The Retail Aspiration

If you haven't had a chance yet, go and check out a video that Goulet Pens released last week which featured an interview between Brian Goulet and the co-founders of Nock Co, Brad Dowdy and Jeff Bruckwicki. It's an interesting look inside a growing business and, as the video was recorded a few months before it was released, viewers end up with some context around comments which were (intentionally) vague in the video. There's plenty of insights for the curious, but the one which struck me was that both the Nock guys seemed keen on transitioning to retail. For today's post, we'll have a look at the economics behind such a transition and why it's not more common.

For startup manufacturers, having a retail store seems to be a common aspiration. I'm sure part of this is because it's good for a business to have one-on-one interaction with customers: to see how customers use and react to features, determine whether prices are appropriate, and to learn about comparable products. Of course, direct interaction with customers also delivers a massive morale boost when you get to put your product directly into someone's hands and see the excitement on their face. I can only imagine how good that feeling is!

While there's some sound commercial motivations, my instinct is that this isn't the main driver of the retail aspiration. The desire seems more visceral and instinctive – it's not driven by costs and benefits but a deeper need to do it – and I'm not sure where that comes from. Maybe startup manufacturers just wanted to be in retail all along but couldn't find products they would be proud to sell; maybe it's a purely social desire (after all, manufacturing without direct customer contact must feel awfully isolated); or maybe it's a sense that a manufacturer with a retail presence has made it. Having your own retail store, selling your own product, is clear evidence of a manufacturing startup's success.

This aspiration has to be squared with the fact that few of these startups end up with stores of their own. In our community, the vast majority of pen, ink, and stationery manufacturers channel their products through independent retailers. A minority of manufacturers have their own retail website and a select few have flagship stores, but these are definitely the exception rather than the rule.

So it seems like lots of manufacturers want to go down this path but few actually commit and execute, and it's not obvious why this is so. As an economist, this is exactly the kind of puzzle which interests me. But for businesses like Nock, thinking through this puzzle can't just be an exercise in idle curiosity: they need to understand why others have decided not to make the leap or why they've been unsuccessful in doing so. It's going to consume time, energy, money, and every other resource available to them, so it's important to know whether it's going to be a wise move for them, and how they can maximise the chances of success.

Design and Marketing

Startups like Nock come about because they identify an opportunity and build a business around that opportunity. In the Goulet video, Brad and Jeff talk about the opportunity that they spotted: leather pen cases generally had plain designs and were expensive, while the rest of the market was low-quality or high-cost fabric cases that weren't designed with the FP community in mind. Nobody was sitting in the middle of that space, so Brad and Jeff decided to fill it.

In building Nock to fill that space, a key question would have been defining the boundaries of their business: what things did they want to do in-house and what did they want to outsource? For many people, outsourcing has a bad name, a legacy of corporate layoffs in the 1980s-2000s. But when you're starting a business – particularly a small business – it's really about identifying the activities where you can excel and where it's better to let other businesses do their thing. Lots of support services (like accounting, legal, and logistics) are best outsourced, but the closer a function is to the core of the business, the more difficult it is to outsource.

Let's imagine starting Nock from scratch and explore the decisions around whether certain functions should be internal or external. I've not spoken to the guys at Nock about this, and it's entirely possible that these decisions were tacit, but it's a useful thought experiment to flesh out some of the important factors. In my opinion, the functions at Nock which are closest to the core of their business are probably design, marketing, production, and distribution.

The decision about internal or external design is, effectively, a question about whether Brad would want to partner with Jeff or hire him as a consultant. Outsourcing design would have enabled Brad to keep full control of the business and left him bearing the entire risk of its success (which means keeping all the profits or bearing all the losses). On the other hand, having Jeff as a cofounder means giving up some control and sharing some of the risk but it also means capturing some benefits which aren't necessarily available from outsourcing. As a partner, Jeff's contacts, expertise, and design curiosity become internal to the business and those are obviously valuable assets. It's also harder for Jeff to leave if he's a co-owner: as a consultant, he's free to leave whenever an interesting new project comes up, even if that leaves Nock in a difficult position.

