The first decisions when adding a location are often these questions:
- Do I want to move into a new geographic area (e.g., a new market, state, city, etc.)?
- If so, where in that area do I want to locate?
- What type of services do I want to provide at that location?
Let me give you an example of walking through these questions. I worked for a bank that was looking at expanding into two new metropolitan areas. Picking these metropolitan areas answered question #1.
The bank decided to enter each market with very different strategies. The exact locations (the answer to question #2) were driven by the types of services we were going to provide in each market (the answer to question #3).
In one market, the bank targeted high-net-worth individuals. We offered private banking and commercial lending services. Our first location was in an office building in the core of the metro area.
In the other market, the bank offered retail and commercial services. The first location was a traditional bank branch. The bank added additional bank branches throughout the metro area over the next few years.
When I worked on this expansion and similar ones, I was part of a diverse group that analyzed it from different perspectives. My role in the decision-making process was usually focused on building the financial projection for the new location. Sales and marketing staff would assess the market potential. Operations staff would estimate the customer service costs for the new location. Facilities staff would gather estimates for the building, furniture, and maintenance costs. This article will focus on the work I did with the sales and marketing staff.
Market Research
The desire to add locations often comes from senior leadership or sales and marketing staff. They gather information from a variety of sources. These sources might include:
- Comments from existing customers
- Comments from employees
- Analysis of transaction patterns or customer addresses
- Market statistics
- Industry reports
- Government and regulatory reports
- Discussions with peers and competitors
- Competitor and peer analysis
Sometimes we hired consultants that provided impressive reports with demographic data, traffic patterns, and potential customer geographic concentrations. They would propose multiple potential locations. These consultants were experts in our industry.
You may decide that consultants like this are beyond your company’s budget or that there aren’t consultants like this in your industry. A source of powerful and free information may be your local library.
Libraries often subscribe to data sources of demographic data, market statistics, and industry journals. Some libraries have a librarian whose focus is business and economic data. If you don’t have access to this via your public library, check with local college libraries.
I worked at a $2 billion financial institution that hired specialized consultants, paid for access to industry databases, and used specialized marketing software. We also brought in our local library’s business librarian to educate staff on all the data available via the library.
Information Sources for Estimating Revenue
After gathering all this information, it’s time to start making revenue estimates for our company’s new location.
Revenue estimates are generally based on three sources:
- The company’s current locations
- External market data
- Competitor location data
Here’s how to use each to estimate revenue.
Current location information
Your best and most detailed information can sometimes come from your existing locations. Tracking your locations from their start to current sales amounts gives you information about the growth rate of new locations.
Sales at new locations may differ from your current locations for many reasons. Some reasons include:
- Lack of brand awareness: Your current locations may have benefited from marketing you’ve done over many years. Customers around your new location may not have heard of you, so it will take time to build awareness of you and trust in you.
- Product mix: Be very careful if you use a location that’s been open for many years to project the product sales mix of a new location. Some products are easier to sell to new customers than others. In banking, it’s easy to get lots of new customers from certificates of deposits (CDs) with high rates. It’s much harder to get new customers to open checking accounts.
- Customer wants: Customers around the new location may have different needs and wants than your current locations. The types of products sold at one location can be very different than those sold at other locations.
- Staffing: Unless you are moving a whole team to a new location, your staff at the new location is untested. You don’t know how they will compare to the staff at existing locations.
External Market Data
Data about a market can give you an idea of the potential for that market. Your job is to estimate what percentage of the market potential you can gain with your new location.
The ability to estimate the market potential can range from fairly accurate to extremely speculative. In banking, we had access to public reports of deposits by state, county, and zip code. You may be able to get reports of sales of different products in a geographic area. You may only be able to get general demographic data and then extrapolate the sales potential based on that data.
Arriving at the percentage of the market you could capture is very subjective. You could look at your share of the market in your current markets. You may only be able to make an educated guess from discussions with sales staff.
Competitor Location Data
Sometimes you can get data for specific competitor locations or the average location amounts in an area. In banking, we could get the deposit amounts of any bank branch from a public regulatory report.
You can buy industry market reports that provide information for average sales, costs, and profits for businesses by industry, size, and location. For example, I worked with a client that was considering starting a truck stop. They had a report of average profitability for small truck stops in the state they were looking at. That’s pretty niche.
