Market Segmentation, Pricing & Profit
What is the “addressable” market opportunity for your product concept?
The term “addressable” refers to a specific customer base (often a subset of a larger market), one that truly defines the universe of potential purchasers of your product, as well as the competitors you will be up against.
Refers to the process of gaining an understanding of the differences in needs and behavior of similar customer groups, and then aggregating those prospective purchasers into the subset who should respond similarly to your product features and advantages.
The quantification of this subset of potential customers (whose needs your product will address) and the collective # of units they might purchase on an annual basis, forms the foundation for your “Addressable Market Opportunity”.
The following is an example of segmentation analysis for the Clinical Diagnostic Testing market:
|Market Segment||Hospital Lab||Reference Lab||Physician Office||Field Testing|
|Product Feature Importance|
| Test Menu
|Cost per Test||HIGH||HIGH||MED||LOW|
|Ease of Use||LOW||LOW||MED||HIGH|
A “tentative” price should be assigned to your product. This will allow a translation of the potential unit sales your market segment represents to the total dollar ($) market opportunity. It will also provide one of the key elements in the establishment of the projected “gross profit” associated with the business venture, which is discussed later within this section.
How competitive do you believe your product will be in the specific market you have defined?
Once you have properly defined the market segment you are addressing, you will then need to determine the existing pricing structure for competitive products.
The following questions are important in the initial pricing analysis:
- What are target customers paying for the leading product(s)?
- How important (to prospective customers) are the key benefits of your product concept?
- How much more (%) will they be willing to pay for your product?
The answers to questions #2 and #3 are, of course, speculative unless you have conducted professional market research. Whatever price you tentatively establish for your product should be defensible according to the comparative advantages and benefits you established based on your earlier FAB Analysis. Keep in mind that once you have performed this much research and analysis on your technology, customers and competitors, you will more often be allowed the “benefit of the doubt” on estimates you provide prospective investors.
You should not attempt to establish market penetration (share) estimates without first being able to rationalize your pricing assumptions...
Unit demand for your product may be very sensitive to pricing, so be realistic in selecting a price (or price range) that will support your subsequent market share projections.
NOTE: Successful products and services are priced according to market demand factors ─ not as a function of the product’s cost to manufacture, or the desire to achieve a particular return on investment.
Also keep in mind that the market-driven price, that you determine would be consistent with successful competition, is the same price you should establish as a guide to Design Engineers in your product development program, and to set future limits for acceptable product manufacturing costs.
Gross Profit Analysis
Gross Profit is a key indicator of potential business profitability, if not viability.
Remember that the tentative Selling Price should be determined by what you reasonably estimate customers will be willing to pay, and Net Revenue is that received either directly from your customer, or from a distributor who will have been invoiced at a significant discount.
Cost of Goods Sold (COGS) is an estimate of the projected costs for not only raw materials and direct labor, but also includes manufacturing overhead. These costs are not easily estimated at this point in your planning; however, the calculation of Gross Profit is as follows:
Net Revenue $ [product unit sales (x) price/unit (-) discounts & returns]
− Total COGS $ [raw materials (+) direct labor (+) manufacturing overhead] _____________
= Gross Profit $
Gross Profit % = Gross Profit $ ÷ Net Revenue $
At this point, you only need to be aware that manufacturing overhead will include such elements as factory and equipment depreciation, utilities, quality control and maintenance personnel. These components will add to the actual COGS and, therefore, reduce the Gross Profit (GP).
Expectations by investors will be determined by the particular industry and market segment you are addressing, but as a guide, a minimum GP of 60% of revenues will be expected for non-pharmaceutical medical products. But GP is not the lone determinant of operational profitability. One must subtract from GP the costs of running the company, including General and Administrative, Research and Development, and Marketing and Sales costs.
If you have evidence that you will be able to sell your product at the GP margins referred to above, and don’t foresee unreasonable costs in running the company, there’s a good chance you may be able to develop a viable business from a profitability perspective. But this is just a high-level sanity check.
For a review of revenue forecasting, visit Market & Sales Projections
At the point in time that potential investors want to see a full Business Plan, you may need to produce a 3-5 year pro forma financial analysis, which will become the document you will use to estimate the long-term profitability and sustainability of your business. This financial forecast may also become the basis for negotiations regarding the pre-investment valuation that will be acceptable to potential investors in your company.
Financial forecasting will require constant re-evaluation, but is a critical element in successful product development and market introduction.
For more discussion on this subject, visit this link.