“Everyone has a plan — until they get punched in the face.” These words of wisdom from boxer Mike Tyson begin a new book titled, Fundamentals for Founders: The Practical Guide to Kick-Starting Your Business.  As co-authors Peter Burchhardt and Dan Hou note, starting a business from scratch is an adventure led by passion, inspiration and innovation. However, like any adventure, startups hold plenty of surprises, and not necessarily all good ones.


It doesn’t have to be that way. In Fundamentals for Founders, Burchhardt and Hou, who have founded a number of businesses in the U.S. and China over the past decade, walk budding entrepreneurs through what they see as the building blocks for a successful startup. Those include lessons on how to conduct market and competitor research, design user-friendly products, use marketing techniques like online advertising and search-engine optimization, as well as craft a financial model to show how much cash the startup needs along the way and which parts of the business will drive profitability.


“With certain guidelines and notions in mind, you can greatly reduce the possibility of falling into some of the pitfalls and reach your goals more efficiently,” explains Burchhardt in a recent interview with China Knowledge at Wharton.


The two authors — former Wharton classmates — have been involved in startups ever since their first university project ten years ago. With a love for bringing ideas from the drawing board to market, their ventures have since included developing a successful business plan for a wireless networking product and launching a file-sharing network company and other small businesses, including one that sells educational games for children.


In their book, the authors “focused on the very beginning phase of a startup, [when] people have an idea and would like to figure out how they can build a business around it,” says Burchhardt. “We wanted to share our combined knowledge and experience, as well as insight from our friends and other entrepreneurs and investors.”


Below is an edited transcript of the interview with Burchardt, who talks about the freedom that comes with starting a business and provides advice for budding entrepreneurs.


China Knowledge at Wharton: Let’s start with your career path. You worked at Microsoft before becoming a full-time entrepreneur. What drove you to make that change and what are the main differences between now and your corporate life back then?


Burchhardt: I wanted to enjoy a greater variety of challenges, have end-to-end responsibility for a business and build equity. Instead of renting my time out for a salary, the goal was to reap an income that wasn’t necessarily proportional to the amount of time I spent working. Another important consideration for me was to enjoy the freedom to go anywhere at any time. That’s mostly a function of me doing relatively scalable businesses, which means I no longer have much of a schedule that requires me to be in certain places at certain times.


China Knowledge at Wharton: What are the most interesting and challenging parts about starting your own business?


Burchhardt: What’s most interesting is the wide range of problems I need to solve. Some are strategic in nature; others are very social, like building and motivating a team; and others involve creativity or engineering skills, like designing products that users will love and building an efficient supply chain. I love how, no matter what the task is, my partners and I have a burning drive to get things done quickly. In orders of magnitude, we’re more productive working in startups than back in larger companies.


[Getting] the right founding team [in place] can be one of the most difficult challenges. It’s a little bit like finding the right girl to marry. You meet someone and there’s mutual attraction at first, then you spend time understanding the softer qualities, like how you handle conflict and how your interests, skill sets and personalities complement each other. And just like with finding a life partner, timing is important. Are they able to devote themselves fully to your new venture or do they have other commitments tying them up? The analogy continues: Strife between partners in a company can be as disastrous as a divorce. Those are some of the reasons why venture capitalists often say they invest primarily in teams, not just in ideas.


China Knowledge at Wharton: Your book covers many Internet and software-related examples. Are traditional businesses also included in the book?


Burchhardt: Our book may appear quite technical because we go into depth about online marketing and working with outsourced designers and engineers, though those tools apply to most traditional businesses as well. For example, I coached readers of our book on language-learning businesses, educational travel and even clothing retail. They all plan to use the Internet as a way to acquire customers, so they’ll all build websites, try online advertising and do search-engine optimization. None of the founders have technical backgrounds, but that’s OK. As long as they can clearly define requirements from an end-user’s perspective, they can let the engineering team handle the implementation details.


China Knowledge at Wharton: Does that mean the founders should have some tech background?


Burchhardt: Given how easy outsourcing has become in the past few years, it’s less important for founders to have technical backgrounds for the company to make effective use of the Internet as a sales and promotional tool. Founders with tech knowledge are only a must if the main product or service is technical in nature and will require several versions. That’s because working only with outsourced engineers makes it difficult to build a product that’s maintainable for several iterations. Also, since it often takes an expert to identify another expert, technical founders are more likely to make better choices in selecting and directing an engineering team.


China Knowledge at Wharton: You spend a significant part of the chapter on marketing discussing online marketing, especially search engines. Do you see search engines as an increasingly important way to market products?


