Entrepreneurship
ENTREPRENEURSHIP E I G H T H E D I T I O N
R O B E RT D . H I S R I C H , P h D
Garvin Professor of Global Entrepreneurship
Director, Walker Center for Global Entrepreneurship
Thunderbird School of Global Management
M I C H A E L P. P E T E R S , P h D
Professor Emeritus
Carroll School of Management
Boston College
D E A N A . S H E P H E R D , P h D
Randall L. Tobias Chair in Entrepreneurial Leadership and
Professor of Entrepreneurship
Kelley School of Business
Indiana University
ENTREPRENEURSHIP
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Library of Congress Cataloging-in-Publication Data
Hisrich, Robert D.
Entrepreneurship / Robert D. Hisrich, Michael P. Peters, Dean A. Shepherd.—8th ed.
p. cm.
Includes index.
ISBN-13: 978-0-07-353032-1 (alk. paper)
ISBN-10: 0-07-353032-8 (alk. paper)
1. New business enterprises. 2. Entrepreneurship. 3. Business planning. 4. Business
enterprises—Finance. 5. Success in business. I. Peters, Michael P. II. Shepherd, Dean A.
III. Title.
HD62.5.H577 2010
658.4'21—dc22
2009037490
www.mhhe.com
To our wives,
Tina, Debbie, and Suzie,
and children,
Kary, Katy, Kelly, Christa, Kimberly, Jack, and Meg,
and grandchildren,
Rachel, Andrew, and Jack,
for their supportive entrepreneurial spirit
A B O U T T H E A U T H O R S
iv
R O B E RT D . H I S R I C H
Robert D. Hisrich is the Garvin Professor of Global Entrepreneurship and Director for the
Walker Center for Global Entrepreneurship at Thunderbird School of Global Management.
He holds an MBA and a doctorate from the University of Cincinnati.
Professor Hisrich’s research pursuits are focused on entrepreneurship and venture cre-
ation: entrepreneurial ethics, intrapreneurship, women and minority entrepreneurs, venture
financing, and global venture creation. He teaches courses and seminars in these areas, as
well as in marketing management and product planning and development. His interest in
global management and entrepreneurship resulted in two Fulbright Fellowships in Budapest,
Hungary; honorary degrees from Chuvash State University (Russia) and University of
Miskolc (Hungary); and being a visiting faculty member in universities in Austria, Australia,
Ireland, and Slovenia. Professor Hisrich serves on the editorial boards of several prominent
journals in entrepreneurial scholarship, is on several boards of directors, and is author or
coauthor of over 300 research articles appearing in such journals as Journal of Marketing,
Journal of Marketing Research, Journal of Business Venturing, Journal of Small Business
Finance, Small Business Economics, Journal of Developmental Entrepreneurship, and En-
trepreneurship Theory and Practice. Professor Hisrich has authored or coauthored 25 books
or editions, including: Marketing: A Practical Management Approach, How to Fix and
Prevent the 13 Biggest Problems That Derail Business, and two recently published books,
International Entrepreneurship: Starting, Developing, and Managing a Global Venture, and
Technology Entrepreneurship: Value Creation, Protection, and Capture.
M I C H A E L P. P E T E R S
Michael P. Peters is Professor Emeritus of the Marketing Department at the Carroll School
of Management, Boston College. He has his PhD from the University of Massachusetts,
Amherst, and his MBA and BS from Northeastern University. Recently retired from full-
time teaching, Professor Peters has been a visiting professor at the American College of
Greece in Athens, Greece, where he has been developing an entrepreneurship and business
planning component in its new MBA program. In addition, he continues to write, lecture,
serve on numerous boards, and assist in the management of a family business. Besides his
passion for assisting entrepreneurs in new ventures, he has consulted and conducted semi-
nars and workshops worldwide related to entrepreneurship, international and domestic
decision making for new product development, market planning, and marketing strategy.
He has published over 30 articles in such journals as the Journal of Business Research,
Journal of Marketing, Journal of Marketing Research, Journal of International Business
Studies, Columbia Journal of World Business, Journal of Business Venturing, and the Sloan
Management Review. Professor Peters has coauthored three texts: Marketing a New Product:
Its Planning, Development, and Control; Marketing Decisions for New and Mature Products;
and Entrepreneurship, now in its eighth edition. He was Department Chair and Director of
the Small Business Institute at Boston College for more than 16 years. He loves photography,
tennis, golf, and kayaking on Cape Cod Bay.
D E A N A . S H E P H E R D
Dean A. Shepherd is the Randall L. Tobias Chair in Entrepreneurial Leadership and Pro-
fessor of Entrepreneurship at the Kelley School of Business, Indiana University. Dean
received his doctorate and MBA from Bond University (Australia) and a Bachelor of Ap-
plied Science from the Royal Melbourne Institute of Technology. His research on entrepre-
neurial leadership includes the decision making of entrepreneurs, new venture strategy,
learning from failure, and pursuit of opportunity. Dean is also an Associate Editor for the
Journal of Business Venturing and on the review board for numerous entrepreneurship and
management journals.
A B O U T T H E A U T H O R S v
PREFACE
vi
Starting and operating a new business involves considerable risk and effort to overcome the
inertia against creating something new. In creating and growing a new venture, the entre-
preneur assumes the responsibility and risks for its development and survival and enjoys the
corresponding rewards. The fact that consumers, businesspeople, and government officials
are interested in entrepreneurship is evident from the increasing research on the subject, the
large number of college courses and seminars on the topic, the more than two million new
enterprises started each year (despite a 70 percent failure rate), the significant coverage and
focus by the media, and the realization that this is an important topic for industrialized,
developing, and once-controlled economies.
Who is the focus of all this attention—who is willing to accept all the risks and put forth
the effort necessary to create a new venture? It may be a man or a woman, someone from
an upper-class or lower-class background, a technologist or someone lacking technologic
sophistication, a college graduate or a high school dropout. The person may be an inventor,
manager, nurse, salesperson, engineer, student, teacher, homemaker, or retiree. It is some-
one able to juggle work, family, and civic responsibilities while meeting payroll.
To provide an understanding of this person and the process of creating and growing a
new venture, this eighth edition of Entrepreneurship is divided into five major sections.
Part 1—The Entrepreneurial Perspective introduces the entrepreneur and the entre-
preneurial process from both a historical and a research perspective. The role and nature of
entrepreneurship as a mechanism for creating new ventures and affecting economic devel-
opment are presented, along with career aspects and the future direction of entrepreneur-
ship. The characteristics and background of entrepreneurs are discussed, as well as some
methods for individual self-assessment. Following the presentation of corporate entrepre-
neurship, this part concludes with a discussion of strategies for generating and exploiting
new entries.
Part 2—From Idea to the Opportunity focuses on the aspects of creativity and inno-
vation and all the elements in the entrepreneurial process that are a part of creating the new
venture. The various sources of ideas as well as trends occurring through this decade are
discussed. Specific attention is also paid to various creative problem-solving technologies,
identifying domestic and international opportunities, and creating an opportunity assessment
plan. The chapter concludes with a discussion of protecting the idea developed as well as
other legal concerns in forming and launching the venture.
Part 3—From the Opportunity to the Business Plan focuses on the all-important
business plan. First, the overall business plan and its various aspects are presented. Then, a
chapter is devoted to each of the major components of the business plan: the marketing
plan, the financial plan, and the organizational plan.
Part 4—From the Business Plan to Funding the Venture focuses on one of the
most difficult aspects of creating and establishing a new venture—raising capital. First
the aspects of debt versus equity and internal versus external funding are discussed. Af-
ter a discussion of the alternative sources of capital (self, family and friends, suppliers
and trade credit, government grants and programs, private placements, and commercial
banks), specific attention is given to three financing mechanisms: informal risk capital,
venture capital, and going public.
Part 5—From Funding the Venture to Launching, Growing, and Ending the New
Venture presents material related to establishing, developing, and ending the venture. Par-
ticular attention is paid to developing an entrepreneurial strategy, establishing strategies for
growth, managing the new venture during growth, early operations, expansion, and access-
ing external resources for growth. Managerial skills that are important to the successful per-
formance and growth of a new venture are included in this section. This part also addresses
methods for ending the venture. Specific topics examined include mergers and acquisitions,
franchising, joint ventures, and human and financial resources needed for growth.
To make Entrepreneurship as meaningful as possible, each chapter begins with chapter
objectives and a profile of an entrepreneur whose career is especially relevant to the chap-
ter material. Numerous examples occur throughout each chapter along with important Web
sites to assist the reader in getting started. Articles and ethics boxes are also included in this
eighth edition. Each chapter concludes with research tasks, class discussion questions, and
selected readings for further information. Cases are now grouped together after the last
chapter in the book, as Part 6.
Many people—students, business executives, entrepreneurs, professors, and publishing
staff—have made this book possible. Of great assistance were the detailed and thoughtful
comments of our reviewers: Melissa Baucus, University of Louisville; Alan Flury, Georgia
Institute of Technology; Lee Grubb, East Carolina University; Brian Hanlon, North Central
College; Matt Rutherford, Virginia Commonwealth University; Richard Smith, Iowa State
University; and Gregory Stoller, Boston College.
Special thanks are given to Carol Pacelli for preparing the manuscript so competently
and to Stephanie Arthur, Falyne Chave, Anetta Hunek, and Sarah Liggett for providing
research material, editorial assistance, and case development for this edition. Also thanks
to our editors Laura Hurst Spell, sponsoring editor, and Jane Beck, editorial assistant.
We are deeply indebted to our spouses, Tina, Debbie, and Suzie, whose support and un-
derstanding helped bring this effort to fruition. It is to future entrepreneurs—our children
Kary, Katy, Kelly, Christa, Kimberly, Jack, and Meg, and grandchildren Rachel, Andrew
and Jack—and the generation they represent—that this book is particularly dedicated. May
you always beg forgiveness rather than ask permission.
Robert D. Hisrich
Michael P. Peters
Dean A. Shepherd
PREFACE vii
C O N T E N T S I N B R I E F
viii
PA RT 1 T H E E N T R E P R E N E U R I A L P E R S P E C T I V E 1
1 Entrepreneurship and the Entrepreneurial Mind-Set 2
2 Entrepreneurial Intentions and Corporate Entrepreneurship 34
3 Entrepreneurial Strategy: Generating and Exploiting New Entries 64
PA RT 2 F R O M I D E A T O T H E O P P O RT U N I T Y 91
4 Creativity and the Business Idea 92
5 Identifying and Analyzing Domestic and International Opportunities 124
6 Protecting the Idea and Other Legal Issues for the Entrepreneur 158
PA RT 3 F R O M T H E O P P O RT U N I T Y T O T H E B U S I N E S S P L A N 185
7 The Business Plan: Creating and Starting the Venture 186
8 The Marketing Plan 222
9 The Organizational Plan 254
10 The Financial Plan 280
PA RT 4 F R O M T H E B U S I N E S S P L A N T O F U N D I N G T H E V E N T U R E 303
11 Sources of Capital 304
12 Informal Risk Capital, Venture Capital, and Going Public 332
PA RT 5 F R O M F U N D I N G T H E V E N T U R E T O L A U N C H I N G , G R O W I N G , A N D E N D I N G T H E N E W V E N T U R E 377
13 Strategies for Growth and Managing the Implications of Growth 378
14 Accessing Resources for Growth from External Sources 410
15 Succession Planning and Strategies for Harvesting and Ending the Venture 438
PA RT 6 C A S E S 463
C O N T E N T S
PREFACE vi
PA RT 1 T H E E N T R E P R E N E U R I A L
P E R S P E C T I V E 1
1 ENTREPRENEURSHIP AND THE
ENTREPRENEURIAL MIND-SET 2
Opening Profile: Ewing Marion Kauffman 3
Nature and Development of Entrepreneurship 6
The Entrepreneurial Process 7
Identify and Evaluate the Opportunity 7
Develop a Business Plan 9
Determine the Resources Required 9
Manage the Enterprise 10
How Entrepreneurs Think 10
Effectuation 10
Cognitive Adaptability 13
As Seen in Entrepreneur Magazine: What Me Worry?
How Smart Entrepreneurs Harness the Power
of Paranoia 14
Learning from Business Failure 18
Recovery and Learning Process 20
A Dual Process for Learning from Failure 21
Ethics and Social Responsibility of Entrepreneurs 21
Ethics: Company’s Code of Ethics 23
Role of Entrepreneurship in Economic Development 23
2 ENTREPRENEURIAL INTENTIONS AND
CORPORATE ENTREPRENEURSHIP 34
Opening Profile: Robert Mondavi 35
The Intention to Act Entrepreneurially 38
Entrepreneur Background and Characteristics 38
Education 38
Ethics: Ethical Conduct of Entrepreneurs versus
Managers 39
Age 40
Work History 40
Role Models and Support Systems 40
Moral-Support Network 41
Professional-Support Network 41
ix
As Seen in Entrepreneur Magazine: Hot or Not? 42
Minority Entrepreneurs 43
As Seen in Entrepreneur Magazine: Provide Advice
to an Entrepreneur about Improving a Business
through Certification as a Woman-Owned
Business 44
Entrepreneurial Intentions within Existing
Organizations 45
Managerial versus Entrepreneurial Decision
Making 45
Strategic Orientation and Commitment to
Opportunity 46
Commitment of Resources and Control of
Resources 46
Management Structure and Reward Philosophy 47
Growth Orientation and Entrepreneurial Culture 48
Causes for Interest in Corporate Entrepreneurship 48
Establishing a Culture for Corporate Entrepreneurship 51
Leadership Characteristics of Corporate Entrepreneurs 53
Establishing Corporate Entrepreneurship in the
Organization 54
Problems and Successful Efforts 56
3 ENTREPRENEURIAL STRATEGY: GENERATING
AND EXPLOITING NEW ENTRIES 64
Opening Profile: Justin Parer 65
New Entry 66
Generation of a New Entry Opportunity 67
Resources as a Source of Competitive Advantage 67
Creating a Resource Bundle That Is Valuable, Rare,
and Inimitable 68
Assessing the Attractiveness of a New Entry
Opportunity 70
Information on a New Entry 70
As Seen in Entrepreneur Magazine: Elevator Pitch
for Project Alabama 71
Comfort with Making a Decision under
Uncertainty 72
Decision to Exploit or Not to Exploit the
New Entry 72
Entry Strategy for New Entry Exploitation 73
Environmental Instability and First-Mover
(Dis)Advantages 74
Customers’ Uncertainty and First-Mover
(Dis)Advantages 76
Ethics: Do the Right Thing 78
Lead Time and First-Mover (Dis)Advantages 78
As Seen in Entrepreneur Magazine: Provide Advice to
an Entrepreneur about Being More Innovative 80
x C O N T E N T S
Risk Reduction Strategies for New Entry
Exploitation 81
Market Scope Strategies 81
Imitation Strategies 82
Managing Newness 84
PA RT 2 F R O M I D E A T O T H E O P P O RT U N I T Y 91
4 CREATIVITY AND THE BUSINESS IDEA 92
Opening Profile: Frederick W. Smith 93
Trends 96
Green Trend 96
Clean-Energy Trend 96
Organic-Orientation Trend 96
Economic Trend 97
Social Trend 97
Health Trend 97
Web Trend 97
Sources of New Ideas 97
Consumers 97
Existing Products and Services 98
Distribution Channels 98
Federal Government 98
Research and Development 98
As Seen in BusinessWeek: The Myth of Creativity 99
Methods of Generating Ideas 99
Focus Groups 99
Brainstorming 100
Brainwriting 100
Problem Inventory Analysis 100
Creative Problem Solving 101
Brainstorming 102
Reverse Brainstorming 102
Gordon Method 102
Checklist Method 103
Free Association 103
Forced Relationships 103
Collective Notebook Method 103
As Seen in BusinessWeek: How to Produce
Big Ideas on Demand 104
Attribute Listing 105
Big-Dream Approach 106
Parameter Analysis 106
Innovation 106
Types of Innovation 106
Defining a New Innovation (Product or Service) 108
Classification of New Products 109
C O N T E N T S xi
Opportunity Recognition 110
Product Planning and Development Process 111
Establishing Evaluation Criteria 111
Ethics: Leadership Is about Doing, Not Saying 112
Idea Stage 114
Concept Stage 114
Product Development Stage 117
Test Marketing Stage 117
E-Commerce and Business Start-Up 117
Using E-Commerce Creatively 118
Web Sites 118
Tracking Customer Information 119
Doing E-Commerce as an Entrepreneurial Company 119
5 IDENTIFYING AND ANALYZING DOMESTIC AND
INTERNATIONAL OPPORTUNITIES 124
Opening Profile: A. Malachi Mixon III 125
Introduction 127
Opportunity Recognition and the Opportunity
Assessment Plan 128
Information Sources 130
General Information 130
Industry and Market Information 131
Competitive Company and Product Information 131
Government Sources 131
As Seen in BusinessWeek: Mom-and-Pop
Multinationals 132
Search Engines 132
Trade Associations 132
Trade Publications 133
The Nature of International Entrepreneurship 133
The Importance of International Business to
the Firm 134
International versus Domestic Entrepreneurship 134
Economics 134
Stage of Economic Development 134
Current Account 135
Type of Economic System 135
Political–Legal Environment 135
Language 137
Technological Environment 137
Ethics: Ethics Must Be Global Not Local 138
Culture 138
Social Structure 140
Religion 141
Political Philosophy 141
Economics and Economic Philosophy 141
Education 141
Manners and Customs 141
xii C O N T E N T S
Available Distribution Systems 142
Motivations to Go Global 142
Strategic Effects of Going Global 143
Foreign Market Selection 144
As Seen in BusinessWeek: Stranger in a
Strange Land 145
Entrepreneurial Entry Strategies 147
Exporting 147
Nonequity Arrangements 148
Direct Foreign Investment 149
Entrepreneurial Partnering 151
Barriers to International Trade 152
General Agreement on Tariffs and Trade
(GATT) 152
Increasing Protectionist Attitudes 152
Trade Blocs and Free Trade Areas 152
Entrepreneur’s Strategy and
Trade Barriers 153
Implications for the Global Entrepreneur 153
Appendix 5A: Example Outline of an International
Business Plan 156
6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES
FOR THE ENTREPRENEUR 158
Opening Profile: Steve Lipscomb 159
What Is Intellectual Property? 161
Need for a Lawyer 161
How to Select a Lawyer 161
As Seen in Entrepreneur Magazine: Provide Advice
to an Entrepreneur about Intellectual Property
Protection 162
Legal Issues in Setting Up the
Organization 163
Patents 163
International Patents 164
The Provisional Application 164
The Patent Application 165
Patent Infringement 166
Business Method Patents 167
Start-Up without a Patent 167
As Seen in BusinessWeek: Provide Advice to an
Entrepreneur Inventor about How to
Make Patents Pay 168
Trademarks 168
Registering the Trademark 169
Copyrights 170
Ethics: How Much Responsibility Should Our Youth
Have for Illegal Downloading? 171
Trade Secrets 171
C O N T E N T S xiii
Licensing 173
Product Safety and Liability 175
Insurance 175
Sarbanes-Oxley Act 177
Contracts 178
PA RT 3 F R O M T H E O P P O RT U N I T Y T O
T H E B U S I N E S S P L A N 185
7 THE BUSINESS PLAN: CREATING AND STARTING
THE VENTURE 186
Opening Profile: Belinda Guadarrama 187
Planning as Part of the Business Operation 189
What Is the Business Plan? 189
Who Should Write the Plan? 190
Scope and Value of the Business Plan—Who Reads
the Plan? 191
As Seen in BusinessWeek: Don't Expect a Fee for Making
an Introduction 192
How Do Potential Lenders and Investors Evaluate
the Plan? 192
Ethics: Protecting Your Business Idea 194
Presenting the Plan 194
Information Needs 195
Market Information 195
Operations Information Needs 198
Financial Information Needs 199
Using the Internet as a Resource Tool 199
Writing the Business Plan 200
Introductory Page 202
Executive Summary 202
Environmental and Industry Analysis 203
Description of Venture 205
Production Plan 207
Operations Plan 207
Marketing Plan 208
Organizational Plan 208
Assessment of Risk 209
Financial Plan 209
As Seen in BusinessWeek: Elevator Pitch for
Perfect Dinner 210
Appendix 210
Using and Implementing the Business Plan 210
Measuring Plan Progress 211
Updating the Plan 212
Why Some Business Plans Fail 212
Appendix 7A: Sample Business Plan—Gopher It 216
xiv C O N T E N T S
8 THE MARKETING PLAN 222
Opening Profile: Warren G. Jackson 223
Industry Analysis 225
Competitor Analysis 225
Marketing Research for the New Venture 226
Step One: Defining the Purpose or Objectives 227
Step Two: Gathering Data from Secondary Sources 227
As Seen in BusinessWeek: How to Expand Your
Customer Base 229
Step Three: Gathering Information from Primary
Sources 229
Step Four: Analyzing and Interpreting the
Results 232
Understanding the Marketing Plan 232
Characteristics of a Marketing Plan 233
Ethics: Devil's Advocate 236
The Marketing Mix 236
Steps in Preparing the Marketing Plan 237
Defining the Business Situation 237
Defining the Target Market: Opportunities and Threats 237
Considering Strengths and Weaknesses 240
Establishing Goals and Objectives 240
Defining Marketing Strategy and Action Programs 240
Marketing Strategy: Consumer versus Business-to-
Business Markets 244
As Seen in Entrepreneur Magazine: Provide Advice
to an Entrepreneur about Web Sites 245
Budgeting the Marketing Strategy 246
Implementation of the Market Plan 246
Monitoring the Progress of Marketing Actions 246
Appendix 8A: Marketing Plan Outlines 250
9 THE ORGANIZATIONAL PLAN 254
Opening Profile: Jim Sinegal 255
Developing the Management Team 256
As Seen in Entrepreneur Magazine: Provide Advice
to an Entrepreneur about Some Legal Aspects of
Starting a Business 257
Legal Forms of Business 258
Ownership 258
Liability of Owners 258
Costs of Starting a Business 260
Continuity of Business 260
Transferability of Interest 261
Capital Requirements 261
Management Control 262
Distribution of Profits and Losses 262
Attractiveness for Raising Capital 263
C O N T E N T S xv
Tax Attributes of Forms of Business 263
Tax Issues for Proprietorship 263
Tax Issues for Partnership 263
Tax Issues for Corporation 265
The Limited Liability Company versus the
S Corporation 265
S Corporation 265
Advantages of an S Corporation 266
Disadvantages of an S Corporation 266
Ethics: Lawyers Explain the Steps to Take If Your
Business Partner Violates His or Her Obligations
to the Business 267
The Limited Liability Company 267
Advantages of an LLC 268
Designing the Organization 268
Building the Management Team and a Successful
Organization Culture 271
As Seen in BusinessWeek: Elevator Pitch
for 20x200 Web Site 272
The Role of a Board of Directors 273
The Board of Advisors 274
The Organization and Use of Advisors 274
10 THE FINANCIAL PLAN 280
Opening Profile: Tony Hsieh 281
Operating and Capital Budgets 282
Ethics: Are You a Good Leader? 284
Pro Forma Income Statements 285
Pro Forma Cash Flow 288
As Seen in BusinessWeek: Provide Advice to an
Entrepreneur about Solving Their Cash-Flow
Problem to Stay in Business 290
Pro Forma Balance Sheet 292
Break-Even Analysis 294
Pro Forma Sources and Applications of Funds 296
As Seen in BusinessWeek: Elevator Pitch
for Beer Chips 297
Software Packages 298
PA RT 4 F R O M T H E B U S I N E S S P L A N T O
F U N D I N G T H E V E N T U R E 303
11 SOURCES OF CAPITAL 304
Opening Profile: Scott Walker 305
An Overview 308
Debt or Equity Financing 308
Internal or External Funds 309
xvi C O N T E N T S
Personal Funds 310
As Seen in BusinessWeek: Show Me the
Moneymen 311
Family and Friends 312
Commercial Banks 312
Types of Bank Loans 313
Cash Flow Financing 314
Bank Lending Decisions 314
Role of the SBA in Small-Business
Financing 315
Ethics: We Need an Ethics Czar 316
Research and Development Limited
Partnerships 318
Major Elements 318
Procedure 319
Benefits and Costs 319
Examples 320
Government Grants 320
As Seen in BusinessWeek: From 401(k) Nest Egg
to Seed Money 321
Procedure 322
Other Government Grants 323
Private Placement 324
Types of Investors 324
Private Offerings 324
Regulation D 324
Bootstrap Financing 326
12 INFORMAL RISK CAPITAL, VENTURE CAPITAL,
AND GOING PUBLIC 332
Opening Profile: Mark Zuckerberg 333
Financing the Business 336
Informal Risk-Capital Market 337
As Seen in BusinessWeek: Old Banks, New
Lending Tricks 338
Venture Capital 341
Nature of Venture Capital 341
As Seen in BusinessWeek: She’s an Angel 342
Overview of the Venture-Capital Industry 342
Venture-Capital Process 347
Locating Venture Capitalists 350
Approaching a Venture Capitalist 350
Valuing Your Company 352
Factors in Valuation 352
Ratio Analysis 353
Liquidity Ratios 353
Activity Ratios 354
Leverage Ratios 354
Profitability Ratios 355
C O N T E N T S xvii
General Valuation Approaches 355
General Valuation Method 357
Evaluation of an Internet Company 358
Deal Structure 359
Going Public 359
Ethics: Financial Transparency a Must 360
Advantages 360
Disadvantages 362
Timing of Going Public and Underwriter
Selection 364
Timing 364
Underwriter Selection 365
Registration Statement and Timetable 366
The Prospectus 367
The Registration Statement 368
Procedure 368
Legal Issues and Blue-Sky Qualifications 369
Legal Issues 369
Blue-Sky Qualifications 369
After Going Public 369
As Seen in BusinessWeek: Where Venture Capital
Never Ventured Before 370
Aftermarket Support 371
Relationship with the Financial Community 371
Reporting Requirements 371
PA RT 5 F R O M F U N D I N G T H E V E N T U R E T O L A U N C H I N G , G R O W I N G , A N D E N D I N G T H E N E W V E N T U R E 377
13 STRATEGIES FOR GROWTH AND MANAGING
THE IMPLICATIONS OF GROWTH 378
Opening Profile: Brian and Jennifer Maxwell 379
Growth Strategies: Where to Look for Growth Opportunities 380
Penetration Strategies 381
Market Development Strategies 382
Product Development Strategies 382
Diversification Strategies 383
As Seen in Entrepreneur Magazine: Provide Advice
to an Entrepreneur about Growing into New
Markets Using the Internet 384
Example of Growth Strategies 385
Economic Implications of Growth 385
Implications of Growth for the Firm 387
Pressures on Existing Financial Resources 387
Pressures on Human Resources 388
xviii C O N T E N T S
Pressures on the Management of Employees 388
Pressures on the Entrepreneur’s Time 388
Overcoming Pressures on Existing Financial
Resources 388
Financial Control 388
Ethics: Lessons from Enron 389
Managing Cash Flow 390
Managing Inventory 392
Managing Fixed Assets 393
Managing Costs and Profits 394
Taxes 395
Record Keeping 396
Overcoming Pressures on Existing Human
Resources 396
Overcoming Pressures on the Management of
Employees 397
As Seen in Entrepreneur Magazine: Elevator Pitch
for eVest 398
Overcoming Pressures on Entrepreneurs’ Time 399
Basic Principles of Time Management 400
Implications of Firm Growth for the Entrepreneur 401
A Categorization of Entrepreneurs and Their
Firms’ Growth 402
14 ACCESSING RESOURCES FOR GROWTH
FROM EXTERNAL SOURCES 410
Opening Profile: Bill Gross 411
Using External Parties to Help Grow a Business 412
Franchising 413
Advantages of Franchising—to the Franchisee 413
Advantages of Franchising—to the Franchisor 415
As Seen in BusinessWeek: Venture Capital’s
Favorite Startups 416
Disadvantages of Franchising 417
Types of Franchises 417
Investing in a Franchise 418
Ethics: Fair Enough 419
Joint Ventures 421
Types of Joint Ventures 422
Factors in Joint Venture Success 423
Acquisitions 424
Advantages of an Acquisition 424
Disadvantages of an Acquisition 425
Synergy 425
Structuring the Deal 425
As Seen in Entrepreneur Magazine: Provide Advice
to an Entrepreneur about Entering into Agreements 426
Locating Acquisition Candidates 427
C O N T E N T S xix
Mergers 428
Leveraged Buyouts 429
Overcoming Constraints by Negotiating for More
Resources 430
15 SUCCESSION PLANNING AND STRATEGIES FOR
HARVESTING AND ENDING THE VENTURE 438
Opening Profile: Teresa Cascioli 439
As Seen in BusinessWeek: Provide Advice to an Entrepreneur on
How to Beat Failure and Be the Boss Again 441
Exit Strategy 442
Succession of Business 442
Transfer to Family Members 443
Transfer to Nonfamily Members 443
Options for Selling the Business 444
Direct Sale 445
Employee Stock Option Plan 446
Management Buyout 446
Ethics: Involving Employees, Bankers, and Business
Associates in the Problem 447
Bankruptcy—An Overview 447
Chapter 11—Reorganization 449
Surviving Bankruptcy 450
As Seen in BusinessWeek: Elevator Pitch for nPower Personal
Energy Generator 451
Chapter 13—Extended Time Payment Plans 452
Chapter 7—Liquidation 452
Strategy during Reorganization 453
Keeping the Venture Going 453
Warning Signs of Bankruptcy 454
Starting Over 455
The Reality of Failure 456
Business Turnarounds 456
As Seen in BusinessWeek: Provide Advice to an Entrepreneur On
How to Beat Failure and Be the Boss Again 441
As Seen in BusinessWeek: Elevator Pitch for nPower Personal
Energy Generator 451
PART 6 CASES 463
Case 1 Turner Test Prep Co. 465
Case 2 Jim Boothe, Inventor 467
Case 3 A. Monroe Lock and Security Systems 468
Case 4 Beijing Sammies 470
Case 5 “Mamma Mia!” The Little Show That Could! 484
Case 6 The Beach Carrier 492
Case 7 Gourmet to Go 495
xx C O N T E N T S
Case 8 Intervela d.o.o. Koper—Victory Sailmakers 502
Case 9 The Gril-Kleen Corporation 509
Case 10 The Winslow Clock Company 516
Case 11 NeoMed Technologies 525
Case 12 Rug Bug Corporation 540
Case 13 Nature Bros. Ltd. 550
Case 14 Amy’s Bread 557
Case 15 Oklahoma National Bank 563
Case 16 Datavantage Corporation 572
Case 17 Dual Pane Company 582
INDEX 584
CONTENTS xxi
1 T H E E N T R E P R E N E U R I A L
P E R S P E C T I V E
C H A P T E R 1
Entrepreneurship and the Entrepreneurial Mind-Set
C H A P T E R 2
Entrepreneurial Intentions and Corporate Entrepreneurship
C H A P T E R 3
Entrepreneurial Strategy: Generating and Exploiting New Entries
1
To introduce the concept of entrepreneurship and explain the entrepreneurial process.
2
To introduce effectuation as a way that expert entrepreneurs sometimes think.
3
To develop the notion that entrepreneurs learn to be cognitively adaptable.
4
To acknowledge that some entrepreneurs experience failure and to recognize the process by which they maximize their ability to learn from that experience.
5
To recognize that entrepreneurs have an important economic impact and an ethical and social responsibility.
1 E N T R E P R E N E U R S H I P A N D T H E
E N T R E P R E N E U R I A L M I N D - S E T
L E A R N I N G O B J E C T I V E S
3
O P E N I N G P R O F I L E
EWING MARION KAUFFMAN
Born on a farm in Garden City, Missouri, Ewing Marion Kauffman moved to Kansas City
with his family when he was eight years old. A critical event in his life occurred several
years later when Kauffman was diagnosed with a leakage of the heart. His prescription
was one year of complete bed rest; he was not even allowed to sit up. Kauffman’s
mother, a college graduate, came up with a solution to
keep the active 11-year-old boy lying in bed—reading.
According to Kauffman, he “sure read! Because nothing
else would do, I read as many as 40 to 50 books every
month. When you read that much, you read anything. So I read the biographies of all
the presidents, the frontiersmen, and I read the Bible twice and that’s pretty rough
reading.”
Another important early childhood experience centered on door-to-door sales.
Since his family did not have a lot of money, Kauffman would sell 36 dozen eggs col-
lected from the farm or fish he and his father had caught, cleaned, and dressed. His
mother was very encouraging during these formative school years, telling young Ewing
each day, “There may be some who have more money in their pockets, but Ewing, there
is nobody better than you.”
During his youth, Kauffman worked as a laundry delivery person and was a Boy
Scout. In addition to passing all the requirements to become an Eagle Scout and a Sea
Scout, he sold twice as many tickets to the Boy Scout Roundup as anyone else in Kansas
City, an accomplishment that enabled him to attend, for free, a two-week scout sum-
mer camp that his parents would not otherwise have been able to afford. According to
Kauffman, “This experience gave me some of the sales techniques which came into
play when subsequently I went into the pharmaceutical business.”
Kauffman went to junior college from 8 to 12 in the morning and then walked two
miles to the laundry where he worked until 7 p.m. Upon graduation, he went to work
at the laundry full time for Mr. R. A. Long, who would eventually become one of his
role models. His job as route foreman involved managing 18 to 20 route drivers, where
he would set up sales contests, such as challenging the other drivers to get more cus-
tomers on a particular route than he could obtain. Ewing says, “I got practice in selling
and that proved to be beneficial later in life.” R. A. Long made money not only at the
www.kauffman.org
laundry business but also on patents, one of which was a form fit for the collar of a
shirt that would hold the shape of the shirt. He showed his young protégé that one
could make money with brains as well as brawn. Kauffman commented, “He was quite
a man and had quite an influence on my life.”
Kauffman’s sales ability was also useful during his stint in the Navy, which he joined
shortly after Pearl Harbor on January 11, 1942. When designated as an apprentice sea-
man, a position that paid $21 per month, he responded, “I’m better than an apprentice
seaman, because I have been a Sea Scout. I’ve sailed ships and I’ve ridden in whale
boats.” His selling ability convinced the Navy that he should instead start as a seaman
first class, with a $54 monthly salary. Kauffman was assigned to the admiral’s staff,
where he became an outstanding signalman (a seaman who transmitted messages from
ship to ship), in part because he was able to read messages better than anyone else due
to his previous intensive reading. With his admiral’s encouragement, Kauffman took a
correspondence navigator’s course and was given a deck commission and made a nav-
igation officer.
After the war was over in 1947, Ewing Kauffman began his career as a pharmaceu-
tical salesperson after performing better on an aptitude test than 50 other applicants.
The job involved selling supplies of vitamin and liver shots to doctors. Working on
straight commission, without expenses or benefits, he was earning pay higher than the
president’s salary by the end of the second year; the president promptly cut the com-
mission. Eventually, when Kauffman was made Midwest sales manager, he made 3 per-
cent of everything his salespeople sold and continued to make more money than the
president. When his territory was cut, he eventually quit and in 1950 started his own
company—Marion Laboratories. (Marion is his middle name.)
When reflecting on founding the new company, Ewing Kauffman commented, “It
was easier than it sounds because I had doctors whom I had been selling office supplies
to for several years. Before I made the break, I went to three of them and said, ‘I’m
thinking of starting my own company. May I count on you to give me your orders if
I can give you the same quality and service?’ These three were my biggest accounts
and each one of them agreed because they liked me and were happy to do business
with me.”
Marion Laboratories started by marketing injectable products that were manufac-
tured by another company under Marion’s label. The company expanded to other ac-
counts and other products and then developed its first prescription item, Vicam, a vitamin
product. The second pharmaceutical product it developed, oyster shell calcium, also
sold well.
To expand the company, Kauffman borrowed $5,000 from the Commerce Trust
Company. He repaid the loan, and the company continued to grow. After several years,
outside investors could buy $1,000 worth of common stock if they loaned the company
$1,000 to be paid back in five years at $1,250, without any intermittent interest. This
initial $1,000 investment, if held until 1993, would have been worth $21 million.
Marion Laboratories continued to grow and reached over $1 billion per year in
sales, due primarily to the relationship between Ewing Kauffman and the people in
4 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
the company, who were called associates, not employees. “They are all stockholders,
they build this company, and they mean so much to us,” said Kauffman. The concept
of associates was also a part of the two basic philosophies of the company: Those who
produce should share in the results or profits, and treat others as you would like to be
treated.
The company went public through Smith Barney on August 16, 1965, at $21 per share.
The stock jumped to $28 per share immediately and has never dropped below that level,
sometimes selling at a 50 to 60 price/earnings multiple. The associates of the company
were offered a profit-sharing plan, where each could own stock in the company. In
1968 Kauffman brought Major League Baseball back to Kansas City by purchasing the
Kansas City Royals. This boosted the city’s economic base, community profile, and civic
pride. When Marion Laboratories merged with Merrill Dow in 1989, there were 3,400
associates, 300 of whom became millionaires as a result of the merger. The new com-
pany, Marion Merrill Dow, Inc., grew to 9,000 associates and sales of $4 billion in 1998
when it was acquired by Hoechst, a European pharmaceutical company. Hoechst Marion
Roussel became a world leader in pharmaceutical-based health care involved in the dis-
covery, development, manufacture, and sale of pharmaceutical products. In late 1999
the company was again merged with Aventis Pharma, a global pharmaceutical company
focusing on human medicines (prescription pharmaceuticals and vaccines) and animal
health. In 2002, Aventis’s sales reached $16.634 billion, an increase of 11.6 percent
from 2001, while earnings per share grew 27 percent from the previous year.
Ewing Marion Kauffman was an entrepreneur, a Major League Baseball team
owner, and a philanthropist who believed his success was a direct result of one funda-
mental philosophy: Treat others as you would like to be treated. “It is the happiest
principle by which to live and the most intelligent principle by which to do business
and make money,” he said.
Ewing Marion Kauffman’s philosophies of associates, rewarding those who produce,
and allowing decision making throughout the organization are the fundamental con-
cepts underlying what is now called corporate entrepreneurship in a company. He
went even further and illustrated his belief in entrepreneurship and the spirit of giving
back when he established the Kauffman Foundation, which supports programs in two
areas: youth development and entrepreneurship. Truly a remarkable entrepreneur,
Mr. K, as he was affectionately called by his employees, will now produce many more
successful “associate entrepreneurs.”
Like Ewing Marion Kauffman, many other entrepreneurs and future entrepreneurs
frequently ask themselves, “Am I really an entrepreneur? Do I have what it takes to be
a success? Do I have sufficient background and experience to start and manage a new
venture?” As enticing as the thought of starting and owning a business may be, the
problems and pitfalls inherent to the process are as legendary as the success stories.
The fact remains that more new business ventures fail than succeed. To be one of the
few successful entrepreneurs requires more than just hard work and luck. It requires
the ability to think in an environment of high uncertainty, be flexible, and learn from
one’s failures.
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 5
NATURE AND DEVELOPMENT OF ENTREPRENEURSHIP
Who is an entrepreneur? What is entrepreneurship? What is an entrepreneurial process?
These frequently asked questions reflect the increased national and international interest in
entrepreneurs by corporate executives, venture capitalists, university professors and stu-
dents, recruiters, and government officials. To an economist, an entrepreneur is one who
brings resources, labor, materials, and other assets into combinations that make their value
greater than before, and also one who introduces changes, innovations, and a new order. To
a psychologist, such a person is typically driven by certain forces—the need to obtain or at-
tain something, to experiment, to accomplish, or perhaps to escape the authority of others.
To one businessman, an entrepreneur appears as a threat, an aggressive competitor, whereas
to another businessman the same entrepreneur may be an ally, a source of supply, a cus-
tomer, or someone who creates wealth for others, as well as finds better ways to utilize re-
sources, reduce waste, and produce jobs others are glad to get.1
Although being an entrepreneur means different things to different people, there is agree-
ment that we are talking about a kind of behavior that includes: (1) initiative taking, (2) the
organizing and reorganizing of social and economic mechanisms to bundle resources in in-
novative ways, and (3) the acceptance of risk, uncertainty, and/or the potential for failure.2
Entrepreneurship is the dynamic process of creating incremental wealth. The wealth is
created by individuals who assume the major risks in terms of equity, time, and/or career
commitment to provide value for some product or service. The product or service may or
may not be new or unique, but the entrepreneur must somehow infuse value by receiving
and bundling the necessary skills and resources.3
To be inclusive of the many types of entrepreneurial behavior, the following definition
of entrepreneurship will be the foundation of this book:
Entrepreneurship is the process of creating something new with value by devoting the neces-
sary time and effort; assuming the accompanying financial, psychic, and social risks and un-
certainties; and receiving the resulting rewards of monetary and personal satisfaction.4
This definition stresses four basic aspects of being an entrepreneur. First, entrepreneur-
ship involves the creation process—creating something new of value. The creation has to
have value to the entrepreneur and value to the audience for which it is developed. This au-
dience can be (1) the market of organizational buyers for business innovation, (2) the hos-
pital’s administration for a new admitting procedure and software, (3) prospective students
for a new course or even college of entrepreneurship, or (4) the constituency for a new serv-
ice provided by a nonprofit agency. Second, entrepreneurship requires the devotion of the
necessary time and effort. Only those going through the entrepreneurial process appreciate
the significant amount of time and effort it takes to create something new and make it op-
erational. As one new entrepreneur so succinctly stated, “While I may have worked as
many hours in the office while I was in industry, as an entrepreneur I never stop thinking
about the business.”
The third part of the definition involves the rewards of being an entrepreneur. The most
important of these rewards is independence, followed by personal satisfaction, but mone-
tary reward also comes into play. For some entrepreneurs, money becomes the indicator of
the degree of success achieved. Assuming the necessary risks and uncertainties is the final
aspect of entrepreneurship. Because action takes place over time, and the future is un-
knowable, action is inherently uncertain.5 This uncertainty is further enhanced by the nov-
elty intrinsic to entrepreneurial actions, such as the creation of new products, new services,
and new ventures.6 Entrepreneurs must decide to act even in the face of uncertainty over the
outcome of that action. Therefore, entrepreneurs respond to, and create, change through
6 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
entrepreneur An
individual who takes
initiative to bundle
resources in innovative
ways and is willing to
bear the risk and/or
uncertainty to act
their entrepreneurial actions, where entrepreneurial action refers to behavior in response to
a judgmental decision under uncertainty about a possible opportunity for profit.7 We now
offer a process perspective of entrepreneurial action.
THE ENTREPRENEURIAL PROCESS
The process of pursuing a new venture is embodied in the entrepreneurial process, which
involves more than just problem solving in a typical management position.8 An entrepre-
neur must find, evaluate, and develop an opportunity by overcoming the forces that resist
the creation of something new. The process has four distinct phases: (1) identification
and evaluation of the opportunity, (2) development of the business plan, (3) determination
of the required resources, and (4) management of the resulting enterprise (see Table 1.1).
Although these phases proceed progressively, no one stage is dealt with in isolation or is
totally completed before work on other phases occurs. For example, to successfully iden-
tify and evaluate an opportunity (phase 1), an entrepreneur must have in mind the type of
business desired (phase 4).
Identify and Evaluate the Opportunity
Opportunity identification and evaluation is a very difficult task. Most good business
opportunities do not suddenly appear, but rather result from an entrepreneur’s alertness to
possibilities or, in some cases, the establishment of mechanisms that identify potential op-
portunities. For example, one entrepreneur asks at every cocktail party whether anyone is
using a product that does not adequately fulfill its intended purpose. This person is con-
stantly looking for a need and an opportunity to create a better product. Another entrepreneur
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 7
entrepreneurial action
Refers to behavior in
response to a judgmental
decision under uncertainty
about a possible
opportunity for profit
entrepreneurial process
The process of creating
something new with value
by devoting the necessary
time and effort, assuming
the accompanying
financial, psychic,
and social risks and
uncertainties, and
receiving the resulting
rewards of monetary and
personal satisfaction
Identify and Evaluate
the Opportunity Develop Business Plan Resources Required Manage the Enterprise
TABLE 1.1 Aspects of the Entrepreneurial Process
• Opportunity assessment
• Creation and length of
opportunity
• Real and perceived
value of opportunity
• Risks and returns of
opportunity
• Opportunity versus
personal skills and
goals
• Competitive
environment
• Title page
• Table of Contents
• Executive Summary
• Major Section
1. Description of
Business
2. Description of
Industry
3. Technology Plan
4. Marketing Plan
5. Financial Plan
6. Production Plan
7. Organization Plan
8. Operational Plan
9. Summary
• Appendixes (Exhibits)
• Determine resources
needed
• Determine existing
resources
• Identify resource gaps
and available suppliers
• Develop access to
needed resources
• Develop management
style
• Understand key
variables for success
• Identify problems and
potential problems
• Implement control
systems
• Develop growth
strategy
opportunity identification
The process by which an
entrepreneur comes up
with the opportunity for a
new venture
always monitors the play habits and toys of her nieces and nephews. This is her way of
looking for any unique toy product niche for a new venture.
Although most entrepreneurs do not have formal mechanisms for identifying business
opportunities, some sources are often fruitful: consumers and business associates, members
of the distribution system, and technical people. Often, consumers are the best source of
ideas for a new venture. How many times have you heard someone comment, “If only there
was a product that would . . .” This comment can result in the creation of a new business.
One entrepreneur’s evaluation of why so many business executives were complaining about
the lack of good technical writing and word-processing services resulted in the creation of
her own business venture to fill this need. Her technical writing service grew to 10 em-
ployees in two years.
Because of their close contact with the end user, channel members in the distribution
system also see product needs. One entrepreneur started a college bookstore after hearing
all the students complain about the high cost of books and the lack of service provided
by the only bookstore on campus. Many other entrepreneurs have identified business
opportunities through a discussion with a retailer, wholesaler, or manufacturer’s repre-
sentative. Finally, technically oriented individuals often conceptualize business opportu-
nities when working on other projects. One entrepreneur’s business resulted from seeing
the application of a plastic resin compound in developing and manufacturing a new type
of pallet while developing the resin application in another totally unrelated area—casket
moldings.
Whether one identifies the opportunity by using input from consumers, business associates,
channel members, or technical people, each opportunity must be carefully screened and
evaluated. This evaluation of the opportunity is perhaps the most critical element of the
entrepreneurial process, as it allows the entrepreneur to assess whether the specific
product or service has the returns needed compared to the resources required. As indi-
cated in Table 1.1, this evaluation process involves looking at the length of the opportu-
nity, its real and perceived value, its risks and returns, its fit with the personal skills and
goals of the entrepreneur, and its uniqueness or differential advantage in its competitive
environment.
The market size and the length of the window of opportunity are the primary bases for
determining the risks and rewards. The risks reflect the market, competition, technology,
and amount of capital involved. The amount of capital needed provides the basis for the re-
turn and rewards. The methodology for evaluating risks and rewards, the focus of Chap-
ters 7 and 10, frequently indicates that an opportunity offers neither a financial nor a per-
sonal reward commensurate with the risks involved. One company that delivered bark
mulch to residential and commercial users for decoration around the base of trees and
shrubs added loam and shells to its product line. These products were sold to the same cus-
tomer base using the same distribution (delivery) system. Follow-on products are important
for a company expanding or diversifying in a particular channel. A distribution channel
member such as Kmart, Service Merchandise, or Target prefers to do business with multi-
product, rather than single-product, firms.
Finally, the opportunity must fit the personal skills and goals of the entrepreneur. It is
particularly important that the entrepreneur be able to put forth the necessary time and ef-
fort required to make the venture succeed. Although many entrepreneurs feel that the desire
can be developed along with the venture, typically it does not materialize. An entrepreneur
must believe in the opportunity so much that he or she will make the necessary sacrifices
to develop the opportunity and manage the resulting organization.
Opportunity analysis, or what is frequently called an opportunity assessment plan, is one
method for evaluating an opportunity. It is not a business plan. Compared to a business
8 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
window of opportunity
The time period available
for creating the new
venture
plan, it should be shorter; focus on the opportunity, not the entire venture; and provide the
basis for making the decision of whether or not to act on the opportunity.
An opportunity assessment plan includes the following: a description of the product or
service, an assessment of the opportunity, an assessment of the entrepreneur and the team,
specifications of all the activities and resources needed to translate the opportunity into a
viable business venture, and the source of capital to finance the initial venture as well as its
growth. The assessment of the opportunity requires answering the following questions:
• What market need does it fill?
• What personal observations have you experienced or recorded with regard to that market need?
• What social condition underlies this market need?
• What market research data can be marshaled to describe this market need?
• What patents might be available to fulfill this need?
• What competition exists in this market? How would you describe the behavior of this competition?
• What does the international market look like?
• What does the international competition look like?
• Where is the money to be made in this activity?
Develop a Business Plan
A good business plan must be developed to exploit the defined opportunity. For example, a
business plan is often required to obtain the resources necessary to launch the business.
Writing a business plan is a very time-consuming phase of the entrepreneurial process. An
entrepreneur usually has not prepared a business plan before and does not have the re-
sources available to do a good job. Although the preparation of the business plan is the fo-
cus of Chapter 7, it is important to understand the basic issues involved as well as the three
major sections of the plan (see Table 1.1). A good business plan is essential to developing
the opportunity and determining the resources required, obtaining those resources, and suc-
cessfully managing the resulting venture.
Determine the Resources Required
The entrepreneur must determine the resources needed for addressing the opportunity.
This process starts with an appraisal of the entrepreneur’s present resources. Any re-
sources that are critical need to be differentiated from those that are just helpful. Care
must be taken not to underestimate the amount and variety of resources needed. The en-
trepreneur should also assess the downside risks associated with insufficient or inappro-
priate resources.
The next step in the entrepreneurial process is acquiring the needed resources in a timely
manner while giving up as little control as possible. An entrepreneur should strive to main-
tain as large an ownership position as possible, particularly in the start-up stage. As the
business develops, more funds will probably be needed to finance the growth of the ven-
ture, requiring more ownership to be relinquished. The entrepreneur also needs to identify
alternative suppliers of these resources, the focus of Chapter 11, along with their needs and
desires. By understanding resource supplier needs, the entrepreneur can structure a deal
that enables the resources to be acquired at the lowest possible cost and with the least loss
of control.
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 9
business plan The
description of the future
direction of the business
Manage the Enterprise
After resources are acquired, the entrepreneur must use them to implement the business
plan. The operational problems of the growing enterprise must also be examined. This in-
volves implementing a management style and structure, as well as determining the key
variables for success. A control system must be established so that any problem areas can
be quickly identified and resolved. Some entrepreneurs have difficulty managing and grow-
ing the venture they created.
HOW ENTREPRENEURS THINK
Entrepreneurs think differently than nonentrepreneurs. Moreover, an entrepreneur in a
particular situation may think differently when faced with a different task or decision
environment. Entrepreneurs must often make decisions in highly uncertain environments
where the stakes are high, time pressures are immense, and there is considerable emo-
tional investment. We think differently in these environments than we do when the nature
of a problem is well understood and we have time and rational procedures at hand to solve
it. Given the nature of an entrepreneur’s decision-making environment, he or she must
sometimes (1) effectuate, (2) be cognitively adaptable, and (3) learn from failure. We now
discuss the thought process behind each of these requirements.
Effectuation
As potential business leaders you are trained to think rationally and perhaps admonished
if you do not. This admonishment might be appropriate given the nature of the task, but it
appears that there is an alternate way of thinking that entrepreneurs sometimes use, es-
pecially when thinking about opportunities. Professor Saras Sarasvathy (from Darden,
University of Virginia) has found that entrepreneurs do not always think through a problem
in a way that starts with a desired outcome and focuses on the means to generate that out-
come. Such a process is referred to as a causal process. Our description of the entrepre-
neurial process in the preceding section reflects a causal explanation. But, entrepreneurs
sometimes use an effectuation process, which means they take what they have (who they
are, what they know, and whom they know) and select among possible outcomes. Profes-
sor Saras is a great cook, so it is not surprising that her examples of these thought processes
revolve around cooking.
Imagine a chef assigned the task of cooking dinner. There are two ways the task can be organ-
ized. In the first, the host or client picks out a menu in advance. All the chef needs to do is list
the ingredients needed, shop for them, and then actually cook the meal. This is a process of
causation. It begins with a given menu and focuses on selecting between effective ways to pre-
pare the meal.
In the second case, the host asks the chef to look through the cupboards in the kitchen for
possible ingredients and utensils and then cook a meal. Here, the chef has to imagine possible
menus based on the given ingredients and utensils, select the menu, and then prepare the meal.
This is a process of effectuation. It begins with given ingredients and utensils and focuses on
preparing one of many possible desirable meals with them.9
Sarasvathy’s Thought Experiment #1: Curry in a Hurry
In this example I [Sarasvathy] trace the process for building an imaginary Indian restaurant,
“Curry in a Hurry.” Two cases, one using causation and the other effectuation, are examined.
For the purposes of this illustration, the example chosen is a typical causation process that
10 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
causal process A
process that starts with a
desired outcome and
focuses on the means to
generate that outcome
effectuation process A
process that starts with
what one has (who they
are, what they know, and
whom they know) and
selects among possible
outcomes
underlies many economic theories today—theories in which it is argued that artifacts such as
firms are inevitable outcomes, given the preference orderings of economic actors and certain
simple assumptions of rationality (implying causal reasoning) in their choice behavior. The cau-
sation process used in the example here is typified by and embodied in the procedures stated by
Philip Kotler in his Marketing Management (1991: 63, 263), a book that in its many editions is
considered a classic and is widely used as a textbook in MBA programs around the world.
Kotler defines a market as follows: “A market consists of all the potential customers shar-
ing a particular need or want who might be willing and able to engage in exchange to satisfy
that need or want” (1991: 63). Given a product or a service, Kotler suggests the following pro-
cedure for bringing the product/service to market (note that Kotler assumes the market exists):
1. Analyze long-run opportunities in the market.
2. Research and select target markets.
3. Identify segmentation variables and segment the market.
4. Develop profiles of resulting segments.
5. Evaluate the attractiveness of each segment.
6. Select the target segment(s).
7. Identify possible positioning concepts for each target segment.
8. Select, develop, and communicate the chosen positioning concept.
9. Design marketing strategies.
10. Plan marketing programs.
11. Organize, implement, and control marketing effort.
This process is commonly known in marketing as the STP—segmentation, targeting, and
positioning—process.
Curry in a Hurry is a restaurant with a new twist—say, an Indian restaurant with a fast food
section. The current paradigm using causation processes indicates that, to implement this
idea, the entrepreneur should start with a universe of all potential customers. Let us imagine
that she wants to build her restaurant in Pittsburgh, Pennsylvania, USA, which will then
become the initial universe or market for Curry in a Hurry. Assuming that the percentage of
the population of Pittsburgh that totally abhors Indian food is negligible, the entrepreneur can
start the STP process.
Several relevant segmentation variables, such as demographics, residential neighbor-
hoods, ethnic origin, marital status, income level, and patterns of eating out, could be used.
On the basis of these, the entrepreneur could send out questionnaires to selected neighbor-
hoods and organize focus groups at, say, the two major universities in Pittsburgh. Analyz-
ing responses to the questionnaires and focus groups, she could arrive at a target segment—
for example, wealthy families, both Indian and others, who eat out at least twice a week.
That would help her determine her menu choices, decor, hours, and other operational de-
tails. She could then design marketing and sales campaigns to induce her target segment to
try her restaurant. She could also visit other Indian and fast food restaurants and find some
method of surveying them and then develop plausible demand forecasts for her planned
restaurant.
In any case, the process would involve considerable amounts of time and analytical effort.
It would also require resources both for research and, thereafter, for implementing the market-
ing strategies. In summary, the current paradigm suggests that we proceed inward to specifics
from a larger, general universe—that is, to an optimal target segment from a predetermined
market. In terms of Curry in a Hurry, this could mean something like a progression from the
entire city of Pittsburgh to Fox Chapel (an affluent residential neighborhood) to the Joneses
(specific customer profile of a wealthy family), as it were.
Instead, if our imaginary entrepreneur were to use processes of effectuation to build her
restaurant, she would have to proceed in the opposite direction (note that effectuation is
suggested here as a viable and descriptively valid alternative to the STP process—not as a
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 11
normatively superior one). For example, instead of starting with the assumption of an existing
market and investing money and other resources to design the best possible restaurant for the
given market, she would begin by examining the particular set of means or causes available to
her. Assuming she has extremely limited monetary resources—say $20,000—she should think
creatively to bring the idea to market with as close to zero resources as possible. She could do
this by convincing an established restaurateur to become a strategic partner or by doing just
enough market research to convince a financier to invest the money needed to start the restau-
rant. Another method of effectuation would be to convince a local Indian restaurant or a local
fast food restaurant to allow her to put up a counter where she would actually sell a selection
of Indian fast food. Selecting a menu and honing other such details would be seat-of-the-pants
and tentative, perhaps a process of satisficing.10
Several other courses of effectuation can be imagined. Perhaps the course the entrepreneur
actually pursues is to contact one or two of her friends or relatives who work downtown and
bring them and their office colleagues some of her food to taste. If the people in the office like
her food, she might get a lunch delivery service going. Over time, she might develop enough
of a customer base to start a restaurant or else, after a few weeks of trying to build the lunch
business, she might discover that the people who said they enjoyed her food did not really
enjoy it so much as they did her quirky personality and conversation, particularly her rather un-
usual life perceptions. Our imaginary entrepreneur might now decide to give up the lunch busi-
ness and start writing a book, going on the lecture circuit and eventually building a business in
the motivational consulting industry!
Given the exact same starting point—but with a different set of contingencies—the entrepre-
neur might end up building one of a variety of businesses. To take a quick tour of some possi-
bilities, consider the following: Whoever first buys the food from our imaginary Curry in a
Hurry entrepreneur becomes, by definition, the first target customer. By continually listening
to the customer and building an ever-increasing network of customers and strategic partners,
the entrepreneur can then identify a workable segment profile. For example, if the first cus-
tomers who actually buy the food and come back for more are working women of varied eth-
nic origin, this becomes her target segment. Depending on what the first customer really wants,
she can start defining her market. If the customer is really interested in the food, the entrepre-
neur can start targeting all working women in the geographic location, or she can think in
terms of locating more outlets in areas with working women of similar profiles—a “Women in
a Hurry” franchise?
Or, if the customer is interested primarily in the idea of ethnic or exotic entertainment,
rather than merely in food, the entrepreneur might develop other products, such as catering
services, party planning, and so on—“Curry Favors”? Perhaps, if the customers buy food from
her because they actually enjoy learning about new cultures, she might offer lectures and
classes, maybe beginning with Indian cooking and moving on to cultural aspects, including
concerts and ancient history and philosophy, and the profound idea that food is a vehicle of
cultural exploration—“School of Curry”? Or maybe what really interests them is theme tours
and other travel options to India and the Far East—“Curryland Travels”?
In a nutshell, in using effectuation processes to build her firm, the entrepreneur can build
several different types of firms in completely disparate industries. This means that the original
idea (or set of causes) does not imply any one single strategic universe for the firm (or effect).
Instead, the process of effectuation allows the entrepreneur to create one or more several pos-
sible effects irrespective of the generalized end goal with which she started. The process not
only enables the realization of several possible effects (although generally one or only a few
are actually realized in the implementation) but it also allows a decision maker to change his
or her goals and even to shape and construct them over time, making use of contingencies as
they arise.11
Our use of direct quotes from Sarasvathy on effectuation is not to make the case that it
is superior to thought processes that involve causation; rather, it represents a way that en-
trepreneurs sometimes think. Effectuation helps entrepreneurs think in an environment of
12 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
high uncertainty. Indeed organizations today operate in complex and dynamic environ-
ments that are increasingly characterized by rapid, substantial, and discontinuous change.12
Given the nature of this type of environment, most managers of firms need to take on an
entrepreneurial mind-set so that their firms can successfully adapt to environmental
changes.13 This entrepreneurial mind-set involves the ability to rapidly sense, act, and
mobilize, even under uncertain conditions.14 In developing an entrepreneurial mind-set,
individuals must attempt to make sense of opportunities in the context of changing goals,
constantly questioning the “dominant logic” in the context of a changing environment
and revisiting “deceptively simple questions” about what is thought to be true about markets
and the firm. For example, effective entrepreneurs are thought to continuously “rethink
current strategic actions, organization structure, communications systems, corporate
culture, asset deployment, investment strategies, in short every aspect of a firm’s operation
and long-term health.”15
To be good at these tasks individuals must develop a cognitive adaptability. Mike
Haynie, a retired major of the U.S. Air Force and now professor at Syracuse University, has
developed a number of models of cognitive adaptability and a survey for capturing it, to
which we now turn.16
Cognitive Adaptability
Cognitive adaptability describes the extent to which entrepreneurs are dynamic, flexible,
self-regulating, and engaged in the process of generating multiple decision frameworks
focused on sensing and processing changes in their environments and then acting on
them. Decision frameworks are organized prior knowledge about people and situations
that are used to help someone make sense of what is going on.17 Cognitive adaptability
is reflected in an entrepreneur’s metacognitive awareness, that is, the ability to reflect
upon, understand, and control one’s thinking and learning.18 Specifically, metacognition
describes a higher-order cognitive process that serves to organize what individuals know
and recognize about themselves, tasks, situations, and their environments to promote ef-
fective and adaptable cognitive functioning in the face of feedback from complex and
dynamic environments.19
How cognitively adaptable are you? Try the survey in Table 1.2 and compare yourself to
some of your classmates. A higher score means that you are more metacognitively aware,
and this in turn helps provide cognitive adaptability. Regardless of your score, the good
news is that you can learn to be more cognitively adaptable. This ability will serve you well
in most new tasks, but particularly when pursuing a new entry and managing a firm in an
uncertain environment. Put simply, it requires us to “think about thinking which requires,
and helps provide, knowledge and control over our thinking and learning activities—it
requires us to be self-aware, to think aloud, to reflect, to be strategic, to plan, to have a
plan in mind, to know what to know, to self-monitor.20 We can achieve this by asking our-
selves a series of questions that relate to (1) comprehension, (2) connection, (3) strategy,
and (4) reflection.21
1. Comprehension questions are designed to increase entrepreneurs’ understanding of the
nature of the environment before they begin to address an entrepreneurial challenge,
whether it be a change in the environment or the assessment of a potential opportunity.
Understanding arises from recognition that a problem or opportunity exists, the nature
of that situation, and its implications. In general, the questions that stimulate individu-
als to think about comprehension include: What is the problem all about? What is the
question? What are the meanings of the key concepts? Specific to entrepreneurs, the
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 13
entrepreneurial mind-set
Involves the ability to
rapidly sense, act, and
mobilize, even under
uncertain conditions
cognitive adaptability
Describes the extent to
which entrepreneurs are
dynamic, flexible, self-
regulating, and engaged
in the process of
generating multiple
decision frameworks
focused on sensing and
processing changes in
their environments and
then acting on them
comprehension questions
Questions designed to
increase entrepreneurs’
understanding of the
nature of the environment
14
A S S E E N I N E N T R E P R E N E U R M A G A Z I N E
WHAT ME WORRY? HOW SMART ENTREPRENEURS HARNESS THE POWER
OF PARANOIA
Depending on whom you’re talking to, paranoia is:
(1) a psychotic disorder characterized by delusions of
persecution, (2) an irrational distrust of others, or
(3) a key trait in entrepreneurial success.
Sound crazy? Not according to Andrew S. Grove,
president and CEO of Intel Corp. in Santa Clara,
California, and author of Only the Paranoid Survive
(Doubleday/Currency). The title of Grove’s book
comes from an oft-repeated quote that has become
the mantra of the chip king’s rise to the top of the
technology business.
“I have no idea when I first said this,” Grove
writes, “but the fact remains that, when it comes to
business, I believe in the value of paranoia.” To those
who suffer from clinical delusions of persecution, of
course, paranoia is neither a joke nor a help. How-
ever, in a business context, the practice of voluntarily
being highly concerned about potential threats to
your company has something of a following.
“If you’re not a little bit paranoid, you’re compla-
cent,” says Dave Lakhani, an entrepreneur in Boise,
Idaho, who offers marketing consulting to small busi-
nesses. “And complacency is what leads people into
missed opportunities and business failure.”
PICK YOUR PARANOIA
Being paranoid, according to Grove, is a matter of re-
membering that others want the success you have,
paying attention to the details of your business, and
watching for the trouble that inevitably awaits. That
basically means he is paranoid about everything. “I
worry about products getting screwed up, and I worry
about products getting introduced prematurely,”
Grove writes. “I worry about factories not performing
well, and I worry about having too many factories.”
For Grove, as for most advocates of paranoia, be-
ing paranoid primarily consists of two things. The
first is not resting on your laurels. Grove calls it a
“guardian attitude” that he attempts to nurture in
himself and in Intel’s employees to fend off threats
from outside the company. Paranoia in business is
also typically defined as paying very close attention
to the fine points. “You need to be detail-oriented
about the most important things in your business,”
says Lakhani. “That means not only making sure
you’re working in your business but that you’re there
every day, paying attention to your customers.”
As an example of paranoia’s value in practice,
Lakhani recalls when sales began slowly slumping
at a retail store he once owned. He could have dis-
missed it as a mere blip. Instead, he worried and
watched until he spotted a concrete cause. “It
turned out one of my employees had developed a
negative attitude, and it was affecting my business,”
Lakhani says. “As soon as I let him go, sales went
back up.”
The main focuses of most entrepreneurs’ paranoia,
however, are not so much everyday internal details as
major competitive threats and missed opportunities.
Situations in which competition and opportunity are
both at high levels are called “strategic inflection
points” by Grove, and it is during these times, typi-
cally when technology is changing, that his paranoia
is sharpest.
Paranoia is frequently a welcome presence at ma-
jor client presentations for Katharine Paine, founder
and CEO of The Delahaye Group Inc. In the past,
twinges of seemingly unfounded worry have caused
Paine to personally attend sales pitches where she
learned of serious problems with the way her firm was
doing business, she says. The head of the 50-person
Portsmouth, New Hampshire, marketing evaluation
research firm traces her paranoid style to childhood
days spent pretending to be an Indian tracking
quarry through the forest. When she makes mental
checklists about things that could go wrong or op-
portunities that could be missed, she’s always keep-
ing an eye out for the business equivalent of a bent
twig. “If you are paranoid enough, if you’re good
enough at picking up all those clues, you don’t have
to just react,” says Paine, “you get to proact and be
slightly ahead of the curve.”
PARANOID PARAMETERS
There is, of course, such a thing as being too para-
noid. “There are times when it doesn’t make any
sense,” acknowledges Lakhani. Focusing on details to
the point of spending $500 in accounting fees to find
a $5 error is one example of misplaced paranoia.
Worrying obsessively about what every competitor is
doing or what every potential customer is thinking is
also a warning sign, he says. Lack of balance with in-
terests outside the business may be another. “If your
whole life is focused around your work, and that’s
15
the only thing you’re thinking about 24 hours a day,
that becomes detrimental,” Lakhani says.
For Paine, failing to act is a sign that you’re going
past beneficial paranoia and into hurtful fear. “Fear
for most of us results in inaction—absolute death for
an entrepreneur,” she says. “If we feared the loss of a
paycheck or feared entering a new market, none of
our businesses would have gotten off the ground.”
All this may be especially true for small-business
owners. While paranoia may be appropriate for
heads of far-flung enterprises, some say entrepre-
neurs are already too paranoid. It’s all too easy for
entrepreneurs to take their desire for independence
and self-determination and turn it into trouble, says
Robert Barbato, director of the Small Business Insti-
tute at the Rochester Institute of Technology in
Rochester, New York. Typically, entrepreneurs take
the attitude that “nobody cares as much about this
business as I do” and exaggerate it to the point of
hurtful paranoia toward employees and even cus-
tomers, he says. “They’re seeing ghosts where ghosts
don’t exist,” warns Barbato.
That’s especially risky when it comes to dealing with
employees. Most people—not just entrepreneurs—
do their work for the sense of accomplishment,
not because they are plotting to steal their em-
ployer’s success, Barbato says. He acknowledges this
may be a difficult concept for competition-crazed
entrepreneurs—especially those who have never
themselves been employees—to understand. “People
who own their own business are not necessarily used
to moving up the ranks,” Barbato notes. Entrepre-
neurs must learn to trust and delegate if their busi-
nesses are to grow.
PRACTICAL PARANOIA
No matter how useful it is, paranoia may be too
loaded a label for some entrepreneurs. If so, critical
evaluation or critical analysis are the preferred terms of
Stephen Markowitz, director of governmental and
political relations of the Small Business Association of
Delaware Valley, a 5,000-member trade group. The dis-
tinction is more than name-deep. “When I say ‘critically
evaluate,’ that means look at everything,” Markowitz
explains. “If you’re totally paranoid, the danger is not
being able to critically evaluate everything.”
For example, Markowitz says a small retailer
threatened by the impending arrival of a superstore
in the market would be better served by critically
evaluating the potential for benefit as well as harm,
instead of merely worrying about it. “If you’re para-
noid,” he says, “you’re not going to critically evaluate
how it might help you.”
Whatever name it goes by, few entrepreneurs
are likely to stop worrying anytime soon. In fact,
experience tends to make them more confirmed in
their paranoia as they go along. Paine recalls the
time a formless fear led her to insist on going to a
client meeting where no trouble was expected. She
lost the account anyway. “The good news is, my
paranoia kicked in,” she says. “The bad news is, it
was too late. That made me much more paranoid in
the future.”
ADVICE TO AN ENTREPRENEUR
A friend who has just become an entrepreneur has
read the above article and comes to you for advice:
1. I worry about my business; does that mean that I
am paranoid?
2. What are the benefits of paranoia and what are
the costs?
3. How do I know I have the right level of paranoia
to effectively run the business and not put me in
the hospital with a stomach ulcer?
4. Won’t forcing myself to be more paranoid take
the fun out of being an entrepreneur?
Source: Reprinted with permission of Entrepreneur Media, Inc., “How Smart Entrepreneurs Harness the Power of Paranoia,” by Mark Henricks, March 1997, Entrepreneur magazine: www.entrepreneur.com.
questions are more likely to include: What is this market all about? What is this tech-
nology all about? What do we want to achieve by creating this new firm? What are the
key elements to effectively pursuing this opportunity?
2. Connection tasks are designed to stimulate entrepreneurs to think about the current
situation in terms of similarities to and differences from situations previously faced and
solved. In other words, these tasks prompt the entrepreneur to tap into his or her
knowledge and experience without overgeneralizing. Generally, connection tasks
focus on questions like: How is this problem similar to problems I have already
connection tasks Tasks
designed to stimulate
entrepreneurs to think
about the current situation
in terms of similarities to
and differences from
situations previously
faced and solved
16 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
How Cognitively Flexible Are You? On a scale of 1 to 10, where 1 is “not very much like me,”
and 10 is “very much like me,” how do you rate yourself on the following statements?
Goal Orientation
I often define goals for myself. Not very much—1 2 3 4 5 6 7 8 9 10—Very much
like me like me
I understand how accomplishment Not very much—1 2 3 4 5 6 7 8 9 10—Very much
of a task relates to my goals. like me like me
I set specific goals before Not very much—1 2 3 4 5 6 7 8 9 10—Very much
I begin a task. like me like me
I ask myself how well I’ve Not very much—1 2 3 4 5 6 7 8 9 10—Very much
accomplished my goals once like me like me
I’ve finished.
When performing a task, I Not very much—1 2 3 4 5 6 7 8 9 10—Very much
frequently assess my progress like me like me
against my objectives.
Metacognitive Knowledge
I think of several ways to solve a Not very much—1 2 3 4 5 6 7 8 9 10—Very much
problem and choose the best one. like me like me
I challenge my own assumptions Not very much—1 2 3 4 5 6 7 8 9 10—Very much
about a task before I begin. like me like me
I think about how others may react Not very much—1 2 3 4 5 6 7 8 9 10—Very much
to my actions. like me like me
I find myself automatically Not very much—1 2 3 4 5 6 7 8 9 10—Very much
employing strategies that have like me like me
worked in the past.
I perform best when I already Not very much—1 2 3 4 5 6 7 8 9 10—Very much
have knowledge of the task. like me like me
I create my own examples to make Not very much—1 2 3 4 5 6 7 8 9 10—Very much
information more meaningful. like me like me
I try to use strategies that have Not very much—1 2 3 4 5 6 7 8 9 10—Very much
worked in the past. like me like me
I ask myself questions about the Not very much—1 2 3 4 5 6 7 8 9 10—Very much
task before I begin. like me like me
I try to translate new information Not very much—1 2 3 4 5 6 7 8 9 10—Very much
into my own words. like me like me
I try to break problems down into Not very much—1 2 3 4 5 6 7 8 9 10—Very much
smaller components. like me like me
I focus on the meaning and Not very much—1 2 3 4 5 6 7 8 9 10—Very much
significance of new information. like me like me
Metacognitive Experience
I think about what I really need Not very much—1 2 3 4 5 6 7 8 9 10—Very much
to accomplish before I begin a task. like me like me
I use different strategies depending Not very much—1 2 3 4 5 6 7 8 9 10—Very much
on the situation. like me like me
I organize my time to best Not very much—1 2 3 4 5 6 7 8 9 10—Very much
accomplish my goals. like me like me
TABLE 1.2 Mike Haynie’s “Measure of Adaptive Cognition”
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 17
I am good at organizing Not very much—1 2 3 4 5 6 7 8 9 10—Very much
information. like me like me
I know what kind of information is Not very much—1 2 3 4 5 6 7 8 9 10—Very much
most important to consider when like me like me
faced with a problem.
I consciously focus my attention on Not very much—1 2 3 4 5 6 7 8 9 10—Very much
important information. like me like me
My ”gut” tells me when a given Not very much—1 2 3 4 5 6 7 8 9 10—Very much
strategy I use will be most effective. like me like me
I depend on my intuition to help Not very much—1 2 3 4 5 6 7 8 9 10—Very much
me formulate strategies. like me like me
Metacognitive Choice
I ask myself if I have considered all Not very much—1 2 3 4 5 6 7 8 9 10—Very much
the options when solving a problem. like me like me
I ask myself if there was an easier Not very much—1 2 3 4 5 6 7 8 9 10—Very much
way to do things after I finish a task. like me like me
I ask myself if I have considered all Not very much—1 2 3 4 5 6 7 8 9 10—Very much
the options after I solve a problem. like me like me
I re-evaluate my assumptions when Not very much—1 2 3 4 5 6 7 8 9 10—Very much
I get confused. like me like me
I ask myself if I have learned as Not very much—1 2 3 4 5 6 7 8 9 10—Very much
much as I could have after I finish like me like me
the task.
Monitoring
I periodically review to help me Not very much—1 2 3 4 5 6 7 8 9 10—Very much
understand important relationships. like me like me
I stop and go back over information Not very much—1 2 3 4 5 6 7 8 9 10—Very much
that is not clear. like me like me
I am aware of what strategies I use Not very much—1 2 3 4 5 6 7 8 9 10—Very much
when engaged in a given task. like me like me
I find myself analyzing the Not very much—1 2 3 4 5 6 7 8 9 10—Very much
usefulness of a given strategy while like me like me
engaged in a given task.
I find myself pausing regularly to Not very much—1 2 3 4 5 6 7 8 9 10—Very much
check my comprehension of the like me like me
problem or situation at hand.
I ask myself questions about how Not very much—1 2 3 4 5 6 7 8 9 10—Very much
well I am doing while I am like me like me
performing a novel task. I stop and
re-read when I get confused.
Result—A higher score means that you are more aware of the way that you think about how you make decisions and are there-
fore more likely to be cognitively flexible.
Source: M. Haynie and D. Shepherd, “A Measure of Adaptive Cognition for Entrepreneurship Research,” Entrepreneurship,
Theory and Practice 33, no. 3 (2009), pp. 695–714.
solved? Why? How is this problem different from what I have already solved? Why?
Specific to entrepreneurs, the questions are more likely to include: How is this new
environment similar to others in which I have operated? How is it different? How is
this new organization similar to the established organizations I have managed? How
is it different?
3. Strategic tasks are designed to stimulate entrepreneurs to think about which
strategies are appropriate for solving the problem (and why) or pursuing the op-
portunity (and how). These tasks prompt them to think about the what, why, and
how of their approach to the situation. Generally, these questions include: What
strategy/tactic/principle can I use to solve this problem? Why is this strategy/
tactic/principle the most appropriate one? How can I organize the information to
solve the problem? How can I implement the plan? Specific to entrepreneurs, the
questions are likely to include: What changes to strategic position, organizational
structure, and culture will help us manage our newness? How can the implemen-
tation of this strategy be made feasible?
4. Reflection tasks are designed to stimulate entrepreneurs to think about their under-
standing and feelings as they progress through the entrepreneurial process. These tasks
prompt entrepreneurs to generate their own feedback (create a feedback loop in their
solution process) to provide the opportunity to change. Generally, reflection questions
include: What am I doing? Does it make sense? What difficulties am I facing? How do
I feel? How can I verify the solution? Can I use another approach for solving the task?
Specific to the entrepreneurial context, entrepreneurs might ask: What difficulties will
we have in convincing our stakeholders? Is there a better way to implement our strat-
egy? How will we know success if we see it?
Entrepreneurs who are able to increase cognitive adaptability have an improved ability
to (1) adapt to new situations—i.e., it provides a basis by which a person’s prior experience
and knowledge affect learning or problem solving in a new situation; (2) be creative—i.e.,
it can lead to original and adaptive ideas, solutions, or insights; and (3) communicate one’s
reasoning behind a particular response.22 We hope that this section of the book has not only
provided you a deeper understanding of how entrepreneurs can think and act with great
flexibility, but also an awareness of some techniques for incorporating cognitive adaptabil-
ity in your life.
We have discussed how entrepreneurs make decisions in uncertain environments and how
one might develop an ability to be more cognitively flexible. It is important to note that
entrepreneurs operate in such uncertain environments because that is where the oppor-
tunities for new entry are to be found and/or generated. There is the possibility that op-
portunities exist in more stable environments, but even in this situation the entrepreneur’s
new entry may create industry instability and uncertainty. Given the inherent uncertainty
in entrepreneurial action, there is the possibility that an entrepreneur will experience fail-
ure. Failure can be valuable if the entrepreneur is able to learn from it. We now investigate
the process of learning from business failure.
Learning from Business Failure23
Businesses fail. In 2008, a total of 6,513 U.S. firms filed for Chapter 11 bankruptcy
(Chapter 11 provides for a business to continue operations while formulating a plan to re-
pay its creditors) and 23,372 U.S. firms filed for Chapter 7 bankruptcy (Chapter 7 is de-
signed to allow individuals to keep certain exempt property while the remaining property
is sold to repay creditors) (www.uscourts.gov). Business failure occurs when a fall in rev-
enue and/or a rise in expense is of such magnitude that the firm becomes insolvent and is
unable to attract new debt or equity funding; consequently, it cannot continue to operate
under the current ownership and management. Projects also fail, such as failure of a new
product development effort, the entry into a new market, or an alliance with a former
18 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
reflection tasks Tasks
designed to stimulate
entrepreneurs to think
about their understanding
and feelings as they
progress through the
entrepreneurial process
strategic tasks Tasks
designed to stimulate
entrepreneurs to think
about which strategies are
appropriate for solving
the problem (and why) or
pursuing the opportunity
(and how)
competitor. Failure is particularly common among entrepreneurial firms because the
newness that is the source of an opportunity is also a source of uncertainty and changing
conditions.
