Who this is for: a hacker with an idea.
Why you should read this: to figure out how much money your idea will make you.
—
The entrepreneur walked me through his mobile app – it was a cool idea, and I’d probably use it.
“How will you make money,” I asked.
“We’ll run ads,” he said.
“What are the CPMs like for this audience? How many users will you need before you hit break even?”
“Um, we haven’t looked at those numbers. But once we hit 1M users it won’t be challenging to make money.”
I see this all the time, and it stings. Probably because far too many times I’ve said the exact same words, only to find out after the blood and sweat of launch that I probably wouldn’t make enough money to be worth it.
“Dude,” I said, “if I were you I’d spend a couple hours in Excel and figure out exactly how many users you need to break even, and ballpark how much money you’ll make when you reach 1M users. Is it 10k a month? 50k? 500k?”
Our coffee date wrapped up, and he went on his way. I hoped he wouldn’t make the same mistakes I had in the past.
—
This step is the absolute first sniff-test you should do to figure out whether you’ll make money if you’re successful.
Excel is about as sexy as a pig wearing a miniskirt, so even I skipped this step in this series of posts on starting a venture. You can save a lot of time and frustration by NOT SKIPPING THIS STEP.
Put another way, there’s a high probability you will be making the same really stupid and avoidable mistake I’ve made (several times) if you don’t do this before you write code.
Don’t waste your life by designing and launching (multiple) app(s) without understanding how and whether the effort of launching will be worth it.
Will your app be profitable?
You want to figure out:
- how many poential customers there are in your market
- what your costs are
- your ballpark price (and thus your gross margins)
Some of these numbers will be hard to nail down as facts; that’s OK – more facts will emerge as you talk to customers. The point of this exercise is to get an answer that helps you decide whether to explore the problem in more depth.
Let’s take a crack at it
I was talking to a couple people who wanted to start a grocery-delivery business. The wrinkle was that they would be delivering exact quantities of raw ingredients along with recipes to customers, so the customers could make meals at their homes.
Regardless of whether people would want this service, let’s take a quick look at the numbers to see whether this is even an idea worth exploring.
I’m going to make some assumptions that are probably wildly inaccurate for the purposes of this blog post. Given that you are actually working on a real business idea, I assume you would be much more thorough.
How many poential customers are there in your market
According to Wikipedia, there are 600k customer in Vancouver (where my friends wanted to start the biz).
Assuming the population follows a bell-curve distribution (25% young, 25% old, 50% just right), let’s say 50% of people are potential customers.
That’s 300k people.
Your costs
My friends wanted to start out buying food from Whole Foods and re-apportioning ingredients into appropriate packages for delivery. Scaling up would involve going direct to food distributors.
So, let’s say you can pay someone $10/h to grocery shop for 10 customers an hour. (I’m ballparking this, but you could test this assumption by going shopping for 10 customers yourself.)
And let’s say re-apportioning and packaging raw ingredients into deliverable meals can be done at the same rate.
And with smart software, delivery can be done at the same rate.
And let’s say you’ve got a set of recipes that will keep your raw ingredients costs to $10 max per customer.
That means your costs per meal delivered are $13, comprised of $10 in raw ingredients and $1 for shopping, $1 for packaging, and $1 for delivery.
You’d also likely have other costs related to cost of good sold – packaging, storing raw ingredients, spoilage, waste – and overhead like salaries, offices, customer acquisition costs, etc. But let’s keep it simple for this post.
Ballpark your price
OK, you’ve got a max cost of $13 per meal delivered. Let’s say you want to charge per meal delivered.
We can calculate your potential price based on a desired gross margin:
Price = Cost / (1 – desired margin)
Based on a $13 cost, here’s a table of margins and prices you could charge per delivered meal:
| Gross Margin | Price | Profit |
|---|---|---|
| 30% | $18.57 | $5.57 |
| 35% | $20 | $7 |
| 40% | $21.67 | $8.67 |
| 50% | $26 | $13 |
| 60% | $32.50 | $19.50 |
The higher gross margin, the more profit for you.
You’d also want to model out alternate business models. What would it look like if you charged a subscription? Could you do this on an ad-supported basis? Etc.
So, how much will you make?
Assume you could reach each of the 300k customers in your market (this is obviously the best case scenario).
A conservative rule of thumb is 1% conversion from potential customer to paying customer.
So you’d have 300,000 * .01 = 3000 customers.
Assume each customer buys one meal a week.
Here’s what your gross profit would look like given the range of prices you might charge:
| Gross Margin | Profit per customer | Gross profit per week |
|---|---|---|
| 30% | $5.57 | $16,710 ($5.57 profit per customer * 3000 customers) |
| 35% | $7 | $21,000 |
| 40% | $8.67 | $26,010 |
| 50% | $13 | $39,000 |
| 60% | $19.50 | $58,500 |
Not a bad little business. Of course, this is a perfect world scenario – you’d likely never reach all 300k potential customers. Would the business be as interesting if you reached 10% of potential customers – 30k – and had 300 of those convert to paying customers?
The take home
This is an extraordinarily valuable exercise, because instead of hand-waving about business models down the road, you’re forced to think through your assumptions.
I see waaaaay too many entrepreneurs who fall in love with their ideas without taking an hour to ballpark some numbers and figure out how viable their *business* is, instead of how cool their product is (and I’ve been guiltier than most)
Once you understand the explicit assumptions you’ve made about how your biz will make money, you can decide whether to move forward with validating your customers’ problems and testing your solution.
Next: figure out how you’ll acquire customers.