little chance of ever turning a profit. But there’s a sequel to the Kozmo story that shows that its business model needn’t have been doomed. What felled the company was not its concept, but the way it grew.

The business model had some big holes, to be sure. The company had no minimum purchase requirement and catered to customers who expected free delivery for whatever their craving of the moment was. I was one of those customers. One of my typical teenage orders would be a rental copy of NBA Showtime for (the original) Sony PlayStation, a pint of Ben & Jerry’s Phish Food, and maybe a DVD like Major League II, for a total price of $15. The delivery on that order cost me nothing, but it cost Kozmo $10.

“That was actually a decent order,” former Kozmo Chief Technology Officer Chris Siragusa tells me. “There were people who would literally order one candy bar.” By the time the company realized its model was a money-loser, it was too late. Customers had grown accustomed to getting something for nothing, and they left in droves when Kozmo tried implementing a $10 delivery fee. When it was still relatively small in 1998, the site lost only $813,000. One year later it lost $26.4 million on $3.5 million in revenue.

In the definitive “Kozmo.com is dying” magazine piece in September 2000, the New Yorker’s James Surowiecki wrote: “In the haze of the New Economy, what investors cared about was how many customers a company had, and not how much they cost.” So what seemed like a world-beating concept turned into a fiasco, emblematic of a brief digital gilded age when venture capitalists showered any company with a “.com” in its name with small fortunes. (Ironically, one of Kozmo’s dying acts was to detach the “.com” from the company name in order to try to remove the stigma.)

Eleven years later, though, there are still lessons in the story of Kozmo and the dot-com bust that are applicable to start-ups today—and not just tech startups. Perfect your business model before you expand. Don’t take on investors who want to see immediate growth before you’re comfortable with the quality of your product. Be patient.

That’s where the sequel comes in. Since regrouping from Kozmo’s crash, Siragusa has been quietly applying those lessons to his own small business, Max Delivery. The company is essentially the same concept as Kozmo, but with a more sensible pricing scheme and a much smaller scale.

Max Delivery opened in New York City in 2005 with Siragusa promising that he was not going to repeat the mistakes of his old company. Kozmo’s founders had become beholden to venture capitalists who were focused on growth above all else, he said at the time. Siragusa would build his company from the ground up, tinkering with the pricing and delivery structure until he found a model that worked.

By 2008, the company had turned a profit delivering groceries, wine, specialty foods, DVDs, drug store items, and other “must-haves” to Lower Manhattan customers in under an hour. By 2010, it was the 86th-ranked retail company on Inc. Magazine’s annual list of the country’s fastest-growing businesses, with $4.1 million in revenue and a 180 percent three-year growth rate.

Max Delivery and its 70 employees just celebrated the company’s seventh birthday, which means it has already lasted more than twice as long as Kozmo. More importantly, Siragusa says his business is still profitable—though he wouldn’t give new revenue numbers—and is finally ready to expand. The tweaks that he made to the Kozmo idea were relatively small ones that the old business could have tried had it not expanded so much, so quickly. Max Delivery tinkered with its price structure for years, until it settled on $2.95 for deliveries under $50 with a minimum purchase of $20 and free delivery for purchases over $50.

Professor Andrew Zacharakis, the author of five books on entrepreneurship and former chair of the entrepreneurship program at Babson College, says that by taking a slow approach, Siragusa seems to be doing it right this time. Small businesses sometimes get caught in the trap of thinking they can fix weaknesses in their cost or revenue structures as they expand, but it’s a rare company that can pull off such a feat—think Facebook or Amazon. “Growing is all-encompassing,” Zacharakis said. “It takes up all of your time, and staying on top of the current business at the same time is a Herculean task.”

Siragusa spent the first five years his business was in operation making a series of seemingly minor innovations in an effort to refine its model. In order to compete with similar services from larger companies like Fresh Direct and Food Emporium, he did not want to rely solely on superior delivery time (the other services do next-day delivery during a two-hour window, rather than one-hour same-day delivery). Max Delivery also had to make sure its service was comprehensive enough to offer most of what its major competitors offered and competitive enough pricewise to offer an affordable alternative to local supermarkets. This meant constantly playing with the product list.

In order to improve customer service and cut costs, Max Delivery started using an instant-messenger service to handle customer complaints. The normal wait time is just 10 to 15 seconds, Siragusa says. When I contacted the company via the IM service, I was chatting with a very helpful person named Jane almost immediately. To further differentiate the business, Siragusa built partnerships with popular local specialty stores like Murray’s Cheese, the Pickle Guys, and Jacques Torres Chocolates.

Because it has spent so much time working on customer service, Siragusa says that a large chunk of the company’s customers come through word of mouth. Out of its 65 Yelp reviews, Max Delivery has an average of four and a half stars and plenty of five-star raves (“MaxDelivery has improved life in NYC for me by at least 20 percent,” “Oh, maxDelivery, how I love thee. Let me count the ways,” “This is just another reason I could never live uptown,” etc.).

Siragusa has long harbored expansion plans, and he says he’s finally ready to make his move: The company is negotiating to purchase real estate for a second location covering the Upper West Side and Midtown. Eventually, after the second store opens, he’s planning on a third location to cover the Upper East Side, before opening up shop in Brooklyn. Only then does he plan to follow Kozmo’s path to Boston; Washington, D.C.; San Francisco; and Chicago.

The slow-go approach that is working for Siragusa applies to more than just online retailers. Professor Ari Ginsberg, the director of the Stern School of Business’s center for entrepreneurial studies, says service companies also often fall into the overexpansion trap. The classic example is People Express, the original low-cost airline, which grew wildly between its birth in 1981 and its absorption by Continental in 1987. The company’s CEO, Don Burr, focused exclusively on growth, and People Express was soon flying to 50 destinations. But it outgrew its infrastructure—there were not enough personnel to answer phones, and they couldn’t train flight attendants fast enough—so the quality of the service suffered.

By 1986, People Express had lost $58 million in a single quarter and was $500 million in debt. “[Burr] knew the jig was up when his mother called and said she was flying a different airline,” Ginsberg says. JetBlue nearly suffered a similar fate after expanding too quickly in the mid-2000s. “This is a vicious cycle,” he says, adding that once customers are turned off because they don’t get the service and quality they expect, it becomes much harder to get them back.

If you slow down and take the time to perfect your model, then it will be easier to raise capital when the time finally does come to expand. Expand without a proven business model, however, and you’ll probably lose money, Babson’s Zacharakis says—“and you’re likely to lose money forever.” Or at least until you go bust.

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