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What are the most important business concepts every entrepreneur must understand?
You don’t need to have an MBA or attend business school to succeed in business. Almost all the knowledge and information you require to start and succeed with your small business is available for free in the real world.
In this article, I will share with you five basic but very important concepts you must understand if you want to succeed as an entrepreneur or business person.
These concepts will help you to easily digest business opportunities and allow you to start making smart, informed and practical business decisions.
The best part is, these concepts will help you to think, talk and act like a modern entrepreneur. All of the concepts you will learn here are important. I think I would consider this a basic, mini-crash course in economics and business rolled into one.
Why are these concepts important to learn?
Today’s world is a fast-paced and rapidly changing one. We live in a time where information is everything.
But what use is any information if you cannot make sense of it? With terms like GDP, ROI, Customer segmentation and several others flying around in the news and on business websites, I can’t imagine the struggles faced by aspiring entrepreneurs as they try to make sense of all the economic and business jargon we’re constantly bombarded with.
To survive in today’s world of modern business, you must understand the basic concepts and speak the language.
Apart from the personal benefits of understanding these concepts, they will also help you in the short and long term as you progress on your entrepreneurial journey.
Imagine standing before an investor who’s considering to invest in your brilliant business idea. He asks: “What will be the ROI if I invest in your business?” Will you stand there moping like you’ve seen a ghost or will you impress him with your knowledge?
Whatever you do may mean the difference between getting the capital you need to kickoff your business or losing a potential investor and regretting your lack of knowledge.
Nobody expects every entrepreneur to have an MBA or a business background. But everybody will expect you to know the basics of business.
In my opinion, these concepts will be most useful to entrepreneurs in writing a business plan and making sense of it.
A business plan is not an essay or a piece of English literature. It has to be written in a language that will excite and convince potential investors, banks, customers etc. Even if you use business plan software, hire a business plan consultant or use a business plan template, you still need to understand the language your plan is written in.
Now that you know why these concepts are important, let’s dig in…
1 – Customer
You may be surprised that I’m starting with this ‘simple’ term.
The term ‘customer’ (or ‘consumer’) is so commonly used nowadays that very few people still understand what it should really mean.
Like it or not, the customer is, and will always be, the MOST IMPORTANT part of any business. It doesn’t matter if you’ve rented an impressively-furnished glass office, hired MBA employees and manufactured a beautiful product. If there are no customers buying the product or service you’re selling, you have no business. Period!
Now you know why they say ‘The Customer is King.’
If the customer is the most important element of every business, what do you think should be the very first step every entrepreneur must take before they even open for business?
You’re right. You must first identify your customer!
Who is the customer for that product or service business you plan to start? What does she want? How, where and when does she want it? What does she not like about the current product or service she’s using? Where does she live and work? How much can she afford for this product you’re about to start selling? Will she be more sensitive to the price or the quality of your product?
The more accurate your answers are to these questions, the more successful and lucrative your business will become.
Understanding the customer means that you should ALWAYS look at your business from the perspective of the customers you’re targeting. It doesn’t matter what your personal likes, tastes and preferences are, if customers don’t want or like what you’re selling, they won’t buy it. And if they don’t buy it, your business WILL die!
A good example will be very useful here.
Hassan is an aspiring entrepreneur who wants to start an ice cream business. Fortunately for him, he has just found out (through this article) that he must identify and understand his target customers if he wants his business to be successful.
He thinks to himself: ‘Who is my customer?’ He does some basic market research and finds out the following:
Who is Hassan’s customer?
His customers are school children in his town who attend Nursery and Primary school, five days every week (Mondays to Fridays). They close for the day in the hot afternoon and are always looking for something cold, tasty and refreshing to compensate for the thirst and heat. Their current options are cold water and CocaCola.
While cold water is cheap and refreshing, the children want something tasty that they can relish. On the other hand, CocaCola is tasty but is more expensive and just a few children can afford it. Chocolate, vanilla and strawberry flavours are the childrens’ top three ice cream choices and they usually prefer them in small bowls so they don’t melt away. These children are also excited to buy ice cream from a friendly seller, and are very likely to remain loyal customers.
Bingo! Hassan has hit something!
By identifying his customer, Hassan has set himself up for success because he now knows exactly what to do in order to satisfy them.
Well satisfied customers always make a successful business.
The next day, just as the school gates open, Hassan is right there in front of the kids waving to them from his ice cream truck with a wide smile on his face.
