I wrote about this on BrightJourney here: http://www.brightjourney.com/q/validating-business-idea-inex...

Here is the full post:

Part 1: Digital products (web apps, mobile apps, ebooks)

Preliminary: We're going to see if there is any competition. If you can't find any competitors, there's likely not enough people willing to pony up the cash for such a product.

I like to find existing markets, not try to create new ones.

Where to check if people have this itch that needs scratching:

Amazon
Google Keyword Tool
Example: if you're writing an ebook, check if someone's selling something similar on Amazon. Is it fairly popular? Check the reviews. Are people clamoring for something the book didn't address?

Process:

1. Figure out what the exact value proposition is.

Your proposition should be an equation of cost vs. benefits that results in the motivation of your prospect to buy.

Motivation to buy = Perceived benefits - Perceived costs

Your success depends on creating perceived benefits higher than what it costs the end user.

You need to put yourself in the customer's shoes and keep asking yourself: What's in it for me?

"Our product is designed nicer..." No! What's in it for me?

"Our product is faster..." No! What's in it for me?

"Our product is easier to use..." No! What's in it for me?

"Our product makes your content accessible across every device you own"... Okay good, now we're getting somewhere.

2. Create a landing page.

Use a tool like Instapage, LeadSquared, GumRoad or even Google Docs to create a quick, dirty landing page to test out your value proposition. It should have a form to collect emails. Don't let your OCD kick in at this stage with regards to the design.

3. Get 10 people to show interest.

I prefer not to sell to my own contacts for digital products because I feel they will sign up to be notified just because we're friends. Instead, I tap into online communities where my target audience is. Reddit, Facebook Groups, Forums, LinkedIn etc.

Don't spam the communities -- be genuine and state you're building this product and giving a discount to the early adopters.

If you can get 10 people to show interest, this idea is worth exploring further.

Part 2: Physical products

Preliminary:

Step 1: Amazon is a goldmine to do research for a physical product. Find your competitors and read the reviews.

Make a list of things people don't like about your competitor's product.

Step 2: We need to check if it's going to be easy to acquire customers in a cost effective manner. Lets head over to Google Keyword Tool.

Check what the average CPC is for what you're trying to sell. This will help you price your product as well. Using the CPC and the average conversion rate in the segment, you can gain insight into how to price your product.

Process:

1. Make a quick mockup of the product.

We aren't actually going to be shipping something in the validation phase, so just creating a mockup is good enough.

2. Setup a landing page with Shopify.

We're going to try and get people to pay us for real. So use a template and create a quick site on Shopify. Alternatively, you could also just try and get people to Paypal you if you want to keep it really simple. I prefer Shopify.

3.a Find 5 people willing to pay you in your network.

For physical products, I like to tap into any and all of my contacts and their networks by just email at first. See if you can get 5 people willing to pony up.

If you can't your own contacts to buy your physical product (and they fit your target audience), it's not a good sign.

By now you must be saying "ummm, but I don't have the product to sell yet".

That's fine. We're not actually going to be keeping their money. You can either refund their money back or if you get a great response, tell them you're back-ordered and get the product quickly made and shipped.

3.b Find 5 people willing to pay you that are not in your network.

Use free AdWords credits to drive traffic to the landing page / Shopify site. Pick targeted keywords to get an objective view of demand.

You can apply this validation approach to a service based business as well. Instead of Amazon, you can use Craigslist to test out demand for your service.