How To Rate Your Business Idea
Before you start a new business, it’s vital that you thoroughly evaluate your idea and think it through first. Otherwise, you can lose some serious time and cash on a bad business model.
I've been fortunate enough to have the opportunity to start many different businesses over my career. Some work well, and others don't. Consequently, I’ve explored and worked with numerous business models, and in doing so, I’ve found the key drivers that impact the success rate, growth potential, and risk of a business.
I like to use a structured process to evaluate a business idea, one that has an objective scoring system. This way, I can easily compare one business idea to another and determine which ones might be best to pursue. You want to brainstorm and see how the business model or idea is going to work in theory before you commit it to practice.
For a lot of driven and ambitious entrepreneurs, one of the hardest things to do is to say “no” to ideas that aren’t ideal. You can’t do everything. When it comes to less-than-ideal business ideas, you should only pursue them if you’ve exhausted your other options that have scored better. It’s important that you learn how to say “no” to protect your valuable time. So a scoring system can also help determine which ideas even make the bar.
I've boiled it down to ten factors can help you determine if your business idea is a good one to pursue, or if another idea might have a better chance. You can also look at the weaker areas and make adjustments to the business model to strengthen it before committing.
The 10 Factors
Use the factors below to rate and compare your business ideas. For each area, you're going to rate the statement on a scale of 1 to 5:
- 1 - Means that you completely disagree with the statement.
- 2 - Means that you somewhat disagree.
- 3 - Means that the idea is neutral or the outcome can go in either direction.
- 4 - Indicates that you generally agree with the statement.
- 5 - Means that you completely agree with the statement.
1. Recurring Income - The majority of the revenue that the business earns comes in the form of recurring income with automatic payments.
The first key factor is recurring income, and the crucial part of the statement is "automatic." You want a model where customers are paying you automatically on a regular basis.
Also, you might think that this would only apply to service-based businesses, but keep in mind that product-based companies can also have a recurring payment component. For example, if you sold something like disposable razors, you might explore an offering where you send out new razors at specific time increments.
2. Inventory - The business does not need to store any physical inventory.
Your company doesn’t necessarily have to hold any physical inventory. Even product based companies can have zero inventory. For example, if your business uses a vendor that drop ships products directly to the consumer, then it's cost-effective for you not to hold your inventory. As your business grows, you may later decide to keep your inventory if it allows you to have higher margins once all associated costs are taken into account.
3. Value-based Pricing - The business sets its pricing based on how much value the product/service provides versus what it costs to produce.
There are many ways to price a product or service. One the most common for service companies is based on an hourly rate. Whereas one of the most common for product companies is a "cost-plus margin." Both of these are problematic because it limits the growth potential of the business. Pricing based on value is ideal whenever possible.
4. Automation - Technology can be used to automate most or all business operations.
Does the business need you to produce the product/service? For your idea, is a specialized skill needed to produce the product/service, or can the work be done via automation, low-skilled labor, or via contractors?
5. Capital Requirements - The business can be started for less than $10,000.
How much will it cost to start your new idea? Not only do you want to look at initial costs, but also any ongoing costs. For example, you might be able to start a T-shirt business for $10K. But if you start getting a bunch of orders at the same time, you might run into additional costs trying to prepay for large orders before you can sell them and recoup your losses. It’s crucial that you brainstorm other costs before you pursue a new business idea to see what sort of cash requirements you might have.
Your number might be different from mine, but the idea here is that you're not risking everything to test a concept.
6. Niche - The business solves a specific problem for a particular group of people.
How niche is your product or service idea? Will you be able to stand apart from the competition or will your business become a commodity, lumped in with all of the other companies operating in a general field?
For example, let’s say you want to provide web development services. You’re going to instantly melt in the background with other web developers because there are a ton of them. But, if you specialize in web development services for mechanics, you stand out as an expert in that area.
7. Market Size - The market is large enough for the business to be able to grow in.
Are you selling to an international audience or a domestic one? Does your potential audience have a big enough pool of paying customers to support your idea?
8. Network - I know one or more potential customers personally who are well connected and can help spread the word about my business.
Do you know other people with the problem that your new product or service will solve? Having people who are interested clients are likely to provide referrals to other people. I call these "Customer Champions." Champions can help you significantly increase your business reach and get early traction when you're trying to get the business initially off the ground.
9. Owner Skill Set - I have all the skills and time necessary to start the business and produce the product/service personally.
Determine if you have the skills and the time necessary to get the idea off the ground and working, without needing to hire new employees or pricey contractors initially. You can hire them later if required, but being able to do everything yourself (initially) can drastically reduce the amount of risk you take on.
10. Margins - The business makes at least 50% margin on every sale.
Margins are closely related to your pricing structure. Does the product or service you want to sell have at least a 50% margin?
What this looks like for a service-based business idea is if you bill out $100 worth of services, it only costs you $50 in direct employee or labor costs to deliver those services.
For product-based businesses, if you sell a product for $100, it should only cost you $50 to manufacture and deliver the product.
The Final Step for Evaluating a Business Idea
Add up your total score based on the 1 to 5 scale for each key determinant. Then, multiply your score by 2. That will give you a percentage score of how much potential your idea may have.
Please keep in mind that the score doesn’t necessarily mean anything on its own. The score is a relative measure of how much potential one idea has versus another business idea. But a general rule of thumb is if your idea isn’t hitting at least 80%, you’ll want to reconsider the business model and tweak it or brainstorm entirely new ideas.
What steps have you taken to evaluate a new business idea? What worked for you and what lessons did you learn? Please leave a comment and let me know your thoughts.