Although there are many causes of failure, the most common is insufficient experi-
ence. That is, entrepreneurs who have more experience will possess the knowledge to
perform more effectively the roles and tasks necessary for success. This experience need
not come solely from success. In fact, it appears that we may learn more from our fail-
ures than our successes.24
A leading entrepreneurship scholar, Rita McGrath, has argued that because entrepre-
neurs typically seek success and try to avoid failure for their projects, errors are intro-
duced that can not only inhibit the learning and interpretation processes but also make
project failure more likely or expensive than necessary. She proposes that there are ben-
efits to be gained from the pursuit of risky opportunities, even if that pursuit increases
the potential for failure. This entrepreneurial process of experimentation generates
improvements in technologies.25 Although Professor McGrath focuses on the failure
of projects within a firm, it appears that the process of learning from failure also
benefits society through the application of that knowledge to subsequent businesses.
Other businesses can learn from an entrepreneur’s mistake and that learning can help
our economy.
Does failure always lead to learning? Perhaps, but it would seem that the issue is more
complex. The motivation for managing one’s own business or the creation of a new project
at work is typically not simply one of personal profit but also loyalty to a product, loyalty
to a market and customers, personal growth, and the need to prove oneself.26 Some entre-
preneurs use their ventures to “create a product that flows from their own internal desires
and needs. They create primarily to express subjective conceptions of beauty, emotion, or
some aesthetic ideal.”27 For members of a family business, the firm may not only be a
source of income but also a context for family activity and the embodiment of family pride
and identity. This suggests that the loss of a business is likely to generate a negative emo-
tional response from the entrepreneur.28
One entrepreneur that I know exhibited a number of worrying emotions when his fam-
ily business failed. There was numbness and disbelief that this business he had created
20-odd years ago was no longer alive. There was some anger toward the economy, competi-
tors, and debtors, but even stronger than anger were his feelings of guilt and self-blame. He
felt guilty that he had caused the failure of the business, that it could no longer be passed
on to his children, and that as a result he had failed not only as a businessperson but also as
a father. These feelings caused him distress and anxiety. He felt the situation was hopeless,
and he became withdrawn and at times depressed. These are all strong negative emotions.
After the failure of their businesses or projects, it is likely that most entrepreneurs feel a
negative emotional response to that loss.
This negative emotional reaction can interfere with entreprenurs’ ability to learn from
the failure and quite possibly their motivation to try again. For entrepreneurs, learning from
failure occurs when they can use the information available about why the venture failed
(feedback information) to revise their existing knowledge of how to manage their ventures
more effectively (entrepreneurial knowledge)—that is, revise assumptions about the conse-
quences of previous assessments, decisions, actions, and inactions. For example, Ravi
Kalakota has learned a number of lessons from the loss of his business, Hsupply.com, such
as, “Don’t let venture capitalists hijack your vision,” “Don’t rapidly burn through capital to
achieve short-term growth,” and “Don’t underestimate the speed others will imitate your
products and services.”29
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 19
Indeed, negative emotion(s) have been found to interfere with individuals’ allocation of
attention in the processing of information. Such interference negatively impacts their abil-
ity to learn from negative events.30 For the entrepreneur, this could mean focusing atten-
tion on the day that the business closed (i.e., dwelling on announcements to employees,
buyers, and suppliers, as well as handing over the office keys to a liquidator), rather than
allocating sufficient attention to feedback information, such as previous actions and/or
inactions that caused the deterioration in business performance and ultimately the loss of
the business.
Recovery and Learning Process
An individual has emotionally recovered from the failure when thoughts about the events
surrounding, and leading up to, the loss of the business no longer generate a negative emo-
tional response. The two primary descriptions of the process of recovering from feelings
arising from failure are classifiable as either loss-oriented or restoration-oriented.
Loss-orientation refers to working through, and processing, some aspect of the loss
experience and, as a result of this process, breaking emotional bonds to the object lost.
This process of constructing a series of accounts about the loss gradually provides the
loss with meaning and eventually produces a changed viewpoint of the self and the
world. Changing the way that an event is interpreted can allow an entrepreneur to regu-
late emotions so that thoughts of the event no longer generate negative emotions.
Entrepreneurs with a loss-orientation might seek out friends, family, or psychologists to
talk about their negative feelings. But they may also focus their thoughts on the time
spent in creating and nurturing the business and may ruminate about the circumstances
and events surrounding the loss. It appears that such thoughts could evoke a sense of
yearning for the way things used to be or foster a sense of relief that the events sur-
rounding the loss (e.g., arguing with creditors, explaining to employees, family, and
friends the business has failed) are finally over. While these feelings of relief and pain
wax and wane over time, in the early periods after the failure, painful memories are
likely to dominate.31
Restoration-orientation is based on both avoidance and a proactiveness toward second-
ary sources of stress arising from failure. For avoidance, it is possible that entrepreneurs
can distract themselves from thinking about the loss of the business or project to speed re-
covery. For the entrepreneur, founding a new venture might enhance recovery from the neg-
ative emotions over the loss of the previous business (although there is the possibility that
the same mistakes will be replicated because these entrepreneurs have not sufficiently
learned from their experience).
A restoration-orientation is not simply about avoidance, however; it also involves the
way that an entrepreneur attends to other aspects of his or her life (e.g., coping with daily
life, learning new tasks). It refers to being proactive toward secondary sources of stress
instead of being concerned with the loss itself. Such activities enable entrepreneurs to dis-
tract themselves from thinking about the loss while simultaneously maintaining essential
activities necessary for restructuring aspects of their lives. This may apply to the entre-
preneur, for whom the loss of the business itself generates a negative emotional response
while causing the loss of income, social status, and positive perceptions of self. For
example, an entrepreneur must reorganize his life to cope without the business. It might
be necessary to apply for jobs, join the unemployment line, and/or sell the house and
move to a less expensive neighborhood (requiring the children to change schools). There
might also be other stressors, such as responding to questions such as: “What do you do
for a living?” or “How is your business going?” In addressing these secondary sources of
20 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
loss-orientation An
approach to negative
emotions that involves
working through, and
processing, some aspect
of the loss experience
and, as a result of this
process, breaking
emotional bonds to the
object lost
restoration-orientation
An approach to negative
emotions based on both
avoidance and a
proactiveness toward
secondary sources of
stress arising from a
major loss
stress, the entrepreneur is able to eventually reduce the negative emotions associated with
thoughts of the events surrounding the loss of the business.
A Dual Process for Learning from Failure
Which process of recovery is most effective in promoting learning from the experience? It is
not an “either/or” choice between the two orientations. Both loss-oriented and restoration-
oriented coping styles are likely to have different costs. A loss-orientation involves confronta-
tion, which is physically and mentally exhausting, whereas a restoration-orientation involves
suppression, which requires mental effort and presents potentially adverse consequences for
health. Oscillation between the two orientations enables an entrepreneur to obtain the bene-
fits of each and to minimize the costs of maintaining one for too long—this dual process
speeds the recovery process.32 Speeding the recovery process is important because it more
quickly reduces the emotional interference with learning.
For example, starting with a loss-orientation provides an individual the ability to first
focus on aspects of the loss experience and begin processing information about the busi-
ness loss as well as breaking the emotional bonds to the failed business or project. When
the entrepreneur’s attention begins to shift from the event to aspects of the emotions
themselves, then learning is likely reduced by emotional interference and the entrepreneur
should switch to a restoration-orientation. Switching to a restoration-orientation en-
courages individuals to think about other aspects of their lives. It also breaks the cycle
of continually thinking about the symptoms arising from the failure; such thoughts can
increase negative feelings.33 This restoration-orientation also provides the opportunity
to address secondary causes of stress, which may reduce the emotional significance of
the failure. When information processing capacity is no longer focused on the symp-
toms, the entrepreneur can shift back to a loss-orientation and use his or her information
processing capacity to generate further meaning from the loss experience and also fur-
ther reduce the emotional significance of the loss of the business. Oscillation should
continue until the entrepreneur has emotionally recovered and been able to fully learn
from the experience.
The dual process of learning from failure has a number of practical implications. First,
knowledge that the feelings and reactions being experienced by the entrepreneur are nor-
mal for someone dealing with such a loss may help to reduce feelings of shame and em-
barrassment. This in turn might encourage the entrepreneur to articulate her feelings, pos-
sibly speeding the recovery process. Second, there are psychological and physiological
outcomes caused by the feelings of loss. Realizing that these are “symptoms” can reduce
secondary sources of stress and may also assist with the choice of treatment. Third, there is
a process of recovery to learn from failure, which offers entrepreneurs some comfort that
their current feelings of loss, sadness, and helplessness will eventually diminish. Fourth,
the recovery and learning process can be enhanced by some degree of oscillation between
a loss- and a restoration-orientation. Finally, recovery from loss offers an opportunity to
increase one’s knowledge of entrepreneurship. This provides benefits to the individual and
to society.
ETHICS AND SOCIAL RESPONSIBILITY OF ENTREPRENEURS
The life of the entrepreneur is not easy. An entrepreneur must take risks with his or her own
capital to sell and deliver products and services while expending greater energy than the
average businessperson to innovate. In the face of daily stressful situations and other diffi-
culties, the possibility exists that the entrepreneur will establish a balance between ethical
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 21
dual process for coping
with negative emotions
Involves oscillation
between a loss-orientation
and restoration orientation
exigencies, economic expediency, and social responsibility—a balance that differs from the
point where the general business manager takes his or her moral stance.34
A manager’s attitudes concerning corporate responsibility are related to the organiza-
tional climate perceived to be supportive of laws and professional codes of ethics. On the
other hand, entrepreneurs with a relatively new company who have few role models usually
develop an internal ethical code. Entrepreneurs tend to depend on their own personal value
systems much more than other managers do when determining ethically appropriate courses
of action.
Although drawing more on their own value system, entrepreneurs have been shown
to be particularly sensitive to peer pressure and general social norms in the community,
as well as pressures from their competitors. The differences between entrepreneurs in
different types of communities and in different countries reflect, to some extent, the
general norms and values of the communities and countries involved. This is clearly the
case for metropolitan as opposed to nonmetropolitan locations within a single country.
Internationally, there is evidence to this effect about managers in general. U.S. man-
agers seem to have more individualistic and less communitarian values than their
German and Austrian counterparts.
The significant increase in the number of internationally oriented businesses has im-
pacted the increased interest in the similarities and differences in business attitudes and
practices in different countries. This area has been explored to some extent within the con-
text of culture and is now beginning to be explored within the more individualized concept
of ethics. The concepts of culture and ethics are somewhat related. Whereas ethics refers to
the “study of whatever is right and good for humans,” business ethics concerns itself with
the investigation of business practices in light of human values. Ethics is the broad field of
study exploring the general nature of morals and the specific moral choices to be made by
the individual in his or her relationship with others.
A central question in business ethics is, “For whose benefit and at whose expense should
the firm be managed?”35 In addressing this question we focus on the means of ensuring that
resources are deployed fairly between the firm and its stakeholders—the people who have
a vested interest in the firm, including employees, customers, suppliers, and society itself.
If resource deployment is not fair, then the firm is exploiting a stakeholder.
Entrepreneurship can play a role in the fair deployment of resources to alleviate the
exploitation of certain stakeholders. Most of us can think of examples of firms that have
benefited financially because their managers have exploited certain stakeholders—receiving
more value from them than they supply in return. This exploitation of a stakeholder
group can represent an opportunity for an entrepreneur to more fairly and efficiently re-
deploy the resources of the exploited stakeholder. Simply stated, where current prices
do not reflect the value of a stakeholder’s resources, an entrepreneur who discovers the
discrepancy can enter the market to capture profit. In this way the entrepreneurial
process acts as a mechanism to ensure a fair and efficient system for redeploying the
resources of a “victimized” stakeholder to a use where value supplied and received is
equilibrated.36
Therefore, while there is evidence that some use the entrepreneurial process to exploit
others for profit, it is important to understand that the entrepreneurial process can be
an important means of helping exploited stakeholders and at the same time setting up a
viable business. Think of the entrepreneurial process as a tool that can be used effectively
to achieve outcomes for the benefit of others (and the entrepreneur) rather than to the
detriment of others. Some aspects of business ethics are indicated in the Ethics box in
each chapter. Ethics is not only a general topic for conversation but also a deep concern
of businesspeople.
22 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
business ethics The
study of behavior and
morals in a business
situation
23
E T H I C S
COMPANY’S CODE OF ETHICS
The financial scandals of 2002 [and 2008] have already
led to increased action by legislators and associations,
and many companies are beginning to develop a code
of ethics for all employees.
There are a number of advantages to implement-
ing a code of ethics. The more your employees are
aware of proper conduct, the more likely they are to
do the right thing. They’ll better understand their re-
sponsibilities and expectations and assume the ap-
propriate level of accountability when identifying
and managing business risks. A code of ethics is more
than just a formal document outlining related poli-
cies. It’s about integrating positive values throughout
an organization. Here are some key components to
an effective program:
Leaders Set the Example: Employees of- ten model their own behavior after executives, man-
agers, and others who’ve succeeded in the company.
Therefore, everyone at every level must adhere to the
firm’s guidelines. What seems like a small action—
discussing confidential financial information with a
colleague, for instance—can have a ripple effect
throughout all staff. If the members of senior man-
agement do not follow the highest ethical standards
at all times, they shouldn’t be surprised when those
who report to them fail to do so.
Ethics Is a Core Value: Companies known for their ethical business practices make ethics a key el-
ement of their corporate culture. Conducting yourself
with integrity is considered as important as bottom-
line results. Ethical standards are applied any time a
decision is made or an action is taken, not just dur-
ing controversial situations. A recent survey by our
company found that more organizations are taking
ethics into account when hiring employees. Fifty-
eight percent of chief financial officers polled said
the qualities that impress them most about appli-
cants, aside from ability and willingness to do the
job, are honesty and integrity. That’s a substantial in-
crease from only 32 percent in 1997.
Employees Feel Safe to Share Con- cerns: The work environment must be one in which people feel they can deliver bad news to man-
agement without fear of repercussions. In an ethics-
driven company, staff members can report any type
of wrongdoing—whether it is false information on
an expense report or major financial fraud—and feel
confident they will not suffer negative career conse-
quences. Once supervisors are made aware of a po-
tential problem, they need to take immediate action.
Failure to follow through on even minor issues can
undermine the success of an ethics program.
Having a code of ethics will not prevent every cri-
sis, but it will ensure that staff members have a clear
understanding of expectations. Collaborate with em-
ployees on defining the rules, and make sure every-
one is aware of the requirements. Then take steps to
instill core values throughout the organization. With
regular reinforcement, ethics will guide every deci-
sion your team makes and become a central element
in the way your company conducts business.
Source: From Max Messmer, “Does Your Company Have a Code of Ethics?” Strategic Finance, April 2003. Excerpted with permission from Strategic Finance published by the Institute of Management Accountants, Montvale, NJ. For more information about reprints from Strategic Finance, contact PARS International Corp. at 212/221-9595.
ROLE OF ENTREPRENEURSHIP IN ECONOMIC DEVELOPMENT
The role of entrepreneurship in economic development involves more than just increasing
per capita output and income; it involves initiating and constituting change in the structure
of business and society. This change is accompanied by growth and increased output,
which allows more wealth to be divided by the various participants. What in an area facil-
itates the needed change and development? One theory of economic growth depicts inno-
vation as the key, not only in developing new products (or services) for the market but also
in stimulating investment interest in the new ventures being created. This new investment
works on both the demand and the supply sides of the growth equation; the new capital cre-
ated expands the capacity for growth (supply side), and the resultant new spending utilizes
the new capacity and output (demand side). This is reflected in the product-evolution
process, a process through which innovation is developed and commercialized through
entrepreneurial activity, which in turn stimulates economic growth.
The product-evolution process, illustrated in Figure 1.1 as a cornucopia, the traditional
symbol of abundance, begins with knowledge in the base technology and science—such
24 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
product-evolution
process The process
for developing and
commercializing an
innovation
Science
Thermodynamics
Industry
Technology
Fluid mechanics
Electronics
II
V
III
IV
Gut feeling Knowledge Vision
I Recognition of social need
II Initiation of technological innovation
M od
eli ng
P la
nn
in g
F in
an ci
ng
M a n u fa
ct ur
in g
M a rk
et in
g I
III Iterative synthesis leading to invention (pressing toward invention)
IV Development phase
V Industrial phase
FIGURE 1.1 Product Evolution
as thermodynamics, fluid mechanics, or electronics—and ends with products or services
available for purchase in the marketplace.37 The critical point in the product-evolution
process is the intersection of knowledge and a recognized social need, which begins the
product development phase. This point, called iterative synthesis, often fails to evolve into
a marketable innovation and is where the entrepreneur needs to concentrate his or her
efforts. The lack of expertise in this area—matching the technology with the appropriate
market and making the needed adjustments—is an underlying problem in any technology
transfer.
The innovation can, of course, be of varying degrees of uniqueness. Most innovations
introduced to the market are ordinary innovations, that is, with little uniqueness or tech-
nology. As expected, there are fewer technological innovations and breakthrough innovations,
with the number of actual innovations decreasing as the technology involved increases.
Regardless of its level of uniqueness or technology, each innovation (particularly the latter
two types) evolves into and develops toward commercialization and generates economic
wealth.
Entrepreneurship has assisted in revitalizing areas of the inner city. Individuals in inner-
city areas can relate to the concept and see it as a possibility for changing their present sit-
uation. One model project in New York City changed a depressed area into one that now
has many small entrepreneurial companies.
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 25
iterative synthesis The
intersection of knowledge
and social need that starts
the product development
process
ordinary innovations
New products with little
technological change
technological
innovations New
products with significant
technological
advancement
breakthrough
innovations New
products with some
technological change
IN REVIEW
S U M M A R Y
The definition of an entrepreneur has evolved over time as the world’s economic struc-
ture has changed and become more complex. In this text, entrepreneurship is defined
as the process of creating something new with value by devoting the necessary time
and effort; assuming the accompanying financial, psychological, and social risks and
uncertainties; and receiving the resultant rewards of monetary and personal satisfac-
tion and independence.
The entrepreneur then goes through the entrepreneurial process, which involves
finding, evaluating, and developing opportunities for creating a new venture. Each
step is essential to the eventual success of the new venture and is closely related to the
other steps. There are both formal and informal mechanisms for identifying business
opportunities. Although formal mechanisms are generally found within a more estab-
lished company, most entrepreneurs use informal sources for their ideas, such as being
sensitive to the complaints and chance comments of friends and associates. Once the
opportunity is identified, the evaluation process begins. Basic to the screening process
is understanding the factors that create the opportunity: technology, market changes,
competition, or changes in government regulations. From this base, the market size
and time dimension associated with the idea can be estimated. It is important that the
idea fit the personal skills and goals of the entrepreneur, and that the entrepreneur
have a strong desire to see the opportunity brought to fruition. In the process of eval-
uating an opportunity, the required resources should be clearly defined and obtained
at the lowest possible cost.
This process requires that the individual and the firm have an entrepreneurial mind-
set. We started our discussion of this mind-set with the concept of effectuation, which
challenges traditional notions of the way that entrepreneurs think about their tasks.
Although entrepreneurs think about some tasks in a causal way, they also are likely to
think about some tasks effectually (and some entrepreneurs more so than other en-
trepreneurs). Rather than starting with the desired outcome in mind and then focus-
ing on the means to achieving that outcome, entrepreneurs sometimes approach tasks
by looking at what they have—their means—and selecting among possible outcomes.
Who is to say whether the “causal chef” who starts with a menu or the “effectual
chef” who starts with what is in the cupboard produces the best meal? But we can say
that some expert entrepreneurs think effectually about opportunities.
Thinking effectually helps entrepreneurs make decisions in uncertain environments.
When dealing with uncertainty, entrepreneurs must remain flexible in the way that
they think and in their actions. In this chapter we introduced the notion of cognitive
flexibility and emphasized that it is something that can be measured and learned. By
asking questions related to comprehension, connection, strategy, and reflection, en-
trepreneurs can maintain an awareness of their thought process and in doing so de-
velop greater cognitive adaptability.
Despite the way that he or she thinks (causally or effectually) and despite being cog-
nitively flexible, an entrepreneur’s firm or project may still fail. Failure represents an
opportunity to learn, but that learning is typically not automatic or instantaneous.
Rather, learning from failure is difficult because failure causes a major loss to the
entrepreneur. Most are likely to feel bad, which interferes with the learning process.
Entrepreneurs who are able to recover from their negative emotional reaction to the
loss more quickly will be in a better position to learn from the experience. The good
news is that there is something that entrepreneurs can do to enhance their recovery
and learning process. By using a dual process that oscillates between a loss- and a
restoration-orientation, entrepreneurs can maximize their processing of information
and minimize the emotional interference to that process. Obviously, the feelings asso-
ciated with failure are more complicated than we have presented here, but there are
benefits to be gained in simply knowing that it is natural to feel bad when something
important is lost, that most people recover, and that there is a process that can enhance
that recovery.
The study of entrepreneurship has relevance today, not only because it helps entre-
preneurs better fulfill their personal needs but because of the economic contribution
of the new ventures. More than increasing national income by creating new jobs, en-
trepreneurship acts as a positive force in economic growth by serving as the bridge
between innovation and the marketplace. The study of entrepreneurship and the ed-
ucation of potential entrepreneurs are essential parts of any attempt to strengthen
this link so essential to a country’s economic well-being.
R E S E A R C H T A S K S
1. Speak to people from five different countries and ask what entrepreneurship
means to them and how their national culture helps and/or hinders
entrepreneurship.
2. Ask an entrepreneur about his business today and ask him to describe the
decisions and series of events that led the business from start-up to its current
form. Would you classify this process as causal, effectual, or both?
26 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
�
3. Ask two entrepreneurs and five students (not in this class) to fill out Mike Haynie’s
“Measure of Adaptive Cognition” (see Table 1.2). How do you rate relative to the
entrepreneurs? Relative to your fellow students?
4. When conducting a homework exercise for another class (especially a case
analysis), ask yourself comprehension questions, connection questions, strategy
questions, and reflection questions. What impact did this have on the outcome of
the task?
5. What impact does entrepreneurship have on your local, state (or province), and
national economies? Use data to back up your arguments.
C L A S S D I S C U S S I O N
1. List the content that you believe is necessary for an entrepreneurship course. Be
prepared to justify your answer.
2. Do you really think that entrepreneurs think effectually? What about yourself—do
you sometimes think effectually? In what ways is it good? Then why are we taught
in business classes to always think causally? Are there particular problems or tasks
in which thinking causally is likely to be superior to effectuation? When might
effectuation be superior to causal thinking?
3. To be cognitively flexible seems to require that the entrepreneur continually
question himself or herself. Doesn’t that create doubt that can be seen by
employees and financiers such that success actually becomes more difficult to
achieve? Besides, although flexibility is a good thing, if the firm keeps changing
based on minor changes in the environment, the buyers are going to become
confused about the nature of the firm. Is adaptation always a good thing?
4. Do you believe that ethics and social responsibility should be part of an
entrepreneurship course, or did the textbook authors just include a section on
it to be “politically correct”?
5. What is the role of government in entrepreneurship? To what extent should it
help protect people from entrepreneurship? Should it simply get out of the way
and leave the market to reward or punish inappropriate behavior? Given your
answers to these questions, what specific steps should the government take or
what steps has it taken that should be reversed?
6. What excites you about being an entrepreneur? What are your major concerns?
S E L E C T E D R E A D I N G S
Baron, Robert. (1998). Cognitive Mechanisms in Entrepreneurship: Why and When Entrepreneurs Think Differently Than Other People. Journal of Business Venturing, vol. 13, no. 4, pp. 275–95.
In this conceptual article, the author presents information on a study that examined the possible differences in the thinking of entrepreneurs and other people. This pa- per offers a number of implications of a cognitive perspective for entrepreneurship research.
Busenitz, Lowell; and Jay Barney. (1997). Differences between Entrepreneurs and Managers in Large Organizations: Biases and Heuristics in Strategic Decision Making. Journal of Business Venturing, vol. 12, no. 1, pp. 9–30.
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 27
�
In this article the authors explore the differences in the decision-making processes between entrepreneurs and managers in large organizations. In particular they focus on a number of biases, such as the overconfidence bias, but also point out some benefits from the use of biases and heuristics.
Gaglio, Connie Marie; and Jerome Katz. (2001). The Psychological Basis of Oppor- tunity Identification: Entrepreneurial Alertness. Small Business Economics, vol. 16, pp. 95–111.
In this article the authors describe a model of entrepreneurial alertness and propose a research agenda for understanding opportunity identification. They investigate the origin of the entrepreneurial alertness concept and the notion of the psycho- logical schema of alertness.
Gifford, Sharon. (1998). Limited Entrepreneurial Attention and Economic Develop- ment. Small Business Economics, vol. 10, no. 1, pp. 17–30.
Economic development depends on the allocation of entrepreneurial resources to efforts to discover new profit opportunities. Limited entrepreneurial attention is allocated between maintaining current activities and starting new activities. The problem of allocating limited entrepreneurial attention in a variety of contexts is addressed.
Hayton, James C.; Gerard George; and Shaker A. Zahra. (Summer 2002). National Cul- ture and Entrepreneurship: A Review of Behavioral Research. Entrepreneurial Theory and Practice, pp. 33–52.
The article reviews and synthesizes the findings of 21 empirical studies that examine the association between national cultural characteristics and aggregate measures of entrepreneurship, individual characteristics of entrepreneurs, and aspects of corpo- rate entrepreneurship.
Hitt, Michael; Barbara Keats; and Samuel DeMarie. (1998). Navigating in the New Com- petitive Landscape: Building Strategic Flexibility and Competitive Advantage in the 21st Century. Academy of Management Executive, vol. 12, pp. 22–43.
The article cites the importance of building strategic flexibility and a competitive advantage for organizations to survive in the face of emerging technical revolution and increasing globalization. The nature of the forces in the new competitive land- scape requires a continuous rethinking of current strategic actions, organization structure, communication systems, corporate culture, asset deployment, and invest- ment strategies—in short, every aspect of a firm’s operation and long-term health.
Ireland, R. Duane; and Michael Hitt. (1999). Achieving and Maintaining Strategic Com- petitiveness in the 21st Century: The Role of Strategic Leadership. Academy of Man- agement Executive, vol. 13, pp. 43–55.
In this article the authors acknowledge that effective strategic leadership practices can help firms enhance performance while competing in turbulent and unpre- dictable environments. They then describe six components of effective strategic leadership. When the activities called for by these components are completed suc- cessfully, the firm’s strategic leadership practices can become a source of compet- itive advantage. In turn, use of this advantage can contribute significantly to achieving strategic competitiveness and earning above-average returns in the next century.
Keh, Hean; Maw Der Foo; and Boon Chong Lim. (2002). Opportunity Evaluation under Risky Conditions: The Cognitive Processes of Entrepreneurs. Entrepreneurship: Theory & Practice, vol. 27, pp. 125–48.
This study uses a cognitive approach to examine opportunity evaluation, as the per- ception of opportunity is essentially a cognitive phenomenon. The authors present
28 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
a model that consists of four independent variables (overconfidence, belief in the law of small numbers, planning fallacy, and illusion of control), a mediating variable (risk perception), two control variables (demographics and risk propensity), and the dependent variable (opportunity evaluation). They find that illusion of control and belief in the law of small numbers are related to how entrepreneurs evaluate opportunities. Their results also indicate that risk perception mediates opportunity evaluation.
McGrath, Rita. (1999). Falling Forward: Real Options Reasoning and Entrepreneurial Failure. Academy of Management Review, vol. 24, pp. 13–30.
Although failure in entrepreneurship is pervasive, theory often reflects an equally pervasive antifailure bias. Here, the author uses real options reasoning to develop a more balanced perspective of the role of entrepreneurial failure in wealth creation, which emphasizes managing uncertainty by pursuing high-variance outcomes but investing only if conditions are favorable. This can increase profit potential while containing costs. The author also offers propositions that suggest how gains from entrepreneurship may be maximized and losses mitigated.
McGrath, Rita; and Ian MacMillan. (2000). The Entrepreneurial Mindset: Strategies for Continuously Creating Opportunity in an Age of Uncertainty. Cambridge, MA: Harvard Business School Press.
In this book the authors provide tips on how to achieve an entrepreneurial mind- set. For example, they discuss the need to focus beyond incremental improvements to entrepreneurial actions, assess a business’s current performance to establish the entrepreneurial framework, and formulate challenging goals by using the compo- nents of the entrepreneurial framework.
McMullen, Jeffery S.; and Dean Shepherd. (2006). Entrepreneurial Action and the Role of Uncertainty in the Theory of the Entrepreneur. Academy of Management Review, vol. 31, pp. 132–52.
By considering the amount of uncertainty perceived and the willingness to bear uncertainty concomitantly, the authors provide a conceptual model of entrepreneurial action that allows for examination of entrepreneurial action at the individual level of analysis while remaining consistent with a rich legacy of system-level theories of the entrepreneur. This model not only exposes limita- tions of existing theories of entrepreneurial action but also contributes to a deeper understanding of important conceptual issues, such as the nature of op- portunity and the potential for philosophical reconciliation among entrepre- neurship scholars.
Mitchell, Ron; Lowell Busenitz; Theresa Lant; Patricia McDougall; Eric Morse; and Brock Smith. (2002). Toward a Theory of Entrepreneurial Cognition: Rethinking the People Side of Entrepreneurship Research. Entrepreneurship: Theory & Practice, vol. 27, no. 2, pp. 93–105.
In this article the authors reexamine “the people side of entrepreneurship” by sum- marizing the state of play within the entrepreneurial cognition research stream, and by integrating the five articles accepted for publication in a special issue focus- ing on this ongoing narrative. The authors propose that the constructs, variables, and proposed relationships under development within the cognitive perspective offer research concepts and techniques that are well suited to the analysis of problems that require better explanations of the distinctly human contributions to entrepreneurship.
Sarasvathy, Saras. (2001). Causation and Effectuation: Toward a Theoretical Shift from Economic Inevitability to Entrepreneurial Contingency. Academy of Management Review, vol. 26, no. 2, pp. 243–64.
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 29
In this article, the author argues that an explanation for the creation of artifacts such as firms/organizations and markets requires the notion of effectuation. Causa- tion rests on a logic of prediction, effectuation on the logic of control. The author illustrates effectuation through business examples and realistic thought experi- ments, examines its connections with existing theories and empirical evidence, and offers a list of testable propositions for future empirical work.
Sarasvathy, Saras. (2006). Effectuation: Elements of Entrepreneurial Expertise. Cheltenham, UK: Edward Elgar Publishers.
This book gives the history of the development of effectuation and provides provocative new applications and future research directions.
Sarasvathy, Saras. www.effectuation.org.
This Web site provides an up-to-date collection of works on effectuation.
Shepherd, Dean. (2003). Learning from Business Failure: Propositions about the Grief Recovery Process for the Self-Employed. Academy of Management Review, vol. 28, pp. 318–29.
In this paper the author uses the psychological literature on grief to explore the emotion of business failure, suggesting that the loss of a business from failure can cause the self-employed to feel grief—a negative emotional response that inter- feres with the ability to learn from the events surrounding that loss. The author discusses how a dual process of grief recovery maximizes the learning from busi- ness failure.
Shepherd, Dean. (2004). Educating Entrepreneurship Students about Emotion and Learning from Failure. Academy of Management Learning & Education, vol. 3, pp. 274–88.
In this article the author offers suggested changes to pedagogy to help students manage the emotions of learning from failure and discusses some of the challenges associated with measuring the implications of these proposed changes. The author then expands his scope to explore the possibility of educating students on how to manage their emotions to avoid failure and, more generally, improve their emo- tional intelligence, and how organizations can improve their ability to help individ- uals regulate their emotions.
Shepherd, Dean. (2009a). Grief Recovery from the Loss of a Family Business: A Multi- and Meso-Level Theory. Journal of Business Venturing, vol. 24, pp. 81–97.
In this article the author develops a multi- and meso-level theory of grief recovery time from the loss of a family business. The multi-level aspect of the model suggests how primarily micro theories of grief and sense making can help explain grief re- covery time at the family group level. The meso-level aspect of the model provides insight into recovery from the loss of a family business by proposing how grief dy- namics interact at the individual level through emotional intelligence and the fam- ily group level through emotional capability. By supplementing theories of grief with those of sense making, the model provides a deeper understanding of the grief recovery process. This model has implications for scholars and practical impli- cations for family business members and the family unit.
Shepherd, Dean. (2009b). From Lemons to Lemonade: Squeeze Every Last Ounce of Success Out of Your Mistakes. Philadelphia, PA: Wharton School Publishing.
As the author states: Face it. Everyone fails, at least sometimes. Especially nowadays. It’s what you do next that makes all the difference. That’s where this book comes in. This book helps you learn all you can from your failure, instead of letting it defeat you. You’ll discover proven techniques for managing the emotional trauma of fail- ure . . . objectively understanding what actually happened . . . and applying those lessons quickly and effectively, so you can transform yesterday’s failure into tomor- row’s triumph!
30 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
E N D N O T E S
1. Karl Vesper, New Venture Strategies (Englewood Cliffs, NJ: Prentice Hall, 1980), p. 2.
2. Albert Shapero, Entrepreneurship and Economic Development (Wisconsin: Project ISEED, LTD, The Center for Venture Management, Summer 1975), p. 187.
3. Robert C. Ronstadt, Entrepreneurship (Dover, MA: Lord Publishing Co., 1984), p. 28.
4. This definition is modified from the definition first developed for the woman entrepreneur. See Robert D. Hisrich and Candida G. Brush, The Woman Entrepreneur: Starting, Financing, and Managing a Successful New Business (Lexington, MA: Lexington Books, 1985), p. 18.
5. L. V. Mises, Human Action: A Treatise on Economics, 4th rev. ed. (San Francisco, CA: Fox & Wilkes, 1949).
6. See T. M. Amabile, “Entrepreneurial Creativity through Motivational Synergy,” Journal of Creative Behavior 31 (1997), pp. 18–26; J. A. Schumpeter, The Theory of Economic Development (New Brunswick: Transaction Pub- lishers, 1934); and W. B. Gartner, “What Are We Talking about When We Talk about Entrepreneurship?” Journal of Business Venturing 5 (1990), pp. 15–29.
7. J. S. McMullen and D. A. Shepherd, “Toward a Theory of Entrepreneurial Action: Detecting and Evaluating Opportunities,” Academy of Management Review 31 (2006), pp. 132–52.
8. A version of this process can be found in Howard H. Stevenson, Michael J. Roberts, and H. Irving Grousbeck, New Business Ventures and the Entrepreneur (Burr Ridge, IL: Richard D. Irwin, 1985), pp. 16–23.
9. S. Sarasvathy, “Causation and Effectuation: Toward a Theoretical Shift from Economic Inevitability to Entrepreneurial Contingency,” Academy of Manage- ment Review 26 (2001), p. 245.
10. H. A. Simon, “Theories of Decision Making in Economics and Behavioral Science,” American Economic Review 49 (1959), pp. 253–83.
11. Sarasvathy, “Causation and Effectuation,” pp. 245–47. 12. M. A. Hitt, “The New Frontier: Transformation of Management for the New
Millennium,” Organizational Dynamics 28, no. 3 (2000), pp. 7–17. 13. R. D. Ireland, M. A. Hitt, and D. G. Sirmon, “A Model of Strategic Entre-
preneurship: The Construct and Its Dimensions,” Journal of Management 29 (2003), pp. 963–90; and Rita McGrath and Ian MacMillan, The Entrepre- neurial Mindset: Strategies for Continuously Creating Opportunity in an Age of Uncertainty (Cambridge, MA: Harvard Business School Press, 2000).
14. Ireland, Hitt, and Sirmon, “A Model of Strategic Entrepreneurship.” 15. M. A. Hitt, B. W. Keats, and S. M. DeMarie, “Navigating in the New Competi-
tive Landscape: Building Strategic Flexibility and Competitive Advantage in the 21st Century,” Academy of Management Executive 12 (1998), pp. 22–43 (from page 26).
16. M. Haynie, D. A. Shepherd, E. Mosakowski, and C. Earley, “A Situated Metacognitive Model of the Entrepreneurial Mindset,” Journal of Business Venturing (2009); and M. Haynie and D. A. Shepherd, “A Measure of Adaptive Cognition for Entrepreneurship Research,” Entrepreneurship: Theory and Practice (2009).
17. Haynie and Shepherd (2009). 18. G. Schraw and R. Dennison, “Assessing Metacognitive Awareness,” Contempo-
rary Educational Psychology 19 (1994), pp. 460–75.
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 31
19. A. Brown, “Metacognition and Other Mechanisms,” in F. E. Weinert and R. H. Kluwe (eds.), Metacognition, Motivation, and Understanding (Hillsdale, NJ: Lawrence Erlbaum Associates, 1987).
20. E. Guterman, “Toward a Dynamic Assessment of Reading: Applying Metacogni- tive Awareness Guiding to Reading Assessment Tasks,” Journal of Research in Reading 25, no. 3 (2002), pp. 283–98.
21. Z. R. Mevarech and B. Kramarski, “The Effects of Metacognitive Training versus Worked-out Examples on Students’ Mathematical Reasoning,” British Journal of Educational Psychology 73, no. 4 (2003), pp. 449–71; and D. Shepherd, M. Haynie, and J. McMullen (working paper), “Teaching Management Students Metacognitive Awareness: Enhancing Inductive Teaching Methods and Developing Cognitive Adaptability.”
22. Mevarech and Kramarski, “The Effects of Metacognitive Training.” 23. Based on D. A. Shepherd, “Learning from Business Failure: Propositions
about the Grief Recovery Process for the Self-Employed,” Academy of Management Review 28 (2003) pp. 318–29. See also D. A. Shepherd, “Grief Recovery from the Loss of a Family Business: A Multi- and Meso-Level Theory,” Journal of Business Venturing, 24 (2009), pp. 81–97. D. A. Shepherd, J. G. Covin, and D. F. Kuratko, “Project Failure from Corporate Entrepreneurship: Managing the Grief Process,” Journal of Business Venturing (2009), in press.
24. S. B. Sitkin, “Learning through Failure: The Strategy of Small Losses,” Research in Organizational Behavior 14 (1992), pp. 231–66.
25. R. McGrath, “Falling Forward: Real Options Reasoning and Entrepre- neurial Failure,” Academy of Management Review 24 (1999), pp. 13–30.
26. A. V. Bruno, E. F. McQuarrie, and C. G. Torgrimson, “The Evolution of New Technology Ventures over 20 Years: Patterns of Failure, Merger, and Survival,” Journal of Business Venturing 7 (1992), pp. 291–302.
27. B. Cova and C. Svanfeldt, “Societal Innovations and the Postmodern Aestheti- cization of Everyday Life,” International Journal of Research in Marketing 10 (1993), pp. 297–310 (quote from page 297).
28. Interviews with employees of organizations that have died reveal negative emotions such as those associated with grief. See S. G. Harris and R. I. Sutton, “Functions of Parting Ceremonies in Dying Organizations,” Academy of Management Journal 29 (1986), pp. 5–30.
29. A. Gilbert, “Lessons Learned from Failure,” Information Week 817 (2000), p. 111.
30. G. H. Bower, “How Might Emotions Affect Learning?” in S. Christianson (ed.), The Handbook of Emotion and Memory: Research and Theory (Hillsdale, NJ: Lawrence Erlbaum, 1992), pp. 3–31; and A. Wells and G. Matthews, Attention and Emotion: A Clinical Perspective (Hove, UK: Lawrence Erlbaum Associates Ltd., 1994).
31. M. S. Stroebe and H. Schut, “The Dual Process of Coping with Bereavement: Rationale and Description,” Death Studies 23 (1999), pp. 197–224.
32. Stroebe and Schut, “The Dual Process of Coping.” 33. S. Nolen-Hoeksema, “Responses to Depression and Their Effects on the Dura-
tion of the Depressive Episode,” Journal of Abnormal Psychology 100 (1991), pp. 569–82.
34. For summary of the research on ethics in entrepreneurship, see the papers published as part of the Ruffin Lecture Series of 2002 by the Business Ethics Society of The Darden School, University of Virginia.
32 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
35. R. E. Freeman, “A Stakeholder Theory of the Modern Corporation,” in T. C. Beauchamp and N. E. Bowie (eds.), Ethical Theory and Business (Englewood Cliffs, NJ: Prentice Hall, 1994), pp. 66–76 (quote from p. 67).
36. S. Venkataraman, “Stakeholder Value Equilibration and the Entrepreneurial Process,” in R. E. Freeman and S. Venkataraman (eds.), Ethics and Entrepre- neurship—The Ruffin Series, Volume 3 (2002).
37. This process is discussed in Yao Tzu Li, David G. Jansson, and Ernest G. Cravalho, Technological Innovation in Education and Industry (New York: Van Nostrand Reinhold, 1980), pp. 6–12.
C H A P T E R 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET 33
1
To introduce the importance of perception of feasibility and desirability in explaining entrepreneurial intentions.
2
To understand the role of individuals’ background characteristics in explaining entrepreneurial intentions.
3
To demonstrate that management can influence the intentions of those within established organizations.
4
To discuss how established firms can develop an entrepreneurial culture.
5
To provide a scale for capturing the extent to which management adopts entrepreneurial or traditional behaviors.
2 E N T R E P R E N E U R I A L I N T E N T I O N S A N D
C O R P O R AT E E N T R E P R E N E U R S H I P
L E A R N I N G O B J E C T I V E S
35
O P E N I N G P R O F I L E
ROBERT MONDAVI
Robert G. Mondavi, the son of poor Italian immigrants, began making wine in California
in 1943 when his family purchased the Charles Krug Winery in Napa Valley, where he
served as a general manager. In 1966, at the age of 54, after a severe dispute over con-
trol of the family-owned winery, Robert Mondavi used his personal savings and loans
from friends to start the flagship Robert Mondavi Winery
in Napa Valley with his eldest son, Michael Mondavi.
Robert’s vision was to create wines in California that could
successfully compete with the greatest wines of the world.
As a result, Robert Mondavi Winery became the first in California to produce and mar-
ket premium wines that were expected to compete with premium wines from France,
Spain, Italy, and Germany.
To achieve this objective Robert believed that he needed to build a Robert Mondavi
brand in the premium wine market segment. This resulted in the initial production of
a limited quantity of premium wines using the best grapes, which brought the highest
prices in the market and had the highest profit margins per bottle. However, he soon
realized that this strategy, while establishing the brand, did not allow the company to
generate enough cash flow to expand the business. To solve this problem Robert de-
cided to produce less expensive wines that he could sell in higher volumes. He dedi-
cated time and effort to finding the best vineyards in Napa Valley for the company’s
production of grapes. In addition, he signed long-term contracts with growers in Napa
Valley and worked closely with each grower to improve grape quality.
Robert Mondavi built a state-of-the-art winery that became a premium wine-
making facility as well as conveying a unique sense of Mondavi wines to the visitors. Soon
the new winery became a place where the best practices in the production of premium
wines were developed, eventually establishing the standard in the wine industry.
Robert Mondavi was the first winemaker to assemble experts with various back-
grounds in the fields of viticulture and wine-making to give advice on the new wines.
He also developed new technology that allowed special handling of grapes and the
cold fermentation of white wines. Furthermore, Mondavi’s company created process
innovations, such as steel fermentation tanks, vacuum corking of bottles, and aging of
wines in new French oak barrels. Dedicated to growing vines naturally, Robert Mondavi
www.mondavi.com
introduced a natural farming and conservation program that allowed enhanced grape
quality, environmental protection, and worker health. Moreover, from the very begin-
ning, the company promoted the presentation of wine as part of a sociable way of
everyday living. Robert Mondavi Winery was one of the first wineries to present con-
certs, art exhibitions, and culinary programs.
In his book, Robert Mondavi describes his search for innovation:
From the outset, I wanted my winery to draw inspiration and methods from the traditional
Old World chateaux of France and Italy, but I also wanted to become a model of state-of-
the-art technology, a pioneer in research and a gathering place for the finest minds in our
industry. I wanted our winery to be a haven of creativity, innovation, excitement, and that
unbelievable energy you find in a start-up venture when everyone is committed, heart and
soul, to a common cause and a common quest.
In 1972 Mondavi’s hard work and dedication to his venture were formally recog-
nized when the Los Angeles Times Vintners Tasting Event selected the 1969 Robert
Mondavi Winery Cabernet Sauvignon as the top wine produced in California.
Despite Robert Mondavi’s relentless efforts, things did not always go smoothly. A
noticeable improvement in the quality and reputation of the Robert Mondavi wines
during the 1970s did not spark the interest of reputable five-star restaurants and top
wine shops across the country. So, for over a decade, Mondavi traveled throughout the
country and abroad, promoting Napa Valley wines and the Robert Mondavi brand
name. Often, while dining alone on business trips, Mondavi offered restaurant em-
ployees the opportunity to taste his wine. Slowly, Mondavi got his wines on the wine
lists of the top five-star restaurants in the United States. By the end of the 1970s,
restaurant owners, famous wine connoisseurs, and industry critics were eager to be in-
troduced to Robert Mondavi products. Recognizing the increased popularity of his
wines, Mondavi began slowly raising the prices of his wines to the price level of com-
parable French wines. Subsequently, the company expanded its capacity to produce
500,000 cases of premium wines annually.
About this time Robert Mondavi started building a portfolio of premium wine
brands to satisfy the needs of consumers in various price and quality segments of the
domestic wine market. As a result, from the late 1970s until the 1980s Robert Mondavi
diversified its portfolio through acquisition and further growth of the Woodbridge,
Byron, and Coastal brands of California wine. Most of these acquisitions were financed
through long-term debt.
In the early 1990s Robert Mondavi faced financial difficulties as a result of the
rapid expansion; the increased competition; and a phylloxera infestation of several
of the company’s vineyards, which necessitated replanting. After contemplating the
matter for several years, Robert Mondavi decided to raise enough capital to con-
tinue expansion of his company while maintaining family control of the company.
On June 10, 1993, Robert Mondavi issued 3.7 million shares of stock at $13.50 a
share and began trading on the NASDAQ as MOND. The initial public offering (IPO)
raised approximately $49.95 million, bringing the company’s market capitalization
to $213.3 million.
36 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
The IPO was structured with two classes of stock: Class A common stock issued to
the Mondavi family, and Class B common stock offered to the public. Class A shares
carried ten votes per share, and Class B shares carried one vote per share. This structure
allowed the Mondavi family to retain 90 percent ownership of the company and, subse-
quently, to preserve control over the company’s destiny. Robert Mondavi stock was
trading at $8 a share a few days after the initial offering and at $6.50 a share six
months later, slashing the company’s value, and the Mondavi family’s wealth, by half.
One factor affecting the price decrease in the stock was the difficulty that the in-
vestment community and analysts had in valuing Robert Mondavi due to a lack of in-
formation on the wine industry. There were only two other publicly traded wine
companies, both in low-end wine categories. To help solve this problem, Robert
Mondavi began educating investors, trying to convince them that it is possible to
build a strong, globally recognized business selling premium wines. As part of his
knowledge-building and awareness-creation campaign, Robert sent teams to New
York, Boston, and Chicago, who brought wine presentations, receptions, and tastings
to the investors. According to Robert Mondavi, “Well, we had to mount an effective
campaign and take it right to them, and not just explain our approach but put our
wines right in their hands! Let them taste, in their own mouths, our expertise and
commitment to excellence.”
At the same time the company was continuing its innovating efforts, creating in
1994 a revolutionary, capsule-free, flange-top bottle design, which became widely ac-
cepted in the industry.
In the mid-1990s, the company started engaging in various multinational partner-
ships on a 50:50 basis: Its partnership with the Baron Philippe de Rothschild of
Chateau Mouton Rothschild in Bordeaux, France, resulted in the creation of Opus
One wine in 1979; with the Frescobaldi family of Tuscany, Italy, Mondavi launched
Luce, Lucente, and Danzante wines in 1995; with the Eduardo Chadwick family of
Chile, it introduced Caliterra wines in 1996; and with Australia’s largest premium pro-
ducer, Southcorp, it began producing and marketing new wines from Australia and
California in 2001.
Today, the company continues to pursue its goals around the world with its unique
cultural and innovative spirit and its consistent growth strategy, reaching revenue of
over $441 million in 2002. The company produces 20 unique and separate labels repre-
senting more than 80 individual wines from California, Italy, Chile, and France and sells
its wines in more than 80 countries. Some of the popular Robert Mondavi fine wine
labels such as Robert Mondavi Winery, Robert Mondavi Coastal Private Selection, and
Woodbridge Winery have gained enormous popularity among wine lovers in the United
States as well as the rest of the world. The company remains a close family business.
Recognized as the global representative of California wines, Robert Mondavi has
been a major force in leading the U.S. wine industry into the modern era and has de-
voted his life to creating a fine wine culture in America. Through hard work and a con-
stant striving for excellence, he has achieved his goal of causing California wines to be
viewed as some of the great wines of the world.
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 37
THE INTENTION TO ACT ENTREPRENEURIALLY
Entrepreneurial action is most often intentional. Entrepreneurs intend to pursue certain op-
portunities, enter new markets, and offer new products—and this is rarely the process of
unintentional behavior. Intentions capture the motivational factors that influence a behav-
ior; they are indications of how hard people are willing to try, of how much of an effort they
are planning to exert to perform the behavior. As a general rule, the stronger the intention
to engage in a behavior, the more likely should be its performance.1 Individuals have
stronger intentions to act when taking action is perceived to be feasible and desirable.
Entrepreneurial intentions can be explained in the same way.
The perception of feasibility has much to do with an entrepreneur’s self-efficacy. Entre-
preneurial self-efficacy refers to the conviction that one can successfully execute the be-
havior required; people who believe they have the capacity to perform (high self-efficacy)
tend to perform well. Thus, it reflects the perception of a personal capability to do a partic-
ular job or set of tasks. High self-efficacy leads to increased initiative and persistence and
thus improved performance; low self-efficacy reduces effort and thus performance. Indeed,
people with high self-efficacy think differently and behave differently than people with low
self-efficacy.2 Self-efficacy affects the person’s choice of action and the amount of effort
exerted. Entrepreneurship scholars have found that self-efficacy is positively associated
with the creation of a new independent organization.3
Not only must an individual perceive entrepreneurial action as feasible for entrepre-
neurial intention to be high, the individual must also perceive this course of action as
desirable. Perceived desirability refers to an individual’s attitude toward entrepreneurial
action—the degree to which she has a favorable or unfavorable evaluation of the poten-
tial entrepreneurial outcomes.4 For example, creative actions are not likely to emerge un-
less they produce personal rewards that are perceived as relatively more desirable than
more familiar behaviors.5
Therefore, the higher the perceived desirability and feasibility, the stronger the intention
to act entrepreneurially. We next investigate the background characteristics of entrepreneurs
to understand why some individuals are more likely to engage in entrepreneurship than
other individuals. That is, we examine how background characteristics provide an indica-
tion of whether certain individuals are more or less likely to perceive entrepreneurial action
as feasible and/or desirable and therefore whether they are more or less likely to intend to
be entrepreneurs.
ENTREPRENEUR BACKGROUND AND CHARACTERISTICS
Education
Although some may feel that entrepreneurs are less educated than the general population,
research findings indicate that this is clearly not the case. Education is important in the
upbringing of the entrepreneur. Its importance is reflected not only in the level of education
obtained but also in the fact that it continues to play a major role in helping entrepre-
neurs cope with the problems they confront. Although a formal education is not necessary
for starting a new business—as is reflected in the success of such high school dropouts as
Andrew Carnegie, William Durant, Henry Ford, and William Lear—it does provide a
good background, particularly when it is related to the field of the venture. For example,
entrepreneurs have cited an educational need in the areas of finance, strategic planning,
marketing (particularly distribution), and management. The ability to communicate
clearly with both the written and the spoken word is also important in any entrepreneurial
activity.
38 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
entrepreneurial
intentions The
motivational factors that
influence individuals to
pursue entrepreneurial
outcomes
entrepreneurial
self-efficacy The
conviction that one can
successfully execute the
entrepreneurial process
perceived desirability
The degree to which an
individual has a favorable
or unfavorable evaluation
of the potential
entrepreneurial outcomes
Even general education is valuable because it facilitates the integration and accumula-
tion of new knowledge, providing individuals with a larger opportunity set (i.e., a broader
base of knowledge casts a wider net for the discovery or generation of potential opportuni-
ties), and assists entrepreneurs in adapting to new situations.6 The general education (and
experiences) of an entrepreneur can provide knowledge, skills, and problem-solving abili-
ties that are transferable across many different situations. Indeed, it has been found that
while education has a positive influence on the chance that a person will discover new op-
portunities, it does not necessarily determine whether he will create a new business to ex-
ploit the discovered opportunity.7 To the extent that individuals believe that their education
has made entrepreneurial action more feasible, they are more likely to become entrepre-
neurs. As entrepreneurs it is likely that aspects of their ethics differ from other managers,
as is discussed in the article in the Ethics box.
39
E T H I C S
Understanding the factors that contribute to and in-
fluence the ethical conduct of managers and entrepre-
neurs is important for the future of the U.S. economic
system as well as the economic system of the world.
The significance of these factors becomes all the more
salient when operating in a hypercompetitive global
economy. In such an environment, competitors aggres-
sively disrupt the status quo and seek to change the
rules of competition. While current businesses impact
the ethical standards used in present business deal-
ings, emerging entrepreneurial companies set the eth-
ical tone for the future economic system of the world.
Although the United States has strong laws, such as
the Foreign Corrupt Practices Act of 1977, and pro-
motes ethical behavior on the part of managers and
entrepreneurs, the ethical attitudes of these groups are
not well understood. How will managers and entrepre-
neurs react in certain situations? Will they have high
ethical standards in their internal and external deal-
ings? Will managers, because of their more bureau-
cratic environment, have higher ethical standards than
entrepreneurs? Or, will entrepreneurs, because their
business practices more closely reflect their personal
values, have higher ethical attitudes than managers?
In one study, 165 entrepreneurs and 128 managers
were surveyed using a detached measuring instru-
ment containing binary, response questions, scenar-
ios, and comprehensive demographic information.
Generally, entrepreneurs and managers differed
only slightly in their views regarding the ethics of vari-
ous activities and their ethical perceptions regarding
others. There were few differences in the two groups
regarding their evaluation of the ethical nature of 12
circumstances and 7 scenarios. The similarities in eth-
ical attitudes between the two groups of decision
makers seem to be one of the important findings,
which can be explained by similar legal, cultural, and
educational factors that affect the ethical attitudes of
both groups. Some significant differences consistently
indicate that entrepreneurs are more prone to hold
ethical attitudes.
The findings indicate that managers need to sacri-
fice their personal values to those of the company
more than entrepreneurs. Also, entrepreneurs consis-
tently demonstrate higher ethical attitudes in the in-
ternal dealings of the company, such as not taking
longer than necessary for a job and not using com-
pany resources for personal use. These findings are
consistent with the theory of property where we
would expect someone to be more ethical in dealing
with his or her own property. This finding suggests
that, through increased ownership, managers might
be motivated to have more ethical dealings with
their company’s assets. Profit-sharing companies (man-
agers and other key employees) can therefore per-
haps reduce the possibilities of moral hazard and op-
portunistic behavior within the company through
some type of managerial ownership. Likewise, long-
term relationships with customers and the commu-
nity in general have to be reflected in the property of
the company through philanthropic acts and differ-
ent liability accounts.
Source: From Branko Bucar and Robert Hisrich, “Ethics of Business Managers vs. Entrepreneurs,” Journal of Developmental Entrepre- neurship 6, no. 1 (2001). Reprinted with permission of The Journal of Developmental Entrepreneurship. All rights reserved.
ETHICAL CONDUCT OF
ENTREPRENEURS VERSUS
MANAGERS
Age
The relationship of age to the entrepreneurial career process also has been carefully re-
searched.8 In evaluating these results, it is important to differentiate between entrepreneur-
ial age (the age of the entrepreneur reflected in his or her experience) and chronological age
(years since birth). As discussed in the next section, entrepreneurial experience is one of the
best predictors of success, particularly when the new venture is in the same field as the pre-
vious business experience.
In terms of chronological age, most entrepreneurs initiate their entrepreneurial careers
between the ages of 22 and 45. A career can be initiated before or after these ages, as long
as the entrepreneur has the necessary experience and financial support, and the high energy
level needed to launch and manage a new venture successfully. Also, there are milestone
ages every five years (25, 30, 35, 40, and 45) when an individual is more inclined to start
an entrepreneurial career. As one entrepreneur succinctly stated, “I felt it was now or never
in terms of starting a new venture when I approached 30.” Generally, male entrepreneurs
tend to start their first significant venture in their early 30s, while women entrepreneurs
tend to do so in their middle 30s. However, an entrepreneurial career is quite popular later
in life when the children have left home, there are fewer financial concerns, and individu-
als start to think about what they would really like to do with the rest of their lives.9
Work History
Work history can influence the decision to launch a new entrepreneurial venture, but it also
plays a role in the growth and eventual success of the new venture. While dissatisfaction
with various aspects of one’s job—such as a lack of challenge or promotional opportuni-
ties, as well as frustration and boredom—often motivates the launching of a new venture,
previous technical and industry experience is important once the decision to launch has
been made. Experience in the following areas is particularly important: financing, product
or service development, manufacturing, development of distribution channels, and prepa-
ration of a marketing plan.
As the venture becomes established and starts growing, managerial experience and skills
become increasingly important. Although most ventures start with few (if any) employees, as
the number of employees increases, the entrepreneur’s managerial skills come more and more
into play. In addition, entrepreneurial experiences, such as the start-up process, making deci-
sions under high levels of uncertainty, building a culture from “scratch,” raising venture cap-
ital, and managing high growth, are also important. Most entrepreneurs indicate that their
most significant venture was not their first one. Throughout their entrepreneurial careers, they
are exposed to many new venture opportunities and gather ideas for many more new ventures.
Finally, previous start-up experience can provide entrepreneurs with expertise in running an
independent business as well as benchmarks for judging the relevance of information, which
can lead to an understanding of the “real” value of new entry opportunities, speed up the busi-
ness creation process, and enhance performance.10 Previous start-up experience is a relatively
good predictor of starting subsequent businesses.11 To the extent that start-up experience pro-
vides entrepreneurs with a greater belief in their ability to successfully achieve entrepreneurial
outcomes, this increased perceived feasibility will strengthen entrepreneurial intentions.
ROLE MODELS AND SUPPORT SYSTEMS
One of the most important factors influencing entrepreneurs in their career path is their
choice of a role model.12 Role models can be parents, brothers or sisters, other relatives, or
other entrepreneurs. Successful entrepreneurs frequently are viewed as catalysts by potential
40 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
work history The past
work experience of an
individual
role models Individuals
whose example an
entrepreneur can aspire
to and copy
entrepreneurs. As one entrepreneur succinctly stated, “After evaluating Ted and his success
as an entrepreneur, I knew I was much smarter and could do a better job. So I started my
own business.” In this way, role models can provide important signals that entrepreneurship
is feasible for them.
Role models can also serve in a supportive capacity as mentors during and after the
launch of a new venture. An entrepreneur needs a strong support and advisory system in every
phase of the new venture. This support system is perhaps most crucial during the start-up
phase, as it provides information, advice, and guidance on such matters as organizational
structure, obtaining needed financial resources, and marketing. Since entrepreneurship is a
social role embedded in a social context, it is important that an entrepreneur establish con-
nections and eventually networks early in the new venture formation process.
As initial contacts and connections expand, they form a network with similar properties
prevalent in a social network—density (the extensiveness of ties between the two individ-
uals) and centrality (the total distance of the entrepreneur to all other individuals and the to-
tal number of individuals in the network). The strength of the ties between the entrepreneur
and any individual in the network is dependent upon the frequency, level, and reciprocity
of the relationship. The more frequent, in-depth, and mutually beneficial a relationship, the
stronger and more durable the network between the entrepreneur and the individual.13 Al-
though most networks are not formally organized, an informal network for moral and pro-
fessional support still greatly benefits the entrepreneur.
Moral-Support Network
It is important for each entrepreneur to establish a moral-support network of family and
friends—a cheering squad. This cheering squad plays a critical role during the many diffi-
cult and lonely times that occur throughout the entrepreneurial process. Most entrepreneurs
indicate that their spouses are their biggest supporters and allow them to devote the exces-
sive amounts of time necessary to the new venture.
Friends also play key roles in a moral-support network. Not only can friends provide ad-
vice that is often more honest than that received from other sources, but they also provide
encouragement, understanding, and even assistance. Entrepreneurs can confide in friends
without fear of criticism. Finally, relatives (children, parents, grandparents, aunts, and un-
cles) also can be strong sources of moral support, particularly if they are also entrepreneurs.
As one entrepreneur stated, “The total family support I received was the key to my success.
Having an understanding cheering squad giving me encouragement allowed me to persist
through the many difficulties and problems.”
Professional-Support Network
In addition to encouragement, the entrepreneur needs advice and counsel throughout the
establishment of the new venture. This advice can be obtained from a mentor, business
associates, trade associations, or personal affiliations—all members of a professional-
support network.
Most entrepreneurs indicate that they have mentors. How does one find a mentor? This
task sounds much more difficult than it really is. Since a mentor is a coach, a sounding
board, and an advocate—someone with whom the entrepreneur can share both problems
and successes—the individual selected needs to be an expert in the field. An entrepreneur
can start the “mentor-finding process” by preparing a list of experts in various fields—
such as in the fundamental business activities of finance, marketing, accounting, law, or
management—who can provide the practical “how-to” advice needed. From this list,
moral-support network
Individuals who give
psychological support to
an entrepreneur
professional-support
network Individuals
who help the entrepreneur
in business activities
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 41
42
A S S E E N I N ENTREPRENEUR M A G A Z I N E
HOT OR NOT?
DO YOU BELIEVE THIS DIGITAL FRIDGE
TECHNOLOGY REPRESENTS AN
OPPORTUNITY?
Why, oh why, must employees stop working just be-
cause they’re having lunch or stoking up on caffeine?
They won’t if your lunchroom is equipped with the
Multi-Media Refrigerator ($8,000) from LG Electron-
ics (www.lgappliances.com). A 25.5-cubic-foot refrig-
erator with an Internet connection and built-in LCD,
the digital fridge lets workers keep researching Web
projects and reading e-mail while they munch. The
fridge has a built-in TV, camera, and Web radio so
you can stretch videoconferences through coffee
breaks. Here’s a morale booster: Alternate photos of
your office manager with those pencil requisition
training videos on its LCD.a
DO YOU BELIEVE THIS “SMALL
WORLD” TECHNOLOGY REPRESENTS
AN OPPORTUNITY?
Rick Snyder, CEO of Ardesta, a holding firm in Ann
Arbor, Michigan, has a mantra: “Smaller, faster, better,
cheaper.” He’s talking about “small tech,” a term
that describes nanotechnology, microtechnology, and
micro-electromechanical systems (MEMS). Nanotech-
nology in particular has gotten a lot of coverage as
big companies like Hewlett-Packard and Intel have
begun to introduce nano into computing. It’s hard to
pinpoint exactly what small tech is because it has so
many wide-ranging applications. “I would call it
more of a revolution than an evolution,” says Snyder.
Nanotechnology, for example, deals with matter at
an atomic and molecular level—that is, with matter
often described as being less than the width of a
human hair in size. It’s appearing in everything from
stainproof coating for fabrics to scratch-resistant
coating for eyeglasses to miniscule computer chip cir-
cuits from HP Labs.
Research funding for small tech is enormous.
Ardesta is devoted to investing in and helping launch
various small tech ventures with an ultimate goal of
bringing actual products to market. Many businesses
in this fledgling technological area are small entre-
preneurial start-ups and spin-offs from research insti-
tutions. Life sciences and materials manufacturing
are two industries that will really feel the early effects
of the growing small tech market. Eventually, though,
small tech will touch just about everything. Snyder
calls it pervasive and transparent.
Some applications are out already and operating
in your business right under your nose. Microtech is
built into inkjet cartridges and portable projectors.
At SmallTimes.com, a clearinghouse for information
on small technology, the section devoted to applica-
tions is an eye-opener: A recent visit to the site brought
up articles on nanotech use in products such as tennis
rackets and LCD monitors, among others.
There are a million microscopic reasons to get ex-
cited, but it’s important to keep them all in perspec-
tive. Snyder sees an accelerating growth curve over
the next five years as small tech makes its way into
real-life markets. But you shouldn’t expect companies
to shout “nano” or “MEMS” in their product adver-
tising. The way you’ll know small tech has touched
your business is when Snyder’s mantra comes into
play: “Smaller, faster, better, cheaper.”b
aSource: Mike Hogan, “Employees Can Munch and Work on the Web at the Same Time with This Time-Saver,” Entrepreneur (Febru- ary 2003), pp. 18–22. bSource: Reprinted with permission of Entrepreneur Media, Inc., “Nanotechnology Will Soon Mean Big Changes in the Way You Do Business,” by Amanda C. Kooser, March 2003, Entrepreneur maga- zine: www.entrepreneur.com.
an individual who can offer the most assistance should be identified and contacted. If the
selected individual is willing to act as a mentor, he or she should be periodically apprised
of the progress of the business so that a relationship can gradually develop.
Another good source of advice can be cultivated by establishing a network of business
associates. This group can be composed of self-employed individuals who have experi-
enced starting a business; clients or buyers of the venture’s product or service; experts such
as consultants, lawyers, or accountants; and the venture’s suppliers. Clients or buyers are a
particularly important group to cultivate. This group represents the source of revenue to the
venture and is the best provider of word-of-mouth advertising. There is nothing better than
word-of-mouth advertising from satisfied customers to help establish a winning business
reputation and promote goodwill.
Suppliers are another important component in a professional-support network. A new
venture needs to establish a solid track record with suppliers to build a good relationship
and to ensure the adequate availability of materials and other supplies. Suppliers also
can provide good information on the nature of trends, as well as competition, in the
industry.
In addition to mentors and business associates, trade associations can offer an excel-
lent professional-support network. Trade association members can help keep the new
venture competitive. Trade associations keep up with new developments and can pro-
vide overall industry data.
Finally, personal affiliations of the entrepreneur also can be a valuable part of a
professional-support network. Affiliations developed with individuals through shared hob-
bies, participation in sporting events, clubs, civic involvements, and school alumni groups
are excellent potential sources of referrals, advice, and information. Each entrepreneur
needs to establish both moral- and professional-support networks. These contacts provide
confidence, support, advice, and information. As one entrepreneur stated, “In your own
business, you are all alone. There is a definite need to establish support groups to share
problems with and to obtain information and overall support for the new venture.”
Therefore, it is important to recognize that entrepreneurial activity is embedded in
networks of interpersonal relationships. These networks are defined by a set of actors
(individuals and organizations) and a set of linkages between them, and they provide indi-
viduals access to a variety of resources necessary for entrepreneurial outcomes.14 These re-
sources may assist in efforts to discover and exploit opportunities, as well as in the creation
of new independent organizations.15 The trust embedded in some of these networks pro-
vides potential entrepreneurs the opportunity to access highly valuable resources. For ex-
ample, business networks are composed of independent firms linked by common interests,
friendship, and trust and are particularly important in facilitating the transfer of difficult-
to-codify, knowledge-intensive skills that are expensive to obtain in other ways.16 These
networks also create opportunities for exchanging goods and services that are difficult to
enforce through contractual arrangements, which facilitates the pursuit of opportunities.17
To the extent that a network provides an individual greater belief in his or her ability to
access resources critical to the successful achievement of entrepreneurial outcomes, this
increased perceived feasibility will strengthen entrepreneurial intentions.
MINORITY ENTREPRENEURS
Another individual characteristic among entrepreneurs that has been studied is gender. There
has been significant growth in female self-employment, with women now starting new ven-
tures at a higher rate than men. In fact, women are starting businesses in the United States at
twice the rate of all businesses and are staying in business longer. According to the latest data
from the Census Bureau and the Small Business Administration’s (SBA) Office of Advocacy,
28 percent of all private companies are women-owned businesses. The Census Bureau’s 2002
survey of business owners found that 6.5 million companies had female owners, 13.2 million
had male owners, and 2.7 million were equally owned by males and females. Women-owned
businesses grew at twice that national rate for all private companies from 1997 to 2002. Nearly
one-third of women-owned businesses are connected with health care and social services.
Based on more recent statistics (as of 2008) reported by the Center for Women’s Business
Research, 10.1 million firms are owned by women (50% ownership or more), employing
more than 13 million people, and generating $1.9 trillion in sales (www.nfwbo.org).
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 43
44
A S S E E N I N ENTREPRENEUR M A G A Z I N E
PROVIDE ADVICE TO AN ENTREPRENEUR ABOUT IMPROVING A BUSINESS
THROUGH CERTIFICATION AS A WOMAN-OWNED BUSINESS
Is becoming a certified Women’s Business Enterprise
(WBE) really beneficial? We spoke with women entre-
preneurs from a variety of industries to find out. Be-
ing certified as a Women’s Business Enterprise (WBE)
means a third-party certifying entity has confirmed
that a business is at least 51 percent owned, managed,
and controlled by a woman or women. The leading
certifier is the Women’s Business Enterprise National
Council (WBENC), which certifies to a national standard
and has 14 partner organizations across the country.
WHAT’S IN IT FOR YOU?
One of WBENC’s goals is to achieve equal procure-
ment opportunities for women. As a WBE, a business
is recognized by more than 500 major U.S. corpora-
tions and eligible to apply for their supplier diversity
programs. WBENC provides members access to data-
bases of information, including contact information
for programs and procurement executives and listings
of sourcing opportunities. Members also are listed in
the WBENC database that corporations and govern-
ment agencies use to find WBEs.
BUT GETTING CERTIFIED IS ONLY
STEP ONE
“Although [my company] had been certified through
the City of Charlotte, North Carolina, for several
years, we hadn’t been able to convert that into actual
contracts,” says Beverly Green, 32, owner of Change-
Ad Letter Co., a $2 million–plus manufacturer of elec-
trical sign components. Further research showed she
had been missing out on many opportunities. “I’d
previously thought the value of certification was
gaining local and regional government work, and
that can be true.” But Green’s target market was cor-
porations. Once she accessed WBENC’s data on corpo-
rate purchasing practices, she was able to use this
information to win major corporate accounts. Julie
Rodriguez, 44, is president and CEO of Epic Cos., a $12
million–plus Harvey, Louisiana, supplier of commercial
divers and utility vessels to the oil and gas industry.
“Like everything else in life, you get out of [WBE]
what you put in,” she says. “The program has more
to offer than just certification.”
GETTING CERTIFIED
Applications and instructions for certification are
available at www.wbenc.org; you can either complete
the application online or print it and mail it in. Fees
range from free to about $200, depending on the cer-
tifying entity and scope (local, regional, or national),
and must be renewed annually. “The process is time-
consuming, and the paperwork can be overwhelming,
though this varies depending on the level of certifica-
tion,” says Green. “My national certification took
about six months.” National applications can require
more than 100 pages of documentation. Women busi-
ness owners say getting certified is worth the effort.
Says Green, “Networking with other women-owned
businesses and getting involved in organizations such
as WBENC can lead to many opportunities and help
open doors you would never have thought of.”
ADVICE TO AN ENTREPRENEUR
A successful woman entrepreneur has read the above
article and comes to you for advice:
In the corporate world I hit the glass ceiling, and that is the
reason why I became an entrepreneur. As an entrepreneur
you are rewarded for good products and a good business,
and gender has not really been an issue to date. Do you think
that I should get certified as a “woman-owned” business? Is
it worth filling out all that paperwork? Is it fair that I in-
crease my access to possible government contracts by being
certified as a woman-owned business? Or should I think
about it more as a competitive advantage because every en-
trepreneur tries to best their competitive advantage into
profits?
Source: Reprinted with permission of Entrepreneur Media, Inc., “Proof Positive: Want the Full Benefits of a Woman-Owned Busi- ness? Get Your Company Certified,” by Aliza Pilar Sherman, Febru- ary 2003, Entrepreneur magazine: www.entrepreneur.com.
There has also been a significant increase in the number of Asian, African American,
Hispanic, and Native American majority owned firms. Of U.S. businesses, Hispanic
Americans owned 5.8 percent; Asian Americans, 4.4 percent; African Americans, 4 percent;
and American Indians, about 1 percent. This 15.8 percent minority share of U.S. busi-
nesses in 2002 reflects the continuation of a positive trend—14.6 percent share in 1997,
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 45
12.5 percent share in 1992, 9.3 percent share in 1987, and 6.8 percent share in 1982. With an
increase in the encouragement of entrepreneurship among minority groups, particularly in
their formative high school years, and the increase in the number of role models, more
minorities are likely to select entrepreneurship as a viable career option.
More and more women and ethnic minorities perceive an entrepreneurial career as per-
sonally feasible and desirable.
ENTREPRENEURIAL INTENTIONS WITHIN
EXISTING ORGANIZATIONS
Earlier in this chapter, we have shown that acting entrepreneurially is something that people
choose to do based on their perceptions of the desirability and feasibility of creating a new
venture to pursue an opportunity. However, existing companies also can pursue opportunities,
but this requires that the management of these firms create an environment that encourages
employees to think and act entrepreneurially. Such an environment is one that helps people
realize that entrepreneurial behavior within the firm is both personally desirable and feasi-
ble. This builds a strong entrepreneurial intention and, as discussed earlier in this chapter,
the general rule is that the stronger the intention to engage in entrepreneurial action, the
more likely it will happen. To create such a culture requires a different orientation toward
the management of the firm, to which we now turn.
MANAGERIAL VERSUS ENTREPRENEURIAL DECISION MAKING
Howard Stevenson, a professor at Harvard University, believes that entrepreneurship represents
a mode of managing an existing firm that is distinct from the way existing firms are tradition-
ally managed. Entrepreneurial management is distinct from traditional management in terms
of eight dimensions: (1) strategic orientation, (2) commitment to opportunity, (3) commitment
of resources, (4) control of resources, (5) management structure, (6) reward philosophy,
(7) growth orientation, and (8) entrepreneurial culture.18 The nature of the differences
among these dimensions is represented in Table 2.1 and described in greater detail below.19
TABLE 2.1 Distinguishing Entrepreneurially from Traditionally Managed Firms
Entrepreneurial Focus Conceptual Dimension Administrative Focus
Driven by perception of opportunity Strategic orientation Driven by controlled resources
Revolutionary with short duration Commitment to opportunity Evolutionary with long duration
Many stages with minimal exposure Commitment of resources A single stage with complete commitment
out of decision
Episodic use or rent of required resources Control of resources Ownership or employment of required
resources
Flat with multiple informal networks Management structure Hierarchy
Based on value creation Reward philosophy Based on responsibility and seniority
Rapid growth is top priority; risk Growth orientation Safe, slow, and steady
accepted to achieve growth
Promoting broad search for opportunities Entrepreneurial culture Opportunity search restricted by
controlled resources; failure punished
Source: This table is taken from T. Brown, P. Davidsson, and J. Wiklund, “An Operationalization of Stevenson’s Conceptualization of Entrepreneurship as
Opportunity-Based Firm Behavior,” Strategic Management Journal 22 (2001), p. 955.
46 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
Strategic Orientation and Commitment to Opportunity
The first two factors that help distinguish more entrepreneurially managed firms from those
that are more traditionally managed relate to strategic issues—strategic orientation and
commitment to opportunity. An emphasis on strategy in developing a deeper understanding
of entrepreneurship at the firm level is not surprising because both entrepreneurship and
strategy have important implications for the performance of the firm.
Strategic orientation refers to those factors that are inputs into the formulation of the
firm’s strategy. We can think of it as the philosophy of the firm that drives its decision about
strategy; the way that it looks at the world and the way it looks at itself and these percep-
tions are the driving factors behind the firm’s strategy. The strategy of entrepreneurial man-
agement is driven by the presence or generation of opportunities for new entry and is less
concerned about the resources that may be required to pursue such opportunities. Acquir-
ing and marshaling the necessary resources represents a secondary step for the entrepre-
neurially managed firm and perhaps part of the thinking about the implementation of
discovered opportunities. Resources do not constrain the strategic thinking of an entrepre-
neurially managed firm. In contrast, the strategy of traditional management is to use the re-
sources of the firm efficiently. Therefore, the type and the amount of resources that the firm
has (or knows it can readily access) represent a key starting point for thinking strategically
about the future of the firm. Only those opportunities that can be pursued effectively using
existing resources are considered the appropriate domain of further strategic thinking.
Both entrepreneurship and strategy are more than simply thinking about the future of the
firm, they are also concerned with the firm taking action. It is through its actions that a firm
is judged, often by analysis of its financial and competitive performance. Entrepreneurially
and traditionally managed firms can be distinguished in terms of their commitment to
opportunity. More entrepreneurially managed firms have an entrepreneurial orientation
toward opportunity in that they are committed to taking action on potential opportunities
and therefore can pursue opportunities rapidly, making the most of windows of opportunity.
They also are able to withdraw their resources from a particular opportunity and do so
rapidly, such that if initial feedback from the pursuit of an opportunity provides informa-
tion suggesting that it might not be the right opportunity for the firm, then management can
“pull the plug,” minimizing losses from the initial pursuit. In contrast, traditionally man-
aged firms tend to place considerable emphasis on information; information is derived from
data collection and analysis of that information to determine, say, the return on resources
to be deployed. If the traditionally managed firm chooses to pursue the given opportunity,
it would be with a much larger initial investment and the intention of remaining in that line
of business for a considerable time.
Commitment of Resources and Control of Resources
It is important to note that entrepreneurs still care about the resources they must com-
mit to the pursuit of an opportunity, but they have an entrepreneurial orientation toward
the commitment of resources that is focused on the opportunity. Thoughts of resources
turn more to how the firm can minimize the resources that would be required in the pur-
suit of a particular opportunity. By minimizing the resources that the firm must invest to
initially pursue an opportunity, the amount of resources at risk if the opportunity does
not “pan out” is also minimized. For example, entrepreneurially managed firms may
“test the waters” by committing small amounts of resources in a multistep manner with
minimal (risk) exposure at each step. This small and incremental process of resource
commitment provides the firm the flexibility to change direction rapidly as new information
entrepreneurial
orientation toward
commitment of resources
A focus on how to
minimize the resources
that would be required in
the pursuit of a particular
opportunity
strategic orientation
A focus on those factors
that are inputs into the
formulation of the firm’s
strategy
entrepreneurial
orientation toward
opportunity
A commitment to taking
action on potential
opportunities
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 47
about the opportunity or the environment comes to light. Psychologically, these smaller
sunk costs help stop entrepreneurially managed firms from becoming entrenched with a
particular course of action, especially if that course of action turns out to be a losing
one. In contrast, when traditionally managed firms decide to commit resources to an op-
portunity, they do so on a large scale. That is, rather than put a toe in to test the water,
they make calculations based on the ambient temperature over the last week, the density
of the water, and whether a pool cover has been used or not. If, based on that calcula-
tion, the water is theoretically deemed to be sufficiently warm, the traditional manager
commits to that assessment with a full swan dive. Having made a large commitment of
resources the firm often feels compelled to justify the initial decision to commit, and so
the initial commitment gains momentum that maintains the status quo of continual re-
source commitment. Therefore, a traditionally managed firm uses in-depth analysis of
available information to go for it or not—and if they do go for it, then the investment of
resources is not easily reversed.
