Is Your Business Idea Good?
How to Identify a Good Idea. Once your Why and Like/Value/Money Filters – addressed in prior posts - have reduced your opportunity set to something manageable, you can start to look for a Good Idea, or two, or two hundred, that are consistent with the output from your filters. Simply put, the Executable Good Idea is a profitable, economically well-grounded and defensible business model.
Is It Profitable? Profitability is straightforward. Does the business make money? I know this sounds silly, but there are millions of business owners that did not get this memo. Some call me wondering why they can’t make money. And I look deeper into their business and learn that their revenues are not able to cover their costs of goods sold, other variable costs, and fixed costs. And they are not able to raise prices because their supply and demand environment would punish them with lower sales if they did that. They are stuck.
Does It Earn Healthy Margins? Get a clear sense of the standard profit margins in the industry you are investigating. Margins vary wildly from industry to industry. And it’s important to understand the two primary types of margins. A gross margin is the percentage of a company’s revenue that remains after direct expenses such as labor and materials have been subtracted. These expenses are usually called costs of goods sold, or COGS. A healthy gross margin varies by industry and business model. In the software industry, healthy is in the 50% to 80% range. In the restaurant business, healthy is in the 35% to 50% range.
And then it’s essential to look at net profit margins. This is the percentage of a company’s revenue that remains after direct expenses and after the operating costs of the business - indirect and often fixed expenses such as rent, utilities, employee compensation, insurance - have been subtracted. Again, a healthy net margin varies by industry and business model. In the software industry, healthy is in the 20% to 40% range. In the restaurant business, healthy is in the 10% to 20% range.
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