When starting a new business, or branching out into new product development (NPD), it’s tempting to set out your plans based on a perceived ‘gap in the market’. Fans of Dragon’s Den will have seen many investment-hungry entrepreneurs having their hopes dashed when told that their innovative new idea has no prospects of ever making money.
So in order to ensure that your business plans are viable and successfully raise funds it’s essential to ensure there is also market in that gap.
A couple of useful techniques which can help to validate the potential of a new product or service are Market Analysis and Financial Modelling.
Market analysis is an essential part of any business plan, whose purpose is to ensure that you don’t waste time and resources in creating a product or service before you’ve determined that your solution is needed. It will also help you to establish that there is sufficient need for your product – aka ‘latent demand’ – that people will pay for it.
Key considerations in a market analysis should include:
Customer identification: This includes demographics, motivations, and may also need to consider media preferences and geography.
Potential size of market: How many customers are there, how much do they spend, how much of that market can we reach and sell to, what is that worth in sales?
Competitors: Who else is offering similar products, what are customers already buying, what do they pay? What are the weaknesses of competitive products, and how does your product address these?
Barriers to Entry: What are the costs and potential risks associated with getting your product to market? These might include start-up costs, regulation, and access to distribution and delivery channels or economies of scale.
Market Testing: It may be necessary to conduct some market testing as part of your initial investigation into the market this might involve market research, prototyping or alpha/beta testing for software. Results of Market Testing should be included in the Market Analysis.
In this context, a financial model will aim to predict the forecast future financial performance of the product (or servicer or company) based on a set of variables. Its purpose is to help you and potential investor see and measure the likely financial results of marketing a new product, before the company raises or commits any funds.
Financial models are usually compiled by an experienced finance manager using inputs from production and operations specialists, sales forecasting and data from the market analysis.
A financial model, which is typically constructed in a spreadsheet, generally includes cash flow projections, depreciation schedules, debt service, inventory levels, rate of inflation, etc. Specialist skills are required to write and test the equations which properly reflect how the business will react to different economic situations or events, and in estimating the outcome of financial decisions.
Building a financial model requires a number of assumptions to be agreed concerning the key variables. These may include production costs, lead time to deliver products to market, the effects of variations in sales volume, costs to main inventory, variations in margin and many other factors.
EFM’s team of part-time portfolio Finance Directors provide real-life support to businesses that are concerned about success, growth, risk reduction and profit maximisation.