Big Data Powered Market Research
LaunchScore's business and data experts deploy machine learning algorithms on small business and city data to estimate the value of entrepreneurial opportunities across the United States.
Unlike targeted comparisons to assess market potential (e.g., comparing three university towns to determine what types of businesses are needed around the campus), we compare data from 750 cities with populations over 50,000 residents.
Our dataset continually grows as new data becomes available for each city and business type we cover. Datasets include Census data, climate, geography, and business population. The volume, velocity, and variety of our data puts us in the category of big data, which requires machine learning algorithms to find useful patterns.
LaunchScore’s algorithms exploit the predictable laws inherent in cities’ business populations to estimate Potential Yearly Earnings (PYE). Viewed as a log log chart, the relationship can be described as sublinear. If it was perfectly linear then we would expect to see a 45 degree angle, but instead the angle is at about 40 degrees. This can be accounted for by economies of scale, where larger cities attract larger establishments (think 200 seat restaurants).
Potential Yearly Earnings (PYE)
Potential Yearly Earnings is a business opportunity’s rated score and is designed to help entrepreneurs more quickly assess the potential of an opportunity in a specific city.
PYE is a monetary estimation of the expected yearly earnings (net profit) after three years. LaunchScore creates an earnings forecast for each business opportunity in every US city with a population over 50,000. The PYE score is based on this earnings forecast.
Year three is set as the PYE based on the assumption that it takes this long for any new business to establish itself in a given market and pay off its startup costs.
Net Present Value (NPV)
Net Present Value (NPV) emanates from the concept of Time Value of Money which is founded on the idea that money available today is more valuable than the same amount of money at a future time because it can start earning interest immediately. In this realm, when computing how much is worth in today’s dollars all cash flows (CFs) to be received (or spent) at a future date one has to compute the so-called “discounted cash flows” (DCFs), i.e. the present value of each expected cash inflow (positive) and outflow (negative). The computation of the DCFs takes into account not only the number of time periods into the future (e.g. years) but also an interest rate to proxy the investor’s opportunity cost (e.g. market interest rate or hurdle rate). Then, NPV is merely equal to the summation of all DCFs.
For example, assume a business that is expected to generate the following series of net cash flows over the next 5 years:
Now, the goal is to assess the value of this business in today’s dollars, i.e. how much would be the fair price to buy or sell it for today. To do so, we need to compute NPV, i.e. the summation of the present value of each CF (i.e., DCF) from year 1 to 5 using the formula below (note: variations of this formula depend on the speed of interest compounding):
Let’s assume that the investor wants a return of 15% per year, then:
A NPV of $789,480 is interpreted as the fair price of this business in today’s dollars given a required return of 15% per year. Note that if the investor wants a higher return, then it has to pay less than this amount. Conversely, if it pays more than this amount it will get a return lower than 15% per year.
To help us gauge the accuracy of LaunchScore’s estimates, we recently surveyed 68 current business owners and asked them to compare the PYE to their own businesses’ net profit by searching for their business type and city on LaunchScore.com. 72% of these business owners found the PYE number to be accurate.
Most of the remaining respondents reported that the PYE was somewhat lower than their current profits. This suggests that the PYE is a lower bound on profitability, and that with good strategy and execution, entrepreneurs can better it!
We hope entrepreneurs will use the PYE to gauge if an opportunity meets their aspirations, and to help them determine their entry and expansion choices.