Managing Costs as a Business
Breakthrough entrepreneurship is about solving problems — but it’s only half the battle. If you’ve brainstormed a business idea and have a sense of the customer pain your product can solve. The next step in your billion-dollar business generating process is to figure out if you can fill that need profitably.
To do this, you need to understand the value proposition you’re creating. Estimate the economics as best you can so as to figure out ahead of time if customers will actually agree to purchase your product or service for significantly more than it costs you to produce it.
Three factors make up your value proposition:
Production cost: What will it cost you to develop and produce your product or service?
Customer utility: What dollar amount can you use to represent the degree to which your customer will value the product?
Price: How much will your customer be willing to pay?
The lower your production costs and the higher the customer utility, the better the value proposition will be. For example, suppose we wanted to calculate a value proposition for a grande soy latte at Starbucks. We’d need to estimate each of the three numbers so that we can plug them into the three parts of the framework.
Begin with production cost, which is often the number you can estimate with the most precision. If you’re selling lattes or planning to manufacture electronics, bake cupcakes or develop games that run on social networking websites, hopefully you know enough to come up with an estimate of what it will cost you to produce them. In this case, you’d probably have direct expenses, such as the cost of beans, soy milk, paper cups and those little corrugated cardboard sleeves so your customers’ hands won’t burn. You’d also have indirect costs: the tables and chairs you need to furnish the store and the marketing campaigns.
What are the true production costs for a single grande soy latte at Starbucks? An educated guess, based on our research and interviews, we’ll say it probably costs Starbucks about $1.75 to produce each latte.