Entrepreneurs usually understand that profit is important, but many are less consciously aware of the actual model by which they will (or will not) make money in their ventures. Entrepreneurship students who understand how profit models work will be better equipped to run their own ventures later on.
In a recent EIX article, University of Florida professors Michael Morris and April Spivack describe a classroom exercise designed to help students understand the interplay between four variables that impact profits: margins, volumes, operating leverage and revenue drivers. This article describes a simple yet powerful diagnostic tool that consultants, students, investors and entrepreneurs can apply to new venture concepts to determine the attractiveness of the underlying profit model, and then improve upon it.
Once all four variables are assessed, the entrepreneur can evaluate the relative attractiveness of the venture. For instance, a model with low volumes, low margins, high operating leverage, and a single revenue driver at a fixed price is going to lose money. A much more attractive economic model is one where margins are high, volumes are medium to high, operating leverage is medium and the firm has multiple revenue drivers with considerable price flexibility. The article includes a list of questions about margins, volumes, operating leverage and revenue drivers to help students and entrepreneurs thoroughly assess each factor.
If you are looking for an engaging way to teach the concept of profit models, you may want to check this out!