Things to Consider when Analyzing a Business Model

Useful Questions for Analyzing an Idea’s Business Model Attractiveness

Macroeconomic Analysis

How difficult will staffing be as you grow?

  • Easier the better; the less staffing requirements (ie. The less human capital intensive) it is to provide, manage and sell your product or service the better.

What laws, regulations, treaties, and other political factors could affect thebusiness?

  • Is there any risk of regulations or restrictions? What inherent risks exist in currency, shipping, or supplier pricing fluctuations caused by these? Can they be mitigated or eliminated if so?

How does the market value it? (Valuation multiples):

  • Will you be able to raise money at a valuation that you are satisfied with? How difficult will be it be to raise enough capital at this threshold? Use comparable public companies to determine what their valuation multiples are based on and what they are to determine this. For example, service companies are typically valued at only 0.8x of their annual revenue — make sure you do your research for your industry and product/service.

Microeconomic Analysis

Who is your competition and what is the market structure?

  • Is it hyper-localized and if so is this an opportunity for branding or an innovative business model to help you stand out, or are your competitors huge behemoths who could potentially crush you. Either way you’ll need to know this, and inform your strategy accordingly.

How will competitors react to you as a new entrant?

  • Eg. If you are developing tech, how hard would it be for large competitors with much more capital to outspend you to innovate faster? Would it be logistically feasible for them?

What is the product/service and what competitive advantages does it have?

  • Is it marketable, can it be explained in a couple short sentences, and how is it better than existing offerings if applicable? It should be 10x better than existing offers in order to get market adoption, as people overvalue what they have by a factor of 3, and companies overvalue what they sell by a factor of 3, meaning you need to more than 9x better, aka. 10x better.

Does it create barriers to entry, if so how?

  • How can you mitigate the risk of others seeing the opportunity and taking it from you? For example, if you are making some app, what is to stop some bigger company from putting a bunch of programmers in a room for a weekend and replicating your app and backing it with superior brand and resources? What is proprietary?

Who is your target market, how big is it, and how much of it could you reasonably capture if all goes well?

  • Do they have money to spend and the propensity to do so on your particular product/service? Is the market size big enough to reach your desired level of growth and attract investors, and how feasible is it to actually secure this?

How much does it rely on each strategic partner/supplier?

  • The less reliance on each supplier or partner the better. That way if you lose them, it doesn’t kill your business. This also gives you more bargaining power.

Does it have a “chicken and the egg problem” (Network Externalities)?

  • “Chicken and Egg” strategy problems occur whenever the value proposition to two separate groups is dependent on penetration in the other. Eg. No one would use Craigslist to buy/sell things if other people were not already doing so. This is bad (expensive, slow), and typically requires large investment into marketing campaigns to get over or taking advantage of focussed networks. (Can be an excellent barrier to entry however eg. Facebook, which was not first to market like Friendster and MySpace, but they took the college route and were able to get adoption that way, while MySpace and Friendster had this network externality problem)

Is the business seasonal? If so, how much and how will that effect survival through slow months (eg. Turnover)?

  • For example, if you’re hiring students, will they go home during the summer? If your largest market is internationals and travellers, will they still be around during off tourist seasons? If it is seasonal, how will we adapt our business model to survive on the off months. If there is no work during those months, how do we keep our staff without having to rehire and retrain every season.

Does it have economies of scale? How important is this to the model?

  • Is operating at a large scale more efficient than operating on a small scale? Look at the market structure to help determine this. Do you need these economies of scale to be competitive and attract investment, if so how long would it take to secure?

Financial Analysis

Does it have a clear pricing/revenue model?

  • The more clearly defined, the easiest it is to hire sales staff for it. Complexly quoted and dynamic service or product offerings are much more difficult to hire and pay salespeople for particularly when heavily based on operational capacity as they won’t know what they can sell or know how much they’ll make, and to forecast revenue from for management and investors.

How much will it cost vs. how much it could make? How quickly can you get it to revenue?

  • Return on investment = opportunity cost, not just for you, but for investors who can help make it a reality. All projected cash flows need to be discounted back to the present value from their future value to do this accurately (as much as possible anyway). Create budgets and financial
    projections for this.

Can it self fund, and if not how will it be funded what will be your burn rate?

  • Can it self fund, and if not how will it be funded what will be your burn rate?: Where will the initial capital injection come from if required, and if so how much is needed? How long until you run out of money to pay your expenses assuming no other outside investment? What happens then?

Does it generate reliable & consistent recurring revenue?

  • Better than discrete: much more predictable forecasting, better for customer feedback & process improvement. It’s far easier to keep customers than get new ones. Aka do you get repeat customers, how frequently do they buy, and can you keep them coming back?

How high is customer concentration?

  • Generally speaking, if a single customer accounts for more than 20 percent of revenue, or if a small number of customers (three to five) accounts for more than 50 percent of revenue, the company may have a customer concentration issue. This is a significant amount of risk, and also represents a lack of bargaining power.

What is the expected customer acquisition cost and lifetime value per customer, and average revenue per user (ARPU)?

  • Lifetime value of a customer must be more than the expected customer acquisition cost otherwise you will never make any money.

When do cash inflows occur relative to cash outflows (eg. Do consumers pay up front prior for service)?

