At Sterling Contractors, we talk a lot about "custom economic models." But what does that actually mean for a hardware store or construction firm owner? This post breaks down the concept into simple, practical terms.
An Economic Model is a Simplified Map of Your Business
Think of an economic model as a map. A map isn't the city itself; it's a simplified representation that helps you navigate. Similarly, an economic model isn't your actual business, but a mathematical representation of its key parts (like sales, costs, and inventory) and how they relate to each other. It helps you navigate business decisions.
Example 1: A Pricing Model
Let's say you want to know the best price for "Super-Strength Cement." We would build a model using your historical sales data. The model would look at how many bags you sold at different price points in the past. It would then create an equation (a demand curve) that predicts how a price change will affect the number of bags you sell. The model's output isn't a single "perfect price," but a tool that lets you ask questions like: "If I increase the price by 2,000 UGX, how much profit will I gain from the higher margin versus how much I might lose from selling fewer bags?" This allows you to find the price that maximizes your total profit, not just your per-item margin.
Example 2: An Inventory Model
For inventory, we might build a time-series forecasting model (like ARIMA, though you don't need to know the name). This model analyzes your past sales data for an item like "Galvanized Iron Sheets," looking for patterns like seasonality (do you sell more in the dry season?), trends (are sales generally increasing over time?), and random fluctuations. It then uses these patterns to project sales for the next few months. This "map" of future demand helps you decide how many sheets to order and when, minimizing both stockouts and overstocking.
Why Not Just Use Intuition?
Your business experience is invaluable. But as your business grows, the number of variables becomes too complex to track in your head. A model can process thousands of data points simultaneously and uncover relationships you might not see. It doesn't replace your expertise; it enhances it by providing a quantitative foundation for your strategic decisions.