MYTHSTAKES and QUESTIONS to evaluate your business idea.

As a college business professor and business owner and entrepreneur I'm frequently a sounding board for the business ideas of friends, acquaintances, and students. For awhile, when I was a partner in a small business consulting agency I even ran a meetup group of about 70 members centered around the idea of Startups and pitching business ideas. As a college professor I teach undergrad and MBA level entrepreneurship classes where students have to brainstorm, pitch, and plan business ideas. All this means is that I've heard a lot of business ideas over the years, maybe over 1,000 if I had to guess, and most of them are either bad or overly ambitious and unrealistic. Occasionally I'll hear one that excites me, but most of the time they just stink.

How do I know they stink? Because I've had and tried and failed at enough stinky business ideas myself to recognize one when I see it.

I've also heard enough compelling ideas, and had personal entrepreneurial success to recognize a good idea when I hear it. Some of the most interesting ideas I now hear are spins on the AirBnB or Uber model, selling access to a traditionally non-commercial asset (or activity). Uber takes your personal car and rethinks it as a business asset, AirBnB re-conceptualizes your home or apartment as something to be monetized. What else could you generate revenue from that you already own? Believe it or not, probably most of what you own. I'm convinced that if the folks who pitched me these ideas don't run with them someone else will. So, I've heard some good ideas too, not just bad ones.

With that in mind I've got 3 MYTHSTAKES, 12 questions, and 1 rule to consider when evaluating that business idea.

3 MYTHSTAKES

Mythstake 1: I Need Something New

Most of what I hear in pitches is people trying to invent some new product or service (FYI: your idea isn't new, someone's probably already tried or is trying your idea. There's always someone out there already doing what you want to do). Yeah, it's more fun to strike gold in virgin territory, but it's far riskier. The reality is there's plenty of gold to mine in existing niches. I'm constantly selling the idea that you can make good money selling things that lots of folks are already selling. Just beat them. Believe me, your competition is probably not as smart or competitive as you've built them up to be, especially if we're talking about industries where small businesses dominate. These small businesses have found a way to make money, and most of them don't want to mess with that too much. Existing businesses are built to perpetuate their already working business model, their not optimized to deal with new environmental threats (new competitors). They tend to rely on their momentum and would prefer not to change what's worked for them in the past. As an example, one business I advised moved into an existing niche with established players. The new upstart didn't do anything new except sell a slight variation at a substantially reduced price and promised delivery in half the time. The existing competitors began to notice that they were losing sales and bewildered and confused about how to adapt they resorted to e-mailing this new business owner about how he was taking their customers and told him he should feel bad because they were a small family business that had been around for years. Sadly, that traditional business eventually went out of business. They couldn't figure out how to compete in a new way.

The reality is that most industries are like this. The competition is just not that sophisticated. For the most part they are complacent and if they have been around for awhile and they are still small it means they're taking most of their revenues as profits (maybe as salary) rather than reinvesting in competitive advantages and adaptive capabilities. That's why I've come to believe the worst thing a business can do is make a profit. If you've got significant profits it means your not re-investing enough in your business. You're destined to lose.

MYTHSAKE 2: I Know My Business Model

Whenever I hear pitches I'm always listening for indications that people misunderstand their own business model. Unless you've already worked in the industry you probably have no idea what you're business model really is.

What's a business model? Put simply, it's your value proposition (what you're selling), the cost of creating that value (the cost and process of making and delivering your product service), and what the people you are targeting are willing to pay for that given your distribution channel.

People often look around and see what other folks are charging for a product or service and think they can charge the same. Wrong. That's what THEY can charge, it's not what YOU can charge. You don't know their costs, their margins, and importantly you don't have their reputation and customer awareness.

Also, you probably don't really know the variable and fixed costs. You have a guess, but you won't really know until you actually start making and delivering it. I hear ideas all the time where people massively underestimate their costs. Delivering your promised value is initially expensive, it's not until you start buying at volume and investing in tools to remove middle men that your costs will actually decline, and even then they may never get in line with your initially unrealistic expectations. In my own business I'm constantly and ruthlessly fighting materials cost. I go to ridiculous lengths to protect my margins. These margins are something I took for granted when I first started, but later realized I would have to fight to maintain, and fight even harder to improve.

