Working out whether a business idea is any good is a tricky proposition. There’s the tried and tested ‘overnight test’ where the entrepreneur can leave the idea overnight and come back to it at a later date to see if it still holds water (and if they still want to do it!) However, as regular Dragon’s Den viewers will attest to, there are three key questions that often crop up.
Firstly, many investors, banks and Dragons included, will want to know the ‘margin’. This is the difference between the price of the product (usually wholesale) and the cost of manufacture; in the case of services, it is the difference between the cost or provision and price placed upon the service. In both cases, it is often quoted as a percentage, but it’s useful to know the actual numbers as well.
This becomes evident when the second question pops up : is the business idea scalable? In other words, are the processes, knowledge, and business activities replicable to the point that a decent return can be had, in terms of the margin? Does the business scale such that the return increases, at least in line, and preferably better than proportionally to the units sold?
A scalable business is attractive because it elevates the business from something that could make a living for one person working out of their own home to a profitable business that could make money for investors, employ staff, and perhaps go on to become a household brand. For example, if all the skill required to produce the product is non-transferable, it isn’t scalable, and therefore isn’t really an investable business.
Whether that matters or not will depend on the needs of the business owner – but even a scalable business needs to react to one final question : how big is the market? One person with a talent and a hungry market can make a living, but it needs a hungry market and a repeatable income generation process to become an investable business.
So, investors need all three to line up – the margin has to be interesting, the business scalable, and the market has to be big enough for it to scale into at those margins. Of course, there’s flexibility in there : higher margin products (houses) need a smaller market to generate the same amount of money as, say, biscuits.
Individuals such as human cannonballs who have a talent that is in demand, can only satisfy a finite market, and so are not examples of scalable businesses, even if they manage to build a profitable income for themselves. To become scalable, they would have to find a way to transfer that talent (stage schools take a similar approach) to others, and build a business that way.
If a business satisfies the margin, scalability and market criteria, and would be attractive to an investor, then it’s half-way to being a good idea, and certainly worth some additional thought!