Evaluating a Business Idea

Evaluating a business idea is a crucial step in determining its potential for success.

By following a systematic approach, entrepreneurs can assess the viability of their ideas, minimize risks, and increase their chances of building a profitable venture.

In this article, we will provide a step-by-step guide on how to evaluate a business idea, covering essential aspects such as idea assessment, customer and market research, startup costs, personal fit, and more.

1. Assess the Viability of the Idea and Define It

Is the business idea a "vitamin" or a "painkiller"?

In other words, does it fulfill a "nice-to-have" desire or does it address a compelling need and alleviate a specific pain point of a major problem?

Keep in mind Sigmund Freud's Pleasure Principle, where the removal of pain drives more action than the promise of pleasure.

Is this a new idea or a new take on an old idea?

Assessing whether the business idea represents a new concept or a fresh perspective on an existing one helps determine its potential for innovation and differentiation in the market.

The concept of "First-mover Advantage" highlights the benefits of being the first to enter a market, capture market share, and establish brand recognition.

The downsides of a completely novel idea is the steep marketing costs required to educate your potential customers on it.

Make a 20 word pitch

Describe the business idea in less than 20 words. In a world where attention spans are shrinking and competition is fierce, the ability to capture attention and convey the essence of the idea quickly is crucial.

This forces the entrepreneur to distill the core value of their idea. This skill not only helps in pitching and networking situations but also in creating effective marketing messages that resonate with the target audience.

Examples

• An on-demand home cleaning service using eco-friendly products.
• A mobile app connecting local artisans with customers seeking unique handmade crafts.
• A subscription-based meal kit delivery service for busy professionals.
• A platform for booking and managing appointments with local beauty and wellness providers.
• An online marketplace for renting outdoor adventure equipment and gear.

Consider potential for adjacent opportunities

By examining related or complementary markets, products, or services, entrepreneurs can identify untapped potential and leverage their existing resources and expertise.

This mindset encourages thinking beyond the immediate scope of the business idea and encourages creativity and innovation. It helps entrepreneurs uncover synergies, partnerships, and new revenue streams that can enhance the overall business proposition.

This strategic thinking aligns with the concept of business ecosystem analysis, where businesses seek to understand the broader landscape and identify potential collaborations and market adjacencies to drive sustainable growth.

2. Understand Your Target Market and Competition

Define your target market and create buyer personas

Conduct comprehensive market research to identify your target market, understand their needs, and analyze your competition.

Use tools like surveys, focus groups, and customer feedback to gather valuable insights. You can read more about it in our detailed article here.

Identify key competitors and understand their strengths and weaknesses

This helps in gaining insights into the competitive landscape and positioning the business effectively. This is sometimes referred to as competitive intelligence. Read more about it in detail here.

Evaluate customers' buying power and the potential for profitability

Consider factors such as average income, disposable income per capita, and income distribution within your target market. Assess whether they're willing and able to pay the price you set.

Validate the idea through consumer feedback and iterate as needed

Gather feedback through polls, leverage AI for validation, create a sign-up landing page, and promote it on social media.

If the feedback indicates poor reception, be prepared to iterate or consider exploring a fresh idea.

3. Analyze the Market Landscape

Determine the Size of the Target Market and Estimate the Number of Potential Buyers

By understanding the market size, entrepreneurs can assess the market's attractiveness and make informed choices about resource allocation and growth strategies.

Assess the Market's Growth Rate, or Contraction, and Trends

By analyzing historical data and industry reports entrepreneurs can gain insights into the market's performance and forecast its future trajectory.

This assessment helps identify whether the market is expanding, contracting, or experiencing stability, which directly impacts the potential success of the business idea.

It also enables entrepreneurs to identify emerging trends, such as technological advancements, shifting consumer preferences, or regulatory changes, which can be leveraged to gain a competitive advantage.

By staying informed about the market's growth and trends, entrepreneurs can make informed decisions and adapt their strategies accordingly.

Analyze Barriers to Entry and Potential Threats

Barriers to entry refer to the obstacles that new entrants face when trying to enter a particular market. These barriers can include factors such as:

• High capital requirements
• Strong brand loyalty among existing customers
• Complex regulatory requirements
• The network effect
• Exclusive distribution agreements

By understanding and evaluating these barriers, entrepreneurs can assess the level of difficulty in entering the market and determine if their business idea can overcome them.

Additionally, identifying potential threats is essential to anticipate challenges that may arise in the competitive landscape. This includes:

• Analyzing direct competitors
• Substitute products or services
• Disruptive technologies that could pose a threat to the success of the business idea
• Government regulation

By conducting a comprehensive analysis of potential threats, entrepreneurs can develop strategies to mitigate risks and differentiate themselves in the market.

