How to assess a business idea?

How to assess a business idea?

Imagine that you want to open a business and are deciding what you want to do. What is more profitable: making benches out of concrete or selling seeds? Or maybe you want to resell garlands from AliExpress? 

For physical goods, the following things are fundamental:

The first is volume and mass

In fact, a piece of physical goods always weighs something and always takes up some space. And in economics, space and mass are related (almost like in the theory of relativity). A heavy but compact commodity is equivalent in its characteristics to a light but voluminous one.

The second is the shelf life

It is either physical (the product spoils), or there is obsolescence (competitors come out with better specifications).

And now I will tell you how these qualities can help or hinder your competition in the market. I will mainly touch on the first aspect - mass and volume of the product, and then you can draw conclusions about the shelf life on your own.

The mass and volume characteristics and economics of products

It does not really matter how much space a product takes or how much it weighs.

What matters is how much a kilogram or a unit of volume costs.

Let's call this characteristic specific weight value or just specific value. Weight is more important for some goods and volume is more important for others. As I said, this is a kind of law of economic relativity of mass and volume. But for the sake of simplicity, I will refer to all of this as kilograms.

In addition, by "cheap goods" or "expensive goods" I will be referring specifically to their classification by volume-weight specific value, not their price in absolute values.

For example, cement and Styrofoam are cheap goods. In the first case, a kilogram is cheap, and in the second case, a cubic meter is cheap (and we don't care as much which is which). And iPhones or medicine are expensive.

Option one: Our product is expensive

A typical example of an expensive product is a smartphone and other small electronics, medicines.

The share of logistics in their total price accounts for, God forbid, a couple of percent of the cost.

  • What this means for us?

A huge, virtually endless market. And at the same time, the toughest competition. We compete with all the players in a large territory - in the country or in the world - because the cost of logistics is relatively small. We are limited only by duties, certifications and other policies, but not by economics.

  • When it's bad for us?

When we don't provide anything unique. An example is any store that sells iPhones at average prices and has no side income from cases, cashback or ditching investors.

The outlook for such a business is exceptionally negative.

  • When it's good for us?

When we sell something unique or can save significantly on costs while being in a country with cheap labor. Example: we make awesome, handmade cutting boards that sell on etsy to Americans.

  • Why get into it?

Your potential market reach is very large. Probably the whole world. By supplying expensive and competitive goods to the whole world, sometimes you can even exist in an extremely narrow niche (like cutting boards).

Expensive goods require lower unit costs for operations, so it can be profitable to make them without economies of scale and even artisanally, if the right niche is chosen.

By the way, how is a service for such goods better than a trade? Very simply: logistics to the end user is always more important for the service. And this means you can escape the harsh world of competition.

So if you are thinking about opening a store with electronic trivia, it is better to open a repair shop. Or manufacture designer shoes or cutting boards. Send me later a can of caviar for sound advice.

Option two: our product - the average cost

This large appliances, furniture, decorating materials, food products with standard shelf life.

The share of logistics in the wholesale price of such goods will be 5-20% of their total cost. The price of logistics is essential for competition in the market, but it is not yet total.

The area of competition is narrowing, but the price of logistics is also growing. All this creates a very complex market landscape. Niche nuances rule here.

In short, there is no general advice. You have to understand the niche. 

How and what can you use macroeconomic estimates for? First of all, to understand the necessary volume of investments.

Option three: cheap goods

The share of the logistics component in the cost of production - 20% or more. Example: cement, soil, firewood, sand, water, building blocks, foam plastic, rolled metal.

In the niche of cheap goods, the price of logistics is decisive. As a result, they have a clear regional connection.
An interesting feature of cheap goods is that they are transported by sea. And transportation by sea is very cheap for large volumes. It is so much more profitable than all other modes of transport that all the ports of the world are, in fact, in the same economic space. 

Logistics is a determining component in the price of cheap goods. So to understand their economics, it can be interesting to look at special maps, such as a map of distances from different places in the world. With the correction of the fact that this particular map does not reflect the cost of transportation, but tells only the speed of the fastest mode of transport. 

Well, and an awesome fact for small businesses in the niche of cheap goods

Paradoxically, the rigid regional binding leads to the fact that starting a business in the low-cost niche can be much easier than in the more expensive ones. First of all, because of the limitation of competition - and especially if you do not do manufacturing, but trade (remember the capital intensity of production in this category!).

But it has to be work with large batches of products, otherwise the transaction costs and the negative effect of scale will eat up all your margins.

If you only have access to small batches, don't get involved with such a business under any circumstances. Growing and selling cheap grain is profitable only by the carload. Vegetables, bricks, sand, water - well, you get the idea. But it already makes sense to grow seedlings on a hectare or two, maybe something will turn out. All this directly follows from the unit price of the both.

Cement, gypsum - same thing. Tons, tens and thousands of tons - norms, kilograms - trash. And decorative panels are more expensive, up to hundreds of rubles per kilogram. This is why their production can be done in much smaller batches and with less capacity.