Over and above their commitment of resources, entrepreneurially and traditionally man-
aged firms differ in their control of resources. Entrepreneurially managed firms are less
concerned about the ownership of resources and more concerned about having access to
others’ resources, including financial capital, intellectual capital, skills, and competencies.
Entrepreneurially managed firms operate from the standpoint, “Why do I need to control
resources if I can access them from others?” Access to resources is possible to the extent
that the opportunity allows the firm to effectively deploy others’ resources for the benefit of
the entrepreneurial firm and the owner of the invested resources. In contrast, traditionally
managed firms focus on the ownership of resources and the accumulation of further re-
sources. They believe that if they control their own resources then they are self-contained.
For these firms, the control that comes with ownership means that resources can be de-
ployed more effectively for the benefit of the firm. They have an entrepreneurial orientation
toward the control of resources.
Management Structure and Reward Philosophy
An entrepreneurial orientation toward management structure is organic. That is, the
organizational structure has few layers of bureaucracy between top management and the
customer and typically has multiple informal communication channels. In this way,
entrepreneurially managed firms are able to capture and communicate more information
from the external environment and are sufficiently “fluid” to be able to take quick action
based on that information.
In addition, entrepreneurially managed firms are more structured to make use of both
their internal networks (for example, through informal communication channels at work)
and external networks (with buyers, suppliers, and financial institutions), which provide
information and other resources important in the discovery/generation and exploitation of
opportunities. In contrast, the traditionally managed firm has a structure well suited for the
internal efficiencies of allocating controlled resources. There is a formalized hierarchy with
clear roles and responsibilities, highly routinized work, and layers of middle management
to “manage” employees’ use of the firm’s resources. Traditionally managed firms have
structures that are typically inwardly focused on efficiency rather than on detecting and rap-
idly acting on changes in the external environment.
Firms are organized not only by their structures but also by their reward philosophy. The
entrepreneurially managed firm is focused on pursuing opportunities for new entry that rep-
resent new value for the firm (and hopefully for others, including society as a whole). It is
not surprising then that entrepreneurially managed firms have an entrepreneurial philosophy
entrepreneurial
philosophy toward
rewards One that
compensates employees
based on their
contribution toward the
discovery/generation and
exploitation of
opportunity
entrepreneurial
orientation toward control
of resources A focus on
how to access others’
resources
entrepreneurial
orientation toward
management structure
More organic focus—has
few layers of bureaucracy
between top management
and the customer and
typically has multiple
informal networks
toward rewards that compensates employees based on their contribution toward the discovery/
generation and exploitation of opportunity. Given the organic structure described earlier,
employees often have the freedom to experiment with potential opportunities and are re-
warded accordingly. The traditionally managed firm rewards management and employees
based on their responsibilities, where responsibilities are typically determined by the
amount of resources (assets and/or people) that each manager or employee controls. Pro-
motion is a reward that provides a manager control of even more resources and, therefore,
further scope for rewards.
Growth Orientation and Entrepreneurial Culture
In a firm that has an entrepreneurial orientation toward growth there is a great desire to
expand the size of the firm at a rapid pace. Although traditionally managed firms may also
desire to grow, they prefer growth to be slow and at a steady pace. That is, they prefer a
pace of growth that is more “manageable” in that it does not “unsettle the firm” by putting
at risk the resources that the firm controls and thus does not put at risk the jobs and power
of top management.
Culture also distinguishes entrepreneurially and traditionally managed firms. A firm
with an entrepreneurial orientation toward culture encourages employees to generate
ideas, experiment, and engage in other tasks that might produce creative output. Such
output is highly valued by entrepreneurial management because it is often the source of
opportunities for new entries. Opportunities are the focus of the entrepreneurially man-
aged firm.
In contrast, the traditionally managed firm begins with an assessment of the resources
that it controls, and this is reflected in its organizational culture. So while a traditionally
managed firm is still interested in ideas, it is mostly interested in ideas that revolve around
currently controlled resources. With only ideas considered that relate to currently con-
trolled resources, the scope of opportunities discovered and generated by a traditionally
managed firm is limited.
It is unlikely that there are many firms that are “purely” entrepreneurially managed or
purely traditionally managed; most firms fall somewhere in between. Table 2.2 presents a
scale for determining how entrepreneurially managed a particular firm is. The higher the
score, the more entrepreneurially managed the firm is.
Causes for Interest in Corporate Entrepreneurship
Earlier we acknowledged that established firms can be considered entrepreneurial, and we
highlighted some of the differences between firms that are more entrepreneurially managed
and those that are more traditionally managed. This interest in entrepreneurship within es-
tablished businesses has intensified due to a variety of events occurring on social, cultural,
and business levels. On a social level, there is an increasing interest in “doing your own
thing” and doing it on one’s own terms. Individuals who believe strongly in their own tal-
ents frequently desire to create something of their own. They want responsibility and have
a strong need for individual expression and freedom in their work environment. When this
freedom is not there, frustration can cause that individual to become less productive or even
leave the organization to achieve self-actualization elsewhere. This new search for meaning,
and the impatience involved, has recently caused more discontent in structured organiza-
tions than ever before. When meaning is not provided within the organization, individuals
often search for an institution that will provide it.
Corporate entrepreneurship is one method of stimulating, and then capitalizing on, indi-
viduals in an organization who think that something can be done differently and better.
48 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
entrepreneurial
orientation toward
growth A focus on
rapid growth
culture The
environment of a
particular organization
entrepreneurial
orientation toward
culture A focus on
encouraging employees
to generate ideas,
experiment, and engage
in other tasks that might
produce opportunities
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 49
Strategic Orientation
As we define our strategies, our major 1 2 3 4 5 6 7 8 9 10 We are not constrained by the resources
concern is how to best utilize at (or not at) hand.
the sources we control.
We limit the opportunities we pursue 1 2 3 4 5 6 7 8 9 10 Our fundamental task is to pursue
on the basis of our current resources. opportunities we perceive as valuable and
then to acquire the resources to exploit
them.
The resources we have significantly 1 2 3 4 5 6 7 8 9 10 Opportunities control our business
influence our business strategies. strategies.
Resource Orientation
Since our objective is to use our 1 2 3 4 5 6 7 8 9 10 Since we do not need resources to
resources, we will usually invest heavily commence the pursuit of an
and rapidly. opportunity, our commitment of
resources may be in stages.
We prefer to totally control and own 1 2 3 4 5 6 7 8 9 10 All we need from resources is the ability
the resources we use. to use them.
We prefer to use only our own resources 1 2 3 4 5 6 7 8 9 10 We like to employ resources that we
in our ventures. borrow or rent.
In exploiting opportunities, access to 1 2 3 4 5 6 7 8 9 10 In exploiting opportunities, having the
money is more important than just idea is more important than just having
having the idea. the money.
Management Structure
We prefer tight control of funds and 1 2 3 4 5 6 7 8 9 10 We prefer loose, informal control. There is
operations by means of sophisticated a dependence on informal relations.
control and information systems.
We strongly emphasize getting things 1 2 3 4 5 6 7 8 9 10 We strongly emphasize getting things
done by following formal processes done even if this means disregarding
and procedures. formal procedures.
We strongly emphasize holding to tried 1 2 3 4 5 6 7 8 9 10 We strongly emphasize adapting freely to
and true management principles and changing circumstances without much
industry norms. concern for past practices.
There is a strong insistence on a uniform 1 2 3 4 5 6 7 8 9 10 Managers’ operating styles are allowed to
management style throughout the firm. range freely from very formal to very
informal.
There is a strong emphasis on getting 1 2 3 4 5 6 7 8 9 10 There is a strong tendency to let the
line and staff personnel to adhere closely requirements of the situation and the
to their formal job descriptions. personality of the individual dictate
proper job behavior.
Reward Philosophy
Our employees are evaluated and 1 2 3 4 5 6 7 8 9 10 Our employees are evaluated and
compensated based on their responsibilities. compensated based on the value they
add to the firm.
Our employees are usually rewarded by 1 2 3 4 5 6 7 8 9 10 We try to compensate our employees by
promotion and annual raises. devising ways that they can benefit from
the increased value of the firm.
An employee’s standing is based on the 1 2 3 4 5 6 7 8 9 10 An employee’s standing is based on the
amount of responsibility s/he has. value s/he adds.
TABLE 2.2 Scale to Capture How Entrepreneurially a Firm Is Managed
50 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
Most people think of Xerox as a large, bureaucratic Fortune 100 company. Although, in
part, this may be true of the $15 billion giant company, Xerox has done something unique
in trying to ensure that its creative employees do not leave like Steve Jobs did to form
Apple Computer, Inc. In 1989, Xerox set up Xerox Technology Ventures (XTV) for the
purpose of generating profits by investing in the promising technologies of the company,
many of which would have otherwise been overlooked.20 Xerox wanted to avoid mistakes
of the past by having “a system to prevent technology from leaking out of the company,”
according to Robert V. Adams, president of XTV.
The fund has supported numerous start-ups thus far, similar to Quad Mark, the brain-
child of Dennis Stemmle, a Xerox employee of 25 years. Stemmle’s idea was to make a
battery-operated, plain paper copier that would fit in a briefcase along with a laptop
computer. Although Xerox’s operating committee did not approve the idea for 10 years, it
was finally funded by XTV and Taiwan’s Advanced Scientific Corporation. As is the case
with all the companies funded by XTV, the founder and key employees of a company own
20 percent of it. This provides an incentive for employees like Dennis Stemmle to take the
risk, leave Xerox, and form a technology-based venture.
XTV provides both financial and nonfinancial benefits to its parent, Xerox. The funded
companies provide profits to the parent company as well as the founders and employees,
and now Xerox managers pay closer attention to employees’ ideas as well as internal tech-
nologies. Is XTV a success? Apparently so, if replication is any indication. The XTV con-
cept contains an element of risk in that Xerox employees forming new ventures are not
guaranteed a management position if the new venture fails. This makes XTV different from
most entrepreneurial ventures in companies. This aspect of risk and no guaranteed em-
ployment is the basis for AT&T Ventures, a fund modeled on XTV.
What Xerox recognized is what hundreds of executives in other organizations are also
becoming aware of: It is important to keep, or instill, the entrepreneurial spirit in an organ-
ization to innovate and grow. This realization has revolutionized management thinking. In
a large organization, problems often occur that thwart creativity and innovation, particularly
in activities not directly related to the organization’s main mission. The growth and diver-
sification that can result from flexibility and creativity are particularly critical since large,
Growth Orientation
Growth is not necessarily our top objective. 12 3 4 5 6 7 8 9 10 It is generally known throughout the firm
Long-term survival may be at least as that growth is our top objective.
important.
It is generally known throughout the firm 1 2 3 4 5 6 7 8 9 10 It is generally known throughout the firm
that steady and sure growth is the best that our intention is to grow as big and as
way to expand. fast as possible.
Entrepreneurial Culture
It is difficult to find a sufficient number 1 2 3 4 5 6 7 8 9 10 We have many more promising ideas than
of promising ideas to utilize all of our we have time and resources to pursue.
resources.
Changes in the society-at-large seldom 1 2 3 4 5 6 7 8 9 10 Changes in the society-at-large often give
lead to commercially promising ideas us ideas for new products and services.
for our firm.
It is difficult for our firm to find ideas 1 2 3 4 5 6 7 8 9 10 We never experience a lack of ideas that
that can be converted into profitable we can convert into profitable
products/services. products/services.
Source: This table is taken from T. Brown, P. Davidsson, and J. Wiklund, “An Operationalization of Stevenson’s Conceptualization of Entrepreneurship as Opportunity-Based Firm Behavior,” Strategic Management Journal 22 (2001), Appendix.
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 51
vertically integrated, diversified corporations are often more efficient in a competitive mar-
ket than smaller firms.
The resistance against flexibility, growth, and diversification can, in part, be overcome
by developing a spirit of entrepreneurship within the existing organization, called corpo-
rate entrepreneurship. An increase in corporate entrepreneurship reflects an increase in
social, cultural, and business pressures. Hypercompetition has forced companies to have an
increased interest in such areas as new product development, diversification, increased pro-
ductivity, and decreasing costs by methods such as reducing the company’s labor force.
Corporate entrepreneurship is most strongly reflected in entrepreneurial activities as
well as in top management orientations in organizations. These entrepreneurial endeavors
consist of the following four key elements: new business venturing, innovativeness, self-
renewal, and proactiveness.21
New business venturing (sometimes called corporate venturing) refers to the creation of
a new business within an existing organization. These entrepreneurial activities consist of
creating something new of value either by redefining the company’s current products or
services, developing new markets, or forming more formally autonomous or semiau-
tonomous units or firms. Formations of new corporate ventures are the most salient mani-
festations of corporate entrepreneurship. Organizational innovativeness refers to product
and service innovation, with an emphasis on development and innovation in technology. It
includes new product development, product improvements, and new production methods
and procedures.
Self-renewal is the transformation of an organization through the renewal of the key
ideas on which it is built. It has strategic and organizational change connotations and in-
cludes a redefinition of the business concept, reorganization, and the introduction of sys-
temwide changes to increase innovation. Proactiveness includes initiative and risk taking,
as well as competitive aggressiveness and boldness, which are particularly reflected in the
orientations and activities of top management. A proactive organization tends to take risks
by conducting experiments; it also takes initiative and is bold and aggressive in pursuing
opportunities. Organizations with this proactive spirit attempt to lead rather than follow
competitors in such key business areas as the introduction of new products or services, op-
erating technologies, and administrative techniques.
Establishing a Culture for Corporate Entrepreneurship
How can the culture for corporate entrepreneurship be established in an organization? In
establishing an entrepreneurial environment within an established organization, certain fac-
tors and leadership characteristics need to be present.22 The overall characteristics of a
good entrepreneurial environment are summarized in Table 2.3. The first of these is that the
organization operates on the frontiers of technology. Since research and development are
key sources for successful new product ideas, the firm must operate on the cutting edge of
the industry’s technology, encouraging and supporting new ideas instead of discouraging
them, as frequently occurs in firms that require a rapid return on investment and a high
sales volume.
Second, experimentation—trial and error—is encouraged. Successful new products or
services usually do not appear fully developed; instead, they evolve. It took time and some
product failures before the first marketable computer appeared. A company wanting to es-
tablish an entrepreneurial spirit has to establish an environment that allows mistakes and
failures in developing new and innovative products. This is in direct opposition to the es-
tablished career and promotion system of the traditional organization. Yet without the op-
portunity to fail in an organization, few, if any, corporate entrepreneurial ventures will be
developed. Almost every entrepreneur has experienced at least one failure in establishing a
corporate
entrepreneurship
Entrepreneurial action
within an established
organization
52 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
successful venture. The importance and the difficulty of learning from the experience are
discussed in Chapter 1.
Third, an organization should make sure that there are no initial organizational obstacles
that inhibit creativity in new product development. Frequently in an organization, various
“turfs” are protected, frustrating attempts by potential entrepreneurs to establish new ven-
tures. In one Fortune 500 company, an attempt to establish an entrepreneurial environment
ran into problems and eventually failed when the potential entrepreneurs were informed
that a proposed new product and venture was not possible because it was in the domain of
another division.
Fourth, the resources of the firm need to be available and easily accessible. As one cor-
porate entrepreneur stated, “If my company really wants me to take the time, effort, and ca-
reer risks to establish a new venture, then it needs to put money and people resources on the
line.” Often, insufficient funds are allocated not to creating something new, but instead to
solving problems that have an immediate effect on the bottom line. Some companies—
like Xerox, 3M, and AT&T—have recognized this problem and have established separate
venture-capital areas for funding new internal as well as external ventures. Even when re-
sources are available, all too often the reporting requirements become obstacles to obtain-
ing them.
Fifth, a multidisciplined team approach needs to be encouraged. This open approach,
with participation by needed individuals regardless of area, is the antithesis of the typical
corporate organizational structure. An evaluation of successful cases of corporate entrepre-
neurship indicated that one key to success was the existence of “skunkworks” involving rel-
evant people. Developing the needed teamwork for a new venture is further complicated by
the fact that a team member’s promotion and overall career within the corporation are based
on his or her job performance in the current position, not on his or her contribution to the
new venture being created.
Besides encouraging teamwork, the corporate environment must establish a long time hori-
zon for evaluating the success of the overall program as well as the success of each individual
venture. If a company is not willing to invest money without a guarantee of return for 5 to
10 years, it should not attempt to create an entrepreneurial environment. This patient atti-
tude toward money in the corporate setting is no different from the investment/return time
horizon used by venture capitalists and others when they invest in an entrepreneurial effort.
TABLE 2.3 Characteristics of an Entrepreneurial Environment
• Organization operates on frontiers of technology
• New ideas encouraged
• Trial and error encouraged
• Failures allowed
• No opportunity parameters
• Resources available and accessible
• Multidiscipline teamwork approach
• Long time horizon
• Volunteer program
• Appropriate reward system
• Sponsors and champions available
• Support of top management
Sixth, the spirit of corporate entrepreneurship cannot be forced upon individuals; it must
be on a volunteer basis. There is a difference between corporate thinking and entrepre-
neurial thinking (discussed earlier and summarized in Table 2.1), with certain individuals
performing much better on one side of the continuum or the other. Most managers in a cor-
poration are not capable of being successful corporate entrepreneurs. Those who do emerge
from this self-selection process must be allowed the latitude to carry a project through to
completion. This is not consistent with most corporate procedures for new product devel-
opment, where different departments and individuals are involved in each stage of the de-
velopment process. An individual willing to spend the excess hours and effort to create a
new venture needs the opportunity and the accompanying reward of completing the proj-
ect. A corporate entrepreneur falls in love with the newly created internal venture and will
do almost anything to help ensure its success.
The seventh characteristic of a good entrepreneurial environment is a reward system.
The corporate entrepreneur needs to be appropriately rewarded for all the energy, effort,
and risk taking expended in the creation of the new venture. Rewards should be based on
the attainment of established performance goals. An equity position in the new venture is
one of the best rewards for motivating and eliciting the amount of activity and effort needed
for success.
Eighth, a corporate environment favorable for corporate entrepreneurship has sponsors
and champions throughout the organization who not only support the creative activity but
also have the planning flexibility to establish new objectives and directions as needed. As
one corporate entrepreneur stated, “For a new business venture to succeed, the corporate
entrepreneur needs to be able to alter plans at will and not be concerned about how close
they come to achieving the previously stated objectives.” Corporate structures frequently
measure managers on their ability to come close to objectives, regardless of the quality of
performance reflected in this accomplishment.
Finally, and perhaps most important, the entrepreneurial activity must be wholeheartedly
supported and embraced by top management, both by their physical presence and by mak-
ing sure that the necessary personnel and financial resources are available. Without top
management support, a successful entrepreneurial environment cannot be created.
Leadership Characteristics of Corporate Entrepreneurs
Within this overall corporate environment, certain individual characteristics have been
identified that constitute a successful corporate entrepreneur. As summarized in Table 2.4,
these include understanding the environment, being visionary and flexible, creating man-
agement options, encouraging teamwork, encouraging open discussion, building a coalition
of supporters, and being persistent.
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 53
TABLE 2.4 Leadership Characteristics of a Corporate Entrepreneur
• Understands the environment
• Is visionary and flexible
• Creates management options
• Encourages teamwork
• Encourages open discussion
• Builds a coalition of supporters
• Persists
54 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
An entrepreneur needs to understand all aspects of the environment. Part of this ability
is reflected in the individual’s level of creativity, which generally decreases with age and
education in most individuals. To establish a successful corporate venture, the individual
must be creative and have a broad understanding of the internal and external environments
of the corporation.
The person who is going to establish a successful new venture within the firm must also
be a visionary leader—a person who dreams great dreams. Although there are many defi-
nitions of leadership, the one that best describes what is needed for corporate entrepre-
neurship is: “A leader is like a gardener. When you want a tomato, you take a seed, put it in
fertile soil, and carefully water under tender care. You don’t manufacture tomatoes; you
grow them.” Another good definition is that “leadership is the ability to dream great things
and communicate these in such a way that people say yes to being a part of the dream.”
Martin Luther King, Jr., said, “I have a dream,” and articulated that dream in such a way
that thousands followed him in his efforts, in spite of overwhelming obstacles. To establish
a successful new venture, the corporate entrepreneur must have a dream and overcome ob-
stacles to achieving it by selling the dream to others.
The third necessary leadership characteristic is that the corporate entrepreneur must be
flexible and create management options. A corporate entrepreneur does not “mind the
store,” but rather is open to and even encourages change. By challenging the beliefs and as-
sumptions of the corporation, a corporate entrepreneur has the opportunity to create some-
thing new in the organizational structure.
The corporate entrepreneur needs a fourth characteristic: the ability to encourage team-
work and use a multidisciplined approach. This also violates the organizational practices
and structures taught in most business schools that are apparent in established organiza-
tional structures. In forming a new venture, putting together a variety of skills requires
crossing established departmental structure and reporting systems. To minimize disruption,
the corporate entrepreneur must be a good diplomat.
Open discussion must be encouraged to develop a good team for creating something
new. Many corporate managers have forgotten the frank, open discussions and disagreements
that were a part of their educational process. Instead, they spend time building protective
barriers and insulating themselves in their corporate empires. A successful new venture
within an established firm can be formed only when the team involved feels free to disagree
and to critique an idea to reach the best solution. The degree of openness among the team
members depends on the degree of openness of the corporate entrepreneur.
Openness leads also to the establishment of a strong coalition of supporters and encour-
agers. The corporate entrepreneur must encourage and affirm each team member, particu-
larly during difficult times. This encouragement is very important, as the usual motivators
of career paths and job security are not operational in establishing a new corporate venture.
A good corporate entrepreneur makes everyone a hero.
Last, but not least, is persistence. Throughout the establishment of any new venture,
frustration and obstacles will occur. Only through the corporate entrepreneur’s persistence
will a new venture be created and successful commercialization result.
ESTABLISHING CORPORATE ENTREPRENEURSHIP
IN THE ORGANIZATION
Over and above the creation of an organizational culture and the leadership characteristics
discussed so far, an organization wanting to establish a more entrepreneurial firm must
implement a procedure for its creation. Although this can be done internally, frequently it
is easier to use someone outside to facilitate the process. This is particularly true when the
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 55
organization’s environment is very traditional and has a record of little change and few new
products being introduced.
The first step in this process is to secure a commitment to corporate entrepreneurship in
the organization by top, upper, and middle management levels. Without top management
commitment, the organization will never be able to go through all the cultural changes nec-
essary for implementation. Once the top management of the organization has been com-
mitted to corporate entrepreneurship for a sufficient period of time (at least three years), the
concept can be introduced throughout the organization. This is accomplished most effec-
tively through seminars, where the aspects of corporate entrepreneurship are introduced
and strategies are developed to transform the organizational culture into an entrepreneurial
one. General guidelines need to be established for corporate venture development. Once the
initial framework is established and the concept embraced, corporate entrepreneurs need to
be identified, selected, and trained. This training needs to focus on identifying viable op-
portunities and their markets and developing the appropriate business plan.
Second, ideas and general areas that top management is interested in supporting
should be identified, along with the amount of risk money that is available to develop the
concept further. Overall program expectations and the target results of each corporate venture
should be established. As much as possible, these should specify the time frame, volume, and
profitability requirements for the new venture, as well as the impact of the organization.
Along with entrepreneurial training, a mentor/sponsor system needs to be established. With-
out sponsors or champions, there is little hope that the culture of the organization can be
transformed into an entrepreneurial one.
Third, a company needs to use technology to make itself more flexible. Technology has
been used successfully for the past decade by small companies that behave like big ones.23
How else could a small firm like Value Quest Ltd. compete against very large money man-
agement firms, except through a state-of-the-art personal computer and access to large data
banks? Similarly, large companies can use technology to make themselves responsive and
flexible like smaller firms.
Fourth, the organization should be a group of interested managers who will train em-
ployees as well as share their experiences. The training sessions should be conducted one
day per month for a specified period of time. Informational items about corporate entre-
preneurship in general—and about the specifics of the company’s activities in developing
ideas into marketable products or services that are the basis of new business venture
units—should be well publicized. This will require the entrepreneurial team to develop a
business plan, obtain customer reaction and some initial intentions to buy, and learn how to
coexist within the organizational structure.
Fifth, the organization needs to develop ways to get closer to its customers. This can be
done by tapping the database, hiring from smaller rivals, and helping the retailer.
Sixth, an organization that wants to become more entrepreneurial must learn to be more
productive with fewer resources. This has already occurred in many companies that have
downsized. Top-heavy organizations are out of date in today’s hypercompetitive environ-
ment. To accommodate the large cutbacks in middle management, much more control has
to be given to subordinates at all levels in the organization. Not surprisingly, the span of
control may become as high as 30-to-1 in divisions of such companies. The concept of
“lean and mean” needs to exist if corporate entrepreneurship is to prevail.
Seventh, the organization needs to establish a strong support structure for corporate en-
trepreneurship. This is particularly important since corporate entrepreneurship is usually a
secondary activity in the organization. Since entrepreneurial activities do not immediately
affect the bottom line, they can be easily overlooked and may receive little funding and sup-
port. To be successful, these ventures require flexible, innovative behavior, with the corporate
top management
commitment Managers
in an organization
strongly supporting
corporate
entrepreneurship
entrepreneurs having total authority over expenditures and access to sufficient funds. When
the corporate entrepreneur has to justify expenses on a daily basis, it is really not a new in-
ternal venture but merely an operational extension of the funding source.
Eighth, support also must involve tying the rewards to the performance of the entrepre-
neurial unit. This encourages the team members to work harder and compete more effec-
tively since they will benefit directly from their efforts. Because the corporate venture is a
part of the larger organization and not a totally independent unit, the equity portion of the
compensation is particularly difficult to handle.
Finally, the organization needs to implement an evaluation system that allows successful
entrepreneurial units to expand and unsuccessful ones to be eliminated. The organization
can establish constraints to ensure that this expansion does not run contrary to the corpo-
rate mission statement. Similarly, corporate ventures that fail to show sufficient viability
should not be allowed to exist just because of vested interests.
Problems and Successful Efforts
Corporate entrepreneurship is not without its problems. One study found that new ventures
started within a corporation performed worse than those started independently by entre-
preneurs.24 The reasons cited were the corporation’s difficulty in maintaining a long-term
commitment, a lack of freedom to make autonomous decisions, and a constrained environ-
ment. Generally, independent, venture-capital-based start-ups by entrepreneurs tend to out-
perform corporate start-ups significantly. On average, not only did the independents become
profitable twice as fast, but they ended up twice as profitable.25
These findings should not deter organizations from starting the process. There are
numerous examples of companies that, having understood the environmental and entre-
preneurial characteristics necessary, have adopted their own version of the implementa-
tion process to launch new ventures successfully. One of the best known of these firms
is Minnesota Mining and Manufacturing (3M). Having had many entrepreneurial suc-
cesses, 3M, in effect, allows employees to devote a percentage of their time to inde-
pendent projects. This enables the divisions of the company to meet an important goal:
to generate a significant percent of sales from new products introduced within the last
five years. One of the most successful of these entrepreneurial activities was the devel-
opment of Post-it Notes by entrepreneur Arthur Fry. This effort developed out of Fry’s
annoyance that pieces of paper marking his church hymnal constantly fell out while he
was singing. As a 3M chemical engineer, Fry knew about the discovery by a scientist,
Spencer Silver, of an adhesive with very low sticking power, which to the company was
a poor product characteristic. However, this characteristic was perfect for Fry’s prob-
lem; a marker with a light-sticking adhesive that would be easy to remove provided a
good solution. Obtaining approval to commercialize the idea proved to be a monumen-
tal task until the samples distributed to secretaries within 3M, as well as to other com-
panies, created such a demand that the company eventually began selling the product
under the name Post-it.
Another firm committed to the concept of corporate entrepreneurship is Hewlett-
Packard (HP). After failing to recognize the potential of Steven Wozniak’s proposal for a
personal computer (which was the basis for Apple Computer Inc.), Hewlett-Packard has
taken steps to ensure that it will be recognized as a leader in innovation and not miss future
opportunities. However, the entrepreneurial road at HP is not an easy one. Such was the
case for Charles House, an engineer who went far beyond his entrepreneurial duty when
he ignored an order from David Packard to stop working on a high-quality video monitor.
The monitor, once developed, was used in NASA’s manned moon landings and in heart
56 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 57
transplants. Although projected to achieve sales of no more than 30 units, these large-screen
displays have obtained good sales and profits.
IBM also decided that corporate entrepreneurship would help spur corporate growth.
The company developed the independent business unit concept, in which each unit is a sep-
arate organization with its own mini-board of directors and autonomous decision-making
authority on many manufacturing and marketing issues. The business units have developed
such products as the automatic teller machine for banks, industrial robots, and the IBM per-
sonal computer. The latter business unit was given a blank check with a mandate to get
IBM into the personal computer market. Corporate entrepreneur Philip Estridge led his
group to develop and market the PCs, through both IBM’s sales force and the retail market,
breaking some of the most binding operational rules of IBM at that time.
These and other success stories indicate that the problems of corporate entrepreneurship
are not insurmountable and that implementing corporate entrepreneurship can lead to new
products, growth, and the development of an entirely new corporate environment and
culture.
IN REVIEW
S U M M A R Y
Individuals become entrepreneurs because they intend to do so. The stronger the inten-
tion to be an entrepreneur, the more likely it is that it will happen. Intentions become
stronger as individuals perceive an entrepreneurial career as feasible and desirable.
These perceptions of feasibility and desirability are influenced by one’s background
and characteristics, such as education, personal values, age and work history, role mod-
els and support systems, and networks. Gender and race are also characteristics of in-
dividuals that help us understand the entrepreneurial phenomenon. Established firms
can create environmental conditions to motivate individuals within their organizations
to act entrepreneurially, that is, conditions that allow organizational members to per-
ceive entrepreneurial outcomes as feasible and desirable. Within existing corporate
structures, this entrepreneurial spirit and effort is called corporate entrepreneurship.
Corporate entrepreneurship requires an entrepreneurial management approach. To
demonstrate this entrepreneurial approach, we contrasted entrepreneurially managed
firms with traditionally managed firms on eight dimensions: (1) strategic orientation,
(2) commitment to opportunity, (3) commitment of resources, (4) control of resources,
(5) management structure, (6) reward philosophy, (7) growth orientation, and (8) en-
trepreneurial culture. Fortunately, three leading Swedish researchers developed a scale
that enables us to assess firms in terms of where they fall on the scale between entre-
preneurial and traditional management.
Organizations desiring an entrepreneurial culture need to encourage new ideas and
experimental efforts, eliminate opportunity parameters, make resources available, pro-
mote a teamwork approach and voluntary corporate entrepreneurship, and enlist top
management’s support. The corporate entrepreneur also must have appropriate leader-
ship characteristics. In addition to being creative, flexible, and visionary, the corporate
entrepreneur must be able to work within the corporate structure. Corporate entrepre-
neurs need to encourage teamwork and work diplomatically across established struc-
tures. Open discussion and strong support of team members are also required. Finally,
the corporate entrepreneur must be persistent to overcome the inevitable obstacles.
The process of establishing corporate entrepreneurship within an existing organi-
zation requires the commitment of management, particularly top management. The
organization must carefully choose leaders, develop general guidelines for ventures,
and delineate expectations before the entrepreneurial program begins. Training ses-
sions are an important part of the process. As role models and entrepreneurial ven-
tures are introduced, the organization must establish a strong organizational support
system, along with a system of incentives and rewards to encourage team members. Fi-
nally, the organization should establish a system to expand successful ventures and
eliminate unsuccessful ones.
R E S E A R C H T A S K S
1. Speak to three entrepreneurs and find out what motivated them to become
entrepreneurs. Also find one person who, at one time, considered becoming an
entrepreneur but did not do so. Find out why.
2. Interview two women entrepreneurs and find out whether they believe that the
tasks of being an entrepreneur are different for them than for their male
counterparts. What are the advantages of being a female entrepreneur? What
are the disadvantages of being a female entrepreneur? Are these differences
substantial or minor?
3. Interview three individuals employed within the research and development (R&D)
departments of large, well-established companies. From the interview, gain an
understanding of what the company does to foster corporate entrepreneurship,
what it does to inhibit corporate entrepreneurship, and what it could be doing
better toward further enhancing entrepreneurship throughout the whole
organization.
4. Search the Internet for four accounts of successful corporate entrepreneurship.
What key factors for success are common across all these accounts? Which are
unique? If one company can foster an entrepreneurial culture within an existing
firm, what stops another company from copying its process and taking away the
initial advantage?
5. Request the participation of managers from two companies and then ask them to
fill out an “entrepreneurial management” scale (see Table 2.2). Based on the scale,
which firm is more entrepreneurially managed? Does this coincide with your “gut
feel” about the businesses?
C L A S S D I S C U S S I O N
1. We know that people with high IQ scores, or even high SAT or high GMAT
scores, do not necessarily do any better than others in school. How
predictive do you believe personality tests are in predicting success as an
entrepreneur? What are the dangers of classifying people using personality
tests as “not very entrepreneurial” or “very entrepreneurial”? What are the
potential benefits?
2. Why do role models have an impact on a person’s decision to become an
entrepreneur? Do you think that a person whose parent was an entrepreneur
of a failed business is more or less likely to start his or her own business than a
person whose parents were managers of large, established companies?
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58 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
3. To what extent do men and women differ as entrepreneurs in terms of the
types of companies they create and manage, the industries in which they
operate, the challenges they face, and their sources of competitive advantage?
Are these differences greater or less than they were five years ago? Are we
going to soon find that there are no differences between women and men
entrepreneurs?
4. Isn’t “corporate entrepreneurship” an oxymoron? Do the characteristics of an
established organization, such as its routines and structure, increase efficiency but
at the same time kill any entrepreneurial spirit? Is there any way that a company
can have the best of both worlds?
5. Is increasing the entrepreneurial orientation of a firm always a good thing? Or are
there circumstances or environments in which the further pursuit of opportunities
can diminish firm performance?
S E L E C T E D R E A D I N G S
Baron, Robert A.; and Gideon D. Markman. (2000). Beyond Social Capital: How Social Skills Can Enhance Entrepreneurs’ Success. Academy of Management Executive, vol. 14, no. 1, pp. 106–16.
This article suggests that entrepreneurs’ social skills—specific competencies that help them interact effectively with others—may play a role in their success. A high level of social capital, built on a favorable reputation, relevant previous experience, and direct personal contacts, often assists entrepreneurs in gaining access to ven- ture capitalists, potential customers, and others.
Boden, Richard J.; and Brian Headd. (October 2002). Race and Gender Differences in Business Ownership and Business Turnover. Business Economics, pp. 61–72.
This article describes a study that uses a novel longitudinal Bureau of the Census employer data series to examine the survival prospects of new employer businesses for four different, mutually exclusive classifications of ownership: white non-Hispanics; white Hispanics; blacks; and Asians and other minorities.
Brown, Terence; Per Davidsson; and Johan Wiklund. (2001). An Operationalization of Stevenson’s Conceptualization of Entrepreneurship as Opportunity-Based Firm Behav- ior. Strategic Management Journal, vol. 22, pp. 953–69.
This article describes a new instrument that was developed specifically for opera- tionalizing Stevenson’s conceptualization of entrepreneurial management. The instrument should open up opportunities for researchers to further evaluate en- trepreneurship in existing firms.
Coleman, Susan. (2002). Constraints Faced by Women Small Business Owners: Evidence from the Data. Journal of Developmental Entrepreneurship, vol. 7, no. 2, pp. 151–74.
This article explores some of the possible constraints faced by women business own- ers. Although results do not demonstrate evidence of noneconomic discrimination against women-owned firms, they do reveal that certain characteristics typical of many women-owned firms, including small size, limited prospects for growth and profitability, and failure to provide collateral or guarantee, reduce the likelihood of obtaining debt capital.
Davidsson, Per; and Benson Honig. (2003). The Role of Social and Human Capital among Nascent Entrepreneurs. Journal of Business Venturing, vol. 18, pp. 301–31.
This study examines nascent entrepreneurship by comparing individuals engaged in nascent activities with a control group and finds that social capital is a robust pre- dictor for nascent entrepreneurs, as well as for advancing through the start-up
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 59
process. With regard to outcomes like first sale or showing a profit, only one aspect of social capital, viz., being a member of a business network, had a statistically sig- nificant positive effect. The study supports human capital in predicting entry into nascent entrepreneurship, but only weakly for carrying the start-up process toward successful completion.
Dess, Gregory; R. Duane Ireland; Shaker Zahra; Steven Floyd; Jay Janney; and Peter Lane. (2003). Emerging Issues in Corporate Entrepreneurship. Journal of Management, vol. 29, pp. 351–78.
In this article, the authors identify four major issues scholars can pursue to further our understanding about corporate entrepreneurship (CE). The issues explored include var- ious forms of CE and their implications for organizational learning; the role of leader- ship and social exchange in the CE process; and key research opportunities relevant to CE in an international context. Throughout the article, the authors use the organiza- tional learning theory as a means of integrating our discussion and highlighting the potential contributions of CE to knowledge creation and effective exploitation.
Dyer, Linda M.; and Christopher A. Ross. (April 2000). Ethnic Enterprises and Their Clientele. Journal of Small Business Management, vol. 38, pp. 48–66.
The goal of this article is to examine the relationships between ethnic-minority busi- nesses and their co-ethnic customers. A theoretical framework emerges, which high- lights three dimensions: (1) the coincident roles of business owner/manager and co-ethnic individual, (2) the easy flow of communication among co-ethnics, and (3) the symbolic aspects of ethnicity. These dimensions are causes of the ambivalent relations that exist between many businesses and their co-ethnic clients.
Eddleston, Kimberly; and Gary N. Powell. (2008). The Role of Gender Identity in Ex- plaining Sex Differences in Business Owners’ Career Satisfier Preferences. Journal of Business Venturing, vol. 23, pp. 244–56.
This study examines how gender identity explains what male and female business own- ers look for from their careers. Results suggest that gender identity, represented by the dimensions of masculinity and femininity, serves as a cognitive mechanism that con- tributes to sex differences in business owners’ career satisfier preferences. Masculinity mediates the relationship between sex and preferences for status-based satisfiers. Fem- ininity mediates the relationships between sex and preferences for employee relation- ship satisfiers and contribution to society satisfiers. These results support the view that entrepreneurship is a gendered process and that incorporation of a feminine perspec- tive into entrepreneurial theories and research is needed. [Abstract from authors.]
Hmieleski, Keith; and Andrew Corbett. (2006). Proclivity for Improvisation as a Predictor of Entrepreneurial Intentions. Journal of Small Business Management, vol. 44, pp. 45–63.
This study examines the relationship between improvisation and entrepreneurial intentions and finds that entrepreneurial intentions are associated with measures of personality, motivation, cognitive style, social models, and improvisation. The strongest relationship is found between entrepreneurial intentions and improvisation.
Ireland, R. Duane; Jeffrey G. Covin; and Don F. Kuratko. (2009). Conceptualizing Corpo- rate Entrepreneurship Strategy. Entrepreneurship: Theory and Practice, vol. 33, pp. 19–46.
In this article the authors conceptualize the components of corporate entrepreneur- ship (CE) to include (1) the individual entrepreneurial cognitions of the organization’s members and external environmental conditions that invite entrepreneurial activity; (2) the top management’s entrepreneurial strategic vision for the firm, organizational architectures that encourage entrepreneurial processes and behavior, and the generic forms of entrepreneurial process that are reflected in entrepreneurial behavior; and (3) the organizational outcomes resulting from entrepreneurial actions, including the development of competitive capability and strategic repositioning.
Jack, Sarah; and Alistair Anderson. (2002). The Effects of Embeddedness on the Entre- preneurial Process. Journal of Business Venturing, vol. 17, pp. 467–87.
60 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
In this study the authors examine the use of Gidden’s theory of structuration to de- velop the conception of entrepreneurship as an embedded socioeconomic process. In particular they focus on the role of embeddedness in shaping and sustaining busi- ness, in recognizing and realizing opportunities, and in the effect of social structure on entrepreneurship.
Krueger, Norris. (2000). The Cognitive Infrastructure of Opportunity Emergence. Entrepreneurship: Theory and Practice, vol. 24, pp. 5–23.
In this article the author argues that seeing a prospective course of action as a cred- ible opportunity reflects an intentions-driven process driven by known critical an- tecedents. On the basis of well-developed theory and robust empirical evidence, he proposes an intentions-based model of the cognitive infrastructure that supports or inhibits how individuals perceive opportunities. The author also shows the practical diagnostic power this model offers to managers.
Kuemmerle, Walter. (May 2002). A Test for the Fainthearted. Harvard Business Review, pp. 122–27.
Starting a business is rarely a dignified affair. The article discusses what really makes an entrepreneur; what characteristics set successful entrepreneurs apart, enabling them to start ventures against all odds and keep them alive even in the worst of times; and finally, whether, if you don’t possess those characteristics, they can be developed.
Kuratko, Donald; R. Duane Ireland; Jeffrey Covin; and Jeffrey Hornsby. (2005). A Model of Middle-Level Managers’ Entrepreneurial Behavior. Entrepreneurship: Theory & Prac- tice, vol. 29, pp. 699–716.
In this article, the authors integrate knowledge about corporate entrepreneurship and middle-level managers’ behaviors to develop and explore a conceptual model. The model depicts the organizational antecedents of middle-level managers’ entre- preneurial behavior, the entrepreneurial actions describing that behavior, and out- comes of that behavior, as well as factors influencing its continuance.
Shepherd, Dean; and Norris Krueger. (2002). An Intentions-Based Model of Entrepre- neurial Teams’ Social Cognition. Entrepreneurship: Theory and Practice, vol. 27, pp. 167–85.
In this article the authors present an intentions-based model of how to promote entrepreneurial thinking in the domain of corporate entrepreneurship. They em- phasize the importance of perceptions of desirability and feasibility and that these perceptions are from the team as well as the individual perspective.
Stevenson, Howard; and J. Carlos Jarillo. (1990). A Paradigm of Entrepreneurship: Entre- preneurial Management. Strategic Management Journal, vol. 11 (Special Issue), pp. 17–27.
In this article the authors propose that the very concept of corporate entrepreneur- ship sounds to many entrepreneurship scholars like something of an oxymoron. They point out that there is no doubt that, of late, entrepreneurship in general has gained its status as a legitimate scholarly research subject, enjoying in addition much public interest. The authors offer a discussion of the concept of entrepre- neurship within established firms.
E N D N O T E S
1. J. Ajzen, “The Theory of Planned Behavior,” Organizational Behavior and Human Decision Processes 50 (1991), pp. 179–211.
2. A. Bandura, “Self-Efficacy: The Exercise of Control (New York: W.H. Freeman and Company, 1997); and D. A. Shepherd and N. Krueger, “An Intentions-Based Model of Entrepreneurial Teams’ Social Cognition,” Special Issue on Cognition and Infor- mation Processing, Entrepreneurship: Theory and Practice 27 (2002), pp. 167–85.
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 61
3. N. F. J. Krueger and D. V. Brazael, “Entrepreneurial Potential and Potential Entrepreneurs.” Entrepreneurship: Theory and Practice 18 (1994), pp. 91–104.
4. Shepherd and Krueger, “An Intentions-Based Model.” 5. C. M. Ford and D. A. Gioia, Creativity in Organizations: Ivory Tower Visions and
Real World Voices (Newbury Park, CA: Sage, 1995). 6. See J. Gimeno, T. Folta, A. Cooper, and C. Woo, “Survival of the Fittest? Entre-
preneurial Human Capital and the Persistence of Underperforming Firms,” Administrative Science Quarterly 42 (1997), pp. 750–83.
7. P. Davidsson and B. Honig, “The Role of Social and Human Capital among Nascent Entrepreneurs,” Journal of Business Venturing 18 (2003), pp. 301–31. D. R. DeTienne, D. A. Shepherd, and J. O. De Castro, “The Fallacy of ‘Only the Strong Survive’: The Effects of Extrinsic Motivation on the Persistence Decisions for Under-Performing Firms,” Journal of Business Venturing 23 (2008), pp. 528–46.
8. Much of this information is based on research findings in Robert C. Ronstadt, “Initial Venture Goals, Age, and the Decision to Start an Entrepreneurial Career,” Proceedings of the 43rd Annual Meeting of the Academy of Management (August 1983), p. 472; and Robert C. Ronstadt, “The Decision Not to Become an Entrepreneur,” Proceedings, 1983 Conference on Entrepreneurship (April 1983), pp. 192–212. See also M. Lévesque, D. A. Shepherd, and E. J. Douglas, “Employ- ment or Self-Employment: A Dynamic Utility-Maximizing Model,” Journal of Business Venturing 17 (2002), pp. 189–210.
9. See also Lévesque, Shepherd, and Douglas, “Employment or Self-Employment.” 10. A. C. Cooper, T. B. Folta, and C. Woo, “Entrepreneurial Information Search,” Jour-
nal of Business Venturing 10 (1995), pp. 107–20; and M. Wright, K. Robbie, and C. Ennew, “Venture Capitalists and Serial Entrepreneurs,” Journal of Business Venturing 12, no. 3, (1997), pp. 227–49.
11. Davidsson and Honig, “The Role of Social and Human Capital.” 12. The influence of role models on career choice is discussed in E. Almquist and
S. Angrist, “Role Model Influences on College Women’s Career Aspirations,” Merrill-Palmer Quarterly 17 (July 1971), pp. 263–97; J. Strake and C. Granger, “Same-Sex and Opposite-Sex Teacher Model Influences on Science Career Commit- ment among High School Students,” Journal of Educational Psychology 70 (April 1978), pp. 180–86; Alan L. Carsrud, Connie Marie Gaglio, and Kenneth W. Olm, “Entrepreneurs-Mentors, Networks, and Successful New Venture Development: An Exploratory Study,” Proceedings, 1986 Conference on Entrepreneurship (April 1986), pp. 29–35; and Howard Aldrich, Ben Rosen, and William Woodward, “The Impact of Social Networks on Business Foundings and Profit: A Longitudinal Study,” Proceed- ings, 1987 Conference on Entrepreneurship (April 1987), pp. 154–68.
13. A thoughtful development of the network concept can be found in Howard Aldrich and Catherine Zimmer, “Entrepreneurship through Social Networks,” in The Art and Science of Entrepreneurship (Cambridge, MA: Ballinger, 1986), pp. 3–24.
14. H. Hoang and B. Antoncic, “Network-Based Research in Entrepreneurship: A Criti- cal Review,” Journal of Business Venturing 18 (2003), pp. 165–88.
15. S. Birley, “The Role of Networks in the Entrepreneurial Process,” Journal of Busi- ness Venturing 1 (1985), pp. 107–17; A. Cooper and W. Dunkelberg, “Entrepre- neurship and Paths to Business Ownership,” Strategic Management Journal 7 (1986), pp. 53–68. B. Johannisson, “Networking and Entrepreneurial Growth,” in D. Sexton and H. Landström (eds.), The Blackwell Handbook of Entrepreneurship (Oxford, MA: Blackwell, 2000), pp. 26–44.
16. A. Larson, “Network Dyads in Entrepreneurial Settings: A Study of the Gover- nance of Exchange Relationships,” Administrative Science Quarterly 37 (1992), pp. 76–104; W. Powell, “Neither Market nor Hierarchy: Network Forms of Organi- zation,” in B. Staw and L. Cummings (eds.), Research in Organizational Behavior (Greenwich, CT: JAI Press, 1990); B. Uzzi, “The Sources and Consequences of
62 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
Embeddedness for the Economic Performance of Organizations: The Network Effect,” American Sociological Review 61 (1996), pp. 674–98.
17. Uzzi, “The Sources and Consequences of Embeddedness.” 18. H. H. Stevenson and D. Gumpert, “The Heart of Entrepreneurship,” Harvard
Business Review 63, no. 2, (1985), pp. 85–94. 19. Based on T. Brown, P. Davidsson, and J. Wiklund, “An Operationalization of
Stevenson’s Conceptualization of Entrepreneurship as Opportunity-Based Firm Behavior,” Strategic Management Journal 22 (2001), pp. 953–69 (table on page 955).
20. For a discussion of XTV, see Larry Armstrong, “Nurturing an Employee’s Brain- child,” BusinessWeek/Enterprise (1993), p. 196.
21. For a discussion of corporate entrepreneurship elements and their measures, see G. T. Lumpkin and G. G. Dess, “Clarifying the Entrepreneurial Orientation Con- struct and Linking It to Performance,” Academy of Management Review 12, no. 1 (1996), pp. 135–72; and B. Antoncic and R. D. Hisrich, “Intrapreneurship: Con- struct Refinement and Cross-Cultural Validation,” Journal of Business Venturing 16, no. 61 (September 2001), pp. 495–527.
22. For a thorough discussion of the factors important in corporate entrepreneur- ship, see R. M. Kanter, The Change Masters (New York: Simon & Schuster, 1983); and G. Pinchot III, Intrapreneuring (New York: Harper & Row, 1985).
23. For a discussion of this aspect, see Peter Coy, “Start with Some High-Tech Magic . . . ,” BusinessWeek/Enterprise (1993), pp. 24–25, 28, 32.
24. N. Fast, “Pitfalls of Corporate Venturing,” Research Management (March 1981), pp. 21–24.
25. For complete information on the relative performance, see R. Biggadike, “The Risky Business of Diversification,” Harvard Business Review (May–June 1979), pp. 103–11; L. E. Weiss, “Start-Up Business: A Comparison of Performances,” Sloan Management Review (Fall 1981), pp. 37–53; and N. D. Fast and S. E. Pratt, “Individual Entrepreneurship and the Large Corporation,” Proceedings, Babson Research Conference (April 1984), pp. 443–50.
C H A P T E R 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP 63
1
To understand that the essential act of entrepreneurship involves new entry.
2
To be able to think about how an entrepreneurial strategy can first generate, and then exploit over time, a new entry.
3
To understand how resources are involved in the generation of opportunities.
4
To be able to assess the attractiveness of a new entry opportunity.
5
To acknowledge that entrepreneurship involves making decisions under conditions of uncertainty.
6
To be able to assess the extent of first-mover advantages and weigh them against first-mover disadvantages.
7
To understand that risk is associated with newness, but there are strategies that the entrepreneur can use to reduce risk.
3 E N T R E P R E N E U R I A L S T R AT E G Y:
G E N E R AT I N G A N D E X P L O I T I N G
N E W E N T R I E S
L E A R N I N G O B J E C T I V E S
65
O P E N I N G P R O F I L E
JUSTIN PARER
Sorry it had taken so long to get back to you. I think in some way I have been avoiding this
because I don’t know if I actually know the answers to what you are asking. I think some-
times you justify afterwards why you did something.
This quote is from Justin Parer, an Australian entrepreneur, in response to my direct
questions about the plan he followed for entrepreneurial
success. His history indicates a series of steps and missteps
that have emerged into a strategy of personal and busi-
ness success—a strategy that may be more obvious to the
objective observer taking a long-run perspective than to the actor who is immersed in
the daily details of a pressurized situation and is making “intuitive” decisions.
Justin’s first entrepreneurial venture failed. The story is not pretty. He started up a
mobile pizza business when he was 18 years old. “The idea for the van was actually
someone else’s. I was working in a pizza shop as a delivery driver trying to decide what
I wanted to do in my life. I had recently been thrown out of uni [university] for gross
failing and was at a loose end. One of the other guys in the shop said, ‘Why don’t they
sell pizzas outside night clubs?’ The market at the time was being serviced by a num-
ber of very unhygienic hot dog vendors who operated out of questionable mobile
huts.” Eventually Justin’s business failed because, among other things, the local coun-
cil terminated permits for these types of mobile food businesses.
When asked about the failed business, Justin’s first comment was that it was the
best learning experience of his life. His second comment was that it was a great moti-
vator. It provided motivation “to avoid that sick feeling that rips at your guts when you
know things are not going well and you can’t pay your bills,” to “face reality,” and
where necessary to “cut your losses” and get out.
He went on to say: “I am not sure that straight after the failure I was that motivated to
get back into it. I knew I enjoyed business and was frustrated that I couldn’t make it work,
but I felt more like a failure than a ‘success waiting to happen.’ My confidence was hurt
and I was looking for a lot more security. How was I ever [going] to buy a house? Have a
family? I had few options and no clear vision, so when the opportunity came along to go
back to university, I grabbed it with both hands. With the pizza van failure I knew I could
work like a dog and get nowhere. I needed to have an edge. University gave me options.”
www.BSE.net.au
Justin’s second attempt at university had no resemblance to his first attempt. He
had become an exceptional student with a passion to learn and a passion to apply that
knowledge. He majored in accounting and his first job out of university was with Ernst
& Young (an accounting consulting firm). Accounting education and experience pro-
vided valuable knowledge about the inner workings of a business (with the auditing
department) and the numbers reflecting the entrepreneurial decision-making process
(in the business services and tax department). Over and above the opportunity to build
important knowledge, Justin also chose accounting as the foundation from which to
relaunch his entrepreneurial career because it gave him legitimacy with others in the
business community (including potential stakeholders), helped him build a large net-
work with influential people, and would act as an income “insurance policy” if his
business failed.
One of Justin’s accounting clients was a slipway (ship building and repair) busi-
ness. From this work he was able to gain considerable industry-specific knowledge
and an industry-specific network. This newly formed network provided early infor-
mation about a business in the industry that might come on the market, and his new
industry-specific knowledge meant that he could assess the value of this opportunity.
He bought the business and is growing it while simultaneously improving its effi-
ciency. The success of the business has even exceeded his own dreams for it at the
time of purchase.
He has recently gone into partnership with his brother Warwick and purchased an-
other business—a metal-working business. This business has considerable potential in
its own right but has the added benefit of synergies with the slipway. This business is
also on the path to success. When I think of the “ideal” entrepreneur, I think of Justin.
Justin is an optimistic and charismatic entrepreneur who attacks his tasks and life with
confidence and passion (with the possible exception of answering questions about his
success). He has control over the money side of his businesses but also has the flexibil-
ity to allow his strategies to emerge.
NEW ENTRY
One of the essential acts of entrepreneurship is new entry. New entry refers to (1) offer-
ing a new product to an established or new market, (2) offering an established product to
a new market, or (3) creating a new organization (regardless of whether the product or
the market is new to competitors or customers).1 Whether associated with a new prod-
uct, a new market, and/or a new organization, “newness” is like a double-edged sword.
On the one hand, newness represents something rare, which can help differentiate a firm
from its competitors. On the other hand, newness creates a number of challenges for en-
trepreneurs. For example, newness can increase entrepreneurs’ uncertainty over the
value of a new product and place a greater strain on the resources necessary for suc-
cessful exploitation.2
66 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
new entry Offering a
new product to an
established or new market,
offering an established
product to a new market,
or creating a new
organization
Entrepreneurial strategy represents the set of decisions, actions, and reactions that first
generate, and then exploit over time, a new entry in a way that maximizes the benefits of
newness and minimizes its costs.
Figure 3.1 illustrates the important elements of an entrepreneurial strategy. An entrepre-
neurial strategy has three key stages: (1) the generation of a new entry opportunity, (2) the
exploitation of a new entry opportunity, and (3) a feedback loop from the culmination of a
new entry generation and exploitation back to stage 1. The generation of a new entry is the
result of a combination of knowledge and other resources into a bundle that its creators
hope will be valuable, rare, and difficult for others to imitate. If the decision is that the new
entry is sufficiently attractive that it warrants exploitation, then firm performance is de-
pendent upon the entry strategy; the risk reduction strategy; the way the firm is organized;
and the competence of the entrepreneur, management team, and the firm.
Although the remainder of this chapter focuses on stages 1 and 2, we should not under-
estimate the importance of the feedback loop of stage 3 because an entrepreneur cannot
rely on the generation and exploitation of only one new entry; rather, long-run performance
is dependent upon the ability to generate and exploit numerous new entries. If the firm does
rely on only one new entry, then as the life cycle for the product enters maturity and de-
clines, so goes the life cycle of the organization.
GENERATION OF A NEW ENTRY OPPORTUNITY
Resources as a Source of Competitive Advantage
When a firm engages in a new entry, it is hoped that this new entry will provide the firm
with a sustainable competitive advantage. Understanding where a sustainable competitive
advantage comes from will provide some insight into how entrepreneurs can generate new
entries that are likely to provide the basis for high firm performance over an extended
C H A P T E R 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES 67
entrepreneurial strategy
The set of decisions,
actions, and reactions that
first generate, and then
exploit over time, a new
entry
Resource bundle
Firm performance
Assessment of new entry opportunity
Entry strategy
Risk reduction strategy
Organization
Knowledge
Other resources
Stage 3: Feedback loop of resources
Stage 1: New entry generation Stage 2: New entry exploitation
FIGURE 3.1 Entrepreneurial Strategy: The Generation and Exploitation of New Entry Opportunities
period of time. Resources are the basic building blocks to a firm’s functioning and per-
formance. A firm’s resources are simply the inputs into the production process, such as
machinery, financial capital, and skilled employees.
These resources can be combined in different ways, and it is this bundle of resources
that provides a firm its capacity to achieve superior performance. For example, a highly
skilled workforce represents an important resource, but the impact of this resource on
performance is magnified when it is combined with an organizational culture that en-
hances communication, teamwork, and innovativeness. To truly understand the impact
of a resource, we need to consider the bundle rather than just the resources that make up
the bundle.
For a bundle of resources to be the basis of a firm’s superior performance over competi-
tors for an extended period of time, the resources must be valuable, rare, and inimitable
(including nonsubstitutable).3 A bundle of resources is:4
• Valuable when it enables the firm to pursue opportunities, neutralize threats, and offer products and services that are valued by customers.
• Rare when it is possessed by few, if any, (potential) competitors.
• Inimitable when replication of this combination of resources would be difficult and/or costly for (potential) competitors.
For example, Breeze Technology Incorporated appeared to have a bundle of resources
that was valuable, rare, and inimitable. It had invented a technology that could be applied
to the ventilation of athletic shoes to reduce foot temperature. A ventilated athletic shoe is
likely to be highly valued by customers because people have problems with their current
athletic shoes—their feet get hot and sweaty, which in turn causes blisters, fungal infec-
tions, and odor. (I know my wife would be happy for me to wear shoes that reduced foot
odor.) The product was also valuable to the newly formed management team of Breeze
Technology because it provided the means of entering into a large and highly lucrative
market.
This technology also appeared to be rare and inimitable. It was rare because others had
failed to adequately ventilate people’s feet. Some had attempted to blow air into the shoe
and found that it only increased foot temperature. Current footwear attempted to passively
ventilate feet, but the porous uppers on shoes were relatively ineffective at this task and also
made the shoe vulnerable to water intrusion—that is, if you stepped into a puddle, your feet
would get wet. Breeze Technology pumped air out of the shoe, which was a novel and un-
obvious approach to shoe ventilation.
Given that this technology was deemed likely to be valuable to customers, novel, and
unobvious, it was provided a patent. The purpose of the patent is to protect the owner of the
technology from people imitating the technology. Along with other intellectual property
protection such as copyrights and trademarks, Breeze Technology had a new product that
could be protected from competition (at least for a period of time). Therefore, Breeze Tech-
nology had a bundle of resources that was valuable, rare, and inimitable. The important
questions are, then: (1) where does this valuable, rare, and difficult-to-imitate bundle of re-
sources come from? and (2) how can it best be exploited?
Creating a Resource Bundle That Is Valuable, Rare, and Inimitable
The ability to obtain, and then recombine, resources into a bundle that is valuable, rare,
and inimitable represents an important entrepreneurial resource. Knowledge is the ba-
sis of this entrepreneurial resource, which in itself is valuable. This type of knowledge
is built up over time through experience, and it resides in the mind of the entrepreneur
68 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
resources The inputs
into the production
process
entrepreneurial resource
The ability to obtain, and
then recombine, resources
into a bundle that is
valuable, rare, and
inimitable
and in the collective mind of management and employees. To a large extent such an ex-
perience is idiosyncratic—unique to the life of the individual—and therefore can be
considered rare. Furthermore, it is typically difficult to communicate this knowledge to
others, which makes it all the more difficult for (potential) competitors to replicate such
knowledge.
Therefore, knowledge is important for generating a bundle of resources that will lead to
the creation of a new venture with a long and prosperous life. Does this mean that only
highly experienced managers and/or firms will typically generate these opportunities for
new entry? On the contrary, the evidence suggests that it is the outsiders that come up with
the most radical innovations. For example, the pioneers of mountain bikes were biking en-
thusiasts, and it was quite a considerable time before the industry giants, such as Schwinn
and Huffy, reacted to the trend.5
It appears that the existing manufacturers of bikes had difficulty “thinking outside the
box” or they had little incentive to do so. Notice that those who did invent the mountain
bike were bike enthusiasts. They had knowledge about current technology and the prob-
lems that customers (themselves included) had with the current technology under certain
circumstances. This knowledge was unique and based upon personal experience. It was this
knowledge that provided the basis for their innovation.
Those wishing to generate an innovation need to look to the unique experiences and
knowledge within themselves and their team. This sort of knowledge is unlikely to be
learned in a textbook or in class, because then everyone would have it and what would be
unique about that? Knowledge that is particularly relevant to the generation of new entries
is that which is related to the market and technology.
Market Knowledge Market knowledge refers to the entrepreneur’s possession of infor- mation, technology, know-how, and skills that provide insight into a market and its cus-
tomers. Being knowledgeable about the market and customers enables the entrepreneur
to gain a deeper understanding of the problems that customers have with the market’s
existing products. In essence the entrepreneur shares some of the same knowledge that cus-
tomers have about the use and performance of products. From this shared knowledge,
entrepreneurs are able to bring together resources in a way that provides a solution to cus-
tomers’ dissatisfaction.
In this case, the entrepreneur’s market knowledge is deeper than the knowledge that
could be gained through market research. Market research, such as surveys, has limited ef-
fectiveness because it is often difficult for customers to articulate the underlying problems
they have with a product or service. Entrepreneurs who lack this intimate knowledge of the
market, and of customers’ attitudes and behaviors, are less likely to recognize or create at-
tractive opportunities for new products and/or new markets.
The importance of this knowledge to the generation of a new entry is best illustrated by
returning to the example of the invention of the mountain bike. These guys were bike en-
thusiasts and therefore were aware of the problems that they personally encountered, as well
as the problems their friends encountered, in using bikes that relied on the current technol-
ogy. It could be that these individuals were using their bikes in a way that was not antici-
pated by the bike manufacturers, such as taking them off-road and exploring rough terrain.
Market research would not likely have revealed this information about deficiencies in
the current technology. It is difficult for people to articulate the need for something that
does not exist. Besides, the manufacturers may have dismissed any information that they
received. For example, “Of course the frame broke, this idiot was going 30 miles per hour
down a stony hiking track.” It was because these bike enthusiasts had an intimate knowl-
edge of the market and customers’ attitudes and behaviors that they were able to bring
market knowledge
Possession of
information, technology,
know-how, and skills that
provide insight into a
market and its customers
C H A P T E R 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES 69
together resources in a way that provided a solution to customers’ dissatisfaction—the
mountain bike represented a solution and opened up a new market.
Technological Knowledge Technological knowledge is also a basis for generating new entry opportunities. Technological knowledge refers to the entrepreneur’s possession of in-
formation, technology, know-how, and skills that provide insight into ways to create new
knowledge. This technological knowledge might lead to a technology that is the basis for a
new entry, even though its market applicability is unobvious.
For example, the laser was invented over 30 years ago and has led to many new entry
opportunities. Those with expertise in laser technology are more able to adapt and improve
the technology and in doing so open up a potentially attractive market. Laser technology
has been adapted to navigation, precision measurement, music recording, and fiber optics.
In surgery, laser technology has been used to repair detached retinas and reverse blind-
ness. These new entries were derived from the knowledge of laser technology, and market
applicability was often of only secondary consideration.6
Similarly, the initial reaction to the invention of the computer was that its market was
rather limited. If we investigate the application of the computer to one industry, we can see
the sort of new markets that have arisen from the further development of computer tech-
nology. Computers are used in the aviation industry to conduct aerodynamic research to
find efficient aircraft designs; in the automation of the navigation and flying functions of
pilots, such as the autopilot; in the radar system used by air traffic control; in flight simu-
lators used by airlines to train pilots on new aircraft; and in the computer network system
for ticketing and tracking baggage (although my bags still seem to get lost).7
Therefore, technological knowledge has led to technological advancement that in many
ways has created new markets rather than generating a technology to satisfy an unmet mar-
ket need. Often these technologies were created by people wanting to advance knowledge,
without concern for commercial applicability. Other times, a technology has been invented
for a specific and narrow purpose only to find out later that the technology has broader im-
plications. For example, Tang, freeze-dried coffee, Velcro, and Teflon were all products in-
vented for the space program but were found to have broader applications.
In sum, a resource bundle is the basis for a new entry. This resource bundle is created
from the entrepreneur’s market knowledge, technological knowledge, and other resources.
The new entry has the potential of being a source of sustained superior firm performance
if the resource bundle underlying the new entry is valuable, rare, and difficult for others
to imitate.
Assessing the Attractiveness of a New Entry Opportunity
Having created a new resource combination, the entrepreneur needs to determine whether
it is in fact valuable, rare, and inimitable by assessing whether the new product and/or the
new market are sufficiently attractive to be worth exploiting and developing. This depends
on the level of information on a new entry and the entrepreneur’s willingness to make a de-
cision without perfect information.
Information on a New Entry
Prior Knowledge and Information Search The prior market and technological knowledge used to create the potential new entry can also be of benefit in assessing the
attractiveness of a particular opportunity. More prior knowledge means that the entrepre-
neur starts from a position of less ignorance about the assessment task at hand. That is,
70 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
technological knowledge
Possession of
information, technology,
know-how, and skills that
provide insight into ways
to create new knowledge
less information needs to be collected to reach a threshold where the entrepreneur feels
comfortable making a decision to exploit or not to exploit.
Knowledge can be increased by searching for information that will shed some light on
the attractiveness of this new entry opportunity. Interestingly, the more knowledge the en-
trepreneur has, the more efficient the search process. For example, entrepreneurs who have
a large knowledge base in a particular area will know where to look for information and
will be able to quickly process this information into knowledge useful for the assessment.
The search process itself represents a dilemma for an entrepreneur. On the one hand, a
longer search period allows the entrepreneur time to gain more information about whether
this new entry does represent a resource bundle that is valuable, rare, and difficult for oth-
ers to imitate. The more information the entrepreneur has, the more accurately she or he
can assess whether sufficient customer demand for the product can be generated and
whether the product can be protected from imitation by competitors.
However, there are costs associated with searching for this information—costs in both
money and time. For example, rather than deciding to exploit a new product, an entrepre-
neur may decide to search for more information to make a more accurate assessment of
whether this new product is an attractive one for her; but while this entrepreneur continues
with her information search, the opportunity may cease to be available.
Window of Opportunity The dynamic nature of the viability of a particular new entry can be described in terms of a window of opportunity. When the window is open, the
71
A wealthy friend has asked you to keep your eye
out for attractive businesses in which she can invest.
Your wealthy friend is very busy and you only want
to introduce those businesses that are genuinely at-
tractive. After hearing the following pitch, would
you introduce Natalie and Enrico to your wealthy
friend?
Entrepreneurs Natalie Chanin (41) and Enrico
Marone-Cinzano (39), co-founders of Project
Alabama in Florence, Alabama
Description Clothing company that largely uses recy-
cled materials
Start-Up 2000 for $20,000
Sales Projecting $1.5 million in 2003
Helping Hands Heading to a party one night,
Chanin hand-sewed a T-shirt and was hooked.
With a costume design and fashion stylist back-
ground, Chanin joined forces with co-founder
Marone-Cinzano, a businessman with experience
in finance and marketing. She was unable to
find a manufacturer in New York to do the
handwork—her collection’s resemblance to
quilting inspired Chanin to return to her native
Alabama and find “quilting circles” that could
lend a hand (she now lives in both New York
and Alabama, but spends most of her time in
Alabama).
Recycled Goods Project Alabama’s growth necessi-
tates branching out to include new materials,
but the core of the collection is made from recy-
cled cotton jersey T-shirts. Retailing for $250 to
$4,000, their target has always been high-end.
“We made a conscious effort to contact those
type of stores,” explains Chanin. “Luckily, we
had some of the world’s best stores buy from
the beginning, like Barneys New York and
Browns in London.”
Supplies Needed “Project Alabama consists of two
components: the use of recycled materials and
the quality of handwork,” says Chanin, speaking
proudly of the 120 women who subcontract
stitchwork. “The kind of pride they have in each
and every piece is rare.”
Source: Reprinted with permission of Entrepreneur Media, Inc., “Natalie Chanin and Enrico Marone-Cinzano,” by April Y. Pennington, February 2003, Entrepreneur magazine: www.entrepreneur.com.
ELEVATOR PITCH FOR PROJECT ALABAMA
A S S E E N I N ENTREPRENEUR M A G A Z I N E
window of opportunity
The period of time
when the environment
is favorable for
entrepreneurs to exploit a
particular new entry
environment is favorable for entrepreneurs to exploit a particular new product or to enter a
new market with an existing product; but the window of opportunity may close, leaving the
environment for exploitation unfavorable. An example of a window of opportunity closing
is when another entrepreneur has entered the industry and erected substantial barriers to
entry and to imitation. While more information is desirable, the time spent in collecting
additional information increases the likelihood that the window of opportunity will close.
Comfort with Making a Decision under Uncertainty
The trade-off between more information and the likelihood that the window of opportu-
nity will close provides a dilemma for entrepreneurs. This dilemma involves a choice of
which error they prefer to commit: Do they prefer to commit an error of commission over
an error of omission, or vice versa?8 An error of commission occurs from the decision to
pursue this new entry opportunity, only to find out later that the entrepreneur had overes-
timated his or her ability to create customer demand and/or to protect the technology from
imitation by competitors. The costs to the entrepreneur were derived from acting on the
perceived opportunity.
An error of omission occurs from the decision not to act on the new entry opportunity,
only to find out later that the entrepreneur had underestimated his or her ability to create
customer demand and/or to protect the technology from imitation by competitors. In this
case, the entrepreneur must live with the knowledge that he let an attractive opportunity slip
through his fingers.
Decision to Exploit or Not to Exploit the New Entry
As illustrated in Figure 3.2, the decision to exploit or not to exploit the new entry op-
portunity depends on whether the entrepreneur has what she or he believes to be suffi-
cient information to make a decision, and on whether the window is still open for this
72 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
FIGURE 3.2 The Decision to Exploit or Not to Exploit the New Entry Opportunity
Go/no go decision
to exploit new entry
Level of information
on new entry
Window of opportunity still open
Comfort with making decision
under uncertainty
Search
Knowledge
Preference for error: Omission
Commission or
error of commission
Negative outcome from
acting
error of omission
Negative outcome from
not acting
new entry opportunity. A determination by an entrepreneur that she has sufficient infor-
mation depends on the stock of information (accumulated through search and from prior
knowledge) and on the level of comfort that this entrepreneur has with making the de-
cision without perfect information (which depends on a preference of one type of error
over another).
It is important to realize that the assessment of a new entry’s attractiveness is less about
whether this opportunity “really” exists or not and more about whether the entrepreneur be-
lieves he or she can make it work—that is, create the market demand, efficiently produce
the product, build a reputation, and develop customer loyalty and other switching costs.
Making it work depends, in part, on entrepreneurial strategies.
ENTRY STRATEGY FOR NEW ENTRY EXPLOITATION
The common catchphrase used by entrepreneurs when asked about their source of com-
petitive advantage is, “Our competitive advantage comes from being first. We are the first
movers.” Whether they are the first to introduce a new product and/or the first to create a
new market, these claims have some merit. Being first can result in a number of advantages
that can enhance performance. These include:
• First movers develop a cost advantage. Being first to offer and sell a particular product to a specific market means that the first mover can begin movement down the
“experience curve.” The experience curve captures the idea that as a firm produces a
greater volume of a particular product, the cost of producing each unit of that product
goes down. Costs are reduced because the firm can spread its fixed costs over a greater
number of units (economies of scale) as well as learn by trial and error over time
(learning curve) to improve products and processes.9
• First movers face less competitive rivalry. Although first movers might initially have only a few customers, if they have correctly assessed the opportunity, the market will
grow rapidly. Even though competitors will enter this growing market, the market
share lost to new competitors will be more than compensated for by market growth. In
fact, in the growth stage of the market, firms are more concerned with keeping up with
demand than they are with taking actions, such as price cutting, to take market share
from others.
• First movers can secure important channels. First movers have the opportunity to select and develop strong relationships with the most important suppliers and distribution
channels. This may represent a barrier to those considering entry and may force those
who do eventually enter to use inferior suppliers and distribution outlets.
• First movers are better positioned to satisfy customers. First movers have the chance to (1) select and secure the most attractive segments of a market, and (2) position
themselves at the center of the market, providing an increased ability to recognize,
and adapt to, changes in the market. In some cases, they may even (3) establish their
product as the industry standard.
• First movers gain expertise through participation. First movers have the opportunity to (1) learn from the first generation of products and improve, for example, product
design, manufacturing, and marketing; (2) monitor changes in the market that might
be difficult or impossible to detect for those firms not participating in the market;
and (3) build up their networks, which can provide early information about attractive
opportunities. These learning opportunities may be available only to those
participating in the market. In this case, knowledge is gained through learning-by-
doing rather than through observing the practices of others (vicarious learning).
C H A P T E R 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES 73
assessment of a new
entry’s attractiveness
Determining whether
the entrepreneur believes
she or he can make the
proposed new entry work
First movers do not always prosper. Many first movers with new products in new mar-
kets have been surpassed by firms that entered later. For example, in the market for video
recorders the first movers were Ampex and Sony, yet they were surpassed by JVC and
Matsushita. Similarly, in the ballpoint pen market the first movers (Reynolds and Ever-
sharp) disappeared, whereas later entrants (Parker and Bic) have been highly successful.
As illustrated by the scales in Figure 3.3, there are forces pushing toward first-mover
advantages, but there are also environmental conditions that can push a first mover to-
ward performance disadvantages. When considering whether to be one of the first to en-
ter with a new product and/or into a new market, entrepreneurs must determine whether
the first-mover advantages outweigh the first-mover disadvantages. Such an assessment
depends on (1) the stability of the environment surrounding the entry, (2) the ability of
the entrepreneur to educate customers, and (3) the ability of the entrepreneur to erect
barriers to entry and imitation to extend the firm’s lead time. We now explore each of
these influences.
Environmental Instability and First-Mover (Dis)Advantages
The performance of a firm depends on the fit between its bundle of resources and the
external environment. If there is a good fit between its resources and the external environ-
ment, then the firm will be rewarded with superior performance; however, if the fit is poor,
then performance will also be poor. For example, if the entrepreneur offers a new product
that has attributes that the market does not value, then there is a poor fit between the firm’s
current product offerings and the external environment and performance will be poor.
To obtain a good fit with the external environment, the entrepreneur must first determine
the key success factors of the industry being targeted for entry. Key success factors are the
requirements that any firm must meet to successfully compete in a particular industry. For
example, maybe the key success factor of an industry is superior service, or reliability, or
the lowest price, or having one’s technology adopted as the industry standard. However, the
key success factors The
requirements that any
firm must meet to
successfully compete in
a particular industry
Cost advantages
Less competition
Secure important channels
Prime position for customers
Expertise from participation
Environmental instability
Customer uncertainty
Short lead time
First-mover advantages
First-mover disadvantages
FIGURE 3.3 Factors That Influence the Decision to Enter the Market Now or to Delay Entry
74 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
first mover will not know these key success factors in advance; rather, the entrepreneur
must commit the firm’s resources based upon his or her best guess of what these key suc-
cess factors might be. If the guess is correct and the environment remains stable, then the
firm has a chance of achieving success. However, if the environment changes, so too will
the key success factors, and, as a result, the entrepreneur’s prior commitment of resources
will be less effective and may even reduce the firm’s ability to recognize and adapt to the
new environment.
Environmental changes are highly likely in emerging industries. Emerging industries
are those industries that have been newly formed. As such, the rules of the game have
not yet been set. This means that the entrepreneur has considerable freedom in how he
or she achieves success, including establishing the rules of the game for the industry
such that the firm is at a competitive advantage. Until the rules of the game have been
established and the industry has matured (aged), the environment of an emerging indus-
try is often changing. Determining whether change will occur and the nature of that
change is often difficult for entrepreneurs because they face considerable demand un-
certainty and technological uncertainty. Even if the change is detected, it is difficult to
respond effectively.
Demand Uncertainty First movers have little information upon which to estimate the potential size of the market and how fast it will grow. Such demand uncertainty makes
it difficult to estimate future demand, which has important implications for new venture
performance as both overestimating and underestimating demand can negatively impact per-
formance. By overestimating demand, the entrepreneur will suffer the costs associated with
overcapacity (there was no need to build such a large factory, for instance) and will find that
the market may be so small that it cannot sustain the entrepreneur’s business. By underes-
timating market demand, the entrepreneur will suffer the costs of undercapacity, such as not
being able to satisfy existing and new customers and losing them to competitors, or will
face the additional costs of incrementally adding capacity.
Demand uncertainty also makes it difficult to predict the key dimensions along which
the market will grow. For example, customers’ needs and tastes may change as the market
matures. If the entrepreneur is unaware of these changes (or is incapable of adapting to
them), then there is an opportunity for competitors to provide superior value to the cus-
tomers. For example, as the personal computer industry matured, the key success factors
changed from reputation for quality to being the low-cost provider. Dell was able to create
a business model that enabled it to sell personal computers at a low price. Those that were
late to adapt to the change in customer demand and continued to rely primarily on their rep-
utation for quality were surpassed by Dell.
Entrepreneurs that delay entry have the opportunity to learn from the actions of first
movers without the need of incurring the same costs. For example, Toyota delayed entry
into the small-car market of the United States and was able to reduce demand uncertainty
by surveying customers of the market leader (Volkswagen) and using this information to
produce a product that better satisfied customers.10 Therefore, followers have the advantage
of more information about market demand. They also have more information about long-run
customer preferences because the additional time before entry means that the market is
more mature and customer preferences are more stable. Therefore, when demand is unsta-
ble and unpredictable, first-mover advantages may be outweighed by first-mover disad-
vantages and the entrepreneur should consider delaying entry.
Technological Uncertainty First movers often must make a commitment to a new technology. There are a number of uncertainties surrounding a new technology, such as
emerging industries
Industries that have been
newly formed and are
growing
demand uncertainty
Considerable difficulty in
accurately estimating the
potential size of the
market, how fast it will
grow, and the key
dimensions along which
it will grow
C H A P T E R 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES 75
whether the technology will perform as expected and whether an alternate technology
will be introduced that leapfrogs the current technology. If the technology does not perform
as expected, the entrepreneur will incur a number of costs that will negatively impact
performance, for example, damage to the entrepreneur’s (and his or her firm’s) reputation
and also the additional R&D and production costs incurred by making necessary changes
to the technology.
