Your business model describes how your business goes from
preparing your product or service to delivering it to your users,
and how many of those transactions you need to execute to keep up
with your operating costs.
You must include these details when creating or reformulating
your business model:
1. Suppliers and the average price of your company's
goods
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2. Labor costs per each unit your company produces
3. Selling price and the resulting gross profit margin
4. The amount your business needs to ship weekly to break
even
5. Your company's annual output and the break-even point as
a percentage of total capacity
A strong business model identifies who is buying your product or
service and why they choose to do business with you as opposed to
your competitors. It then offers a clear rationale for why buyers
will pay the price you're charging (say, $50 per unit).
Once you give solid reasons for the buying decision, you need to
report how many sales per day you make. If you say daily sales
activity averages 250 customers (5,000 each month), then the
revenue component of your model at $50 per unit is $12,500 each
day. This metric has to make sense with respect to the scale and
scope of your operation.
Next, you clarify your labor and materials costs in relation to
your expenses. Perhaps your labor and materials costs for each sale
are $28, leaving you with $22 per sale in gross profit, a 44
percent margin. If your overhead is $85,000 a month, that $22
profit margin needs to happen about 3,860 times every 30 days to
break even with your fixed monthly costs. So the model now rests on
whether you have the capability to do that kind of volume. If so,
you have a sustainable business model where the first 3,860
customers each month cover all your costs, and the next 1,140
contribute $22 each ($25,000) to your pretax profit.
Take a look at this example of a poorly-thought-out business
model: You have a "cool idea" that costs $60 in labor and
materials to manufacture, and overhead runs $100,000 per month. You
might believe a price of $75 will draw potential buyers, but with a
$15 profit margin, you'll need to sell nearly 6,700 units every
30 days--and right now you're doing business at an average rate
of less than 125 customers per day. These metrics don't
work.
Or maybe you project a price of $100 (a 40 percent margin),
which would drop your monthly volume point to 2,500 units. The
problem is, there's no way to sustain that price-point given
the competitive environment. In both these cases, the numbers
don't add up, and the business model is not sustainable. There
are many cases where entrepreneurs have come up with poor business
models where the volume needed to cover monthly fixed costs would
have to be 75 percent of the overall market share. Again, that
scenario is unreasonable, and investors won't support it.
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