Go with your Gut

Posted on 18 August 2009

I develop a lot of startup business plans and I suspect that one of the biggest unknowns is the assumptions made around deriving your top line – revenue.  It is relatively easy to come up with the number of people you are going to need to start your company, you know that you will or will not need an office space, you may need a few computers, this is all easy to estimate.  Furthermore, your estimate is probably reasonable and is within an order of magnitude of what it will actually end up being, but these are all expenses.

Where it’s not so easy is around sales and estimating revenue.  The level of complexity around this estimation is dependent upon the nature of the business plan.  As an example, if you are writing a business plan for a new hotel that you want to build or purchase, it might be a little easier because your business by nature is bounded.  If I build a hotel that has an occupancy of 100 rooms, I can safely estimate that my revenue is going to be a factor of the occupancy rate (between 0 – 100%) for any given day.  A difference of 60% occupancy versus 70% occupancy might make or break a business opportunity, but at the end of the day, it’s basically a 10% difference in revenue over that period.  There are some methods to try to fine tune your estaimates, probably the most useful is comparables (often referred to as “comps”).  You can go to neighboring hotels and count cars in the parking lot to determine your competitions nightly occupancy.  You will likely not get the same occupancy the day you open, but your business plan can start to become more realistic when you have that type of data at your disposal.

Now look at what the internet has done for us.  A web based business plan is open for business 24 hours per day, 7 days per week.  It’s open in literally every region and country of the world.  It is not limited by only having 100 rooms of occupancy.  I always hear the guy that invented the pet rock is a millionaire.  I don’t know if it’s true or not, but lets say that when he invented it he had the internet at his disposal.  The inventor creates a web site, puts a picture of his pet rocks on the site for the world to see, and puts an order form on the site so that anyone in the world can order his pet rocks.

There are a number of unknowns with the pet rock business plan.  What is the size of the market, are all 6.7 billion people on this earth your market?  Probably not, only about 24% of the world’s population has access to the internet.  And what percentage of those internet users will ever see your site, not many?  Once on your site, what percentage will actually go about filling out the form and paying for the pet rock?  You see where I’m going, you end up with click through rates times conversion rates times other rates I haven’t even mentioned – a myriad of compounded rates.  What you end up with is a revenue estimate that is very sensitive, a conversion rate on your website of 2% versus 3% might make or break your business plan and mean the difference in millions of dollars of revenue.  There are industry standards that you can lean on, but in the end you have to use your gut feel for what washes out to be some sort of revenue estimate.

My advice to people is to ask themselves, does this revenue model feel right in my gut.  Does the revenue make sense, does it grow smoothly or are there huge spikes?  Is it conservative, did you back into the revenue?  If you are comfortable with those things, then it’s likely that your business plan is realistic and hopefully will have legs.

1 Response to Go with your Gut

  • […] putting together an estimated revenue stream for a start-up, and how sometimes you just have to go with your gut feeling. What I have learned to do is to back into my revenue calculation, using a worst case […]

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