Connecting the Dots

Oct. 1, 2000

Connecting the Dots

By Bill de Decker October 2000

What do you do when you, or someone you work with, gets an idea for a new product or service? The obvious question is; "How can we develop this idea and make it a success?" Over the years, I've had a lot of ideas, and some have even been successful, including one that Greg Napert wrote about in his editorial in the July 2000 issue of AMT - a course called Principles of Troubleshooting.

It so happens, I was part of the small team that developed that course for FlightSafety in the mid-eighties. I thought it might be interesting to look at the process we used to determine if an idea I had while flying in an airplane was worthy of being developed into what has proven to be very successful course. There is a very definite process involved in determining whether an idea can be turned into a viable product or service and this process is the same whatever the idea may be. Each step helps pave the way for the next one and shows you whether you're on the right track. It's sort of like a series of dots and your job is to connect the dots and see if it makes a great picture or not.

Does it pass the reality check?
It all starts with an idea. Sometimes the idea comes to you out of the clear, blue sky and sometimes it is the result of long discussions and debate. In either case, once an idea for a new product or service has formed, the very next step is a reality check. The reality check consists of two questions. The first question focuses on how well the proposed product or service fits in with the focus of your company. Every successful organization has a strong focus that helps it excel with its customers. As long as the new opportunity fits into the overall focus of the company, the company can bring most, or all, of the resources that have proved successful, to help solve the challenges presented by the new opportunity. But, if the opportunity does not fit the company's focus, little of its knowledge or resources are of any use to solve the inevitable problems.
The second question is whether anybody else thinks this is a good idea. Three groups of people need to be included in this check:
1. Management - after all, they will have to pay for the development.
2. Co-workers - those that will have to help you develop and implement it. If they don't see the potential, they will not be very cooperative.
3. Potential customers - people who will have to pay for the product or the service. If they don't see the need for the product or service, there is not much point in continuing.

What are the risks involved?
The second step takes a close look at the downside potential of the idea. Specifically, it focuses on the risks involved and what can be done to do to manage them. These risks, of course, vary for each opportunity, but there are several risks that are common to all new ideas and must be analyzed for each new opportunity.
One important consideration is whether you will be selling a new service to your existing customer base; or an existing product or service to a new group of potential customers; or a new product or service to new customers. In the first two cases, one half of the selling equation is well-known, can be analyzed fairly easily, and therefore, the risk of failure is low or, at most, moderate. On the other hand, if both the service and the potential customers are new to your operation, the risk is high, because, without extensive research, you won't know enough about your customers' needs or the benefits of your new service to make a convincing marketing case.
Competition will have a major impact on the success of the new opportunity. If you are launching your new product or service or looking for new customers in a very competitive environment, you will be fighting an uphill battle. However, if there is little or no competition, the risks are a lot less. Your potential customers will have fewer choices and there will be no existing loyalties that need to be loosened. They will also be a lot more tolerant of the inevitable problems experienced during the start-up.

Lowering your risks
Thus, the opportunities with the lowest risk and the highest probability of success involve marketing new products or services to existing customers. When the customers know and trust you, the only sale you have to make is that you understand how to provide the new service.
If the competition is weak, marketing existing services to new customers will be easy, since you have a good track record to point to. If the competition is strong, this will be difficult, since you will have to detach the bonds of customer loyalty plus sell your capabilities.
Lastly, experience shows that marketing a new service to new customers can usually only be done in the absence of strong competition and even then, it may not be successful.
Another risk question concerns who will implement, manage and market the new product or service. If you use in-house people, can it be added to their existing workload and/or who will take over their existing responsibilities? Whatever you do, you don't want to mess up your existing business. If the answer is you will need to add some people, where will you find them and what will you do with them if the product or service does not work out? Remember, it is hard to hire good people and it is even harder to let them go.

What are the finances?
The third step always concerns itself with the money, specifically, finances. The finances in this case are not the kind of numbers that would be found in an annual report or a business plan. Instead, what is needed is the big picture, based on estimates of the major cost and revenue elements associated with the opportunity. No detail is required and amounts can be rounded to the nearest $1,000.
The first area to examine is the potential profit. This is obtained by subtracting the estimated expenses from the estimated revenues. For example, assume you have calculated that the potential revenues for a new type of overhaul service are about $150,000 per year. Next, you will need an estimate of the expenses. This can be hard to do, but here is a proven approach. First, estimate the annual salaries of the people required to develop, produce, and market the product or service. Then, add any major material costs or services you will have to buy from vendors. Finally, double the resulting costs. Experience shows this is a reasonable approximation of the expenditures required for the program. When the estimated expenses are subtracted from the estimated revenues, you will be left with the estimated profit. Let's assume the expenses for this example are $100,000, which leaves a profit of $50,000. That means the opportunity is potentially very profitable. If, on the other hand, the projected profit is only $5,000, there is almost no room for unexpected expenses and this would indicate it is not a very good opportunity.
Another important cost factor to determine is the break-even point. Assume in the example above that selling 50 overhauls at an average of $3,000 each generates the revenues of $150,000 per year. But, what happens to the profit picture if your best marketing generates only 30 overhauls? Obviously, this would lower the estimated expenses somewhat, but most of the expenses (such as salaries) would remain about the same. The expenses might only reduce to $80,000, yielding a profit of just $10,000. By plotting this, it can be shown that the break-even point is 25 overhauls, showing that there is a margin between break-even and the predicted market of almost 2:1. By business planning standards, this is a very conservative margin that indicates there is sufficient extra revenue to cover unexpected expenses. This is important because experience indicates that expenses on a new project almost always exceed the original predictions. So, any ratio of less than perhaps 1.5:1 should be cause for further study.

The flipside - losses
The last question concerns the size of the loss if the project turned out to be a failure. In the preceding example, this might be $10,000 for materials and sunk marketing expenses. It's not pleasant, but it is important to know the size of this potential cash loss. If it is larger than your company can handle, it indicates it is really important to review the risk involved in the opportunity. And, what should you do if you can't afford the potential loss and the risk remains significant? Very simple, don't get enchanted with the potential profits. Instead, walk away from the opportunity, or figure out another way to make it happen.

Timeline for analysis?
Maybe 8 to 10 hours and a number of meetings and telephone calls spread over several days. Will it cause you to avoid some opportunities that might have worked? Absolutely. Is it worth the effort? Definitely. Because this kind of analysis gives you some assurance that you'll be putting your limited time and even more limited money into the ideas that have a high probability for success.