Furthermore, analyzing barriers to entry and potential threats aligns with the Industrial Organization Theory, which examines how market structures and competitive forces influence industry performance.

Evaluate the Intensity of Competition

Assessing the intensity of competition involves analyzing the number of existing competitors, their market share, and their competitive advantages.

This evaluation helps entrepreneurs understand the level of competition they will face and identify opportunities to differentiate their business.

It is crucial to examine factors such as product differentiation, pricing strategies, customer loyalty, legal battles, constant acquisitions, and barriers to entry that contribute to the competitive landscape.

What’s Its Potential Longevity in the Market?

Is the product or service riding a trend or is it here for the long haul? Which of these sounds more like appropriate description:

1. It will withstand changing trends, economic factors, and government regulations
2. It will leverage the present market conditions for a brief time before pivoting or closing shop

Develop a Unique Selling Proposition (USP) That Sets Your Idea Apart

Competitive strategy is about being different. It means deliberately choosing a different set of activities to deliver a unique mix of value.
- Michael Porter, renowned economist and professor at Harvard Business School.

It should communicate why customers should choose your offering over others, highlighting its unique features, value, or positioning. A well-crafted USP not only grabs attention but also helps build brand identity and customer loyalty. It should focus on the unique benefits or advantages that are difficult for competitors to replicate.

Remember the principle of differentiation from marketing theory, which highlights the importance of standing out in the market by offering something distinct and valuable. You can read more in depth about it in Marketing Success Through Differentiation; a Harvard Business Review article from 1980 that still applies!

Case Examples

What success looks like: Tesla recognized the growing demand for electric vehicles and positioned itself as a leader in the industry. By focusing on sustainability and innovative technology, Tesla tapped into a market need for eco-friendly transportation solutions.

What failure looks like: Webvan, an online grocery delivery company, faced challenges with its complex logistics system and overestimated customer demand. They incurred massive costs in building infrastructure, leading to bankruptcy.

4. Evaluate Startup Costs and Financial Viability

Calculate the cost per unit or subscriber

To calculate the cost per unit, you need to consider the Cost of Goods Sold (COGS).

COGS includes the costs directly tied to the production process, such as raw materials, direct labor, and manufacturing overhead.

To calculate the COGS per unit, add up all the costs directly related to production and divide it by the total number of units produced.

It allows you to evaluate the efficiency of your production processes, identify areas for cost reduction or optimization, and ensure that your pricing aligns with your desired profit margins.

Bear in mind the Law of Diminishing Returns affects the cost per unit calculation. As you increase production output, there may be a point where the additional cost incurred for each unit produced begins to outweigh the benefits. Understanding this principle helps you optimize production levels and find the balance between maximizing output and managing costs effectively.

For calculating the cost per subscriber, you'll need to evaluate the expenses related to acquiring and retaining customers.

This includes:

• Customer Acquisition Costs (CAC). To calculate CAC, divide the total cost of acquiring customers (including marketing campaigns, advertising expenses, sales team salaries, etc.) by the number of new customers acquired within a specific time period.
• Customer Retention Costs (CRC). While the traditional term used in business is Customer Acquisition Cost (CAC), there isn't a widely recognized metric specifically called CRC. However, businesses often calculate metrics related to customer retention to understand the costs associated with retaining existing customers as they're much cheaper than acquiring a new customer. To calculate CRC, divide the the total cost to keep customers (customer support staff and marketing and ad campaigns directed at existing customers like loyalty programs or discounts, and account management, onboarding materials, etc.) by total active customers.
• Any costs relating directly to the operation of the service itself.

Now divide the total costs by the number of subscribers to determine the true cost per subscriber.

Identify the necessary resources, equipment, and personnel, and estimate their costs

It's crucial to figure out if your idea requires 1 person or 30. If it's 30, are they working from home or in an office? If it's an office, what will they need? If from home, how will you effectively manage them?

Determine the scope of your operations and the specific roles required to run the business effectively. Consider the skills, expertise, and experience needed for each role and evaluate whether it can be handled by existing team members or requires hiring new talent.

Outline the equipment and technology necessary to support your operations, whether it's office infrastructure, machinery, software, or tools. Research the market to determine the cost of acquiring or leasing the required equipment.

Develop a loose financial plan for your burn rate and runway

Most startups burn money for a time. Some for only a very short time. But many for a longer period of time. During that period of cash consumption, it is critical to keep a close eye on cash balance and burn rate and cash out date.
- Fred Wilson, co-founder of Union Square Ventures

Generally speaking, a company will not be operating at a profit on its first day or first year. Creating a financial plan that includes your burn rate and runway is essential to navigate this turbulent time.

Burn rate measures the rate at which a business is spending its cash reserves or losing money on a monthly basis.

If you completed the previous step (identify the necessary resources, equipment, and personnel, and estimate their costs), you're already halfway done.