Burchhardt: Yes, most businesses will find some ways to use the Internet to acquire customers. Online advertising is powerful because it can be very scalable and measurable. You can start with a small budget, measure results, then iterate and optimize. Compared to offline media, that makes online advertising especially suitable for startups because you have far greater control and visibility over how you spend your ad budget. In addition, there’s a trend toward increasing control over how [online] ads can target different types of users. Going forward, advertisers will be able to specify even more granular target criteria, increasing the effectiveness and then the price of those ads. Facebook and LinkedIn are at the forefront here, allowing users to be targeted by not just detailed demographics, but also interests and work history.


There are, of course, plenty of businesses for which online advertising isn’t suitable, ultimately because their per-sale profits aren’t high enough to cover their customer acquisition costs. It depends primarily on the rate at which the business converts visitors into paying customers and the cost per click of advertisements. That conversion rate can be quite low in markets where users aren’t able or willing to pay online, or where it’s difficult to establish sufficient trust only through a website. Similarly, there are markets in which advertisers have bid up the price of advertising to such high levels that it’s no longer profitable for others. In our book, we describe ways in which entrepreneurs can set up simple tests to estimate the chances of the combination of costs and conversion rate being above certain thresholds to make online advertising profitable.


China Knowledge at Wharton: In terms of financial models, what are the most important lessons that entrepreneurs should take away?


Burchhardt: We regularly meet entrepreneurs who don’t have a clear picture of their financial model and therefore make bad decisions by spending their time researching or optimizing parts of their business that don’t significantly influence profitability. Our first important [piece of advice]: Build a financial model and keep it up to date. Use it to understand which variables have the biggest influence on your bottom line, then calculate which thresholds the values need to exceed in order for you to be profitable. Consider setting up experiments to validate your assumptions for those critical values before investing further in the business. Focus less on the accuracy of the predictions, but more on checking the likelihood of the values exceeding the thresholds.


China Knowledge at Wharton: What are the major factors contributing to a startup’s success or failure? And what are the human traits needed behind the scenes?


Burchhardt: It depends a lot on the industry. Businesses with “network effects,” like community-based websites, may benefit directly from a well-timed wave of PR. For others, the quality or level of innovation of their product may matter more, and yet others see their success start with winning a flagship customer early on, which then lets them start a cycle of referrals and build credibility. However, regardless of the industry, most of these factors are ultimately a function of the quality of the founding team. The founders’ personal networks are key to winning the first customers and finding a pool of excellent people to recruit.


Some common human traits to successful founders are independent problem-solving skills and the ability to attract and motivate great people. Founders will need to perform many different roles themselves, from CEO to administrative assistant, so they’ll face plenty of problems they’ve never seen before yet will need to solve quickly. At the same time, they’ll have to attract employees or co-founders, and each person’s decision whether to join will depend a lot on the personality of the founder.


China Knowledge at Wharton: Do you think your book will be as valuable for entrepreneurs in China as in the West? What are the major differences in starting a business in China and in the U.S. or Europe?


Burchhardt: There are plenty of universal concepts for founding companies that apply in China as much as anywhere else. For example, the principles of product design, building for scale and modeling finances are just as relevant. That said, one major difference between Chinese and Western startups is [the West’s] willingness to outsource. The Chinese are used to inexpensive labor, which leads many startups to do work in-house without giving much consideration to outsourcing. That may be in part because outsourcing has a reputation for being used for global wage arbitrage…. Clearly, the benefit is reduced in China.


But possibly an even greater benefit of outsourcing is its ability to fill skill gaps quickly and cost effectively. Rather than investing in finding employees and committing to keeping them long term, outsourcing enables companies to find worldwide experts for each task, pay for performance and hire them only for the specific projects as needed. In many cases, that turns a fixed cost into a variable cost and can deliver better quality faster and at lower costs. In our book, we cover how to use marketplaces like elance.com to outsource projects to specialists around the world.


The online advertising market in China is also quite different from its Western counterparts. The principles are the same, but the execution can be quite different, such as optimizing for Baidu versus Google. Also, online advertising in China can be relatively cheap. There are huge and growing inventories of ad slots to be sold. China already has the largest Internet user base with more than 300 million users, yet that’s still less than 25% penetration compared to 75% in the U.S., meaning there’s lot of growth still to come. Meanwhile, there’s relatively little advertising competition online. I just saw a Nielson report saying only 3% of 2008 advertising budgets in China were spent online, compared with 12% in the U.S. That’s partly because of a general difficulty to monetize traffic, caused by a combination of factors such as low average incomes, low credit card penetration rates combined with “friction” costs to pay with a bank card, as well as a high willingness to seek pirated content.

My key takeaway: In this challenge there is also an opportunity. It means that buying traffic is cheap, which can give a great ROI for online marketers who’ve found a way to monetize their traffic.