There’s a lot to be said for a simple “back of the envelope” (BOTE) calculation. Done properly, it helps you quickly assess new venture ideas and explore alternative business models.
For example, if you see an opportunity in widgets, there are many ways of going after it. You could sell widgets direct to customers; sell widgets wholesale; rent widgets out; sell leads to retailers; sell advertising to widget-brands; advise widget customers; consult to widget makers; etc etc. How do you decide which to use?
One approach I’ve found very useful is to spend a few hours with pen, paper, calculator, search engine and (most importantly) an open mind. Running some back of the envelope calculations like this can really help before committing to an idea and specific business model.
I like to start with the outcome I want/need (e.g. $1.0M sales) and work backwards to arrive at the number of customers/users/units/…etc required to achieve it. Use your trusty search engine (or a phone call) to quickly find benchmarks or industry averages for the intermediate steps (e.g. conversion rates from visitors to customers; employee salaries; etc). Adjust these depending on your model – for instance, you can’t typically expect to offer distinctive customer service with a lower than average number of service staff. And once you arrive back at the “start”, apply some sanity checks on your assumptions and implied results. How consistent and/or reasonable are they?
Back of the envelope calculations can also highlight key differences between business models. For instance, they may suggest that a direct sales model is best if customers will pay more than $50 each but otherwise you’re best going with an advertising model (assuming an industry-average rate card). You can then go and quickly test how much customers are actually willing to pay and make a confident decision on business model accordingly.
So if you’ve got a business idea, make sure you thoroughly explore the options by investing a few hours up front in back-of-the-envelope calculations…