Please stop
Between judging business plan competitions, sitting on loan fund award panels and responding to inbound entrepreneurial referrals, I read a lot of business plans. Over the past two days I read through five different plans in preparation for the initial review round of a regional loan fund.
Entrepreneurs, we need to talk.
Remember last week when I asked you if your great idea was a great business? Remember how we talked about market research and market analysis? Apparently, many of you didn’t realize I was serious about the “research” and “analysis” parts.
When it comes to market analysis, many of the business plans we read fall into what some of us call the “Chinese glove” fallacy. It goes something like this: “There are a billion people in China. They all wear gloves. We intend to sell gloves for $1. If we only get 10% of the market, then we will make $100M. And that’s just China. We’re all going to be rich!”
What’s wrong here? For starters, even though the statement is about the market, the entrepreneur forgot both the research and the analysis.
Here’s a couple more real-world examples, from business plans I’ve reviewed lately (paraphrased as bolded for anonymity).
Research Service reports that if only 10% of installed locations adopted our technology, the global market for these types of systems alone could reach $50 billion by 2012.
And another:
The market segments both benefit from our product and they, alone, provide our company with very strong
revenue and EBITDA projections, if only capturing a small fraction of the total opportunity.
Please stop.
Entrepreneurs, you absolutely need market information in your business plans, but you need to do your homework. This is a critical section of your plan, one that many of the people reading your plan will turn to first or second, and if your information is self-serving or not adequately reasoned, you are going to greatly reduce the chances of your business being seriously considered.
All of us have our own opinions as to what needs to go in these sections. With this post and talk about what I look for and some of the basics you absolutely have to do.
Start with Top Down
First thing to do is define your Total Addressable Market.
Ultimately, every product or service is purchased by a human. There are roughly 6.8B people in the world. This does not mean your total addressable market is 6.8B people. Absurd example, yes. Disturbingly similar to language I read every week? Also yes.
Your TAM is generally reflected as the total potential amount of yearly sales for your product or service. It’s purpose is to show both the size of your market and your business’ potential upside. However, it also has to be realistic or your numbers will be discounted. Coming up with a realistic yet comprehensive representation of your TAM is not so much art form as good top down research.
Let’s say you’re that glove manufacturer and you want to represent your TAM. I’ll leave it to you to fill in the numbers, but your market overview might go something like this:
We intend to focus on the North American market first to minimize distribution costs. With our focus on industrial gloves, our research shows X sectors that heavily use industrial gloves. Further, our research shows that X% of total workers use gloves with a replacement rate of Y% / year.
Now come Bottom Up
Once you have a reasonable total addressable market, now you need to figure out what portion of that market you can sell to. Even with good top down market research, odds are you are not going to sign up the entire market as customers. This also shows those that read your plan that you’ve put real thought into how big your realistic market is. This makes us feel a lot better about your sales forecasts and by showing good analysis of your market, you may get a carryover halo effect to your sales forecasts.
So what might bottom up analysis look like for our glove manufacturer:
Taking those starting market segments, we are factoring out industrial locations with employment less that 100 factory floor workers. Of the remaining locations, our focus group research shows us that our product offers unique benefits to oil refiners and chemical processors. That leaves us with a total addressable market of Z gloves / year, or $
Good market analysis is critical for your business. Without solid, critical market analysis as the foundation for your business plan and sales forecasts, not only will you not get far with most investors reviewing your plan, more importantly you’re selling yourself and the potential success of your business short.
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Comments
You are right Simon – passion, faith and commitment are essential to entrepreneurship, and often entrepreneur see possibility where the rest of us don’t. It’s a fine line between giving giving “real world” feedback and not killing dreams and potentials. That’s why I at least tend to coach entrepreneurs along the process versus try to assess the viability of their concept.
This is great Dave. You must see many more business plans than I do, but on the occasions that I see ridiculous claims of a potential market, it makes me cringe.
It’s hard, though, not to get excited and to thoroughly believe that ones product can address the needs of everyone at the right price and quality.
Research often tells us what we don’t want to hear, too, and we reject it. The emotional blow can be painful.
But ultimately, disappointment and wasted money are the result unless we do a proper job of the research and analysis.
I wonder how Pontiac execs felt after the launch of the Aztec? (‘Everyone wants an SUV that they can afford that has room like a minivan, but styled like a saloon… All the hard-up SUV, minivan and saloon owners in America will surely want one!’) DISAPPOINTED I’ll bet.