Economics 101

Why talk about economics in a blog focused on investing? Because the core of any good business is economics. This brings up the question that is our focus today: how can a business leverage economics to make a case to its investors?

Every business at its core has to solve one of the two sides of a central economic tenant, the cost benefit model. This may mean reducing the cost or enhancing the benefits for a buyer. This tells us that a buyer will only take action if, and only if, the additional benefits outweigh the associated costs. This needs to be articulated to investors by letting them know exactly what your product solves for. Make sure they understand not only what you are selling, but also understand the costs as well. And remember to include both those implicit and explicit costs so that investors, or the buyers themselves, understand the full opportunity cost of your product or service. Put the dots very close together - tell investors what this product is going to do, its opportunity cost, and which side of the cost benefit equation you are solving for.

You also must clearly define the market for your idea. No matter what type of product or service you have, a target market has to be defined. Conceptually, there has to be at least one person who is willing to purchase your product before you have a market for your product at all. You must convince the investor that there is not only a market, but that you have identified the correct market and that said market is sufficiently large, easily accessible, or both. Identifying the market does not mean you will be instantly successful, but there is no way to be successful without identifying a market in the first place.

This goes back to the basics of supply and demand and the perceived identification of equilibrium. This is the point at which there are just as many buyers as sellers and everything is “just right.” You must be able to identify how both supply and demand work for your product in order to understand what that equilibrium price “should” be. You may choose to price above or below that price, but understanding where it most likely exists will help you determine if your current model can be profitable and sustainable. Showing an investor that you understand these concepts is critical to prove that you did the homework before making your pricing decisions and will further help articulate how you defined your market.

In conclusion, study some economics and do your homework, because every potential investor needs to see that you understand the basics. Pick up a number two pencil, sharpen it and show investors the numbers. This will display and understanding of economics and make it more likely that an investor believes you when you say your business can succeed.
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