Even if the technology works as expected, there is the possibility that a superior tech-
nology might be introduced that provides later entrants a competitive advantage. For ex-
ample, Docutel provided almost all the automatic teller machines in 1974. However, when
technology became available that allowed customers to electronically transfer funds, com-
panies such as Honeywell, IBM, and Burroughs were in a position to adopt the new tech-
nology and better satisfy customer demands. As a result, Docutel’s market share dropped
to 10 percent in just four years.11
Delayed entry provides entrepreneurs with the opportunity to reduce technological
uncertainty. For example, they can reduce technological uncertainty by learning from the
first mover’s R&D program. This could involve activities such as reverse engineering the first
mover’s products. This provides a source of technological knowledge that can be used to
imitate the first mover’s product (unless there is intellectual property protection) or to im-
prove upon the technology. Delayed entry also provides the opportunity to observe and
learn from the actions (and mistakes) of the first mover. For example, a first mover may en-
ter a particular market segment only to find out that there is insufficient demand to sustain
the business. The later entrant can learn from this failure and can avoid market segments
that have proved themselves to be unattractive. Therefore, when technological uncertainty
is high, first-mover advantages may be outweighed by first-mover disadvantages and the
entrepreneur should consider delaying entry.
Adaptation Changes in market demand and technology do not necessarily mean that first movers cannot prosper. They do mean that the entrepreneur must adapt to the new environ-
mental conditions. Such changes are difficult. The entrepreneur will likely find it difficult
to move away from the people and systems that brought initial success and toward new
configurations requiring changes to employees’ roles and responsibilities as well as
changes to systems. In other words, the organization has an inertia that represents a force
for continuation that resists change. For example, Medtronics was the market leader in
heart pacemakers but lost its position after it was slow to change from its existing technol-
ogy to a new lithium-based technology. A new entrant, unconstrained by organizational in-
ertia, was able to exploit and penalize Medtronics for its tardiness.12
In addition, the entrepreneurial attributes of persistence and determination, which are so
beneficial when the new venture is on the “right course,” can inhibit the ability of the en-
trepreneur to detect, and implement, change. For example, there is a tendency for entrepre-
neurs to escalate commitment; that is, when faced with a new technology, the entrepreneur
commits more resources to his or her current technology and reinforces the initial strategic
direction, rather than adopting the new technology and changing strategic direction,13
which has the effect of accelerating the firm’s demise. Therefore, adaptation to changes in
the external environment is important for all firms (especially first movers) but is often a
very difficult task to conduct in practice.
Customers’ Uncertainty and First-Mover (Dis)Advantages
Whether introducing a new product into an established market or an established product
into a new market, the entry involves an element of newness. Embedded in this newness is
76 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
technological uncertainty
Considerable difficulty
in accurately assessing
whether the technology
will perform and whether
alternate technologies
will emerge and leapfrog
over current technologies
C H A P T E R 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES 77
uncertainty for customers. They may be uncertain about how to use the product and
whether it will perform as expected. Even if it does perform, they may wonder to what
extent its performance provides benefits over and above the products that are currently be-
ing used. Customers, like most people, are uncertainty averse, which means that even if the
potential benefits of the new product are superior to existing products, customers may still
not switch from the old to the new because of the uncertainties described earlier. Therefore,
offering a superior product is not sufficient to enable a first mover to make sales; the entre-
preneur must also reduce customer uncertainties.
To do this, the entrepreneur can offer informational advertising that, for example, pro-
vides customers with information about how the product performs and articulates the
product’s benefits. The entrepreneur may even use comparison marketing to highlight
how the product’s benefits outweigh those of substitute products. If this approach works,
customers will be more likely to switch to the firm’s product. The “home shopping”
channels on television provide numerous examples of this informational advertising. For
example, an advertisement describes a set of plastic bags into which clothes (or other
things) may be inserted, and the air within the bags evacuated (using a vacuum cleaner),
which substantially reduces the volume of the clothes and allows more to be packed into
a suitcase (so much so that the weight of the case exceeds one’s ability to lift it, as I
learned by experience).
However, providing customers with information on the performance of a new product
does not always work. When the new product is highly innovative, as are the products that
create a new market, the customers may lack a frame of reference for processing this in-
formation.14 For example, products developed for the purpose of national defense and for
other high-technology government purposes may provide an opportunity for new entry but
require that customers be given a context for understanding their application. Teflon, de-
veloped for use in construction of the space shuttle, required customers to develop a new
frame of reference before they could understand how it performed as a nonstick surface in
frying pans and the benefits to them from this surface.15 Therefore, entrepreneurs may be
faced with the challenging task of creating a frame of reference within the potential cus-
tomers before providing informational advertising.
Potential customers’ uncertainty may also stem from the broader context in which the
product is to be used. For example, even if the potential customers understand how the prod-
uct performs, they are unlikely to purchase a product until they are convinced that the product
is consistent with enabling products, systems, and knowledge. For example, a customer
may know that a new software package provides more powerful spreadsheet functions and
at a lower price but will remain reluctant to purchase the new product until she or he knows
how long it will take to learn how to use the new software. In this circumstance, the entre-
preneur can educate customers through demonstration and documentation on how to use
the product. This could include an extensive tutorial as part of the software package as well
as a free “help line.”
Those that decide to enter later face a market that is more mature and one in which cus-
tomers’ uncertainties have already been substantially reduced by those who pioneered
the market. In essence, by delaying entry into a market that requires considerable educa-
tion, the entrepreneur may be able to receive a free ride on the investments made by the first
movers.
However, it still may pay to be a first mover in this type of market if the educational
effort can be used for the firm’s advantage rather than to the advantage of the industry as a
whole. For example, education may direct customer preferences in ways that will give the
firm an advantage over potential customers (e.g., it may create an industry standard around
the firm’s products); it might enable the entrepreneur to build a reputation as “founder,”
uncertainty for
customers Customers
may have considerable
difficulty in accurately
assessing whether the
new product or service
provides value for them
78
E T H I C S
SMART ENTREPRENEURS ARE DOING
WELL BY DOING GOOD
Charlie Wilson is trying to run an ethical business.
He’s made social responsibility part of the mission
statement at his $1.6 million Houston-based salvage
company, SeaRail International Inc. And he’s made
“self-actualization”—not wealth—his ultimate goal
as an entrepreneur.
But don’t mistake Wilson for some moralistic stick-
in-the-mud. It’s all about success. “Ethics is what’s
spearheading our growth,” says Wilson. “It creates
an element of trust, familiarity and predictability in
the business. We’re in an industry where a lot of peo-
ple cut corners. I just don’t think that’s good for busi-
ness. You don’t get a good reputation doing things
that way. And eventually, customers don’t want to do
business with you.”
For years, ethics and business had a rocky mar-
riage. Ask entrepreneurs to talk about ethics, and the
responses ranged from scorn to ridicule. Here are
folks who—by definition—like breaking the rules.
Suggesting that entrepreneurs should follow a pre-
defined set of edicts was about as popular as asking
them to swear off electricity. But this may be changing.
Whether people are hung over from the freewheeling
’80s or reflective about the coming millennium, talk
about values, integrity, and responsibility is not
only becoming acceptable in the business commu-
nity, it’s almost required.
“This looks just like the quality movement of
20 years ago,” says Frank Walker, chairman of
Indianapolis-based Walker Information Inc., a research
and consulting company that tracks customer satis-
faction and business ethics. “Customers need a way
to differentiate one firm from another.” For years,
the dominant point of differentiation has been
quality. Now, says Walker, “Everyone can deliver
quality, [so businesses] need to step up to a higher
plane.”
Are the nation’s entrepreneurs ready to ascend to
new heights of ethical literacy and compliance? Well,
sort of. Although most entrepreneurs still aren’t try-
ing to unseat the likes of Socrates and Plato, many
are giving considerable thought to improving their
ethics, with hopes that doing good business will be
good for business as well.
Source: Reprinted with permission of Entrepreneur Media, Inc., “Do the Right Thing,” by Gayle Sato Stodder, August 1998, Entrepreneur magazine: www.entrepreneur.com.
DO THE RIGHT THING
encouraging customer loyalty; and it could benefit the company through the erection of
other barriers to entry and imitation. We now explore the role of barriers to entry and imi-
tation in influencing the performance of an entrepreneur’s entry strategy.
Lead Time and First-Mover (Dis)Advantages
Being first to market might provide some initial advantages, but unless the entrepreneur
can stop or retard potential competitors from entering the industry and offering similar
products, the initial advantage will be quickly eroded, diminishing firm performance.
Entry barriers provide the first mover (and nobody else) with the opportunity to operate in
the industry for a grace period under conditions of limited competition (although the firm
must still battle for customers with firms that offer substitute products). This grace period
represents the first mover’s lead time.
The lead time gives the entrepreneur a period of limited competition to best prepare the
firm for when competition does increase. This preparation could involve a concerted effort
to influence the direction in which the market develops to the advantage of the first mover.
For example, during the lead time the entrepreneur can use marketing to define quality in
the minds of existing and potential customers—a definition of quality that is highly con-
sistent with the entrepreneur’s products.
lead time The grace
period in which the first
mover operates in the
industry under conditions
of limited competition
Lead time can be extended if the first mover can erect barriers to entry. Important
barriers to entry are derived from relationships with key stakeholders, which may dissuade
entry by (potential) competitors. This can be done by:
Building customer loyalties. First movers need to establish their firms and their
products in the minds of their customers and thus build customer loyalty. Such
customer loyalty will make it more difficult and more costly for competitors
to enter the market and take the first mover’s customers. Loyalty is sometimes
established when customers associate the industry with the first mover. For
example, Japanese beer drinkers associated “super-dry beer” with the pioneer of
a new form of beer, Asahi. This customer loyalty made it more difficult for others,
including the dominant beer producer (Kirin), to enter the super-dry market and
gain market share.
Building switching costs. First movers need to develop switching costs in an effort
to lock in existing customers. This is a mechanism by which customer loyalty is
enhanced. Reward programs, such as frequent flyer points with a particular airline,
establish for the customer a financial and/or emotional attachment to the first mover,
which makes it costly for the customer to switch to a competitor.
Protecting product uniqueness. If the uniqueness of the product is a source of advantage
over potential competitors, then first movers need to take actions to maintain that
uniqueness. Intellectual property protection can take the form of patents, copyrights,
trademarks, and trade secrets (detailed in Chapter 6).
Securing access to important sources of supply and distribution. First movers that
are able to develop exclusive relationships with key sources of supply and/or key
distribution channels will force potential entrants to use less attractive alternatives
or even to develop their own. For example, Commercial Marine Products was the
first to find an infestation of a special kind of seaweed in Tasmania, Australia.
This seaweed is called wakame and is a staple food for Japanese and Koreans.
Commerical Marine Products was able to obtain an exclusive license to manage
and harvest this area of the Tasmanian coast, the only known location in Australia
(and possibly the Southern Hemisphere) where wakame was growing. Being
first meant that Commercial Marine Products was able to secure the only source
of supply.
These barriers to entry can reduce the amount of competition faced by the first mover.
Because competition typically puts downward pressure on prices and may increase mar-
keting costs, it usually results in reduced profit margins and a drop in overall profitability.
However, competition is not always bad; sometimes it can enhance the firm’s perform-
ance. Competition within an industry can have a positive effect on industry growth. For
example, competition among firms encourages them to become efficient and innovative to
create even more value in their products for customers. Increases in customer value
(whether from increases in product quality, lower prices, or both) will mean that more cus-
tomers will enter the new market. New customers might be added by entering interna-
tional markets.
Therefore, first movers need to keep in mind that they might win the battle by lowering
the level of potential competition within an industry through the creation of barriers to
entry but lose the war because insufficient customers are willing to substitute into the new
industry. Under these conditions the first mover should consider allowing a number of com-
petitors into the industry to share the pioneering costs and then working together to erect
barriers to subsequent entry by potential competitors.
switching costs The
costs that must be borne
by customers if they are
to stop purchasing from
the current supplier and
begin purchasing from
another
C H A P T E R 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES 79
80
A S S E E N I N ENTREPRENEUR M A G A Z I N E
PROVIDE ADVICE TO AN ENTREPRENEUR ABOUT BEING MORE INNOVATIVE
When Neil Franklin began offering round-the-clock
telephone customer service in 1998, customers loved
it. The offering fit the strategic direction Franklin had
in mind for Dataworkforce, his Dallas-based telecom-
munications-engineer staffing agency, so he invested
in a phone system to route after-hours calls to his 10
employees’ home and mobile phones. Today, Franklin,
38, has nearly 50 employees and continues to explore
ways to improve Dataworkforce’s service. Twenty-
four-hour phone service has stayed, but other trials
have not. One failure was developing individual Web
sites for each customer. “We took it too far and spent
$30,000, then abandoned it,” Franklin recalls. A try at
globally extending the brand by advertising in major
world cities was also dropped. “It worked pretty
well,” Franklin says, “until you added up the cost.”
Franklin’s efforts are similar to an approach called
a “portfolio of initiatives” strategy. The idea, accord-
ing to Lowell Bryan, a principal in McKinsey & Co.,
the New York City consulting firm that developed it,
is to always have a number of efforts under way to
offer new products and services and attack new mar-
kets or otherwise implement strategies, and to ac-
tively manage these experiments so you don’t miss an
opportunity or overcommit to an unproven idea.
The portfolio of initiatives approach addresses a
weakness of conventional business plans—that they
make assumptions about uncertain future develop-
ments, such as market and technological trends,
customer responses, sales, and competitor reactions.
Bryan compares the portfolio of initiatives strategy to
the ship convoys used in World War II to get supplies
across oceans. By assembling groups of military and
transport vessels and sending them in a mutually sup-
portive group, planners could rely on at least some
reaching their destination. In the same way, entre-
preneurs with a portfolio of initiatives can expect
some of them to pan out.
MAKING A PLAN
Three steps define the portfolio of initiatives ap-
proach. First, you search for initiatives in which you
have or can readily acquire a familiarity advantage—
meaning you know more than competitors about
a business. You can gain familiarity advantage using
low-cost pilot programs and experiments or by part-
nering with more knowledgeable allies. Avoid busi-
nesses in which you can’t acquire a familiarity advan-
tage, Bryan says.
After you identify familiarity-advantaged initia-
tives, begin investing in them using a disciplined, dy-
namic management approach. Pay attention to how
initiatives relate to each other. They should be diverse
enough that the failure of one won’t endanger the
others, but should also all fit into your overall strate-
gic direction. Investments, represented by product de-
velopment efforts, pilot programs, market tests, and
the like, should start small and increase only as they
prove themselves. Avoid overinvesting before initia-
tives have proved themselves. The third step is to pull
the plug on initiatives that aren’t working out, and
step up investment in others. A portfolio of initiatives
will work in any size company. Franklin pursues 20 to
30 at any time, knowing 90 percent won’t pan out.
“The main idea is to keep those initiatives running,”
he says. “If you don’t, you’re slowing down.”
ADVICE TO AN ENTREPRENEUR
An entrepreneur who wants his firm to be more in-
novative has read the above article and comes to you
for advice:
1. This whole idea of experimentation seems to
make sense, but all these little failures can add
up, and if there are enough of them, then this
could lead to one big failure—the business going
down the drain. How can I best get the advan-
tages of experimentation in terms of innovation
while also reducing the costs so that I don’t run
the risk of losing my business?
2. My employees, buyers, and suppliers like working
for my company because we have a lot of wins. I
am not sure how they will take it when our com-
pany begins to have a lot more failures (even if
those failures are small)—it is a psychological
thing. How can I handle this trade-off?
3. Even if everyone else accepts it, I am not sure
how I will cope. When projects fail it hits me
pretty hard emotionally. Is it just that I am not cut
out for this type of approach?
Source: Reprinted with permission of Entrepreneur Media, Inc., “Worth a Try. Who Knows What’s Going to Work? So Put as Many Ideas as You Can to the Test,” by Mark Henricks, February 2003, Entrepreneur magazine: www.entrepreneur.com.
RISK REDUCTION STRATEGIES FOR NEW ENTRY EXPLOITATION
A new entry involves considerable risk for the entrepreneur and his or her firm. Risk here
refers to the probability, and magnitude, of downside loss,16 which could result in bank-
ruptcy. The risk of downside loss is partly derived from the entrepreneur’s uncertainties
over market demand, technological development, and the actions of competitors. Strategies
can be used to reduce some or all of these uncertainties and thereby reduce the risk of
downside loss. Two such strategies are market scope and imitation.
Market Scope Strategies
Scope is a choice by the entrepreneur about which customer groups to serve and how to
serve them.17 The choice of market scope ranges from a narrow- to a broad-scope strategy
and depends on the type of risk the entrepreneur believes is more important to reduce.
Narrow-Scope Strategy A narrow-scope strategy offers a small product range to a small number of customer groups to satisfy a particular need. The narrow scope can reduce
the risk that the firm will face competition with larger, more established firms in a number
of ways.
• A narrow-scope strategy focuses the firm on producing customized products, localized business operations, and high levels of product quality. Such outcomes provide the
basis for differentiating the firm from larger competitors who are oriented more toward
mass production and the advantages that are derived from that volume. A narrow-scope
strategy of product differentiation reduces competition with the larger established
firms and allows the entrepreneur to charge premium prices.
• By focusing on a specific group of customers, the entrepreneur can build up specialized expertise and knowledge that provide an advantage over companies that
are competing more broadly. For instance, the entrepreneur pursuing a narrow-scope
strategy is in the best position to offer superior product quality, given his or her
intimate knowledge of the product attributes customers desire most.
• The high end of the market typically represents a highly profitable niche that is well suited to those firms that can produce customized products, localized business
operations, and high levels of product quality. From the first point listed, we know that
firms pursuing a narrow-scope strategy are more likely to offer products and services
with these attributes than are larger firms that are more interested in volume.
However, a narrow-scope strategy does not always provide protection against competi-
tion. For example, the firm may offer a product that the entrepreneur believes is of superior
quality, yet customers may not value the so-called product improvements or, if they do per-
ceive those improvements, they may be unwilling to pay a premium price for them, prefer-
ring to stick with the products currently being offered by the larger firms. That is, the
boundary between the market segment being targeted by the entrepreneur and that of the
mass market is not sufficiently clear and thus provides little protection against competition.
Furthermore, if the market niche is attractive, there is an incentive for the larger and
more established firms (and all firms) to develop products and operations targeted at this
niche. For example, a larger, more mass market–oriented firm might create a subsidiary to
compete in this attractive market segment.
Although a narrow-scope strategy can sometimes reduce the risks associated with
competition, this scope strategy is vulnerable to another type of risk: the risk that market de-
mand does not materialize as expected and/or changes over time. For example, a narrow-scope
risk The probability,
and magnitude, of
downside loss
scope A choice about
which customer groups
to serve and how to serve
them
C H A P T E R 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES 81
strategy focuses on a single customer group (or a small number of customer groups), but if the
market changes and decreases substantially the size and attractiveness of that market segment,
then the firm runs a considerable risk of downside loss. Having a narrow-scope strategy is like
putting all your eggs in one basket. If that basket is fundamentally flawed, then all the eggs
will be dropped and broken. A broad-scope strategy, on the other hand, provides a way of
managing demand uncertainty and thereby reducing an aspect of the entrepreneur’s risk.
Broad-Scope Strategy A broad-scope strategy can be thought of as taking a “portfolio” approach to dealing with uncertainties about the attractiveness of different market seg-
ments. By offering a range of products across many different market segments, the entre-
preneur can gain an understanding of the whole market by determining which products are
the most profitable. Unsuccessful products (and market segments) can then be dropped and
resources concentrated on those product markets that show the greatest promise. In
essence, the entrepreneur can cope with market uncertainty by using a broad-scope strategy
to learn about the market through a process of trial and error.18
The entrepreneur’s ultimate strategy will emerge as a result of the information provided
by this learning process. In contrast, a narrow-scope strategy requires the entrepreneur to
have sufficient certainty about the market that he is willing to focus his resources on a small
piece of the market, with few options to fall back on if the initial assessment about the
product proves incorrect. Offering a range of products across a range of market segments
means that a broad-scope strategy is opening the firm up to many different “fronts” of com-
petition. The entrepreneur may need to compete with the more specialized firms within nar-
row market niches and simultaneously with volume producers in the mass market.
Therefore, a narrow-scope strategy offers a way of reducing some competition-related
risks but increases the risks associated with market uncertainties. In contrast, a broad-scope
strategy offers a way of reducing risks associated with market uncertainties but faces in-
creased exposure to competition. The entrepreneur needs to choose the scope strategy that
reduces the risk of greatest concern. For example, if the new entry is into an established
market, then competitors are well entrenched and ready to defend their market shares. Also
the market demand is more stable and market research can inform the entrepreneur on the
attractiveness of the new product with a particular group of customers. In this situation,
where the risk of competition is great and market uncertainties are minimal, a narrow-scope
strategy is more effective at risk reduction.
However, if new entry involves the creation of a new market or entry into an emerging
market, then competitors are more concerned with satisfying new customers entering the
market than on stealing market share from others or retaliating against new entrants. Also
there is typically considerable market uncertainty about which products are going to be
winners and which are going to be losers. In this situation, a broad-scope strategy reduces
the major risk, namely, risks associated with uncertainties over customer preferences.
Imitation Strategies
Why Do It? Imitation is another strategy for minimizing the risk of downside loss asso- ciated with new entry. Imitation involves copying the practices of other firms, whether
those other firms are in the industry being entered or from related industries. This idea of
using imitation strategies to improve firm performance at first appears inconsistent with the
argument at the start of the chapter that superior performance arises from the qualities of
being valuable, rare, and inimitable. An imitation strategy cannot be rare or inimitable.
Although this may be true, an imitation strategy can still enhance firm performance be-
cause a successful new entry does not need to be valuable, rare, and inimitable in terms of
82 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
imitation strategies
Copying the practices of
other firms
every aspect of the firm’s operations. Rather, imitation of others’ practices that are periph-
eral to the competitive advantage of the firm offers a number of advantages.
Entrepreneurs may simply find it easier to imitate the practices of a successful firm than
to go through the process of a systematic and expensive search that still requires a decision
based on imperfect information.19 In essence, imitation represents a substitute for individ-
ual learning and is well illustrated by the following quote from the president of Rexhaul
Industries (a firm that sells cheaper recreational vehicles than its competitors): “In this
industry, we call it R&C: research and copy.”20
Imitating some of the practices of established successful firms can help the entrepreneur de-
velop the skills necessary to be successful in the industry, rather than attempting to work out
which skills are required and develop these skills from scratch. This use of imitation allows the
entrepreneur to quickly acquire the skills that will be rewarded by the industry without neces-
sarily having to go through the process of first determining what those key success factors
actually are. It is a mechanism that allows the entrepreneur to skip a step in the stages of solv-
ing a puzzle (or at least to delay the need, and the importance, of solving that particular step).
Imitation also provides organizational legitimacy. If the entrepreneur acts like a well-
established firm, it is likely to be perceived by customers as well established. Imitation is a
means of gaining status and prestige. Customers feel more comfortable doing business with
firms that they perceive to be established and prestigious. This is particularly the case for
service firms. For example, a new consulting firm will need to go out of its way to look like
an established prestigious firm, even though some of its trappings (e.g., a prime location of-
fice, leather chairs and couches, and a well-tailored suit) put a strain on resources and are
only incidental to the quality of the service.
Types of Imitation Strategies Franchising is an example of a new entry that focuses on imitation to reduce the risk of downside loss for the franchisee. A franchisee acquires
the use of a “proven formula” for new entry from a franchisor. For example, an entrepre-
neur might enter the fast food industry by franchising a McDonald’s store in a new geo-
graphic location. This entrepreneur is imitating the business practices of other McDonald’s
stores (in fact, imitation is mandatory) and benefits from an established market demand; an
intellectual property–protected name and products; and access to knowledge of financial,
marketing, and managerial issues.
This new entry is unique because it is the only McDonald’s store in a dedicated geo-
graphical area (although it must compete with Burger King, KFC, etc.) More broadly, this
McDonald’s store is differentiated from potential competitors in the same geographic
space. Much of the risk of new entry for the entrepreneur has been reduced through this im-
itation strategy (Chapter 14 discusses franchising in more detail).
Franchising is not the only imitation strategy. Some entrepreneurs will attempt to copy
successful businesses. For example, new entry can involve copying products that already
exist and attempting to build an advantage through minor variations. This form of imitation
is often referred to as a “me-too” strategy. In other words, the successful firm occupies a
prime position in the minds of customers, and now the imitator is there too and hopes to be
considered by the customers. Variation often takes the form of making minor changes to the
launch product being offered, taking an existing product or service (which is unprotected
by intellectual property rights) to a new market not currently served, or delivering the product
to customers in a different way.
Ice cream shops are an example of a “me-too” imitation strategy, where new entrants
have imitated successful stores but have also been able to differentiate themselves from
those already in the industry by offering some form of variation. We have seen compet-
ing ice cream shops imitate each other by offering similar shop layouts and locations
C H A P T E R 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES 83
“me-too” strategy
Copying products that
already exist and
attempting to build an
advantage through minor
variations
(e.g., inside malls), the same choice of flavors and cones (e.g., waffle cones), and similar
promotional strategies (such as, “Taste before you buy”). Often the point of variation is sim-
ply the location of the store.
In the ice cream retail industry we have noticed that new entrants are increasingly re-
lying on even greater levels of imitation to provide the necessary competitive advantage—
more and more new entrants are entering into a franchise agreement with Baskin-Robbins,
Häagen-Dazs, or other international franchisors. These franchisors have introduced a
national or global brand name and reputation (previously only regional), standardized
operating procedures, interstore communication, and economies of scale in marketing.21
However, a “me-too” imitation strategy might be more difficult to successfully imple-
ment than first expected. The success of the firm being copied may depend on its underly-
ing organizational knowledge and corporate culture. Peripheral activities may not produce
the desired outcomes when used in a different organizational context. Furthermore, entre-
preneurs are often legally prevented from other avenues of imitation, such as the use of reg-
istered trademarks and brand names.
Overall, an imitation strategy can potentially reduce the entrepreneur’s costs associated
with research and development, reduce customer uncertainty over the firm, and make the
new entry look legitimate from day one. In pursuing an imitation strategy for new entry, the
entrepreneur should focus on imitating those elements of the business that are not central
to the firm’s competitive advantage. These central aspects of advantage must be valuable,
rare, and inimitable for the firm to achieve high performance over an extended period of time.
Managing Newness
New entry can occur through the creation of a new organization. The creation of a new
organization offers some challenges not faced by entrepreneurs who manage established
firms. These liabilities of newness arise from the following unique conditions.
• New organizations face costs in learning new tasks. It may take some time and training to customize employees’ skills to the new tasks they are asked to perform.
• As people are assigned to the roles of the new organization, there will be some overlap or gaps in responsibilities. This will often cause conflict until the boundaries around
particular roles are more formally set (once management has gained sufficient
knowledge to do so) and/or until they have been informally negotiated by the parties to
the conflict.
• Communication within the organization occurs through both formal and informal channels. A new organization has not yet had the opportunity to develop informal
structures, such as friendships and organizational culture. It takes time for a new firm
to establish these informal structures.
Managing a new firm requires special attention to educating and training employees so
that their knowledge and skills will develop quickly to meet the needs of their tasks, to fa-
cilitate conflicts over roles, and to foster social activities that will in turn quickly foster in-
formal relationships and a functional corporate culture. If these liabilities of newness can
be overcome, then the entrepreneur can benefit from some assets of newness. These assets
acknowledge the advantages that a new organization has over a mature one, particularly in
environments that are changing.
Although mature organizations have established routines, systems, and processes that
increase the efficiency of their operations, these routines, systems, and processes can be a
liability when there is a need for those firms to adapt to changes in their environment. Pre-
vious practices create a momentum along the same path, and redirection is difficult. Mature
84 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
liabilities of newness
Negative implications
arising from an
organization’s newness
assets of newness
Positive implications
arising from an
organization’s newness
firms also find it difficult to attain new knowledge because their thoughts are narrowed by
what has been done in the past and what they are good at rather than by the external envi-
ronment and what is needed.
In contrast, new firms find that their lack of established routines, systems, and processes
means that they have a clean slate, which gives them learning advantages over older firms.22
They do not need to unlearn old knowledge and old habits to learn new knowledge and create
the new routines, systems, and processes that are more attuned with the changed environment.
A heightened ability to learn new knowledge represents an important source of compet-
itive advantage that needs to be fostered by the entrepreneur. It is particularly advantageous
in a continuously changing environment because the firm needs to incrementally build its
strategy as it learns information while acting. Previous strategic planning will not be suc-
cessful in such environments because the development of such an environment is not know-
able in advance (unless the entrepreneur is extremely lucky).
Therefore, although entrepreneurs must be aware of, and manage, liabilities of newness,
it is not all doom and gloom. Rather, new ventures have an important strategic advantage
over their mature competitors, particularly in dynamic, changing environments. Entrepre-
neurs need to capitalize on these assets of newness by creating a learning organization that
is flexible and able to accommodate this new knowledge in its future actions. This shifts the
emphasis in understanding firm performance from a heavy reliance on strategic plans to
greater emphasis on the strategic learning and flexibility of the entrepreneur and his or her
management team.
C H A P T E R 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES 85
IN REVIEW
S U M M A R Y
One of the essential acts of entrepreneurship is new entry—entry based on a new
product, a new market, and/or a new organization. Entrepreneurial strategies repre-
sent the set of decisions, actions, and reactions that first generate, and then exploit
over time, a new entry in a way that maximizes the benefits of newness and minimizes
its costs. The creation of resource bundles is the basis for new entry opportunities. A re-
source bundle is created from the entrepreneur’s market knowledge, technological
knowledge, and other resources. The new entry has the potential of being a source of
sustained superior firm performance if the resource bundle underlying the new entry
is valuable, rare, and difficult for others to imitate. Therefore, those wishing to gener-
ate an innovation need to look to the unique experiences and knowledge within
themselves and their team.
Having created a new resource combination, the entrepreneur needs to determine
whether it is in fact valuable, rare, and inimitable by assessing whether this new prod-
uct and/or new market is sufficiently attractive to be worth exploiting and then acting
on that decision. The decision to exploit or not to exploit the new entry opportunity
depends on whether the entrepreneur has what she or he believes to be sufficient in-
formation to make a decision and on whether the window is still open for this new en-
try opportunity. The entrepreneur’s determination of sufficient information depends
on the stock of information and the entrepreneur’s level of comfort in making such a
decision without perfect information.
Successful new entry requires that the entrepreneur’s firm have an advantage over
competitors. Entrepreneurs often claim that their competitive advantage arises from
being first to market. Being first can result in a number of advantages that can enhance
performance, such as cost advantages, reduced competition, securing important sources
of supply and distribution, obtaining a prime position in the market, and gaining ex-
pertise through early participation. But first movers do not always prosper, and in fact
there are conditions that can push a first mover toward performance disadvantages,
such as high instability of the environment surrounding the entry, a lack of ability among
the management team to educate customers, and a lack of ability among the man-
agement team to erect barriers to entry and imitation to extend the firm’s lead time.
A new entry involves considerable risk for the entrepreneur and his or her firm. This
risk of downside loss is partly derived from the entrepreneur’s uncertainties over market
demand, technological development, and the actions of competitors. Strategies can be
used to reduce some or all of these uncertainties and thereby reduce the risk of down-
side loss. Two such strategies are market scope and imitation. Scope is a choice by the en-
trepreneur about which customer groups to serve and how to serve them—for example,
the choice between a narrow and a broad scope. Imitation involves copying the prac-
tices of other firms, whether those other firms are in the industry being entered or in
related industries; for instance, “me too” and franchising are both imitation strategies.
Entrepreneurship also can involve the creation of a new organization. The creation
of a new organization offers some challenges for entrepreneurs that are not faced by
those who manage established firms. These challenges, referred to as liabilities of new-
ness, reflect a new organization’s higher costs of learning new tasks, increased conflict
over newly created roles and responsibilities, and the lack of a well-developed infor-
mal communication network. However, new organizations also may have some assets
of newness, the most important of which is an increased ability to learn new knowl-
edge, which can provide an important strategic advantage over mature competitors,
particularly in dynamic, changing environments.
R E S E A R C H T A S K S
1. Choose three major inventions that have led to successful products. Who were the
inventors? How did they invent the technology? Why do you believe they were
the first to invent this technology?
2. Find three examples of firms that pioneered a new product in a new market and
were able to achieve long-run success based on that entry. Find three examples of
firms that were not the pioneers but entered later to eventually overtake the
pioneer as market leader. In your opinion, why were the successful pioneers
successful, and why were the unsuccessful ones unsuccessful?
3. What is the failure rate of all new businesses? What is the failure rate of all new
franchises? What inferences can you make from these numbers?
C L A S S D I S C U S S I O N
1. Come up with five examples of firms that have used imitation as a way of
reducing the risk of entry. What aspects of risk was imitation meant to reduce?
Was it successful? What aspects of the firm were not generated by imitation, made
the firm unique, and were a potential source of advantage over competitors?
2. Provide two examples of firms with a broad scope, two with a narrow scope, and
two that started narrow and became broader over time.
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86 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
3. Is it a waste of time to detail the firm’s strategy in the business plan when the
audience for that plan (e.g., venture capitalists) knows that things are not going
to turn out as expected and, as a result, places considerable importance on the
quality of the management team? Why not submit only the resumes of those in
the management team? If you were a venture capitalist, would you want to see
the business plan? How would you assess the quality of one management team
relative to another?
S E L E C T E D R E A D I N G S
Ardichvili, Alexander; Richard Cardozo; and Sourav Ray. (2003). A Theory of Entrepre- neurial Opportunity Identification and Development. Journal of Business Venturing, vol. 18, no. 1, pp. 105–24.
This paper proposes a theory of the opportunity identification process. It identifies the entrepreneur’s personality traits, social networks, and prior knowledge as antecedents of entrepreneurial alertness to business opportunities. Entrepreneurial alertness, in its turn, is a necessary condition for the success of the opportunity identification triad: recognition, development, and evaluation. A theoretical model, laws of inter- action, a set of propositions, and suggestions for further research are provided.
Barney, Jay B. (2001). Resource-Based “Theories” of Competitive Advantage: A Ten- Year Retrospective on the Resource-Based View. Journal of Management, vol. 27, no. 6, pp. 643–751.
The resource-based view is discussed in terms of its positioning relative to three theoretical traditions: SCP-based theories of industry determinants of firm perform- ance, neoclassical microeconomics, and evolutionary economics. It also discusses some of the empirical implications of each of these different resource-based theories.
Boulding, William; and Christen Markus. (2008). Disentangling Pioneering Cost Advan- tages and Disadvantages. Marketing Science, vol. 27, pp. 699–716.
In this paper, the authors empirically test three different sources of long-term pioneering cost advantage—experience curve effects, preemption of input factors, and preemption of ideal market space—and three different sources of pioneering cost disadvantage—imitation, vintage effects, and demand orientation. The complex- ity of their findings suggests that managers need to think carefully about their par- ticular conditions before making assumptions about the cost and, therefore, profit implications of a pioneering strategy.
Bruton, Gary D.; and Yuri Rubanik. (2002). Resources of the Firm, Russian High- Technology Startups, and Firm Growth. Journal of Business Venturing, vol. 17, no. 6, pp. 553–77.
This study investigates the extent to which founding factors in Russia help high- technology firms to prosper. It was found that the team establishing the business mitigated the liability of newness. However, in contrast to the culture of the United States, the culture of Russia does not produce negative results if the founding team grows very large. Additionally, it was shown that firms that pursued more techno- logical products and entered the market later performed best.
Erikson, Truls. (2002). Entrepreneurial Capital: The Emerging Venture’s Most Impor- tant Asset and Competitive Advantage. Journal of Business Venturing, vol. 17, no. 3, pp. 275–91.
This study presents a parsimonious model of entrepreneurial capital, defined as a multiplicative function of entrepreneurial competence and entrepreneurial commitment. The presence of both entrepreneurial competence and commitment
C H A P T E R 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES 87
lays the foundation for enterprise generation and performance. Inherent in this view on competence is the capacity to identify opportunities.
Fiol, C. Marlene; and Edward J. O’Connor. (2003). Waking Up! Mindfulness in the Face of Bandwagons. Academy of Management Review, vol. 28, no. 1, pp. 54–71.
This article models the interactions between mindfulness as a decision-maker char- acteristic and the decision-making context, and shows the impact of those interac- tions on managers’ ability to discriminate in the face of bandwagons. The authors illustrate the framework by applying it to recent integration and disintegration bandwagon behaviors in the U.S. health care market.
Haynie, J. Michael; Dean A. Shepherd; and Jeffery S. McMullen. (2009). An Opportunity for Me? The Role of Resources in Opportunity Evaluation Decisions. Journal of Man- agement Studies, vol. 46, no. 3, pp. 337–61.
The authors apply the prescriptions of the resource-based perspective to develop a model of entrepreneurial opportunity evaluation. They propose that opportunity evaluation decision policies are constructed as future-oriented, cognitive represen- tations of “what will be,” assuming one were to exploit the opportunity under eval- uation. Their findings suggest that entrepreneurs are attracted to opportunities that are complementary to their existing knowledge resources; however, we also identify a set of opportunity-specific and firm-specific conditions that encourage en- trepreneurs to pursue the acquisition and control of resources that are inconsistent with the existing, knowledge-based resources of the venture.
Keh, Hean T.; Maw Der Foo; and Boon C. Lim. (2002). Opportunity Evaluation under Risky Conditions: The Cognitive Processes of Entrepreneurs. Entrepreneurship: Theory & Practice, vol. 27, no. 2, pp. 125–49.
This study uses a cognitive approach to examine opportunity evaluation. It finds that illusion of control and belief in the law of small numbers are related to how en- trepreneurs evaluate opportunities. The results also indicate that risk perception mediates opportunity evaluation.
Lévesque, Moren; and Dean A. Shepherd. (2004). Entrepreneurs’ Choice of Entry Strat- egy in Emerging and Developed Markets. Journal of Business Venturing, vol. 19, no. 1, pp. 29–45.
From speculations over the differences between emerging and developed economies, the model offers a systematic way to determine the optimal entry strategy in terms of entry timing and level of mimicry. An implication of the model is that the cost/benefit ratio of using a high-mimicry entry strategy is lower for companies en- tering emerging economies than it is for companies entering developed economies.
Lichtenstein, Benyamin; G. Thomas Lumpkin; and Rodney Shrader. (2003). A Theory of Entrepreneurial Action. In J. Katz and D. A. Shepherd (eds.), Advances in Entrepre- neurship: Firm Emergence and Growth (vol. 6). (Greenwich, CT: JAI Press).
This chapter categorizes the organizational learning literature into behavioral, cog- nitive, and action learning and suggests a number of ways in which new ventures could be more successful at learning than larger and older organizations. It also ex- plores three entrepreneurial contexts in which learning might be particularly im- portant and matches them to the categories of learning.
Lieberman, Marvin B.; and David B. Montgomery. (1998). First-Mover (Dis)advantages: Retrospective and Link with the Resource-Based View. Strategic Management Journal, vol. 19, no. 12, pp. 1111–26.
This article suggests that the resource-based view and first-mover advantage are re- lated conceptual strategic planning frameworks that can benefit from closer link- age. It presents an evolution of the literature based on these concepts.
88 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
McEvily, Susan K.; and Bala Chakravarthy. (2002). The Persistence of Knowledge-Based Advantage: An Empirical Test for Product Performance and Technological Knowledge. Strategic Management Journal, vol. 23, no. 4, pp. 285–306.
The authors find that the complexity and tacitness of technological knowledge are useful for defending a firm’s major product improvements from imitation, but not for protecting its minor improvements. The design specificity of technological knowledge delayed imitation of minor improvements in this study.
Robinson, William T.; and Sungwook Min. (2002). Is the First to Market the First to Fail? Empirical Evidence for Industrial Goods Businesses. Journal of Marketing Research, vol. 39, no. 1, pp. 120–29.
The main conclusion of this study is that the pioneer’s temporary monopoly over the early followers plus its first-mover advantages typically offset the survival risks associated with market and technological uncertainties. These results are consistent with previous research in the sense that first-mover advantages that increase a pioneer’s market share also help protect the pioneer from outright failure.
Teplensky, Jill D.; John R. Kimberly; Alan L. Hillman; and J. Stanford Schwartz. (1993). Scope, Timing and Strategic Adjustment in Emerging Markets: Manufacturer Strategies and the Case of MRI. Strategic Management Journal, vol. 14, pp. 505–27.
This study examines the realized strategies of domestic manufacturers in a growing, high-technological industrial market in the United States. It offers a typology of en- try strategies focusing on issues of timing and scope and on the impact that these entry strategies have on a firm’s performance.
Ucbasaran, Deniz; Mike Wright; Paul Westhead; and Lowell W. Busenitz. (2003). The Impact of Entrepreneurial Experience on Opportunity Identification and Exploita- tion: Habitual and Novice Entrepreneurs. In J. Katz and D. A. Shepherd (eds.), Ad- vances in Entrepreneurship: Firm Emergence and Growth (vol. 6). (Greenwich, CT: JAI Press).
This paper synthesizes human capital and cognitive perspectives to highlight be- havioral differences between habitual and novice entrepreneurs. Issues related to opportunity identification and information search as well as opportunity exploita- tion and learning are discussed.
Watson, Warren; Wayne Stewart, Jr.; and Anat BarNir. (2003). The Effects of Human Capital, Organizational Demography, and Interpersonal Processes on Venture Partner Perceptions of Firm Profit and Growth. Journal of Business Venturing, vol. 18, no. 2, pp. 145–65.
This study examines the effects of human capital, organizational demography, and interpersonal processes on partner evaluations of venture performance, de- fined as the presence of profit and growth. The results support this approach in analyzing venture teams, and it is proposed that this perspective be included in future venture viability assessment and used for intervention to enhance venture success.
Zahra, Shaker A.; Donald O. Neubaum; and Galal M. El–Hagrassey. (2002). Competitive Analysis and New Venture Performance: Understanding the Impact of Strategic Uncer- tainty and Venture Origin. Entrepreneurship: Theory & Practice, vol. 27, no. 1, pp. 1–29.
Using survey data from 228 new ventures, this study concludes that the formality, comprehensiveness, and user orientation of competitor analysis activities are posi- tively associated with new venture performance. Strategic uncertainty and venture origin also significantly moderate the relationship between competitive analysis and new venture performance.
C H A P T E R 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES 89
E N D N O T E S
1. G. Lumpkin and G. G. Dess, “Clarifying the Entrepreneurial Orientation Con- struct and Linking It to Performance,” Academy of Management Review 21, no. 1 (1996), pp. 135–72.
2. F. H. Knight, Risk, Uncertainty and Profit (New York: Houghton Mifflin, 1921); E. M. Olson, O. C. Walker, Jr., and R. W. Ruekert, “Organizing for Effective New Product Development: The Moderating Role of Product Innovativeness,” Journal of Marketing 59 (January 1995), pp. 48–62; H. J. Sapienza and A. K. Gupta, “Impact of Agency Risks and Task Uncertainty on Venture Capitalist- Entrepreneur Relations,” Academy of Management Journal 37 (1994), pp. 1618–32.
3. J. B. Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management 17 (1991), pp. 99–120.
4. This list is adapted from M. A. Hitt, R. D. Ireland, and R. E. Hoskisson, Strategic Management: Competitiveness and Globalization, 3rd ed. (London: South- Western Publishing Co., 1999).
5. S. P. Schnaars, Managing Imitation Strategies: How Later Entrants Seize Markets from Pioneers (New York: Free Press, 1994).
6. Nathan Rosenberg, “Trying to Predict the Impact of Tomorrow’s Inventions,” USA Today 123 (May 1995), pp. 88ff.
7. Ibid. 8. J. McMullen and D. A. Shepherd, “A Theory of Entrepreneurial Action,” in J. Katz
and D. A. Shepherd (eds.), Advances in Entrepreneurship: Firm Emergence and Growth (vol. 6) (Greenwich, CT: JAI Press, 2003), pp. 203–48.
9. D. A. Shepherd and M. Shanley, New Venture Strategy: Timing, Environmental Uncertainty and Performance (Newburg Park, CA: The Sage Series in Entrepre- neurship and the Management of Enterprises, 1998).
10. M. B. Lieberman and D. B. Montgomery, “First Mover Advantages,” Strategic Management Journal 9 (1988), pp. 127–40.
11. D. F. Abell, “Strategic Windows,” Journal of Marketing 42, no. 3 (1978), pp. 21–26.
12. D. A. Aaker and G. S. Day, “The Perils of High Growth Markets,” Strategic Management Journal 7 (1986), pp. 409–21; Shepherd and Shanley, New Venture Strategy.
13. Shepherd and Shanley, New Venture Strategy. 14. S. F. Slater, “Competing in High Velocity Markets,” Industrial Marketing
Management 24, no. 4 (1993), pp. 255–68. 15. Shepherd and Shanley, New Venture Strategy. 16. T. W. Ruefli, J. M. Collins, and J. R. LaCugna, “Risk Measures in Strategic
Management Research: Auld Lang Syne?” Strategic Management Journal 20 (1999), pp. 167–94.
17. J. D. Teplensky, J. R. Kimberly, A. L. Hillman, and J. S. Schwartz, “Scope, Timing and Strategic Adjustment in Emerging Markets: Manufacturer Strategies and the Case of MRI,” Strategic Management Journal 14 (1993), pp. 505–27.
18. Shepherd and Shanley, New Venture Strategy. 19. Ibid. 20. Schnaars, Managing Imitation Strategies. 21. Shepherd and Shanley, New Venture Strategy. 22. B. B. Lichtenstein, G. T. Lumpkin, and R. Shrader, “A Theory of Entrepreneurial
Action,” in J. Katz and D. A. Shepherd (eds.), Advances in Entrepreneurship: Firm Emergence and Growth (vol. 6) (Greenwich, CT: JAI Press, 2003).
90 PA RT 1 THE ENTREPRENEURIAL PERSPECTIVE
2 F R O M I D E A T O T H E O P P O RT U N I T Y
C H A P T E R 4
Creativity and the Business Idea
C H A P T E R 5
Identifying and Analyzing Domestic and International Opportunities
C H A P T E R 6
Protecting the Idea and Other Legal Issues for the Entrepreneur
1
To identify various sources of ideas for new ventures.
2
To discuss methods available for generating new venture ideas.
3
To discuss creativity and the techniques for creative problem solving.
4
To discuss the importance of innovation.
5
To understand an opportunity analysis plan.
6
To discuss the aspects of the product planning and development process.
7
To discuss aspects of e-commerce and starting an e-commerce business.
4 C R E AT I V I T Y A N D T H E B U S I N E S S I D E A
L E A R N I N G O B J E C T I V E S
93
O P E N I N G P R O F I L E
FREDERICK W. SMITH
Who would think that an entrepreneur with a $10 million inheritance would need
more capital to get his company off the ground? The business world is filled with sto-
ries of companies, large and small, that started in a garage with an initial investment
of a few hundred dollars. But none of those companies needed a nationwide distribu-
tion system in place, complete with a fleet of airplanes and
trucks, before accepting its first order. And none of those
garage start-ups grew to be Federal Express.
Frederick W. Smith, a Memphis native whose father
made his fortune by founding a bus company, conceived of the idea for his air-cargo
company while studying economics at Yale University in the 1960s. The professor of one
of Smith’s classes was a staunch supporter of the current system of air freight han-
dling in which a cargo package literally hitched a ride in any unused space on a passen-
ger flight. Fred Smith saw things differently and, in a paper, described the concept of
a freight-only airline that would fly all packages to one central point, where they
would then be distributed and flown out again to their destinations. This operation
could take place at night when the airports were less crowded, and, with proper logis-
tics control, the packages could be delivered the next day. Whether it was the novelty
of the idea, the fact that it went against the professor’s theories, or the fact that it was
written in one night and was turned in late, the first public display of Smith’s grand
idea earned him a C.
Smith’s idea constituted far more than a concept for a creative term paper, however.
He had seen how the technological base of the country was changing. More compa-
nies were becoming involved in the production and use of small, expensive items such
as computers, and Smith was convinced that businesses could use his air-cargo idea to
control their inventory costs. Overnight delivery from a single distribution center to
anywhere in the country could satisfy customers’ needs without a company needing a
duplicate investment in inventory to be stored in regional warehouses. Smith even
thought of the Federal Reserve Bank as a potential customer with the vast quantities
of checks that had to be delivered to all parts of the country every day. But the Vietnam
War and a family history of patriotic service intervened. Smith joined the Marine Corps
and was sent to Vietnam, first as a platoon leader and then as a pilot.
www.fedex.com
After nearly four years of service and 200 ground support missions as a pilot, he left
Vietnam, ready to start building something. He went to work with his stepfather, first
managing and subsequently purchasing a controlling interest in Arkansas Aviation
Sales, a struggling aircraft modification and overhaul shop. Difficulty in getting parts
to the shop in Little Rock, Arkansas, revived his interest in the air-cargo concept. He
commissioned two feasibility studies, both of which returned favorable results based
on a high initial investment. The key to this company would be its ability to serve a
large segment of the business community from the very beginning, and the key to the
required level of service was cash. Full of optimism, Smith went to Chicago and New
York, confident that he would be returning with basket loads of investment checks.
Progress turned out to be slower than Smith had anticipated, but through his bound-
less energy, belief in his idea, and technical knowledge of the air-freight field, he was
finally able to get enthusiastic backing (around $5 million in capital) from New Court
Securities, a Manhattan-based, Rothschild-backed venture-capital investment bank.
This commitment from New Court spurred substantial additional financing. Five other
institutions, including General Dynamics and Citicorp Venture Capital, Ltd., got involved,
and Smith went back to Memphis with $72 million. This was the largest venture-
capital start-up deal in the history of American business.
Federal Express took to the skies on March 12, 1973, to test its service. Servicing an
11-city network (extending from Dallas to Cincinnati), it initially shipped only six pack-
ages. On the night of April 17, the official start-up of Federal Express, the network had
been expanded to include 25 cities (from Rochester, New York, to Miami, Florida), ship-
ping a total of 186 packages. Volume picked up rapidly and service was expanded; it
looked as though Federal Express was a true overnight success. Smith’s understanding
of a market need had been accurate, but he had not counted on OPEC causing a mas-
sive inflation of fuel costs just as his company was getting started. By mid-1974, the
company was losing more than $1 million a month. His investors were not willing to
keep the company going, and his relatives were suing him for mismanaging the family
fortune (nearly $10 million of Smith money had been invested). But Smith never lost
faith in his idea and finally won enough converts in the investment community to keep
the doors open long enough to straighten out the pricing problems caused by OPEC.
After losing $27 million in the first two years, Federal Express turned a profit of
$3.6 million in 1976. The development and growth of Federal Express were tightly regu-
lated. Because of old laws designed to protect the early pioneers of the passenger air-
line industry, Smith was required to obtain approval for operating any aircraft with a
payload in excess of 7,500 pounds. Since the major airlines—at the time, the giants of
the industry—were not ready to share the cargo market, he was not able to obtain this
needed approval and had to operate a fleet of small Falcon jets instead. While this sit-
uation worked well at start-up, by 1977 his operation had reached the capacity of
these smaller planes. Since the company was already flying several jets on the most ac-
tive routes, it did not make sense to buy more Falcons. Smith took his salesmanship to
Washington and, with the help of a grassroots Federal Express employee effort, was
able to obtain legislation creating a new class of all-cargo carriers. This gave Smith the
operating latitude he needed.
94 PA RT 2 FROM IDEA TO THE OPPORTUNITY
Although Smith had the approval to operate large jets, he needed to find a way to
purchase them. The corporate balance sheet of the company was still a mess from early
losses, and the long-suffering early investors needed some reward. Thus, Smith took his
company public on April 12, 1978, raising enough money to purchase used Boeing 727s
from ailing passenger airlines. The investors were indeed richly rewarded, with General
Dynamics watching its $5 million investment grow to more than $40 million by the time
Federal Express was first traded on the New York Stock Exchange in December 1978.
The company continued to perform well since its public offering, combining technical
innovation and an obsession with customer orientation (Federal Express was the first
company to win the Malcolm Baldrige National Quality Award in the service category,
and in 1994 it became the first global express transportation company to receive simul-
taneous worldwide ISO 9001 certification) to ensure exceptional growth.
Since 2002, with sales revenue of $20.6 billion and the company’s first-in-its-history
cash dividend, FedEx has continued to grow. In the fiscal year ending in 2008, the com-
pany had grown to $38 billion in revenues, offering just the right mix of transporta-
tion, e-commerce, and business solutions. FedEx is composed of Federal Express, FedEx
Ground, FedEx Freight, FedEx Kinko’s Office and Print Services, FedEx International Pri-
ority, FedEx International Priority Freight, FedEx SmartPost, FedEx Home Delivery,
FedEx Customer Critical, FedEx Trade Networks, FedEx National LTL, FedEx Supply
Chain Services, and FedEx Services. In 2008, FedEx averaged: (1) more than 7.5 million
shipments a day for express, ground, freight, and expedited delivery services; (2) more
than 290,000 employees and contractors worldwide; and (3) more than 220 countries
and territories, including every address in the United States.
The company has over 18 million Web site visitors monthly and processes more than
5 million tracking requests daily. There are more than 20 million packages shipped via
FedEx Ship Manager monthly and 670 aircrafts serving more than 375 airports world-
wide. FedEx has more than 80,000 motorized vehicles for express, ground, freight, and
expedited delivery service; 725 FedEx World Service Centers; 1,281 FedEx Kinko’s Office
and Print Centers; 6,505 FedEx Authorized ShipCenters; and 44,008 FedEx Drop Boxes
(including 4,979 U.S. Postal Service locations). The firm’s stock price saw a high of $109
in July 2007, up from $62 in July 2003 (though it saw a steep decline during the
2008/2009 recession, seeing a low of $34 in March 2009).
At the heart of Frederick Smith’s success story is the creativity and uniqueness of the ini-
tial business concept. This part of the new venture creation process is perhaps the most
difficult to actualize. What specific features does the new product or service need? A wide
variety of techniques can be used to obtain the new product idea. Smith expressed his
original idea in a paper he wrote to complete a college course. For others—such as Bob
Reis of Final Technology, Inc., and Frank Perdue of Perdue Chickens—the idea came from
work experience. No matter how it occurs, a sound, unique idea for a new product (or
service), properly evaluated, is essential to successfully launching a new venture. Through-
out this evaluation, or opportunity analysis, the entrepreneur must remember that most
ideas do not provide the basis for a new venture; rather, it is important to sift through and
identify those ideas that can provide such a basis so that they can be the entrepreneur’s
focus. A good method for doing this is to look at trends that will occur in the next decade.
C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 95
96 PA RT 2 FROM IDEA TO THE OPPORTUNITY
TRENDS
A trend often provides one of the greatest opportunities for starting a new venture, particu-
larly when the entrepreneur can be at the start of a trend that lasts for a considerable period
of time. Seven trends that will provide opportunities, indicated in Table 4.1, include: green
trend, clean-energy trend, organic-orientation trend, economic trend, social trend, health
trend, and Web trend.
Green Trend
The green sector is brimming with opportunities for entrepreneurs around the world. While
today’s consumers are very conscious about spending, considering the economic condi-
tions, many are still willing to pay more for green products. Water is one aspect of this
green trend that provides opportunities, particularly in the area of irrigation, such as recla-
mation programs for golf courses and parks, smart irrigation systems, and consulting firms
that increase water-use efficiency. Other business areas worth looking at include eco-
friendly printing, recycling, and green janitorial services.
Clean-Energy Trend
One of the most pressing environmental concerns of consumers is global warming with the
resulting opportunities in clean energy. Many feel that the power of the 21st century will
come from solar, wind, and geothermal sources. A significant factor that will accelerate this
movement from coal being the power in the 19th century and oil in the 20th century is
when solar costs are equal to the costs of electricity either from cost reductions and effi-
ciency in solar conversion capacity and/or tax breaks for solar production and use. Smaller
businesses and homeowners are a significant untapped market in this area.
Organic-Orientation Trend
The organic trend is increasing significantly, particularly in the food sector, which has been
accelerated by the shrinking price gap between organic and nonorganic foods. The sales
growth in all organic foods including meat, dairy, fruits, vegetables, breads, and snack
foods averages about 25 percent per year. Total organic nonfood sales are also growing,
particularly in apparel. Oscar and Belle was started in 2007 by Anna Gustafson to provide
organic apparel for babies. The baby clothing, size newborn to 2T, is distributed through
retail outlets and online (oscarandbelle.com).
TABLE 4.1 Trends of the Next Decade
• Green
• Clean energy
• Organic orientation
• Economic
• Social
• Health
• Web
Economic Trend
The impact of the credit crunch, bank failures, and the housing slide and foreclosures has
forced consumers to be much more careful in their spending. This increase in more frugal
spending provides significant opportunities in such areas as garden products, business
coaching, discount retailing, credit and debt management, virtual meetings, outsourcing,
and the entire do-it-yourself movement. Luxury products have not yet been significantly
adversely affected.
Social Trend
The social trend is evident throughout the world with more networking events and oppor-
tunities occurring each week. These include the popular Facebook and MySpace as well as
social networking for businesses. There are also opportunities in related areas of financial
planning and travel as individuals want to have the ability to be financially solvent and
viable in their longer life spans and enjoy the benefits of seeing new places with their chil-
dren and grandchildren. Longevity Alliance, for example, is a one-stop advisory service
offering counseling in long-term care and financial planning.
Health Trend
Health maintenance and concerns about health care provisions together are one of the
biggest trends today that will continue in the next decade as the world population ages. This
provides many opportunities for entrepreneurs, including cosmetic procedures, mind ex-
pansion such as the “brain gym” of Vibrant Brains, personal health portals, point-of-care
testing facilities, fitness centers, fitness toys such as the latest Fit Flops and Wii Fit periph-
erals, fit food, convenient care clinics, and wellness coaches.
Web Trend
The Web trend is creating many new forms of communication and purchasing, which is
opening up massive opportunities for entrepreneurs. This has been driven by Web 2.0. The
opportunities, with low-cost barriers to entry, are in numerous areas such as Web 2.0
consulting, blogging, online video, mobile applications (apps), and Wi-Fi apps.
An entrepreneur should carefully monitor these trends to see if any produce ideas and
opportunities that make sense. He or she should also look at the many sources of ideas
as well.
SOURCES OF NEW IDEAS
Some of the more frequently used sources of ideas for entrepreneurs include consumers,
existing products and services, distribution channels, the federal government, and research
and development.
Consumers
Potential entrepreneurs should continually pay close attention to potential customers. This
attention can take the form of informally monitoring potential ideas and needs or formally
arranging for consumers to have an opportunity to express their opinions. Care needs to be
taken to ensure that the idea or need represents a large enough market to support a new
venture.
C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 97
Existing Products and Services
Potential entrepreneurs should also establish a formal method for monitoring and evaluat-
ing competitive products and services on the market. Frequently, this analysis uncovers
ways to improve on these offerings that may result in a new product or service that has
more market appeal and better sales and profit potential.
Distribution Channels
Members of the distribution channels are also excellent sources for new ideas because
of their familiarity with the needs of the market. Not only do channel members fre-
quently have suggestions for completely new products, but they can also help in market-
ing the entrepreneur’s newly developed products. One entrepreneur found out from a
salesclerk in a large department store that the reason his hosiery was not selling well
was its color. By heeding the suggestion and making the appropriate color changes, his
company became one of the leading suppliers of nonbrand hosiery in that region of the
United States.
Federal Government
The federal government can be a source of new product ideas in two ways. First, the files
of the Patent Office contain numerous new product possibilities. Although the patents
themselves may not be feasible, they can frequently suggest other more marketable prod-
uct ideas. Several government agencies and publications are helpful in monitoring patent
applications. The Official Gazette, published weekly by the U.S. Patent Office, summarizes
each patent granted and lists all patents available for license or sale. Also, the Government
Patents Board publishes lists of abstracts of thousands of government-owned patents; a
good resource for such information is the Government-Owned Inventories Available for
License. Other government agencies, such as the Office of Technical Services, assist entre-
preneurs in obtaining specific product information.
Second, new product ideas can come in response to government regulations. For
example, the Occupational Safety and Health Act (OSHA) mandated that first-aid kits be
available in business establishments employing more than three people. The kits had to
contain specific items that varied according to the company and the industry. For exam-
ple, the weatherproofed first-aid kit needed for a construction company had to be differ-
ent from the one needed by a company manufacturing facial cream or a company in
retail trade. In response to OSHA, both established and newly formed ventures marketed
a wide variety of first-aid kits. One new company, R&H Safety Sales Company, was suc-
cessful in developing and selling first-aid kits that allowed companies to comply with the
standards of the act.
Research and Development
The largest source of new ideas is the entrepreneur’s own “research and development”
efforts, which may be a formal endeavor connected with one’s current employment or an
informal lab in a basement or garage. One research scientist in a Fortune 500 company de-
veloped a new plastic resin that became the basis of a new product, a plastic molded mod-
ular cup pallet, as well as a new venture—the Arnolite Pallet Company, Inc.—when the
Fortune 500 company was not interested in developing the idea.
98 PA RT 2 FROM IDEA TO THE OPPORTUNITY
A S S E E N I N B U S I N E S S W E E K
THE MYTH OF CREATIVITY
Creativity is in. Seminars teach employees to “think
outside the box” and release their inner Picasso.
Managers preach innovation, and today’s rich and
powerful prefer to describe themselves as creative
heroes, valiantly besting the naysayers to bring us the
radical changes that add up to progress. Richard
Florida’s best-selling The Rise of the Creative Class
argues that societal progress increasingly comes from
places like New York and San Francisco, in part be-
cause those cities encourage creativity by embracing
bohemian self-expression and openness to diversity
in dress, speech, or even sexuality.
Despite this affirming chorus, much of the hoopla
over creativity is a crock. Why? Because we are already
up to our eyeballs in it. Make no mistake: Innovation
matters. Nothing is more essential for long-term eco-
nomic growth. But to get more innovation we may
want less, not more, creativity.
The sobering truth is that the dramatic artistic
creations or intellectual insights we most admire for
their striking “creativity” matter little for economic
growth. Creative new clothes or music may change
fashion, but are soon eclipsed by newer fashions.
Large and lasting economic innovations, like steam
engines or cell phones, are rare and tend to be
independently “invented” by many people. One less
visionary would matter little.
Instead, the innovations that matter most are
the millions of small changes we constantly make to
our billions of daily procedures and arrangements.
Such changes do not require free-spirited self-
expression. Instead, people quite naturally think of
changes as they go about their routine business and
social lives.
What society needs is not more creativity or sugges-
tions for change but better ways to encourage people
to focus on important issues, identify the most promis-
ing ideas, and tell the right people about them. But
our deification of creativity gets in the way.
In truth, we don’t need more suggestion boxes or
more street mimes to fill people with a spirit of cre-
ativity. We instead need to better manage the flood
of ideas we already have and to reward managers for
actually executing them.
Source: Reprinted from the September 23, 2006 issue of Business- Week by special permission, copyright © 2006 by The McGraw-Hill Companies, Inc., “The Myth of Creativity,” by Robin Hanson, BusinessWeek, Issue 3991, p. 134.
METHODS OF GENERATING IDEAS
Even with such a wide variety of sources available, coming up with an idea to serve as the
basis for a new venture can still pose a problem. The entrepreneur can use several methods
to help generate and test new ideas, such as focus groups, brainstorming, brainwriting, and
problem inventory analysis.
Focus Groups
Focus groups have been used for a variety of purposes since the 1950s. A moderator leads a
group of people through an open, in-depth discussion rather than simply asking questions to
solicit participant response. For a new product area, the moderator focuses the discussion of
the group in either a directive or a nondirective manner. The group of 8 to 14 participants is
stimulated by comments from each other in creatively conceptualizing and developing a
new product idea to fill a market need. One company interested in the women’s slipper
market received its new product concept for a “warm and comfortable slipper that fits like
an old shoe” from a focus group of 12 women from various socioeconomic backgrounds
in the Boston area. The concept was developed into a new women’s slipper that was a
market success. Even the theme of the advertising message came from comments of focus
group members.
focus groups Groups of
individuals providing
information in a
structured format
99
In addition to generating new ideas, the focus group is an excellent method for initially
screening ideas and concepts. With the use of one of several procedures available, the re-
sults can be analyzed more quantitatively, making the focus group a useful method for gen-
erating new product ideas.1
Brainstorming
The brainstorming method allows people to be stimulated to greater creativity by meeting with
others and participating in organized group experiences. Although most of the ideas generated
by the group have no basis for further development, sometimes a good idea emerges. This has
a greater frequency of occurrence when the brainstorming effort focuses on a specific prod-
uct or market area. When using brainstorming, these four rules should be followed:
1. No criticism is allowed by anyone in the group—no negative comments.
2. Freewheeling is encouraged—the wilder the idea, the better.
3. Quantity of ideas is desired—the greater the number of ideas, the greater the likeli-
hood of the emergence of useful ideas.
4. Combinations and improvements of ideas are encouraged; ideas of others can be used
to produce still another new idea.
The brainstorming session should be fun, with no one dominating or inhibiting the
discussion.
A large commercial bank successfully used brainstorming to develop a journal that
would provide quality information to its industrial clients. The brainstorming among finan-
cial executives focused on the characteristics of the market, the information content, the
frequency of issue, and the promotional value of the journal for the bank. Once a general
format and issue frequency were determined, focus groups of vice presidents of finance of
Fortune 1000 companies were held in three cities—Boston, Chicago, and Dallas—to dis-
cuss the new journal format and its relevancy and value to them. The results of these focus
groups served as the basis for a new financial journal that was well received by the market.
Brainwriting
Brainwriting is a form of written brainstorming. It was created by Bernd Rohrbach at the
end of the 1960s under the name Method 635 and differs from classical brainstorming by
giving participants more time to think than in brainstorming sessions, where the ideas are
expressed spontaneously. Brainwriting is a silent, written generation of ideas by a group of
people. The participants write their ideas on special forms or cards that circulate within the
group, which usually consists of six members. Each group member generates and writes
down three ideas during a five-minute period. The form is passed on to the adjacent person,
who writes down three new ideas, and so on, until each form has passed all participants. A
leader monitors the time intervals and can reduce or lengthen the time given to participants
according to the needs of the group. In a variation of this idea-generation method, the par-
ticipants are located at their own workplaces and the sheets are rotated by e-mail; in this
case, the time interval can be longer.2
Problem Inventory Analysis
Problem inventory analysis uses individuals in a manner that is analogous to focus groups
to generate new product ideas. However, instead of generating new ideas themselves, con-
sumers are provided with a list of problems in a general product category. They are then
asked to identify and discuss products in this category that have the particular problem.
100 PA RT 2 FROM IDEA TO THE OPPORTUNITY
brainstorming A group
method for obtaining new
ideas and solutions
problem inventory
analysis A method for
obtaining new ideas and
solutions by focusing on
problems
This method is often effective since it is easier to relate known products to suggested prob-
lems and arrive at a new product idea than to generate an entirely new product idea by it-
self. Problem inventory analysis can also be used to test a new product idea.
An example of this approach in the food industry is illustrated in Table 4.2. One of the
most difficult problems in this example was in developing an exhaustive list of problems,
such as weight, taste, appearance, and cost. Once a complete list of problems is developed,
individuals can usually associate products with the problem.
Results from product inventory analysis must be carefully evaluated as they may not ac-
tually reflect a new business opportunity. For example, General Foods’s introduction of a
compact cereal box in response to the problem that the available boxes did not fit well on
the shelf was not successful, as the problem of package size had little effect on actual pur-
chasing behavior. To ensure the best results, problem inventory analysis should be used pri-
marily to identify product ideas for further evaluation.
CREATIVE PROBLEM SOLVING
Creativity is an important attribute of a successful entrepreneur. Unfortunately, creativ-
ity tends to decline with age, education, lack of use, and bureaucracy. Creativity gener-
ally declines in stages, beginning when a person starts school. It continues to deteriorate
C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 101
A. Weight
• Fattening
• Empty
calories
B. Hunger
• Filling
• Still hungry
after eating
C. Thirst
• Does not
quench
• Makes one
thirsty
D. Health
• Indigestion
• Bad for
teeth
• Keeps one
awake
• Acidity
A. Taste
• Bitter
• Bland
• Salty
B. Appearance
• Color
• Unappetizing
• Shape
C. Consistency/
texture
• Tough
• Dry
• Greasy
A. Meal planning
• Forget
• Get tired of it
B. Storage
• Run out
• Package
would not fit
C. Preparation
• Too much
trouble
• Too many
pots and pans
• Never turns
out
D. Cooking
• Burns
• Sticks
E. Cleaning
• Makes a mess
in oven
• Smells in
refrigerator
A. Portability
• Eat away
from home
• Take lunch
B. Portions
• Not enough
in package
• Creates
leftovers
C. Availability
• Out of
season
• Not in
supermarket
D. Spoilage
• Gets moldy
• Goes sour
E. Cost
• Expensive
• Takes
expensive
ingredients
A. Serve to
company
• Would not
serve to
guests
• Too much
last-minute
preparation
B. Eating alone
• Too much
effort to cook
for oneself
• Depressing
when
prepared for
just one
C. Self-image
• Made by a
lazy cook
• Not served by
a good
mother
TABLE 4.2 Problem Inventory Analysis
Psychological Sensory Activities Buying Usage Psychological/Social
Source: From Journal of Marketing by Edward M. Tauber. Copyright © 1975 by American Marketing Association (AMA-Chicago). Reproduced with permission
of American Marketing Association via Copyright Clearance Center.
through the teens and continues to progressively lessen through ages 30, 40, and 50.
Also, the latent creative potential of an individual can be stifled by perceptual, cultural,
emotional, and organizational factors. Creativity can be unlocked and creative ideas and
innovations generated by using any of the creative problem-solving techniques indicated
in Table 4.3.3
Brainstorming
The first technique, brainstorming, is probably the most well known and widely used for
both creative problem solving and idea generation. In creative problem solving, brainstorm-
ing can generate ideas about a problem within a limited time frame through the sponta-
neous contributions of participants. A good brainstorming session starts with a problem
statement that is neither too broad (which would diversify ideas too greatly so that nothing
specific would emerge) nor too narrow (which would tend to confine responses).4 Once the
problem statement is prepared, 6 to 12 individuals are selected to participate. To avoid in-
hibiting responses, no group member should be a recognized expert in the field of the prob-
lem. All ideas, no matter how illogical, must be recorded, with participants prohibited from
criticizing or evaluating during the brainstorming session.
Reverse Brainstorming
Reverse brainstorming is similar to brainstorming, except that criticism is allowed. In fact,
the technique is based on finding fault by asking the question, “In how many ways can this
idea fail?” Since the focus is on the negative aspects of a product, service, or idea, care
must be taken to maintain the group’s morale. Reverse brainstorming can be effectively
used before other creative techniques to stimulate innovative thinking.5 The process usually
involves the identification of everything wrong with an idea, followed by a discussion of
ways to overcome these problems. Reverse brainstorming almost always produces some
worthwhile results as it is easier for an individual to be critical about an idea than to come
up with a new idea.
Gordon Method
The Gordon method, unlike many other creative problem-solving techniques, begins with
group members not knowing the exact nature of the problem. This ensures that the solu-
tion is not clouded by preconceived ideas and behavioral patterns.6 The entrepreneur starts
by mentioning a general concept associated with the problem. The group responds by
expressing a number of ideas. Then a concept is developed, followed by related concepts,
through guidance by the entrepreneur. The actual problem is then revealed, enabling the
group to make suggestions for implementation or refinement of the final solution.
creative problem solving
A method for obtaining
new ideas focusing on the
parameters
reverse brainstorming
A group method for
obtaining new ideas
focusing on the negative
Gordon method Method
for developing new ideas
when the individuals are
unaware of the problem
102 PA RT 2 FROM IDEA TO THE OPPORTUNITY
• Brainstorming • Forced relationships
• Reverse brainstorming • Collective notebook method
• Brainwriting • Attribute listing method
• Gordon method • Big-dream approach
• Checklist method • Parameter analysis
• Free association
TABLE 4.3 Creative Problem-Solving Techniques
Checklist Method
In the checklist method, a new idea is developed through a list of related issues or sugges-
tions. The entrepreneur can use the list of questions or statements to guide the direction of
developing entirely new ideas or concentrating on specific “idea” areas. The checklist may
take any form and be of any length. One general checklist is as follows:7
• Put to other uses? New ways to use as-is? Other uses if modified?
• Adapt? What else is like this? What other ideas does this suggest? Does past offer parallel? What could I copy? Whom could I emulate?
• Modify? New twist? Change meaning, color, motion, odor, form, shape? Other changes?
• Magnify? What to add? More time? Greater frequency? Stronger? Larger? Thicker? Extra value? Plus ingredient? Duplicate? Multiply? Exaggerate?
• Minify? What substitute? Smaller? Condensed? Miniature? Lower? Shorter? Lighter? Omit? Streamline? Split up? Understated?
• Substitute? Who else instead? What else instead? Other ingredient? Other material? Other process? Other power? Other place? Other approach? Other tone of voice?
• Rearrange? Interchange components? Other pattern? Other layout? Other sequence? Transpose cause and effect? Change track? Change schedule?
• Reverse? Transpose positive and negative? How about opposites? Turn it backward? Turn it upside down? Reverse roles? Change shoes? Turn tables? Turn other cheek?
• Combine? How about a blend, an alloy, an assortment, an ensemble? Combine units? Combine purposes? Combine appeals? Combine ideas?
Free Association
One of the simplest yet most effective methods that entrepreneurs can use to generate new
ideas is free association. This technique is helpful in developing an entirely new slant to a
problem. First, a word or phrase related to the problem is written down, then another and
another, with each new word attempting to add something new to the ongoing thought
processes, thereby creating a chain of ideas ending with a new product idea emerging.
Forced Relationships
Forced relationships, as the name implies, is the process of forcing relationships among
some product combinations. It is a technique that asks questions about objects or ideas in
an effort to develop a new idea. The new combination and eventual concept is developed
through a five-step process:8
1. Isolate the elements of the problem.
2. Find the relationships between these elements.
3. Record the relationships in an orderly form.
4. Analyze the resulting relationships to find ideas or patterns.
5. Develop new ideas from these patterns.
Table 4.4 illustrates the use of this technique with paper and soap.
Collective Notebook Method
In the collective notebook method, a small notebook that easily fits in a pocket—containing a
statement of the problem, blank pages, and any pertinent background data—is distributed.
Participants consider the problem and its possible solutions, recording ideas at least once, but
C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 103
checklist method
Developing a new idea
through a list of related
issues
free association
Developing a new idea
through a chain of word
associations
forced relationships
Developing a new idea by
looking at product
combinations
collective notebook
method Developing
a new idea by group
members regularly
recording ideas
A S S E E N I N BUSINESSWEEK
HOW TO PRODUCE BIG IDEAS ON DEMAND
What if we told you that you could come up with a
great idea anytime you wanted?
We’ll go further. We can show you how not only
to summon new and innovative concepts on command
but also to teach your people the same skill. This may
sound like an infomercial (“Order our revolutionary
system within the next 20 minutes, and we’ll throw in
a set of steak knives absolutely free”), but it’s true.
The five techniques outlined below have one
thing in common: They free your brain to let your
best ideas flow.
As it is, you undoubtedly have too much on your
mind. When you’re driving during rush hour, you are
too busy dealing with traffic to notice the scenery
and enjoy the ride. The following practices eliminate
mental traffic and help you liberate the great ideas
inside you that are desperately trying to get out.
1. Shower your way to creativity. Yep, it’s absolutely
true. There is a scientific theory that water hitting
your head helps trigger the synapses and that’s
why people get great ideas in the shower. But we
think it’s simpler than that: The ideas occur because
you are not making an effort to think. You aren’t
worried about anything. You are not stressed.
Hence some of your best thinking occurs.
2. Sleep on it. Remember how your mom used to
say, “Why don’t you sleep on it, honey?” when
you were wrestling with a big issue? Well, when
it comes to big ideas and problem solving,
Mother really does know best. The next time you
want to solve a major challenge or be unusually
brilliant, think about it in bed. Don’t push your-
self to figure out the answer before you fall
asleep. Instead, just go through the issues at hand
and tell yourself that you will have the answer in
the morning. In our experience, this technique
amplifies the power of the shower, because there
are even fewer distractions to occupy your mind
when you are asleep.
You can employ an alternate version of this
while awake. The next time you can’t think of
a name, date, or important fact, just tell yourself
aloud, “I will not think about this for a while,
and the answer will come to me.” This technique
clears the traffic in your mind and lets your sub-
conscious go to work. Your answer will often pop
into your head the moment you stop “thinking
about it.”
3. Engage in mind-mapping. Purging is a great
way to make new connections and create bigger
ideas. Have a tough challenge to solve? Get a
giant piece of paper (write small if you can’t find
one). In each quarter of the paper, write a
keyword related to the challenge. For example,
if you want to plan a cool family vacation, you
might write the words “destinations,” “trans-
portation,” “memories,” and “kids.” Then, in no
104
Elements: Paper and Soap
Forms Relationship/Combination Idea/Pattern
Adjective Papery soap Flakes
Soapy paper Wash and dry travel aid
Noun Paper soaps Tough paper impregnated
with soap and usable for
washing surfaces
Verb-correlates Soaped papers Booklets of soap leaves
Soap “wets” paper In coating and impregnation processes
Soap “cleans” paper Suggests wallpaper cleaner
TABLE 4.4 Illustration of Forced Relationship Technique
Source: William E. Souder and Robert W. Ziegler, “A Review of Creativity and Problem Solving Techniques,” Research Man-
agement (July 1975), p. 37.
particular order, begin to brainstorm any word that
comes to mind when you think of each of the key-
words. For example, for “Transportation”: plane,
train, automobile, John Candy, pillows, sleep,
sleeping bag, tent, treehouse, memories, dreams,
daydreams, smells, popcorn, movies, adventure,
pirates, islands, Swiss Family Robinson. Eventually,
you will begin to make connections, and ideas that
unify the key aspects of your goal will pop off the
page. Strive for as many words as you can, and
don’t judge the words. Judging is looking at the
traffic when you are driving—it keeps you from
coming up with ideas. Eliminate the traffic.
You can employ this simple technique your-
self or do it in groups to loosen up your team.
Imagine how much fun you’ll have explaining
to your family how you came up with the idea
of renting a tree house for your vacation in
Costa Rica.
4. Schedule your daydreaming. We all have a time
of day when our brains work the best. For many,
it is first thing in the morning, before rush hour.
Unfortunately, the CrackBerry addiction has many
of us checking our e-mail just when our brains are
the most capable of creating. The moment you
check your e-mail, voice mail, or to-do list, you
have hijacked your imagination. You have
created a mental traffic jam. Do yourself a favor
and schedule daydreaming. Unplug during the
time that you know you do your best thinking
and find a place that makes you feel energized. A
lot of people love the local coffee shop. The buzz
of conversation, the smells, colors, and energy
create a safe haven for the mind to wander. Some
prefer the library or the park. Whichever it is, go
there. Let your mind wander.
5. Yuk it up. Laughing is another great way to liberate
your brain. Often consciously doing silly-seeming
things will get the creative juices flowing. Spin a
top. Get an ice cream cone.
As you test these five techniques, you’ll find some
work better than others. If it turns out you really do
get your best ideas in the shower, be conscious of the
circumstances under which they occurred. What was
the water temperature like? How long had you been
in there? What time was it? Replicate the experience.
You’ll find the effort worthwhile. “The bottom line
is that gifted performers are almost always made, not
born, and that the journey to superior performance is
for neither the faint of heart nor the impatient,” says
Rand Stagen, senior partner of Stagen, a manage-
ment consulting firm that specializes in helping mid-
market companies scale. “Just as in sports, becoming
an elite performer in business requires struggle, sacri-
fice, and honest (often painful) self-assessment. De-
pending on the scope and difficulty of the skill to be
learned, it will take months and probably years to
achieve a high level of proficiency or mastery.”