  • It is vastly preferred to have cash inflows come before cash outflows. If cash outflows come first it will prevent your ability to scale quickly.

How do costs grow with scale; what is the expected operational efficiency (SGA expense (sales, general, admin expense) to gross sales ratio?

  • Scaling is expensive and risky. What new management, staffing, and bureaucratic expenses will you need to take on as you expand? How will this affect the bottom line?

Logistical Analysis

How difficult is business development? (the acquisition of sales & strategic partnerships)

  • Is it easy to secure partnerships and new sales? How big is each sale? If it takes a long time to make each sale, and each sale isn’t worth very much, then you may want to review your revenue model. The ideal solution is the ability to have a high volume of high value sales, though there is usually a tradeoff between time spent to get a sale and the value of the sale itself.

What existing technology is available to help?

  • Can you use existing technology to grow your business in ways previously not possible? Facebook and Linkedin are great examples of how businesses are now able to use connectivity technology to rapidly grow their teams and run more targeted advertisements cheaply.

What are the steps to success? How long will it take?

  • Think about the future state you want, then work backwards. How can you achieve these milestones? Is it feasible?

Do you have the right team?

  • You need: culture fit, shared values (myers-briggs is great for this, https://www.16personalities.com/ ), shared vision, different but complimentary skillsets that covers everything required to start and grow, time commitments, defined roles & hierarchy (be cautious about working with friends because of this), and many other things. Make sure you have A players, not B players.

How much control over product delivery/sales does management have? Is it reliable?

  • Quality control, consistency, and scalability suffer without control (this is why software usually attracts more investment than human delivery). Eg. If your revenue generation depends on people who are not always dependable, that is a problem. Account for this systematically; build into the model the realistic and conservative assumption that the average person is not 100% reliable, then figure out how to ensure quality control and sales. (SaaS is a great example of solving this problem)

Why are you making/doing this & what problem are you solving?

  • Money as a motivation is not enough, you will burn out, not be able to motivate others (especially when cash becomes tight as it almost always does in startups), and fail otherwise. You need a convincing “why” because people don’t buy what you do they buy why you do it. Social impact factors work great for this and are easier to get money for.

How difficult will operating across multiple cities or markets be? How hard will it be to grow to those cities/markets? What would need to happen?

  • Consider what it will take to expand to a new city, a new country, or a new continent. If applicable to your desired rate of growth, how will that affect everything else? Costs, human capital, investment, etc. If you can avoid it, it is better to consolidate a market first, and then rapidly expand using your base as a financial springboard.

What is the expected annual & monthly churn rate?

  • Look at different benchmarks for your industry, but generally you want to minimize the amount of customers who stop using your service (churn).

What is the expected daily active user and daily monthly user rate as a percentage of total customers? How is this expected to change?

  • Having a lot of users with few actually using your service isn’t progress. Optimize for users, not downloads.

What is your business’s viral coefficient and the velocity (speed) of that exponential coefficient

  • ie. what is the average organic growth rate per customer (coefficient greater than 1 indicates for every 1 customer you have, they will generate 1 organic customer as well per time unit defined in granularity)). This is difficult to predict for a startup, but what strategies can you use to maximize this, how does this work with your model? For example, a new type of paper is not likely to have a high viral coefficient, whereas a new multiplayer video game might since users could possibly be persuaded to invite their friends to join.

How high is customer retention by cohort? (Ie. % of installed initial base still transacting)

  • What will attract your initial base of customers vs. future cohorts? Early adopters typically accept lower value propositions than late adopters, but they also may have different needs and desires. How will this affect your ability to keep existing customers as you grow?

How is the supply chain structured and is disintermediation possible?

  • Are they multiple intermediaries driving market prices up and cutting profits for suppliers at the beginning of the chain, if so how can this be avoided or disrupted. For example fishermen selling their fish cheaply to wholesalers who then distribute it, and sell it for higher prices to restaurants, rather than fishermen selling it for a better price for them at a cheaper price for the restaurants because no wholesalers would be involved who needs to also profit.

How compatible with existing behaviours is the product?

  • Product adoption is considerably slower if adoption occurs at all when new products are not compatible with existing behaviours. This does not mean they must be identical, just not a huge stretch for consumers to make the change. For example Robo automatic vacuum cleaners. You still have to get the vacuum cleaner out to vacuum the floors, but instead of having to manually do it, you can just press a button and the robot will do it for you.

How complex is the product for consumers to understand how it works?

  • The harder it is for someone to understand, the less likely they are to use it. How easily can the product be explained to a user? Genius comes from making complex ideas simple, and easy to understand by the masses.

Are consumers able to test the product prior to purchase?

  • Similar to why many SaaS companies offer free trials, it is very important for people to validate for themselves whether or not something is worth buying. If they cannot do this, it represents a risk for them, and they are less likely to want to adopt your product.

Can consumers see others using the product?

  • Similar to being able to test it themselves, people want to see others using the product for social validation and be able to watch someone using it so that they can learn themselves, making it easier to understand and thus purchase.

Does the business only work in the best case scenario(s)?

  • Things never go exactly as planned in startups, and with the risk so high, betting on the best case scenario is like driving a hummer through a minefield and hoping you don’t get hit. The business should ideally work even in the worst case scenario if possible, or at the very least a reasonably likely one.