How To Research A New Business Idea
Peter Druker, the management guru, liked to say that the purpose of a business is to create and keep a customer. That process begins with a value proposition. A business is built around a value proposition: that business says to customers that it offers a product or service that is so uniquely different from that of its competitors, that the customers have to buy from them. What the business promises to deliver, communicate and acknowledge is the value that they are offering their customers. On the other side of the coin, how customers perceive what the business will deliver, and cause the customer to experience, represents value. A whole business can be said to have a value proposition, but the idea can be extended to business units, products or services, or customer accounts. Without a value proposition, a business cannot exist. When you are thinking about going into business, the most important question you have to ask yourself is, “What is my value proposition?” The search for this business idea will determine if you can build a business that can earn and grow revenue and earn a rate of return greater than the cost of capital.
What are Your Passions?
We live in a world where a business model can be effectively built out of a person’s passions. In the past, this advice has been problematic, simply because what a person is passionate about does not always make any money. However, the internet and the digital tools that have emerged to get jobs done, have changed that. Digital Media estimates that the “passion economy” is worth some $38 billion.
The passion economy has existed for some time, but the global pandemic accelerated its evolution. Digital tools allow creators to build an audience of “true fans”, audiences who love their content so much that they are willing to pay for that content. The newsletter platform, Substack, for example, gives writers a platform to deliver their content to an audience composed of paid and freemium consumers. Twitch allows gamers to monetize their skill by playing games before a paying audience. Platforms like Podia allow “knowledge influencers” to teach their skills to their audience. It has been pointed out that a business can be built with as few as 1000 true fans, although others have suggested that a thriving passion business just needs 100 true fans. The idea of a passion economy highlights the ease and zero-cost way in which a business can be discovered and earn revenue from its audience.
Analyse the Economics of an Industry
When Jeff Bezos was thinking about the kind of business that Amazon would be, one of the most important decisions he had to make was figuring out what to sell. In a 2003 TED Talk, Bezos explained why he decided to start off by selling books.
Bezos analysed the economics of the book industry and figured that three qualities made the industry attractive:
- Books prices are stable, low and have great margins of 40-45% (i.e. he was referring to physical books, not ebooks).
- There are millions of possible titles which can be sold, thanks to the “long tail” or “infinite aisle” of supply. So Amazon could guarantee supply and choice.
- A person does not need to hold a book in their hands before they buy it.
Based on these three features, Bezos made the decision to start Amazon as an online book vendor and begin the journey to creating a $1 trillion company.
As you think about your business idea, you have to ensure that the economics of the idea make sense. If the economics don;t make sense, then either you have to abandon the idea, or change the game. You have to think in terms of base rates, or prior probabilities so that you make the best decision. So ask yourself what the typical business in the industry does in terms of operating and financial results. That will anchor your decisions on firm ground. Notice that Bezos did not say to himself, “The industry has margins of 40-45% but I can do 80%”. He started off with the facts as they were and built the business from there. Amazon’s genius was in allowing people to shop for books online. But Bezos did not tell himself he could change the economics of the industry. Be humble and start with the facts.
Study the Competitive Landscape
Your ability to earn a return on invested capital that is greater than your cost of capital, is a function of your competitive advantages, the most important of which are barriers to entry. Competition is great for customers: it gives them choice and low prices. But for businesses, competition is death. A business that lives in fear of competition is forced to keep its prices low, and when its costs rise, does not have the freedom to raise prices in order to maintain its profitability. This is because if it tried to raise prices, a market entrant could easily enter the industry and offer lower prices, gambling that it can grow its way to profitability.
Look at the restaurant business. The industry has a high failure rate because anyone can open a restaurant and no matter how great a chef you are, there is someone out there who can match your skill and open a restaurant. So restaurants struggle for profitability because no restaurant has the ability to raise prices at will. Now look at the reverse: Amazon is the dominant ecommerce firm and it has raised prices over the years without losing any customers. You buy on Amazon, not just because Amazon is a great company, but because there are no real alternatives. Many traders admit that the Reuters terminal is a poor product, but the cost of switching to an alternative service are so high that it makes more sense to stick with an inferior service, than to change to a better one! The competitive side of business is often ignored but it is more decisive for a business’ fortunes and almost every other feature of a business.
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