Learning how to implement these approaches is
often what separates a brilliant thinker from a cre-
ative want-to-be. Really. At first, you may feel silly,
but we promise they will work.*
TRY THIS!
In the next week, try each of these techniques, one
each day. Come up with at least one idea from each
method.
*Source: Reprinted from December 16, 2008 issue of BusinessWeek by special permission, copyright © 2008 by The McGraw-Hill Companies, Inc., “How to Produce Big Ideas on Demand,” by G. Michael Maddock and Raphael Louis Vitón, www.businessweek.com/managing/ content/dec2008/ca20081216_497312.htm.
preferably three times, a day. At the end of a week, a list of the best ideas is developed, along
with any suggestions.9 This technique can also be used with a group of individuals who
record their ideas, giving their notebooks to a central coordinator who summarizes all the ma-
terial and lists the ideas in order of frequency of mention. The summary becomes the topic of
a final creative focus group discussion by the group participants.
Attribute Listing
Attribute listing is an idea-finding technique that requires the entrepreneur to list the attrib-
utes of an item or problem and then look at each from a variety of viewpoints. Through this
process, originally unrelated objects can be brought together to form a new combination
and possible new uses that better satisfy a need.10
105
attribute listing
Developing a new idea by
looking at the positives
and negatives
Big-Dream Approach
The big-dream approach to coming up with a new idea requires that the entrepreneur
dream about the problem and its solution—in other words, think big. Every possibility
should be recorded and investigated without regard to all the negatives involved or the re-
sources required. Ideas should be conceptualized without any constraints until an idea is
developed into a workable form.11
Parameter Analysis
A final method for developing a new idea—parameter analysis—involves two aspects: pa-
rameter identification and creative synthesis.12 As indicated in Figure 4.1, step one (para-
meter identification) involves analyzing variables in the situation to determine their relative
importance. These variables become the focus of the investigation, with other variables
being set aside. After the primary issues have been identified, the relationships between
parameters that describe the underlying issues are examined. Through an evaluation of the
parameters and relationships, one or more solutions are developed; this solution develop-
ment is called creative synthesis.
INNOVATION
Innovation is the key to the economic development of any company, region of a country, or
country itself. As technologies change, old products decrease in sales and old industries
dwindle. Inventions and innovations are the building blocks of the future of any economic
unit. Thomas Edison reportedly said that innovative genius is 1 percent inspiration and
99 percent perspiration.
Types of Innovation
There are various levels of innovation based on the uniqueness of the idea. As indicated in
Figure 4.2, there are three major types of innovation, in decreasing order of uniqueness: break-
through innovation, technological innovation, and ordinary innovation. As you would expect,
the fewest innovations are of the breakthrough type. These extremely unique innovations often
establish the platform on which future innovations in an area are developed. Given that they are
often the basis for further innovation in an area, these innovations should be protected as much
106 PA RT 2 FROM IDEA TO THE OPPORTUNITY
big-dream approach
Developing a new idea by
thinking without
constraints
parameter analysis
Developing a new idea by
focusing on parameter
identification and creative
synthesis
Technology observation
Need analysis
Realization
Invention
which meets
the need
Market Need
Parameter identification
Step 1
Creative synthesis
Step 2
The Invention Process
Parameter Analysis
FIGURE 4.1 Illustration of Parameter Analysis
C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 107
U n
iq u
e n
e s s
Number of Events
Breakthrough innovation
Technological innovation
Ordinary innovation
FIGURE 4.2 Innovation Chart
as possible by strong patents, trade secrets, and/or copyrights (see Chapter 6). Breakthrough
innovations include such ideas as: penicillin, the steam engine, the computer, the airplane, the
automobile, the Internet, and nanotechnology. One person in the field of nanotechnology who
invents elegant solutions to engineering problems is Chung-Chiun Liu, a professor and direc-
tor of the Center for Micro and Nano Processing at Case Western Reserve University. Dr. Liu
is a world expert on sensor technology and invents and builds nano sensor systems for automo-
tive, biomedical, commercial, and industrial applications. Despite publishing a majority of his
inventions, Dr. Liu still holds 12 patents in electrochemical and sensor technology, many of
which have been licensed. One of his inventions is the technology for an electrochemical sen-
sor system that can transmit findings to a nearby receiver. One of these nano devices can ana-
lyze the condition of motor oil from inside an engine. Another nano device can measure blood
glucose levels. One of his latest nano inventions can detect black mold in homes, hidden
bombs, illegal drugs, and termites; this technology is presently being commercialized through
a licensing agreement with Development Corporation.
The next type of innovation—technological innovation—occurs more frequently than
breakthrough innovation and in general is not at the same level of scientific discovery and
advancement. Nonetheless, these are very meaningful innovations, as they do offer ad-
vancements in the product/market area. As such, they usually need to be protected. Such in-
novations as the personal computer, the flip watch for containing pictures, voice and text
messaging, and the jet airplane are examples of technological innovations.
Analiza, Inc., a twelve-year-old bioscience company, invented, developed, and sells a
system that allows drug manufacturers to quickly screen chemical compounds for the ones
most suitable for new drugs. This automated discovery workstation simultaneously tests many
different drug compounds, identifying the compounds most suitable for a new drug based on
how the human body is likely to react to the compound. The company is further exploring
other technological innovations such as an advanced blood test product for diagnosing cancer,
a product for extending the shelf life of blood platelets, and a pregnancy test for cows.
The final type of innovation—ordinary innovation—is the one that occurs most frequently.
These more numerous innovations usually extend a technological innovation into a better
product or service or one that has a different—usually better—market appeal. These innova-
tions usually come from market analysis and pull, not technology push. In other words, the
market has a stronger effect on the innovation (market pull) than the technology (technology
push). One ordinary innovation was developed by Sara Blakely, who wanted to get rid of un-
sightly panty lines. To do this, she cut off the feet of her control-top panty hose to produce
footless panty hose. Investing her total money available ($5,000), Sara Blakely started Spanx,
an Atlanta-based company, which in five years had annual earnings of $20 million.
Similarly, Martha Aarons, the second flutist of the Cleveland Symphony, practices a
5,000-year-old Hindu system of physical and spiritual exercise. One of the exercises—the
Downward Facing Dog—requires a “sticky mat” in order to prevent the gloves and slippers
from sliding. Not wanting to carry the mat along with her instrument on trips, Martha
Aarons invented gloves and slippers with a gripping substance. She is now in the process
of commercializing her skid-free slippers and gloves.
Defining a New Innovation (Product or Service)
One of the dilemmas faced by entrepreneurs is defining a “new” product or identifying
what is actually new or unique in an idea. Fashion jeans became very popular even though
the concept of blue jeans was not new. What was new was the use of names such as
Sassoon, Vanderbilt, and Chic on the jeans. Similarly, Sony made the Walkman one of the
most popular new products of the 1980s, although the concept of cassette players had been
in existence for many years.
In these examples, the newness was in the consumer concept. Other types of products,
not necessarily new in concept, have also been defined as new. When coffee companies in-
troduced naturally decaffeinated coffee, which was the only change in the product, the ini-
tial promotional campaigns made definite use of the word new in the copy.
Other old products have simply been marketed in new packages or containers but have
been identified as new products by the manufacturer. When soft drink manufacturers intro-
duced the can, some consumers viewed the product as new, even though the only difference
from past products was the container. The invention of the aerosol can is another example of
a change in the package or container that added an element of newness to old, established
products, such as whipped cream, deodorant, and hair spray. Flip-top cans, plastic bottles,
aseptic packaging, and the pump have also contributed to a perceived image of newness in
old products. Some firms, such as detergent manufacturers, have merely changed the colors
of their packages and then added the word new to the package and their promotional copy.
Panty hose are another product that has undergone significant marketing strategy
changes. L’eggs (a division of Hanes Corporation) was the first to take advantage of super-
market merchandising, packaging, lower prices, and a new display.
In the industrial market, firms may call their products “new” when only slight changes or
modifications have been made in the appearance of the product. For example, improvements
in metallurgical techniques have modified the precision and strength of many raw materials
that are used in industrial products, such as machinery. These improved characteristics have
led firms to market products containing the new and improved metals as “new.” Similarly,
each new version of Microsoft Word usually includes only minor improvements.
In the process of expanding their sales volume, many companies add products to their
product line that are already marketed by other companies. For example, a drug company
that added a cold tablet to its product line and a long-time manufacturer of soap pads that
entered the dishwasher detergent market both advertised their products as new. In both
cases the product was new to the manufacturer but not new to the consumer. With the in-
creased emphasis on diversification in the world economy, this type of situation is quite
108 PA RT 2 FROM IDEA TO THE OPPORTUNITY
common today. Firms are constantly looking for new markets to exploit to increase profits
and make more effective use of their resources. Other firms are simply changing one or
more of the marketing mix elements to give old products a new image.
Classification of New Products
New products may be classified from the viewpoint of either the consumer or the firm.
Both points of view should be analyzed by the entrepreneur since both the ability to estab-
lish and attain product objectives and consumer perception of these objectives can deter-
mine the success or failure of any new product.
From a Consumer’s Viewpoint There is a broad interpretation of what may be labeled a new product from the consumer’s viewpoint. One attempt to identify new products classifies
the degree of newness according to how much behavioral change or new learning is required
by the consumer to use the product. This technique looks at newness in terms of its effect on
the consumer rather than whether the product is new to a company, is packaged differently, has
changed physical form, or is an improved version of an old or existing product.
The continuum proposed by Thomas Robertson and shown in Figure 4.3 contains three
categories based on the disrupting influence that use of the product has on established con-
sumption patterns. Most new products tend to fall at the “continuous innovations” end of the
continuum. Examples are annual automobile style changes, fashion style changes, package
changes, or product size or color changes. Products such as compact discs, the Sony Walkman,
and the iPod tend toward the “dynamically continuous” portion of the continuum. The truly
new products, called “discontinuous innovations,” are rare and require a great deal of new
learning by the consumer because these products perform either a previously unfulfilled func-
tion or an existing function in a new way. The Internet is one example of a discontinuous inno-
vation that has radically altered our society’s lifestyle. The basis for identifying new products
according to their effect on consumer consumption patterns is consistent with the marketing
philosophy that “satisfaction of consumer needs” is fundamental to a venture’s existence.
From a Firm’s Viewpoint The innovative entrepreneurial firm, in addition to recognizing the consumer’s perception of newness, may also find it necessary to classify its new products
on some similar dimensions. One way of classifying the objectives of new products is shown
C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 109
Continuous Innovations
Dynamically Continuous Innovations
Discontinuous Innovations
(Least disrupting influence on established
consumption patterns)
(Involves the establishment
of new consumption patterns and the
creation of previously unknown products)
(Some disrupting influence on established
consumption patterns)
FIGURE 4.3 Continuum for Classifying New Products
Source: Adapted from Thomas Robertson, “The Process of Innovation and the Diffusion of Innovation,” Journal of Marketing
(January 1967), pp. 14–19.
in Figure 4.4. In this figure, an important distinction is made between new products and new
markets (i.e., market development). New products are defined in terms of the amount of im-
proved technology, whereas market development is based on the degree of new segmentation.
The situation in which there is new technology and a new market is the most compli-
cated and difficult—and it has the highest degree of risk. Since the new product involves
new technology and customers that are not now being served, the firm will need a new and
carefully planned marketing strategy. Replacements, extensions, product improvements,
reformulations, and remerchandising involve product and market development strategies
that range in difficulty depending on whether the firm has had prior experience with a sim-
ilar product or with the same target market.
OPPORTUNITY RECOGNITION
Some entrepreneurs have the ability to recognize a business opportunity, which is fundamen-
tal to the entrepreneurial process as well as growing a business. A business opportunity rep-
resents a possibility for the entrepreneur to successfully fill a large enough unsatisfied need
that enough sales and profits result. There has been significant research done on the oppor-
tunity recognition process and several models developed.13 One model that clearly identifies
the aspects of this opportunity recognition process is indicated in Figure 4.5.
As is indicated, recognizing an opportunity often results from the knowledge and expe-
rience of the individual entrepreneur and, where appropriate, the entrepreneurial business.
This prior knowledge is a result of a combination of education and experience, and the rel-
evant experience could be work related or could result from a variety of personal experi-
ences or events. The entrepreneur needs to be aware of this knowledge and experience and
have the desire to understand and make use of it. The other important factors in this process
are entrepreneurial alertness and entrepreneurial networks. There is an interaction effect
between entrepreneurial alertness and the entrepreneur’s prior knowledge of markets and
customer problems. Those entrepreneurs who have the ability to recognize meaningful
business opportunities are in a strategic position to successfully complete the product plan-
ning and development process and successfully launch new ventures.
110 PA RT 2 FROM IDEA TO THE OPPORTUNITY
Product
Objectives
Market
Newness
No market change
New market New use
Add new segments that can use present products
Add new segments modifying present products
Add new markets with new products developed from new technology
Market extension
No Technological
Change
Reformation
Replace existing product with new one based on improved technology
Improved
Technology
Change in formula or physical product to optimize costs and quality
Strengthened market Remerchandising
Technology Newness
Increase sales to existing customers
Improved product Improve product's utility to customers
Diversification
Replacement
New Technology
Product life extension Add new similar products to line; serve more customers based on new technology
FIGURE 4.4 New Product Classification System
Each and every innovative idea and opportunity should be carefully assessed by the
global entrepreneur. One good way to do this is to develop an opportunity analysis plan,
which is discussed in Chapter 5.
PRODUCT PLANNING AND DEVELOPMENT PROCESS
Once ideas emerge from idea sources or creative problem solving, they need further devel-
opment and refinement. This refining process—the product planning and development
process—is divided into five major stages: idea stage, concept stage, product development
stage, test marketing stage, and commercialization; it results in the start of the product life
cycle (see Figure 4.6).14
Establishing Evaluation Criteria
At each stage of the product planning and development process, criteria for evaluation need
to be established. These criteria should be all-inclusive and quantitative enough to screen
the product carefully in the particular stage of development. Criteria should be established
C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 111
Education
Experience
Networks
Entrepreneurial alertness
Prior knowledge of markets and
customer problems
Outcome: successful opportunity recognition
Personal experiences
Work experience
FIGURE 4.5 A Model of the Opportunity Recognition Process
Source: From Alexander Ardichvili and Richard N. Cardozo, “A Model of the Entrepreneurial Opportunity Recognition Process,”
Journal of Enterprising Culture 8, no. 2 (June 2000). Reprinted with permission of World Scientific Publishing Co, Inc.
product life cycle The
stages each product goes
through from introduction
to decline
Idea stage
Id e a
E v a lu
a te
E v a lu
a te
E v a lu
a te
E v a lu
a te
L a b o ra
to ry
d e ve
lo p m
e n t
P il o t p ro
d u c ti o n r
u n
S e m
ic o m
m e rc
ia l
p la
n t ri a ls
Concept stage
Commercialization stage Product life cycle
Product development stage
Test marketing stage
Introduction Growth Maturity Decline
FIGURE 4.6 The Product Planning and Development Process
Source: From Marketing Decisions for New and Mature Products, 2nd edition, by Robert D. Hisrich and Michael P. Peters,
1991. Reprinted by permission of Pearson Education, Inc., Upper Saddle River, NJ.
product planning and
development process
The stages in developing
a new product
to evaluate the new idea in terms of market opportunity, competition, the marketing system,
financial factors, and production factors.
A market opportunity in the form of a new or current need for the product idea must ex-
ist. The determination of market demand is by far the most important criterion of a pro-
posed new product idea. Assessment of the market opportunity and size needs to consider
the following: the characteristics and attitudes of consumers or industries that may buy the
product, the size of this potential market in dollars and units, the nature of the market with
respect to its stage in the life cycle (growing or declining), and the share of the market the
product could reasonably capture.
Current competing producers, prices, and marketing efforts should also be evaluated,
particularly in terms of their impact on the market share of the proposed idea. The new idea
should be able to compete successfully with products/services already on the market by
having features that will meet or overcome current and anticipated competition. The new
idea should have some unique differential advantage based on an evaluation of all compet-
itive products/services filling the same consumer needs.
The new idea should have synergy with existing management capabilities and market-
ing strategies. The firm should be able to use its marketing experience and other expertise
in this new product effort. For example, General Electric would have a far less difficult time
LEADERSHIP IS ABOUT DOING, NOT SAYING
Those plaques on the walls! Those inspiring mottos!
Companies have wasted millions of dollars and count-
less hours agonizing over buzzwords and slogans that
are hung on walls. There is a clear assumption that
people’s behavior will change because the pronounce-
ments on plaques are “inspirational” or certain words
“integrate our strategy and values.” There is an implicit
hope that when people—especially managers—hear
great words, they will start to exhibit great behavior.
Sometimes these words or phrases morph as people
try to keep up with the latest trends in corporate-
speak. A company may begin by striving for “customer
satisfaction,” then advance to “total customer satisfac-
tion,” and then finally reach the pinnacle of “customer
delight.”
ENRON TALKED A GOOD GAME But this obsession with words belies one very large
problem: There is almost no correlation between the
words on the wall and the behavior of leaders. Every
company says it wants “integrity,” “respect for peo-
ple,” “quality,” “customer satisfaction,” “innovation,”
and “return for shareholders.” Sometimes companies
get creative and toss in something about “commu-
nity” or “suppliers.” But since the big messages are all
basically the same, the words quickly lose meaning for
employees.
Enron is a great example. Before the energy con-
glomerate’s collapse in 2001, I had the opportunity to
review Enron’s values during a meeting with its sen-
ior management team. I was shown a wonderful
video on Enron’s ethics and integrity. I was greatly
impressed by the high-minded beliefs the company
espoused and the care that was put into the video.
Examples of Enron’s good deeds in the community
and the professed character of Enron’s executives
were particularly noteworthy.
It was one of the most smoothly professional pre-
sentations on ethics and values that I have ever seen.
Clearly, Enron spent a fortune “packaging” these
wonderful messages. It didn’t really matter. Despite
the lofty words, a number of Enron’s top executives
either have been indicted or are in jail.
J&J ADHERES TO ITS CREDO The situation couldn’t be more different at Johnson
& Johnson (JNJ), where I had the opportunity to work
with that company’s top 2,000 leaders. The pharma-
ceutical company is famous for its “Credo,” which
was written many years ago and reflects the sincere
values of the leaders of the company at that time.
The J&J Credo could be considered rather quaint by
today’s standards. It contains several old-fashioned
phrases, such as “must be good citizens—support
E T H I C S
112
good works and charities —and bear our fair share of
taxes” and “maintain in good order the property
that we are privileged to use.” Like most values state-
ments, it conveyed a great message, but it had none
of the slick PR packaging that Enron’s did.
Yet, even with its less-powerful language and
seemingly dated presentation, the J&J Credo works—
primarily because over many years, the company’s
management has taken its values seriously. J&J exec-
utives have consistently challenged themselves and
employees not just to understand the values, but to
exhibit them in their day-to-day behavior. Whenever
I conducted leadership training for J&J, one of its
most senior executives would spend many hours with
every class. The executive’s task was not to talk about
compensation or other perks of J&J management; it
was to discuss living the company’s values.
My partner, Howard Morgan, and I completed a
study of more than 11,000 managers in eight major
corporations. We looked at the impact of leadership
development programs in changing executive behav-
ior. As it turns out, each of the eight companies had
different values and different words to describe ideal
leadership behavior.
But these differences in words made absolutely no
difference in determining the way leaders behaved.
One company spent thousands of hours composing
just the right words to express its view of how leaders
should act—in vain. I am sure that the first draft
would have been just as useful. In our study we
found that leaders who took training and feedback
seriously, made a personal commitment to improve-
ment, and followed up with their co-workers became
more effective. Leaders who just listened to the talk
but took no action or made no commitment im-
proved no more than those who hadn’t even heard
the talk.
ACTIONS SPEAK LOUDEST
Companies that do the best job of living up to their
values and developing ethical employees, including
managers, recognize that the real cause of success—or
failure—is always the people, not the words. Rather
than wasting time on reinventing words about desired
leadership behavior, companies should ensure that
leaders get (and act upon) feedback from employees—
the people who actually observe this behavior. Rather
than wasting time on changing performance appraisal
forms, leaders need to learn from employees to ensure
that they are providing the right coaching.
Ultimately, our actions will say much more to
employees about our values and our leadership skills
than our words ever can. If our actions are wise, no
one will care if the words on the wall are not perfect.
If our actions are foolish, the wonderful words posted
on the wall will only make us look more ridiculous.
Source: Reprinted from the December 2007 issue of BusinessWeek by special permission, copyright © 2007 by The McGraw-Hill Com- panies, Inc., “Leadership Is About Doing, Not Saying,” by Marshall Goldsmith, www.businessweek.com/managing/content/dec2007/ ca2007124_971542.htm?chan=careers_managing⫹your⫹team⫹ page_leadership⫹development.
113
adding a new lighting device to its line than Procter & Gamble. Several factors should be
considered in evaluating the degree of fit: the degree to which the ability and time of the
present sales force can be transferred to the new product; the ability to sell the new product
through the company’s established channels of distribution; and the ability to “piggyback”
the advertising and promotion required to introduce the new product.
The proposed product/service idea should be able to be supported by and contribute to
the company’s financial well-being. The manufacturing cost per unit, the marketing ex-
pense, and the amount of capital need to be determined along with the break-even point and
the long-term profit outlook for the product.
The compatibility of the new product’s production requirements with existing plant, ma-
chinery, and personnel should also be evaluated. If the new product idea cannot be inte-
grated into existing manufacturing processes, more costs such as plant and equipment are
involved which need to be taken into account. All required materials for the production of
the product need to be available and accessible in sufficient quantity.
When dealing with competition and competitive situations, concerns regarding ethics
and ethical behavior frequently arise, as indicated in the Ethics box.
Entrepreneurs need to be concerned with formally evaluating an idea throughout its evo-
lution. Care must be taken to be sure the product can be the basis for a new venture. This
can be done through careful evaluation that results in a go or no-go decision at each of the
stages of the product planning and development process: the idea stage, the concept stage,
the product development stage, and the test marketing stage.
Idea Stage
Promising new product/service ideas should be identified and impractical ones eliminated in
the idea stage, allowing maximum use of the company’s resources. One evaluation method
successfully used in this stage is the systematic market evaluation checklist, where each new
idea is expressed in terms of its chief values, merits, and benefits. Consumers are presented
with clusters of new product/service values to determine which, if any, new product/service
alternatives should be pursued and which should be discarded. A company can test many new
idea alternatives with this evaluation method; promising ideas can be further developed and
resources not wasted on ideas that are incompatible with the market’s values.
It is also important to determine the need for the new idea as well as its value to the
company. If there is no need for the suggested product, its development should not be
continued. Similarly, the new product/service idea should not be developed if it does not
have any benefit or value to the firm. To accurately determine the need for a new idea, it
is helpful to define the potential needs of the market in terms of timing, satisfaction,
alternatives, benefits and risks, future expectations, price-versus-product performance
features, market structure and size, and economic conditions. A form for helping in this
need determination process is indicated in Table 4.5. The factors in this table should be
evaluated not only in terms of the characteristics of the potential new product/service but
also in terms of the new product/service’s competitive strength relative to each factor.
This comparison with competitive products/services will indicate the proposed idea’s
strengths and weaknesses.
The need determination should focus on the type of need, its timing, the users involved
with trying the product/service, the importance of controllable marketing variables, the
overall market structure, and the characteristics of the market. Each of these factors should
be evaluated in terms of the characteristics of the new idea being considered and the aspects
and capabilities of present methods for satisfying the particular need. This analysis will in-
dicate the extent of the opportunity available.
In the determination of the value of the new product/service to the firm, financial
scheduling—such as cash outflow, cash inflow, contribution to profit, and return on
investment—needs to be evaluated in terms of other product/service ideas as well as invest-
ment alternatives. With the use of the form indicated in Table 4.6, the dollar amount of each
of the considerations important to the new idea should be determined as accurately as
possible so that a quantitative evaluation can be made. These figures can then be revised as
better information becomes available and the product/service continues to be developed.
Concept Stage
After a new product/service idea has passed evaluation in the idea stage, it should be further
developed and refined through interaction with consumers. In the concept stage, the refined
idea is tested to determine consumer acceptance. Initial reactions to the concept are obtained
from potential customers or members of the distribution channel when appropriate. One
method of measuring consumer acceptance is the conversational interview in which selected
respondents are exposed to statements that reflect the physical characteristics and attributes
of the product/service idea. Where competing products (or services) exist, these statements
can also compare their primary features. Favorable as well as unfavorable product features
114 PA RT 2 FROM IDEA TO THE OPPORTUNITY
concept stage Second
stage in product
development process
idea stage First stage in
product development
process
C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 115
Competitive New Product Idea
Factor Aspects Capabilities Capability
Type of Need
Continuing need
Declining need
Emerging need
Future need
Timing of Need
Duration of need
Frequency of need
Demand cycle
Position in life cycle
Competing Ways to Satisfy Need
Doing without
Using present way
Modifying present way
Perceived Benefits/Risks
Utility to customer
Appeal characteristics
Customer tastes and preferences
Buying motives
Consumption habits
Price versus Performance Features
Price-quantity relationship
Demand elasticity
Stability of price
Stability of market
Market Size and Potential
Market growth
Market trends
Market development requirements
Threats to market
Availability of Customer Funds
General economic conditions
Economic trends
Customer income
Financing opportunities
TABLE 4.5 Determining the Need for a New Product/Service Idea
Source: From Marketing Decisions for New and Mature Products, 2nd edition, by Robert D. Hisrich and Michael P. Peters,
1991. Reprinted by permission of Pearson Education, Inc., Upper Saddle River, NJ.
116 PA RT 2 FROM IDEA TO THE OPPORTUNITY
Value Consideration Cost (in $)
Cash Outflow
R&D costs
Marketing costs
Capital equipment costs
Other costs
Cash Inflow
Sales of new product
Effect on additional sales of existing products
Salvageable value
Net Cash Flow
Maximum exposure
Time to maximum exposure
Duration of exposure
Total investment
Maximum net cash in a single year
Profit
Profit from new product
Profit affecting additional sales of existing products
Fraction of total company profit
Relative Return
Return on shareholders’ equity (ROE)
Return on investment (ROI)
Cost of capital
Present value (PV)
Discounted cash flow (DCF)
Return on assets employed (ROA)
Return on sales
Compared to Other Investments
Compared to other product opportunities
Compared to other investment opportunities
TABLE 4.6 Determining the Value of a New Product/Service Idea
Source: From Marketing Decisions for New And Mature Products, 2nd edition, by Robert D. Hisrich and Michael P. Peters,
1991. Reprinted by permission of Pearson Education, Inc., Upper Saddle River, NJ.
can be discovered by analyzing consumers’ responses, with the favorable features then be-
ing incorporated into the new product/service.
Features, price, and promotion should be evaluated for both the concept being studied
and any major competing products by asking the following questions:
How does the new concept compare with competitive products/services in terms of
quality and reliability?
C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 117
product development
stage Third stage in
product development
process
test marketing stage
Final stage before
commercialization in
product development
process
Is the concept superior or deficient compared with products/services currently
available in the market?
Is this a good market opportunity for the firm?
Similar evaluations should be done for all the aspects of the marketing strategy.
Product Development Stage
In the product development stage, consumer reaction to the physical product/service is
determined. One tool frequently used in this stage is the consumer panel, in which a group
of potential consumers is given product samples. Participants keep a record of their use of
the product and comment on its virtues and deficiencies. This technique is more applicable
for product ideas and works for only some service ideas.
The panel of potential customers can also be given a sample of the product and one or
more competitive products simultaneously. Then one of several methods—such as multiple
brand comparisons, risk analysis, level of repeat purchases, or intensity of preference
analysis—can be used to determine consumer preference.
Test Marketing Stage
Although the results of the product development stage provide the basis of the final market-
ing plan, a market test can be done to increase the certainty of successful commercialization.
This last step in the evaluation process, the test marketing stage, provides actual sales results,
which indicate the acceptance level of consumers. Positive test results indicate the degree of
probability of a successful product launch and company formation.
E-COMMERCE AND BUSINESS START-UP
Throughout the evaluation process of a potential new idea as well as in the development of
marketing strategy, the role of e-commerce needs to be continually assessed. E-commerce of-
fers the entrepreneur the opportunity to be very creative and innovative. Its increasing
importance is indicated in the continually increasing amount of both business-to-business and
business-to-consumer e-commerce sales. E-commerce (Internet spending) continues to in-
crease on an annual basis. According to comScore Networks, total Internet spending (including
travel) reached $214.4 billion in 2008, an increase of 7 percent over the total spending in 2007.
This 7 percent growth rate, however, reflects the economic recession, as 2008 exhibited the
lowest increase in e-commerce spending since 2001, when comScore Networks began follow-
ing consumer online spending. The $214.4 billion was composed of $130.1 billion nontravel
spending and $84.3 billion travel spending. Video games, consoles, and accessories together
constituted one of the fastest-growing categories, up 29 percent over 2007.
Other categories that experienced a significant increase in 2008 sales over 2007 sales
included sport and fitness (25 percent); event tickets (13 percent); consumer electronics
(9 percent); and apparel and accessories (4 percent). Travel’s increase to $84.3 billion in
2008 had risen 9 percent—from $77.3 billion in 2007.
Factors that facilitated the high growth of electronic commerce on a business-to-
consumer or business-to-business basis are still in existence today: widespread use of
personal computers, the adoption of intranets in companies, the acceptance of the Internet
as a business communications platform, and faster and more secure systems. Numerous
benefits—such as access to a broader customer base, lower information dissemination
costs, lower transaction costs, and the interactive nature of the Internet—will continue to
expand the volume of e-commerce.
Using E-Commerce Creatively
Electronic commerce is increasingly used by existing corporations to extend their marketing
and sales channels, as well as being the basis for some new ventures. The Internet is espe-
cially important for small and medium-sized companies, as it enables them to minimize
marketing costs while reaching broader markets. An entrepreneur starting an Internet com-
merce venture needs to address the same strategic and tactical questions as any other entre-
preneur. Additionally, some specific issues of doing business online need to be addressed
due to the new and perpetually evolving technology used in Internet commerce. An entre-
preneur has to decide whether he or she will run the Internet operations within the company
or outsource these operations to Internet specialists. In the case of in-house operations, com-
puter servers, routers, and other hardware and software as well as support services such as
Web site information have to be maintained. Alternatively, there are numerous possibilities
for outsourcing the Internet business. The entrepreneur can hire Web developers to design
the company’s Web pages and then upload them on the server maintained by the Internet
service provider. In this case, the entrepreneur’s main task is to regularly update the infor-
mation on the Web pages. Another option is to use the packages for e-commerce available
from different software companies. The correct decision between in-house operations or out-
sourcing depends on the size of the Internet-related business, particularly where Internet
operations are the company’s primary business, and the relative costs of each alternative.
The two major components of Internet commerce are front-end and back-end opera-
tions. Front-end operations are encompassed in the Web site’s functionality. Search capa-
bilities, shopping cart, and secure payment are only a few examples. The biggest mistake
made by many companies on the Internet is believing that an attractive, interactive Web site
will secure success; this leads to underestimating the importance of back-end operations.
Seamless integration of customer orders should be developed, with distribution channels
and manufacturing capabilities that are flexible enough to handle any specific customer’s
desire. The integration of front-end and back-end operations represents the greatest chal-
lenge for doing Internet business and at the same time provides the opportunity for developing
a sustained competitive advantage.
Web Sites
The use of Web sites by entrepreneurial firms has been increasing at a significant rate.
About 90 percent of small businesses today have operating Web sites. However, the major-
ity of small businesses and entrepreneurs feel that they do not have the technical capability
to build and operate quality Web sites.
One of the keys to a good Web site is ease of use. In a 2008 ranking by Forrester of 114 Web
sites according to usefulness, ease of use, and enjoyability, Barnes & Noble was ranked num-
ber one, followed by USAA, Borders, Amazon, Costco, and Hampton Inn/Suites.
In developing a Web site, an entrepreneur needs to remember that a Web site is a com-
munication vehicle and should address the following questions: Who is the audience? What
are the objectives for the site? What do you want the consumers to do upon visiting the
site? Is the Web site an integral part of the venture’s total communications program? In ad-
dressing these questions, the entrepreneur needs to structure the Web site and organize the
information to effectively engage the target market. This requires that the material be fresh,
with new material added on a regular basis. The material should be interactive to engage
the individual. And, of course the Web site needs to be known and as visible as possible.
One of the most important features of every Web site is search capability. It should be
easy to find information about the products and services that a company offers over the
118 PA RT 2 FROM IDEA TO THE OPPORTUNITY
Internet. This function can be accomplished through an advanced search tool, site map, or
subject browsing. Other functions that should be available on every e-commerce Web site
are shopping cart, secure server connection, credit card payment, and a customer feedback
feature. Shopping cart is software that accepts product orders and automatically calculates
and totals customers’ orders based on the product availability information. Orders and other
sensitive customer information should be transferred only through secure servers. Another
important feature of the Web site is an e-mail response system that allows customers to
send their feedback to the company.
There are three characteristics of successful Web sites: speed, speed, and speed. Addition-
ally, a Web site should be easy to use, customized for specific market target groups, and com-
patible with different browsers. Ease of use goes hand in hand with speed; if visitors find Web
pages easy to navigate, then they will be able to quickly find products, services, or informa-
tion. One of the greatest advantages of the Internet is the simplicity of customization of the
Web site content for different market segments. It should also take into consideration the
international nature of the Internet and any nontargeted segments. For example, if a company
is not planning to sell products beyond the U.S. border, then it should clearly indicate on its
Web site that it is shipping its products only within the United States. If, on the other hand,
the company is targeting international markets as well, then issues of translation and cultural
adaptation need to be considered. As for the technical aspects, the designer should ensure that
the Web site works properly in different browsers and platforms that are used by Internet
visitors. Once the Web site is operational, it is important that it appears in all marketing mate-
rials, including business cards, company letterhead, and of course company advertising.
A good example of Web site development and operation is Transition Networks Inc.
(www.transition.com). The Minneapolis-based company is in the high-technology business of
marketing local area network (LAN) hardware. The company had these goals for its Web site:
help control collateral costs, provide a mechanism for easily accessible product and technol-
ogy training for resellers, provide a mechanism for getting to know resellers better, and pro-
vide company exposure to end users of the company’s products. To meet these goals, Transi-
tion Networks designed a Web site that is multilayered. The site is interactive in the test
procedure with the participant getting immediate feedback concerning responses given. The
site is coordinated in both content and graphics with other marketing communications of the
company, with the front page of the site updated weekly to draw people and give them a rea-
son to revisit. The content of the site is updated every two weeks with at least one new item.
Tracking Customer Information
Electronic databases support the strategy of personalized one-to-one marketing. The data-
base can not only track activity of the industry, segment, and company but also support
personal marketing targeted at individual clients. The motivation for tracking customer
information is to capture customer attention with customized one-to-one marketing. Care
must be taken in doing this to follow the laws protecting the privacy of individuals.
Doing E-Commerce as an Entrepreneurial Company
The decision to go online for the first time and develop an e-commerce site for your busi-
ness needs to be a strategic one and should be based on several factors. First, the products
should be able to be delivered economically and conveniently. Fresh fruits and vegetables
for individual consumers are not very appropriate for online sales and long-distance deliv-
eries. Second, the product has to be interesting for a large number of people and the com-
pany must be ready to ship the product outside its own geographical location. Third, online
C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 119
operations have to bring significant cost reductions compared with the present brick-and-
mortar operations. The fourth factor reflects the company’s ability to economically draw
customers to its Web site.
Conflict between traditional and online marketing channels (channel conflict) arises be-
cause of disagreements between manufacturers and retailers, which eventually lead into a
hostile, competing position of once-partnering companies. Partners in supply chains have
to focus on their core competencies and outsource the noncore activities. When introduc-
ing the competing distribution channels, companies have to weigh the costs and benefits of
that decision while taking into account the loss of existing business.
120 PA RT 2 FROM IDEA TO THE OPPORTUNITY
IN REVIEW
S U M M A R Y
The starting point for any successful new venture is the basic product or service to be of-
fered. This idea can be generated internally or externally through various techniques.
The possible sources of new ideas range from the comments of consumers to
changes in government regulations. Monitoring the comments of acquaintances, eval-
uating the new products offered by competitors, becoming familiar with the ideas
contained in previously granted patents, and becoming actively involved in research
and development are techniques for coming up with a good product idea. In addition,
there are specific techniques entrepreneurs can use to generate ideas. For example, a
better understanding of the consumer’s true opinions can be gained from using a
focus group. Another consumer-oriented approach is problem inventory analysis,
through which consumers associate particular problems with specific products and
then develop a new product that does not contain the identified faults.
Brainstorming, a technique useful in both idea generation and problem solving,
stimulates creativity by allowing a small group of people to work together in an open,
nonstructured environment. Other techniques useful in enhancing the creative process
are checklists of related questions, free association, idea notebooks, and the “big-
dream” approach. Some techniques are very structured, while others are designed to
be more free form. Each entrepreneur should know the techniques available.
Once the idea or group of ideas is generated, the planning and development
process begins. If a large number of potential ideas has been uncovered, the ideas
must be screened and evaluated to determine their appropriateness for further devel-
opment. Ideas showing the most potential are then moved through the concept stage,
the product development stage, the test marketing stage, and finally into commercial-
ization. The entrepreneur should constantly evaluate the idea throughout this process
to be able to successfully launch the venture.
R E S E A R C H T A S K S
1. Choose a product or technology. Interview five consumers who buy that product
and ask them what major problems they have with the product (or what major
things they dislike about it). Then ask them to describe the attributes of the
“perfect product” that would satisfy all their needs and replace the existing
product. Next, interview the representatives of five companies that offer the
product and ask them what they believe are the major problems customers
experience with their product. Come up with some futuristic solutions.
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C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 121
2. Obtain a patent of a technology (e.g., go to the patent office Web site) and come
up with 10 creative uses of the technology.
3. Choose three different products that you might be interested in purchasing and
that are sold on the Internet. For each product, visit three Web sites and go
through the process as if you were going to actually purchase the product. Which
Web site was the best? Why? Which was the worst? Why? If you could create the
perfect Web site, what features would it have?
C L A S S D I S C U S S I O N
1. Take the following problem statement and brainstorm solutions. Be prepared to
present your three most “creative” solutions. Problem statement: “Customers too
frequently use an airline and fly to a destination only to find out that their
luggage has not arrived.”
2. Choose a product and use the checklist method to develop new ideas. Be prepared
to discuss your product and the three most creative ideas generated.
3. Do you think that the Internet can be a source of advantage for one firm over
other firms or do you think that it is a necessity just to be able to compete? Be
prepared to justify your answer.
S E L E C T E D R E A D I N G S
Anonymous. (June 2008). Can America Keep Its Competitive Edge? The Economist.com. Available from: Global Agenda. Business View. London: The Economist Newspaper Limited, 3. www.economist.com/business/displaystory.cfm?story_id=11482838.
The anonymous author of this article critiques an April 2008 report released by the Brookings Institute and the Information Technology & Innovation Foundation, two Washington, D.C., think tanks. Home to Benjamin Franklin, Eli Whitney, the Wright brothers, and Jonas Salk, the United States has prided herself on her track record of entrepreneurial inventiveness. The U.S. business climate—historically conducive to protecting intellectual property rights and nurturing adventurers—will stagnate without increased federal funding for inventors, according to the think-tank fore- cast. The author disagrees with this solution, citing as an example the small surgical technology firm that displaced the now-defunct Bear Stearns on the S&P.
Barrett, Mike; and Mark Simmonds. (January 1, 2009). Creativity on Tap. Training Jour- nal, pp. 34–38.
Two British marketing coaches authored a four-part series about coupling business processes with personal development. The article is packed with illustrations, graphs, and tables demonstrating the inextricable link between a person’s social interac- tions and his or her creativity. Cooperative teams have the potential to incubate the most revolutionary innovations; powerful is the team whose members are commu- nicative, receptive, and at ease with each other. The authors attempt to pin down the ephemeral subtleties that can help or hinder a group’s collective productivity. Through several anecdotal examples, the authors package the key ingredients nec- essary for a fruitful group endeavor.
Baucus, Melissa S.; William I. Norton, Jr.; David A. Baucus; and Sherrie E. Human.
(2008). Fostering Creativity and Innovation without Encouraging Unethical Behavior. Journal of Business Ethics, vol. 81, no. 1, pp. 97–115. Available from: ABI/INFORM Global. Accessed March 11, 2009, Document ID: 1502952361.
The principal author of this article is an entrepreneurship professor at the University of Louisville. Interested in scandals in the business sector, the author—in this
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122 PA RT 2 FROM IDEA TO THE OPPORTUNITY
article—illustrates the ethical dilemma inherent in contemporary innovation and creativity models. Every MBA go-getter and corporate pedant knows the cliché recipe for success: buck the system, rock the boat, think outside the box, throw caution to the wind, defy the odds, eliminate “can’t” from the vocabulary, take no prisoners, etc. The article includes empirical research data suggesting this puffy rhetoric is ineffective and outdated; businesses want employees to toe the line.
Hamel, Gary. (February 2009). Moon Shots for Management. Harvard Business Review, vol. 87, no. 2, pp. 91–98.
This article details the results of a study conducted by the Silicon Valley’s Manage- ment Lab. Founded by professors from the London Business School and funded in part by UBS, the Management Lab collaborates with corporations to design original management strategies. In May 2008, the Lab organized an effort to describe a plan for managers in the next century. The “moon shots” to which the author refers are objectives for tomorrow’s business managers. Among these aspirations are impera- tives to better maximize employees’ talents and resourcefulness.
Harrison, Sam. (January 1, 2009). Be Inspired to Innovate. Communication World, pp. 17–20.
The author of this article compares entrepreneurial innovators to gamblers at a Las Vegas casino. Just as intelligent blackjack or baccarat players devise strategies to improve their chances of a winning hand, so can entrepreneurs train their brain- storming process for optimal success. The author purports, human creativity is not haphazard; entrepreneurs can develop a mechanism to effectively nurture and channel their bright ideas in order to beat bankruptcy and stave off insolvency, for example. Mr. Harrison, in his article, provides a five-step guide to sharpening the focus of the mind’s eye to achieve practical results.
Newman, Rick. (September 25, 2006). Lessons from the Rule Breakers: These “Maver- icks” at Work Use Fresh Thinking to Win at Business. U.S. News & World Report.
Rick Newman, journalist for U.S. News & World Report, in this article reviews yet an- other addition to the how-to-succeed-in-business literature: Mavericks at Work: Why the Most Original Minds in Business Win by William Taylor and Polly LaBarre. Published in 2006, the book includes profiles of 32 entrepreneurs of note; these “mavericks,” as the title suggests, have gone against the grain of traditional busi- ness norms and been rewarded with success. Rick Newman condenses the book into five key tips for would-be innovators stuck in the 9-to-5 grind.
Petersen, Chris. (October 22, 2008). Inspiring Creativity: The Big Ideas. U.S. Business Review, pp. 8–9. Available from: Schofield Media Ltd. Accessed March 11, 2009. www.usbusiness-review.com/content/view/1074/31/.
This article is a brief exploration into the whys and wherefores of business produc- tivity, which, opines the author, is closely related to business creativity. Though creativity and productivity are equally important to the successful functioning of the business, enforcing employee creativity is a decidedly more elusive task. The author illustrates four insightful guidelines for motivating imagination and boost- ing a business’s creativity quotient.
E N D N O T E S
1. For an in-depth presentation on focus group interviews in general and quanti- tative applications, see “Conference Focuses on Focus Groups: Guidelines, Re- ports, and ‘the Magic Plaque,’” Marketing News (May 21, 1976), p. 8; Keith K. Cox, James B. Higginbotham, and John Burton, “Application of Focus Group Interviews in Marketing,” Journal of Marketing 40, no. 1 (January 1976), pp. 77–80; and Robert D. Hisrich and Michael P. Peters, “Focus Groups: An
C H A P T E R 4 CREATIVITY AND THE BUSINESS IDEA 123
Innovative Marketing Research Technique,” Hospital and Health Service Administration 27, no. 4 (July–August 1982), pp. 8–21.
2. Knut Holt, “Brainstorming—From Classics to Electronics,” Journal of Engineer- ing Design 6, no. 1 (1996), pp. 77–84.
3. A discussion of each of these techniques can be found in Robert D. Hisrich and Michael P. Peters, Marketing Decisions for New and Mature Products (Columbus, OH: Charles E. Merrill, 1984), pp. 131–46; and Robert D. Hisrich, “Entrepreneurship and Intrapreneurship: Methods for Creating New Companies That Have an Impact on the Economic Renaissance of an Area,” in Entrepreneurship, Intrapreneurship, and Venture Capital (Lexington, MA: Lexington Books, 1986), pp. 77–104.
4. For a discussion of this aspect, see Charles H. Clark, Idea Management: How to Motivate Creativity and Innovation (New York: AMACOM, 1980), p. 47.
5. For a discussion of this technique, see J. Geoffrey Rawlinson, Creative Thinking and Brainstorming (New York: John Wiley & Sons, 1981), pp. 124, 126; and W. E. Souder and R. W. Ziegler, “A Review of Creativity and Problem-Solving Techniques,” Research Management 20 (July 1977), p. 35.
6. This method is discussed in J. W. Haefele, Creativity and Innovation (New York: Van Nostrand Reinhold, 1962), pp. 145–47; Sidney J. Parnes and Harold F. Harding (eds.), A Source Book for Creative Thinking (New York: Charles Scribner’s Sons, 1962), pp. 307–23; and Souder and Ziegler, “A Review of Creativity and Problem- Solving Techniques,” pp. 34–42.
7. Alex F. Osborn, Applied Imagination (New York: Scribner Book Companies, 1957), p. 318.
8. Rawlinson, Creative Thinking, pp. 52–59. 9. For a thorough discussion of the collective notebook method, see J. W. Haefele,
Creativity and Innovation, p. 152. 10. Parnes and Harding, A Source Book for Creative Thinking, p. 308. 11. For a discussion of this approach, see M. O. Edwards, “Solving Problems Cre-
atively,” Journal of Systems Management 17, no. 1 (January–February 1966), pp. 16–24.
12. The procedure for parameter analysis is thoroughly discussed in Yao Tzu Li, David G. Jansson, and Ernest G. Cravalho, Technological Innovation in Educa- tion and Industry (New York: Reinhold, 1980), pp. 26–49, 277–86.
13. For some examples of this research and models, see Lenny Herron and Harry J. Sapienza, “The Entrepreneur and the Initiation of New Venture Launch Activi- ties,” Entrepreneurship: Theory and Practice (Fall 1992), pp. 49–55; C. M. Gaglio and R. P. Taub, “Entrepreneurs and Opportunity Recognition,” Babson Research Conference (May 1992), pp. 136–47; L. Busenitz, “Research on Entrepreneurial Alertness,” Journal of Small Business Management 34, no. 4 (1996), pp. 35–44; S. Shane, “Prior Knowledge and Discovery of Entrepreneurial Opportunities,” Organizational Science 11, no. 4 (2000), pp. 448–69; Hean Tat Keh, Maw Der Foo, and Boon Chong Lim, “Opportunity Evaluation under Risky Conditions: The Cognitive Process of Entrepreneurs,” Entrepreneurship: Theory and Prac- tice (Winter 2002), pp. 125–48; and Noel J. Lindsay and Justin Craig, “A Frame- work for Understanding Opportunity Recognition,” Journal of Private Equity (Winter 2002), pp. 13–25.
14. For a detailed description of this process, see Robert D. Hisrich and Michael P. Peters, Marketing Decisions for New and Mature Products (Columbus, OH: Charles E. Merrill, 1991), pp. 157–78.
1
To understand the aspects and importance of identifying good domestic or international opportunities.
2
To be able to identify these opportunities.
3
To be able to create an opportunity analysis plan.
4
To present the problems and barriers of entering global markets.
5
To be able to select a global market.
6
To understand the options for entering a foreign market.
5 I D E N T I F Y I N G A N D A N A LY Z I N G D O M E S T I C
A N D I N T E R N AT I O N A L O P P O RT U N I T I E S
L E A R N I N G O B J E C T I V E S
125
O P E N I N G P R O F I L E
A. MALACHI MIXON III
Creativity, risk taking, and innovation in entrepreneurship are essential not only to the
inception of new products and ventures, but also to a firm’s successful transition into
global markets. The case of Mal Mixon’s notable revitalization of tiny Invacare Corpo-
ration exemplifies this connection.
Invacare traces its existence to the 1895 beginnings of
the Worthington Company, a small Elyria, Ohio, firm that
manufactured a line of vehicles especially designed for the
physically challenged. Having undergone numerous changes
due to mergers and acquisitions, the Worthington Company’s small wheelchair business
was sold to local investors, but on the basis of traditional business evaluation measures,
there was not much to buy. Sales in 1979 were $19 million with 350 employees; the
principal products were unwieldy, clunky steel manual wheelchairs, and no new products
were on the drawing boards. The 1979 pro forma earnings statement that followed a
Mixon-led leveraged buyout (LBO) indicated net earnings of only $100,000. Everest &
Jennings, a public competitor more than seven times Invacare’s size, controlled 80 percent
of the domestic wheelchair market.
Mal Mixon, then vice president of marketing for the CT scanner products division
of Johnson & Johnson’s Technicare subsidiary, saw beyond manual wheelchairs and
focused instead on the potential for home medical products. Assembling a group of
local investors, he spearheaded a leveraged acquisition funded with $1.5 million of
equity and $6.3 million in debt. The influence of Mixon’s nurturing father, coupled with
the effects of his upbringing in the small Oklahoma farming town of Spiro, instilled
Mixon with confidence and a strong sense of purpose and determination. Intellectually
curious, he learned to dream of the possibilities in life, to question everything, to take
intelligent risks, to be persistent, and to become a fierce competitor. After he gradu-
ated from Harvard College, these traits were reinforced and supplemented with lead-
ership skills acquired through four years of service in the Marine Corps, where he also
learned how to deal with adversity. “You are taught to reach your objective no matter
what . . . you never have an excuse for failure,” says Mixon. Returning from the Marine
Corps in 1966, Mal went back to Harvard for his MBA, graduating with distinction. He
initially worked as a salesman, then became sales manager, and later was director of
www.invacare.com
marketing for the Cleveland-based Harris Corporation. He moved to Ohio Nuclear, a
subsidiary of Technicare, where he rose to vice president of sales and marketing of the
CT scanner division. Mal was 39 years old when Johnson & Johnson divested Invacare.
Investing $10,000 of his own funds, $40,000 borrowed from friends, and a $100,000
note from Invacare, Mal took control of the company on January 2, 1980, retaining a
15 percent share. With a fierce tenacity reminiscent of the Marine Corps’s “bulldog”
mascot, Mixon’s restructuring of Invacare was immediate and total. He soon replaced
16 of the 18 direct sales staff—“They didn’t have fire in their bellies, and they didn’t
have the necessary talent”—and, more importantly, began working with the com-
pany’s engineers to produce new products, believing that without a good product,
nothing else matters. He initiated “one-stop shopping” by expanding the home health
care line and cajoling, pleading, and offering volume discounts to skeptical customers
to increase business. The three-pronged attack of revitalization, product/service devel-
opment, and aggressive competitive orientation proved effective, and soon Invacare
was capturing market share from Everest & Jennings. In the process, Invacare reduced
the weight of its standard wheelchairs from 68 to 15 pounds, introduced microproces-
sor electronic control systems for power wheelchairs, and offered “30 different crazy
colors,” while dramatically reducing lead times. Everest & Jennings watched its wheel-
chair market share erode from 80 to 5 percent today.
Sales and earnings accelerated through the early 1980s and by the end of 1983, In-
vacare had $70 million in sales and $2.8 million in net earnings. In 1984, the company
went public to obtain operating capital and to pay down the short-term debt that
helped fund the company’s growth during the 1980s. The initial public offering ($11
adjusted to two stock splits, or $2.75/share on NASDAQ) raised $15 million.
A major challenge presented itself in 1986 when a Taiwanese competitor began sell-
ing in the United States at 20 percent below prevailing prices. Aided by the facilities
consolidations and plan reconfigurations that were launched in 1985, Invacare relo-
cated some of its manufacturing to Mexico. This further improved its overall cost struc-
ture and competitive position. Invacare attacked the competition, meeting the imports
head-on in price, with a superior product and a more extensive distribution and serv-
ice capability. Because of Invacare’s aggressive response, the Taiwanese imports failed
to gain a foothold and ceased to be a major market factor by 1987. Sales, product
lines, and earnings have increased steadily since. Invacare posted $100 million in sales
in 1986, surpassed $200 million in 1990, $600 million in 1996, $1 billion in 2001, and
$1.8 billion in 2008.
Product lines now include manual and powered wheelchairs; home respirator de-
vices for oxygen, aerosol, and sleep therapy; home care beds; assistive aids; replace-
ment parts; disposables; and electronic control systems. From a tenuous and ambitious
beginning ($19 million in sales and a 10 percent market share in standard wheelchairs),
Invacare, headquartered in Elyria, Ohio, has manufacturing plants in the United States,
Australia, Canada, China, Denmark, Germany, France, Mexico, New Zealand, Portugal,
Sweden, Switzerland, and the United Kingdom, and has 6,100 employees worldwide.
The company conducts business in more than 80 countries around the world and has
126 PA RT 2 FROM IDEA TO THE OPPORTUNITY
the largest distribution network in the industry. In 2008, Invacare had revenue of
$1.8 billion, experiencing a 17 percent (from $19 million in 1979 to $1.8 billion in 2008)
annual compounded average sales growth. Net income had a 23 percent increase from
$100,000 in 1979 to $38.6 million in 2008 annual compounded growth in net income.
Mal Mixon continues to adapt and successfully manage a rapidly expanding com-
pany on a global level. Mixon is also recognized as a visionary leader. As stated by a
friend and business acquaintance, “He’s able to develop a vision faster than most peo-
ple can pick up the telephone.” The abilities to develop and articulate a sound vision,
plan and execute an appropriate strategy for the enterprise, and maintain sound val-
ues are important elements of leadership, according to Mixon. Frequently, however, it
is difficult for an entrepreneur to bridge the gap, or to manage and expand a venture,
as evidenced by Steve Jobs and the turbulent growth of Apple Computer. As a new
venture grows, there can be a need for more and more administration. It appears that
this has been attended to in Invacare, as Mal has built a strong management team.
Also, at times, a new infusion of the entrepreneurial spirit that has formed the venture
is needed. Balancing entrepreneurship with administration becomes the challenge. As
Mal puts it, “Entrepreneurship is creating business as opposed to administering business
and having extensive personal capital at risk as opposed to compensation for a job.”
INTRODUCTION
Unlike Mal Mixon, many entrepreneurs find it difficult to identify a market opportunity
and expand the venture, especially in the global marketplace. To start and expand a venture,
an entrepreneur needs to identify opportunities for domestic and international expan-
sion. As a new venture grows and matures, a need can develop for different management
skills as well as for a new infusion of the entrepreneurial spirit (intrapreneurship), as dis-
cussed in Chapter 2. Some entrepreneurs forget that a basic axiom in business is that the only
constant is change. Entrepreneurs like Mal Mixon, who understand this axiom, effectively
manage change by continually adapting organizational culture, structure, procedures,
strategic direction, and products in both a domestic and an international orientation. Entre-
preneurs in such developed countries as the United States, Japan, the United Kingdom, and
the European Union must sell their products in a variety of new and different domestic
market areas early on in the development of their firms or, as in the case of Mal Mixon’s
Invacare, determine how to expand into and prosper in international markets.
Never before in the history of the world have there been such interesting and excit-
ing international business opportunities. The opening of the once-controlled economies
of Eastern and Central Europe, the former U.S.S.R., the People’s Republic of China, and
Vietnam to market-oriented enterprise and the advancement of the Pacific Rim are just
a few of the myriad of possibilities for entrepreneurs wanting to start or grow in a foreign
market.
As more and more countries become market oriented and developed, the distinction be-
tween foreign and domestic markets will be less pronounced. What was once only pro-
duced domestically is now produced internationally. This blurring of national identities will
C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 127
continue to accelerate as more and more products are introduced outside domestic bound-
aries earlier in the life of entrepreneurial firms.
In the past decade, organizations have been attempting to redefine themselves as truly
global organizations. The pressure to internationalize is being felt in virtually every organ-
ization: nonprofit and for-profit, public and private, large and small. This need to inter-
nationalize is accelerating due to the self-interest of the organizations themselves as well
as the impact of a variety of external events and forces. Who would have believed a
decade ago that today seven-eighths of the markets of the world would have some degree
of market economics? Few predicted the rapid collapse of controlled economies that
opened up astoundingly large new market opportunities and potentially more significant
competition. Who would have ever imagined that a trading agreement would emerge be-
tween Canada, Mexico, and the United States, creating one of the world’s largest and
most prosperous trading blocs? Or who would have imagined the rise of economic power
in China to become one of the largest economies in the world? Or the solidification of
diverse nations into the European Union?
These changes are well recognized by organizations, which are investing trillions of
dollars in a world economy that features emerging markets as the vehicles of future growth
and one in need of major investment in infrastructure. Just ask the potato farmers in the
Chuvash Republic of Russia, who saw 26 percent of their crop rot because of inadequate
distribution and warehousing, whether there is a need for such investment in infrastructure.
Or, ask the economics professor in the former U.S.S.R., who has to leave the university to
find other employment due to the low university wages, whether massive investment is
needed. Clearly, developing countries need training and education as well as infrastructure
to support their development and growth in the next century.
There are also new market opportunities in Latin and South America, Africa, the Pacific
Rim, Vietnam, Iraq, and countries throughout the world that are in transition. These areas
are becoming major attractions to companies that want to grow and establish a market
position as these economies change and go through privatization and deregulation.
The internationalization of entrepreneurship and business creates wealth and employ-
ment that benefits individuals and nations throughout the world. International entrepreneur-
ship is exciting as it combines the many aspects of domestic entrepreneurship with such
other disciplines as anthropology, economics, geography, history, jurisprudence, and lan-
guage. In today’s hypercompetitive world with rapidly changing technology, it is essential
for an entrepreneur to at least consider entering a market outside the company’s national
borders.
International markets offer entrepreneurial companies new market opportunities. Since
1950, the growth of international trade and investment has been generally larger than the
growth of domestic economies. A combination of domestic and international sales offers
the entrepreneur an opportunity for expansion and growth that is not available in the do-
mestic market alone. Using today’s rapidly changing technology, an entrepreneur can have
an even brighter growth potential in the future in today’s truly global world.
OPPORTUNITY RECOGNITION AND THE OPPORTUNITY
ASSESSMENT PLAN
The key to successful domestic and international entrepreneurship is to develop an idea
that has a market with a need for the product or service idea conceived. The ideation
process explained in Chapter 4 needs to be thought of in terms of satisfying a specific market
need or as one entrepreneur stated, “making the customer more profitable.”
What is deemed to be “profitable” varies by the product/service idea and particularly
whether the idea is an industrial product (business-to-business market) or a consumer product
128 PA RT 2 FROM IDEA TO THE OPPORTUNITY
(business-to-consumer market). This is best accomplished through the development of a
market opportunity analysis plan.
Opportunity assessment is often best accomplished by developing an opportunity as-
sessment plan. An opportunity assessment plan is not a business plan. Compared to a busi-
ness plan, it should:
• Be shorter.
• Focus on the opportunity, not the venture.
• Have no computer-based spreadsheet.
• Be the basis for making the decision to either act on an opportunity or wait until another, better opportunity comes along.
An opportunity assessment plan has four sections—two major sections and two minor
sections. The first major section develops the product/service idea, analyzes the competi-
tive products and companies, and identifies the uniqueness of the idea in terms of its unique
selling propositions. This section includes:
• A description of the product or service.
• The market need for the product or service.
• The specific aspects of the product or service.
• The competitive products available filling this need and their features.
• The companies in this product market space.
• The unique selling propositions of this product or service.
Some data sources for determining competition and market size are further discussed in
the section on foreign market selection in this chapter.
The second major section of the opportunity assessment plan focuses on the market—
its size, trends, characteristics, and growth rate. It includes:
• The market need filled.
• The social condition underlining this market need.
• Any market research data available to describe this market need.
• Any potential patents that could be obtained.
• The size and characteristics of the domestic and/or international market.
• The growth rate of the market.
The third section (a minor one) focuses on the entrepreneur and the management team
in terms of their skills and experience. It should include answers to the following questions:
• Why does this opportunity excite you?
• How does the product/service idea fit into your background and experience?
• What business skills do you have?
• What business skills are needed?
• Do you know someone who has these skills?
The final section of the opportunity assessment plan develops a time line indicating
what steps need to be taken to successfully launch the venture and translate the idea into a
viable business entity. This minor section should focus on:
• Identifying each step.
• Determining the sequence of activities and putting these critical steps into some expected sequential order.
C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 129
• Determining the time and money required at each step.
• Determining the total amount of time and money needed.
• Identifying the source of this needed money.
INFORMATION SOURCES
There are many sources of information both on competitive companies and products/services
and the market size and characteristics available to the entrepreneur in identifying an
appropriate opportunity as well as assistance in starting a new venture. These will be dis-
cussed in terms of general information sources, industry and market information sources,
competitive company and product information, government sources, search engines, trade
associations, and trade publications.
General Information
Information and assistance is readily available for entrepreneurs, particularly those starting
a new venture. SCORE (www.score.org) is a nonprofit organization that provides free on-
line and in-person assistance in about 400 chapter locations throughout the United States.
The assistance takes the form of training, consulting, and mentoring provided mainly by
retired executives and entrepreneurs.
Small Business Development Centers (sba.gov/aboutsba/sbaprograms/sbdc/sbdclocator/
index.html) has small business development centers in over 1,100 locations throughout the
United States. It provides counseling, training, and technical assistance on all aspects of
starting and managing a new venture. Each location also has an on-site resource library.
These centers are a part of the overall SBA (Small Business Administration) (sba.gov),
which also provides a wide variety of resources and tools for the entrepreneur. One of the
helpful items in the SBA’s resource library is the Small Business Planner, a step-by-step
guide for starting your new venture. The SBA also has a Women’s Business Center and a
Minority Business Center.
The U.S. Chamber Small Business Center (uschamber.com/sb) provides start-up as-
sistance mainly through Web-based tools and resources. Its start-up toolkit is very help-
ful in starting a business as it focuses on everything from evaluating an idea to developing
a business plan, accessing capital, and launching the venture. Other useful tools for var-
ious business documents, such as spreadsheet templates and other government forms, are
also provided under the “Tools” section.
Other valuable Web sites providing useful information include:
1. National Association of Small Business Investment Companies (nasbic.org). Provides
an online database of small venture capital firm members and a guide to obtaining
SBIC financing.
2. National Venture Capital Association (nvca.org). Provides information on the venture
capital industry as well as access to state and regional venture capital firms.
3. National Business Incubation Association (nbia.org). Provides information on the role
of incubators, how to select the right incubator, and a listing of national and interna-
tional incubators.
4. FastTrac (www.fasttrac.org). Funded by the Kauffman Foundation, provides educa-
tional programs for entrepreneurs throughout the United States.
5. Active Capital (ACE-Net, activecapital.org). Provides an opportunity for entrepreneurs
to connect with accredited investors throughout the United States. Counseling, men-
toring, and training are also provided.
130 PA RT 2 FROM IDEA TO THE OPPORTUNITY
6. Collegiate Entrepreneurs’ Organization (CEO, c-e-o.org). Provides information on
entrepreneurship programs at the undergraduate level at numerous colleges and
universities.
7. Consortium for Entrepreneurship Education (entre-ed.org). Provides information on
entrepreneurship programs and education throughout the United States.
8. Ewing Marion Kauffman Foundation (kauffman.org). Provides resources for entrepre-
neurship education and research and lists the angel (private investor) groups through-
out the United States.
Industry and Market Information
There are a wide variety of databases available that provide significant information about
the industry and market. These include:
1. Plunkett. Provides industry data, market research, trends and statistics on markets, and
forecasts.
2. Frost and Sullivan. Provides very industry-specific information on industries such as
aerospace and defense, chemicals/materials, telecom/IT, consumer products, elec-
tronics, energy, health care, industrial automation, and transportation.
3. Euromonitor. Provides consumer market sizes and marketing parameters as well as
information on companies and brands.
4. Gartner. Provides information on technology markets.
5. Gale Directory Library. Provides industry statistics and a directory of nonprofit organ-
izations and associations.
Competitive Company and Product Information
Besides personally investigating what is available by looking at the various options presently
available for satisfying the market need, several sources supply significant information on
competing products/services and their companies:
1. Business Source Complete. Provides company and industry information by scanning
the Datamonitor reports.
2. Hoovers. Provides information on both large and small companies with links to competi-
tors in the same NAICS (North American Industrial Classification System) category.
3. Mergent. Provides detailed company and product information on U.S. and interna-
tional companies.
Government Sources
There are numerous information sources available from the U.S. government. These in-
clude the following:
• Census reports
• factfinder.census.gov
• www.census.gov/ipc/www/idb
• www.census.gov/econ/census/ (ratios)
• Export/import authority
• UN Comtrade
• www.business.gov/expand/import-export
C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 131
• North American Industrial Classification System (NAICS) and Standard Industrial Classification (SIC) codes
• www.naics.com/info.htm
• www.osha.gov/pls/imis/sic_manual.html
Search Engines
There are many key terms for searching for the needed industry, market, and competitive
information. Some of the better ones are:
• Search: _______ and statistics
• Search: _______ and market share
• Search: _______ and industry
• Search: _______ and association
Trade Associations
Trade associations in the United States and throughout the world are also a good source for
industry data about a particular country. Some trade associations do market surveys of their
members’ domestic and international activities and are strategically involved in interna-
tional standards issues for their particular industry.
132
A S S E E N I N BUSINESSWEEK
MOM-AND-POP MULTINATIONALS
From the outside, the gray Victorian with the stained-
glass windows on a gentrified block in Dorchester,
Mass., is a typical middle-class dream house. But it also
is the headquarters of what you might call a micro-
multinational. Randy and Nicola Wilburn run real es-
tate, consulting, design, and baby food companies
out of their home. They do it by taking outsourcing
to the extreme.
Professionals from around the globe are at their
service. For $300, an Indian artist designed the cute logo
of an infant peering over the words “Baby Fresh Or-
ganic Baby Foods” and Nicola’s letterhead. A London
freelancer wrote promotional materials. Randy has
hired “virtual assistants” in Jerusalem to transcribe
voice mail, update his Web site, and design PowerPoint
graphics. Retired brokers in Virginia and Michigan
handle real estate paperwork.
Global outsourcing is no longer just for big corpo-
rations. Increasingly, Main Street businesses from car
dealers to advertising agencies are finding it easier to
farm out software development, accounting, support
services, and design work to distant lands. Elance, the
Mountain View (Calif.) online-services marketplace
that is the Wilburns’ main connection to the cyber-
workforce, boasts 48,500 small businesses as clients—
up 70% in the past year—posting 18,000 new proj-
ects a month. Sites such as Guru.com, Brickwork
India, DoMyStuff.com, and RentACoder also report
fast growth.
But while other forms of e-commerce caught fire
quickly, Web sites for freelancers have only recently be-
gun to generate much momentum. Market researcher
Evalueserve estimates that revenues for online service
marketplaces will grow 20% in 2008, to $190 million,
far from the initial hype.
Why has it taken buyers and sellers of services
longer to get comfortable trading online than com-
panies dealing in physical goods? An eBay for serv-
ices, says Elance CEO Fabio Rosati, “was a brilliant
idea that started too soon.” But improved software,
search engines, and new features are boosting the in-
dustry. Several sites now allow buyers to view de-
tailed work samples and customer ratings for thou-
sands of service vendors. Guru launched a payment
system to mediate disputes and lets buyers put funds
in escrow until work is received. Elance developed
software to track work in progress and handle billing,
pay, and tax records.
Trade Publications
There are numerous domestic and international publications specific to a particular indus-
try that are also good sources of information. The editorial content of these journals can
provide interesting information and insights on trends, companies, and trade shows by giv-
ing a more local perspective on the particular market and market conditions. Sometimes
trade journals are the best, and often the only, source of information on competition and
growth rates in a particular industry.
THE NATURE OF INTERNATIONAL ENTREPRENEURSHIP
Simply stated, international entrepreneurship is the process of an entrepreneur conducting
business activities across national boundaries. It may consist of exporting, licensing, open-
ing a sales office in another country, or something as simple as placing a classified adver-
tisement in the Paris edition of the International Herald Tribune. The activities necessary
for ascertaining and satisfying the needs and wants of target consumers take place in more
than one country. When an entrepreneur executes his or her business model in more than
one country, international entrepreneurship is occurring.
With a commercial history of only 300 years, the United States is relatively new to the
international business arena. As soon as settlements were established in the New World,
133
Those upgrades are starting to make a difference.
Elance, which makes money by charging subscription
fees and a 4% to 6% cut of each project, expects to-
tal billings to rise 50%, to $60 million, this year. Guru
predicts similar growth, to $26 million.
The Wilburns began buying graphic designs
through Elance in 2000. They say they shifted to rad-
ical outsourcing after reading the 2007 Timothy Ferriss
best-seller, The 4-Hour Workweek: Escape 9-5, Live
Anywhere and Join the New Rich, which extols the
merits of freeing up time by hiring cheap offshore
“virtual assistants” to handle scheduling and other
routine tasks.
Remote help has allowed 38-year-old Randy Wilburn
to shift gears with the economy. His real estate busi-
ness has slowed, so he spends more time advising
nonprofits across the U.S. on how to help homeown-
ers avoid foreclosure. Virtual assistants have handled
routine correspondence and put together business
materials while he’s on the road, all for less than
$10,000 a year. He figures a full-time secretary would
run $45,000. Nicola, a 35-year-old designer, decided
to work from home after she had their second child.
Nicola now farms out design work to freelancers
and is starting to sell organic baby food she cooks
herself. She is setting up a Web site for that busi-
ness and offered $500 for the design work. Of the
20 bidders who responded via Elance, 18 are from
outside the U.S.
The couple uses two main offshore vendors. One
is GlobeTask, a Jerusalem outsourcing firm that
employs dozens of graphic artists, Web designers,
writers, and virtual assistants in Israel, India, and
the U.S. It generally charges $8 an hour. The other
is Kolkata’s Webgrity, which has a staff of 45 and
charges $1 to $1.20 an hour. Five years ago, says
founder Amit Keshan, 32, his company designed
Web sites for Indian clients. Now he does all his busi-
ness through Elance, handling up to 300 jobs each
month for U.S., British, and Australian clients. For
$125, Webgrity designed a logo for Wilburn’s real es-
tate business that Wilburn says would have cost as
much as $1,000 in the U.S.
A worldwide market where even mom-and-pop
businesses outsource could still be years from attain-
ing wide appeal. But micro-multinational entrepre-
neurs like the Wilburns may not be rarities for much
longer. “People will do it the old way until it becomes
a no-brainer to do it the new way,” predicts Elance’s
Rosati.
Source: Reprinted from July 14, 2008 issue of BusinessWeek by special permission, copyright © 2008 by The McGraw-Hill Companies, Inc., “Mom-and-Pop Multinationals,” by Pete Engardio, BusinessWeek, pp. 77–78.
international
entrepreneurship
An entrepreneur doing
business across his or her
national boundary
134 PA RT 2 FROM IDEA TO THE OPPORTUNITY
American businesses began an active international trade with Europe. Foreign investors
helped build much of the early industrial trade as well as much of the early industrial base
of the United States. The future commercial strength of the United States will similarly
depend on the ability of U.S. entrepreneurs and established U.S. companies to successfully
do business in markets outside the country.
THE IMPORTANCE OF INTERNATIONAL BUSINESS TO THE FIRM
International business has become increasingly important to firms of all sizes—particularly
today, when every firm is competing in a hypercompetitive global economy. There can be
little doubt that today’s entrepreneur must be able to move in the world of international
business. The successful entrepreneur will be someone who fully understands how interna-
tional business differs from purely domestic business and is able to respond accordingly,
thereby successfully “going global.”
INTERNATIONAL VERSUS DOMESTIC ENTREPRENEURSHIP
Although both international and domestic entrepreneurs are concerned with sales, costs, and
profits, what differentiates domestic from international entrepreneurship is the variation in
the relative importance of the factors affecting each decision. International entrepreneurial
decisions are more complex due to such uncontrollable factors as economics, politics, tech-
nology, and culture (see Table 5.1).
Economics
In a domestic business strategy, a single country at a specified level of economic devel-
opment is the focus of the firm’s entrepreneurial efforts. The entire country is organized
under a single economic system and has the same currency. Creating a business strategy for
a multicountry area means dealing with differences in levels of economic development;
currency valuations; government regulations; and banking, venture capital, marketing, and
distribution systems. These differences manifest themselves in each aspect of the entrepre-
neur’s international business plan and method of doing business.
Stage of Economic Development
The United States is an industrially developed nation with regional variances. While need-
ing to adjust the business plan according to regional differences, an entrepreneur doing
TABLE 5.1 International versus Domestic Business
• Economics
• Stage of economic development
• Current account
• Type of economic system
• Political–legal environment
• Language
C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 135
business only in the United States does not have to worry about significant lacking of such
fundamental infrastructures as roads, electricity, communication systems, banking facilities
and systems, adequate educational systems, a well-developed legal system, and established
business ethics and norms. These factors vary greatly in other countries, which impacts a
firm’s ability to successfully engage in international business.
Current Account
With the present system of flexible exchange rates, a country’s current account (the differ-
ence between the value of a country’s imports and exports over time) affects the valuation
of its currency. The valuation of one country’s currency affects business transactions
between countries. At one time, Italy’s chronic balance of payments deficit led to a radical
depreciation in the value of the lira, the currency of Italy. Fiat responded by offering signif-
icant rebates on cars sold in the United States. These rebates cost Fiat very little because
fewer dollars purchased many more lire due to the decreased value of the lira. Similar ex-
change rate divergences have occurred for Japanese automobile manufacturers and many
products produced by Chinese firms, including steel and steel alloys.
Type of Economic System
Pepsi-Cola began considering the possibility of marketing in the former U.S.S.R. as
early as 1959, following the visit of U.S. Vice President Richard Nixon. When Premier
Nikita Khrushchev expressed his approval of Pepsi’s taste, the slow wheels of
East–West trade began moving, with Pepsi entering the former U.S.S.R. 13 years later.
Instead of using its traditional type of franchise bottler in this entry, Pepsi used a barter-
type arrangement that satisfied both the socialized system of the former U.S.S.R. and
the U.S. capitalist system. In return for receiving technology and syrup from Pepsi, the
former U.S.S.R. provided the company with Soviet vodka and the distribution rights in
the United States. Many such barter or third-party arrangements have been used to in-
crease the amount of business activity in countries in various stages of development and
transition.
Political–Legal Environment
The variety of different political and legal environments in the international market cre-
ates vastly different business problems, opening some market opportunities for entrepre-
neurs and eliminating others. One significant event in the political–legal environment
involves the price fluctuations and significant increases and decreases in oil and other
energy products.
A country’s legal environment can influence each element of the business strategy of an
entrepreneur. Pricing decisions in a country that has a value-added tax (VAT) will differ
from pricing decisions made by the same entrepreneur in a country with no value-added
tax. The value-added tax addition may increase the price above a price threshold and/or
distort the advantage of ending a price in .79, .89, or .99. Advertising strategies are affected
by variations in what can be said in the copy or in the support needed for advertising claims
in different countries. Product decisions are affected by legal requirements with respect to
labeling, ingredients, and packaging. Types of ownership and organizational forms vary
widely throughout the world. The laws governing business arrangements also vary greatly,
with more than 150 different legal systems and national laws.
current account The
trade status of imports/
exports between countries
barter A method of
payment using nonmoney
items
third-party arrangements
Paying for goods
indirectly through another
source
136 PA RT 2 FROM IDEA TO THE OPPORTUNITY
While most entrepreneurs generally prefer to do business in stable and freely gov-
erned countries, good business opportunities often occur in different conditions. It is im-
portant to assess each country’s policies and stability. This assessment is referred to as
political risk analysis. While there is some political risk in every country, the range from
country to country varies significantly, and even in a country with a history of stability and
consistency, these conditions could change. There are three major types of political risks
that might be present: operating risk (risk of interference with the operations of the ven-
ture), transfer risk (risk in attempting to shift assets or other funds out of the country),
and—the biggest risk of all—ownership risk (risk where the country takes over the ven-
ture’s property and employees). Of course, conflict and changes in the solvency of the
country are major risks to an entrepreneur in a particular country. This can take such forms
as guerilla warfare, civil disturbances, and even terrorism where the entrepreneur’s com-
pany and employees are targets.
A country’s legal system, composed of the rules and laws that are used to regulate behav-
ior as well as the processes by which the laws are enforced, also impacts the entrepreneur.
The laws of a country regulate the business practices in that country, the manner in which
business transactions are executed, and the rights and obligations involved in any business
transaction between parties.
The entrepreneur should have an overall sense of the legal system of a country but usu-
ally needs legal counsel when it comes to specifics. Ideally this legal counsel would have
its headquarters in the United States, with an office in the target country. Several areas are
critical to some extent for every entrepreneur: (1) property rights, (2) contract law, (3) product
safety, and (4) product liability.
Countries vary significantly in the degree to which their legal system protects the prop-
erty rights of the individual and the business. The property rights of a business are the re-
sources owned, the use of these resources, and the income earned from this use. Besides
buildings, equipment, and land, the protection of intellectual property is a very great con-
cern, particularly for technology entrepreneurs. Intellectual property—such as a book,
computer software, a score of music, a video, a formula for a new chemical or drug, or
some other protected idea—is very important to a firm and needs to be protected when go-
ing outside the United States. Legal issues and property protection are discussed in Chap-
ter 6. Few countries have laws and court procedures protecting intellectual property like
those in the United States. You probably have heard how videos can be purchased in China
at 10 percent of the cost in the United States—sometimes even before being officially re-
leased. Even this book—which has legal editions in several languages, including Arabic,
Chinese, Hungarian, Indonesian, Portuguese, Russian, Slovenian, and Spanish—has an il-
legal edition in the Iranian language, as Iran does not recognize world copyright laws. Be-
fore entering a country, the entrepreneur needs to assess that country’s protection of the
intellectual property of her venture and the costs if these are copied illegally.
Another area of legal concern is the contract law of the country and how it is enforced.
A contract specifies the conditions for an exchange and the rights and duties of the parties
involved in this exchange. Contract law varies significantly from country to country, in part
reflecting the two types of legal tradition—common law and civil law. Countries operating
under common law include the United Kingdom, the United States, and most countries of
the former British colonies. Countries operating under civil law include France, Germany,
Japan, and Russia. Common law tends to be relatively nonspecific, so contracts under this
law are longer and more detailed, with all the contingencies spelled out. Since civil law is
much more detailed, contracts under it are much shorter.
In addition to the law itself, the entrepreneur needs to understand how the law might be
enforced and the judicial system securing this enforcement. If the legal system of the country
political risk analysis
Prior to entering into
business in another
country, an assessment of
that country’s political
policies and its stability
C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 137
does not have a good track record of enforcement, the contract should contain an agreement
that any contract disputes will be heard in the courts of another country. Since each com-
pany might have some advantage in its home country, usually another country is selected.