Burn rate helps entrepreneurs understand their cash outflow and plan their runway accordingly. Here's how to calculate it:

1. Determine the time period: Decide on the time frame for which you want to calculate the burn rate (e.g., monthly, quarterly, or annually).
2. Calculate total expenses: Add up all the operating expenses incurred during the chosen time period. This includes salaries, rent, utilities, marketing expenses, cost of goods sold (COGS), and any other relevant costs.
3. Adjust for non-cash expenses: Exclude any non-cash expenses like depreciation or amortization from the total expenses calculation.
4. Divide total expenses by the time period: Divide the total expenses by the chosen time period to get the average monthly burn rate.

Example: If your business had total expenses of $50,000 in a month, the burn rate would be $50,000 per month.

Calculating runway refers to determining the length of time a business can sustain its operations with the available financial resources before running out of funds.

To calculate runway:

1. Determine your current cash balance: Take stock of the cash and cash equivalents available to your business.
2. Estimate monthly burn rate: (see previous step)
3. Divide cash balance by monthly burn rate: Divide the cash balance by the monthly burn rate to get the number of months your business can sustain its operations without additional funding.

Example: If your business has $100,000 in cash and your average monthly expenses are $10,000, your runway would be 10 months ($100,000 divided by $10,000).

Explore realistic funding sources

When seeking funding for your business, consider diverse sources like bootstrapping, angel investors, venture capital, crowdfunding, SBA loans, and grants.

Each option has unique benefits and considerations. Strive for a balanced funding strategy to reduce dependence on a single source.

You can read more about exploring funding sources in our article on it here.

5. Assess Personal Fit and Capability

Determine your passion and enthusiasm for the idea

Success is not the key to happiness. Happiness is the key to success. If you love what you are doing, you will be successful.
- Albert Schweitzer, philosopher and Nobel laureate.

Reflect on how the idea resonates with your values, interests, and long-term goals. Passion fuels perseverance and drives the entrepreneurial journey.

Ask yourself if you're willing to dedicate significant time and effort to turn the idea into reality.

Passionate founders are more likely to inspire and lead their teams effectively.

Evaluate your skills and capabilities to execute the business idea successfully

Without proper self-evaluation, failure is inevitable.
- John Wooden

Evaluate your skills and capabilities to ensure you can successfully execute the business idea.

Identify areas where you excel and can leverage your personal strengths to drive the venture forward. The concept of "Core Competencies" emphasizes focusing on what you do best to gain a competitive advantage.

However, if you lack certain skills, consider partnering with individuals who complement your strengths and fill any gaps. Collaborating with others can enhance the overall skill set and increase the likelihood of success.

Remember, successful execution requires a combination of self-awareness, leveraging strengths, and seeking strategic partnerships.

Consider the opportunity costs of you pursuing this idea

"Opportunity Cost" is an economic concept which highlights the value of the next best alternative forgone. Consider the opportunity costs of pursuing this idea over another by evaluating the potential benefits and drawbacks:

1. Assess the trade-offs in terms of time, resources, and foregone alternatives.
2. Determine which idea aligns best with your goals and has the highest potential for long-term success.
3. Seek insights from experienced entrepreneurs and advisors to make an informed decision.

Case Examples

What success looks like: Steve Jobs. He co-founded Apple and led the company with his passion, vision, and relentless pursuit of excellence. His personal dedication and commitment to innovation played a significant role in Apple's success.

What failure looks like: Theranos. The healthcare technology company faced major issues when its founder, Elizabeth Holmes, was unable to deliver on the company's promises and misled investors and consumers. This lack of personal capability and integrity led to the downfall of the company.

In Brief

Evaluating a business idea involves a comprehensive assessment of its viability, market potential, financial aspects, and personal fit. By following a systematic approach entrepreneurs can mitigate risks and increase the chances of building a successful and sustainable business.

Related Articles

Defining a Target Market and Buyer Personas

Defining the target market and creating buyer personas is a crucial step in assessing the viability of a business idea. It involves identifying and understanding the specific group of customers that the business intends to serve. “The aim of marketing is to know and understand the customer so well…

STRATEGIST.IOEdward Zeiden

Decoding Competitors

By identifying key competitors and understanding their strengths and weaknesses, entrepreneurs can position their business strategically. It allows them to capitalize on untapped market opportunities and address gaps in the offerings of competitors. This aligns with the competitive analysis princi…

STRATEGIST.IOEdward Zeiden

Determining a Funding Source

Exploring realistic funding sources is a critical step in bringing your business idea to life. Securing adequate financial support can fuel growth and provide the resources needed to turn your vision into a reality. “Capital isn’t scarce; vision is.” - Sam Walton, Founder of Walmart Funding sourc…

STRATEGIST.IOEdward Zeiden