Like any decision, this is a case of weighing up the pros and cons of each option. For me, the key consideration is the ease with which Jeff could have been replaced if he had resigned. By all accounts, it would be near-impossible to replace him if he decided to move on so this strengthens the argument that design should be an internal function. If there were a million Jeffs out there and he was easy to replace, this argument could have gone the other way and Nock would have been a dramatically different business. (But, of course, that's not the case!)

After design, the next function is marketing. The word 'marketing' is often used synonymously with advertising (including by me), and that's an oversimplification. Marketing is really about understanding the market: knowing the customers in the market, what they want, the alternative products they might buy, how much they are willing to pay, etc. Informing the design of a product, ensuring it meets their preferences, is the most important part of marketing. Advertising is the next step: letting customers know that you have something they will (hopefully) appreciate.

With that in mind, the question is whether marketing should be an internal activity for Nock or something which is better outsourced. In other words: should Jeff have partnered with Brad to launch Nock, or just hired him as an external consultant? You'll notice this is basically the same decision Brad had to make about Jeff, just with the roles reversed and a different activity. As Brad's marketing skills are as difficult to replace as Jeff's design skills, it makes sense that marketing is a core, internalised activity for Nock.

At this point, Nock arguably has two of the three elements required for a startup to succeed: there is an identified opportunity in the market and the business has the capabilities – the skills and expertise – which enables them to exploit that opportunity. The third element is execution, which requires the business to be laser-focussed on doing what they do best and not burning resources on things which can be better outsourced. The big question is whether production and distribution are activities best handled inside or outside of Nock.

Production

Things become a little more complicated here, where we consider whether production should be handled internally or outsourced. I believe firms ought to understand their strengths – the things which they are uniquely good at – and focus exclusively on activities where that matters. Everything else is better handled by someone with an advantage in that area.

(Few things frustrate me quite as much as stressed, overworked business owners who insist on doing the accounts personally – despite a complete lack of expertise in that area. They usually argue that it saves money, while ignoring the fact their time could be much more profitably used in growing the business.)

When I look at Nock, neither of the founders stand out as someone whose time is best spent running a production line. In the video, Brad admits that he just breaks things, while Jeff seems like someone who loves design and excels at that. It doesn't make a lot of sense for people with specialist skills to spend their time on other things, even if they are capable of doing those other jobs. Barack Obama is entirely capable of answering his phone and opening the mail, but it's probably better for him to spend his time on the things where he is uniquely placed to make a difference. The same principle applies for business managers or anyone else with valuable specialist skills. In a perfect world, Nock would be a brand that uses its understanding of the community to identify unmet needs and its design skills to develop products that satisfy those needs. Production would be outsourced to a firm which lacks marketing or design chops, but has an obvious gift for manufacturing high-quality, low-cost product.

But this isn't a perfect world and Nock don't outsource production. Brad has previously spoken about one reason for this – the difficulty of finding a manufacturer who can consistently turn out high-quality product – but I think an equally important problem is scale. For all its popularity in our community, Nock is a small manufacturer in the wider world. Specialist manufacturers generally have capacity to handle batches with tens or hundreds of thousands of units, so they're less interested in small-batch manufacturing. Some are willing to do it, but they can't exploit economies of scale and so the unit costs can be prohibitively expensive. For Nock, outsourcing production either means high costs or unreliable quality.

Internal production isn't obviously the better choice. Moving into that activity doesn't leverage the specialist skills which Brad and Jeff bring to the table, so it requires a lot more resources. Time and energy must be devoted to learning the manufacturing process and it can be expensive to move up the learning curve – most learning is through trial-and-error or mistakes, neither of which come free. This also exposes the firms to Samsung-style competition, where firms copy the product and leverage their own production expertise to churn it out at a lower cost.

This leaves Nock in a position where neither option is all that appealing and the co-founders have to choose between the lesser of two evils. They've decided to keep production internal to maintain control over cost and quality, but I suspect this decision would be reconsidered if they found a reliable production partner. (Indeed, if Nock grows to a certain scale it could even make it possible for a manufacturing expert to start a business exclusively producing for Nock. I suspect this would be the optimal outcome for all concerned, combining the cost advantages of production expertise with a commitment to high quality. At some point, Brad and Jeff might even look to divest this part of the business to achieve that outcome.)