This aspect is very important for entrepreneurs operating in developing economies with lit-
tle or even a bad history of enforcement. One company exporting Hungarian wine into Russia
made sure any disputes in its Russian contracts would be heard in the Finnish court system
rather than the Russian court system.
The final overall area of legal concern pertains to the laws of the country regarding
product safety and liability. Again, these laws vary significantly among countries, from
very high liability and damage awards in the United States to very low levels in Russia and
China. These laws also raise an ethical issue for the entrepreneur, particularly one from the
United States. When doing business in a country where the liability and product safety
laws are much lower than in your home country, should you follow the more relaxed local
standards or adhere to the stricter standards of your home country and risk not being com-
petitive and losing the business?
Language
Sometimes one of the biggest problems for the entrepreneur is finding a translator. As indi-
cated in Table 5.2, significant problems can occur with careless translation. To avoid such
errors, care should be taken to hire a translator whose native tongue is the target language
and whose expertise matches that of the original authors.
TECHNOLOGICAL ENVIRONMENT
Technology, like culture, varies significantly across countries. The variation and availabil-
ity of technology are often surprising, particularly to an entrepreneur from a developed
country. While U.S. firms produce mostly standardized, relatively uniform products that
can be sorted to meet industry standards, this is not the case in many countries, making it
more difficult to achieve a consistent level of quality.
New products in a country are created based on the conditions and infrastructure oper-
ating in that country. For example, U.S. car designers can assume wider roads and less expen-
sive gasoline than European designers. When these same designers work on transportation
vehicles for other parts of the world, their assumptions need to be significantly altered.
TABLE 5.2 Lost in Translation
Even the best-laid business plans can be botched by a careless translator. Here’s how some of
America’s biggest companies have managed to mess things up:
Kentucky Fried Chicken English: “Finger lickin’ good.” Chinese: “Eat your fingers off.”
Adolph Coors Co. English: “Turn it loose.” Spanish: “Drink Coors and get
diarrhea.”
Otis Engineering Corp. English: “Complete equipment.” Russian: “Equipment for
orgasms.”
Parker Pen Co. English: “Avoid embarrassment.” Spanish: “Avoid pregnancy.”
Perdue Farms Inc. English: “It takes a tough man Spanish: “It takes a sexually
to make a tender chicken.” excited man to make a
chick affectionate.”
Source: From “Speaking in Tongues,” Inc. magazine, June 2003. Reprinted with permission of Inc. magazine.
138
CULTURE
Probably the single most important problem confronting the entrepreneur occurs when
crossing cultures. While culture has been defined in many different ways, the term gen-
erally refers to common ways of thinking and behaving that are passed on from parents
to children or transmitted by social organizations, developed, and then reinforced
through social pressure. Culture is learned behavior and the identity of an individual and
society.
Culture encompasses a wide variety of elements, including language, social structure,
religion, political philosophy, economic philosophy, education, and manners and customs
(see Figure 5.1). Language, sometimes thought of as the mirror of culture, is composed
of verbal and nonverbal components. Messages and ideas are transmitted by the spoken
words used, the voice tone, and nonverbal actions such as body position, eye contact, and
gestures. An entrepreneur or someone on her team must have command of the language in
the country in which business is being done. Not only is it important for information gath-
ering and evaluation, but it is also essential for communication among those involved as
well as eventually in developing the advertising campaign. Even though English has gen-
erally become the general language of business, dealing with languages other than English
E T H I C S
In business school, we used to debate whether your
business ethics should adapt to the local environment
or be the same around the world. Many of my class-
mates argued, “When in Rome, do as the Romans
do.” In other words, follow local practices. Those were
the days when leading ethicists like Joseph Fletcher
and James Adams at Harvard were promoting “situa-
tion ethics,” based on flexible, pragmatic approaches
to complex dilemmas.
I listened to their arguments but never could figure
out how leaders of business organizations could op-
erate with one set of principles in their homeland
and another overseas.
In the 1970s, the Foreign Corrupt Practices Act
(FCPA) sent a chill throughout the business commu-
nity by criminalizing the act of making payments
outside the United States in pursuit of contracts. Yet
the practice persisted. Many U.S. executives lobbied
to relax the FCPA’s provisions, arguing that they were
at a competitive disadvantage in bidding against non-
U.S. companies.
RISKING THE COMPANY’S REPUTATION These days the business world has gone global,
which has intensified the ethics debate. Making pay-
ments to obtain business is common practice in many
developing markets in Asia, Africa, the Middle East,
and Eastern Europe, and some companies feel obliged
to play the game to compete. Witness Germany’s
Siemens (SI), which has admitted to nearly $2 billion
in bribes, leading to the resignations of both its
board chairman and its CEO in 2007. Then there’s
Britain’s BAE Systems, which has been accused of
making a $2 billion payment to a Saudi prince to
secure $80 billion in government contracts. (The com-
pany denied the allegation, which is being investi-
gated by the U.S. Justice Dept.)
What’s significant about these ethical scandals is
the damage they do to great institutions. If you were
leading such an organization, would you risk perma-
nently damaging your company to win a few over-
seas contracts? Regrettably, for some executives the
answer is yes.
Forty years of experience has strengthened my
belief that the only way to build a great global com-
pany is with a single global standard of business
practices, vigorously communicated and rigorously
enforced. Applying “situation ethics” in developing
countries is the fastest way to destroy a global organ-
ization. To sustain their success, companies must follow
the same standards of business conduct in Shanghai,
Mumbai, Kiev, and Riyadh as in Chicago.
ENGAGE THE CEO IN THE PROCESS How else will employees in far-flung locations know
what to do when pressured by customers or competi-
ETHICS MUST BE GLOBAL, NOT LOCAL
139
almost always requires local assistance, whether in the form of a local translator, a local
market research firm, or a local advertising agency.
One U.S. entrepreneur was having a difficult time negotiating an agreement on import-
ing a new high-tech microscope from a small entrepreneurial firm in St. Petersburg, Russia.
The problems were resolved when the entrepreneur realized that the translations were not
being done correctly and hired a new translator.
Equally important to the verbal language is the nonverbal or hidden language of the cul-
ture. This can be thought of in terms of several components—time, space, and business
relationships. In most parts of the world, time is much more flexible than it is in the United
States. For example, due to the variability in traffic and the possibility of significant con-
gestion, it is difficult to set exact appointment times in Beijing or Hong Kong. “Irish time”
means that a meeting usually starts anywhere from 15 to 30 minutes after the established
posted time—which one U.S. professor at an Irish university found out when he was in the
meeting room at the appointed starting time and no one showed up until 10 minutes later.
The meeting actually started 15 minutes after that.
The second aspect of nonverbal language is space—in particular, how much room
should exist between individuals when they talk. While Germans prefer more space than
Americans, Arabic and Latin Americans like to stand closer when talking. Also, some cultures,
tors to deviate from company standards? If overseas
managers miss their financial targets because they
adhere to strict ethical standards, can they be confi-
dent management will back them up?
Operating ethically requires much more than a
code of conduct. The CEO and top management must
engage with employees around the world to insist on
transparency and compliance. Otherwise, they will
never know what’s going on. The company must
have a closed-loop system of monitoring and audit-
ing local marketing practices. The “don’t look, don’t
tell” approach is bound to destroy your company’s
reputation. High standards must be enforced with a
zero tolerance policy.
This well-established approach is employed by the
companies on whose boards I serve—ExxonMobil
(XOM), Goldman Sachs (GS), and Novartis (NOVN).
Their employees throughout the world know pre-
cisely what is expected of them. Nothing is more im-
portant to these companies than their reputations,
and they know that nothing destroys reputations
faster than ethical violations.
ETHICS CREATE SHAREHOLDER VALUE
General Electric’s (GE) former general counsel, Ben
Heineman, writes in “Avoiding Integrity Land Mines”
in the Harvard Business Review about high perfor-
mance with high integrity, proposing that performance
and ethics go hand in hand. Heineman argues per-
suasively that CEOs can’t just publish their policies
and enforce them. Rather, they must get personally
involved in ensuring ethical behavior and engaging
employees in vigorous discussions of real-world is-
sues. Otherwise, marginal practices like using agents
to make payments will abound.
Despite the best efforts, there will be deviations.
That’s when leaders are watched most closely by their
subordinates. Will management make an exception
for a top performer?
Early in my time as CEO of Medtronic (MDT) I had
to deal with numerous such deviations that led to the
termination of such high-performing executives as
the president of our European operations and country
managers of Japan, Argentina, and Italy. These actions
sent a powerful message that we were serious about
company standards, and no one was exempt.
The bottom line is that good ethics is good business.
There is a direct correlation between behaving ethi-
cally and creating long-term shareholder value. Fur-
thermore, high integrity in external business dealings
goes hand in hand with creating greater transparency
and increased integrity in internal relationships. This
necessitates choosing leaders who are not only ethi-
cal themselves but also committed to ensuring their
organizations operate ethically at all times.
Bill’s True North Principle: Great global organiza-
tions can be built only from a solid ethical foundation.
Source: Reprinted from February 12, 2008 BusinessWeek by special permission, copyright © 2008 by The McGraw-Hill Companies, Inc., “Ethics Must Be Global, Not Local,” by Bill George, www.businessweek.com/managing/content/feb2008/ ca20080212_394828.htm.
like Hungarian, Russian, and Slavic, hug and even kiss when greeting a known business
partner regardless of gender.
The final aspect of nonverbal language, business relationships, is also critical for the
entrepreneur to understand. In most countries, it is far more important to interact with a
potential business partner on a personal level before any transactions occur or even before
business is discussed. One entrepreneur in Australia met the president, the management
team, and the family on different social occasions before any business was discussed.
Social Structure
Social structure and institutions are also aspects of the culture. While the family unit in the
United States usually consists of parent(s) and children, in many cultures it is extended to
include grandparents and other relatives. This, of course, radically affects lifestyles, living
standards, and consumption patterns.
Social stratification can be very strong in some cultures, significantly affecting the
way people in one social strata behave and purchase. India, for example, is known for its
hierarchical and relatively rigid social class system.
Reference groups in any culture provide values and attitudes that influence behavior.
Besides providing overall socialization, reference groups develop a person’s concept of self
and provide a baseline for compliance with group norms. As such, they significantly impact
an individual’s behavior and buying habits.
The entrepreneur also needs to recognize that the social structure and institutions of a
culture will impact the roles of manager and subordinate and how the two relate. In some
cultures, cooperation between managers and subordinates is elicited through equality, while
in other cultures, the two groups are separated.
140 PA RT 2 FROM IDEA TO THE OPPORTUNITY
Religion
Social structure
Language
Manners and customs Education
Economics and economic philosophy
Political philosophy
Culture Norms and
Value System
FIGURE 5.1 Various Aspects of Culture
C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 141
Religion
Religion in a culture defines the ideas for life that are reflected in the values and attitudes
of individuals and the overall society. The impact of religion on entrepreneurship, con-
sumption, and business in general will vary depending on the strength and impact of the
dominant religious tenets on the values and attitudes of the culture. Religion also provides
the basis for some degree of transcultural similarity under shared beliefs and attitudes, as
seen in some of the dominant religions of the world.
Political Philosophy
The political philosophy of an area also impacts its culture. The rules and regulations of a
country significantly impact the entrepreneur and the way business is conducted. For exam-
ple, embargoes or trade sanctions, export controls, and other business regulations may pre-
clude an entrepreneur from doing business in a particular culture or at the very least will
impact the attitudes and behaviors of people in that culture when business is transacted.
Economics and Economic Philosophy
The economics and economic philosophy of a country impact its culture and the entrepre-
neur. Whether the country overall is in favor of trade or trade restrictions, its attitudes toward
balance of payments and balance of trade, its convertible or nonconvertible currency, and its
overall trading policy all affect not only the decision about whether it is advantageous to do
business in a certain market, but also the types and efficiency of any transactions occurring.
Some countries use import duties, tariffs, subsidization of exports, and other restrictions to
protect the country’s own industry by having more exports than imports. Think how difficult
it would be to do business in a country that restricted the exportation of profits.
Education
Both formal and informal education affect the culture and the way the culture is passed on.
An entrepreneur needs to be aware not only of the education level and the literacy rate of a
culture, but also the degree of emphasis on particular skills or career paths. China, Japan,
and India, for example, emphasize the sciences and engineering more than many cultures.
The technology level of the firm’s products may be too sophisticated depending on the
educational level of the culture. This level also influences whether customers are able to use
the goods or services properly and whether they are able to understand the firm’s advertis-
ing or other promotional messages.
Manners and Customs
Understanding manners and customs, the final aspect of culture, is particularly important for
the entrepreneur in negotiations and gift giving. In negotiations entrepreneurs can come to an
incorrect conclusion because their interpretations are based on their own frame of reference—
not the frame of reference of the culture. For example: the silence of the Chinese and Japan-
ese has been used effectively in negotiating with American entrepreneurs who interpret this
(incorrectly) as a negative sign. Agreements in these countries, as well as other countries in
Asia and the Middle East, take much longer because of the desire to discuss unrelated issues.
Aggressively demanding last-minute changes is a mannerism used by Russian negotiators.
Probably the area that requires the most sensitivity is gift giving. Gifts can be an important
part of developing relationships in a culture, but great care must be taken to ascertain whether
it is appropriate to give a gift, what type of gift to give, how to wrap the gift, and the manner
in which the gift should be given. For example, in China a gift is given with two hands and is
usually not opened at the time of giving but rather in the privacy of the recipient.
AVAILABLE DISTRIBUTION SYSTEMS
While the entrepreneur needs to be less concerned about worldwide logistics today, due to
state-of-the-art transportation methods and the ensuing cost reductions, one of the entre-
preneur’s biggest challenges is related to the distribution channels in the target country.
Distribution channels vary significantly from one country to another, and it should quickly
become apparent that the channel of distribution in any country is a very powerful and
strategic position, critical to the success of the global company.
In determining the best channel of distribution system for a country, the entrepreneur needs
to consider several factors: (1) the overall sales potential, (2) the amount and type of competi-
tion, (3) the cost of the product, (4) the geographical size and density of the country, (5) the in-
vestment policies of the country, (6) exchange rates and any controls, (7) the level of political
risk, and (8) the overall marketing plan. Each of these factors affects the choice of the distribu-
tion system that will yield the greatest sales and profit results in the country.
MOTIVATIONS TO GO GLOBAL
Unless they are born with a global mind-set, many entrepreneurs, particularly from the
United States, will pursue international activities reluctantly. As indicated in Table 5.3, a
variety of motivations can cause an entrepreneur to become involved in international busi-
ness. Profits, of course, are one of the most significant reasons for going global. Usually,
the expected profitability of going global is not reflected in the actual profits obtained. The
profitability is adversely affected by the costs of getting ready to go global, an underesti-
mation of the costs involved, and losses resulting from mistakes. The difference between
the planned and actual results may be significant in the entrepreneur’s first attempt to go
global. Anything that the entrepreneur thinks won’t happen most likely will, such as having
significant shifts in foreign exchange rates.
The allure of profits is a strong motivation to sell to other markets. For a U.S.-based
entrepreneurial firm, the 95 percent of the world’s population living outside the United
States offers a very large market opportunity. These sales may even be necessary to cover
any significant research and development and start-up manufacturing costs that have been
incurred in the domestic market. Without sales to international markets, these costs have
to be spread over domestic sales alone, resulting in less profit, which can be a problem,
particularly in price-sensitive markets.
Sales to other markets also may reflect another reason for going global—the home
domestic market may be leveling or even declining. This is occurring in several markets in
the United States due in part to the changing demographics.
142 PA RT 2 FROM IDEA TO THE OPPORTUNITY
TABLE 5.3 Motivations for Going Global
• Profits
• Competitive pressures
• Unique product(s) or service(s)
• Excess production capacity
• Declining home country sales
• Unique market opportunity
• Economies of scale
• Technological advantage
• Tax benefits
Sometimes an entrepreneur moves into international markets to avoid increased indus-
try regulations or governmental or societal concerns about the firm’s products or services.
Cigarette companies such as Philip Morris, confronted with increased government regula-
tions and antismoking attitudes, have aggressively pursued sales outside the United States,
particularly in developing economies. Sometimes this has taken the form of purchasing
existing companies in these foreign markets, which is what occurred in Russia.
When the entrepreneur’s technology becomes obsolete in the domestic market and/or
the product or service is near the end of its life cycle, there may be sales opportunities in
foreign markets. One entrepreneur found new sales in the European Union for the company’s
gas-permeable hard contact lenses and solutions when the domestic market in the United
States was negatively affected by highly competitive soft lenses. Volkswagen continued to
sell its original VW Beetles in both Latin and South America for years after stopping its
sales in the United States; after several years VW reentered the U.S. market.
Entrepreneurs often go global to take advantage of lower costs in foreign countries in
such things as labor, manufacturing overhead, and raw materials. The HourPower Flip
Watch could never be marketed at its price point in Things Remembered and JCPenney
stores had it not been produced in China. Waterford is producing some products in Prague
to help offset the higher labor costs in Ireland. There are often some cost advantages of hav-
ing at least a distribution and sales office in a foreign market. Graphisoft, a Hungarian
software company, found that its sales significantly increased in the United States when it
opened a sales office in Los Angeles, California.
Several more esoteric motivations, beyond the traditional ones of sales and profits, also
can motivate an entrepreneur to go global. One of the more predominant motivations is the
desire to establish and exploit a global presence. When an entrepreneur goes global, many
company operations can be internationalized and leveraged. For example, when going
global, an entrepreneur will establish a global distribution system and an integrated manu-
facturing capability. Establishing these gives the entrepreneurial company a competitive
advantage as they not only facilitate the firm’s successful production and distribution of
present products, but also help keep out competitive products. By going global, an entre-
preneur can offer a variety of different products at better price points.
STRATEGIC EFFECTS OF GOING GLOBAL
While going global presents a wide variety of new environments and new ways of doing
business, it is also accompanied by an entirely new set of wide-ranging problems. Carrying
out business internationally involves a variety of new documents, such as commercial in-
voices, bills of lading, inspection certificates, and shippers’ export declarations, as well as
the need to comply with an entirely new set of domestic and international regulations.
One major effect of going global centers around the concept of proximity to the firm’s
customers and ports. Physical and psychological closeness to the international market
affects the way business occurs. Geographic closeness to the foreign market may not nec-
essarily provide a perceived closeness to the foreign customer. Sometimes cultural vari-
ables, language, and legal factors can make a foreign market that is geographically close
seem psychologically distant. For example, some U.S. entrepreneurs perceive Canada,
Ireland, and the U.K. as being much closer psychologically, due to similarities in culture
and language, than Mexico, which may be closer in distance.
Three issues are involved in this psychological distance. First, the distance envisioned by
the entrepreneur may be based more on perception than reality. Some Canadian and even
Australian entrepreneurs focus too much on the similarities they share with the U.S. market,
losing sight of the vast differences. These differences, which exist in every international
market to varying extents, need to be taken into account to avoid costly mistakes. Second,
C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 143
closer psychological proximity does make it easier for an entrepreneurial firm to enter a
market. It may be advantageous for the entrepreneur to start going global by selecting a
market that is closer psychologically to gain some experience before entering markets
that are more psychologically distant. Finally, the entrepreneur should also keep in mind
that there are more similarities than differences between individual entrepreneurs regard-
less of the country. Each entrepreneur has gone through the entrepreneurial process, taken
the risks, worked hard for success, and passionately loves the business idea.
FOREIGN MARKET SELECTION
With so many prospective countries available, two critical issues for the entrepreneur are
foreign market selection and market entry strategies. Should you enter the top market
prospect or should you employ a more regional focus? Should you choose the largest mar-
ket possible or one that is easier to understand and navigate? Is a foreign market that is
more developed preferable to one that is developing?
These are just some of the questions confronting the entrepreneur in deciding which
market to enter. The market selection decision should be based on both past sales and com-
petitive positioning as well as an assessment of each foreign market alternative. Data need
to be collected on a systematic basis on both a regional and country basis. A region can be
a collection of countries, such as the European Union, or an area within a country, such as
the southeastern part of China.
A systematic process is needed so that a ranking of the foreign markets being considered
can be established. Why is ranking markets so important? Ranking helps avoid the mistake
of so many entrepreneurs—doing a poor job of establishing a rigorous market selection
process and relying too much on assumptions and gut feel. The significant differences be-
tween global and domestic markets and the entire global decision process require that the
market selection process be based on as much information as possible. These data should
cover at least three years so that trends appear. The data collected and analyzed for market
selection also will be used in developing the appropriate entry strategy and marketing plan.
While there are several market selection models available, one good method employs a
five-step approach: (1) develop appropriate indicators, (2) collect data and convert into
comparable indicators, (3) establish an appropriate weight for each indicator, (4) analyze
the data, and (5) select the appropriate market from the market rankings.
In step 1, appropriate indicators need to be developed based on past sales, competitive
research, experience, and discussions with other entrepreneurs doing global business. Spe-
cific indicators for the company need to be developed in three general areas: overall mar-
ket size indicators, market growth indicators, and product indicators. Market size indicators
generally center around: (1) population, (2) per capita income, (3) the market for the spe-
cific product (for consumer products), and (4) the types of companies and their sales and
profits of particular products (for industrial products). In terms of market growth, the over-
all country growth (GDP) should be determined as well as the growth rate for the particu-
lar market of the venture. Finally, appropriate product indicators such as the size of the
export of the specific product category to the market, the number of sales leads, and the
level of interest should be established.
Step 2 involves collecting data for each of these indicators and making the data compa-
rable. Both primary data (original information collected for the particular requirement) and
secondary data (published data already existing) need to be collected. Typically, secondary
data are collected first to establish what information (if any) still needs to be collected
through primary research. When collecting international secondary data, there are several
problems that can occur based on the stage of economic development of the country. These
144 PA RT 2 FROM IDEA TO THE OPPORTUNITY
145
As even the smallest companies become more global in
their operations, many family-owned businesses are
seizing opportunities to expand overseas. But others
are resisting and, in turn, missing opportunities that
could sustain their success. Much of their reluctance is
due to the conservative fiscal management and risk
avoidance that characterize many family businesses.
Expanding overseas takes capital, often a loan with a
long payback period. Currency fluctuations also are a
hazard. So business owners find themselves looking
hard for easier, faster domestic growth opportunities.
Managing risk will always be important, as compa-
nies must carefully balance their desire to invest capi-
tal for growth with shareholders’ needs for liquidity.
But by taking the following steps, you can diminish
the dangers of going global.
Start Small. Selling a product overseas, perhaps with
the assistance of a foreign sales representative,
is much less chancy than establishing your own
distribution and production facilities. Those early
sales also will help you gauge demand in the
new market. If you are still not ready to commit
to your own sales force and facilities, you can
outsource distribution and manufacturing to a
partner. Try to team up with another family-
owned business, because family businesses, even
those in different countries, often can find com-
mon ground and may be more likely to under-
stand and respect one another.
Develop a Business Plan. Make a thorough plan for
the global opportunity and build a strong, elo-
quent case for it. Unless you can convince other
family members of the merits of the idea and
give them parameters for measuring its success,
they may continue to see it as risky.
Get Directly Involved. It’s a myth that you can manage
remotely using sophisticated financial information
and control systems. Different reporting practices,
cultures, compensation, and incentives mean you
can’t manage solely by trying to detect financial
variances. Meeting business, government, and
education leaders, plus local employees and com-
petitors, provides intelligence on strategies that will
work in particular markets. Matt Litzler, the third-
generation president of C.A. Litzler, a specialty
machinery manufacturer in Cleveland, says his
company has been exporting to Asia and Europe
since the 1950s because the U.S. market for its con-
tinuous-process drying machine is limited. “We
keep our passports up to date and we know that
at any time we can be on a plane,” says Litzler.
Invest in the Brand. You may have a great reputa-
tion at home, but global brand equity often is
created from scratch. Listen to local customers
and do local advertising, and provide the quality
and exceptional service that will differentiate
your product. Because rivals often find it hard to
replicate intangible advantages, it pays to have
caring, skilled employees, and superior quality
and performance.
Build an Advisory Board. If you do open a foreign
subsidiary, develop a local board to oversee it.
Advisers with local knowledge can help you
understand culture, regulations, and competi-
tors. Having a trusted and committed network
will make venturing abroad far less risky and far
more profitable.*
ADVICE TO AN ENTREPRENEUR
An entrepreneur who has been trying to expand his
family business globally but has been unsuccessful
due to resistance from his business partners reads
this article and comes to you for advice. He wants to
persuade his partners to go global and needs help
determining what to tell them.
1. What are potential business opportunities that
may be missed out on by not extending the
company globally?
2. What actions can be taken to minimize the risk
of failure?
After a few weeks of discussion, all the partners
are aligned and have decided to export their products
to Europe.
1. How should the entrepreneur and his partners pre-
pare personally, as they begin the expansion pro-
cess, to ensure the success of their overseas business?
2. What are some ways they can begin networking
with business professionals in Europe to build an
advisory board?
*Source: Reprinted from August/September, 2007, BusinessWeek by special permission, copyright © 2007 by The McGraw-Hill Companies, Inc. “Stranger in a Strange Land,” by Ernesto Poza, www.businessweek.com/magazine/content/07_36/b4048434.htm.
STRANGER IN A STRANGE LAND
A S S E E N I N B U S I N E S S W E E K
problems include: (1) comparability (the data for one country will not be the same as the
data of another), (2) availability (some countries have much more country data than others,
depending upon the stage of economic development), (3) accuracy (the data can be col-
lected using rigorous standards or not as rigorous and even biased due to the interests of
the government of the country), and (4) cost (only the United States has the Freedom of In-
formation Act, which makes all government-collected data—with the exception of data re-
lated to security and defense—available to all). One entrepreneur was interested in setting
up the first Western health club in Moscow. He was going to charge two rates: a higher hard
currency rate to foreigners and a lower ruble rate to Russians and other citizens of countries
in the former Soviet Union. In determining the best location, he was interested in identify-
ing areas of the city where most foreigners lived. After significant searching to no avail and
a high degree of frustration, he finally was able to buy the data needed from the former
KGB (Soviet Union Security branch).
When researching foreign markets, the entrepreneur will usually want economic and demo-
graphic data such as population, GDP, per capita income, inflation rate, literacy rate, unem-
ployment, and education levels. There are many sources for this and other foreign information
in government agencies, Web sites, and embassies. One important source of data is STAT-USA
and its National Trade Data Bank (NTDB), which is managed by the U.S. Department of
Commerce. The STAT-USA database has good information due in part to the large number
of government agencies contributing information. STAT-country name provides data on
other countries. For example, STAT-Austria provides information on the country of Austria.
This results in a large number of international reports such as Country Reports, Country
Analysis Briefs (CABs), Country Commercial Guides (CCG), Food Market Reports, Inter-
national Reports and Reviews, Department of State Background Notes, and Import/Export
Reports.
Another good source of data is trade associations and U.S. and foreign embassies. While
trade associations are a good source of domestic and international data, sometimes more
specific information can be obtained by contacting the U.S. Department of Commerce
industry desk officer or the economic attaché in the appropriate U.S. or foreign embassy.
The collected data for each selected indicator need to be converted to a point score so
that each indicator of each country can be numerically ranked against the other countries.
Various methods can be used to achieve this, each of which involves some judgment on the
part of the entrepreneur. Another method is to compare country data for each indicator
against global standards.
The third step is to establish appropriate weights for the indicators to reflect the impor-
tance of a particular indicator in predicting foreign market potential. For one company
manufacturing hospital beds, the number and types of hospitals, the age of the hospitals
and their beds, and the government’s expenditure on health care and its socialized system
were the best country indicators in selecting a foreign market. This procedure results in
each indicator receiving a weight that reflects the relative importance of the indicator. The
assignment of points and weights as well as the selection of indicators vary greatly from
one entrepreneur to another and indeed are somewhat arbitrary. Regardless, this requires
intensive thinking and internal discussion and results in far better market selection deci-
sions being made.
Step 4 involves analyzing the results. When looking at the data, the entrepreneur should
carefully scrutinize and question the results. He or she should also look for errors, as mis-
takes can be easily made. Also, a what-if analysis should be conducted by changing some
of the weights and seeing how the results vary.
The final step—step 5—involves selecting a market to enter as well as follow-up mar-
kets so that an appropriate entry strategy can be selected and a market plan developed.
146 PA RT 2 FROM IDEA TO THE OPPORTUNITY
ENTREPRENEURIAL ENTRY STRATEGIES
There are various ways an entrepreneur can market products internationally. The method
of entry into a market and the mode of operating overseas are dependent on the goals of
the entrepreneur and the company’s strengths and weaknesses. The modes of entering or
engaging in international business can be divided into three general categories: exporting,
nonequity arrangements, and direct foreign investment. The advantages and disadvantages
of some of the modes are indicated in Table 5.4.
Exporting
Frequently, an entrepreneur starts doing international business through exporting. Exporting
normally involves the sale and shipping of products manufactured in one country to a cus-
tomer located in another country. There are two general classifications of exporting: direct
and indirect.
C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 147
Entry Mode Advantage Disadvantage
Exporting
Turn-key contracts
Licensing
Franchising
Joint ventures
Wholly owned
subsidiaries
Ability to capitalize on
experiences in location
selection
Ability to earn returns from
process technology skills in
countries where FDI is restricted
Low development costs and risks
Low development costs and
risks
• Access to local partner’s
knowledge
• Shared development costs
and risks
• Politically acceptable
• Protection of technology
• Ability to engage in global
strategic coordination
• Ability to realize location
and experience curve
economies
• High transport costs
• Trade barriers
• Problems with local marketing
agents
• Creation of efficient competitors
• Lack of long-term market
presence
• Lack of control over technology
• Inability to realize location and
experience curve economies
• Inability to engage in global
strategic coordination
• Lack of control over quality
• Inability to engage in global
strategic coordination
• Lack of control over technology
• Inability to engage in global
strategic coordination
• Inability to realize location and
experience curve economies
• High costs and risks
TABLE 5.4 Various Entry Modes
exporting The sale and
shipping of products
manufactured in one
country to a customer
located in another country
148 PA RT 2 FROM IDEA TO THE OPPORTUNITY
Indirect Exporting Indirect exporting involves having a foreign purchaser in the local mar- ket or using an export management firm. For certain commodities and manufactured goods,
foreign buyers actively seek out sources of supply and have purchasing offices in markets
throughout the world. An entrepreneur wanting to sell in one of these overseas markets can
deal with one of these buyers. In this case, the entire transaction is handled as though it were a
domestic transaction, even though the goods will be shipped out of the country. This method
of exporting involves the least amount of knowledge and risk for the entrepreneur.
Export management firms, another avenue of indirect exporting, are located in most
commercial centers. For a fee, these firms will provide representation in foreign markets.
Typically, they represent a group of noncompeting manufacturers from the same country
who have no interest in becoming directly involved in exporting. The export management
firm handles all the selling, marketing, and delivery, in addition to any technical problems
involved in the export process.
Direct Exporting If the entrepreneur wants more involvement without any financial commitment, direct exporting through independent distributors or the company’s own over-
seas sales office is a way to get involved in international business. Independent foreign
distributors usually handle products for firms seeking relatively rapid entry into a large
number of foreign markets. This independent distributor directly contacts foreign cus-
tomers and potential customers and takes care of all the technicalities of arranging for
export documentation, financing, and delivery for an established rate of commission.
Entrepreneurs also can open their own overseas sales offices and hire their own sales-
people to provide market representation. In starting out, the entrepreneur may send a U.S.
or domestic salesperson to be a representative in the foreign market. As more business is
done in the overseas sales office, warehouses are usually opened, followed by a local as-
sembly process when sales reach a level high enough to warrant the investment. The assem-
bly operation can eventually evolve into the establishment of manufacturing operations in
the foreign market. Entrepreneurs can then export the output from these manufacturing
operations to other international markets.
Nonequity Arrangements
When market and financial conditions warrant the change, an entrepreneur can enter into
international business by one of three types of nonequity arrangements: licensing, turn-key
projects, and management contracts. Each of these allows the entrepreneur to enter a mar-
ket and obtain sales and profits without direct equity investment in the foreign market.
Licensing Licensing involves an entrepreneur who is a manufacturer (licensee) giving a foreign manufacturer (licensor) the right to use a patent, trademark, technology, production
process, or product in return for the payment of a royalty. The licensing arrangement is
most appropriate when the entrepreneur has no intention of entering a particular market
through exporting or direct investment. Since the process is low risk, yet provides a way to
generate incremental income, a licensing agreement can be a good method for the entre-
preneur to engage in international business. Unfortunately, some entrepreneurs have entered
into these arrangements without careful analysis and have later found that they have licensed
their largest competitor into business or that they are investing large sums of time and
money in helping the licensor adopt the technology or know-how being licensed.
Turn-Key Projects Another method by which the entrepreneur can do international business without much risk is through turn-key projects. The underdeveloped or lesser-
developed countries of the world have recognized their need for manufacturing technology
and infrastructure and yet do not want to turn over substantial portions of their economy to
direct exporting
Involves the use of
independent distributors
or the company’s own
overseas sales office in
conducting international
business
nonequity arrangement
A method by which an
entrepreneur can enter a
market and obtain sales
and profits without direct
equity investment in the
foreign market
licensing Involves
giving a foreign
manufacturer the right to
use a patent, technology,
production process, or
product in return for the
payment of a royalty
turn-key projects
A method of doing
international business
whereby a foreign
entrepreneur supplies the
manufacturing technology
or infrastructure for a
business and then turns it
over to local owners
indirect exporting In
international business,
involves having a foreign
purchaser in the local
market or using an export
management firm
C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 149
foreign ownership. One solution to this dilemma has been to have a foreign entrepreneur
build a factory or other facility, train the workers, train the management, and then turn it
over to local owners once the operation is going—hence the name turn-key operation.
Entrepreneurs have found turn-key projects to be an attractive alternative. Initial profits
can be made from this method, and follow-up export sales can also result. Financing is pro-
vided by the local company or the government, with periodic payments being made over
the life of the project.
Management Contracts A final nonequity method the entrepreneur can use in interna- tional business is the management contract. Several entrepreneurs have successfully en-
tered international business by contracting their management techniques and skills. The
management contract allows the purchasing country to gain foreign expertise without
giving ownership of its resources to a foreigner. For the entrepreneur, the management con-
tract is another way of entering a foreign market without a large equity investment.
Direct Foreign Investment
The wholly owned foreign subsidiary has been a preferred mode of ownership for entrepre-
neurs using direct foreign investment for doing business in international markets. Joint ven-
tures and minority and majority equity positions are also methods for making direct foreign
investments. The percentage of ownership obtained in the foreign venture by the entrepre-
neur is related to the amount of money invested, the nature of the industry, and the rules of
the host government.
Minority Interests Japanese companies have been frequent users of the minority equity position in direct foreign investment. A minority interest can provide a firm with a source of
raw materials or a relatively captive market for its products. Entrepreneurs have used minority
positions to gain a foothold or acquire experience in a market before making a major commit-
ment. When the minority shareholder has something of strong value, the ability to influence
the decision-making process is often far in excess of the amount of ownership.
Joint Ventures Another direct foreign investment method used by entrepreneurs to enter foreign markets is the joint venture. Although a joint venture can take on many forms,
in its most traditional form, two firms (for example, one U.S. firm and one German firm)
get together and form a third company in which they share the equity.
Entrepreneurs use joint ventures most often in two situations: (1) when the entrepreneur
wants to purchase local knowledge as well as an already established manufacturing fa-
cility, and (2) when rapid entry into a market is needed. Sometimes joint ventures are dis-
solved with one party assuming 100 percent ownership.
Even though using a joint venture to enter a foreign market is a key strategic decision,
the keys to its success are not well understood, and the reasons for forming a joint venture
today are different from those of the past. Previously, joint ventures were viewed as part-
nerships and often involved firms whose stock was owned by several other firms.
Joint ventures in the United States were first used by mining concerns and railroads as early
as 1850. The use of joint ventures, mostly vertical joint ventures, started increasing signifi-
cantly during the 1950s. Through the vertical joint venture, two firms could absorb the large
volume of output when neither could afford the diseconomies associated with a smaller plant.
What has caused this significant increase in the use of joint ventures, particularly when
many have not worked? Studies examining the success and failure of joint ventures have
found many different reasons for their formation. One of the most frequent reasons an en-
trepreneur forms a joint venture is to share the costs and risks of a project. Projects where
costly technology is involved frequently need resource sharing. This can be particularly
management contract
A nonequity method of
international business in
which an entrepreneur
contracts his or her
management techniques
and skills to a (foreign)
purchasing company
minority interest A
form of direct foreign
investment in which the
investing entrepreneur
holds a minority
ownership position in the
foreign venture
joint venture The
joining of two firms in
order to form a third
company in which the
equity is shared
important when an entrepreneur does not have the financial resources necessary to engage
in capital-intensive activities.
Synergy between firms is another reason that an entrepreneur may form a joint venture.
Synergy is the qualitative impact on the acquiring firm brought about by complementary
factors inherent in the firm being acquired. Synergy in the form of people, customers, in-
ventory, plant, or equipment provides leverage for the joint venture. The degree of the syn-
ergy determines how beneficial the joint venture will be for the companies involved.
Another reason for forming a joint venture is to obtain a competitive advantage. A joint
venture can preempt competitors, allowing an entrepreneur to access new customers and
expand the market base.
Entrepreneurs frequently use joint ventures to enter markets and economies that pose
entrance difficulties or to compensate for a company’s lack of foreign experience. This has
been the case for the transition economies of Eastern and Central Europe and the former
U.S.S.R. It is not surprising that it is easier to establish a joint venture in Hungary because
that country has fewer registration requirements for establishing a joint venture than it does
for registering a new business start-up.
Majority Interest Another equity method by which the entrepreneur can enter interna- tional markets is through the purchase of a majority interest in a foreign business. In a tech-
nical sense, anything over 50 percent of the equity in a firm is majority interest. The majority
interest allows the entrepreneur to obtain managerial control while maintaining the acquired
firm’s local identity. When entering a volatile international market, some entrepreneurs take
a smaller position, which they increase up to 100 percent as sales and profits occur.
Mergers An entrepreneur can obtain 100 percent ownership to ensure complete control. Many U.S. entrepreneurs desire complete ownership and control in cases of foreign invest-
ments. If the entrepreneur has the capital, technology, and marketing skills required for suc-
cessful entry into a market, there may be no reason to share ownership.
Mergers and acquisitions have been used significantly in international business as well as
within the United States. During periods of intense merger activity, entrepreneurs may spend
significant time searching for a firm to acquire and then finalizing the transaction. While any
merger should reflect the basic principles of any capital investment decision and make a net
contribution to shareholders’ wealth, the merits of a particular merger are often difficult to as-
sess. Not only do the benefits and costs of a merger need to be determined, but also special ac-
counting, legal, and tax issues must be addressed. The entrepreneur, therefore, must have a
general understanding of the benefits and problems of mergers as a strategic option as well as
an understanding of the complexity of integrating an entire company into present operations.
There are five basic types of mergers: horizontal, vertical, product extension, market ex-
tension, and diversified activity. A horizontal merger is the combination of two firms that
produce one or more of the same or closely related products in the same geographic area.
The merger is motivated by economies of scale in marketing, production, or sales. An ex-
ample of a horizontal merger is the acquisition of convenience food store chain Southland
Stores by 7-Eleven Convenience Stores.
A vertical merger is the combination of two or more firms in successive stages of produc-
tion that often involve a buyer–seller relationship. This form of merger stabilizes supply
and production and offers more control of these critical areas. Examples are McDonald’s
acquiring its store franchises and Phillips Petroleum acquiring its gas station franchises. In
each case, these outlets become company-owned stores.
A product extension merger occurs when acquiring and acquired companies have related
production and/or distribution activities but do not have products that compete directly with
150 PA RT 2 FROM IDEA TO THE OPPORTUNITY
majority interest The
purchase of over
50 percent of the equity
in a foreign business
horizontal merger A
type of merger combining
two firms that produce
one or more of the same
or closely related
products in the same
geographic area
vertical merger A type
of merger combining
two or more firms in
successive stages of
production
product extension merger
A type of merger in which
acquiring and acquired
companies have related
production and/or
distribution activities but
do not have products that
compete directly with
each other
C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 151
each other. Examples are the acquisitions of Miller Brewing (beer) by Philip Morris (ciga-
rettes), and Western Publishing (children’s books) by Mattel (toys).
A market extension merger is a combination of two firms producing the same products
but selling them in different geographic markets. The motivation is that the acquiring firm
can economically combine its management skills, production, and marketing with those of
the acquired firm. An example of this type of merger is the acquisition of Diamond Chain
(a West Coast retailer) by Dayton Hudson (a Minneapolis retailer).
The final type of merger is a diversified activity merger. This is a conglomerate merger
involving the consolidation of two essentially unrelated firms. Usually, the acquiring firm
is not interested in either using its cash resources to expand shareholder wealth or actively
running and managing the acquired company. An example of a diversified activity merger is
Hillenbrand Industries (a caskets and hospital furniture manufacturer) acquiring American
Tourister (a luggage manufacturer).
Mergers are a sound strategic option for an entrepreneur when synergy is present. Sev-
eral factors cause synergy to occur and make two firms worth more together than apart.
The first factor, economies of scale, is probably the most prevalent reason for mergers.
Economies of scale can occur in production, coordination, and administration, and in the
sharing of central services such as office management and accounting, financial control,
and upper-level management. Economies of scale increase operating, financial, and man-
agement efficiency, thereby resulting in better earnings.
The second factor is taxation or, more specifically, unused tax credits. Sometimes a firm
has had a loss in previous years but not enough profits to take advantage of the tax-loss car-
ryover. Corporate income tax regulations allow the net operating losses of one company to
reduce the taxable income of another when they are combined. By combining a firm that
has a loss with a firm that has a profit, the tax-loss carryover can be used.
The final important factor for mergers refers to the benefits received in combining comple-
mentary resources. Many entrepreneurs will merge with other firms to ensure a source of sup-
ply for key ingredients, to obtain a new technology, or to keep the other firm’s product from
being a competitive threat. It is often quicker and easier for a firm to merge with another that
already has a new technology developed—combining the innovation with the acquiring
firm’s engineering and sales talent—than it is to develop the technology from scratch.
Regardless of the entry mode, a successful entry strategy and growth in a global market
often require the development of a global business plan. The global business plan varies
somewhat from the domestic business plan discussed in Chapter 7. An outline of a typical
global business plan is presented in Appendix 5A, at the end of this chapter.
ENTREPRENEURIAL PARTNERING
One of the best methods for an entrepreneur to enter an international market is to partner
with an entrepreneur in that country. These foreign entrepreneurs know the country and
culture and therefore can facilitate business transactions while keeping the entrepreneur
current on business, economic, and political conditions. This partnering is facilitated by un-
derstanding the nature of entrepreneurship in the country.
There are several characteristics of a good partner. A good partner can help the entrepre-
neur achieve his or her goals such as market access, cost sharing, or core competency
obtainment. Good partners also share the entrepreneur’s vision and are unlikely to try to op-
portunistically exploit the partnership for their own benefit.
How does the entrepreneur go about selecting a good partner? First, he or she needs to col-
lect as much information as possible on the industry and potential partners in the country. This
information can be obtained from embassy officials, members of the country’s chamber of
market extension merger
A type of merger
combining two firms that
produce the same products
but sell them in different
geographic markets
diversified activity merger
A conglomerate merger
involving the consolidation
of two essentially
unrelated firms
commerce, firms doing business in that country, and customers of the potential partner. The en-
trepreneur also will need to attend any appropriate trade shows. References for each potential
partner should be checked, and each reference should be asked for other references. Finally, it
is most important that the entrepreneur meet several times with a potential partner to get to
know the individual and the company as well as possible before any commitment is made.
BARRIERS TO INTERNATIONAL TRADE
There are varying attitudes throughout the world concerning trade. Starting around 1947
with the development of general trade agreements and the reduction of tariffs and other trade
barriers, there has been an overall positive atmosphere concerning trade between countries.
General Agreement on Tariffs and Trade (GATT)
One of the longest-lasting agreements on trade is the General Agreement on Tariffs and Trade
(GATT), which was established in 1947 under U.S. leadership. GATT is a multilateral agree-
ment with the objective of liberalizing trade by eliminating or reducing tariffs, subsidies, and
import quotas. GATT membership includes over 100 nations and has had eight rounds of
tariff reductions, one of which is the Uruguay Round, which lasted from 1986 to 1993, and
another is the Doha Development Round, which is in progress (2001). Another round should
start in the 2010 time frame. In each round, mutual tariff reductions are negotiated between
member nations and monitored by a mutually agreed-upon system. If a member country feels
that a violation has occurred, it can ask for an investigation by the Geneva-based administra-
tors of GATT. If the investigation uncovers a violation, member countries can be asked to
pressure the violating country to change its policy and conform to the agreed-upon tariffs and
agreements. Sometimes this pressure has not been sufficient to get an offending country to
change. While GATT has assisted in developing more unrestricted trade, its voluntary mem-
bership gives it little authority to ensure that this type of trade will occur.
Increasing Protectionist Attitudes
Support for GATT goes up and down. Although down in the 1970s, the support increased
in the 1980s due to the rise in protectionist pressures in many industrialized countries. The re-
newed support reflected three events. First, the world trading system was strained by the per-
sistent trade deficit of the United States, the world’s largest economy, a situation that caused
adjustments in such industries as automobiles, semiconductors, steel, and textiles. Second, the
economic success of countries perceived as not playing by the rules (e.g., Japan and then
China) also strained the world’s trading system. The success of Japan and China as the world’s
large traders and the perception that their internal markets are, in effect, closed to imports and
foreign investment have caused problems. Finally, in response to these pressures, many coun-
tries have established bilateral voluntary export restraints to circumvent GATT. The economic
prosperity of the 1990s and the downturn from 2008 have lessened the interest in GATT.
Trade Blocs and Free Trade Areas
Around the world, groups of nations are banding together to increase trade and investment
between nations in the group and exclude those nations outside the group. One little-known
agreement between the United States and Israel, signed in 1985, establishes a Free Trade
Area (FTA) between the two nations. All tariffs and quotas except on certain agricultural
products were phased out over a 10-year period. In 1989, an FTA went into effect between
Canada and the United States that phased out tariffs and quotas between the two countries,
which are each other’s largest trading partners.
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C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 153
Many trading alliances have evolved in the Americas. In 1991, the United States signed
a framework trade agreement with Argentina, Brazil, Paraguay, and Uruguay to support the
development of more liberal trade relations. The United States has also signed bilateral trade
agreements with Bolivia, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Honduras,
Peru, and Venezuela. The North American Free Trade Agreement (NAFTA) among the
United States, Canada, and Mexico is a much publicized agreement to reduce trade barriers
and quotas and encourage investment among the three countries. Similarly, the Americas,
Argentina, Brazil, Paraguay, and Uruguay operate under the Treaty of Asunción, which cre-
ated the Mercosur trade zone, a free trade zone among the countries.
Another important trading bloc has been developed by the European Community (EC).
Unlike GATT or NAFTA, the EC is founded on the principle of supranationality, with
member nations not being able to enter into trade agreements on their own that are incon-
sistent with EC regulations. As nations are added, the EC trading bloc becomes an increas-
ingly important factor for entrepreneurs doing international business.
Entrepreneur’s Strategy and Trade Barriers
Clearly, trade barriers pose problems for the entrepreneur who wants to become in-
volved in international business. First, trade barriers increase an entrepreneur’s costs of
exporting products or semifinished products to a country. If the increased cost puts the
entrepreneur at a competitive disadvantage with respect to indigenous competitive prod-
ucts, it may be more economical to establish production facilities in the country. Second,
voluntary export restraints may limit an entrepreneur’s ability to sell products in a coun-
try from production facilities outside the country, which may also warrant establishing
production facilities in the country in order to compete. Finally, an entrepreneur may
have to locate assembly or production facilities in a country to conform to the local con-
tent regulations of the country.
IMPLICATIONS FOR THE GLOBAL ENTREPRENEUR
The cultural, political, economic, and distribution systems of a country clearly influence
its attractiveness as a potential market and potential investment opportunity. Generally,
the costs and political risks are lower in those market-oriented countries that are more
advanced economically and politically. However, the long-run benefits to an entrepre-
neur are the country’s future growth and expansion. This opportunity may indeed occur
in less developed and less stable countries. The entrepreneur must carefully analyze the
countries to determine the best one(s) (if any) to enter and then develop an appropriate
entry strategy.
IN REVIEW
S U M M A R Y
Identifying both domestic and international market opportunities is becoming increas-
ingly important to more and more entrepreneurs and to their countries’ economies.
International entrepreneurship—the conducting of business activities by an entrepre-
neur across national boundaries—is occurring much earlier in the growth of new ven-
tures as opportunities open up in the hypercompetitive global arena. Several factors
trade barriers
Hindrances to doing
international business
154 PA RT 2 FROM IDEA TO THE OPPORTUNITY
(economics, stage of economic development, balance of payments, type of system,
political–legal environment, technological environment, and cultural environment)
make decisions regarding international entrepreneurship more complex than those re-
garding domestic entrepreneurship.
Once an entrepreneur decides to be involved in international business, three gen-
eral modes of market entry need to be considered: exporting, nonequity arrange-
ments, and equity arrangements. Each mode includes several alternatives that provide
varying degrees of risk, control, and ownership.
Entrepreneurs in the United States can find their counterparts in a wide variety of
economies. Entrepreneurship is thriving from Dublin to Hong Kong, providing new
products and services, new jobs, and new opportunities for partnering.
R E S E A R C H T A S K S
1. Interview three managers of multinational businesses to ascertain the benefits
generated from engaging in international business as well as some of the
challenges (problems).
2. Choose a country. Research and be prepared to report on that country’s (a) stage of
economic development, (b) political–legal environment, (c) cultural environment,
and (d) technological environment. If you were advising an entrepreneur who was
considering entering this country to sell his or her products, what would you say
were the major strategic issues? (Be specific to the country chosen.)
3. Choose a transition economy. Research that country and its recent economic
progress. Do you believe its economy will flourish or stagnate? Why? What can
that country’s government do (if anything) to “help” the economy flourish?
4. Choose a specific industry in a specific country. Which mode of entry has been
used the most by foreign firms entering this industry in this country? Explain why,
using examples of successful entry and examples of unsuccessful entry.
C L A S S D I S C U S S I O N
1. Make sure, if possible, there is one foreign student in each small group. The
group needs to discuss, and then report back to class on, the nature of business
and entrepreneurship in the foreign student’s home country. Such a discussion
should include the country’s (a) stage of economic development, (b) political–
legal environment, (c) technological environment, and (d) cultural environment.
Also explore how entrepreneurship and business failure are perceived in this
country.
2. We typically focus on firms from well-developed economies entering markets of
less developed economies. Do firms from less developed economies have a chance
of success if they enter developed markets, such as the United States? What
competitive advantage could a firm from a less developed economy rely on
in entering developed markets? What would likely be the best entry mode?
3. Is going international something that only large and established firms should
pursue after they have achieved success in their domestic markets “right off the
bat”? Which sorts of products are more amenable to “going international” by
small and new firms?
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C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 155
S E L E C T E D R E A D I N G S
Baron, Robert A.; and Michael D. Ensley. (September 2006). Opportunity Recognition as the Detection of Meaningful Patterns: Evidence from Comparisons of Novice and Ex- perienced Entrepreneurs. Management Science, vol. 52, no. 9, pp. 1331–44.
The ability to discern a business opportunity is a popular research theme in entre- preneurship literature. The contemporary school of thought indicates the practiced entrepreneur is generally more perspicacious than the greenhorn. The authors of this article—who are professors at the Lally School of Management and Technology at Rensselaer Polytechnic Institute in Troy, New York—examine the topic from a more scientific angle. Based on e-mails and phone conversations with entrepreneurs with varying experience levels, the study was designed to uncover cognitive blue- prints behind both sets of entrepreneurs’ opportunity identification processes. The authors’ methods are impeccable, and the resultant article presents their valiant efforts to eliminate analytical bias and preserve the integrity of the data collected.
DeTienne, Dawn R.; and Gaylen N. Chandler. (May 2007). The Role of Gender in Opportunity Identification. Entrepreneurship: Theory & Practice, vol. 31, no. 3, pp. 365–86.
This scholarly paper includes research investigating a correlation between an entre- preneur’s gender and his or her proclivity for spotting an opportunity. The authors’ research methods include two sample groups: college seniors studying technology and 189 entrepreneurs working in the technology field. According to the study’s findings neither gender proved more adept at perceiving business opportunities; similarly, the opportunities discovered by each gender group were no more or less gainful. However, the article does include observations about the two gender groups’ distinct capabilities for opportunity identification.
Riddle, Liesl. (Fall 2008). Diasporas: Exploring Their Development Potential. Economic Self-Reliance (ESR) Review, vol. 10, no. 2, pp. 28–35. Brigham Young University: http://findarticles.com/p/articles/mi_qa5457/is_200810/ai_n3117124.
In 2006 the author of this article cofounded the George Washington University Dias- pora Capital Investment Project. This article describes globalization’s phenomenon of the diaspora: expatriates, persons living away from their native lands. Capital generated by these “diasporans” is of particular interest to economists and finan- ciers. Typically, the members of these diasporas send a large portion of their earnings to their home countries. Rather than bemoaning this capital flight, the author of this article presents diasporans’ investment activity as a boon for all entrepreneurs.
Schaper, Michael. (July 2005). Being a Green Entrepreneur: Does It Make Business Sense? Business Source Complete, vol. 13, no. 3, pp. 5–7.
Dr. Michael Schaper, an adjunct professor at Australia’s Curtin University of Technol- ogy, has published an article for university students about the benefits of green busi- ness. Dr. Schaper maintains that young entrepreneurs need not take a vow of poverty when electing the socially responsible route when choosing a career. The green initia- tive actually presents many profitable business opportunities. Dr. Schaper’s article fur- nishes examples of entrepreneurs who have committed to environmentally friendly practices, and provides a road map for those considering the journey.
Ucbasaran, Deniz; Paul Westhead; and Mike Wright. (March 2009). The Extent and Na- ture of Opportunity Identification by Experienced Entrepreneurs. Journal of Business Venturing, vol. 24, no. 2, p. 99.
A seasoned entrepreneur is better able to recognize a business opportunity than the immature entrepreneur: the authors of this article observed 630 entrepreneurs to test this hypothesis. Entrepreneurs with some business ownership under their belts demonstrated a heightened sensitivity to unexploited areas of commerce. According
to the study’s results, a veteran entrepreneur is not only better able to envisage possi- bilities for profit, but he also tends to be a more accurate handicapper of an option’s viability. The authors—in their research—analyze the possible relationship between the quality and quantity of an entrepreneur’s past performance; apparently the number of failed businesses in an entrepreneur’s portfolio, proportional to the number of businesses owned, did affect the prolificacy of opportunities detected.
Watkins-Mathys, Lorraine; and M. John Foster. (May 2006). Entrepreneurship: The Missing Ingredient in China’s STIPs? Entrepreneurship and Regional Development, vol. 18, no. 3, pp. 249–74.
This article uses China’s Science Technology Industry Parks (STIPs) as its focus. In its con- tinual drive for sovereignty, the Chinese government has championed technological advancement for its citizens. These industry parks are intended to corral the country’s research and development talent and resources and encourage this industry to grow and flourish. The Chinese government supports companies in these high-tech zones with financial incentives such as tax breaks and large salaries. The authors of the arti- cle developed their research approach by questioning whether these parks help or hin- der innovation in technology. Especially interesting is the authors’ consideration of Chinese technology companies located outside of the parks: despite enjoying less cap- ital than government-supported companies, the non-STIP companies were far more enthusiastic about pursuing entrepreneurial activities than their STIP counterparts.
Williams, Colin C.; and John Round. (2009). Evaluating Informal Entrepreneurs’ Motives: Evidence from Moscow. International Journal of Entrepreneurial Behaviour & Research, vol. 15, no. 1, pp. 94–107.
This research paper is the collaborative effort of two British college professors at two different universities in two different U.K. cities: the first author teaches public pol- icy, and the second, human geography. The authors’ respective scholarly interests— entrepreneurship, small businesses, and socioeconomic transformation in the countries of Eastern and Central Europe—support the framework of this methodology. Based on a 2005–2006 survey conducted in Moscow, Russia, more than a quarter of the respon- dents were identified as entrepreneurs. In developing countries whose infrastructures are in the embryonic stages, a large part of a nation’s labor force and GDP frequently passes under the nose of government, untaxed and unregulated. The authors study the impetus for entrepreneurs operating in such informal economies: Do these entre- preneurs choose self-employment out of need or because they smell opportunity?
Woodward, David. (November 2007). A Place in the Sun. Director. vol. 61, no. 4, pp. 52–57.
This article profiles five young British technology entrepreneurs who decided to leave England and move to the United States to pursue their careers in technology. Their hometown of London, however, is starting to invest handsomely in its fledgling Inter- net start-ups. Why, then, would these bright, up-and-coming self-starters not want to remain on their side of the pond and ride the crest of London’s tech wave? The author interviews the young men about their respective career paths, and, in the process, reveals the draw and unique advantages of California’s Silicon Valley.
APPENDIX 5A EXAMPLE OUTLINE OF AN INTERNATIONAL BUSINESS PLAN
I. EXECUTIVE SUMMARY
One-page description of the project.
II. INTRODUCTION
The type of business proposed, followed by a brief description of the major
product and/or service involved. A brief description of the country proposed for
trade, the rationale for selecting the country, identification of existing trade
156 PA RT 2 FROM IDEA TO THE OPPORTUNITY
C H A P T E R 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES 157
barriers, and identification of sources of information (research resources and
interviews).
III. ANALYSIS OF THE INTERNATIONAL BUSINESS SITUATION
A. Economic, Political, and Legal Analysis of the Trading Country
1. Describe the trading country’s economic system, economic information im-
portant to your proposed product and/or service, and the level of foreign
investment in that country.
2. Describe the trading country’s governmental structure and stability, and
how the government controls trade and private business.
3. Describe laws and/or governmental agencies that affect your product
and/or service (i.e., labor laws, trade laws, etc.).
B. Trade Area and Cultural Analysis
1. Geographic and demographic information, important customs and tradi-
tions, other pertinent cultural information, and competitive advantages
and disadvantages of the proposed business opportunity.
IV. PLANNED OPERATION OF THE PROPOSED BUSINESS
A. Proposed Organization
Type of ownership and rationale; start-up steps to form the business; planned
personnel (or functional) needs; proposed staffing to handle managerial, fi-
nancial, marketing, legal, and production functions; proposed organization
chart; and brief job descriptions, if necessary.
B. Proposed Product/Service
1. Product and/or service details include potential suppliers, manufacturing
plans, and inventory policies, if applicable. Include necessary supplies if a
service is provided.
2. Transportation information includes costs, benefits, risks of the transporta-
tion method, and documents needed to transport the product.
C. Proposed Strategies
1. Pricing policies include what currency will be used, costs, markups, mark-
downs, relation to competition, and factors that could affect the price of
the product (e.g., competition, political conditions, taxes, tariffs, and trans-
portation costs).
2. Promotional program details include promotional activities, media avail-
ability, costs, one-year promotional plan outline, and local customs related
to business readiness.
V. PLANNED FINANCING
A. Projected Income and Expenses
1. Projected income statements for first year’s operation.
2. Balance sheet for the end of the first year.
3. A brief narrative description of the planned growth of the business, including
financial resources, needs, and a brief three-year plan projection.
VI. BIBLIOGRAPHY
VII. APPENDIX
1
To identify and distinguish intellectual property assets of a new venture including software and Web sites.
2
To understand the nature of patents, the rights they provide, and the filing process.
3
To understand the purpose of a trademark and the procedure for filing.
4
To learn the purpose of a copyright and how to file for one.
5
To identify procedures that can protect a venture’s trade secrets.
6
To understand the value of licensing to either expand a business or start a new venture.
7
To recognize the implications of new legislation that affects the board of directors and internal auditing processes for public companies.
8
To illustrate important issues related to contracts, insurance, and product safety and liability.
6 P R O T E C T I N G T H E I D E A A N D O T H E R
L E G A L I S S U E S F O R T H E E N T R E P R E N E U R
L E A R N I N G O B J E C T I V E S
159
O P E N I N G P R O F I L E
STEVE LIPSCOMB
One of the hottest media concepts today is television poker. As this market continues
to gain popularity and spin dozens of new innovations for entrepreneurs, it repre-
sents one of the most difficult business models for which to provide any intellectual
property protection. Steve Lipscomb has emerged as one of the most aggressive and
innovative entrepreneurs among those trying to
compete in this media market. His World Poker
Tour, broadcast on the cable television Travel
Channel, became an instant hit show in 2003, as
evidenced by its audience size or television rating points. With this success, however,
new competitors evolved, making the strategy of protecting his investment even more
challenging.
Steve Lipscomb grew up in Nashville, Tennessee, and came from a long line of
Baptist ministers. His first entrepreneurial effort, after becoming an attorney, was to
launch an attorney referral venture. However, even after early entrepreneurial suc-
cess, his career made some dramatic changes, primarily because of discrimination
issues experienced by his mother after she had chosen to enter the Baptist Church
seminary. His anger over this experience led him to make a documentary film so that
the world would be made more aware of some of these discriminatory issues. He
then sold his attorney referral business, taught himself filmmaking, and proceeded
to make Battle of the Minds, which won acclaim and numerous awards after ap-
pearing on PBS television. This success resulted in a friendship with producer Norman
Lear and a film project to provide audiences with an inside look at the World Series
of Poker.
Although poker was not a foreign concept to Lipscomb, having once entered a
$100 satellite tournament, he felt that ESPN’s televising of the World Series of Poker
was poorly presented. After his film project, Lipscomb had the strong vision that not
only could poker be made to be more interesting but that it would be possible to cre-
ate a major league of poker that would allow for entrepreneurial expansion into
merchandise, foreign licensing, Internet competition, and other business opportuni-
ties. With the help of two friends with television and licensing experience, Lipscomb
established a league of poker players who could enter tournaments as they pleased
www.worldpokertour.com
160 PA RT 2 FROM IDEA TO THE OPPORTUNITY
for prize money raised from sponsors. His business model was to establish a league
of poker players similar to golf’s PGA Tour. Thus, anyone with $10,000 could enter
one of the World Poker Tour events with a chance to win a large prize of $1 million
or more.
Lipscomb’s strategy was to produce a show before getting television to buy it. With
the support of Lakes Entertainment, a developer of casino gaming, and an investment
of $3.5 million, the World Poker Tour and WPT Enterprises were born, including a list-
ing on the NASDAQ (WPTE). With this investment Lipscomb subsequently had to give
up 70 percent control of his business, but he was able to retain 16.5 percent for himself.
Armed with this infusion of venture capital Lipscomb hit the road to try to persuade the
many popular casinos to support these poker tournaments. His format included two
unique concepts to make the televising of poker more interesting to the viewer. One
of these was a small camera under the table that allowed the viewers to see the two
cards that were dealt face down. Viewers could then play along with the tournament
players. In addition, he added unique graphics that presented on-screen icons of each
player’s cards. Odds of winning were included at each stage of the betting process,
making this programming unique and more interesting to the television audience.
Lipscomb regarded these unique additions as intellectual property, but this has
created controversy with some of the competition. ESPN has duplicated Lipscomb’s
camera and graphics in its presentation of another league, the World Series of Poker
Circuit. Lipscomb argues that the camera and graphics are proprietary with applica-
tions for patents pending. Without any resolution to the intellectual property issue,
Lipscomb has embarked on an aggressive strategy to build the image of WPTE. More
tournaments, more casinos, new products, higher stakes, international growth and
syndication, and the recent contract with Fox Sports Network (FSN) are all intended
to increase visibility and profitability to the company. Fox Sports Network is a much
better fit for WPT than the Travel Channel or Game Show Network. Audiences will be
higher, exposure will be greater, and FSN plans to include WPT in the Monday sports
block of programming. In addition to the new network, WPTE now owns and operates
WPT China, a multimedia company based in Beijing specializing in television produc-
tion of the WPT China National Traktor Poker Tour. Traktor Poker is a national card
game in China, and this 10-year exclusive deal is expected to add substantial income
not only from the tour but also from licensing and other partnerships with Chinese
firms.
Now in its seventh season, the company continues to struggle financially with losses of
about $9.7 million in 2007 compared to positive profits of $7.8 million in 2006. Sales in
2007 compared to the previous year were also down from $29.3 million to $21.7 million.
Higher costs and less exposure with the existing network were major contributing
factors to this decline. Lipscomb is confident that the business outlook is favorable
now that the new network is in place and other international deals are complete. Even
though the intellectual property issues previously discussed may not be resolved very
soon, if at all, Lipscomb will continue to explore new opportunities through innovation
and creativity that will enhance sales and profitability.1
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WHAT IS INTELLECTUAL PROPERTY?
Intellectual property—which includes patents, trademarks, copyrights, and trade secrets—
represents important assets to the entrepreneur and should be understood even before
engaging the services of an attorney. Too often entrepreneurs, because of their lack of
understanding of intellectual property, ignore important steps that they should have taken
to protect these assets. This chapter will describe all the important types of intellectual
property, including software and Web sites, which have become unique problems to the
Patent and Trademark Office.2
NEED FOR A LAWYER
Since all business is regulated by law, the entrepreneur needs to be aware of any regulations
that may affect his or her new venture. At different stages of the start-up, the entrepreneur
will need legal advice. It is also likely that the legal expertise required will vary based on
such factors as whether the new venture is a franchise, an independent start-up, or a buy-
out; whether it produces a consumer versus an industrial product; whether it is nonprofit;
and whether it involves some aspect of computer software, exporting, or importing.
We begin with a discussion of how to select a lawyer. Since most lawyers have devel-
oped special expertise, the entrepreneur should carefully evaluate his or her needs before
hiring one. By being aware of when and what legal advice is required, the entrepreneur can
save much time and money. Many of the areas in which the entrepreneur will need legal
assistance are discussed in this chapter.
HOW TO SELECT A LAWYER
Lawyers, like many other professionals, are specialists not just in the law but in specific
areas of the law. The entrepreneur does not usually have the expertise or know-how to han-
dle possible risks associated with the many difficult laws and regulations. A competent
attorney is in a better position to understand all possible circumstances and outcomes related
to any legal action.
In today’s environment, lawyers are much more up-front about their fees. In fact, in
some cases these fees, if for standard services, may even be advertised. In general, the
lawyer may work on a retainer basis (stated amount per month or year) by which he or she
provides office and consulting time. This does not include court time or other legal fees
related to the action. This gives the entrepreneur the opportunity to call an attorney as the
need arises without incurring high hourly visit fees.
In some instances the lawyer may be hired for a one-time fee. For example, a patent at-
torney may be hired as a specialist to help the entrepreneur obtain a patent. Once the patent
is obtained, this lawyer would not be needed, except perhaps if there was any litigation re-
garding the patent. Other specialists for setting up the organization or for purchase of real
estate may also be paid on a service-performed basis. Whatever the fee basis, the entrepre-
neur should confront the cost issue initially so that no questions arise in the future.
Choosing a lawyer is like hiring an employee. The lawyer with whom you work should
be someone you can relate to personally. In a large law firm, it is possible that an associate
or junior partner would be assigned to the new venture. The entrepreneur should ask to
meet with this person to ensure that there is compatibility.
A good working relationship with a lawyer will ease some of the risk in starting a new
business and will give the entrepreneur necessary confidence. When resources are very lim-
ited, the entrepreneur may consider offering the lawyer stock in exchange for his or her
C H A P T E R 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 161
intellectual property
Any patents, trademarks,
copyrights, or trade
secrets held by the
entrepreneur
A S S E E N I N ENTREPRENEUR M A G A Z I N E
PROVIDE ADVICE TO AN ENTREPRENEUR ABOUT INTELLECTUAL
PROPERTY PROTECTION
Locked doors and a security system protect your
equipment, inventory, and payroll. But what protects
your business’s most valuable possessions? Intellec-
tual property laws can protect your trade secrets,
trademarks, and product design, provided you take
the proper steps. Chicago attorney Kara E. F. Cenar of
Welsh & Katz, an intellectual property firm, contends
that businesses should start thinking about these is-
sues earlier than most do. “Small businesses tend to
delay securing intellectual property protection be-
cause of the expense,” Cenar says. “They tend not to
see the value of intellectual property until a competi-
tor infringes.” But a business that hasn’t applied for
copyrights or patents and actively defended them
will likely have trouble making its case in court.
One reason many business owners don’t protect
their intellectual property is that they don’t recog-
nize the value of the intangibles they own. Cenar ad-
vises business owners to take their business plans to
an experienced intellectual property attorney and
discuss how to deal with these issues. Spending
money up front for legal help can save a great deal
later by giving you strong copyright or trademark
rights, which can deter competitors from infringing
and avoid litigation later.
Once you’ve figured out what’s worth protecting,
you have to decide how to protect it. That isn’t al-
ways obvious. Traditionally, patents prohibit others
from copying new devices and processes, while copy-
rights do the same for creative endeavors such as
books, music, and software. In many cases, though,
the categories overlap. Likewise, trademark law now
extends to such distinctive elements as a product’s
color and shape. Trade dress law concerns how the
product is packaged and advertised. You might be
able to choose what kind of protection to seek.
For instance, one of Welsh & Katz’s clients is Ty Inc.,
maker of plush toys. Before launching the Beanie
Baby line, Cenar explains, the owners brought in busi-
ness and marketing plans to discuss intellectual prop-
erty issues. The plan was for a limited number of toys
in a variety of styles, and no advertising except word-
of-mouth. Getting a patent on a plush toy might have
been impossible and would have taken several years,
too long for easily copied toys. Trademark and trade
dress protection wouldn’t help much, because the
company planned a variety of styles. But copyrights
are available for sculptural art, and they’re inexpen-
sive and easy to obtain. The company chose to regis-
ter copyrights and defend them vigorously. Cenar’s
firm has fended off numerous knockoffs.
That’s the next step: monitoring the marketplace
for knockoffs and trademark infringement, and tak-
ing increasingly firm steps to enforce your rights.
Efforts typically begin with a letter of warning and
could end with a court-ordered cease-and-desist order
or even an award of damages. “If you don’t take the
time to enforce [your trademark], it becomes a very
weak mark,” Cenar says. “But a strong mark deters in-
fringement, wins lawsuits and gets people to settle
early.” Sleep on your rights, and you’ll lose them. Be
proactive, and you’ll protect them—and save money
in the long run.
ADVICE TO AN ENTREPRENEUR
An inventor with a newly invented technology comes
to you for advice on the following matters:
1. In running this new venture, I need to invest all
available resources in producing the products and
attracting customers. How important is it for me
to divert money from those efforts to protect my
intellectual property?
2. I have sufficient resources to obtain intellectual
property protection, but how effective is that
protection without a large stock of resources to
invest in going after those who infringe on my
rights? If I do not have the resources to defend a
patent, is it worth obtaining one in the first
place?
3. Are there circumstances when it is better for
me not to be an innovator but rather produce
“knockoffs” of others’ innovations? What do I
need to watch out for when imitating the prod-
ucts of others?
Source: Reprinted with permission of Entrepreneur Media, Inc. “You Have to Get Tough with Transgressors If You Want to Protect Your Intellectual Property,” by Steven C. Bahls and Jane Easter Bahls, January 2003, Entrepreneur magazine: www.entrepreneur.com.
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C H A P T E R 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 163
services. The lawyer then will have a vested interest in the business and will likely provide
more personalized services. However, in making such a major decision, the entrepreneur
must consider any possible loss of control of the business.
LEGAL ISSUES IN SETTING UP THE ORGANIZATION
The form of organization as well as franchise agreements are discussed in Chapters 9 and
14 and will not be addressed in detail here. Since there are many options that an entrepre-
neur can choose in setting up an organization (see Chapter 9), it will be necessary to under-
stand all the advantages and disadvantages of each regarding such issues as liability, taxes,
continuity, transferability of interest, costs of setting up, and attractiveness for raising capital.
Legal advice for these agreements is necessary to ensure that the most appropriate decisions
have been made.
PATENTS
A patent is a contract between the government and an inventor. In exchange for disclosure
of the invention, the government grants the inventor exclusivity regarding the invention for
a specified amount of time. At the end of this time, the government publishes the invention
and it becomes part of the public domain. As part of the public domain, however, there is
the assumption that the disclosure will stimulate ideas and perhaps even the development
of an even better product that could replace the original.
Basically, the patent gives the owners a negative right because it prevents anyone else
from making, using, or selling the defined invention. Moreover, even if an inventor has
been granted a patent, in the process of producing or marketing the invention he or she may
find that it infringes on the patent rights of others. The inventor should recognize the dis-
tinction between utility and design patents and some of the differences in international
patents that are discussed later in this chapter.
• Utility patents. When speaking about patents, most people are referring to utility patents. A utility patent has a term of 20 years, beginning on the date of filing with the
Patent and Trademark Office (PTO). Any invention requiring FDA approval has also
been amended to extend the term of the patent by the amount of time it takes the FDA
to review the invention. Initial filing fees for a utility patent for a small entity can vary
from $82 online to $165 by mail. Additional fees exist depending on the number of
claims made in the patent application.
A utility patent basically grants the owner protection from anyone else making, using,
and/or selling the identified invention and generally reflects protection of new, useful,
and unobvious processes such as film developing, machines such as photocopiers, com-
positions of matter such as chemical compounds or mixtures of ingredients, and articles
of manufacture such as the toothpaste pump.
• Design patents. Covering new, original, ornamental, and unobvious designs for articles of manufacture, a design patent reflects the appearance of an object. These patents are
granted for a 14-year term and, like the utility patent, provide the inventor with a
negative right excluding others from making, using, or selling an article having the
ornamental appearance given in the drawings included in the patent. The initial filing
fee for each design application for a small entity is $110. There are also issuance fees,
depending on the size of the item. These fees are much lower than for a utility patent.
Traditionally, design patents were thought to be useless because it was so easy to
design around the patent. However, there is renewed interest in these patents. Examples
patent Grants holder
protection from others
making, using, or selling
a similar idea
are shoe companies such as Reebok and Nike that have become more interested in
obtaining design patents as a means of protecting their ornamental designs. These types
of patents are also valuable for businesses that need to protect molded plastic parts,
extrusions, and product and container configurations.
• Plant patents. These are issued under the same provisions as utility patents and are for new varieties of plants. These patents represent a limited area of interest, and thus very
few of these types of patents are issued.
Patents are issued by the PTO. In addition to patents, this office administers other pro-
grams and many online services for the entrepreneur, such as software for filing patents and
forms for trademarks and copyrights, discussed later in this chapter. Although the Disclo-
sure Document Program ended in 2007, it has been replaced by the Provisional Patent
Application Program.
A patent reform bill was introduced to Congress in 2007, but with changes made inde-
pendently by both the House and Senate there has not been any compromise. President
Obama has indicated a desire to move on patent reform, and there will likely be changes in
the near future. The most important part of the reform bill is the “first to file” system used
in most other countries. What this means is that regardless of the date of the invention, it is
the first one to file who will be granted the patent.3
International Patents
With the World Trade Organization (WTO) and its predecessor, the General Agreement on
Tariffs and Trade (GATT), more global free trade has been encouraged. However, although
international trade has increased at the rate of about 6 percent per year since GATT was
created in 1948, until recently there still was a need for an international patent law to pro-
tect firms from imitations and knockoffs. Another mechanism also was needed to provide
firms some protection in global markets.4
In response, the Patent Cooperation Treaty (PCT)—with over 100 participants—was
established to facilitate patent filings in multiple countries in one office rather than filing in
each separate country. Administered by the World Intellectual Property Organization (WIPO)
in Geneva, Switzerland, it provides a preliminary search that assesses whether the filing firm
will face any possible infringements in any country.5 The company can then decide whether
to proceed with the required filing of the patent in each country. It has a 30-month time frame
to file for these in-country patents. Even though the PCT allows for simultaneous filing of a
patent in all member countries, there may be significant differences in patent laws in each of
these countries. For example, patent laws in the United States allow computer software to re-
ceive both patent and copyright protection. On the other hand, in the European Union, patent
protection is not always extended to software, although recent court judgments in the U.K.
may change this as well.6
The Provisional Application
It is recommended that the entrepreneur first file a provisional patent application to es-
tablish a date of conception of the invention. This provisional application replaces the
disclosure document that was previously accepted by the PTO. The disclosure document
was more loosely defined in its requirements and often led to issues when more than one
person claimed the patent rights. In addition, the new provisional application is consis-
tent with European procedures and can be critical when there is a foreign company
164 PA RT 2 FROM IDEA TO THE OPPORTUNITY
provisional patent
application The initial
application to the U.S.
Patent and Trademark
Office providing evidence
of first to market
involved in the patent application. Basically, this application gives the entrepreneur who
files the rights to the patent based on the simple concept of first to file. As stated previ-
ously the requirements of the provisional application are somewhat more complete than
the prior disclosure document since the entrepreneur must prepare a clear and concise de-
scription of the invention. In addition to the written material, drawings may be included,
if deemed necessary to understand the invention. Upon receipt of the information, the
PTO will file the application on behalf of the inventor. The actual filing of the patent in
its final form must occur no later than 12 months after the provisional disclosure docu-
ment is filed.
Before actually applying for the patent it is advisable to retain a patent attorney to con-
duct a patent search. After the attorney completes the search, a decision can be made as to
the patentability of the invention.
The Patent Application
The patent application must contain a complete history and description of the invention as
well as claims for its usefulness. The actual form can be downloaded from the Patent and
Trademark Office Web site. In general, the application will be divided into the following
sections:
• Introduction. This section should contain the background and advantages of the invention and the nature of problems that it overcomes. It should clearly state how
the invention differs from existing offerings.
• Description of invention. Next the application should contain a brief description of the drawings that accompany it. These drawings must comply with PTO requirements.
Following this would be a detailed description of the invention, which may include
engineering specifications, materials, components, and so on, that are vital to the
actual making of the invention.
• Claims. This is probably the most difficult section of the application to prepare since claims are the criteria by which any infringements will be determined. They serve to
specify what the entrepreneur is trying to patent. Essential parts of the invention should
be described in broad terms so as to prevent others from getting around the patent. At the
same time, the claims must not be so general that they hide the invention’s uniqueness
and advantages. This balance is difficult and should be discussed and debated with the
patent attorney.
In addition to the preceding sections, the application should contain a declaration
or oath that is signed by the inventor or inventors. Your attorney will supply this form. The
completed application is then ready to be sent to the PTO, at which time the status of the
invention becomes patent pending. This status is important to the entrepreneur because it
now provides complete confidential protection until the application is approved. At that
time, the patent is published and thus becomes accessible to the public for review.
A carefully written patent should provide protection and prevent competitors from
working around it. However, once granted, it is also an invitation to sue or be sued if there
is any infringement.
The fees for filing an application will vary, depending on the patent search and on claims
made in the application. Attorney fees are also a factor in completing the patent application.
Applicants may also file online using the EFS Web service provided by the PTO. This
online service enables applicants to file their application without the need for special soft-
ware, resulting in faster application processing.
C H A P T E R 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 165
Patent Infringement
To this point, we have discussed the importance of and the procedures for filing a patent. It
is also important for the entrepreneur to be sensitive about whether he or she is infringing
on someone else’s patent. The fact that someone else already has a patent does not mean
the end of any illusions of starting a business. Many businesses, inventions, or innovations
are the result of improvements on, or modifications of, existing products. Copying and
improving on a product may be perfectly legal (no patent infringement) and actually good
business strategy. If it is impossible to copy and improve the product to avoid patent
infringement, the entrepreneur may try to license the product from the patent holder.
