How good is your business model's product-market fit, feasibility and profitability?

You have your business model in place. Do you know it’s any good?

Heikki Immonen, Karelia University of Applied Sciences

There are three fundamental viewpoints that help you evaluate your business plan and business model, specifically. Two of these viewpoints are not discussed in this article: 1. Is your business model -related understanding and knowledge of reality valid? 2. Have you correctly accounted for the limiting factors of the broader business environment?

The focus of this article is the third viewpoint that focuses on studying how well the elements of your business model work together to produce successful business outcome.

To evaluate the quality of your business model, you need to ask three main evaluation questions.

Business literature and experienced business people know various types of criteria and frameworks you can use to evaluate your business model. One type of framework, used in the Draft Program® is inspired by Scott Anthony’s three-dimensional model (2014), but which we have adjusted throughout the years.

Key to understanding these types of frameworks, including ours, is to see them as parts of what it means to be successful. In our case we define business success as having a good product-market fit, good feasibility and good profitability. When all of these three things come together, we have a successful business.

Product-Market Fit

Do your potential customers want to buy your product? If nobody wants to buy your product at the price you have defined, your business will fail. You have a good product-market fit if your product solves a currently poorly solved important customers problem better and/or more cheaply than existing competing solutions.

Two commonly known processes related to developing a good product-market fit are called market research, and product development. A specific combination of a product, price, customer need and competition, is called a value proposition.

Based on our experience, a novice entrepreneur often focuses only on the product and its features, and misses the market i.e. the other aspect of the product-market fit.

Feasibility

Are you able to deliver a product that works as planned? If not, your business will fail. Does the product or service you are offering really work? Is it really solving the problem as planned? Do you have the resources, such as skills, to produce it as planned? What about funding and other consumable resources?

Processes linked to improving feasibility are called resource management, human resource development, recruitment, resource acquisition and fundraising. When new business models are based on what is already feasible, it is called effectuation.

A common scenario we have witness in our business advising work during the past decade or so, is a situation where a person has developed an idea for a software product, but lacks the skills to produce it. They think that the solution is to get funding and pay some external software company to develop the software they need. This strategy fails too often as there is rarely enough funding to develop a new software to completion without the entrepreneurs themselves investing their time on developing their product.

Profitability

Will the business generate the amount of income and profit you want? You might have a good product-market fit and a high feasibility, but your business will not bring you and your investors the income you want. This will result in business failure. To evaluate profitability an approach called reverse income statement is used a lot in the Draft Program®. It starts from your financial goals and it gives you how much you have to sell to reach that goal.

Lean production and thinking are processes that make business processes more efficient and less wasteful resulting in lower costs.

One of the saddest end-results when launching a new business is when the business is up and running, but the business even in theory cannot produce enough profit and income. This happens, when novice entrepreneurs fail to calculate properly how many customers they need to reach their goals. Because of this they get trapped in a too small business.

Business planning is a balancing act between different trade-offs.

Trade-offs can happen at different levels of your business. As you change and modify your business model, for example by increasing pricing, you improve an aspect of your business, such as profitability. If this however results in worsening of some other success factor, like product-market fit, you have a trade-off.

A high-level trade-off happens when improving one of the three business success elements (product-market fit, feasibility, profitability) worsens one or more of the other two success elements.

Lower-level trade-offs happen within a specific success element. A classic trade-off related to feasibility is time and money. You can spend money to get something done quickly. On the other hand, you can spend more time yourself, and thus save money as you don’t have to buy the services of somebody else.

In business planning, trade-offs pop-up all the time. When you realize they exist, you avoid the trap of focusing on optimizing a single aspect of your business while forgetting to think how it affects all the other parts of your business. Let’s look at some of the most crucial ones.

Price-related trade-offs

This a classic one. Product-Market Fit -thinking teaches you that if you lower the price of your product, the demand will increase. However, as you lower the price while your costs remain the same, your margins per sale drop dramatically. Thus, even though you might even get more revenue, your profitability will drop. On the other hand, raising the price can dramatically increase your profitability. The problem is that higher price requires typically a corresponding increase in your product quality. Do you have the resources and competence to improve your product in such a way? Is there even need market for such increased quality?

One of the best ways to avoid setting up a too small price, is to do a profitability calculation using a reverse income statement. If you price is too low, the number of needed customers grows way too large.

Product-related trade-offs

The quality of your product as experienced by the customer affects directly the price-level they feel as appropriate. Increasing product quality might increase revenue, but it also can easily make manufacturing much more costly, which will result in poorer profitability. A higher-quality product can also easily require capabilities and resources that you don’t (yet) have. Plus, there is always the case where the number of customers capable of paying a higher price even if the quality increases, is limited.

One of the least appreciated business strategies is to focus on the low-end segment of the market of which is un-attractive to existing companies serving that market. Strategy that is based on offering an affordable, though lower quality, product to this market is called disruptive strategy (Christensen, 1997)

Production or marketing process -related trade-offs

A fundamental trade-off all business processes have is between adaptability and cost-efficiency and speed. If you want to have production process that allows you to tailor each product based on each customer, you will almost automatically increase your production costs and time. On the other hand, as tailored products are typically one factor of product quality, such a high-quality product could allow you to have a higher price. This trade-off applies also to products where more processing is needed, even though the products themselves are identical.

There is a great systematic way for a startup to make all-important first recruitments. First make list of the tasks expected of the new recruit. The review applicants’ background and work history to find evidence of person successfully accomplishing similar tasks in the past. (Smart & Street, 2008)

Resource-related trade-offs

In entrepreneurship, and in life in general, there is a fundamental principle, which says that your resources (skills, tools, time, money, energy) define and limit what you can do. So, if you increase and diversify your resources, you have the possibility to do more and more types of things.

With a lot of different types of resources, you are better able to find a product that has an excellent product-market fit, or a marketing process that is most cost-effective. The problem is, of course, that by investing more of your resources to your business, the required profitability can become much challenging to reach as it takes more time to pay for the initial investments. You sacrifice short-term profitability for long-term profitability.

Another trade-off related to resources is not, however, as obvious as with some other aspects of a business model. The problem with a lot of resources, is that you feel less pressure to innovate and find more efficient new ways to build and produce things. Thus, scarcity can be a blessing in the long-term as you become very cost-conscious and eventually out-innovate the competition.

Target market –related trade-offs

When you select your target market, the key trade-off to keep in mind is the trade-off between market size, competition and profitability. Big markets, like big cities, have fierce competition and your product-market fit must be very good for your business to succeed. If you succeed, a lot of potential customers translates then to big revenues and good profitability.

On the other hand, should you select a smaller target market, the competition is typically less fierce, which makes it easier to gain successful product-market fit. You can also then specialize to your specific niche market. The problem you face then, is whether or not there are enough customer in total to satisfy your profit and income goals.

Because of internet and globalization, in general, a very specialized niche market can be big enough to support profitable businesses. This is because, even though, number of customers on any given geographical area is not big enough for a profitable business, together the market is big enough.

About this article

The writing of this article was supported by the INnoVations of REgional Sustainability: European UniversiTy Alliance project. https://www.invest-alliance.eu/ . This project is funded by the Erasmus+ Program.

The content of this article represents the views of the author only and is his sole responsibility. The European Commission and the Agency do not accept any responsibility for use that may be made of the information it contains.