Distribution

The final function is the point of this post: whether distribution should be handled internally or externally. There's a broad range of options available – Nock can outsource directly to retailers, or indirectly via a distributor; they can handle it internally through a website, pen shows, or a physical store; or they can choose some combination of the options. That makes it complicated, but the basic question about internal and external remains the same.

This is a different decision than design and marketing because it's unlikely that any retailer or channel will become as indispensable to Nock as each of the founders are (though I imagine Brian G will have a crack at it!). It's also different to the production decision as there's no need for them to control the cost or quality at retail, and it's not a necessity as there are plenty of retailers ready and willing to carry the brand. 

Outsourcing here seems to bring plenty of benefits and relatively few costs. A single distributor for North America means Nock is essentially dealing with a single customer, simplifying almost everything. They buy in bulk and handle all the retail relationships in exchange for a cut of the retail price. Dealing directly with retailers means Nock keeps more of the retail price for themselves, but it also means a lot more work – building and maintaining all of those relationships for themselves, handling many more accounts and smaller, more frequent orders, etc. (Usually the choice between these two options is just determined by the number of retailers involved: at some point, it's cheaper to pay a distributor to deal with them on your behalf.)

Retail, on the other hand, brings relatively little benefit for substantial costs. As I noted at the top of the essay, the main advantages are the direct interaction and feedback with customers – benefits which Nock already captures, to some extent, from Brad's engagement with the community. On the other hand, Nock would have to commit to time and money to learning a whole new business (again) and struggle with yet another learning curve. Running a small shop might seem like a simple business from the outside, the reality is quite different – as anyone who has started a retail shop will tell you.

On top of all this, the reality is that running a brand-specific retail business is extremely challenging. Goulet Pens doesn't carry dozens of brands for fun, it's because that variety helps them to make ends meet and have the business succeed. Despite all their expertise and their reputation, carrying a single brand almost certainly wouldn't be enough for them to survive. It's not clear to me that Nock has some secret weapon that would enable them to do what retail specialists cannot.

On balance, it's hard to see a commercial case for Nock to move into retail. The demands of that move don't seem to align with the strengths of the business or its founders, and outsourcing seems to be an option where the benefits are much greater, and the costs much smaller. Retail isn't a move that would make Nock more agile or competitive, and I find it very hard to believe that this would be the best use of Nock's resources. Surely there are other possibilities for them which could yield a greater return.

Earlier in the post, I noted that Nock has two of the three elements for a startup to be successful. I worry that getting involved in activities like production and distribution will be a distraction and a drain on their resources, something which makes it more difficult for the business to execute. That isn't to say that running a retail store would lead to Nock's demise, but rather that it would impair their ability to grow into what they could become.

Conclusion

I'm not the target market for Nock (plain leather products are my jam) so their decisions about internal and external functions don't affect me personally. But I find them to be an interesting and creative business – a genuinely entrepreneurial startup – and it's exciting to see them grow and what they take on. And while the retail aspiration is understandable, it's hard not to feel that the pursuit of it would be a mistake, a way of growing the business in an unhealthy way that makes it a burden instead of a liberating joy.

Personally, I think it'd be preferable – both for Nock and for the broader community – if the founders shelved the idea of retail and decided to play to their strengths: finding unmet needs and developing innovative products that don't yet exist (but should). That's the thing they can do which most others can't, so it makes sense that this is where their focus should be. I hope that they are successful in their pursuits, that the business continues to be a source of pride and joy, and I'm looking forward to seeing where they go next.

 

Update 

Brad got in touch right after this was published, to say that the outsourcing had already begun. Then I had several other emails in the next hour basically with the same news, and I'm grateful to those who reached out. This post was something I toyed with, in various forms, over several months and so this has been a valuable reminder that I have to keep up the research throughout that process. Cheers!