You’ve got an idea you’re certain is a winner, a plan to make money and the beginnings of what you are sure will be a future internet powerhouse. Inevitably while you sit crafting your plans you will start working out some figures for this new venture. So you start throwing around imaginary numbers. A certain number of people visit the site, so many sign up, another number purchase and then probably you do some calculations, a x b x c = You are going to be rich, rich, rich!
But there is a catch… Until you have actually started doing business these numbers are completely fictional. It is OK though, because even if you were a seasoned entrepreneur they would still be hypothetical. The truth is until the doors open nobody really knows how successful a business is going to be. There are no sure-fire hits. What you need to make sure is that you’ve thought through what is going to happen rationally and kept the wild assumptions in check.
Here are four pitfalls to avoid when “calculating” your expected revenues:
Pitfall #1 – Overestimating Your Market Size
When we started FlashDen, I can remember thinking “There are like 1 million Flash users, if only 1 in 10 of them is interested in our product that is 100,000 customers” … But just because there are X million people who might possibly fall into your market, does not mean that your market size is X million people. In reality our market for FlashDen was people who use Flash in their work, who purchase off the internet, who speak English, who … etc. That is our real market and it is a lot smaller than 1 million. Guy Kawasaki likes to describe this problem as the “all we have to do is get 1% of the people in China to buy our product” pitch. It sounds like a silly trap when you hear it from the outside, but overestimating your market size is actually pretty easy to do.
Pitfall #2 – Forgetting Your Costs
Whenever I go into a restaurant and look at the prices on the menu, almost always in my head I think something like “Well cucumbers cost $1, tomatoes cost $2, this salad costs $20 … these guys are making a killing!” Of course anyone who has ever been in the restaurant business or even just watched Gordon Ramsay hitting the kitchens of run down eateries will tell you it’s one of the hardest around. There are many hidden costs that I in my infinite wisdom reading my menu am forgetting, like marketing, rent, personnel, insurance, wasted materials, non-food materials like the menu I am holding and so on.
Assuming that all the costs that you can think of in just a few minutes of contemplation are all the costs can be a fatal assumption. This is one of the reasons writing a business plan is such a good idea, because it forces you to think carefully about many different parts of the business. Even so, for first-timers, you might want to add in some sort of buffer cost to factor in those things you wouldn’t have imagined until you’re actually out there, running the business.
Pitfall #3 – Assuming People Will Pay
Every business boils down to selling something to someone, be it a one-off sale, an ad sale, a subscription, a donation, or even the sale of the business itself. At some point you need to make assumptions and guesses about what people will pay. In my experience however pricing is often done in no small part through a bit of trial and error, going up and down to find what the market will bear, what people are and aren’t prepared to pay.
There are no magic ways that I know of to guess this one right every time. You can go by industry norms if there are some, you can go by what you yourself are prepared to pay, you can even do market research. Inevitably however you will have to make a leap of faith and guess, so I say be conservative – if there are surprises they will hopefully be happy ones.
Pitfall #4 – Assuming that Once its Built, the Hard Work is Done
Assuming that the product development – whether its programming some software, getting a web storefront ready or writing an ebook – is all there is to creating a successful business is another hazard. Maintenance, marketing, sales, ongoing development, bug-fixing, advertising, administration and support can really add up.
I can’t count the number of times I tell people how many staff we have working on FlashDen only to get a response of “But the websites are built, what else do you have to do? Don’t you just sit back and let the money roll in?” Perhaps there are businesses where you just build it and leave it, but I’ve never come across one. Passive income as it’s sometimes called only seems to work on a small scale in my experience. For a decent sized business building the thing is only the beginning, but then that’s what makes it so interesting!
Be Conservative
Knowing these pitfalls doesn’t mean you don’t fall in them anyway. I have fallen prey to all four at various times, and I think it’s easy to get caught up in the excitement of a new a business and find yourself counting the ways you’ll spend those millions just awaiting collection. But it’s important that you don’t let common sense go out the window, especially if it’s a business that is carrying your hopes and livelihood with it. If you use common sense, take the time to think things through and keep your assumptions conservative you should do OK. And remember you can always iterate through your business to improve it over time until you’ve gotten things pitch perfect!
Hey Collis,
Thanks for this post. I have been planning my own business for quite a while now and find all of your posts help me in one way or another.
I find it’s always good to learn from people who are where you want to be, so keep the posts coming!
nice one Collis
i’m exactly sharing the same vision. people should carefully plan and re-plan their plans 
and keep their feet on the ground
cheers
Thanks Collis. This answers my question made in the comments on one of your previous posts.
http://thenetsetter.com/blog/startups/so-you-want-to-start-a-startup-5-places-to-start/comment-page-1/#comment-1136
Very smart list of things to keep in mind. My girlfriend is actually in the process of starting up her own business, and I’m definitely forwarding this gem to her.
Very good information the very last part is the most important in my opinion. Be very conservative.
This is a great article and should be a part of every business plan. Thank you for this.
Very interesting points to consider. Thanks.
Great post. Very sensible things to consider!
Building a couple of apps at the moment. I will keep these in mind!
Very interesting and important information….
Thanks
2.9 times cost of goods is a good starting point. While you may have to adjust — and actually lose money introducing yourself to the market — with a goal of about 3% annual net revenues (it’s not profit until you sell the business) 2.9 x COGs should be a near term goal — with a long term goal of 5X GOGs — at least for creative businesses.
nicely said. its true that hard work is important for any biz to win.
Collis, great article. Over estimating your market size has to be one of the greatest pitfalls out there. I know I’ve done that before. Thinking if I can get only a percent of a percent the business would boom. Reality is so much different.
Excellent info, especially the perspective on hidden costs.
well done!! we need to remember Pitfall #2
thanks you for your post.
I think a lot of smaller netsetters are asking will this pay my bills and let me have fun on the way.
It’s a way to start a new business and design a lifestyle rather then $$$$$$
The point on overestimating the market reminded me of a presentation given by David Heinemeier Hansson of 37Signals a while back.
He took the route of putting things into perspective. It wasn’t about overestimating the market, as appreciated a much smaller one. As he pointed out, the success of “rags to riches” sites like YouTube and Facebook have distorted the perception of success for many startups.
You don’t need the 1 million users to do well, even if that is a small amount of the total number. You just need to do your best with the group you have. I think it was probably one of the most inspiring down-to-earth talks I’ve seen in recent memory.
Here’s the link:
http://www.omnisio.com/startupschool08/david-heinemeier-hansson-at-startup-school-08
Excellent advice… but don’t forget the business tax
Collis, Thanks for this post.
I am starting up my own blog about Graphic and Web Design and this reminded me about the maintenance and marketing is still to be done.
Thanks again and great advise, as always.