The research and work needed to really analyze a business idea can take a lot of time. For that reason, it is a good idea to do a “first glance” look. A first glance requires very little research and can help determine if the idea is worth taking time to perform a lengthier, more detailed analysis that should be included in your business plan. This first glance look is referred to as a high-level analysis because it represents only the tip of the iceberg, a simple easy way to determine if your idea makes good business sense. Later you will dig deep with lots of research.
Here are several questions that need to be considered when doing a high-level analysis:
- Will there be customers who need, desire, and will pay for the product or service?
- How many customers are there?
- What price will customers be willing to pay?
- How can I reach the potential customers?
- How much revenue would the idea generate if every potential customer purchased the idea?
- What portion of potential customers are you expecting to attract?
- Will this be a fad or will there be a need for the business long-term?
- What will it cost to develop and produce the product or service?
- What will it cost to sustain the company employees, equipment, operations, etc.?
- Will the business profit (revenue minus costs) be high enough to make it worthwhile?
Although these questions seem simple, you should give them a lot of thought and discuss these concepts with your mentor. People who start their own businesses are often overly optimistic about their chances. Answering these questions can help you see the idea in a more realistic light and obtain input from others. The following example will help you practice analyzing a business idea.
Case Study
Here is a short example to illustrate how important your idea vetting process should be. Roberta is thinking about opening a bookstore in the city of Fairview. A quick search online showed her that Fairview has a population of 26,000 people made up of 8,000 households. The city consists of 10 square miles. The average income in Fairview is $60,000, with 5% of the population below the poverty line. There are no colleges in Fairview, but there is one vocational school, one senior high school, two junior high schools, and eight elementary schools.
Most stores in Fairview are located on or near Main Street. The town has a medium-sized library that hosts a book club. The only bookstore in town sells used books; however, there are several large bookstores in Riverview, a larger town 15 miles north of Fairview, but the larger bookstores have no plans to open stores in Fairview. Roberta is worried about competition from online bookstores.
Roberta has found a retail location on Main Street about 2 miles east of the freeway on-ramp. The rent would be $1,400 per month with utilities costing around $400 per month. Roberta figures that she will need 7 part-time employees who would work 20 hours a week each and be paid $12 per hour (about $7280 per month).
She thinks it will take $60,000 to buy all the books that she will need before opening, along with the cash register, bookshelves, and decorations. Although she hasn’t called any banks yet, she has read that the average business loan charges 8% interest over 10 years. Using an online loan calculator, she figured that the monthly payments would be $727.97.
Roberta imagines her customers to be individuals and families who earn at least $35,000 per year, and plans to have large children and teen sections in her store for families with children in school. She assumes that the bookstore will be open 8 hours a day, 6 days a week, and that she will get an average of 4 customers an hour who will spend $20 each giving her total revenue of $16,640 per month. She will price the books at double the wholesale cost that she pays.
Roberta currently works as an editor at the Riverview Inquirer (the nearest newspaper) where she earns $50,000 per year ($4,166 per month). She would like to earn an income from the business similar to what she earns at her current job.
Try it Out
Now use the example of Roberta’s bookstore to do a high-level analysis of your business idea. A first glance requires very little research and can help determine if the idea is worth taking the time to perform a lengthier, more detailed analysis to be included in your business plan.
Revenue Sources
Companies often sell more than one product or offer more than one service. Many companies offer both products and services. Here are some examples: Heating and air conditioning companies offer two basic products: heating systems and cooling systems. For each product they also offer two basic services: installation and repair/maintenance.
Many websites are built with the purpose of selling a single product, such as a book, video or health product. Grocery stores sell hundreds of products. Tracking each revenue source under one category would not be effective so they separate products in to categories such as: meats, dairy, baked goods, canned goods, produce, etc.
When starting a new business, it is sometimes a good idea to begin by offering only a few products or services and expanding into other products and services as the business grows. It is important to organize a tracking system to help you keep track of where you are making the most sales.
Changes During the Year
Some products sell better during certain times of the year than they do at other times. This is usually referred to as seasonality. Here are some examples of seasonality:
- Toy stores make most of their sales during the winter holidays season.
- The sale of children’s clothing and school supplies rise in the fall just before school starts.
- More camping gear is sold during the warm summer months.
- Heating and air conditioning companies make more air conditioning sales in warm seasons and fewer in cold season. On the other hand, they sell more heating systems during cold seasons and fewer in warm season.
Almost all products and services experience seasonality. It is extremely important that you forecast when your business will make higher sales and when it will make fewer sales. This is so you can save during busy times to cover expenses and costs during times when the business has fewer sales.
As you think of your business’s possible revenue sources, keep in mind of how seasonality could affect them. Will some revenue sources sell well during one season but not another? Is there a way the business could make more money during times when it would usually make fewer sales? You will explore these issues in more depth in future sections.
Expenses and Costs
There’s a popular saying that says “you must spend money to make money.” There is a lot of truth in that saying. Underestimating the cost of doing business can result in unrealistic expectations and a lower income than expected. When evaluating business costs there are two types of costs every business needs to consider: variable costs and fixed costs. We will go in more depth on those cost types below.
Variable Costs
Variable costs are the things you spend money on for each sale. For example, if Harry sold mail-order hats his variable costs would include the cost he spent purchasing the hats, the cost of packaging supplies, and the shipping costs.
Fixed Costs
Fixed costs are the expenses that do not change with each purchase. Businesses pay for fixed costs whether they make a sale or not. Examples of fixed costs include: rent, utilities, and employee wages.