5 signs your business model will work

SMALL-BUS-MODEL

If you’re starting a business, the odds are stacked against you from the get-go. Statistics* indicate that more than 60 percent of small businesses will close within three years of starting.

Similarly, it’s a rare business that gets the traction required to turnover $1million dollars+ in sales. The reality for many business owners is if they calculated the profit they obtain from their business and divide it by the hours they put into their business, it would be more economically viable for them to get a job with someone else.

With this in mind, I examined some traits I see in successful businesses to give you a checklist as to whether or not your business model is likely to work. You can apply this if you’re considering starting a business or if you already operate one.

Here are five criteria against which you might find it useful to measure yourself.

1. Adequate funding

One of the biggest reasons businesses fail is they simply run out of cash.

In the early days of a business, there is likely to be significant spend on setting things up. This usually occurs before any revenue has been earned.

Then, assuming the business starts to make sales, many business owners are not well educated in how the money cycle works. For example, if you offer your customers credit, you might find you are paying your suppliers before you receive any cash from your customers. This can put a strain on cash flow.

Similarly, once you register for GST, it’s important to have a cash buffer so that you can meet your quarterly obligations. In fact, a good sign that a business is in it for the long haul is if it has made it through its first three years — that is a really good indication that the business owner understands and can manage the tax cycles.

To help ensure your business has sufficient capital to thrive, look for opportunities early on to secure finance. Find a good bank manager and see if you can negotiate an overdraft facility, even if you don’t need it yet. It’s easier to obtain finance when you don’t need than when you’re desperate, so it’s a good thing to have tucked into your back pocket just in case.

For more on this topic, see Financing your small business.

2. Diversify your suppliers and customers

Is your business restricted by a small number of suppliers or customers?

This is a strategic issue. If your business or business idea is subject to severe buyer or supplier dominance and it does not otherwise have any significant competitive strength, you might be facing an uphill battle. In these circumstances, margins are often dictated by the supplier or the buyer, meaning you have very little room to move in terms of increasing prices or negotiating better terms with your suppliers.

Your business is also fraught with risk — imagine you have only two customers and one of them goes out of business or moves to a lower cost supplier. Suddenly, half your business is gone.

Look for ways to expand your products or services so that you can reach a broader customer base. And avoid the temptation to get too locked in to one or two key suppliers. Explore your options — you may have more opportunity to negotiate better terms than you think.

3. Clearly established demand

Is there a clearly established demand for your product or service?

There’s no question that new products or services have the potential for very substantial rewards. The first successful entrant into the industry usually has a big payoff. But statistics speak for themselves. As noted above, new product or service ventures have a high failure rate. Furthermore, innovative entrepreneurs generally commit all their resources to the design concept. There’s not likely to be much left over to cover your time investment and the costs involved in creating a market. Sometimes business owners can get so attached to their new invention that they can’t see the wood for the trees.

As an example, I recently listened to a radio interview with an entrepreneur. His invention was a gadget to install in your wine cellar that would assess time, temperature and other conditions to determine which wine you should drink first from your collection. Pretty cool idea. The interviewer asked a great question, though: Is there actually a market for this product? ‘Most of my friends tell me that if a bottle of wine makes it to the weekend without being drunk, they’ve done well’, he said. I thought that was a very insightful point. What’s the potential market size for your product or service? Is there a clearly established demand? If the answer is yes, are there enough potential customers within your local area, or would it benefit you to explore expansion into new geographical markets to fulfil the potential of your business?

4. Does your product have scope for product or service differentiation?

Many products and services are becoming commoditised by technology or other changes. Commoditisation creates price pressure, which ultimately erodes profitability and potentially business viability. Customers have more and more information than ever before (think online customer reviews, or simply the ability to Google anything.) It is not uncommon to see a shopper in a retail store find an item they want, then go online, find it cheaper and order it online — in the shop!

A major key to being able to maintain prices or charge premium prices is the ability to differentiate your product or service. If you are the same as everyone else, expect a hard time on price. But if you can prove you are different, you have a fighting chance. One way of differentiating is through customer service. You might want to read a book called Raving Fans by Ken Blanchard and Sheldon Bowles. It’s an oldie but a goodie, and you’ll find some great tips on how you can position your business differently in order to evade the commoditisation trap. The authors summarise the keys as:

  1. Decide what you want.
  2. Discover what the customer wants.
  3. Deliver plus one.

Many businesses operate in a sea of sameness and will not all survive. What can you do to stand apart and thrive?

5. Does your business (or idea) have the potential to make a profit?

I’ve left this till last because it is the ultimate measure of a business model that will work. If a customer is prepared to pay you more for your product or service than it costs you to make or deliver it (including your general business overhead, not just your cost of sales) then you are in business. This comes down to getting the right balance of pricing, production or delivery cost, efficiency and cost structure. Once you are profitable, you can consider scaling your business, at which time it is particularly important to understand the cash flow implications of driving additional revenue (such as potentially increased marketing costs and a slower cash cycle if you have to offer longer credit terms to attract new or larger customers.)

In terms of increasing profitability, think about what drives profit in your business. For many businesses, the key drivers are the number of customers you deal with (or for retail, the number of transactions), the number of times per year people buy from you and the average transaction value. These are critically important drivers of sales, cash and profitability.

How did you do on the checklist? Don’t worry if you didn’t get 5/5. Simply use this as a guide to help you understand where to focus your energies to increase the chances that your business will survive and thrive into the future.

 

*Source: Australian Bureau of Statistics