Revenue Estimation

Now, let’s continue our discussion on business plans. The next step in the process, is developing an intuitive sense of the financials behind your business. I’ll go through the revenue side and costs side separately to prevent random confusion.

Revenue is just basically how you’re going to make money as a business. Revenue is pretty much just a function of the products you sell, and how much you’re pricing them at. Figuring out the pricing is pretty easy – it’s very easy to determine if something is going to work or not based on nearby market trends, am I right? For instance, if you were going to start a brand new restaurant selling a particular type of cuisine, you can easily look up how much other restaurants are charging. The problem however, arises when you try to sell someone something that they have never heard of before, like Uber before it came out. What should you price it as? I have no idea, and neither do you. That’s okay.

There are many schools of thought on pricing. There is the ‘competitor approach’, which is figure out what the closest substitute to your product is, and charge at that price. Going back to Uber, they price their cars at pretty much the same price as taxis. This is much easier said than done sometimes though. For instance, if your product is a brand new razor that is 10 times better than anything on the market, should you price the product at 10 times the price of a normal razor? Hmm.

The next pricing approach is actually the ‘value approach’. This is basically figuring out what your product is worth to somebody, and base your decisions from there. Take the digital camera for example. Back in the day, if you needed to produce photos, you needed film and you needed to bring that film to the shop to be processed. Digital cameras solve that by allowing the photo to be seen almost instantly. How much is that worth to someone?

The last approach, is the ‘cost approach’. This is by far the worst method, yet still worth mentioning. It’s basically figuring out how much it will cost you to produce a single unit of the product, and slapping a margin on it. This obviously does NOT always work. To the great chagrin of the American car industry, the Japanese carmakers managed to undercut them by pricing based off what consumers would pay, and doing everything to get their costs down to a profitable price.

The next post, we’ll briefly touch on quantity estimations.

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