Want to Change Things? Change The Economics

Posted by Jeff Carter
on October 19th, 2012

Start ups always have problems. They build a business plan, and put some numbers to it. It’s a joke among entrepreneurs and investors. Virtually every financial plan I have seen for a start up looks like this:

The chart above is a global warming chart and it’s about as true as any financial projection you’ll see in an entrepreneurs presentation! So why do investors like to see the numbers?

Because it gives everyone a bit of insight as to how the business thinks it will generate revenue from customers, and allocate the cash flows across the business to keep growing. The numbers essentially are your business strategy quantified. They show the world where the business is putting its priorities. They give you discipline. Are you hiring engineers or salespeople? What looks like the most critical piece of your business? How much is it going to cost you to acquire customers? Marketing costs? What kind of margin are you projecting? Traditionally if your business sector has a 10% margin and you are showing a 20% margin, you better have a good reason why. It’s all in your projections so that’s why they are important.

Numbers mean something. But on the run real numbers that you see in your business should mean something too. When businesses struggle they need to take a step back and ask themselves a question. What is the number that’s most important to us to drive the business forward? Then ask, what’s stopping us from improving that number?

This is where thinking like a Coaseian freshwater economist can help the business. Each of your potential customers is going to be choosing between you and something else. It’s not enough to just listen to them, find out what’s driving them. They are each going to make the best choice for themselves. Sometimes, even when a pencil sell shows they will save money using you, they don’t. There is more to it. Look and see if there are any externalities in the market that are pushing them away from you. Can you find a way around those constructs? Can you change them? Can you buy them off? Are there network effects stopping you? Can you get network effects working for you and ride a wave?

Maybe its the interface. Maybe its the way you are serving up your message. Maybe your target market is totally incorrect. There is a chance that you aren’t solving a problem that the market values. One other way to use economic theory to think about your business is to try and frame the business as a supply and demand curve. Figure out what your supply curve is. It’s much easier to wring randomness out of a supply curve than a demand curve. Generate a plan to build a supply curve into your business. This forces you to think hard about what you are taking to the market. Demand will follow if you build the supply curve correctly.

You need to get really close to your customers and listen to them. Too often entrepreneurs go through the motions. They think they are smarter than their customers. That’s just like a trader saying they are smarter than the market. When you think you are smarter than the market-you go out of business.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.