number six in a series taken from: How to Evaluate and Profit from a Business Opportunity - The Entrepreneur's Guide It's important that you understand how the business makes money.
You must take that business down to its essence.
For example banks make money by loaning it out at higher rates than it pays to get the money.
What it pays to investors as interest, to its shareholders as dividends, and what it pays in interest to the other institutions it borrows from are its costs.
It has to get the money (Its inventory) it has and has access to out into our hands as loans at rates that produce more income than its costs.
It really is no different than a car dealer.
The dealer has inventory -- cars, which it doesn't own until it sells, on which it pays interest (usually to the manufacturer.
) If it prices its cars too high and doesn't sell them quickly the interest on the inventory exceeds the profits on the sales and it winds up in trouble.
If the bank prices its inventory, money to loan -- too high, and it doesn't move out the inventory, its costs (above) exceed the profits on the loans it makes.
Remember that the next time you go into a bank to make a loan.
The bank needs you! Every business, at its heart, has a simple plan.
Take McDonalds -- many think it is in the business of selling franchises.
It isn't, in fact I don't think you can buy one anymore.
Some think that it makes its money by getting a percentage of everything the store sells.
It does, but that's not its real business.
McDonalds' real business is real estate! That's right it owns all those properties and collects rent and as they go up in value, it will rent them to somebody else who will pay even more rent.
When I was in the business of selling manufactured homes, I made it a point to find out how my competitors made money.
Some were interested in high volume and would take small profits or even losses if they thought it would move them into a higher discount bracket.
Others were interested in maximizing the profit on each transaction.
When my salespeople brought me a deal to consider I wanted to know who else the customer was talking to.
If it was a retailer who was focused on volume, one who would take the deal at any price, I negotiated like crazy and then let them have it a price, which would be below my cost (their's too- most likely).
It was my way of helping them go out of business quicker.
As you evaluate opportunities find out what they do.
If they sell primarily to one large customer, that could be trouble.
A buyer that takes a large portion of a vendor's capability can easily maneuver them into a position where they become so important that they dictate the price and terms of what they buy.
The auto industry is notorious for loading a parts manufacturer with orders, watching them expand through borrowing money to purchase new equipment and then demanding price cuts, which leave the supplier with virtually no profits.
Does the business you are considering rely too heavily on the skills and talent of one person? If so how will you keep him or her if you buy the business? Does the opportunity's success come from a legal document, like a patent or a trademark? If so will you have enough money to defend that document if a competitor decides to ignore it and put a similar product or service in the marketplace.
Ever think about what happened to the corner gas station that used to repair cars? As the automobile became high tech, the skills of a repair mechanic were replaced by the read-out on an electronic analyzer.
The guy who was willing to stop rebuilding the starter on a workbench to go put gas in your car and see if you needed a new fan belt is gone.
The fellow who now owns the shop that has five technicians doesn't care about trying to sell you thirty bucks worth of gas because he knows that his guys can't spot a problem before it happens.
Make sure the business you are considering is not passing into history -- know how it makes money.
You must take that business down to its essence.
For example banks make money by loaning it out at higher rates than it pays to get the money.
What it pays to investors as interest, to its shareholders as dividends, and what it pays in interest to the other institutions it borrows from are its costs.
It has to get the money (Its inventory) it has and has access to out into our hands as loans at rates that produce more income than its costs.
It really is no different than a car dealer.
The dealer has inventory -- cars, which it doesn't own until it sells, on which it pays interest (usually to the manufacturer.
) If it prices its cars too high and doesn't sell them quickly the interest on the inventory exceeds the profits on the sales and it winds up in trouble.
If the bank prices its inventory, money to loan -- too high, and it doesn't move out the inventory, its costs (above) exceed the profits on the loans it makes.
Remember that the next time you go into a bank to make a loan.
The bank needs you! Every business, at its heart, has a simple plan.
Take McDonalds -- many think it is in the business of selling franchises.
It isn't, in fact I don't think you can buy one anymore.
Some think that it makes its money by getting a percentage of everything the store sells.
It does, but that's not its real business.
McDonalds' real business is real estate! That's right it owns all those properties and collects rent and as they go up in value, it will rent them to somebody else who will pay even more rent.
When I was in the business of selling manufactured homes, I made it a point to find out how my competitors made money.
Some were interested in high volume and would take small profits or even losses if they thought it would move them into a higher discount bracket.
Others were interested in maximizing the profit on each transaction.
When my salespeople brought me a deal to consider I wanted to know who else the customer was talking to.
If it was a retailer who was focused on volume, one who would take the deal at any price, I negotiated like crazy and then let them have it a price, which would be below my cost (their's too- most likely).
It was my way of helping them go out of business quicker.
As you evaluate opportunities find out what they do.
If they sell primarily to one large customer, that could be trouble.
A buyer that takes a large portion of a vendor's capability can easily maneuver them into a position where they become so important that they dictate the price and terms of what they buy.
The auto industry is notorious for loading a parts manufacturer with orders, watching them expand through borrowing money to purchase new equipment and then demanding price cuts, which leave the supplier with virtually no profits.
Does the business you are considering rely too heavily on the skills and talent of one person? If so how will you keep him or her if you buy the business? Does the opportunity's success come from a legal document, like a patent or a trademark? If so will you have enough money to defend that document if a competitor decides to ignore it and put a similar product or service in the marketplace.
Ever think about what happened to the corner gas station that used to repair cars? As the automobile became high tech, the skills of a repair mechanic were replaced by the read-out on an electronic analyzer.
The guy who was willing to stop rebuilding the starter on a workbench to go put gas in your car and see if you needed a new fan belt is gone.
The fellow who now owns the shop that has five technicians doesn't care about trying to sell you thirty bucks worth of gas because he knows that his guys can't spot a problem before it happens.
Make sure the business you are considering is not passing into history -- know how it makes money.
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