Profits Come From Models, Not Ideas

by Shonali Burke on April 28, 2010

Put on your thick skin. It’s time to get down to business.

A model approach

Image: Franz Janusiewicz, Creative Commons

As a successful entrepreneur, friends regularly approach me to share new business ideas.

Can I be honest? I’m not that interested in your idea, or even how fabulous your product is.

What I care about is how your business will make profit.

Don’t start throwing your hard-earned dollars into product development until you clarify your financial model.

1. Get real on costs.

All products cost money: e.g. materials, labor, shipping, and some portion of your overhead (rent, utilities, taxes). As production costs rise, your sales margins drop. So let’s consider the price.

2. Pick your price carefully.

Price is a core issue, notes Megan Auman, CEO and founder of CraftMBA.com, and the author of a new ebook, released last month.

“Too often, entrepreneurs fail to grasp the difference between wholesale and retail price,” she says.

Auman’s rule of thumb: Wholesale price = Cost of materials + labor + expenses + a markup for profit.

3. Calculate customer acquisition cost

Calculate what it costs you to acquire each new customer, advises David Ronick, founder of UpStartAdvisors.com.

Whether you’re selling a product or service, “Pick a time frame, like three months,” he says, “then figure out how many new customers the company attracted during that time, and what were all the expenses involved in acquiring that customer?”

Your expenses divided by the number of customers yields the cost of acquiring one customer.

Ronick adds that the margin (i.e. what you pocket) should be about three times the acquisition cost.

Bottom line

Love your idea. Love your model more.

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Amanda Steinberg is the founder of DailyWorth.com, a free daily email about personal finance for women. DailyWorth gives women key insights into building net worth. Sign up today!

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