How to Evaluate Your Business Idea
One of the most common problems new business owners run into is that they've created a low paying job for themselves rather than a business. There's a subtle difference between running a business and just being self-employed. Here's a test you can use to evaluate a business idea.
The Million Dollar Business Idea Test
We'll get into some additional questions to ask yourself in a minute, but a quick test you can use is if you can see how your business can generate a million dollars a year, you might have a solid business idea.
Let's look at the math.
Say you sell a million dollars worth of product and have excellent margins of 50%. That leaves you with $500,000 in gross profit. Divide that by ten employees, and that leaves you with $50,000 per employee, roughly the median wage for US workers.
That's before any other expenses, of which there are many.
How much of your product or services do you need to sell to make a million dollars a year?
For example, if it's a $5 product, you'll have to sell 200,000 of those items to hit a million dollars. If it's a $50,000 product, you only have to sell 20 of those a year to hit a million.
If you're selling your time at $100 an hour, that's 10,000 hours or 27 hours a day, seven days a week. Doing everything yourself for an hourly rate usually doesn't meet the million dollars a year business test. It doesn't mean that what you're doing isn't a good business idea, just that you'll hit a limit on how much income you can personally produce.
Scaling a Service Business
To scale a service business, try taking on apprentices and selling their time, figuring out how to bill multiple customers at the same time, adding products, and automating things. That's why some stars make millions; they charge 20,000 people $95 each to attend a single concert. On top of that, they sell products such as music, shirts, and movies that they create once then sell a million times.
If you can generate a million dollars in revenue, you can likely figure out a way to scale that to ten or a hundred million.
If you can't figure out how you can generate a million dollars a year, you probably don't have a business idea that is going to scale very well. That's not to say you can't make a decent living from that idea, but it's not likely to grow into a business that can support a bunch of employees.
Putting “Small Business” Into Perspective
The US Small Business Administration defines a small business for some industries as less than $40 million in annual receipts or less than 1500 employees. It varies by industry, though. For example, roofing contractors are still considered small up to “only” $16.5 million in annual receipts.
If you can't scale, your growth is limited, and your business idea may need some tweaking.
7 Additional Questions to Evaluate Your Business Idea
As you evaluate your business idea, you'll want to ask yourself some questions. Here are seven additional questions to get you thinking.
- Will people actually buy your product or service? Test it on a small scale and see before putting a lot of money behind scaling it up. Investors always want to see proof that your idea works before they'll invest, so create a prototype and sell it.
- Assuming you lose a lot of deals to your competitors, is the market demand still sufficient to sell that amount of product or services?
- Are there competitors in your space? If not, why is no one else doing this? Often lack of competition is reflective of a lack of demand.
- How much of your time or money is required to create and sell your product or service vs how much you charge? For example, if you are spending an hour handcrafting each of your $5 products or pay $5 to get that $5 widget produced and then still have to sell them, that's not scalable. That's the way businesses lose money.
- Can you automate the process or hire people to do the work so you can stop trading your time for money? If you're doing work that only you can do, there's a limit on how much your business can grow. Here's a hint…there's pretty well nothing that only one person in the world is capable of doing.
- Can you generate recurring revenue? For example, if you are mowing yards, you can charge your customers every week. An IT company can charge maintenance on systems they install to keep them running. A convenience store will have regulars that stop by and buy soda every day. Look for recurring revenue opportunities from existing customers.
- Have you created a business plan? If not be sure to do that.
I hope this helps as you evaluate your business idea! If you're ready to set your business up properly and get started, check out the article “How to Create an LLC: Starting a Business.”
If you need some business ideas that pass this test, grab a copy of our report “Just Mow Yards: 100+ Highly Profitable Niche Businesses You Can Start Today.”
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