Monday, June 30, 2014

Spotting a Good Business

"If anything is good for pounding humility into you permanently, it's the restaurant business."

-Anthony Bourdain

Welcome to The Golden Sense! For many, achieving the American Dream means taking control of their destiny, quitting their nine to five, and opening the doors of their very own business. These brave entrepreneurial souls have shaped American enterprise, and today, they’re playing the very important role of helping business grow in America.

Purchasing a business or starting a new business is an exciting venture. It's an opportunity to change paths and create wealth for yourself and others. There are numerous variables to look at when evaluating a new business. The best way to gain clarity on the future success of a business is to break through the noise and look at a three simple metrics.  

First you want to look at the net profit margin. While that may seem obvious, some people confuse sales growth with profits. Sales may be growing in a particular industry, but if profit margins are thin or nonexistent, you could have your work cut out for you when it comes to building the business and taking home a paycheck. After all, the profit margin represents how much you take home for every dollar in sales, so higher margins are definitely a good thing. More simply put, the net profit margin is the most reliable indicator you could use in trying to determine whether you will actually make money from your venture or not.

Sageworks, a financial information company that analyzes privately held companies, recently researched which industries had the highest profit margins over the past 12 months.

As the list shows the majority of industries with solid net profit margins are in professional services. These industries show consistent demand (no matter what the economy is doing). When a company has a strong profit margin it shows that not only the owners are taking home a solid income but that the company itself is equipped to handle the many financial challenges and variables it will face in the future.

The second indicator to look at is product or service differentiation. Differentiation looks to make a product more attractive by contrasting its unique qualities with other competing products. Successful product or service differentiation creates a competitive advantage for the business, as customers view the company as superior. If the company lacks differentiation their sales will slowly diminish as the customers will not find value in the company. 

The third indicator to look at is the cost of customer acquisition. This is the cost associated in convincing a customer to buy a product or service. This cost is inclusive of the product cost, research cost, marketing, and accessibility costs. This is an important metric because it plays a major role in calculating the value of the customer to the company and the resulting return on investment.

A common problem for new business start-ups is to hurry into elaborate print advertisements and radio commercials without knowing the target market and researching other market data. The costs associated with marketing and advertising can be expensive. If a business does not know who its target market is, then it may be a waste of money to print these ads that may contain incorrect messaging and don’t reach the company’s target market.

Cost of customer acquisition tells you whether your marketing and advertising investments are paying for themselves. Over time, your cost of acquisition should go down as growth and your brand image goes up. Sometimes customer acquisition is just about location. Some locations lend itself to naturally attract customers so marketing is less of a focus. It is important to understand the industry norms for your type of business to see if you are competitive.

By understanding the net profit margin, differentiation, and cost of customer acquisition you can get a good understanding of whether a business will either succeed or fail. A business start-up requires a tremendous time commitment and a strong will. By strategically making the right moves and keeping a close eye on these key metrics you can fulfill the dream of owning a successful business. 

As Sanford Weill said:

"Details create the big picture"

Signing off for now

T. Norman