One of the first things an entrepreneur should do before investing time and money into a new venture, is to determine whether the market is big enough to support your business. In this blog post I am going to go through an example that will demonstrate how to estimate the size of your market, and how to determine whether it is big enough to allow you to meet your goals as a business owner.
Market for an Innovative Startup
This process is really back of the napkin type math, but it is so simple that many entrepreneurs simply overlook its necessity.
For example, let’s say you have a new payment technology that would make it more efficient for consumers to make large one time payments. Your solution is an alternative to a wire transfer from your local bank which may cost the consumer between $20 and $50 just to wire the funds. Maybe your solution is much more efficient and you only charge $1 to transfer any amount of funds up to $1 million. Sounds great right? Everyone should start to use your product, but now the question is, even if everyone starts to use the product, is the market big enough for you to make a profit?
After a bit of research you find that the average consumer performs a wire transfer once every 5 years. Most people will never make a wire transfer, and those that do, don’t transfer large sums very often. Let’s say you find that there are 10 million wire transfers made by consumers each year. You know that if you advertise you can acquire a customer for every $1 of advertising. So let’s say you invest a million dollars in development of the system and a million dollars in marketing/advertising.
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This will allow you to acquire 1,000,000 users.
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Each user will perform (on average) 1 wire transfer every 5 years.
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You have 90% gross profit margins per transfer, in other words you make 90 cents per transfer
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So in year 1 after investing $2 million you will make 200,000 transfer x .90 = $180,000
So is the market big enough in this scenario? No. It would take you over 10 years to generate $2 million in gross profit. The back of the napkin math does not work, so you should not waste your time, energy and money to take on this project.
The purpose of this blog post is not to tell you that wire transfer technology is a bad idea, it is simply to show you the process that you should think through before you start a company. If all goes as planned, is your market even big enough to allow you to generate a profit someday? If not, don’t waste your time.