You don’t need to be a prophet to predict that Hassan’s business will flourish and succeed as long as he continues to give his customers what they want, how they want it, where they want it and when they want it.
Lesson: Entrepreneurs, know thy customer!
2 – Supply and Demand
In every market, there are two key groups of people: buyers (demand) and sellers (supply). Suppliers alone cannot make a market; neither can buyers.
All entrepreneurs and business people are suppliers by nature.
If you’re in business, you must be supplying (selling) something; a product (like fruits, vegetables, electronics) or service (like a consulting or taxi business). For a supplier to make any money and remain in business, customers must be willing to buy the product or service they’re selling.
Let’s talk a little more about demand.
The concept of ‘demand’ describes a consumer’s desire and willingness to pay a price for a product you’re selling. Demand is clearly different from ‘wishes’ and ‘wants’. Anybody can wish and want anything, but if they’re not willing to open their wallets and pay for it, that’s not demand.
Let’s say I have a shop on a university campus and I’m in the soap business. Each of my soaps sell for $1 and students love to buy them because of the sweet fragrance and beautiful packaging. More importantly, students love to buy my soap because they can afford to pay for it. Yes, my soap enjoys a huge demand.
Imagine that I suddenly increase the price of each soap to $50, what do you think will happen? While there is still demand for soap, I can guarantee that I may not sell a single soap!
Why? No demand.
Although the students still have need for soap (for bathing, washing etc.), they are unwilling to pay for it because it’s been priced out of their reach. They still miss the fragrance and colour of my soaps but they can’t afford it. What they feel about my soap is no longer ‘demand’. My soap has become a wish or want.
Image credit: imgarcade.com
Quantity, like price, is also another factor that affects supply and demand.
Let’s imagine that there are other shops like mine on the university campus that sell soap, and we all sell each soap for $1. The problem is, there are only 100 students in school but we have more than 1,000 soaps to sell. If we assume that a student will buy only one soap, what do you think will happen in this market?
Some sellers will start to reduce their price in order to attract more customers. On the other hand, if there were more students than soaps, sellers can easily get away with inflating their prices.
This brings us to one of the most basic but very important principles of Economics. It’s called the Principle of Supply and Demand. This principle states that when supply is higher than demand, prices usually fall. And when demand is greater than supply, prices are likely to rise.
Lesson: Understand the nature of supply and demand in your market. It can help you better plan, price and profit in your business.
3 – Competition
How would you feel if you owned the only business that sold mobile phones in your country?
That would be great, wouldn’t it?
It means you could sell any type of phones you want, at any price you like. You could decide to sell only red-coloured phones because red is your favourite colour.
Who cares what the customer wants? If they don’t like the quality, colour or price of your phones, what other options do they have? You’re the ONLY business they can buy from. They can hate, blame and groan about your terrible customer service but it won’t affect your business. As long as they need mobile phones to communicate, you’ll always be in business!
Economists refer to this type of business as a ‘monopoly’.
Unfortunately, most of the world now operates a ‘free market economy’ where anybody with the means can start a business and prices of goods and services are determined, not by a single business or individual, but by the interaction of supply and demand in the market.
Simply put, the market is a race and every business is trying to outrun the other to win more customers.
Every day you wake up as a business owner, there is another business somewhere that is trying to compete against you and run ahead of you. And what is the prize businesses compete for? Customers! Remember, customers are the most important element in every business.
Every business continues to look for new and effective ways to be more attractive to customers. If they are more attractive, they can win over customers from their competition.
By providing products that are of higher quality, services that provide more value, convenience and greater satisfaction, your competition is likely to ‘steal’ your customers. If your customers find out that they can get a better deal and enjoy more friendly services at your competitor’s, you may lose them forever.
Your competition will always look for weaknesses that they can exploit in your products and services. This is why every business should have a ‘competitive advantage’; a quality that makes it difficult for other businesses to exploit its weaknesses or copy its style.
A popular trademark brand, a patented product or ‘mind blowing’ customer service are just a few examples of competitive advantages a business can have.
In the world of business, only the strong survive and a competitive advantage is a strength that you have that keeps you alive in the market. It is something unique you can provide to customers that they can’t get anywhere else. And as long as this advantage aligns with everything your customers want, you’ll remain successful in your business!
Lesson: If your business can’t compete, it’ll definitely die. Find your competitive advantage and keep improving it!
4 – Return on Investment
Yes, let’s get a bit more technical with the terms.
