Table of Contents
1 Introduction
Do you have a business idea, but are not sure whether it's actually a good one?
In the following, you will learn about a simple methodology that helps you assess the market potential of any business idea very quickly.
Therefore, we will look at the most important parameters an early-stage investor would consider when making the decision whether to invest in a startup or not.
The methodology presented is inspired by the work of Jared Friedman from Y Combinator, who is undoubtedly one of the best minds when it comes to evaluating business ideas.
At the end, your business ideas should:
- Solve a big problem,
- which exists in a large market,
- with you having a unique insights on how to solve it.
Let's look at each of these points in more detail.
Is the problem significant enough?
Understanding the problem you are attempting to solve is the best indicator for future success. The bigger the problem, the more willing customers are to use your solution to solve it and pay you for doing so.
Therefore, ask yourself whether your business idea is solving a big enough problem. A big problem can have different characteristics, such as:
- Painful: the more your customers suffer, the better
- Growing: the problem keeps getting bigger
- Urgent: customers need to solve the problem right now
- Expensive: it is expensive to solve the problem
- Mandatory: customers are required to solve the problem
- Frequent: customers frequently encounter the problem
Your business idea does not need to meet all of these characteristics; a few will be sufficient. However, if the problem you are trying to solve is very painful, expensive to solve, and growing fast, then you have a strong foundation to build a business around it.
If you are not sure whether potential customers really perceive something as a problem, then simply reach out to them and conduct a brief interview.
Such conversations will generate lots of valuable insights and help you understand whether you are actually trying to solve a meaningful problem.
Is the market large enough?
Betting on a big problem is not enough if only a few people have it. Therefore, you must find a business idea in a market that is large enough or growing quickly.
But what qualifies as large enough and growing fast?
1 Billion USD +
In general, you should target business ideas that address a market of 1 Billion USD or greater.
To measure the size of a market, investors typically consider the total available market (TAM), which is the total value of products and services sold in a market over a year. You may find this information when researching the size of your target market. However, I prefer a bottom-up calculation, which is more graspable.
Consider how many potential customers you could target in a market per year, and multiply that amount by a potential price for your product. This calculation will give you the market size:
Market size = potential customers in target market per year * potential product price
Imagine that you can capture 1% of a market worth 1 Billion USD (which is already difficult). Assume you would realize a 10% profit margin (a standard rate). Your business would create a profit of 1 Million USD per year. This is something, but not necessarily huge.
Investors usually prefer to see greater potential. Entering a business with profit potential below 1 Million USD is generally considered unattractive. Therefore, look for markets larger than 1 Billion USD.
Growing above 20% (CAGR)
There is only one reason to build a business in a market smaller than 1 Billion USD: if it is growing quickly.
Fast-growing markets present many opportunities, as products and services are just beginning to emerge and establish. In the best case, such markets become huge, and early movers may become dominant companies.
The speed of growth is usually expressed as CAGR, or Combined Annual Growth Rate—the rate at which a market is growing each year.
It's that simple to determine whether you have a good business idea. Get these points right, and you'll be off to a great start.
Do you have a unique insight?
Having a unique insight is important, as it can greatly ease the process. However, having a unique insight does not necessarily mean that you have to invent a completely new solution that no one has ever imagined.
A unique insight can come in many forms, such as:
- Having a special set of skills, experiences, or talents to solve the problem
- Knowing how to make things 10 times better
- Being able to create a rock-star team in that relevant field
- Having an invention that can solve the problem
- Having access to certain assets that others don't have
- Already having an existing and suitable marketing channel
- Being the first mover
- The timing being just perfect
At the end of the day, simply ask yourself: "Why am I the one succeeding in this field?"
Summary
How do you know whether your business idea is any good?
This article discusses how to assess the market potential of any business idea by asking three main questions:
- How big is the problem
- How large is the market
- Do you have a unique insight
This methodology may be simple, but the questions it poses are crucial in determining whether the foundational aspects of a business idea are solid.
Intuitively, these questions make a lot of sense. If you can solve a major problem in a sizable market with a unique approach, then you may be onto something promising.
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