Raising Capital: Dealing With Revealed Preferences, Part Ten
If you haven’t already, please read our article from last week about Revealed Preferences (RPs) and how they can affect your sales forecast and overall decision making. We’ll dig more into RPs this week to help you avoid the traps they present.
An Overview of Revealed Preferences
Sophisticated investors may not know the term revealed preferences, but most are familiar with the effects. RPs often catch many companies by surprise, forcing them to shut down when actual product demand doesn’t meet their forecast and they run out of cash.
So, how do you avoid overestimating the market size and forecasting sales that are too high?
Key Point. When you conduct product trials, focus groups, or other market research, know that there is a propensity for the participants involved in the trials to over-inflate their regard for your product.
With this in mind, you must look for unique ways to conduct product market testing and trials that avoids this predisposition.
The Importance of Small Scale Trials
To illustrate the point, let’s say that you’ve developed a new technology that allows you to cost-effectively manufacture an 8K ultra high definition television. After running some statistically valid focus groups, you believe that your product is amazing. The data show that at your projected price point, 87% of customers in the market for a new television will buy your product over other televisions.
To prevent over-estimating your serviceable market size and forecasting sales that are too high, here are a few creative ways that may help you deal with RPs effectively:
Conduct actual customer trials at one or more small retail stores in your target market geographies.
Set up a live product demonstration outside of a shopping mall, pitting your new television against competitive products. For the sales data to be valid, you must allow the consumer to buy your product immediately or within a very short time.
Work with a larger retailer such as BestBuy® who can sell products in a small number of their stores within select geographies. This may be advantageous to them as well if they are very interested in your product, as it will give them real data prior to launching the product store-wide. Note: To agree to this trial, a retailer may want an exclusivity on your product for a period of time.
The key to the above examples is that you gather sales data in as close to a real sales/purchase environment as possible, giving you better visibility on your customers, the market, and forecast sales volumes.
You can create the same types of sales trials in a B to B environment—you just need to get creative so that you don’t miss the RPs.
So that you can justify your sales forecast to yourself and to investors, it’s critical that your SAM and SOM are as accurate as you can get them, with the limited information that you have before a full product introduction. From experience, investors “know” that entrepreneurs overestimate revenues.
To raise capital successfully, you need to understand the marketplace and provide data that grounds your forecasts and business plan. Demonstrating that you understand and have accounted for Revealed Preferences will go a long way towards helping you justify your projections.
Until next week!
All the best,
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