Figure 6.1 illustrates the steps that an entrepreneur should follow as he or she considers
marketing a product that may infringe on an existing patent. The entrepreneur can now
make use of the Internet to identify Web sites and services that can assist in the search
process. If there is an existing patent that might involve infringement by the entrepreneur,
licensing may be considered. If there is any doubt as to this issue, the entrepreneur should
hire a patent attorney to ensure that there will not be any possibility of patent infringement.
Table 6.1 provides a simple checklist that should be followed by an entrepreneur to mini-
mize any patent risks.
BUSINESS METHOD PATENTS
With the growth of Internet use and software development has emerged the use of business
method patents. For example, Amazon.com owns a business method patent for the single-
clicking feature used by a buyer on its Web site to order products. A few years ago eBay was
166 PA RT 2 FROM IDEA TO THE OPPORTUNITY
FIGURE 6.1 Options to Avoid Infringement
Assess whether patent now exists
No
Yes
File for patent
New Do expired patents exist that accomplish same purpose?
Is patent recent or is it nearly expired?
No
Can product be changed slightly without infringement?
Ready to expire
Begin planning for introduction when existing patent expires
Yes
Develop product using older designs
No Yes
Seek license Develop modified version
Source: Adapted from H. D. Coleman and J. D. Vandenberg, “How to Follow the Leader,” Inc. (July 1988), pp. 81–82.
sued by Tom Woolston and his company MercExchange claiming a violation of a patent he
owned that covered many fundamental aspects of eBay’s operations, such as the buying and
selling of products through a reverse auction process. Priceline.com claims that it holds a
patent related to its service where a buyer can submit a price bid for a particular service.
Expedia was forced to pay royalties to Priceline.com after being sued for patent infringement
by Priceline.com. Many firms that hold these types of patents have used them to assault com-
petitors and subsequently provide a steady stream of income from royalties or licensing fees.7
Given the increase in the assaults and because of the growth of digital technologies such
as the Internet, computer software, and telecommunications, concerns have evolved regard-
ing these business method patents. Examples of the focus of these concerns are tax strate-
gies, the determination of insurance rates, or how commodities are purchased through a
third party. These business practice patents are now being threatened by a recent court rul-
ing that denied a patent for a process of hedging risks in commodity trading. The Federal
Circuit Court denied the patent because it did not meet the machine or transformation test.
This simply means that any business method or practice must be tied to a machine such as
a computer. Thus, a mental process of calculations for hedging risks in commodity trading
did not include a machine or computer and therefore was not granted a patent.8
START-UP WITHOUT A PATENT
Not all start-ups will have a product or concept that is patentable. In this case the entrepre-
neur should understand the competitive environment (see Chapters 7 and 8) to ascertain any
advantages that may exist or to identify a unique positioning strategy (see Chapter 8). With
a unique marketing plan, the entrepreneur may find that striking early in the market pro-
vides a significant advantage over any competitors. Maintaining this differential advantage
will be a challenge but represents an important means of achieving long-term success.
TRADEMARKS
A trademark may be a word, symbol, design, or some combination of such, or it could
be a slogan or even a particular sound that identifies the source or sponsorship of certain
goods or services. Unlike the patent, a trademark can last indefinitely, as long as the mark
C H A P T E R 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 167
• Seek a patent attorney who has expertise in your product line.
• The entrepreneur should consider a design patent to protect the product design or
product look.
• Before making an external disclosure of an invention at a conference or to the media, or
before setting up a beta site, the entrepreneur should seek legal counsel since this
external disclosure may negate a subsequent patent application.
• Evaluate competitor patents to gain insight into what they may be developing.
• If you think your product infringes on the patent of another firm, seek legal counsel.
• Verify that all employment contracts with individuals who may contribute new products
have clauses assigning those inventions or new products to the venture.
• Be sure to properly mark all products granted a patent. Not having products marked
could result in loss or damages in a patent suit.
• Consider licensing your patents. This can enhance the investment in a patent by creating
new market opportunities and can increase long-term revenue.
TABLE 6.1 Checklist for Minimizing Patent Risks
trademark A
distinguishing word,
name, or symbol used to
identify a product
A S S E E N I N BUSINESSWEEK
PROVIDE ADVICE TO AN ENTREPRENEUR INVENTOR ABOUT
HOW TO MAKE PATENTS PAY
The niche patent-licensing business of Acacia Research
(ACTG) is bearing fruit—and it has proved to be quite
lucrative. Titans like Apple (AAPL), Verizon (VZ), Sie-
mens (SI), and Dell Inc. (DELL) have opted to license
certain patents held by Acacia. For Acacia, that makes
the business all the more rewarding.
What’s tiny Acacia’s business strategy? It teams
up with small, little-known tech companies and takes
licenses on their patented technologies. Acacia then
goes after companies it believes have infringed those
patents. Fortunately for Acacia, it has settled quite
a number of such patent violations out of court. And
those companies that settle infringement claims usu-
ally end up paying fees.
The latest company to come to terms with Acacia
is giant computer maker Dell, which entered into a
settlement that included a licensing agreement cov-
ering a patent relating to network multifunction prin-
ter technology.
In 2008, Apple signed two tech licenses with Acacia,
and Verizon Wireless took a license on a process that
synchronizes IP addresses between wireless network
devices, says Acacia Chairman and CEO Paul Ryan. He
figures that with the more than 100 patents Acacia
now holds, many other companies are likely to end
up signing licensing deals with Acacia.
So far, Acacia has been on a rapid growth path,
according to both CEO Ryan and analysts. In 2008,
says Ryan, Acacia was No. 42 on Deloitte Technol-
ogy’s list of the 500 fastest-growing tech outfits in
the U.S. He says Acacia expects revenue growth to
come from 45 patent licensing programs that have
already begun generating revenues, including those
signed in 2009.
Acacia’s “growth prospects remain strong,” says
analyst Sean O’Neill of Singular Research, who rates
Acacia a buy. Revenues in the third quarter of 2008,
he notes, increased 44.6% from a year earlier, exceed-
ing analysts’ expectations. On a sequential quarter-
to-quarter basis, revenues jumped 93%, from the $7.1
million Acacia reported in the second quarter, notes
O’Neill.
O’Neill expects Acacia to become profitable in
2009, with estimated earnings of 11¢ a share on pro-
jected revenues of $67.9 million. In 2008, Acacia is es-
timated by analysts to have posted a loss of 46¢ a
share on sales of $44 million.
If, as CEO Ryan predicts, more prominent compa-
nies sign agreements to settle patent infringements,
Acacia’s top and bottom lines would leap, along with
its stock price.
Acacia CEO Ryan won’t say which companies he
expects will sign patent licensing agreements, but he
is confident more big tech players will end up signing
agreements this year. Expect some surprises.*
ADVICE TO AN ENTREPRENEUR
A friend of yours has read the above article and wants
to know if he could benefit from some of the patents
he owns, just as Acacia was able to do. How would
you advise him to proceed to learn if any of his patents
are being used by other companies? He also wants to
know if Acacia may be interested in any of his patents
and what he could do to find out.
*Source: Reprinted from February 2, 2009 issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Compa- nies, Inc., from “Acacia Research Finds Ways to Make Patents Pay,” by Gene Marcial, www.businessweek.com.
168
C H A P T E R 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 169
continues to perform its indicated function. For all registrations filed after November 16,
1989, the trademark is given an initial 10-year registration with 10-year renewable terms.
In the fifth to sixth year, the registrant is required to file an affidavit with the PTO indicat-
ing that the mark is currently in commercial use. If no affidavit is filed, the registration is
canceled. Between the ninth and tenth year after registration, and every 10 years thereafter,
the owner must file an application for renewal of the trademark. Otherwise, the registration
is canceled. (There is a six-month grace period.)
Trademark law allows the filing of a trademark solely on the intent to use the trademark
in interstate or foreign commerce. The filing date then becomes the first date use of the
mark. This does not imply that the entrepreneur cannot file after the mark has already been
in use. If this is the case, the entrepreneur may file a sworn statement that the mark is in
commercial use, listing the date of first use. A properly worded declaration is included in
the PTO application form.
It is also possible to file for a trademark if you intend to use this mark in the future. You
are allowed to file in good faith along with a sworn statement in the application that there
is intent to use the trademark. Actual use of the trademark must occur before the PTO will
register the mark.9
The protection awarded is dependent on the character of the mark itself. There are four
categories of trademarks: (1) coined marks denote no relationship between the mark and
the goods or services (e.g., Mercedes, Kodak) and afford the possibility of expansion to a
wide range of products; (2) an arbitrary mark is one that has another meaning in our lan-
guage (e.g., Apple) and is applied to a product or service; (3) a suggestive mark is used to
suggest certain features, qualities, ingredients, or characteristics of a product or service
(e.g., Halo shampoo). It differs from an arbitrary mark in that it tends to suggest some
describable attribute of the product or service. Finally, (4) a descriptive mark must have
become distinctive over a significant period of time and gained consumer recognition be-
fore it can be registered. The mark then is considered to have secondary meaning; that is, it
is descriptive of a particular product or service (e.g., Rubberoid as applied to roofing mate-
rials that contain rubber.10
Registering a trademark can offer significant advantages or benefits to the entrepreneur.
Table 6.2 summarizes some of these benefits.
Registering the Trademark
As indicated earlier, the PTO is responsible for the federal registration of trademarks. To
file an application, the entrepreneur must complete a simple form that can be downloaded
• It provides notice to everyone that you have exclusive rights to the use of the mark
throughout the territorial limits of the United States.
• It entitles you to sue in federal court for trademark infringement, which can result in
recovery of profits, damages, and costs.
• It establishes incontestable rights regarding the commercial use of the mark.
• It establishes the right to deposit registration with customs to prevent importation of
goods with a similar mark.
• It entitles you to use the notice of registration (®).
• It provides a basis for filing trademark application in foreign countries.
TABLE 6.2 Benefits of a Registered Trademark
170 PA RT 2 FROM IDEA TO THE OPPORTUNITY
and either submitted by mail or filed electronically using the Trademark Electronic Appli-
cation System (TEAS) available on the PTO Web site.
Filing of the trademark registration must meet four requirements: (1) completion of the
written form, (2) a drawing of the mark, (3) five specimens showing actual use of the mark, and
(4) the fee. Each trademark must be applied for separately. Upon receipt of this information,
the PTO assigns a serial number to the application and sends a filing receipt to the applicant.
The next step in the registering process is a determination by the examining attorney at
the PTO as to whether the mark is suitable for registration. Within about three months, an
initial determination is made as to its suitability. Any objections by the entrepreneur must
be raised within six months, or the application is considered abandoned. If the trademark is
refused, the entrepreneur still has the right to appeal to the PTO.
Once accepted, the trademark is published in the Trademark Official Gazette to allow any
party 30 days to oppose or request an extension to oppose. If no opposition is filed, the regis-
tration is issued. This entire procedure usually takes about 13 months from the initial filing.
COPYRIGHTS
A copyright protects original works of authorship. The protection in a copyright does not
protect the idea itself, and thus it allows someone else to use the idea or concept in a differ-
ent manner.
The copyright law has become especially relevant because of the tremendous growth of
the use of the Internet, especially to download music, literary work, pictures, and videos, to
name a few. Although software was added to copyright law in 1980, the issues surrounding
access to material on the Internet have led to major legal battles for the entertainment industry.
When Napster made its entrance in 1999, Internet users were able to exchange music
files at will. The music industry scrambled and fought against this use since its sales of CDs
were significantly impacted. After three years, the music industry was able to win its battle
with Napster. In addition, the Supreme Court ruled that StreamCast and Grokster, which
both have extensive peer-to-peer file sharing software, must implement content filters in
their software to reduce any copyright-infringing capabilities.11
The Recording Industry Association of America (RIAA) has also aggressively pursued
universities and individual students that have been found to be illegally downloading mu-
sic. In addition to the 12 universities recently sent prelitigation letters, the RIAA is also
pursuing individuals in what is referred to as “John Doe” lawsuits. One lawsuit involves a
20-year-old woman from Texas who admitted to downloading pirated music in her teens;
she is being asked to pay $7,400 to settle the suit.12
Copyright protection related to the Internet will continue to be a concern and a gray area
until precedents and regulations are made clear. Although these issues seem complicated,
the registering procedure for copyright protection is fairly simple.
Copyrights are registered with the Library of Congress and will not usually require an
attorney. To register a work, the applicant can send a completed application (available on-
line at www.copyright.gov), two copies of the work, and the required filing fees (the initial
filing fee is $35 if filed online or $45 if filed by mail, but other fees may apply based on the
number of works included). As a general rule for works created after January 1, 1978, the
term of the copyright is the life of the author plus 70 years.
Besides computer software, copyrights are desirable for such things as books, scripts, ar-
ticles, poems, songs, sculptures, models, maps, blueprints, collages, printed material on board
games, data, and music. In some instances, several forms of protection may be available. For
example, the name of a board game may be protected by trademark, the game itself protected
by a utility patent, the printed matter or the board protected by a copyright, and the playing
pieces covered by a design patent.
copyright Right given
to prevent others from
printing, copying, or
publishing any original
works of authorship
171
TRADE SECRETS
In certain instances, the entrepreneur may prefer to maintain an idea or process as confiden-
tial and to sell or license it as a trade secret. The trade secret will have a life as long as the
idea or process remains a secret.
A trade secret is not covered by any federal law but is recognized under a governing
body of common laws in each state. Employees involved in working with an idea or
process may be asked to first sign a confidential information agreement that will protect
against their giving out the trade secret either while an employee or after leaving the
organization. A simple example of a trade secret nondisclosure agreement is illustrated
in Table 6.3. The entrepreneur should hire an attorney to help draw up any such agree-
ment. The holder of the trade secret has the right to sue any signee who breaches such an
agreement.
What or how much information to give to employees is difficult to judge and is often
determined by the entrepreneur’s judgment. Historically, entrepreneurs tended to protect
sensitive or confidential company information from anyone else by simply not making
them privy to this information. Today, there is a tendency to take the opposite view, that the
more information entrusted to employees, the more effective and creative employees can
be. The argument is that employees cannot be creative unless they have a complete under-
standing of what is going on in the business.
Most entrepreneurs have limited resources, so they choose not to find means to protect
their ideas, products, or services. This could become a serious problem in the future, since
gathering competitive information legally is so easy to accomplish, unless the entrepreneur
takes the proper precautions. For example, it is often easy to learn competitive information
trade secret Protection
against others revealing
or disclosing information
that could be damaging
to business
E T H I C S
The lines have been drawn between the file-sharing
companies (P2P) that provide software for free down-
loading of music and movies and the entertainment
industry. The Supreme Court has ruled that these
P2P companies do in fact facilitate the illegal down-
loading and sharing of entertainment. However, in
spite of the fact that there has been so much publicity
surrounding the legality of such initiatives, the youth
of our nation continue to illegally download material
that has been given copyright protection. This in-
cludes college students as well, recently evidenced
by the fact that the Recording Industry Association
of America (RIAA) filed copyright infringement law-
suits against 405 students at 18 different colleges.
This list of colleges included Columbia, Harvard, and
Princeton. According to the lawsuit, these students
were allegedly using a new file-sharing application
called i2hub to download songs and movies at light-
ning speeds. The RIAA also has evidence that this
high-speed network is also being used at another
140 schools in 41 states.
In addition to these college and university incidents,
a recent Harris Interactive poll found that kids and
teens, ranging in age from 8 to 18, continue to down-
load and share files that are copyright protected—
in spite of the fact that nearly 90 percent know it is
illegal. What is alarming in this study is the fact that
80 percent of the participants understand the mean-
ing of a copyright, yet they continue to perform ille-
gal functions. This finding illustrates a challenging
ethical dilemma that persists in our society. The par-
ticipants were more concerned with downloading
a virus or spyware than they were with getting in
trouble with the law. It is apparent from this re-
search that young people consider stealing software
a victimless crime, which would seem to underline
the need for more ethics education at home and at
school.
Sources: Sebastian Rupley, “Infringing Copyrights at Mach 5,” PC Magazine (June 7, 2005), p. 24, and “Majority of Youth Under- stand ‘Copyright,’ but Many Continue to Download Illegally,” PR Newswire (May 18, 2004) pp. 1–3.
HOW MUCH RESPONSIBILITY SHOULD OUR YOUTH HAVE
FOR ILLEGAL DOWNLOADING?
172 PA RT 2 FROM IDEA TO THE OPPORTUNITY
through such means as trade shows, transient employees, media interviews or announce-
ments, and even Web sites. In all instances, overzealous employees are the problem. To try
to control this problem, entrepreneurs should consider some of the ideas listed below.
• Train employees to refer sensitive questions to one person.
• Provide escorts for all office visitors.
• Avoid discussing business in public places.
• Keep important travel plans secret.
• Control information that might be presented by employees at conferences or published in journals.
WHEREAS, New Venture Corporation (NVC), Anywhere Street, Anyplace, U.S.A., is the Owner
of information relating to; and
WHEREAS, NVC is desirous of disclosing said information to the undersigned (hereinafter
referred to as “Recipient”) for the purposes of using, evaluating, or entering into further
agreements using such trade secrets as an employee, consultant, or agent of NVC; and
WHEREAS, NVC wishes to maintain in confidence said information as trade secret; and
WHEREAS, the undersigned Recipient recognizes the necessity of maintaining the strictest
confidence with respect to any trade secrets of NVC.
Recipient hereby agrees as follows:
1. Recipient shall observe the strictest secrecy with respect to all information presented by
NVC and Recipient’s evaluation thereof and shall disclose such information only to
persons authorized to receive same by NVC. Recipient shall be responsible for any
damage resulting from any breach of this Agreement by Recipient.
2. Recipient shall neither make use of nor disclose to any third party during the period of
this Agreement and thereafter any such trade secrets or evaluation thereof unless prior
consent in writing is given by NVC.
3. Restriction on disclosure does not apply to information previously known to Recipient or
otherwise in the public domain. Any prior knowledge of trade secrets by the Recipient
shall be disclosed in writing within (30) days.
4. At the completion of the services performed by the Recipient, Recipient shall within
(30) days return all original materials provided by NVC and any copies, notes, or other
documents that are in the Recipient’s possession pertaining thereto.
5. Any trade secrets made public through publication or product announcements are
excluded from this agreement.
6. This agreement is executed and delivered within the State of _____ and it shall be
construed, interpreted, and applied in accordance with the laws of that State.
7. This agreement, including the provision hereof, shall not be modified or changed in any
manner except only in writing signed by all parties hereto.
Effective this ________________ day of _____________ 20 _____
RECIPIENT: ______________________________________
NEW VENTURE CORPORATION:
By: _________________________
Title: _______________________
Date: _______________________
TABLE 6.3 A Simple Trade Secret Nondisclosure Agreement
C H A P T E R 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 173
• Use simple security such as locked file cabinets, passwords on computers, and shredders where necessary.
• Have employees and consultants sign nondisclosure agreements.
• Debrief departing employees on any confidential information.
• Avoid faxing any sensitive information.
• Mark documents confidential when needed.
Unfortunately, protection against the leaking of trade secrets is difficult to enforce. More
important, legal action can be taken only after the secret has been revealed. It is not neces-
sary for the entrepreneur to worry extensively about every document or piece of informa-
tion. As long as minimal precautions are taken, most problems can be avoided, primarily
because leaks usually occur inadvertently.
LICENSING
Licensing may be defined as an arrangement between two parties, where one party has
proprietary rights over some information, process, or technology protected by a patent,
trademark, or copyright. This arrangement, specified in a contract (discussed later in this
chapter), requires the licensee to pay a royalty or some other specified sum to the holder
of the proprietary rights (licensor) in return for permission to copy the patent, trademark,
or copyright.
Thus, licensing has significant value as a marketing strategy to holders of patents, trade-
marks, or copyrights to grow their business in new markets when they lack resources or ex-
perience in those markets. It is also an important marketing strategy for entrepreneurs who
wish to start a new venture but need permission to copy or incorporate the patent, trade-
mark, or copyright with their ideas.
A patent license agreement specifies how the licensee would have access to the patent.
For example, the licensor may still manufacture the product but give the licensee the rights
to market it under their label in a noncompetitive market (i.e., foreign market). In other
instances, the licensee may actually manufacture and market the patented product under its
own label. This agreement must be carefully worded and should involve a lawyer, to ensure
the protection of all parties.
Licensing a trademark generally involves a franchising agreement. The entrepreneur
operates a business using the trademark and agrees to pay a fixed sum for use of the
trademark, pay a royalty based on sales volume, buy supplies from the franchisor (exam-
ples would be Shell, Dunkin’ Donuts, Pepsi Cola or Coca Cola bottlers, or Midas muffler
shops), or some combination of these. Franchising is discussed later in the text as an
option for the entrepreneur as a way to start a new business or as a means of financing
growth.
Copyrights are another popular licensed property. They involve rights to use or copy
books, software, music, photographs, and plays, to name a few. In the late 1970s, computer
games were designed using licenses from arcade games and movies. Television shows have
also licensed their names for board games or computer games. Celebrities will often license
the right to use their name, likeness, or image in a product (i.e., Tiger Woods golf clothing,
Jessica Simpson perfume, Elvis Presley memorabilia, or Mickey Mouse lunch boxes). This
is actually analogous to a trademark license.
Licensing has become a revenue boom for many Fortune 500 companies. These firms
spend billions of dollars each year on the research and development of new technologies
that they will never bring to market. As a result, they will often license patents, trademarks,
and other intellectual property to small companies that can profit from them. Microsoft
licensing Contractual
agreement giving rights to
others to use intellectual
property in return for a
royalty or fee
Corporation, with its IP Ventures Division, is a great example of a firm that has offered
technologies for biometric identity authentication, counterfeit-resistant labels, face detec-
tion and tracking, and other intellectual property that it does not know how to market or has
no intent to market.13 These agreements have generated millions of dollars in revenue for
Microsoft. IBM continues to generate more than $1 billion from its licensing agreements.14
ARC International, the world leader in computer processors, has increased its licensing of
its technology to semiconductor companies in their chip design. At present there are about
140 companies worldwide that rely on ARC’s technology.15
Although technology is one of the largest generators of licensing revenue, there are
other significant players in this market. The entertainment industry, particularly motion
picture studios such as Disney, DreamWorks, Fox, Sony, and Warner Brothers, generates
millions of dollars for its bottom line with licensing agreements for clothing, toys, games,
and other related items. NBC Universal Inc., with its television, movie, music, and con-
sumer products, amassed about $1 billion in revenues in 2008. Just recently, NBC Univer-
sal released a full line of products from its successful television show “Heroes.”16 Although
in 2006 Disney ended its 10-year licensing agreement with McDonald’s, it has inked huge
deals with retailers to market a variety of products based on the success of “High School
Musical” and “Hannah Montana.” These products are expected to result in $2.7 billion in
global retail sales. In fact global retail sales of all Disney’s licensed merchandise exceeded
$30 billion in 2008.17 McDonald’s, on the other hand, has moved on and signed licensing
agreements with other motion picture studios such as DreamWorks Animation SKG and
Pixar Animation Studios.18
Licensing is also popular around special sporting events, such as the Olympics,
marathons, bowl games, and tournaments. Licenses to sell T-shirts, clothing, and other
accessories require written permission in the form of a license agreement before sales are
allowed.
Licensing represents opportunities for many firms to expand into new markets, expand
product lines, or simply reach more customers within its existing target markets. Some
examples include Microsoft’s MSN Mobile group, which recently signed a licensing agree-
ment with DeviceAtlas to incorporate their database so MSN can improve the content it
presently delivers to its customers. This agreement has already resulted in significant in-
creases in mobile registrations.19 Retailers faced with economic pressures are looking for
ways to increase sales of higher-margin items. For example, Safeway has been using Bugs
Bunny and his Looney Tunes friends as part of their new Eating Right Kids food and bev-
erage line. These items can command higher prices and provide what retailers feel is a
value-added endorsement.20
Before entering into a licensing agreement, the entrepreneur should ask the following
questions:
• Will the customer recognize the licensed property?
• How well does the licensed property complement my products or services?
• How much experience do I have with the licensed property?
• What is the long-term outlook for the licensed property? (For example, the loss of popularity of a celebrity can also result in an end to a business involving that
celebrity’s name.)
• What kind of protection does the licensing agreement provide?
• What commitment do I have in terms of payment of royalties, sales quotas, and so on?
• Are renewal options possible and under what terms?
174 PA RT 2 FROM IDEA TO THE OPPORTUNITY
Licensing is an excellent option for the entrepreneur to increase revenue, without the
risk and costly start-up investment. To be able to license requires the entrepreneur to have
something to license, which is why it is so important to seek protection for any product,
information, name, and so on, with a patent, trademark, or copyright. On the other hand,
licensing can also be a way to start a new venture when the idea may infringe on someone
else’s patent, trademark, or copyright. In this instance, the entrepreneur has nothing to lose
by trying to seek a license agreement from the holder of the property.
Licensing continues to be a powerful marketing tool. With the advice of a lawyer, entre-
preneurs may find that licensing opportunities are a way to minimize risk, expand a business,
or complement an existing product line.
PRODUCT SAFETY AND LIABILITY
It is very important for the entrepreneur to assess whether any product that is to be mar-
keted in the new venture is subject to any regulations under the Consumer Product
Safety Act. The original act, which was passed in 1972 and then amended in 1990, created
a five-member commission that has the power to prescribe safety standards for more than
15,000 types of consumer products. In August of 2008 there were significant changes that
were made into law, now requiring stricter standards for potentially hazardous and unsafe
products.
Large fines as well as recalls of any products that are deemed unsafe are the typical
outcomes of any action enforced by the commission. For example, in 2007 U.S. compa-
nies were forced to make more than 100 recalls involving about 9 million toys. Polly
Pocket play sets and Batman action figures highlighted these recalls, given that these
products were found to have high lead content or that they contained small accessories
that could be potentially hazardous if swallowed by a child. The public outcry from
these recalls was a major factor in getting Congress to act quickly on the new legisla-
tion. In the past two decades, the Consumer Product Safety Commission had been oper-
ating on tighter budgets and smaller staff and was not able to oversee the large number
of new products being launched or imported each year. With a new budget, significantly
larger staff, and support from the administration it is expected that the commission will
now be able to take a more active role in making sure that firms meet the new legal re-
quirements for product safety. Stricter enforcement as well as the threat of significant
increases in fines for violations should improve the situation. As an example, the fines
for violations in the past were $5,000 per violation. The new law allows for fines of
$100,000 per violation with a cap of $15 million. The commission will also be able to
take a more active role in demanding recalls where in the past it only could oversee any
voluntary recalls. The development of stricter regulations regarding labeling and adver-
tising is also part of the commission’s responsibility under the new law. It is clear with
just these mentioned changes that any entrepreneur involved in marketing potentially
hazardous or unsafe products will need to make sure that products are tested by approved
third-party testing facilities.21
INSURANCE
Some of the problems relating to product liability were discussed in the previous section.
Besides being cautious, it is also in the best interests of the entrepreneur to purchase insur-
ance in the event that problems do occur. Service-related businesses such as day-care cen-
ters, amusement parks, and shopping centers have had significant increases in the number
of lawsuits.
C H A P T E R 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 175
product safety and
liability Responsibility
of a company to meet any
legal specifications
regarding a new product
covered by the Consumer
Product Safety Act
In general, most firms should consider coverage for those situations as described in
Table 6.4. Each of these types of insurance provides a means of managing risk in the new
business. The main problem is that the entrepreneur usually has limited resources in the be-
ginning. Thus, it is important to first determine whether any of these types of insurance are
needed. Note that some insurance, such as disability and vehicle coverage, is required by
law and cannot be avoided. Other insurance, such as life insurance of key employees, is not
required but may be necessary to protect the financial net worth of the venture. Once the
entrepreneur determines what types of insurance are needed, then a decision can be made
as to how much insurance and from what company. It is wise to get quotes from more than
one insurance firm since rates and options can also vary. The total insurance cost represents
an important financial planning factor, and the entrepreneur needs to consider increasing
premiums in cost projections.
Skyrocketing medical costs have probably had the most significant impact on insurance
premiums. This is especially true for workers’ compensation premiums, which for some
entrepreneurs have doubled or tripled in the last few years. Insurance companies calcu-
late the premium for workers’ compensation as a percentage of payroll, the type of busi-
ness, and the number of prior claims. Given the problems with fraudulent or suspicious
claims, some states are beginning to undertake reforms in the coverage. Even before re-
forms are enacted, the entrepreneur can take some action to control the premiums by pay-
ing attention to details, such as promoting safety through comprehensive guidelines that
176 PA RT 2 FROM IDEA TO THE OPPORTUNITY
Types of Insurance Coverage Possible
Property • Fire insurance to cover losses to goods and premises resulting
from fire and lightning. Can extend coverage to include risks
associated with explosion, riot, vehicle damage, windstorm
hail, and smoke.
• Burglary and robbery to cover small losses for stolen property
in cases of forced entry (burglary) or if force or threat of
violence was involved (robbery).
• Business interruption will pay net profits and expenses when
a business is shut down because of fire or other insured cause.
Casualty • General liability covers the costs of defense and judgments
obtained against the company resulting from bodily injury or
property damage. This coverage can also be extended to cover
product liability.
• Automobile liability is needed when employees use their own
cars for company business.
Life • Life insurance protects the continuity of the business
(especially a partnership). It can also provide financial
protection for survivors of a sole proprietorship or for loss
of a key corporate executive.
Workers’ compensation • May be mandatory in some states. Provides benefits to
employees in case of work-related injury.
Bonding • This shifts responsibility to the employee for performance of a
job. It protects company in case of employee theft of funds or
protects contractor if subcontractor fails to complete a job
within an agreed-upon time frame.
TABLE 6.4 Types of Insurance and Possible Coverage
are communicated to every staff member. Being personally involved with safety can, in
the long run, significantly control workers’ compensation premiums.
Entrepreneurs also have to consider health care coverage. This is an important ben-
efit to employees and will require the venture to cover a significant portion of this
expense for the employee. Rates to the company will vary significantly depending on
the plan and its various options. Health insurance premiums are less expensive if there
is a large group of insured participants. This is, of course, difficult for a start-up venture
but can be resolved by joining a group such as a professional association that offers such
coverage.
However, if you are a self-employed entrepreneur, the options are limited. If you are
leaving a corporate position, consider extending your health care benefits with COBRA.
This usually allows you to continue on the same health care policy you were on for
about three years. However, you now will have to pay the entire premium on the policy.
If your COBRA has expired or one is not available, you can consider contacting your
state insurance department, which can supply a list of insurance companies that provide
individual health care insurance. Policies that have higher deductibles can also be con-
sidered because of their lower premiums. For additional assistance in these matters it is
recommended that the entrepreneur contact the Association of Health Insurance Agents,
the Health Insurance Association of America, or the U.S. Labor Department, all located
in Washington, D.C.
Most recently there has been some controversy regarding safety for employees in home-
based businesses. The government’s response has been that the company is responsible for
safety or health violations in home-based offices. The best protection for entrepreneurs
operating home-based businesses is to write handbooks with stated policies on home office
safety.
Seeking advice from an insurance agent is often difficult because the agent is trying to
sell insurance. However, there are specialists at universities or the Small Business Admin-
istration who can provide this advice at little or no cost.
SARBANES-OXLEY ACT
After a lengthy period of reported corporate misconduct involving companies such as
Enron and Arthur Andersen, Congress passed the Sarbanes-Oxley Act in 2002. Although
this act has provided a mechanism for greater control over the financial activities of public
companies, it also has created some difficulties for start-ups and smaller companies. Argu-
ments are now being put forth that the law was passed too quickly as a result of all the cor-
porate scandals and that the provisions are too vague and their implementation by CPAs too
rigid. In fact it is argued that the cost of compliance is not only prohibitive but that it has
led to a decline in the number of start-ups going public.22
The act contains a number of provisions, and no attempt will be made here to cover
them all. Instead an overview of the law’s requirements will be discussed. The complete
law or relevant sections can be downloaded from the Internet.
The Sarbanes-Oxley Act covers a wide range of corporate governance activities.
Under this law, CEOs are required to vouch for financial statements through a series of
internal control mechanisms and reports. Directors must meet background, length of
service, and responsibilities requirements regarding internal auditing and control. Any
attempt to influence the auditor or impede the internal auditing process is considered a
criminal act. In addition, the law covers bank fraud; securities fraud; and fraud by wire,
radio, or TV.23
C H A P T E R 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 177
With the passage of this law there has been some concern as to the interpretation of this
law and subsequent directors’ liability. For example, will this law discourage qualified in-
dividuals from being members of important boards because of their concern for negative
publicity that could be initiated by a disgruntled employee or stockholder?
Foreign companies that trade on U.S. stock exchanges are often delisted since there
are major conflicts with the provisions of the new law and the laws of that foreign country.
For example, independent audit committees, required by the new law, conflict with some
foreign countries’ rules and customs. This is only one example of the many conflicts that
presently exist with foreign laws and customs.24
At present, private companies are not included in this act. However, there could be some
future controls established to prevent any of these governance issues in private companies.
Private companies are also subject to control if they consult with a public company and in
any way influence that public company in any wrongdoing established by the Sarbanes-
Oxley Act.
The other option, of course, is for the entrepreneur to set up a board of advisors instead
of an extended board of directors. Advisors would not be subject to liability since they do
not formulate final policy for the venture but only provide recommendations to the actual
board of directors, which in this case could consist of the management of the start-up ven-
ture. If a venture capitalist or even an angel investor were involved, they would require a
board seat, in which case the use of a board of advisors would not likely be acceptable and
liability protection would be necessary.
CONTRACTS
The entrepreneur, in starting a new venture, will be involved in a number of negotiations
and contracts with vendors, landlords, and clients. A contract is a legally enforceable agree-
ment between two or more parties as long as certain conditions are met. Table 6.5 identi-
fies these conditions and the outcomes (breaches of contract) should one party not live up
to the terms of the contract. It is very important for the entrepreneur to understand the
178 PA RT 2 FROM IDEA TO THE OPPORTUNITY
contract A legally
binding agreement
between two parties
Contract Conditions
• An offer is made. It can be oral or written but is not binding until voluntary acceptance of offer is given.
• Voluntary acceptance of offer.
• Consideration (something of value) is given by both parties.
• Both parties are competent and/or have the right to negotiate for their firms.
• Contract must be legal. Any illegal activities under a contract are not binding. An example might be gambling.
• Any sales of $500 or more must be in writing.
Results of a Contract Breach
• The party in violation of a contract may be required to live up to the agreement or pay damages.
• If one party fails to live up to its end of a contract, the second party may also agree to drop the matter and thus not live up to the agreement as well. This is referred to as contract restitution.
TABLE 6.5 Contract Conditions and Results of a Breach of Contract
fundamental issues related to contracts while also recognizing the need for a lawyer in
many of these negotiations.
Often business deals are concluded with a handshake. Ordering supplies, lining up
financing, reaching an agreement with a partner, and so on, are common situations in which
a handshake consummates the deal. Usually, when things are operating smoothly, this pro-
cedure is sufficient. However, if there are disagreements, the entrepreneur may find that
there is no deal and that he or she may be liable for something never intended. The courts
generally provide some guidelines based on precedence of cases. One rule is to never rely
on a handshake if the deal cannot be completed within one year. For example, a company
that trains salespeople asked another firm to produce videotapes used in the training. The
training firm was asked to promise to use the tapes only for its own sales force and not to
sell the tapes to others. Some time after the tapes were produced, this firm began to produce
and sell the tapes under a newly formed company. The original developer of the tapes
brought suit, and the courts ruled that an oral agreement for more than one year is not en-
forceable. The only way that this could have been prevented was if the copying firm had
signed a contract.
In addition to the one-year rule of thumb, the courts insist that a written contract ex-
ist for all transactions over $500. Even a quote on a specified number of parts from a
manufacturer may not be considered a legal contract. For example, if an entrepreneur
asked for and received a quote for 10 items and then ordered only 1 item, the seller
would not have to sell that item at the original quoted price unless a written contract ex-
isted. If the items totaled over $500, even the quoted price could be changed without a
written contract.
Most sellers would not want to try to avoid their obligations in the preceding example.
However, unusual circumstances may arise that force the seller to change his or her mind.
Thus, the safest way to conduct business deals is with a written contract, especially if the
amount of the deal is over $500 and is likely to extend beyond one year.
Any deal involving real estate must be in writing to be valid. Leases, rentals, and pur-
chases all necessitate some type of written agreement.
Although a lawyer might be necessary in very complicated or large transactions, the en-
trepreneur cannot always afford one. Therefore, it is helpful for the entrepreneur to under-
stand that before signing a contract he or she should do the following:
1. Understand the terms and conditions in the contract.
2. Cross out anything that you do not agree to.
3. Do not sign if there are blank spaces (these can be crossed out).
4. Make a copy for your files after signing.
C H A P T E R 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 179
IN REVIEW
S U M M A R Y
This chapter explores some of the major concerns regarding intellectual property of
the entrepreneur, as well as other important legal issues such as product safety, insur-
ance, contracts, and the Sarbanes-Oxley Act. The problems with intellectual property
have become more complicated with the growth of the Internet. It is important for the
entrepreneur to seek legal advice in making any intellectual property legal decisions
such as patents, trademarks, copyrights, and trade secrets. Lawyers have specialties
that can provide the entrepreneur with the most appropriate advice under the circum-
stances. There are also resources identified in the chapter that should be considered
before hiring an attorney. Some of this information can save time and money for the
entrepreneur.
A patent requires a patent attorney, who assists the entrepreneur in completing an
application to the Patent and Trademark Office with the history and description of the
invention, as well as claims for its usefulness. An assessment of the existing patent(s)
will help to ascertain whether infringement is likely and to evaluate the possibilities of
modifying the patented product or licensing the rights from the holder of the patent.
A provisional patent can be filed that will give the entrepreneur 12 months to finalize
the patent. Being the first to file with a provisional patent can be very useful to pro-
vide immediate notification of ownership of the patent rights as well as provide time
to develop business strategies.
A trademark may be a word, symbol, design, or some combination, or a slogan or
sound that identifies the source of certain goods or services. Trademarks give the en-
trepreneur certain benefits as long as the following four requirements are met: (1) com-
pletion of the written application form, (2) submission of a drawing of the mark,
(3) submission of five specimens showing actual use of the mark, and (4) payment of
the required fees.
Copyrights protect original works of authorship. Copyrights are registered with the
Library of Congress and do not usually require an attorney. Copyrights have become
relevant to the use of the Internet, especially to download music, literary works, pic-
tures, or videos. Copyright protection related to the Internet will continue to be a gray
area until regulations are made clearer. Both trademark and copyright applications can
be filed electronically.
Licensing is a viable means of starting a business using someone else’s product,
name, information, and so on. It is also an important strategy that the entrepreneur
can use to expand the business without extensive risk or large investments.
The entrepreneur should also be sensitive to possible product safety and liability
requirements. Careful scrutiny of possible product problems, as well as insurance, can
reduce the risk. Other risks relating to property insurance, life insurance, health insur-
ance, workers’ compensation, and bonding should be evaluated to ascertain the most
cost-effective program for the entrepreneur.
Contracts are an important part of the transactions that the entrepreneur will
make. As a rule of thumb, oral agreements are invalid for deals over one year and over
$500. In addition, all real estate transactions must be in writing to be valid. It is impor-
tant in a written agreement to identify all the parties and their respective roles, to
describe the transaction in detail, to specify the value of the deal, and to obtain the
signatures of the persons with whom you are doing business.
The Sarbanes-Oxley Act was passed in 2002 and places a great burden on public
companies to streamline their financial reporting, modify the role and responsibility
of boards of directors, and basically provide more checks and balances to avoid
repeating the scandals of WorldCom, Enron, and others. There are a number of pro-
visions of the law, and entrepreneurs should be aware of any relevant requirements,
particularly if there is intent to take the company public. At this point the law
applies only to public companies, but there are possible interactions with private
firms as well as likely changes to these laws that will require continued scrutiny by
entrepreneurs.
180 PA RT 2 FROM IDEA TO THE OPPORTUNITY
R E S E A R C H T A S K S
1. Using the Internet, obtain copies of three patents that are at least three years
old. What are the elements that are common across these patents? What are the
differences? Which do you believe will be the greatest success? Can you find any
evidence of products that are now on the market that incorporate any of these
patented technologies?
2. Search press reports for patent infringement cases. Describe the process and
the outcome. Of particular value are examples that list the legal costs of
defending patent infringements and the amount awarded for a successful
defense.
3. What are some of the world’s most famous trademarks? Use data to back up your
answer.
4. Provide a real-life example for each of the following different types of product
liability: (a) negligence, (b) warranty, (c) strict liability, and (d) misrepresentation.
When possible, report both the details and the payouts.
5. How much does it cost to apply for and obtain a patent?
C L A S S D I S C U S S I O N
1. Provide three examples of companies that use trade secrets to keep competitors
from imitating their products. What activities do they undertake to maintain this
secrecy? How effective do you think they are?
2. Should copyrighted music be available on the Internet free of charge, even if it is
against the wishes of the artist and the recording company? Consider both sides
of the argument to make a more convincing argument.
3. To what extent should the government be involved in creating and enforcing
safety laws and to what extent should companies (and industries) be responsible
for creating their own standards and self-policing those standards?
S E L E C T E D R E A D I N G S
Baroncelli, Eugenia; Carsten Fink; and Beata Javorcik. (2005). The Global Distribution of Trademarks: Some Stylised Facts. World Economy, vol. 28, no. 6, pp. 765–82.
This paper provides the first empirical analysis of the global distribution of trade- marks. The analysis is based on data compiled and published by the World Intellec- tual Property Organization. It includes an analysis of trademark registrations across countries of different income groups and different sectors of the economy. The re- sults provide implications for changes in intellectual property protection in interna- tional trade.
Caballero-Sanz, F.; R. Moner-Colonques; and J. Sempere-Monerris. (2005). Licensing Policies for a New Product. Economics of Innovation & New Technology, vol. 14, no. 8, pp. 697–713.
This paper assesses the licensing policies for the developer of a new product. The study argues that the best licensing policy is fixed-fee licensing with an exclusive ter- ritory clause. Consumers are felt to be better off with the fixed-fee arrangement but do not prefer the exclusive territory provision.
�
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C H A P T E R 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 181
Chaudhry, Rahul; and Kajigailiu G. Kamei. (July 2008). Can Your Firm Keep Its Secrets? Managing Intellectual Property, Issue 181, pp. 109-12.
Trade secrets have become an important strategy of choice to protect confidential information. The information age has enhanced the amount and importance of nonpatentable information. This article focuses on a definition of a trade secret and describes ways to protect this information.
Cromley, Timothy. (2004). Twenty Steps for Pricing a Patent. Journal of Accountancy, vol. 198, no. 5, pp. 31–34.
There are a number of steps that can be followed to assist the accountant in deter- mining an evaluation of a patent. In addition to a discussion of these procedures, this paper also discusses the makeup of a valuation team.
Depoorter, Ben; Francisco Parisi; and Sven Vanneste. (2005). Problems with the Enforcement of Copyright Law: Is There a Social Norm Backlash? International Journal of the Economics of Business, vol. 12, no. 3, pp. 361–69.
Copyright norms have developed in opposition to existing copyright laws. This arti- cle argues that copyright enforcement efforts may actually induce further copyright disobedience by reinforcing the moral and social beliefs against conventional copy- right law.
Dodwell, William J. (2008). Six Years of the Sarbanes-Oxley Act. CPA Journal, vol. 78, no. 8, pp. 38–43.
An assessment of corporate financial reporting is provided in this review of the effectiveness of the Sarbanes-Oxley Act. The backlash of negative factors that was created from the new law is presented as well as a subsequent cost-benefit analysis of the relative significance of each of these factors.
France, M.; and S. Siwolop. (1996). How to Skin a Copycat. BusinessWeek (October 21, 1996), pp. 4–7.
Small businesses are particularly vulnerable to knockoffs because of their limited resources. A number of examples, with effective strategies that can be used to fight knockoffs, are presented.
Johnson, E. Scott. (February 2003). Using and Protecting Trademarks. CPA Journal, pp. 39–41.
This article argues that because a trademark is an appreciating asset with a poten- tially perpetual life, it is important to choose trademarks carefully and protect them through federal registration and controlled licensing. It discusses issues of trade- mark clearance, the establishment of trademark rights, the federal trademark reg- istration and application process, and domain names.
Marshall, Jeffrey; and Ellen M. Heffes. (July/August 2008). Smaller Firms Get Hit Harder Overseas, Survey Finds. Financial Executive, pp. 9–10.
The expansion of many small entities into foreign markets raises some significant legal issues. Differences in laws, languages, currencies, and styles of conducting business enhance the need for hiring a lawyer. The survey reported here indicates a shift in relevant factors in doing business overseas from terrorism and political insta- bility to currency risk and supply chain failure.
Ryan, Kenneth E. (February 2003). Product Liability Risk Control. Professional Safety, pp. 20–25.
In the current legal climate, parties injured by the defective product can easily sue not only the manufacturer of the product, but also any commercial supplier in the distribution channel, including the wholesaler and the retailer. The article discusses some of the risks and liabilities that these parties face and some of the product quality guidelines that they can follow to limit their liability.
182 PA RT 2 FROM IDEA TO THE OPPORTUNITY
Weiss, Carter. (2006). Innovative Designs Make Us Successful, but Defending Our Intellectual Property Keeps Us in Business. Fortune Small Business, vol. 16, no. 9, pp. 81–82.
This article relates the experience of an entrepreneur trying to protect one of his company’s signature products, a neoprene wine tote, from copycats. It further dis- cusses how the company managed to maintain its legal rights to this product by spending a certain amount of its budget each year policing copycats and how the threat of a lawsuit usually led to negotiation and resolution of the issue.
E N D N O T E S
1. See L. Olmstead, “How Steve Lipscomb Reinvented Poker and Built the Hottest Business in America,” Inc. (May 2005), pp. 80–92; “World Poker Tour®
Season VII Premiers January 4 on Fox Sports Network; Series Joins FSN’s Sunday Night Sports Block,” Business Wire (December 22, 2008), pp. 1–2; www.WorldPokerTour.com, 2007 Annual Report, pp. 1–34.
2. Patent and Trademark Office, U.S. Department of Commerce Web site (www.uspto.gov).
3. J. Rutherford, “Patent Licensing,” Licensing Journal (February 2008), pp. 28–29.
4. “Weighing Up the WTO,” Economist (November 23, 2002), p. 72. 5. W. B. State, “Filing Strategies under the Patent Cooperation Treaty,” Intellec-
tual Property and Technology Law Journal (October 2002), pp. 1–6. 6. J. P. Kamath, “Judge Backs UK Patents for Software,” Computer Weekly
(March 25, 2008), p. 6. 7. R. C. Scheinfeld and J. D. Sullivan, “Internet-Related Patents: Are They Paying
Off?” New York Law Journal (December 10, 2002), p. 5. 8. See G. Pike, “Business Method Patents in Jeopardy,” Information Today
(January 2009), pp. 15, 17; and J. Rapoza, “Hope for Innovation,” EWeek (November 10, 2008), p. 52.
9. See www.uspto.gov/main/trademarks.htm. 10. S. W. Halpern, C. A. Nard, and K. L. Port, Fundamentals of United States Intellec-
tual Property Law (Boston: Kluwer Law International, 1999), pp. 30–34. 11. “Face the Music,” Economist (April 2, 2005), pp. 57–58. 12. K. Fritz, “Playing a Different Tune,” Information Today (December 2008), p. 15;
D. O. Blood and Kee-Min Ngiam, “A Focus on Filters: Latest Developments in MGM v. Grokster,” Intellectual Property & Technology Law Journal (February 2008), pp. 7–8.
13. “Patents: Cuffing Innovation,” Electronics Design (April 28, 2005), pp. 49–55. 14. K. Chow, “Patent Play: Making Money from Intellectual Property,” Ottawa
Business Journal (September 29, 2008), p. 12. 15. “ARC Announces New Licensing Agreements with Leading European
Semiconductor Companies and Design Teams,” Business Wire (March 6, 2007), p. 1.
16. C. Purcell, “Finding Revenue beyond the Screen,” Television Week (April 21, 2008), pp. 6–7.
17. “Retailing Today,” News in Brief (June 23, 2008), p. 4. 18. M. Marr and S. Grey, “McDonald’s Woos New Partners as Disney Pact
Nears End,” The Wall Street Journal, Eastern Edition (June 6, 2005) pp. B1–B2.
19. “MSN Mobile and Morodo Join Number of Companies Adopting DeviceAtlas Database for Delivering Device-Aware Content,” PR Newswire (August 5, 2008), pp. 1–2.
C H A P T E R 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 183
20. “Licensed to Sell: Direct-to-Licensing Agreements Appear to be a Natural Evolution for Retailers’ Private Label Lines, Which Keep Trending Upward to Gourmet, Organic, and Other High-Quality Alternatives,” Private Label Buyer (November 1, 2008), pp. 85–87.
21. A. Nicholas, “Dangerous Goods,” Inside Counsel (November 2008), pp. 16–18. 22. I. Mount, “Death of the IPO Dream,” Fortune Small Business (April 2005),
pp. 16–18. 23. G. Weiss, “Tighter Nooses for White Collars,” BusinessWeek (April 7, 2003),
p. 10. 24. P. S. Foote and J. Chen, “Accounting Standards, Disclosure Requirements,
and Foreign Company Listings on Stock Exchanges,” Chinese Business Review (September 2008), p. 35.
184 PA RT 2 FROM IDEA TO THE OPPORTUNITY
3 F R O M T H E O P P O RT U N I T Y T O T H E
B U S I N E S S P L A N
C H A P T E R 7
The Business Plan: Creating and Starting the Venture
C H A P T E R 8
The Marketing Plan
C H A P T E R 9
The Organizational Plan
C H A P T E R 1 0
The Financial Plan
1
To define what the business plan is, who prepares it, who reads it, and how it is evaluated.
2
To understand the scope and value of the business plan to investors, lenders, employees, suppliers, and customers.
3
To identify information needs and sources for each critical section of the business plan.
4
To enhance awareness of the value of the Internet as an information resource and marketing tool.
5
To present examples and a step-by-step explanation of the business plan.
6
To present helpful questions for the entrepreneur at each stage of the planning process.
7
To understand how to monitor the business plan.
7 T H E B U S I N E S S P L A N : C R E AT I N G A N D
S TA RT I N G T H E V E N T U R E
L E A R N I N G O B J E C T I V E S
187
O P E N I N G P R O F I L E
BELINDA GUADARRAMA
The business plan, although it is often criticized as being “dreams of glory,” is
probably the single most important document to the entrepreneur at the start-up
stage. Potential investors are not likely to consider investing in a new venture until
the business plan has been completed. In addition, the business plan helps the en-
trepreneur maintain perspective as to what needs to be
accomplished.
The development and preparation of a business plan
can entail many obstacles and takes a strong commitment
by an entrepreneur before it can actually be completed and then implemented. No
one knows this better than Belinda Guadarrama, the president and CEO of GC Micro
Corporation. Her company supplies computer hardware and software to Fortune 1000
companies as well as the defense and aerospace industry.
As the entrepreneur of this now multi-million-dollar company, Belinda has been
recognized by two Hispanic organizations—the U.S. Hispanic Chamber of Commerce
and the Latin Business Association—as Hispanic Businesswoman of the Year 2002.
Her firm has been consistently ranked among the 500 largest Hispanic-owned
companies, and in 2008 it received the Boeing Performance Excellence Award and
the U.S. Department of Agriculture Woman-Owned Business Contractor of the Year
award.
Although today she is a successful entrepreneur, the journey was a long and ardu-
ous process with a number of highs and lows. After graduating from Trinity University
and taking a number of graduate courses at the University of Texas at Austin, she be-
gan working for the Texas attorney general as the director of personnel and training.
She later moved to California during the 1980s technology boom to work for a mail-
order software company. Like many others, she arrived at work one day to find a note
on the door indicating that the business was closed.
At that point Belinda made the decision to start her own business. She felt it was a
great time to take some risks since she had no job and limited prospects. In 1986, with
a few former co-workers, she launched GC Micro Corporation. To raise initial capital
and money for other expenses while a business plan was being developed, she sold
her house and cashed in her retirement money. She made a conscious decision at this
www.gcmicro.com
point to put everything on the line. Eventually, with business plan in hand, she began
knocking on doors to try to raise money for the start-up. It was then that she began
to face some of the lows in the entrepreneurial process as she incurred one rejection
after another. She could not even get a bank to lend her $5,000 to keep going. Fortu-
nately, she persisted until she came upon the Small Business Administration (SBA) loan
program that guarantees a large percentage of a loan through a local participating
bank. After submitting her plan through this program, she received her first loan
from a local bank.
Raising the start-up capital was only one of the early obstacles that she overcame.
Being a woman and a Latina, she had to overcome many negative stereotypes. In one
meeting with a potential client she was told that as a minority woman she did not
have sufficient management qualifications to represent its product line and was hence
turned down. However, her hard work and persistence paid off, and at the end of the
first year of business the company attained revenue of $209,000. With this success, the
client that had turned her down changed its mind and she became an authorized
dealer for its products.
Other success followed, and soon she was pursuing contracts with the U.S. Depart-
ment of Defense. In researching this market, she discovered that many government
contractors are required to include a percentage of minority-owned businesses as
subcontractors. She also discovered that there were not enough minority-owned
businesses, presenting great opportunities for her venture. However, as she contin-
ued to investigate her opportunities she found she was blocked from records to
which she had previously had access. She decided to pursue this in court, knowing
that this could put her entire business on the line. Subsequently, the case GC Micro
Corporation v. the Defense Logistics Agency reached the courts and then dragged on
for several years. During this time her business was in jeopardy since many companies
stated they would no longer work with her. Eventually she won her case. Her reputa-
tion as someone not afraid to take a stand and with strong leadership skills spread
throughout the industry.
The company has become one of the few just-in-time (JIT) system contract suppli-
ers. In 2003 the company received the JIT Supplier Partnership Award. Guadarrama’s
entrepreneurial skills have also spilled over to civic-minded activities, supporting
such programs as the California Latino-Chicano High School Drop-Out Prevention
Program, the Canal Community Alliance, the Ochoa Migrant Farm Workers Camp,
and the Gilroy YMCA. Belinda’s success is a tribute to her strong entrepreneurial
character. She was not afraid of the hard work required to plan her business—and
she was not afraid to stand up for what she felt was right. Her commitment to the
community has made her an inspiration to many other Hispanic businessmen and
women.
GC Micro Corporation now has 14 warehouses across the United States and is an
authorized dealer for about 200 manufacturers such as Sun Microsystems, IBM,
Hewlett-Packard, Storage Tek, Cisco, Dell, Apple, and Sony. Now with 30 employees,
sales revenue has reached $35 million.1
188 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
PLANNING AS PART OF THE BUSINESS OPERATION
Before we begin a discussion of the business plan, it is important for the reader to un-
derstand the different types of plans that may be part of any business operation. Plan-
ning is a process that never ends for a business. It is extremely important in the early
stages of any new venture when the entrepreneur will need to prepare a preliminary
business plan. The plan will become finalized as the entrepreneur has a better sense of
the market, the product or services to be marketed, the management team, and the finan-
cial needs of the venture. As the venture evolves from an early start-up to a mature busi-
ness, planning will continue as management seeks to meet its short-term or long-term
business goals.
For any given organization, it is possible to find financial plans, marketing plans, hu-
man resource plans, production plans, and sales plans, to name a few. Plans may be
short-term or long-term, or they may be strategic or operational. Plans will also differ in
scope depending on the type of business or the anticipated size of the start-up operation.
Even though they may serve different functions, all these plans have one important pur-
pose: to provide guidance and structure to management in a rapidly changing market
environment.
WHAT IS THE BUSINESS PLAN?
The business plan is a written document prepared by the entrepreneur that describes all the
relevant external and internal elements involved in starting a new venture. It is often an
integration of functional plans such as marketing, finance, manufacturing, and human re-
sources. As in the case of Belinda Guadarrama, it addresses the integration and coordina-
tion of effective business objectives and strategies when the venture contains a variety of
products and services. It also addresses both short-term and long-term decision making for
the first three years of operation. Thus, the business plan—or, as it is sometimes referred to,
the game plan or road map—answers the questions, Where am I now? Where am I going?
and How will I get there? Potential investors, suppliers, and even customers will request or
require a business plan.
If we think of the business plan as a road map, we might better understand its signifi-
cance. Let’s suppose you were trying to decide whether to drive from Boston to Los Angeles
(mission or goal) in a motor home. There are a number of possible routes, each requiring
different time frames and costs. Like the entrepreneur, the traveler must make some impor-
tant decisions and gather information before preparing the plan.
The travel plan would consider external factors such as emergency car repair, weather
conditions, road conditions, sights to see, and available campgrounds. These factors are
basically uncontrollable by the traveler but must be considered in the plan, just as the en-
trepreneur would consider external factors such as new regulations, competition, social
changes, changes in consumer needs, or new technology.
On the other hand, the traveler does have some idea of how much money is available;
how much time he or she has; and the choices of highways, roads, campgrounds, sights,
and so forth. Similarly, the entrepreneur has some control over manufacturing, marketing,
and personnel in the new venture.
The traveler should consider all these factors in determining what roads to take, what
campgrounds to stay in, how much time to spend in selected locations, how much time and
money to allow for vehicle maintenance, who will drive, and so on. Thus, the travel plan re-
sponds to three questions: Where am I now? Where am I going? and How do I get there?
Then the traveler in our example—or the entrepreneur, the subject of our book—will be
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 189
business plan Written
document describing all
relevant internal and
external elements and
strategies for starting a
new venture
190 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
able to determine how much money will be needed from existing sources or new sources to
achieve the plan.
We saw in the opening example of this chapter how Belinda Guadarrama used the busi-
ness plan to address these questions. The functional elements of the business plan are
discussed here but are also presented in more detail in the chapters that follow.
WHO SHOULD WRITE THE PLAN?
The business plan should be prepared by the entrepreneur; however, he or she may consult
with many other sources in its preparation. Lawyers, accountants, marketing consultants,
and engineers are useful in the preparation of the plan. Some of these needed sources
can be found through services offered by the Small Business Administration (SBA),
the Senior Corps of Retired Executives (SCORE), small-business development centers
(SBDCs), universities, and friends or relatives. The Internet also provides a wealth of
information as well as actual sample templates or outlines for business planning. Most
of these sources are free of charge or have minimal fees for workshop attendance or to
purchase or download any information. In many instances entrepreneurs will actually
hire or offer equity (partnership) to another person who might provide the appropriate
expertise in preparing the business plan as well as become an important member of the
management team.
To help determine whether to hire a consultant or to make use of other resources, the
entrepreneur can make an objective assessment of his or her own skills. Table 7.1 is an
illustration of a rating to determine what skills are lacking and by how much. For exam-
ple, a sales engineer designed a new machine that allows a user to send a 10-second per-
sonalized message in a greeting card. A primary concern was how best to market the
machine: as a promotional tool a firm could use for its distributors, suppliers, sharehold-
ers, or employees; or as a retail product for end users. This entrepreneur, in assessing his
skills, rated himself as excellent in product design and sales, good in organizing, and
only fair or poor in the remaining skills. To supplement the defined weaknesses, the
entrepreneur found a partner who could contribute those skills that were lacking or weak.
Through such an assessment, the entrepreneur can identify what skills are needed and
where to obtain them.
Skills Excellent Good Fair Poor
Accounting/taxes
Planning
Forecasting
Marketing research
Sales
People management
Product design
Legal issues
Organizing
TABLE 7.1 Skills Assessment
SCOPE AND VALUE OF THE BUSINESS PLAN—
WHO READS THE PLAN?
The business plan may be read by employees, investors, bankers, venture capitalists, suppli-
ers, customers, advisors, and consultants. Who is expected to read the plan can often affect
its actual content and focus. Since each of these groups reads the plan for different purposes,
the entrepreneur must be prepared to address all their issues and concerns. In some ways, the
business plan must try to satisfy the needs of everyone, whereas in the actual marketplace
the entrepreneur’s product will be trying to meet the needs of selected groups of customers.
However, there are probably three perspectives that should be considered in prepar-
ing the plan. First is the perspective of the entrepreneur, who understands better than any-
one else the creativity and technology involved in the new venture. The entrepreneur must
be able to clearly articulate what the venture is all about. Second is the marketing perspec-
tive. Too often, an entrepreneur will consider only the product or technology and not
whether someone would buy it. Entrepreneurs must try to view their business through the
eyes of their customer. This customer orientation is discussed further in Chapter 8. Third,
the entrepreneur should try to view his or her business through the eyes of the investor.
Sound financial projections are required; if the entrepreneur does not have the skills to pre-
pare this information, then outside sources can be of assistance.2
The depth and detail in the business plan depend on the size and scope of the proposed
new venture. An entrepreneur planning to market a new high-tech machine will need a
comprehensive business plan, largely because of the nature of the product and market. An
entrepreneur who plans to open a retail clothing store will not need the comprehensive cov-
erage required by a new high-tech machine manufacturer. A new e-commerce business,
however, may require a very different focus, particularly on how to market the Web site that
will offer the goods and services. Thus, differences in the scope of the business plan may
depend on whether the new venture is a service, involves manufacturing, or is a consumer
good or industrial product. The size of the market, competition, and potential growth may
also affect the scope of the business plan.
The business plan is valuable to the entrepreneur, potential investors, or even new per-
sonnel, who are trying to familiarize themselves with the venture, its goals, and objectives.
The business plan is important to these people because:
• It helps determine the viability of the venture in a designated market.
• It provides guidance to the entrepreneur in organizing his or her planning activities.
• It serves as an important tool in helping to obtain financing.
Potential investors are very particular about what should be included in the business
plan. Even if some of the information is based on assumptions, the thinking process re-
quired to complete the plan is a valuable experience for the entrepreneur since it forces him
or her to assess such things as cash flow and cash requirements. In addition, the thinking
process takes the entrepreneur into the future, leading him or her to consider important issues
that could impede the road to success.
The process also provides a self-assessment by the entrepreneur. Usually, he or she feels
that the new venture is assured of success. However, the planning process forces the entre-
preneur to bring objectivity to the idea and to reflect on such questions as: “Does the idea
make sense? Will it work? Who is my customer? Does it satisfy customer needs? What kind
of protection can I get against imitation by competitors? Can I manage such a business?
Whom will I compete with?” This self-evaluation is similar to role playing, requiring the en-
trepreneur to think through various scenarios and consider obstacles that might prevent the
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 191
venture from succeeding. The process allows the entrepreneur to plan ways to avoid such
obstacles. It may even be possible that, after preparing the business plan, the entrepreneur
will realize the obstacles cannot be avoided or overcome. Hence, the venture may be ter-
minated while still on paper. Although this certainly is not the most desirable conclusion,
it would be much better to terminate the business endeavor before investing further time
and money.
HOW DO POTENTIAL LENDERS AND INVESTORS
EVALUATE THE PLAN?
As stated earlier, there are a number of cookie-cutter or computer-generated software packages
or samples on the Internet that are available to assist the entrepreneur in preparing a busi-
ness plan. These sources, however, should be used only to assist in its preparation, since the
business plan should address the needs of all the potential readers or evaluators and should
reflect the strengths of management and personnel, the product or service, and available
resources. There are many different ways to present a quality business plan and thus any at-
tempt to imitate or fit your strategy and objectives into a cookie-cutter approach could have
very negative results. The plan needs to focus on the above-mentioned factors and should
ultimately consider its purpose.
It is conceivable that the entrepreneur will prepare a first draft of the business plan from his
or her own personal viewpoint without consideration of the constituencies that will ultimately
192
A S S E E N I N B U S I N E S S W E E K
DON’T EXPECT A FEE FOR MAKING AN INTRODUCTION
Q: I’m an independent record producer. About
30 years ago, I introduced a close friend to a record-
ing artist, and we all became friends and produced
a song together. We lost touch with the artist, who
is now a millionaire, but recently my friend con-
tacted him, and they plan to form a partnership.
Since I introduced them initially, do I deserve any
monetary compensation from their joint venture?
—R.B., Manasquan, N.J.
A: The compensation you’re asking about might
be termed a “finder’s fee,” in which an individual
gets a flat fee or a percentage of a business deal that
he or she helped arrange, typically by making an in-
troduction. “A finder’s fee is associated with the per-
formance of some type of service. The finder acts as
an agent and thus is entitled to a fee for perform-
ance,” says Robert Chell, a longtime business consult-
ant in Indian Wells, Calif.
However, in your case, that introduction took place
30 years ago, and then the parties lost touch. After
many years passed, your friend took it upon him-
self to reestablish contact with the (apparently
now-successful) recording artist and form a new
partnership.
Since you didn’t make the introduction this time—
the parties already knew each other, and you weren’t
asked to be a conduit—it is pretty tough to make the
case that you deserve compensation from their joint
venture, Chell says: “If you’d done something spe-
cific this time—maybe. But in this case, maybe not.”
Other experts agreed. “If the business relationship
began and ended with the production of the song
way back in 1979, then an expectation of some re-
ward, monetary or otherwise, is not in order,” says
Sheldon Kopin, president of JBS Associates, a man-
agement consulting firm in Cincinnati.
Source: Reprinted from September 15, 2009, issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Com- panies, Inc., from “Don’t Expect a Fee for Making an Introduction” by Karen E. Klein, www.businessweek.com/smallbiz.
read and evaluate the plan’s feasibility. As the entrepreneur becomes aware of who will
read the plan, appropriate changes will be necessary. For example, one constituency may
be suppliers, who may want to see a business plan before signing a contract to produce
either components or finished products or even to supply large quantities of materials on
consignment. Customers may also want to review the plan before buying a product that
may require significant long-term commitment, such as a high-tech telecommunications
system. In both cases the business plan should consider the needs of these constituencies,
who may pay more attention to the experience of the entrepreneur(s) and his or her projec-
tion of the marketplace.
Another group that may evaluate the plan are the potential suppliers of capital. These
lenders or investors will likely vary in terms of their needs and requirements in the
business plan. For example, lenders are primarily interested in the ability of the new
venture to pay back the debt including interest within a designated period of time.
Banks want facts with an objective analysis of the business opportunity and all the poten-
tial risks inherent in the new venture. It is also important that, along with a solid busi-
ness plan, the entrepreneur develop a strong personal relationship with the loan officer
of the bank.
The story of Peter Pap, a successful dealer in oriental rugs, provides a good example of
how lenders may evaluate a business plan. He needed additional financing to buy more rugs
but was frustrated by the fact that banks would not lend him funds using his existing inven-
tory of oriental rugs as collateral. He discovered that Fortune Small Business supported
small businesses with a group of consultants that could help him with his plan and his
attempt to get additional financing. These consultants from banking and accounting firms
recommended that he modify his Web site, increase his advertising, and hire a marketing
manager. He discovered that it was not the collateral that was the issue but his business plan
that lacked any basis for how the loan would be used. Now with changes in his business
plan and advice from one of the banking consultants he is considering approaching the
Small Business Administration for a 7A project loan to expand his business. This is a loan
guaranteed by the SBA but actually provided by a federal bank.3
Typically, lenders focus on the four Cs of credit: character, cash flow, collateral, and eq-
uity contribution. Basically, what this means is that lenders want the business plan to reflect
the entrepreneur’s credit history, the ability of the entrepreneur to meet debt and interest
payments (cash flow), the collateral or tangible assets being secured for the loan, and the
amount of personal equity that the entrepreneur has invested.
Investors, particularly venture capitalists, have different needs since they are providing
large sums of capital for ownership (equity) with the expectation of cashing out within five
to seven years. Investors often place more emphasis on the entrepreneur’s character than
lenders do, and often spend much time conducting background checks. This is important
not only from a financial perspective but also because the venture capitalist will play an im-
portant role in the actual management of the business. Hence, investors want to make sure
that the entrepreneur is compliant and willing to accept this involvement. These investors
will also demand high rates of return and will thus focus on the market and financial
projections during this critical five- to seven-year period.
In preparing the business plan, it is important for entrepreneurs to consider the needs of
external sources and not merely provide their own perspective. This will keep the plan from
being an internalized document that emphasizes only the technical advantages of a product
or market advantages of a service, without consideration of the feasibility of meeting
market goals and long-term financial projections.
Entrepreneurs, in sharing their business plan with others, often become paranoid, fear-
ing that their idea will be stolen by one of the external readers. Most external advisors and
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 193
194
E T H I C S
One of the serious concerns that entrepreneurs voice
relates to how to protect their business ideas, when
they are also advised to share their business plans
with many friends and associates. Since these plans
provide comprehensive discussion of the new ven-
ture, the concern is understandable. Most individuals
who are asked to comment and review a business
plan would act in an ethical and professional manner
in providing any advice to entrepreneurs. However,
there are also many examples of situations in which a
family member, friend, or business associate has been
accused of “stealing” an idea.
The best strategy for an entrepreneur, outside of
seeking the advice of an attorney, is to ask all readers
who are not representing a professional firm (such as
a venture capitalist) to sign a noncompete or nondis-
closure agreement. An example of such an agreement
can be found in Chapter 6. Those representing a pro-
fessional organization (such as a bank or venture capi-
talist) need not be asked to complete a nondisclosure
form since they would be insulted and would be in-
clined to reject the venture before they had even
read the plan.
PROTECTING YOUR BUSINESS IDEA
potential investors are bound by a professional code of ethics, and the entrepreneur should
not be deterred from seeking external advice (see Ethics box).
PRESENTING THE PLAN
Often, colleges and universities or locally sponsored business meetings offer an opportu-
nity for selected entrepreneurs to present their business plans in a competitive and struc-
tured setting. Typically, each selected entrepreneur is asked to present the highlights of his
or her business plan in a defined time frame. The entrepreneur is expected to “sell” his or
her business concept in this designated period of time. This implies that the entrepreneur
must decide what to say and how to present the information. Typically the entrepreneur will
focus on why this is a good opportunity, providing an overview of the marketing program
(how the opportunity will convert to reality) and the results of this effort (sales and profits).
Concluding remarks might reflect the recognized risks and how the entrepreneur plans to
address them.
Audiences at these presentations usually include potential investors who are given an
opportunity to ask pointed questions regarding any of the strategies conveyed in the busi-
ness plan presentation. After the completion of all the scheduled business plan presenta-
tions, a winner is usually declared, with a financial reward that can range from $10,000 to
$50,000. The benefit of these competitions is not necessarily the financial award since there
can be only one winner. However, since the audience is made up of professional investors,
there is always the opportunity for any one of the business plans presented to attract the
attention of a venture capitalist or private investor. This interest may result in further nego-
tiations and perhaps a future investment in the new venture. The number of schools that
sponsor these business plan competitions seems to be growing significantly, and often the
schools will advertise, requesting that interested entrepreneurs submit an application for
participation in the competition.4
Some investors describe these presentations as elevator pitches, since they are anal-
ogous to an entrepreneur getting on an elevator with one or more investors and trying to
persuade them that his or her business concept is a good investment before the elevator
reaches its final destination. Even for those who do not win a prize, the opportunity to
present a plan and then make adjustments in the plan based on the feedback is a great
learning experience.
INFORMATION NEEDS
Before committing time and energy to preparing a business plan, the entrepreneur should
do a quick feasibility study of the business concept to see whether there are any possible
barriers to success. The information, obtainable from many sources, should focus on mar-
keting, finance, and production. The Internet, discussed later in the chapter, can be a valu-
able resource for the entrepreneur. Before beginning the feasibility study, the entrepreneur
should clearly define the goals and objectives of the venture. These goals help define what
needs to be done and how it will be accomplished. These goals and objectives also provide
a framework for the business plan, marketing plan, and financial plan.
Goals and objectives that are too general or that are not feasible make the business plan
difficult to control and implement. For example, an entrepreneur starting a sporting goods
store that specialized in offbeat sports (e.g., rollerblading, skateboarding, and snowboarding)
developed a business plan that called for six stores to be opened by year 2 of the start-up.
A friend and business confidant read the plan and immediately asked the entrepreneur to
explain how and where these stores would be located. Not having a clear understanding of
the answers to these questions suggested to the entrepreneur that his business objectives
needed to be much more reasonable and that they needed to be clarified in the marketing and
strategy segments of the plan. The business associate explained to the entrepreneur that a
business plan is similar to building a house, in that it is necessary that each step in the process
be related to the goals and objectives or outcome of the construction. From this experience
the entrepreneur rewrote the business plan to reflect more reasonable goals and objectives.
Jay Jackson determined, while managing an audiovisual distribution business in South-
east Asia, that there may be a market for custom-made teak furniture. He and his wife JL
decided to launch a furniture importing business in the United States by having teak furni-
ture manufactured in Indonesia that would be produced from teak walls and floors that
were being ripped out of homes destined for renovation or demolition. The business de-
pended on gathering potential customers from trade shows. However, potential customers
at these trade shows did not seem enthusiastic and saw this product as just another furniture
company. By talking to these customers in greater depth, they found that they were most
intrigued by the concept of recycling the teak wood. It also appeared from these discussions
that the more upscale consumer interested in ecofriendly products would be the best target
market. As a result of listening to their customers, the Jacksons refocused their business plan
objectives to appeal to a more upscale customer interested in ecofriendly products. In addition,
they modified their intended offerings to focus on house and garden furniture. They then
proceeded to identify nontraditional, unique trade shows that would include their target
market such as a collector antique trade show. The attendees at these shows matched their
target market and soon business took off. They now expect to exceed sales of $1 million.5
From the first example, we can see the importance of feasible, well-defined goals and ob-
jectives in the business plan. In the second example, we note that a well-defined business
strategy based on market information can provide a more effective focus of the business
model. Once this solid foundation is in place, strategy decisions can then be established
that will allow the company to achieve those goals and objectives.
Market Information
One of the initial pieces of information needed by the entrepreneur is the market potential
for the product or service. To ascertain the size of the market, it is first necessary for the en-
trepreneur to define the market. For example, is the product most likely to be purchased by
men or women? People of high income or low income? Rural or urban dwellers? Highly
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 195
educated or less educated people? A well-defined target market will make it easier to pro-
ject market size and subsequent market goals for the new venture. For example, let’s assume
that an entrepreneur in the Boston area notes the success of businesses such as Au Bon Pain
and Panera Bread Company and thus is considering launching a food business that offers
the convenience of “fast food” but with the taste of a sit-down restaurant. With a huge
tourism trade the entrepreneur decides on a mobile (food cart) crepe business that will in-
clude a number of carts situated in high-traffic areas.
To build a strong marketing plan with reasonable and measurable market goals and ob-
jectives the entrepreneur will need to gather information on the industry and market. Most
entrepreneurs have difficulty with this stage and do not often know where to begin. The
best way to start is to first visualize this process as an inverted pyramid (see Figure 7.1).
This means that we start with very broad-based data and information and work down until
we can develop a positioning strategy and quantifiable goals and objectives. All this infor-
mation can then be used in the industry analysis and marketing planning sections of the
business plan that are discussed later in this chapter. (Also see Chapter 8.)
As noted in Figure 7.1, we begin the process by evaluating general environmental trends.
This would include household income trends, population shifts, food consumption habits
196 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
FIGURE 7.1 An Upside-Down Pyramid Approach to Gathering Market Information
Market objectives
Market positioning
General environmental and demographic trends
National food industry trends
Local environmental and demographic trends
Local food industry trends
Local competition strengths and weaknesses
and trends, travel, and employment trends. This information can be found in sources such as
the U.S. Census Bureau, Bureau of Labor Statistics, Forrester, Reuter Business Insights, and
Statistical Abstracts, to name a few. These sources are available in the local college or uni-
versity library. Some sources such as the U.S. Census Bureau can be found online or in the
local community library. Table 7.2 provides a partial list of sources that can be considered
for typical census-related data. Forrester and Business Insights are private services and can
be obtained from libraries or by purchasing specific reports on your industry or market.
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 197
Source Description
1. U.S. Census (www.census.gov) A. U.S. Population Projections for 2010 Projections of population by area. B. Service Annual Survey Estimates in dollar volume of receipts in
selected service industries. Also includes year-to-year ratios.
C. County Business Patterns Economic data of small areas by industry for analyzing market potential, budgeting, and forecasting.
D. Statistical Abstracts Statistics on social and economic variables at national, state, and metropolitan levels.
E. Annual Survey of Manufactures Statistics such as industry outputs, inputs, and operating data on manufacturing activity, by industry groups.
F. Current Industrial Reports Regular reports measuring production and shipments of wide range of products.
2. Industry and Market Data A. Encyclopedia of American Industries Industry trends and market data compiled
on all SIC-coded firms. B. Standard & Poor’s (NetAdvantage Wide array of industry and market survey
and Market Insight) data on private and public firms. C. Stat-USA (U.S. Department of A large database of financial and trade
Commerce) information. Also provides financial and operating ratios.
D. Market Share Reporter Compilation of market share statistics across array of products and services.
E. RDS TableBase Provides market share, rankings, industry/ product forecasts.
F. Other sources on industry or market trends are MarketLine, Forrester, Investext, and Mintel Reports. These reports may be purchased or accessed through a university library.
3. Financial and Industry Operating Ratios A. RMA eStatement Studies (Robert Compilation of 150,000 financial statements
Morris Associates) of banking customers with ratios and benchmarks.
B. Almanac of Business and Industrial Historical compilation of financial data on Financial Ratios (Leo Troy) 4.7 million companies.
C. Industry Norms and Key Ratios Ratios and financial percentages of over (Dun & Bradstreet) 1 million financial statements.
D. Financial Studies of the Small Business Ratios of 70 business categories for over 3,000 companies earning less than $1 million.
E. Bizminer (www.bizminer.com) Local and regional market research reports, financial ratios on over 16,000 products and services in 300 U.S. markets. Most cost less than $100.
TABLE 7.2 Sources of Data on Environmental Trends, Industry Trends, Financial Ratios, and Other Benchmarks
The next step is the assessment of trends in the national food service industry. We
would look for data on total food sales and commercial restaurant sales by type of restau-
rant. This information can be found in such sources as Dun and Bradstreet’s AllBusiness,
Standard & Poor’s (S&P’s) Market Insight, and S&P’s NetAdvantage. Standard and
Poor’s also provides very specific data on the food industry such as in its Industry Sur-
veys: Restaurants and the National Restaurant Association. Also see Table 7.2 for more
in-depth information on some of the important sources of information that can be used in
this analysis.
Notice that the first two stages in Figure 7.1 focus on the national market, and the next
two stages consider trends in the local market where the business will be located. This con-
sists of general local economic trends and an assessment of the local food service industry.
The sources may include the same ones mentioned above except data related only to the
local market would be considered. In addition, the state of Massachusetts publishes data on
tourism (the Massachusetts Travel Industry Report) and economic trends (U.S. Census
Bureau). Also implicit in this local food service industry analysis is the regulatory environ-
ment. Each state has distinct regulations regarding alcohol and food delivery license
requirements. These data can also be found online or in your local library.
The final step is an analysis of the local competitive environment. In this example the
entrepreneur would need to identify any restaurants, food stands, or push-cart food services
that could be competitors. This list can be found in the yellow pages, local town hall (food
license bureau), or through observation. Each local competitor’s strengths and weaknesses
should be assessed. This can be judged by using marketing research (discussed in Chap-
ter 8); evaluating the competitors’ Web sites, advertising, menus, and locations; and review-
ing any published articles that have appeared in the local media. A spreadsheet can then be
prepared with the list of competitors in the first column, followed by columns devoted to
their strengths and weaknesses.