I've also noticed that many folks pitching ideas have very little idea of the reality of their own business model supply chain. They have some guesses as it relates to who suppliers might be and what price they'll be able to get from suppliers, but it's probably wrong. Things and prices you think you'll be able to get from other people are either wrong or it's not the right way to do it. The reality is that to turn a profit you will probably have to be your own supply chain. You will have to do most things in house, things you thought you could just pay some other company to do. Outsourcing is expensive, especially if it's small scale. That's going to eat your profit margin up. Take your supply chain and imagine if you had to do it all in house (because you will probably have to do 80% of it) and then build the cost of setting that up into your fixed costs. Now we're talking.

MYTHSTAKE 3: The Hard Part is Having a Good Idea

No. The hard part is generating transactions. It's been said that you don't have to figure out how to make a million dollars, you just have to figure out how to make $1 and repeat it a million times. It's true. Though I like to say, you don't have to repeat it a million times. You have to repeat it maybe 5000 times. Hopefully by then you've re-invested that into something that is going to make you $5, $10, $20, $100 margins. You don't need a million dollar business idea, you need a $5,000 business idea so you can fund your million dollar idea.

Secondly, there are lots of "good ideas". I hear great ideas or see cool products all the time that never make money. At the most fundamental level transactions are about awareness and trust. If I don't know about your product or if I don't trust you then you're not getting my money, even if it's the best idea in the world.

Great products and services aren't rare, but a method for reliable sales is. You might have a great idea but just as important, if not more, is you have to figure out how to get in front of your market and get them to trust you. Again, you might have a great idea, but getting people to buy it is going to be just as hard if not harder. Getting those first sales is hard. If you can do that then you've got something. (That's why my favorite question below is question 12).

THE 12 QUESTIONS

So what are the questions I ask when evaluating a business idea? These are designed to address the 3 myths.

1.    What is your value proposition? What are you going to sell?

I'm looking to see how well do they really understand this? Are they trying to re-invent the wheel? It's fine if they are but it raises even more questions.

2.    Who do you think you are going to sell it to?

Is this market big enough? Are they already catered to? The most valuable results from asking this question are often re-directing them to a more under-served market niche.

3.    How much will it cost you to set up?

I'm looking to see if they really know their supply chain and how much they plan to do in house. If they think they'll outsource everything then it's probably going to have really small margins and be unreliable.

4.    How much will people pay per unit?

For the most part people overestimate this. They look at what the major competitors are charging. Remind them that's the price that the competition can charge with established trust and established awareness.

5.    Unit price ______ - Variable cost ________ = ________ (margin)

This is definitely a guess on their part. This is a good gauge for how much research they've done on the raw material inputs. They're probably underestimating their unit costs because they are underestimating the amount they'll actually have to input and the cost of those inputs. Basically it's the planning fallacy, our tendency to underestimate needed resources. An example: If their opening a home and office cleaning service how much soap they'll use , or how many towels they'll go through, and the price of those materials).

6.    Given your “margin” how many must you sell to cover your setup cost?

I feel like you have to ask this question, but the break-even question is pure speculation. At least it gets them to see the big picture. What we're really looking for here is realistically how big can this thing really get? How much money can it really generate. I see successful sellers online on Ebay, Amazon, and Etsy and it says they've got 4,000 sales and you say "WOW! Their doing great!" and then you do the actual math (# of sales x avg price of their products) and you realize their 4,000 sales in 3 years is really just $120,000 revenue, minus their costs, so maybe they've made $80K in 3 years. Yay. You're not making a living off of that. Nothing to see here.

7.    What are competing products/services?

For most folks starting a small business the competition is mostly irrelevant at the startup stage, I believe. Competition is relevant later on, when you're actually competing for market share.

