OK, we’ve all read the theory about using value to identify market opportunities – can we see an example?
Restaurant Inventory Optimization
Imagine we are product managers, and we make a software product that helps restaurants manage their food ordering and inventory. We believe, based on our research, that our customers in our target market (proprietor-owned restaurants) have an opportunity to increase profits by wasting less food.
Our Current Market Position
We have an existing, successful product that helps our target market manage their food ordering from suppliers.
This product is valuable to our customers, but in a small way. The kitchen manager for one of our customers could manually do everything that our software helps her do, with a few hours of work every two weeks. All told, our average customer saves about $1,000 per year using our product to manage their food purchases.
Because of competition (we don’t have any truly differentiated value), we sell our product for less than a year’s savings for our customers. This provides a reasonable profit for us, but we’d like to do something more significant.
Understanding Our Market
When we talk with our customers about what their biggest problems are, one idea keeps appearing – they feel like they waste a lot of food. One of our customers allowed us to review their financial transaction data over the course of a year, and we found something odd.
Our customer averaged $25,000 in food orders every week, and sold $60,000 worth of meals.
We’ve analyzed the costs of the food that went into those meals, and found that they were only using $20,000 worth of food each week. This means that they are wasting $5,000 worth of food every week. After reviewing this data with our customer, they were convinced that it is due primarily to food spoilage, and not theft or operational losses. We spent a couple weeks on site, and measured the amount of spoiled food they threw out each night. We found an average of $4,000 in spoilage each week, and we noticed that the food that was being discarded seemed to be different every day.
Our customer, with $3 million in annual sales (and $300,000 in profits), is spoiling $200,000 a year in food. If our customer could cut spoilage in half, it would represent an increase of profits by a third. We spoke to several of our customers, who all felt that spoilage was a large problem for them too. They all expressed that their problem is that they can’t predict the right mix of food to order to accomodate their customers without incurring an unpalatable risk of “eighty-sixing” items on the menu. [86’ing is removing an item from the menu temporarily because you’ve run out of the ingredients].
This is our market opportunity.
Sole-proprietor restaurants are losing over 5% of their top line sales in food spoilage.
Defining A Market Requirement
We realize that solving this problem requires us to be able to predict the mix of food sales that will happen for our customer. We also have to be able to provide our customers with a level of confidence for those predictions, so that they will be willing to trust the software.
Sizing The Market Requirement
We believe that we can solve this problem, and we are willing to commit $1 million to develop a solution, over the course of a year. We also think that it is prudent to budget for an ongoing annual support cost of $250 thousand.
For us to make our financial targets, and get sufficient return on that investment, our sales and marketing team has identified that we would need to be able to sell the software for $10,000 per copy. At that price, we believe we can sell enough copies to hit our target margins.
Our vision for selling products is that our customers should get 10X payback on our software. This tells us that we have to save our customers $100,000 per year in spoilage – or 50% of the value.
This is our market requirement.
Sole-proprietor restaurants will reduce the amount of food spoilage by 50%, by making better food purchasing decisions.
Summary
We nurture an understanding of our market (spoilage is a problem). We use data to qualify and quantify the market opportunity (over 5% of sales is lost in spoilage by our customers). We used our financial goals and sales forecasts, combined with our strategy to define the precise goal (50% reduction).
[Update: Keep reading with the example being converted from a market requirement to product requirements.]
Nice example, Scott. I look forward to seeing how you go from the market requirements to the product requirements. I remain skeptical of the distinction, but I think you’re off to a great start.