This morning I helped counsel aspiring entrepreneurs through SCORE, a non-profit group that offers free advice to folks looking to startup businesses. During those conversations, I kept returning to two essential questions:
1. Can you do this profitably? (Unit economics.)
2. How can you do this now? (Bootstrapping.)
These questions are vital to assessing a business venture's potential and getting it started. The first is somewhat theoretic--it addresses how the business could work; the second is much more practical--it addresses how the business will work. We often conflate the two and confuse ourselves, so treating them separately is vital to assessing an opportunity well: once you've established the opportunity is really profitable, you can build a plan to capture that profit.
Can you do this profitably?
Start with the sale and build a model of 'unit economics.' What are you selling? In what increment does the customer buy it? What does it cost to make each one? What costs are incurred for each sale? This kind of analysis seeks whether each sale is worth doing, aside from other and ongoing costs.
How profitable is each sale?
While simplistic, the following calculation is essential for building a profitable business. Every business can be reduced to these terms, no matter how complex.
Start with: amount customer pays you
Subtract: costs to make each unit
Subtract: costs to deliver and/or install each unit
Subtract: costs that you incur in order to make the sale
Result: profit you make every time you sell one unit
How many sales do I need to make?
This part is what people skip and what makes many ventures fail. This isn't 'how cheap can we be during startup?', this is 'what will this thing require when it's actually working?' We need to figure out whether this thing can work. After proving the sale works, we add this first order of complexity to the business: fixed costs. These costs will be necessary regardless of whether the business sells anything. It may need rented space, customer service personnel, marketing expenses, insurance, and a whole host of other things. Even if it's a startup, I'd include salaries for the founders and necessary staff. While no one may actually draw a salary during startup, we're trying to figure out if the business has legs--and no one will work for free forever.
Total fixed costs / profit per unit = units we need to sell to break even.
Can we get to breakeven? What will we need to invest? Can we feasibly recoup that investment?
These questions open up a pandora's box of projections and assumptions. The goal may be to build an awesome cash flow projection to convince a bank or investor to fund your business. If so, fancy math and predictions are required. I prefer to keep this simple. Identify the actual market you could reach--not 1% of anything, the people you can really sell to. Figure out if you have the cash to fund yourself during startup, and if there is a potential to make significant money down the road.
The next major question comes in from here: if the opportunity looks good so far, what can you do to make it happen and capture the potential profit.
[I'll cover that next, in my tome on 'bootstrapping.]