A good free resource for Canadian companies is the Canadian Industry Statistics website. It may also be useful for similar countries. This has a huge database of income statements by industry code and size. It’s a good resource to learn how much common expenses are as a percentage of revenue.
Projecting Revenue
Once you’ve gathered some source information, it’s time to make your revenue projections. You may also want to check out my course on managing cash flow.
You’re really projecting two items when projecting revenue:
- Sales
- Costs of goods sold and direct labor
The net of these two is your gross profit. The gross profit as a percent of your gross sales is your gross margin.
Some people project sales dollars and the cost of goods sold or direct labor from the P&L based on one or more of their existing locations. I would recommend that you project units of sales and the average price per unit. This isolates two key assumptions (i.e., units sold and price) that you can independently sensitivity test.
Many businesses have a similar cost of goods sold or direct labor cost across locations. For other businesses, labor costs are higher in some markets than others. There’s a chance that the costs of goods may be different for different locations. In banking, the cost of funds differed based on the terms of the loans (which is interest revenue for a bank) each location had. If your costs differ by location, this is another assumption you want to model.
I mentioned earlier that the profit margins for your new locations will likely be lower than your existing locations. You may discount your products and services to gain market share. New customers will likely first buy lower-margin products and then start buying higher-margin products from you.
This means you will likely want to project lower prices and lower profits, at least for the beginning of the new location. You’ll also want to model a different product mix for new locations than the product mix of current locations.
Whoever is making the revenue projection will need to understand the marketing for the new location. New locations are often supported by promotions that drive a high volume of specific promoted products. Promoting certain products may cause cross-sales of other products or could detract from sales of other products. You will have to determine the impact on your product mix.
Projecting sales volumes is difficult for new locations. You can look at the sales amounts by month for other new sites. However, every location is different, and the opening strategy between sites may be different.
Another option is to use a current location and decide how long it will take the new location to achieve the same sales. For example, you may have a current site that sells 6,000 units, and you expect the new site to hit that level in five years. A simple projection is to build from zero units to 6,000 units in 5 years, which is 60 months. You would project sales of 100 units in the first month, 200 in the second month, and continue this until sales reach 6,000 units in the 60th month. Then adjust that for opening promotions or slower sales in the early months.
You can also use data you gained about competitors in the area of the new location to use the projection methods I just discussed.
I go into more detail on building projections and show a sample analysis in my article on how to create a cash flow and profit projection for your new location.
There is more uncertainty and gamesmanship in projecting revenues than in any other part of a new location projection. People who are proponents of the new location will talk about big sales in early discussions. They may then be held responsible for reaching the projection amounts. They suddenly project more conservative amounts if their performance will be judged on how well they hit those amounts. You have to know the bias of the person from whom you’re gaining info from to make projections.
Budgets and projections are collections of guesses. Each assumption and amount comes with varying levels of certainty and subjectivity. Someone, or a small team, must make these guesses. It should be done by whoever has the best chance of making the guess. Sometimes the finance person putting together the projection can make the best guess. Often, though, it’s someone else. I’ve had to coax many managers to state a number for a projection.
Sometimes managers will say they can’t guess how many sales a new location will do. This may be because of extreme uncertainty or because they are afraid to state a number they will be held to. In these cases, breakeven analysis is very useful.
Cannibalization
Some customers may stop shopping at the old location and start shopping at the new location. In other words, the new locations will “cannibalize” sales from other locations.
I prefer to put the full amount of sales at the new location in the revenue section of the projection. I put the decrease in the sales of other locations below the net contribution of the new location. Another option is to put the decrease in sales of other locations below the revenue line.
I don’t recommend showing the net new sales from the new location (i.e., sales at the new location less the sales decrease at other locations) as a single line in the analysis. I prefer to show the gross revenues and expenses in the analysis so they can be used for future budgets. It also allows us to track the actual results compared to the projection or budgets.
Of course, the net profitability of the company is the sum of what happens at the new location and its impact on the rest of the company. That’s why I put the impact on the rest of the company at the bottom of the analysis.
You may also need to model price cannibalization of promotional pricing that’s offered at current locations. I show how to do this in my article on how to create a cash flow and profit projection for your new location.
The information in this article is just one part of many that I cover in my course on Analyzing Whether to Add New Locations.
For more info, check out these topics pages: