Before making any significant investment, competent business managers thoroughly analyze the opportunity. They will perform a financial analysis to justify the investment. The typical analytical model employed is a discounted cash flow analysis. The two major components of this methodology are the upfront investment and the ongoing cash flow from operations. The initial investment is straightforward. It includes the outlay for land, building, furniture, fixtures, and other startup costs to be capitalized. A cash flow analysis employs the typical expenses incurred in your existing outlets. The cost of Goods Sold and Labor vary with sales. Most other expenses are fixed, at least on an annual basis.
Business activity is reflected in revenue. Revenue is the critical component of cash flow from operations. The business owner must determine the revenue required to achieve the target Return on Investment. The revenue target is the product of the number of transactions and your average transaction value. The average transaction value is revenue divided by the number of transactions. You must know your customer’s behavior to make that forecast. You must know who they are and why they visit your establishment. You must know how often they trade with you and how much they spend. You must know their demographics, i.e., their age and income level. You must know as much as you can about your customers. Detailed customer information will help you build a revenue model to complete the cash flow expectation.
Early in my career, I was the Director of Planning and analysis for the Retail Group of a Fortune 500 Conglomerate. I spent most of my time evaluating investment proposals for prospective new stores. Later in my career, I became adept at prioritizing markets for expansion. Every market, (think SMSA) is a collection of trade areas (think neighborhoods). You determine the viability of a market by researching its trade areas. Understanding the trade areas means understanding their demographics. The prioritization of potential trade areas is based on the performance of existing outlets in their trade areas.
Once you have established the revenue required to achieve your target ROI you must determine if it is reasonable. The business owner can confidently move forward if the revenue estimate is reasonable. If the revenue cannot be justified, further consideration is required. The data from one point of distribution is not enough. One needs three to five locations or more to generate reliable data.
How does one validate the revenue required to make an investment work? Forecasting the exact revenue amount is not realistic, however, one can determine a reasonable range. One obvious metric is to compare an existing location to the site under consideration. The comparable location should match the size of the trade area, accessibility to prospective customers, the number of competitors, and the number of prospective customers with the ideal demographic profile, etc. The revenue generated by the comparable existing location suggests the potential for the site under consideration. There are other ways to validate the targeted revenue, but this example is instructive.
What do you need to know about your customers?
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- Who are they? Socio-economic profile
- Where are they coming from, home, work, other
- How far do they travel? Time/distance
- How often do they trade with you?
- How much do they spend?
- Age
- Household income?
The entrepreneur must assemble the customer information required to complete their analysis. There are many sources to consider data owned by the entrepreneur. Credit Card vendors can supply some of the data, and some may be acquired by a third-party researcher at a cost.
Begin by collecting your customers’ data from your internal records. Internal records reveal average transaction value (check average), activity by day, daypart, and month. Credit card companies can provide aggregated information about consumer demographics and residence. Third-party marketing researchers can help determine the boundaries of your trade areas. They do this by plotting the customer’s home and work address. The point is to know enough to forecast the revenue potential from prospective trade areas.
Finding customer data
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- Customer Surveys
- Data shared by credit card and other 3rd party vendors
- Size of trade area by home/workplace, map their address
- Beware of destination venues for projections
SUMMARY AND CONCLUSION
The successful entrepreneur knows his customers. He continually works to understand their evolving wants and needs. This is fundamental to running a successful business. Continued success for any size business requires customer knowledge. This knowledge helps the business owner retain their customers. New products, services, and programs are based on customer insights. Without a customer insights program, the business owner is on shaky ground. Without solid customer data, significant growth of the business is not realistic.
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Jim Weber – Managing Partner, ITB Partners
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