Editor's Note: Contributing Editor Dale Traxler is a former ecommerce owner who now consults with other businesses on financial and strategy matters. His piece below describes his work for a startup manufacturer and retailer.
I mentioned in previous articles that I’m involved in two startups. In both cases, we are going through the process of developing a model that evaluates all aspects of the business — our target customers, products and services, organization, infrastructure, channels, financial projections, and funding needs.
In particular, the process of building a solid financial model forces you to think through things like payroll costs, equipment purchases, research and development, sales channels, and even office space. I found myself adding new elements to every part of our business model as I focused on the financial aspects.
I was reminded this week of how important it is to view them all as a whole instead of as the individual parts. I will share the details on one of those startups in this article.
Our business risks were highest in four main areas; we focused on them first. We really did not spend a lot of time on the organization or infrastructure, but those elements played a large part in our decisions in the other areas we looked at. Here is a summary of our experiences.
Is There a Need?
First, we validated that our target customers felt they had the problem that we were trying to solve with our product. We tested our product with them and found a niche in the market where they were willing to pay a certain amount for the type of product we described to them.
- Analysis. Good. We found a product, a potential solution, and a big market. We need to do more thorough research, but we have enough data to believe we are on to something.
The focus here was on the technical feasibility of the product we envisioned. After a couple of months of detailed research, we know we can build the product — but at a much higher cost than we hoped. The costs will likely decrease in the future and with a higher upfront manufacturing commitment. But the higher cost of goods sold will have a big impact on our ability to meet the price point that customers seem willing to pay.
- Analysis. The good news: We can build it. The bad news: The cost is 40 percent higher than our target.
Our focus was on both the sales channel and the marketing channel. On the sales side, the question was should we sell directly to consumers via our own website or through distribution channels in specialty stores? Or both? We knew our margins were going to be tight. So our first goal was to sell directly to consumers to protect our margins.
On the marketing side, the big question was could we reach enough of our target customers through search marketing to generate the visits from qualified customers? Unfortunately, we found that it would be difficult to generate the search marketing traffic necessary to hit our sales objectives.
So, we looked more closely at indirect distribution channels because they are better equipped to reach our target customers. The good news is that there's a mature and rich channel with more than 4,000 stores. The bad news is they would eat up half of our margin, and require sales and marketing support, such as channel sales managers and manufacturers reps to reach the specialty retailers. Once the channel is clicking, the potential is high. But at what cost? We would incur expenses on new personnel, travel, trade shows, and promotional displays.
- Analysis. Neutral.
I’m never get too excited about a business proposition until I can see profits from it. In the case of this startup, I built a detailed financial model to test the different scenarios that were coming out of our research into customers, products, and channels. We needed to plug in different selling prices, cost of goods sold, marketing investments, research-and-development expenses, and payroll. We also needed to build a cash flow model to determine our capital and funding needs at various stages.
As we inserted the data, it became apparent that our target retail price for the product was going to be much higher than we hoped. In turn, that would limit the demand. We also saw that we needed to grow the indirect channel because we would not sell enough of our product through our own website until the product became well known, and less expensive.
As we examined the funding requirements to build a prototype and bring the product to market, we also realized that fundraising was going to be challenging. Demonstrating a return-on-investment to the investors was becoming a stretch. Profitability was well down the road. We would likely need more money than we hoped — adding more risk.
- Analysis. Bad.
We are likely going to "pivot" — to use a modern business term. We need to change direction to a new product or market. We know our target market has the problem we identified. But we need to evaluate a different solution or find a broader market for our products to spread the development and manufacturing across a much bigger playing field. The financial model simply did not meet the requirements for a good investment.
For this example startup, we are not discouraged. The process worked. By doing the required research, we are making an informed decision.
Every business — ecommerce, brick-and-mortar, or other — should develop its investment and growth strategies. If you look at all the elements of a business decision together, you will reduce risk and have a clear blueprint for success.