‘Return on Investment’ or ROI is a popular term with investors, bankers and professional business people.
ROI is commonly used when an investor or entrepreneur is considering several business or investment options. A good example will be useful here. (image credit: fareexchange.co.uk)
Rebecca currently works a 9 to 5 job and dreams of starting her own business. Like many wannabe entrepreneurs, she has been looking for a profitable business idea that can be transformed into a successful business.
Finally, she stumbles on three exciting business opportunities on smallstarter.com – pig farming, importing small goods from China and a laundry business.
The problem is, as much as she would love to, she cannot start all three businesses because she only has sufficient capital (about $6,000) to start one. As a result, she now has to choose one business idea out of the three and build it into a viable business.
To choose the best option, Rebecca needs an objective and unbiased method to evaluate all three business opportunities without letting her personal feelings get in the way.
If her heart had to decide, she would go for pig farming because her father raised pigs while she was a child. She loves pigs and has a lot of experience in pig farming.
But is pig farming the best and most profitable option for her? What if the import business will make her more money than pig farming? How can she know this?
ROI is one of the effective tools that can help business people and entrepreneurs choose the best and most rewarding option out of a number of options. And don’t be scared, the calculation for ROI is quite simple.
By dividing the Benefit (the profits she’ll make) by the Cost of investment (the cost of setting up and running the business), you can easily calculate the ROI for any number of business opportunities.
From this simple formula, Rebecca calculates the ROI for all three opportunities as shown in the table below.
According to these results, it turns out that the laundry business will give the highest return on investment (ROI) than all the other options.
The laundry business option will return three times (300%) the capital Rebecca invests in it. Although at $2,000, it is the cheapest to start of all the options, it surprisingly provides the highest returns.
Based on these results, Rebecca’s best option would be to start a laundry business.
Lesson: Always, always choose the business or investment option that maximizes your ROI.
5 – Fixed and Variable costs
To make money, you need to spend money.
Costs (or expenses) are everything you spend on or pay for to start, run and keep your business alive. Rent, equipment, salaries for staff, internet bills, transportation, advertising and bank charges are just a few examples of costs that most businesses have to bear.
Unfortunately, most small businesses are suffering from a lot of costs they could have avoided or significantly reduced.
Understanding your costs is one of the key elements of success in any business. Cost is very important because it is one of only two factors (the other being ‘Revenue’ or ‘Sales’) that will determine if you make a profit or loss in your business.
No matter how much revenue your business makes, it would be totally impossible to turn a single profit if your costs are greater than your revenue.
There are essentially two main types of costs you need to know about as a business owner and entrepreneur. They are: fixed costs and variable (or ‘marginal’) costs.
Fixed costs (also known as ‘overhead costs’) are costs that do not change regardless of the quantity of products or services a business does. Rent and equipment/machines are two of the most common fixed costs.
Let’s say you pay $1,000 as rent for a laundry and dry cleaning business you just started. Whether you do business or not in your first year of business will not change the rent you have paid for that year. Same thing goes for equipment, salaries, insurance and electricity/water bills for your business. All of these are fixed costs that remain constant.
Variable or ‘marginal’ costs (as the name implies) are costs that change with the level of business activity. If you sell more products or deliver more services, this type of cost will increase and vice versa.
Using our laundry business example again, what kind of costs do you think would qualify as variable costs? Stuff like detergent and other things you use to wash your customers’ clothes are variable costs. If you wash more clothes, you’ll spend more on detergents (higher costs), and if you wash less, you’ll spend less (lower costs).
Most entrepreneurs make the mistake of taking on too much fixed costs at the start of their business. They buy machines and equipment when they should have leased (which is less costly and more flexible). They employ more employees than necessary and pile on huge salary (fixed) costs when they could employ less or pay on a wage and commission basis (which are more variable).
Entrepreneurs have to be conscious of the impact of fixed and variable costs on their business at all times.
The only way to overcome fixed costs (if you cannot avoid or reduce them) is to do enough business. The higher your fixed (overhead) costs, the higher the volume of goods or services you will have to sell to make a profit and vice versa.
These are very important business concepts every entrepreneur must understand
This article is the first in a series that will increase your knowledge of the key concepts (and how they work) in the world of business.
Entrepreneurship is an exciting and testy journey. You will need to pick up and apply the knowledge you have acquired as you move along. A favourite quote of mine goes:
“Education is something others do to you. Learning is something you do to yourself.”
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To your success!