This question is important though because it helps me understand how biased and locked onto preconceived notions they are about the business models of others.

At the startup stage your competition is really yourself and your own stuck in the mud ideas about your product, what you have to charge, what you think customers want etc. Looking at your competition is really just a starting point for you to consider what worked FOR SOMEONE ELSE. You can beat the competition but not through your own careful calculation of the competition.

You can sell the same product or service as your competition, yes, but you're going to have to discover for yourself how you're actually going to generate sales. Maybe you can copy them, but more probably you can't, at least at first.

8.    What makes yours stand out from theirs?

I always say, you can sell the same ice, just make sure your ice looks better than theirs. Make BOLD products. Does the product elicit a strong reaction? Do people love it or hate it? Indifference is worse than hate.

Your competition can get away with same old boring stuff because they've already figured out how to sell it.

a.    Is this difference bold enough to make it truly stand out? Will it cause people to have a strong reaction?

Even if it's the same product make it stand out. Cover your bag of ice in yellow smiley faced emoji's, I don't care. It just can't look the same. Also, I'm not a differentiation only guy. You can sell it for cheaper, in fact if you're trying to get traction as a new business you need to sell it for cheaper (take lower margins) but you also need to make it stand out. The exception being something like Amazon sellers where you're in a situation where the only differentiator is price because you are literally selling the exact same listing as other sellers. It's a race to the bottom.

9.    What asset or capability do you have or will you develop that will make it harder for folks to match your offering and price? (example: a machine that most others aren’t willing to buy that makes it easier and cheaper for you to deliver your value proposition and offer it at a lower price than others).

I'm looking to see if they're planning to take profits and spend it or if they're going to re-invest it to actually develop some meaningful competitive advantage that will improve margins and/or quality. In my own business I've taken much of the profits and re-invested it in expensive tools that are assets that allow me to do and sell things that most of my competition cannot.

10. Where will you sell this?

Here I'm just gauging their marketing and distribution channel ideas. If they say "my website", that's blah. You need a website, yes, but the worlds full of them and getting traction on an e-commerce site is ridiculously challenging compared to the ease of getting traffic from established e-commerce platforms like Amazon, Etsy, Ebay , etc.

If it's a service then are they willing to do the hard work of sales calls, ad spend, lead generation, etc. In my opinion starting a service business takes an outgoing conscientious personality. I don't like service models because you're trading time for dollars, and it's a lot harder to scale. If they're going to do it then they have to be ready to work long hours, put on a happy face when they don't want to, and be ready to hire and manage people.

11. How will you tell people about it? How will they learn about your offering?

Just a basic question here. If they say social media (mental eye roll) and website SEO then red flag. People have this idea that social media and SEO is a magic bullet.

Sure, you should be on social and you should have a website but you're better off getting onto an existing seller platform (Amazon, Ebay, etc.) and spending dollars on ads. Of course you've got to build this into your variable costs.

12. How can you test this idea tomorrow without having to invest more than $200? 

This is the biggie. Enough talk. Go try and sell it. We've heard alot about this over the last 7 or 8 years with lean startup, Steve Blank, MVP (min. viable product), but in my opinion it's the best lesson we've learned in business in the last 30 years. Stop it already with your business planning. You've got an idea then put it up and see if anyone will buy it. You don't need to set up the business, figure out a logo and a name and all that jazz, just list your product or service on an existing platform (again, Ebay, Amazon, Etsy, Craigslist, Gig Salad, whatever) and see if someone will buy it at the price you are asking.

If you don't get any sales then list a variation of it. Keep listing variations of it on different platforms, and changing the price until you've either gotten a sale or two or tried all the variations you can at a profitable margin and had no luck.

At this point you've either discovered a profitable value proposition and transaction model or you haven't. If so, then start building. If not then cut bait.

CONCLUSION

So that's it. These MYTHSTAKES and Questions aren't hard and fast. There are always exceptions, and for the most part my opinions here are most accurate when applied to small business ideas.