Once all this analysis has been completed, the entrepreneur is ready to clarify the prod-
uct or service offering, actual market positioning in the competitive environment, and mar-
ket objectives. These are part of the marketing plan and are discussed in more detail in
Chapter 8. These data, in addition to contributing to the preparation of the marketing plan,
lay the groundwork for the financial projections and forecasts discussed in Chapter 10.
Operations Information Needs
The relevance of a feasibility study of the manufacturing operations depends on the nature
of the business. Most of the information needed can be obtained through direct contact with
the appropriate source. The entrepreneur may need information on the following:
• Location. The company’s location and its accessibility to customers, suppliers, and distributors need to be determined.
• Manufacturing operations. Basic machine and assembly operations need to be identified, as well as whether any of these operations would be subcontracted and to
whom.
• Raw materials. The raw materials needed and suppliers’ names, addresses, and costs should be determined.
• Equipment. The equipment needed should be listed, with its cost and whether it will be purchased or leased.
• Labor skills. Each unique skill needed, the number of personnel required for each skill, pay rate, and an assessment of where and how these skills will be obtained
should be determined.
198 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
• Space. The total amount of space needed should be determined, including whether the space will be owned or leased.
• Overhead. Each item needed to support manufacturing—such as tools, supplies, utilities, and salaries—should be determined.
Most of the preceding information should be incorporated directly into the business plan.
Each item may require some research, but this information is necessary to those who will
assess the business plan and consider funding the proposal.
FINANCIAL INFORMATION NEEDS
Before preparing the financial section of the business plan, the entrepreneur will need to
prepare a budget that includes a list of all possible expenditures in the first year and a list
of all revenue sources, including sales and any external available funds. Thus the budget
includes capital expenditures, direct operating expenses, and cash expenditures for nonex-
pense items. The revenue from sales must be forecast from market data, as discussed
earlier. Forecasting is discussed in more detail in Chapter 8. To prepare the actual budget
(see Chapter 10) the entrepreneur will need to identify benchmarks in the industry that can
be used in preparing the final pro forma statements in the financial plan. These benchmarks
or norms establish reasonable assumptions regarding expenditures based on industry his-
tory and trends. This is a very acceptable method to arrive at the necessary projected costs
for the new venture.
We return to our crepe business example. In projecting his costs for operating the
business, our entrepreneur might choose to consider the many secondary sources that
provide percentage norms for such costs. For example, these sources would provide per-
centage norms in the industry for such costs as food, beverages, equipment, personnel,
and licenses. Expenditures such as rent, utilities, insurance, and personnel costs can also
be ascertained from newspapers or advertisements, or from phone conversations with
real estate agents, insurance agents, equipment suppliers, and the utility companies in
the area.
The benchmarks or financial ratios needed to prepare financial statements can be found
in such sources as Financial Studies of the Small Business (Financial Research Associates),
Industry Norms and Key Business Ratios (Dun & Bradstreet), Annual Statement Studies
(Robert Morris Associates), RMA eStatement Studies, and the Almanac of Business and
Financial Ratios (Leo Troy). More detailed information on the services these sources pro-
vide can be found in Table 7.2. It is also possible to find benchmarks by reviewing 10K
reports of similar public competitors. Trade associations and trade magazines also may
publish valuable data that can supplement the preceding sources to prepare the financial
statements in the business plan. These pro forma statements will need to be prepared
monthly in the first year and then either quarterly or annually for the next two years. Some
investors require five-year projections, so the entrepreneur may need to clarify exactly what
is needed by those who review the business plan.
USING THE INTERNET AS A RESOURCE TOOL
The changing world of technology offers new opportunities for entrepreneurs to be able
to access information for many business activities efficiently, expediently, and at very little
cost. The Internet can serve as an important source of information in the preparation of
the business plan for such segments as the industry analysis, competitor analysis, and
measurement of market potential, to name a few. Entrepreneurs will also find the Internet
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 199
a valuable resource in later-stage planning and decision making. Besides being a business
intelligence resource, the Internet also provides opportunities for marketing strategy;
through its Web site, a firm can provide information on the company, its products and
services, and ordering instructions.
According to data published by the Department of Commerce, online sales have con-
tinued to increase in spite of the economic downturn. In the third quarter of 2008 online
sales were up 6 percent over the same period one year earlier. E-commerce sales reached
$34.4 billion in the third quarter of 2008. Although online retail sales accounts for only
3.4 percent of all retail sales, it continues to grow each year as more and more consumers
enjoy the benefit of ordering products from their home.6
An entrepreneur in the process of writing a business plan can also access one of the pop-
ular search engines: Google, Yahoo!, MSN, AOL, or Ask Jeeves. Simply conducting a
search of a topic (for example, “online sporting goods”) may reveal several Web sites, arti-
cles, or sources of information to assist the entrepreneur in writing the business plan. Use
of these searches has grown about 20 percent over the past two years, depending on the
search engine.7
An entrepreneur should access competitors’ Web sites to gain more knowledge about
their strategy in the marketplace. Internet service is not costly and is an important vehicle
for the entrepreneur to gather information about the market, competition, and customers as
well as to distribute, advertise, and sell company products and services.
In addition to accessing Web sites, the entrepreneur can also investigate social networks,
blogs, and discussion groups. Discussion groups such as Yahoo! Groups and Usenet are the
most noteworthy, although many Web sites also have discussion groups associated with
them. Blogs refer more to talking to or about something rather than creating a dialogue.
Social networks are Web sites where those with similar interests can communicate using
such sites as MySpace, Bebo, or Facebook. These sites may serve many uses depending on
the needs of the entrepreneur. Using Usenet, which represents the newsgroups on the Inter-
net, the entrepreneur can use keywords to identify the most appropriate newsgroups. These
newsgroups represent potential customers who can be asked specific questions on their
needs, competitive products, and potential interest in the new venture’s products and ser-
vices. Individuals who are members of the newsgroups will then respond to these ques-
tions, providing valuable information to the entrepreneur.
Compared with alternative sources the entrepreneur need only make a small investment
in hardware and software to be ready to use these online services. With its continuous im-
provements and modifications, the Internet will continue to provide invaluable opportuni-
ties for the entrepreneur in planning the start-up or the growth of a venture.
WRITING THE BUSINESS PLAN
The business plan could take hundreds of hours to prepare, depending on the experience
and knowledge of the entrepreneur as well as the purpose it is intended to serve. It should
be comprehensive enough to give any potential investor a complete picture and understand-
ing of the new venture, and it should help the entrepreneur clarify his or her thinking about
the business.
Many entrepreneurs incorrectly estimate the length of time that an effective plan will
take to prepare. Once the process has begun, however, the entrepreneur will realize that it
is invaluable in sorting out the business functions of a new venture.
The outline for a business plan is illustrated in Table 7.3. Each of the items in the out-
line is detailed in the following paragraphs of this chapter. Key questions in each section
are also appropriately detailed.
200 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 201
I. Introductory Page
A. Name and address of business
B. Name(s) and address(es) of principal(s)
C. Nature of business
D. Statement of financing needed
E. Statement of confidentiality of report
II. Executive Summary—Two to three pages summarizing the complete business plan
III. Industry Analysis
A. Future outlook and trends
B. Analysis of competitors
C. Market segmentation
D. Industry and market forecasts
IV. Description of Venture
A. Product(s)
B. Service(s)
C. Size of business
D. Office equipment and personnel
E. Background of entrepreneur(s)
V. Production Plan
A. Manufacturing process (amount subcontracted)
B. Physical plant
C. Machinery and equipment
D. Names of suppliers of raw materials
VI. Operations Plan
A. Description of company’s operation
B. Flow of orders for goods and/or services
C. Technology utilization
VII. Marketing Plan
A. Pricing
B. Distribution
C. Promotion
D. Product forecasts
E. Controls
VIII. Organizational Plan
A. Form of ownership
B. Identification of partners or principal shareholders
C. Authority of principals
D. Management team background
E. Roles and responsibilities of members of organization
IX. Assessment of Risk
A. Evaluate weakness(es) of business
B. New technologies
C. Contingency plans
X. Financial Plan
A. Assumptions
B. Pro forma income statement
C. Cash flow projections
D. Pro forma balance sheet
E. Break-even analysis
F. Sources and applications of funds
XI. Appendix (contains backup material)
A. Letters
B. Market research data
C. Leases or contracts
D. Price lists from suppliers
TABLE 7.3 Outline of a Business Plan
Introductory Page
This is the title or cover page that provides a brief summary of the business plan’s contents.
The introductory page should contain the following:
The name and address of the company.
The name of the entrepreneur(s), telephone number, fax number, e-mail address, and
Web site address if available.
A paragraph describing the company and the nature of the business.
The amount of financing needed. The entrepreneur may offer a package (e.g., stock
or debt). However, many venture capitalists prefer to structure this package in their
own way.
A statement of the confidentiality of the report. This is for security purposes and is
important for the entrepreneur.
This title page sets out the basic concept that the entrepreneur is attempting to develop.
Investors consider it important because they can determine the amount of investment
needed without having to read through the entire plan. An illustration of this page can be
found in Table 7.4.
Executive Summary
This section of the business plan is prepared after the total plan is written. About two to
three pages in length, the executive summary should stimulate the interest of the potential
investor. This is a very important section of the business plan and should not be taken
lightly by the entrepreneur since the investor uses the summary to determine if the entire
business plan is worth reading. Thus, it should highlight in a concise and convincing
manner the key points in the business plan.
202 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
KC CLEANING SERVICE
OAK KNOLL ROAD
BOSTON, MA 02167
(617) 969-0010
www.cleaning.com
Co-owners: Kimberly Peters, Christa Peters
Description of Business:
This business will provide cleaning service on a contract basis to small and medium-sized businesses. Services include cleaning of floors, carpets, draperies, and windows, and regular sweeping, dusting, and washing. Contracts will be for one year and will specify the specific services and scheduling for completion of services.
Financing:
Initial financing requested is a $100,000 loan to be paid off over six years. This debt will cover office space, office equipment and supplies, two leased vans, advertising, and selling costs.
This report is confidential and is the property of the co-owners listed above. It is intended for use only by the persons to whom it is transmitted, and any reproduction or divulgence of any of its contents without the prior written consent of the company is prohibited.
TABLE 7.4 Sample Introductory Page
Generally the executive summary should address a number of issues or questions that
anyone picking up the written plan for the first time would want to know. For example:
What is the business concept or model?
How is this business concept or model unique?
Who are the individuals starting this business?
How will they make money and how much?
If the new venture has a strong growth plan and in five years expects to be positioned for
an initial public offering (IPO), then the executive summary should also include an exit
strategy. If the venture is not initially expecting this kind of growth, the entrepreneurs
should avoid any discussion of an exit strategy in the executive summary.
Any supportive evidence, such as data points from marketing research or legal docu-
ments or contracts that might strengthen the case on the preceding issues, also should be in-
cluded. Under no circumstances should the entrepreneur try to summarize every section of
the plan, especially since the emphasis placed on the preceding issues depends on who is
reading the plan.
It should be remembered that this section is only meant to highlight key factors and mo-
tivate the person holding the plan to read it in its entirety. Key factors for some plans might
be the people involved. For example, if one of the entrepreneurs has been very successful
in other start-ups, then this person and his or her background needs to be emphasized. If the
venture has a contract in hand with a large customer, then this would be highlighted in the
executive summary. It is similar to the opening statement a lawyer might make in an impor-
tant court trial or the introductory statements made by a salesperson in a sales call.
Environmental and Industry Analysis
It is important to put the new venture in a proper context by first conducting an
environmental analysis to identify trends and changes occurring on a national and inter-
national level that may impact the new venture. This process was described earlier in
this chapter. Examples of these environmental factors are:
Economy. The entrepreneur should consider trends in the GNP, unemployment by
geographic area, disposable income, and so on.
Culture. An evaluation of cultural changes may consider shifts in the population by
demographics, for example, the impact of the baby boomers or the growing elderly
population. Shifts in attitudes, such as “Buy American,” or trends in safety, health, and
nutrition, as well as concern for the environment, may all have an impact on the
entrepreneur’s business plan.
Technology. Advances in technology are difficult to predict. However, the entrepreneur
should consider potential technological developments determined from resources
committed by major industries or the U.S. government. Being in a market that is
rapidly changing due to technological development will require the entrepreneur to
make careful short-term marketing decisions as well as to be prepared with
contingency plans given any new technological developments that may affect his or
her product or service.
Legal concerns. There are many important legal issues in starting a new venture; these
were discussed in Chapter 6. The entrepreneur should be prepared for any future
legislation that may affect the product or service, channel of distribution, price, or
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 203
environmental analysis
Assessment of external
uncontrollable variables
that may impact the
business plan
promotion strategy. The deregulation of prices, restrictions on media advertising (e.g.,
ban on cigarette ads or requirements for advertising to children), and safety regulations
affecting the product or packaging are examples of legal restrictions that can affect any
marketing program.
All the preceding external factors are generally uncontrollable. However, as indicated,
an awareness and assessment of these factors using some of the sources identified can pro-
vide strong support for the opportunity and can be invaluable in developing the appropriate
marketing strategy.
As stated earlier (see Figure 7.1), this process can be visualized as an upside-down pyra-
mid leading to specific market strategy and objectives. Once an assessment of the environ-
ment is complete, the entrepreneur should conduct an industry analysis that will focus on
specific industry trends. Some examples of these factors are:
Industry demand. Demand as it relates to the industry is often available from published
sources. Knowledge of whether the market is growing or declining, the number of new
competitors, and possible changes in consumer needs are all important issues in trying
to ascertain the potential business that might be achieved by the new venture. The
projected demand for the entrepreneur’s product or service will require some additional
marketing research, which will be discussed in Chapter 8.
Competition. Most entrepreneurs generally face potential threats from larger corporations.
The entrepreneur must be prepared for these threats and should be aware of who the
competitors are and what their strengths and weaknesses are so that an effective marketing
plan can be implemented. Most competitors can be easily identified from experience,
trade journal articles, advertisements, Web sites, or even the yellow pages.
There are numerous sources that the entrepreneur can consult to attain general industry
and competitive data for inclusion in this part of the business plan. Some of these were
mentioned earlier in this chapter (also review Table 7.2), in relation to our discussion of the
gathering of market information. Many of these sources can be found in local or university
libraries. They include: Encyclopedia of American Industries, Encyclopedia of Emerging
Industries, Standard and Poor’s Industry Surveys, MarketLine Business Information Cen-
tre, Forrester, Investext Plus, and Mintel Reports. Each of these sources focuses on differ-
ent types of industries or markets and can be easily evaluated as to their benefit either by an
online search (such as Google) or by a visit to a local library. Most of these sources also
provide published reports that are available for purchase.
The last part of the business plan’s industry analysis section should focus on the specific
market, which would include such information as who the customer is and what the busi-
ness environment is like in the specific market and geographic area where the venture will
compete. Thus, any differences in any of the preceding variables that reflect the specific
market area in which the new venture will operate must be considered. This information is
particularly significant to the preparation of the marketing plan section of the business plan,
which is discussed in Chapter 8.
In addition to the numerous industry sources given, there are also many market databases
that can be researched for relevant data to incorporate into this section of the business plan.
Market share and size of market often can be assessed from databases such as: TableBase
and Business & Industry, Market Share Reporter, Economic Census, County Business Pat-
terns, Current Industrial Reports, Service Annual Survey, and Monthly Retail and Food Ser-
vice Sales and Inventories. More specific data on demographic trends and possible target
market numbers can be found in: Profiles of General Demographic Characteristics 2000
Census/Population, Population Projections (projections for 2010 available), Mediamark
204 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
industry analysis
Reviews industry trends
and competitive strategies
Reporter, and Lifestyle Market Analyst. Finally, state-by-state population, demographic, and
housing data usually are available from each state’s Web site.
A list of some key questions the entrepreneur should consider for this section of the
business plan is provided in Table 7.5.
Description of Venture
The description of the venture should be detailed in this section of the business plan. This
will enable the investor to ascertain the size and scope of the business. This section should
begin with the mission statement or company mission of the new venture. This statement
basically describes the nature of the business and what the entrepreneur hopes to accom-
plish with that business. This mission statement or business definition will guide the firm
through long-term decision making. After the mission statement, a number of important
factors that provide a clear description and understanding of the business venture should
be discussed. Key elements are the product(s) or service(s), the location and size of the
business, the personnel and office equipment that will be needed, the background of the
entrepreneur(s), and the history of the venture. Table 7.6 summarizes some of the impor-
tant questions the entrepreneur needs to answer when preparing this section of the busi-
ness plan.
The location of any business may be vital to its success, particularly if the business is re-
tail or involves a service. Thus, the emphasis on location in the business plan is a function
of the type of business. In assessing the building or space the business will occupy, the en-
trepreneur may need to evaluate such factors as parking; access from roadways to facility;
and access to customers, suppliers, distributors, delivery rates, and town regulations or zon-
ing laws. An enlarged local map may help give the location some perspective with regard
to roads, highways, access, and so forth.
Recently an entrepreneur considered opening a new doughnut shop at a location diago-
nally across from a small shopping mall on a heavily traveled road. Traffic counts indicated
a large potential customer base if people would stop for coffee, and so on, on their way to
work. After enlarging a local map, the entrepreneur noted that the morning flow of traffic
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 205
TABLE 7.5 Critical Issues for Environmental and Industry Analysis
1. What are the major economic, technological, legal, and political trends on a national
and an international level?
2. What are total industry sales over the past five years?
3. What is anticipated growth in this industry?
4. How many new firms have entered this industry in the past three years?
5. What new products have been recently introduced in this industry?
6. Who are the nearest competitors?
7. How will your business operation be better than this?
8. Are the sales of each of your major competitors growing, declining, or steady?
9. What are the strengths and weaknesses of each of your competitors?
10. What trends are occurring in your specific market area?
11. What is the profile of your customers?
12. How does your customer profile differ from that of your competition?
description of the
venture Provides
complete overview of the
product(s), service(s), and
operations of a new
venture
required drivers to make a left turn into the doughnut shop, crossing the outbound lane. Un-
fortunately, the roadway was divided by a concrete center strip with no break to allow for a
left-hand turn. The only possibility for entry into the shop required the customer to drive
down about 400 yards and make a U-turn. It would also be difficult for the customer to get
back on the roadway traveling in the right direction. Since the town was unwilling to open
the road, the entrepreneur eliminated this site from any further consideration.
This simple assessment of the location, market, and so on, saved the entrepreneur from
a potential disaster. Maps that locate customers, competitors, and even alternative locations
for a building or site can be helpful in this evaluation. Some of the important questions that
might be asked by an entrepreneur are as follows:
How much space is needed?
Should I buy or lease the building?
What is the cost per square foot?
Is the site zoned for commercial use?
What town restrictions exist for signs, parking, and so forth?
Is renovation of the building necessary?
Is the facility accessible to traffic?
Is there adequate parking?
Will the existing facility have room for expansion?
What is the economic and demographic profile of the area?
Is there an adequate labor pool available?
What are local taxes?
Are sewage, electricity, and plumbing adequate?
If the building or site decision involves legal issues, such as a lease, or requires town
variances, the entrepreneur should hire a lawyer. Problems relating to regulations and
206 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
TABLE 7.6 Describing the Venture
1. What is the mission of the new venture?
2. What are your reasons for going into business?
3. Why will you be successful in this venture?
4. What development work has been completed to date?
5. What is your product(s) and/or service(s)?
6. Describe the product(s) and/or service(s), including patent, copyright, or trademark status.
7. Where will the business be located?
8. Is your building new? old? in need of renovations? (If renovation is needed, state costs.)
9. Is the building leased or owned? (State the terms.)
10. Why is this building and location right for your business?
11. What office equipment will be needed?
12. Will equipment be purchased or leased?
13. What experience do you have and/or will you need to successfully implement the
business plan?
leases can be avoided easily, but under no circumstances should the entrepreneur try to
negotiate with the town or a landlord without good legal advice.
Production Plan
If the new venture is a manufacturing operation, a production plan is necessary. This
plan should describe the complete manufacturing process. If some or all of the manu-
facturing process is to be subcontracted, the plan should describe the subcontractor(s),
including location, reasons for selection, costs, and any contracts that have been com-
pleted. If the manufacturing is to be carried out in whole or in part by the entrepreneur,
he or she will need to describe the physical plant layout; the machinery and equipment
needed to perform the manufacturing operations; raw materials and suppliers’ names,
addresses, and terms; costs of manufacturing; and any future capital equipment needs.
In a manufacturing operation, the discussion of these items will be important to any
potential investor in assessing financial needs.
Table 7.7 summarizes some of the key questions in this section of the business plan.
If the new venture does not include any manufacturing functions, this section should be
eliminated from the plan.
Operations Plan
All businesses—manufacturing or nonmanufacturing—should include an operations plan
as part of the business plan. This section goes beyond the manufacturing process (when
the new venture involves manufacturing) and describes the flow of goods and services
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 207
TABLE 7.7 Production Plan
1. Will you be responsible for all or part of the manufacturing operation?
2. If some manufacturing is subcontracted, who will be the subcontractors? (Give names
and addresses.)
3. Why were these subcontractors selected?
4. What are the costs of the subcontracted manufacturing? (Include copies of any written
contracts.)
5. What will be the layout of the production process? (Illustrate steps if possible.)
6. What equipment will be needed immediately for manufacturing?
7. What raw materials will be needed for manufacturing?
8. Who are the suppliers of new materials and what are the appropriate costs?
9. What are the costs of manufacturing the product?
10. What are the future capital equipment needs of the venture?
If a Retail Operation or Service:
1. From whom will merchandise be purchased?
2. How will the inventory control system operate?
3. What are the storage needs of the venture and how will they be promoted?
4. How will the goods flow to the customer?
5. Chronologically, what are the steps involved in a business transaction?
6. What are the technology utilization requirements to service customers effectively?
production plan Details
how the product(s) will
be manufactured
from production to the customer. It might include inventory or storage of manufactured
products, shipping, inventory control procedures, and customer support services. A non-
manufacturer such as a retailer or service provider would also need this section in the
business plan to explain the chronological steps in completing a business transaction. For
example, an Internet retail sports clothing operation would need to describe how and
where the products offered would be purchased, how they would be stored, how the in-
ventory would be managed, how products would be shipped, and, importantly, how a
customer would log on and complete a transaction. In addition, this would be a conven-
ient place for the entrepreneur to discuss the role of technology in the business transac-
tion process. For any Internet retail operation, some explanation of the technology
requirements needed to efficiently and profitably complete a successful business transac-
tion should be included in this section.
It is important to note here that the major distinction between services and manufactured
goods is services involve intangible performances. This implies that they cannot be
touched, seen, tasted, heard, or felt in the same manner as manufactured products. Airlines,
hotels, car rental agencies, theaters, and hospitals, to name a few, rely on business delivery
or quality of service. For these firms, performance often depends on location, facility lay-
out, and personnel, which can, in turn, affect service quality (including such factors as re-
liability, responsiveness, and assurance). The process of delivering this service quality is
what distinguishes one new service venture from another and thus needs to be the focus of
an operations plan. Some key questions or issues for both the manufacturing and nonman-
ufacturing new venture are summarized in Table 7.7.
Marketing Plan
The marketing plan (discussed in detail in Chapter 8) is an important part of the business
plan since it describes how the product(s) or service(s) will be distributed, priced, and pro-
moted. Marketing research evidence to support any of the critical marketing decision strate-
gies as well as for forecasting sales should be described in this section. Specific forecasts
for a product(s) or service(s) are indicated to project the profitability of the venture. The
budget and appropriate controls needed for marketing strategy decisions are also discussed
in detail in Chapter 8. Potential investors regard the marketing plan as critical to the suc-
cess of the new venture. Thus, the entrepreneur should make every effort to prepare as com-
prehensive and detailed a plan as possible so that investors can be clear as to what the goals
of the venture are and what strategies are to be implemented to effectively achieve these
goals. Marketing planning will be an annual requirement (with careful monitoring and
changes made on a weekly or monthly basis) for the entrepreneur and should be regarded
as the road map for short-term decision making.
Organizational Plan
The organizational plan is the part of the business plan that describes the venture’s form of
ownership—that is, proprietorship, partnership, or corporation. If the venture is a partnership,
the terms of the partnership should be included. If the venture is a corporation, it is important
to detail the shares of stock authorized and share options, as well as the names, addresses, and
resumes of the directors and officers of the corporation. It is also helpful to provide an organ-
ization chart indicating the line of authority and the responsibilities of the members of the or-
ganization. Table 7.8 summarizes some of the key questions the entrepreneur needs to answer
in preparing this section of the business plan. This information provides the potential investor
with a clear understanding of who controls the organization and how other members will
208 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
marketing plan
Describes market
conditions and strategy
related to how the
product(s) and service(s)
will be distributed,
priced, and promoted
organizational plan
Describes form of
ownership and lines of
authority and
responsibility of members
of new venture
interact in performing their management functions. Chapter 9 provides more detail on this
part of the business plan.
Assessment of Risk
Every new venture will be faced with some potential hazards, given its particular industry and
competitive environment. It is important that the entrepreneur make an assessment of risk in
the following manner. First, the entrepreneur should indicate the potential risks to the new ven-
ture. Next should be a discussion of what might happen if these risks become reality. Finally,
the entrepreneur should discuss the strategy that will be employed to either prevent, minimize,
or respond to the risks should they occur. Major risks for a new venture could result from a
competitor’s reaction; weaknesses in the marketing, production, or management team; and
new advances in technology that might render the new product obsolete. Even if these factors
present no risks to the new venture, the business plan should discuss why that is the case.
Financial Plan
Like the marketing, production, and organization plans, the financial plan is an important
part of the business plan. It determines the potential investment commitment needed for the
new venture and indicates whether the business plan is economically feasible. (The finan-
cial plan is discussed in more detail in Chapter 10.)
Generally, three financial areas are discussed in this section of the business plan. First,
the entrepreneur should summarize the forecasted sales and the appropriate expenses for at
least the first three years, with the first year’s projections provided monthly. The form for
displaying this information is illustrated in Chapter 10. It includes the forecasted sales, cost
of goods sold, and the general and administrative expenses. Net profit after taxes can then
be projected by estimating income taxes.
The second major area of financial information needed is cash flow figures for three
years, with the first year’s projections provided monthly. Since bills have to be paid at dif-
ferent times of the year, it is important to determine the demands on cash on a monthly ba-
sis, especially in the first year. Remember that sales may be irregular, and receipts from
customers also may be spread out, thus necessitating the borrowing of short-term capital to
meet fixed expenses such as salaries and utilities. A form for projecting the cash flow needs
for a 12-month period can be found in Chapter 10.
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 209
TABLE 7.8 Organization Structure
1. What is the form of ownership of the organization?
2. If a partnership, who are the partners and what are the terms of agreement?
3. If incorporated, who are the principal shareholders and how much stock do they own?
4. How many shares of voting or nonvoting stock have been issued and what type?
5. Who are the members of the board of directors? (Give names, addresses, and resumes.)
6. Who has check-signing authority or control?
7. Who are the members of the management team and what are their backgrounds?
8. What are the roles and responsibilities of each member of the management team?
9. What are the salaries, bonuses, or other forms of payment for each member of the
management team?
assessment of risk
Identifies potential
hazards and alternative
strategies to meet
business plan goals and
objectives
financial plan
Projections of key
financial data that
determine economic
feasibility and necessary
financial investment
commitment
The last financial item needed in this section of the business plan is the projected bal-
ance sheet. This shows the financial condition of the business at a specific time. It summarizes
the assets of a business, its liabilities (what is owed), the investment of the entrepreneur and
any partners, and retained earnings (or cumulative losses). A form for the balance sheet is
included in Chapter 10, along with more detailed explanations of the items included. Any
assumptions considered for the balance sheet or any other item in the financial plan should
be listed for the benefit of the potential investor.
Appendix
The appendix of the business plan generally contains any backup material that is not nec-
essary in the text of the document. Reference to any of the documents in the appendix
should be made in the plan itself.
Letters from customers, distributors, or subcontractors are examples of information that
should be included in the appendix. Any documentation of information—that is, secondary
data or primary research data used to support plan decisions—should also be included.
Leases, contracts, or any other types of agreements that have been initiated also may be in-
cluded in the appendix. Finally, price lists from suppliers and competitors may be added.
USING AND IMPLEMENTING THE BUSINESS PLAN
The business plan is designed to guide the entrepreneur through the first year of operations.
It is important that the implementation of the strategy contain control points to ascertain
progress and to initiate contingency plans if necessary. Some of the controls necessary in
manufacturing, marketing, financing, and the organization are discussed in subsequent
chapters. Most important to the entrepreneur is that the business plan not end up in a drawer
somewhere once the financing has been attained and the business launched.
There has been a tendency among many entrepreneurs to avoid planning. The reason of-
ten given is that planning is dull or boring and is something used only by large companies.
A S S E E N I N BUSINESSWEEK
ELEVATOR PITCH FOR PERFECT DINNER
A relative who has been very successful in the restau-
rant business has recently sold his restaurant for a
huge profit and is looking for a good investment for
some of his funds. He knows that you are a good re-
source since, as a struggling entrepreneur in your
own right, you try to maintain an awareness of other
start-ups in the area. Would you consider introducing
your uncle to Karen and Jill after reading about their
unique idea?
Forget Boston Market or the prepared-foods sec-
tion of Jewel or Whole Foods. In Oak Park, there’s the
Perfect Dinner, a kitchen that prepares “home-style”
take-out and delivered meals. The startup is aimed
mostly at “El” riders, who can go online to scope
out the shop’s menu of eight to 10 daily entrées
and order ahead before exiting Oak Station on the
Green Line.
The business was founded by Karen Gruber, 48,
who formerly handled the Kraft cheese account at ad
agency J. Walter Thompson, and Jill Haas, 47, a one-
time food scientist at Kraft Foods. The Perfect Dinner
broke even with $500,000 in revenue last year—the
average check is $41—and is looking at 8% to 10%
growth this year, Gruber says. The pair, who started
the venture with $250,000 from friends, family, and
their own savings, is now trying to drum up $700,000
to open two more sites this fall.
Source: Reprinted from May 16, 2008 issue of BusinessWeek by special permission, copyright © 2008 by The McGraw-Hill Compa- nies, Inc., from “Perfect Dinner” by Howard Wolinsky, from “America’s Most Promising Startups,” www.businessweek.com/smallbiz.
210
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 211
This may be an excuse; perhaps the real truth is that some entrepreneurs are afraid to plan.8
Planning is an important part of any business operation. Without good planning, the entre-
preneur is likely to pay an enormous price. All one has to do is consider the planning done
by suppliers, customers, competitors, and banks to realize that it is important for the entre-
preneur. It is also important to realize that without good planning the employees will not
understand the company’s goals and how they are expected to perform in their jobs.
Bankers are the first to admit that few business failures result from a lack of cash but, in-
stead, that businesses fail because of the entrepreneur’s inability to plan effectively. Intelli-
gent planning is not a difficult or impossible exercise for the inexperienced entrepreneur.
With the proper commitment and support from many outside resources, such as those
shown in Table 7.2, the entrepreneur can prepare an effective business plan.
In addition, the entrepreneur can enhance effective implementation of the business plan
by developing a schedule to measure progress and to institute contingency plans. These fre-
quent readings or control procedures will be discussed next.
Measuring Plan Progress
During the introductory phases of the start-up, the entrepreneur should determine the points
at which decisions should be made as to whether the goals or objectives are on schedule.
Typically, the business plan projections will be made on a 12-month schedule. However,
the entrepreneur cannot wait 12 months to see whether the plan has been successfully
achieved. Instead, on a frequent basis (i.e., the beginning of each month) the entrepreneur
should check the profit and loss statement; cash flow projections; and information on in-
ventory, production, quality, sales, collection of accounts receivable, and disbursements for
the previous month. Company Web sites should also be assessed as part of this process.
This feedback should be simple but should provide key members of the organization with
current information in time to correct any major deviations from the goals and objectives
outlined. A brief description of each of these control elements is given here:
• Inventory control. By controlling inventory, the firm can ensure maximum service to the customer. The faster the firm gets back its investment in raw materials and finished
goods, the faster that capital can be reinvested to meet additional customer needs.
• Production control. Compare the cost figures estimated in the business plan with day- to-day operation costs. This will help to control machine time, worker hours, process
time, delay time, and downtime cost.
• Quality control. This will depend on the type of production system but is designed to make sure that the product performs satisfactorily.
• Sales control. Information on units, dollars, specific products sold, price of sales, meeting of delivery dates, and credit terms is useful to get a good perspective of the
sales of the new venture. In addition, an effective collections system for accounts
receivable should be set up to avoid aging of accounts and bad debts.
• Disbursements. The new venture should also control the amount of money paid out. All bills should be reviewed to determine how much is being disbursed and for what
purpose.
• Web site control. With more and more sales being supported or garnered from a company’s Web site, it is very important to continually evaluate the Web site to
ascertain its effectiveness in meeting the goals and objectives of the plan. There are
many services and software packages available to assist the entrepreneur in this
process. These service companies and software alternatives are too numerous to
mention here but can easily be identified from an Internet search.9
212 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
Updating the Plan
The most effective business plan can become out-of-date if conditions change. Environmental
factors such as the economy, customers, new technology, or competition—and internal factors
such as the loss or addition of key employees—can all change the direction of the business
plan. Thus, it is important to be sensitive to changes in the company, industry, and market. If
these changes are likely to affect the business plan, the entrepreneur should determine what re-
visions are needed. In this manner, the entrepreneur can maintain reasonable targets and goals
and keep the new venture on a course that will increase its probability of success.
WHY SOME BUSINESS PLANS FAIL
Generally, a poorly prepared business plan can be blamed on one or more of the following
factors:
• Goals set by the entrepreneur are unreasonable.
• Objectives are not measurable.
• The entrepreneur has not made a total commitment to the business or to the family.
• The entrepreneur has no experience in the planned business.
• The entrepreneur has no sense of potential threats or weaknesses to the business.
• No customer need was established for the proposed product or service.
Setting objectives requires the entrepreneur to be well informed about the type of business
and the competitive environment. Objectives should be specific and not so mundane as to
lack any basis of control. For example, the entrepreneur may target a specific market share,
units sold, or revenue. These objectives are measurable and can be monitored over time.
In addition, the entrepreneur and his or her family must make a total commitment to the
business to be able to meet the demands of a new venture. For example, it is difficult to op-
erate a new venture on a part-time basis while still holding onto a full-time position. And it
is also difficult to operate a business without an understanding from family members as
to the time and resources that will be needed. Lenders or investors will not be favorably
inclined toward a venture that does not have full-time commitment.
Generally, a lack of experience will result in failure unless the entrepreneur can either
attain the necessary knowledge or team up with someone who already has it. For example,
an entrepreneur trying to start a new restaurant without any experience or knowledge of the
restaurant business would be in a disastrous situation.
The entrepreneur should also document customer needs before preparing the plan. Cus-
tomer needs can be identified from direct experience, letters from customers, or marketing
research. A clear understanding of these needs and how the entrepreneur’s business will
effectively meet them is vital to the success of the new venture.
IN REVIEW
S U M M A R Y
This chapter has established the scope and value of the business plan and has outlined the
steps in its preparation. The business plan may be read by employees, investors, lenders,
suppliers, customers, and consultants. The scope of the plan will depend on who reads it,
the size of the venture, and the specific industry for which the venture is intended.
The business plan is essential in launching a new venture. The result of many hours
of preparation will be a comprehensive, well-written, and well-organized document
that will serve as a guide to the entrepreneur and as an instrument to raise necessary
capital and financing.
Before beginning the business plan, the entrepreneur will need information on
the market, manufacturing operations, and financial estimations. This process can be
viewed as an upside-down pyramid, beginning with a very broad-based analysis
down to specific market positioning and the determination of specific goals and
objectives. The Internet represents a low-cost service that can provide valuable infor-
mation on the market, customers and their needs, and competitors. This information
should be evaluated based on the goals and objectives of the new venture. These
goals and objectives also provide a framework for setting up controls for the busi-
ness plan.
The chapter presents a comprehensive discussion and outline of a typical business
plan. Each key element in the plan is discussed, an information-gathering process is
described, and examples are provided. Control decisions are presented to ensure the
effective implementation of the business plan. In addition, some insights as to why
business plans fail are discussed.
R E S E A R C H T A S K S
1. Approximately how many books have been written on “how to write a business
plan”? How many software packages are there that aim to help entrepreneurs
write a business plan? Use data to back up your estimates. Why are there so
many?
2. Find five business plans. What are the common topics covered across all five plans?
What are the differences? Choose the one that you believe is the best written and
then describe why you believe it is better than the others.
3. Speak to five entrepreneurs and find out why they have (or do not have) a
business plan. For those who do have a business plan, find out when it was
written, the purpose for which it was created, and whether it has been used
and/or kept up-to-date.
C L A S S D I S C U S S I O N
1. Given the difficulties in accurately predicting the future, is a business plan
useful?
2. What makes an excellent business plan?
3. Would the entrepreneur be better off spending more time selling his or her
product rather than investing so much time in writing a business plan?
4. If a business plan is to be used to raise capital, then why would the entrepreneur
want to advertise the firm’s major risks by detailing them in the business
plan?
5. What is the purpose of the business plan if the audience is (a) the entrepreneur,
(b) an investor, or (c) a key supplier? How might the plan be adapted for these
different audiences? Or do you believe that it is better to simply have one business
plan that serves all audiences?
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 213
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S E L E C T E D R E A D I N G S
Babaei, Ari. (November 2008). Plan for the Worst. Fortune Small Business, vol. 18, no. 9, p. 72.
Contingency planning should be an important function of the entrepreneur. Most entrepreneurs and small-business owners lack experience in hiring people and often end up making a poor choice. Preparation in making bad decisions should be reflected in a plan so the entrepreneur will know what action to take when poor decisions are made. In addition, other staff members should also be involved and be aware of any contingency plan.
Burmeister, Paul. (March 2003). What to Present to Venture Capitalists. Strategic Finance, pp. 36–39.
This article describes some of the key aspects of each section of the business plan that should be presented to venture capitalists. It also emphasizes the importance of the format and the presentation of the business plan.
Chiagouris, Larry; and Brant Wansley. (September/October 2003). Start-Up Marketing. Marketing Management, vol. 12, no. 5, pp. 38–43.
This paper reflects on the experience of the authors as consultants and executives and develops insight as to marketing practices that make a difference for a start-up company. They report that the executives of these firms, representing a wide vari- ety of industries, all created formal marketing and business plans to obtain financ- ing for their ventures. Many also regarded monitoring competitor activity and industry trends as essential to success.
Clarke, Geri. (Summer 2005). International Marketing Environment Analysis. Marketing Review, pp. 159–73.
This paper proposes a framework for international industry and environmental analysis. The authors argue that international market analysis is lacking and that domestic environmental audits are not sufficient in the more complicated interna- tional markets.
Duffy, Bobby; Kate Smith; George Terhanian; and John Bremer. (2005). Comparing Data from Online and Face-to-Face Surveys. International Journal of Market Research, vol. 47, no. 6, pp. 615–39.
This paper explores some of the issues surrounding the use of Internet-based methodologies compared to face-to-face data collection. Data from parallel surveys using both data collection techniques are compared. The authors put forth a num- ber of theories as to why differences may exist.
Henricks, Mark. (December 2008). Do You Really Need a Business Plan? Entrepreneur, vol. 36, no. 12, pp. 92–95.
This article emphasizes the significance of preparing a business plan for a new venture. The cofounders of a new energy drink discuss how the business plan guided them through the start-up phase. In addition, they mention how the experience of the actual writing of the plan, through many revisions, convinced them of the benefits of the planning process.
Macrae, John. (October/November 2008). Improve Performance Before It’s Too Late. U.S. Business Review, vol. 9, no. 8, pp. 14–15.
One of the inefficiencies of efforts to gather business and competitor intelligence is that analysis tends to focus on explaining the past rather than trying to understand what decisions need to be made in the future. A software intelligence tool called Dashboard allows users direct access to information that can improve their ability to make future management decisions.
214 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
Mason, Colin; and Matthew Stark. (June 2004). What Do Investors Look for in a Busi- ness Plan? A Comparison of the Investment Criteria of Bankers, Venture Capitalists and Business Angels. International Small Business Journal, vol. 22, no. 3, pp. 227–48.
This article studies investors’ perceptions of the business plan. The business plan is the ticket of admission giving the entrepreneur his first and often only chance to impress prospective sources of finance with the quality of the proposal. The decision by the prospective funder whether to proceed beyond the initial reading of the business plan to consider the proposal in more detail will therefore depend on the quality of the business plan used to support the funding proposal.
Matherne, Brett P. (November 2004). If You Fail to Plan, Do You Plan to Fail? Academy of Management Executive, vol. 18, no. 4, pp. 156–57.
This article discusses a study completed by Delmar and Shane regarding the signifi- cance of business planning. Their finding supports the argument that planning first, before any action is taken in starting a new venture, reduces the chance of failure. In this article it is argued that not only should planning take place but that the founders of any new venture need to also act immediately, even at the expense of completion of the business plan.
Mohanty, Soumendra. (December 2008). Measuring the Value of Intelligence in Busi- ness Intelligence. DM Review, vol. 18, no. 12, pp. 20–23.
This article focuses on the measurement of the value of intelligence in business intelligence (BI). BI is important in assisting the user to analyze large amounts of data and finding trends and activities in the environment that need action by man- agement. Identifying key performance indicators and quickly disseminating the data is an important part of effective business intelligence application.
Perry, Stephen C. (2001). The Relationship between Written Business Plans and the Fail- ure of Small Businesses in the U.S. Journal of Small Business Management, vol. 39, no. 3, pp. 201–8.
This paper describes a study that investigates the influence of planning on U.S. small-business failures. The main conclusion is that very little formal planning goes on in U.S. small businesses; however, nonfailed firms do more planning than similar failed firms prior to failure.
Sahlman, William A. (1997). How to Write a Great Business Plan. Harvard Business Review, vol. 75, no. 4, pp. 98–108.
This paper proposes that a great business plan is one that focuses on a series of questions relating to four factors critical to the success of every new venture. These factors are: the people, the opportunity, the context, and the possibilities for both risk and reward. The questions related to these four factors are discussed.
Stein, Alexander. (December 2008/January 2009). Fear. Fortune Small Business, vol. 18, no. 10, pp. 78–81.
The recent financial crisis has affected many small businesses. This article discusses how fear and anxiety during a crisis can affect business decisions.
E N D N O T E S
1. See Katherine A. Diaz, “A Champion for Small Business: GC Micro’s Belinda Guadarrama Breaks Barriers,” HispanicTrends.com (Spring 2003), pp. 1–6; GC Micro’s ‘Huge Step’: Petaluma Computer Contractor Selected to Provide Equipment for Federal Agencies,” The Press Democrat (November 7, 2007); and www.gcmicro.com.
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 215
2. Donald F. Kuratko and Arnold Cirtin, “Developing a Business Plan for Your Clients,” The National Public Accountant (January 1990), pp. 24–27.
3. Brian O’Reilly, “Rugs to Riches,” Fortune Small Business (May 2007), pp. 51–54. 4. David E. Gumpert, “A Winning Plan Is Just the Start,” BusinessWeek Online
(November 22, 2005). 5. Kristin Ohlson, “Get Creative,” Entrepreneur (July 2008), pp. 62–67. 6. William Hoffman, “Retailers’ Online Gains,” Traffic World (December 15, 2008), p. 15. 7. Marshall Breeding, “Winning the Competition for Attention on the Web,”
Computers in Libraries (June 2008), p. 31. 8. Mark Henricks, “Do You Really Need a Business Plan?” Entrepreneur (December
2008), pp. 92–95. 9. John Clyman, Molly K. McLaughlin, Michael J. Steinhart, and Sahil Gambhir,
“Manage Your Customers and Contacts,” PC Magazine (November 30, 2004), pp. 146–47.
APPENDIX 7A: SAMPLE BUSINESS PLAN—GOPHER IT
The following business plan has been condensed and edited somewhat because of
space requirements. However, the areas where editing has taken place are clearly iden-
tified and do not in any way detract from the meaningfulness of this example. An
average business plan will vary in length depending on the industry, the size of the
appendix, and the number of illustrations. The actual text of a business plan would
conservatively range between 15 and 25 pages.
Venture Description
Gopher It is a personal shopping service located in the downtown business district of
Boston, Massachusetts. It is based on the belief that people’s schedules today are more
demanding; thus the value of personal leisure time has increased. As we continue the
21st century with more and more dual-career families, personal convenience services
are a high-growth market opportunity. The professional white-collar employee in the
downtown district, who has high disposable income and a strong motive to increase
leisure time, represents the main focus of the venture’s marketing efforts.
Running errands before work, during lunch breaks, or after work takes time and is
often irritating. People often have to wait in line for services, fight traffic, and skip
lunch or an opportunity for a quiet time away from the pressures of the office. Gopher
It has established an errand service for professionals in the heart of the downtown
business district of Boston. The company will be located at _____ Street, on the first
floor, where employees will have direct access to public transportation and customers
will be able to stop by and conveniently request any service. Employees will typically be
college students, who will perform services on foot, use public transportation, or ride
a bicycle to efficiently meet customer needs. The office will contain storage space for
pickup and delivery items as well as refrigeration for any specific food products. The
entry area where customers will place their service order will be professionally deco-
rated and staffed with trained individuals to answer questions and attend to customer
needs. The number of staff will vary, depending on when the office is most busy (early
morning, lunchtimes, and at close of business day).
The diverse services that will be offered are categorized as standard or custom.
Standard services include dropping off and/or picking up laundry, dry cleaning, mail,
tickets such as airline or theater, and prescriptions; shopping for groceries or gifts; and
216 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
making bank deposits. Customized or special services, not specifically listed or identi-
fied, may also be offered based on the amount of time it takes to complete the errand.
An example of a special service would be picking up an automobile that was being
repaired. These special services would be priced on an hourly basis and, in the case of
an automobile, may also include the expense of parking.
Industry Analysis
The service sector in the United States continues to grow. Entrepreneurs have initiated
many new ventures in the service sector in response to greater demand for leisure
time, the increasing number of dual-career families, and more disposable income.
Demographic Trends [This section of the business plan would provide statistical data
and discussion of some of the significant demographic trends that would support the
needs being addressed by this proposed venture.]
Competitor Analysis Although there are many indirect competitors to Gopher It,
there are none in the Boston market that offer such a broad range of services. Courier
services have existed for many years, but other service businesses have been slow in their
response to customer needs by offering only pickup and delivery services. Today it is
more common to find supermarkets, dry cleaners, restaurants, video stores, and auto re-
pair shops offering pickup and/or delivery for their customers. Typically this service tends
to be ad hoc, with little effort made to organize it based on customer needs.
Although there are a number of small businesses in other states that offer pickup and
delivery services, none compares with Gopher It in terms of the extent of services offered.
Shopping services for professional clients exist in almost every major market. However,
Gopher It will not offer this service since it requires a distinctive trained and knowledge-
able staff. There are also businesses that will pick up and deliver laundry, and others that
will provide grocery shopping services. Most of these businesses are in the specific retail
business for which they are providing the service; hence, their purpose is to offer pickup
and delivery as an incentive to buy their retail goods. Some of the companies that offer
pickup and delivery services that would indirectly compete with Gopher It are as follows:
[Direct and indirect competitors would be listed here with a description of their
businesses and the services they provide.]
Marketing Plan
The marketing strategy was designed on the basis of personal interviews conducted
with employers and business professionals in the downtown Boston market, which
represents our target market. These interviews indicated that the individuals preferred
to have someone else perform many of the time-consuming errands that they were re-
quired to do on a weekly or regular basis. The majority of these individuals com-
mented that they had less leisure time than in the past and, as a result, valued this free
time more than ever before. They indicated a need for the types of services offered by
Gopher It and a willingness to pay for these services.
The errand market is untapped and has a large customer base. The target market
for our services would be white-collar, highly educated baby boomers, working in
professional jobs and likely members of two-career professional households. The
office is located in the downtown business district and near a major transit station
where there are many individuals who fit our target market. Recent traffic statistics
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 217
indicated that more than 13,000 individuals would pass our office to and from their
office to their transit stop. This high-traffic location lends itself to the convenience
services that we can provide for our target market.
Marketing Goals
• To meet the growing needs of a target market defined on the basis of geography,
demographics, lifestyle, and buyer intentions.
• To evaluate the competitive environment and continue to establish a differential
advantage.
• To establish an effective and profitable marketing mix of service, place, price, and
promotion.
Marketing Objectives
• To establish a customer base of 10 percent of the defined target market in the
first year.
• To generate $150,000 in sales for the first year.
• To increase sales by 10 percent annually for the first three years.
• To expand to at least two new locations by the end of the first three years.
Size of Market According to our research, there are about 250,000 people in the cen-
tral business district of the city of Boston. There are approximately 10,300 to 13,200
people (represents the primary market) who pass our office every business day. On the
basis of our research and on demographic studies conducted in the city of Boston,
about 75 percent of these individuals match our target market. This would consist of
individuals between the ages of 28 and 65, male or female, with high disposable
income, employed as professional businesspersons or office staff.
There is also the potential to reach an additional 10,000 customers who work on the
fringe of this area and may not directly pass our office on a regular basis. This secondary
market may be penetrated through advertising, word of mouth, and the distribution
of marketing literature.
On the basis of the preceding information, it is estimated that the potential market is
between 17,000 and 20,000 people. Our objective is to reach 10 percent of the primary
market and 5 percent of the secondary market. Thus, in our first year the market
would consist of about 1,275 customers.
Service The services that will be provided by Gopher It are designed to provide cus-
tomers with the benefits of convenience and the saving of time. Although the services
vary widely, there are standard services offered to the customer. Standard services in-
clude lunch delivery, dry cleaning pickup and drop-off, grocery shopping (maximum of
10 items), and gift shopping in the downtown area. Customized services of almost any
kind will also be offered on a fee-for-time basis. Examples of these customized services
are auto pickup and/or drop-off, pickup of theater tickets, supply pickup, post office
visits, and bank deposits. Delivery and pickup will typically involve walking, riding a
bicycle, or using the transit. The most efficient and economic solution will be chosen for
each situation.
Price Pricing strategy is based on a fee per errand. This strategy was determined from
an evaluation of Errands Unlimited, a similar business located in Milwaukee, Wisconsin,
as well as a marketing research study of the target market. For the customized services
218 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
the price will be based on the amount of time necessary to perform the errand, includ-
ing time in transit. The lowest fee would be $5 for a quick errand that took less than
five minutes. Prices for errands taking longer than five minutes would increase accord-
ingly and are indicated below.
Miscellaneous Personal Services
Pick up tickets for theater district shows.
Pick up tickets for sporting events.
Wait in line for a book autograph.
Pick up automobile at repair shop.
Post office visits.
Office supply shopping.
Bank deposits.
Any other personal errands.
Time Spent (in Minutes) Price
0–5 $10
6–10 $15
11–15 $20
16–20 $25
21–25 $30
26 ⫹ $40
Regular or Standard Services Price
Express lunch delivery $7
Dry cleaning drop-off $7
Dry cleaning pickup $7
Grocery shopping (maximum of 10 items) $12
Gift shopping in downtown area $18
Promotion Gopher It will rely extensively on word-of-mouth advertising. However, it
will be important to create an awareness of our services to the target market. To at-
tract attention and to create awareness, signs will display our name and describe our
services to the many individuals who actually pass by the office. Pamphlets will also be
distributed to office buildings in the target market.
Facilities Plan The location of Gopher It will be in the lobby at _____ Street in the
downtown district of Boston. This location is ideal because it provides access to a large
base of potential customers who pass the office going to and from work to the transit
station or garage as well as those who stroll around the area during lunchtime. Esti-
mates of the daily traffic are between 4,000 and 5,000 individuals passing through the
lobby at each rush hour, which projects to between 8,000 and 10,000 passes per day.
There are also about 1,000 people who work in this building and another 1,300 to
2,200 individuals who pass through the lobby at non-rush-hour time. Thus, in a typical
day there are between 10,300 and 13,200 potential consumers who are likely to pass
by our business location. If we also include the Bank of Boston and Shawmut building,
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 219
both on a connecting street, we have effectively extended our potential market to
over 20,000 people. This large base of potential consumers is an excellent target mar-
ket for our services. Even with limited resources, our storefront and location will be an
important asset in promoting an awareness of Gopher It’s services.
The initial location will be leased. Rent will be based on a $40 per square foot price.
With electricity and other charges the rental cost will be $50 per square foot or $10,000
per month.
Certain equipment will also be necessary to operate the business effectively—a mul-
tiline phone system; computer and printer; fax machine; storage for hot and cold
foods; and storage for garments, gifts, and groceries. Counters will be set up in a small
area at the front of the office for conducting business with clients. Little space is
needed for the attendant, whose main function will be to take orders from walk-in
clients and to answer the phone for call-in orders. The storage space would have food
storage on one side and garment and gift storage on the other.
Organizational Plan
Gopher It will be established as a partnership. There will be three partners: David
Wilson, Jack Welch, and Laura Shanley. Each will assume an equal ownership in the
business. Background and roles of each of the three partners are described in the fol-
lowing. A partnership agreement is summarized in the Appendix.
Management Team Background David Wilson was born in San Diego, California, and
graduated from Swarthmore College with an accounting degree. Past employers include
numerous restaurants, a specialty retailer, and a large bank (mutual funds). He has sig-
nificant experience in managing and training people as well as financial management.
Jack Welch was born in Atlanta, Georgia, and has a food science degree from the
University of Maryland and an MBA degree from Boston College. He has had extensive
experience in food retailing and more recently in sales and marketing with a large con-
sumer food producer.
Laura Shanley was born in Jamaica Plain, Massachusetts, and has a bachelor of
science degree in marketing from Boston College. She has extensive experience in a
family business, a chain of small retail gift shops. This gift shop experience involved
expansion to new locations, buying, promotion, and customer relations. The business
has since been sold, and Laura is seeking new endeavors in a start-up venture.
Duties and Responsibilities of the Partners
Laura Shanley—General Administrator and Manager Laura will oversee the daily
operations of the business. This includes the hiring and firing of employees as well
as training and supervising. Periodic employee evaluations will be completed by
the general administrator and manager. She will also handle all purchasing for the
office and will be responsible for opening and closing the office each day.
Jack Welch—Marketing and Sales Manager Jack will be responsible for creating
promotional activities, monitoring sales, and establishing effective strategies for
creating awareness of the business. He will be responsible for the design and
distribution of all direct marketing materials.
David Wilson—Financial Manager David will be responsible for finance,
accounting, payroll, billing, taxes, and any other matters related to sales and
revenue budgets.
220 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
The Financial Plan
Financial statements are presented in the following pages. Explanations of all financial
information are also provided. The business is expected to break even in the early part
of the second year with the first positive profit achieved in the month of August. Total
start-up expenditures will be about $20,000. We are seeking a $40,000 loan that will be
paid back over five years at 12 percent.
Risk Assessment
The proposed errand service offered by Gopher It, although free from any direct compe-
tition, has a very low barrier to entry. Setup costs and high liquidity will be a significant
attraction to competitors, who could subsequently penetrate some of Gopher It’s mar-
ket. Gopher It will need to rely on its quality of service and being first in the market to
protect its market share. Our convenient location and flexibility in providing a wide
range of services should support the long-term success of Gopher It in this market.
Appendix*
Resumes of Partners
Partnership Agreement
Lease Agreement
Facility Layout
Market Research Survey Results
Marketing Brochure with Price List
C H A P T E R 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE 221
*The actual information in the Appendix has not been included because of space. However, the student should be able to infer from the example provided here the scope and content of a complete business plan.
1
To understand the relevance of industry and competitive analysis to the market planning process.
2
To describe the role of marketing research in determining marketing strategy for the marketing plan.
3
To illustrate an effective and feasible procedure for the entrepreneur to follow in engaging in a market research study.
4
To define the steps in preparing the marketing plan.
5
To explain the marketing system and its key components.
6
To illustrate different creative strategies that may be used to differentiate or position the new venture’s products or services.
8 T H E M A R K E T I N G P L A N
L E A R N I N G O B J E C T I V E S
223
O P E N I N G P R O F I L E
WARREN G. JACKSON
Some experts argue that organizing and launching a business is the easiest part of
getting started, while sustaining the business is the most difficult and challenging part.
As we’ve seen in earlier chapters, businesses fail at an alarming rate, yet too often we
blame lack of finances or poor management for the demise. A closer look often reveals
that the real problems relate to marketing issues such as
identifying the customer, defining the right product or
service to meet customer needs, pricing, distribution, and
promotion.
As technology continues to change, providing easier access to extended interna-
tional markets, it is significantly more important that today’s entrepreneur become
more focused on developing a comprehensive and detailed marketing plan. Markets
are much more dynamic than ever before, making it necessary to anticipate changes in
consumer needs and make the necessary changes in marketing actions. Planning, as
discussed in Chapter 7, spans a wide range of activities and is intended to formally de-
tail the business activities, strategies, responsibilities, budgets, and controls to meet
specific, designated goals. The marketing plan is a tool that can assist the entrepreneur
in monitoring critical short-term goals and objectives and marketing strategies, as well
as a tool that can alert the entrepreneur to make necessary changes in those strategies
to avoid long-term failure.
One of the most important marketing challenges facing the entrepreneur is to effec-
tively position the venture’s products or services in a highly competitive environment.
Most markets already contain major players that may dominate the market and have
significant resources to defend against any new venture. However, within many of
these large markets there are customers who are not completely satisfied with the
existing offerings. Effective marketing planning that targets and positions the new ven-
ture’s products or services can meet the needs of these customers, leading to opportu-
nity and long-term success. Such an approach was taken by Circulation Expertí, Ltd.
This family-run company is a wholly black-owned public relations, advertising, mar-
keting, and consulting firm. It officially began in 1968 as the brainstorm of Warren
G. Jackson, who recognized that major newspapers were not effectively reaching the
African American community.
www.experti.com
Warren Jackson entered the newspaper business at The New York Times in 1952,
where he eventually became an assistant manager in the circulation department. Later
working for the Amsterdam News, he was asked by Time, Inc., to assist that firm in the
circulation and distribution of a new general market daily afternoon publication.
Although it was never published, Warren realized that his newspaper knowledge and
expertise could be beneficial to media and major corporations all across the country.
With this knowledge and a $12,500 contract from Tuesday magazine, he then started
Circulation Expertí out of his home. Within a year of this beginning, Expertí’s contract
volume reached $200,000, leading Warren to move the business out of his home to a
new small office in Hartsdale, New York. Although he was not armed with a formal
marketing plan, Warren’s understanding and recognition of the unmet needs of a sig-
nificant and growing consumer target market led Expertí to become the largest and
most prominent minority-owned public relations agency in the United States.
This successful company is unique—not only in the growth it has experienced over the
years but also because the firm has remained a family-owned organization involving
Warren’s wife, Tena, who came on as CFO in 1972, and their three children, Tenley-Ann,
Terrance, and Garrison. Warren and Tena have since given up the reins of the day-to-day
activities, with Garrison now assuming the position of president and CEO.
Over the years the company has added an advertising division (1978) and a Hispanic
division (1988). Both new divisions have allowed the company to offer one-stop
shopping to clients looking for African American and Hispanic marketing. This effort
has provided opportunities to add major clients to an already noteworthy list. The
company has serviced many major Fortune 500 clients such as JPMorgan Chase, Colgate-
Palmolive, IBM, Miller Brewing, Seven-Up, Kraft, General Motors, Reebok, Sears, Ryder
Systems, Unilever, and General Mills, to name a few. Billings have also grown, from
around $1 to $2 million in the early years to $20 million in more recent years. The com-
pany has positioned itself well to withstand the current economic downturn. Anticipat-
ing minimal growth in 2009 from large multinational clients, the company has shifted
its primary focus toward midsize companies and well-funded start-ups that can benefit
from Expertí’s marketing and multicultural experience. The agency will continue to
manage several company-owned initiatives launched in 2006 as well.
The Jacksons represent a unique success story dating back to Warren’s recognition of a
need that he felt he could meet with a marketing plan. This firm’s success is not notable
for its client base alone but also because of the significant amount of charity and philan-
thropic work in which all members of the family are actively engaged. For its success in
business and related philanthropic endeavors the company has been recognized with nu-
merous awards from PRWeek, Black Enterprise magazine, National Association of Market
Developers, Public Relations Society of America, and Family Digest magazine, in addition
to receiving numerous awards from major corporations and the New York City Depart-
ment of Health. The firm was inducted into the Business Council of Westchester’s Cham-
ber of Commerce Hall of Fame in 2006. Under the direction of Garrison and his brother
and sister, and with Warren and Tena always there for support, the firm’s outlook is ex-
tremely favorable. Today the company plans and sets clear goals and objectives and con-
tinues to evaluate market opportunities to sustain successful long-term growth.1
224 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
As we can see from the example of Circulation Expertí, many opportunities exist in
a competitive environment. Warren’s efforts in creating the venture began with an
understanding and assessment of the needs of a particular segment of the market.
Developing an appropriate strategy to meet those needs includes an understanding
and assessment of the industry, which is where we will begin our discussion in this
chapter.
C H A P T E R 8 THE MARKETING PLAN 225
INDUSTRY ANALYSIS
Prior to the preparation of the marketing plan the entrepreneur will need to complete the
industry analysis section of the business plan. The primary focus of the industry analysis
is to provide sufficient knowledge of the environment (national and local market) that can
affect marketing strategy decision making. In Chapter 7 we described this information-
seeking process as an upside-down pyramid (see Figure 7.1). It begins with the broadest-
based assessment of environmental and industry trends. Then it proceeds to more local
market environmental and industry trends, including competition. The entrepreneur should
review this section of Chapter 7 to understand what information is included and how it can
be obtained.
Secondary sources can provide much of the information needed on each of these issues.
Sample sources along with an appropriate example are also identified in Chapter 7. In ad-
dition to the secondary sources, the entrepreneur may also decide that a market research
initiative is needed to secure more specific information on such variables as customer
needs, competitive strengths and weaknesses, price, promotion, distribution, and product
or service benefits. This market research project may add important valuable insights that
can assist the entrepreneur in determining the most effective market position, setting mar-
ket goals and objectives, and determining what action programs are necessary to meet
those goals and objectives. The steps in the market research process and the avenues avail-
able to the entrepreneur for obtaining assistance in this process are discussed later in this
chapter.
One of the important benefits of the upside-down pyramid approach to industry analysis
is that the entrepreneur can begin to understand competitors’ strengths and weaknesses,
which may provide valuable insight into how to position the products or services of the
new venture. Techniques for recording and evaluating this information on the competitive
environment are discussed in the following section.
Competitor Analysis
The entrepreneur should begin this step by first documenting the current strategy of each
primary competitor. This can be organized by using the model in Table 8.1. The informa-
tion on competitors can be gathered initially by using as much public information as possi-
ble and then complementing this with a marketing research project. Newspaper articles,
Web sites, catalogs, promotions, interviews with distributors and customers, and any other
marketing strategy or company information available should be reviewed. A simple
Google, Yahoo!, or MSN search can link the entrepreneur to many good sources of infor-
mation on competitors. A library search using such databases as Business Source Com-
plete, LexisNexis, Factiva, or Hoover’s can also provide access to any newsworthy articles
on specific competitors. These articles should be scanned for information on competitor
strategies and should identify the names of individuals who were interviewed, referenced,
or even mentioned in the article. Any of these individuals as well as the author of the arti-
cle can then be contacted to obtain further information. All the information can then be
summarized in the model provided in Table 8.1. Once the strategy has been summarized,
the entrepreneur should begin to identify the strengths and weaknesses of each competitor,
as shown in the table.
All the information included in Table 8.1 can then be utilized to formulate the market
positioning strategy of the new venture. Will the new venture imitate a particular com-
petitor or will it try to satisfy needs in the market that are not being filled by any other
company? This analysis will enlighten the entrepreneur and provide a solid basis for any
marketing decision making discussed in the marketing plan. If a more formal data collec-
tion process is being considered, the following paragraphs will help explain the steps in
gathering primary data as well as some of the secondary sources that can provide data to
the entrepreneur.
MARKETING RESEARCH FOR THE NEW VENTURE
Information for developing the marketing plan may necessitate conducting some market-
ing research. Marketing research involves the gathering of data to determine such informa-
tion as who will buy the product or service, what is the size of the potential market, what
price should be charged, what is the most appropriate distribution channel, and what is the
most effective promotion strategy to inform and reach potential customers. Since market-
ing research costs vary significantly, the entrepreneur will need to assess available resources
and the information needed. There are also some research techniques that are not costly and
can provide, at least initially, significant evidence to support the market potential for the
new venture. One of these techniques is the focus group, which is discussed later in this
section.
Marketing research may be conducted by the entrepreneur or by an external supplier
or consultant. There are also opportunities for entrepreneurs to contact their local colleges
or universities to identify faculty who teach marketing and are willing to have external
clients for student research projects. Suggestions on how to conduct market research are
discussed next.
226 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
TABLE 8.1 An Assessment of Competitor Marketing Strategies and Strengths and Weaknesses
Competitor A Competitor B Competitor C
Product or service
strategies
Pricing
strategies
Distribution
strategies
Promotion
strategies
Strengths and
weaknesses
Market research begins with a definition of objectives or purpose. This is often the most
difficult step since many entrepreneurs lack knowledge or experience in marketing and of-
ten don’t even know what they want to accomplish from a research study. This, however, is
the very reason why marketing research can be so meaningful to the entrepreneur.2
Step One: Defining the Purpose or Objectives
The most effective way to begin is for the entrepreneur to sit down and make a list of the
information that will be needed to prepare the marketing plan. For example, the entrepre-
neur may think there is a market for his or her product but not be sure who the customers
will be or even whether the product is appropriate in its present form. Thus, one objective
would be to ask people what they think of the product or service and whether they would
buy it, and to collect some background demographics and attitudes of these individuals.
This would satisfy the objective or problem that the entrepreneur defined earlier. Other
objectives may be to determine the following:
• How much would potential customers be willing to pay for the product or service?
• Where would potential customers prefer to purchase the product or service?
• Where would the customer expect to hear about or learn about such a product or service?
Step Two: Gathering Data from Secondary Sources
Secondary sources, discussed earlier in this chapter and in Chapter 7, offer a means of
gathering information for the industry analysis section of the business plan. There are
many other market research secondary sources that may be used to address the specific
objectives of the project identified in step one. As mentioned, trade magazines, newspaper
articles, libraries, government agencies, and the Internet can provide much information on
the industry market and competitors. The Internet can even be used to gather informal
primary data through chat groups.
Commercial data may also be available, but the cost may be prohibitive to the entre-
preneur. However, business libraries may subscribe to some of these commercial services
such as Nielsen Indexes, Audits and Surveys’ National Market Indexes, and Information
Resources, Inc.
Before considering either primary sources or commercial sources of information, the
entrepreneur should exhaust all free secondary sources. At the federal level, the U.S Cen-
sus Bureau publishes a wide range of census reports, as does the Department of Com-
merce. Other excellent sources at the state and local levels are the State Department of
Commerce, chambers of commerce, local banks, state departments of labor and industry,
and local media. A comprehensive list of Web sites (some are fee based and others are
free) as well as a number of excellent databases can be found in Table 8.2. Some of the
fee-based sources may actually be accessible through a local university or community
library. In addition to all the sources of data described in Table 8.2, the entrepreneur
should also review any possible sources of research data at the Small Business Admin-
istration Web site (www.sba.gov).
The most important purpose of reviewing secondary sources is to obtain information
that will assist the entrepreneur in making the best decisions regarding the marketing of a
product or service. Improvements in information technology today make this a very effec-
tive source in gathering information on customers, competitors, and market trends. Com-
pletion of this task will also determine if more data are needed, in which case a primary data
gathering will then need to be planned.
C H A P T E R 8 THE MARKETING PLAN 227
228 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
Commercial Sources
Each of these sources provides a wide range of research support and data on industries, consumer behavior,
products, and technology. Some of these firms publish reports that may be accessible at a university library or online.
The fees range from free to very expensive, but many of these are worth a look.
The Nielsen Company (www.nielsen.com) Audits and Surveys (www.gfkauditsandsurveys.com)
Hoover’s (www.hoovers.com) iMarketInc (www.imarketinc.com)
IRI (www.us.infores.com) IDC (www.idc.com)
TableBase (www.gale.cengage.com) Harris Poll (www.harrispollonline.com)
Web-Related Demographic/Consumer Research Information
These sites are typically free online or accessible at a local university library.
American Consumer Satisfaction (www.bus.mich.edu/research). Maintained and produced by the University of
Michigan, it provides an index of satisfaction toward a wide range of products and services.
Bureau of Labor Statistics (www.stats.bls.gov). Provides information on consumer buying habits related to different
consumer and household characteristics.
ClickZ (www.clickz.com/stats). Provides news-related statistical information on digital marketing issues such as
advertising and consumer behavior.
Statistical Abstracts of the United States (www.census.gov/compendia/statab/). Guide to summary statistics on a
wide range of social, political, and economic variables. Available on state and county levels.
U.S. Census Bureau (www.census.gov). Contains demographic data in tables from the U.S. Census Bureau.
Free Internet Marketing Resources
Marketing for Success (www.marketingforsuccess.com/free-stuff.html). This site provides articles, data on how much
to spend on marketing, audio answers, profit calculators, networking guide, and advertising analysis, as well as a
free newsletter.
Free Demographics (www.freedemographics.com). This site allows you to analyze and compare any demographic
variable by geographic area using census data.
InfoTrends (www.infotrends.com/freedemo.html). Allows you to search one year of market data free. Provides data
on sales, shipments, market share, and other important market statistics on the information technology industry.
MarketingSherpa (www.marketingsherpa.com). Publishes many free reports with tips, benchmark guides, and
marketing ideas. Provides advice on how to improve any fee-related searches.
Other Library Databases
Bloomberg. Provides real-time integrated market data and news for all market sectors.
Business Source Complete. Contains more than 3,000 full-text articles covering a wide range of topics in economics,
finance, accounting, marketing, and general management.
Forrester. In-depth marketing research reports in emerging technologies and their impact on business.
LexisNexis. Covers a wide range of industry news topics such as market trends, finance, technology, accounting, tax
information, and law reviews.
Mediamark Research (MRI). Published survey of product usage and media exposure of all persons 18 years and older
in a wide range of markets.
Mintel Reports. Provides market research reports on U.S. and European marketplace on such sectors as consumer
goods, travel, tourism, finance, Internet, retail, and food and drink. The focus is on market size and trends in these
sectors.
TABLE 8.2 Sources of Secondary Market Research Data
229
A S S E E N I N B U S I N E S S W E E K
HOW TO EXPAND YOUR CUSTOMER BASE
Q: I’ve been hired by a small company to sell low-
cost, lightweight stainless steel tubing and to license
its proprietary technology. We have been under ex-
clusive contract with Ford Motor, but that contract
expired in 2009. We need additional sales reps that
are very well connected with buyers. How would I
find them, and what else can I do to increase our cor-
porate profile?—D.G., Escondido, Calif.
A: Small companies that rely on long-term, exclusive
contracts often find themselves in difficult straits when
those contracts expire. They can have the best products
and the most innovative technology, but without a
coherent marketing strategy, sales infrastructure, and
customer relationships, they won’t succeed.
Before you hire additional sales staff, build a brief
but concise go-to-market strategy, says Joanne Black,
a speaker, sales trainer, and founder of NoMoreCold-
Calling. While automakers struggle, for instance, can
you find applications for your products and technol-
ogy in other markets? Should you think about start-
ing a government division that supplies federal or
state agencies with stainless steel tubing? Evaluate
your technology's bottom-line value and find a way
to demonstrate it to customers.
Next, redefine the profile of your ideal customer
and identify half a dozen new industry segments.
Rather than bringing in commission-based sales reps
who don’t know your product or how best to sell it,
“your money will be better spent hiring someone
who does strategic planning or marketing plans and
can help you devise a strategy and implement it,”
she says.
Barry Trailer, founder of CSO Insights, a research
firm that studies sales effectiveness, agrees. “The
notion of investing in infrastructure in sales and
marketing is not what first comes to mind for small
companies, but it is one of the first things they need
to address,” he says.
Make sure anyone you hire is tech-savvy, so they
can take advantage of software that has made cus-
tomer relations and sales management easier and
more affordable for small companies. “Bring automa-
tion into your business and start leveraging technol-
ogy” by using software that is sold as a service and
can help you educate, train, and manage your sales
team, says Trailer. “The bad news is that in a crowded
marketplace you must market even the most incredi-
ble technology—but the good news is that small
companies can compete on the Internet with much
larger players.”
Once you’ve defined your target customers and
new markets, you'll know whether you can handle
sales in-house, or whether you should expand your
sales team with independent reps. You can find them
through associations such as the Manufacturers’
Agents National Association and Web sites such as
RepHunter.net.*
After reading the above article how would you
respond to the following questions?
1. Once you have developed the marketing strategy,
are you better off hiring your own sales staff or
using independent reps or both?
2. What if your company has both exclusive con-
tracts and open contracts. Do you still need to
develop a marketing strategy first?
*Source: Reprinted from August 28, 2009 issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Companies, Inc., “How to Expand Your Customer Base.” by Karen E. Klein, www.businessweek.com.
Step Three: Gathering Information from Primary Sources
Information that is new is primary data. Gathering primary data involves a data col-
lection procedure—such as observation, networking, interviewing, focus groups, or
experimentation—and usually a data collection instrument, such as a questionnaire.
Observation is the simplest approach. The entrepreneur might observe potential cus-
tomers and record some aspect of their buying behavior. Networking, which is more of
an informal method to gather primary data from experts in the field, can also be a valu-
able low-cost method to learn about the marketplace. One study of new ventures found that
the most successful ventures (based on growth rate) were focused on information about
competitors, the customer, and the industry, using networking, trade associations, and re-
cent publications. Less successful ventures were more focused on gathering information on
general economic and demographic trends and hence had less of a sense of what was
happening in their specific target market.3
Interviewing or surveying is the most common approach used to gather market informa-
tion. It is more expensive than observation but is more likely to generate more meaningful
information. Interviews may be conducted in person, by telephone, through the mail, or on-
line, an approach growing in popularity, particularly for firms with an existing customer
base. Each of these methods offers advantages and disadvantages to the entrepreneur and
should be evaluated accordingly.4 Table 8.3 provides comparisons of each of these three
methods of data collection.
The questionnaire, or data collection instrument, used by the entrepreneur should
include questions specifically designed to fulfill one or more of the objectives the entrepre-
neur listed earlier. Questions should be designed so they are clear and concise, do not bias
the respondent, and are easy to answer. Table 8.4 illustrates a sample questionnaire employed
by an entrepreneur trying to assess the need for a personal errand service, such as the
venture Gopher It, whose business plan is used as an example in Chapter 7. The questions
are designed to satisfy the objectives of the entrepreneur, which are to ascertain the need,
230 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
Telephone
Personal
Internet
Can be
inexpensive,
depending on
telephone
distance and
length of
interview.
Can be
inexpensive,
depending on
number of units
mailed and
weight.
Most expensive
technique.
Requires face-to-
face contact.
Inexpensive.
Some flexibility;
possible to
clarify or explain
questions.
No flexibility
since
questionnaire
is self-
administered.
Instrument
needs to be self-
explanatory.
Most flexible of
all methods
because of face-
to-face contact.
No flexibility
since self-
administered.
Good response
rate possible
(possible 80%)
depending on
not-at-homes or
refusals.
Poorest response
rate since
respondent has
choice of
whether to
complete
questionnaire.
The most
effective
response rate
because of face-
to-face contact.
Good response
rate with
incentives, but
still relatively
new method.
Fastest method
of obtaining
information. Can
contact many
respondents in a
short period.
Slowest method
because of time
required to mail
and wait for
respondents to
complete and
return
questionnaire.
Somewhat slow
because of dead
time needed for
travel.
Very fast
method since
questionnaire
is sent
electronically.
Least detailed
because of 8- to
10-minute time
limitation.
Some depth
possible since
respondent
completes
questionnaire at
his or her
leisure.
Most detailed
because of open-
ended questions.
Some depth
possible since
respondent
completes
questionnaire
at his or her
leisure.
Characteristics of Methods
Method Costs Flexibility Response Rate Speed Depth
TABLE 8.3 A Comparison of Survey Methods
C H A P T E R 8 THE MARKETING PLAN 231
1. Of the following, please check the three most frequent errands that you are likely to carry out during the workweek. _____ Dry cleaners _____ Post office _____ Drugstore _____ Bank _____ Shopping for clothing items _____ Shopping for nonclothing and nongrocery items _____ Buying a gift _____ Automotive service or repair _____ Other ____________ _____ Other ____________
Please specify Please specify
2. Of the following, please indicate which items you would be willing to pay for someone to carry out for you. _____ Dry cleaners _____ Post office _____ Drugstore _____ Bank _____ Shopping for clothing items _____ Shopping for nonclothing and nongrocery items _____ Buying a gift _____ Automotive service or repair _____ Other ____________ _____ Other ____________
Please specify Please specify
3. What do you consider the two most important reasons for having someone else complete an errand? (Check only two.) _____ Waiting in lines _____ Inconvenient location _____ Imposes on my relaxation time _____ Difficult work schedule _____ Traffic _____ Other ____________
Please specify _____ Other ____________
Please specify
4. If an errand service was conveniently available to you, how much would you be willing to pay for a standard errand such as delivering or picking up dry cleaning, going to the post office, or picking up a prescription?
_____ $3.00 _____ $4.00 _____ $5.00 _____ $6.00 _____ $7.00 _____ $8.00 _____ $9.00 _____ $10.00 _____ More than $10.00
5. Please indicate by rank ordering (1 being highest rank, 2 being second highest rank, and so on) your preference for the most convenient location for a personal errand service.
_____ In my building _____ Near my office _____ Near the train station _____ Prefer to have item(s) delivered to my office
6. The following information is needed for categorizing the results of the survey. Please check the appropriate box. Sex: _____ Male _____ Female Marital/household status: _____ Bachelor
_____ Single parent _____ Married, both spouses working _____ Married, one spouse working
Age: _____ Under 25 _____ 25–34 _____ 35–44 _____ 45–54 _____ 55 and over
Household income: _____Under $40,000
_____$40,000–$54,000
_____$55,000–$69,000
_____$70,000–$84,000
_____$85,000–$99,000
_____$100,000 and above
TABLE 8.4 Sample Questionnaire for Personal Errand Service
location, and determination of the most important services to offer and price. Support in the
design of questionnaires can often be attained through small-business development centers,
members of the Service Corps of Retired Executives (SCORE), or students in marketing
research classes at a local college or university. Since the instrument is important in the re-
search process, it is recommended that entrepreneurs seek assistance if they have no expe-
rience in designing questionnaires.
Focus groups are a more informal method for gathering in-depth information. A focus
group is a sample of 10 to 12 potential customers who are invited to participate in a discus-
sion relating to the entrepreneur’s research objectives. The focus group discusses issues in
an informal, open format, enabling the entrepreneur to ascertain certain information.
For example, two entrepreneurs were considering a chain of hair salons that would spe-
cialize in hair styling and hair care services for African Americans. To understand the hair
care needs and most effective marketing strategy for this market, focus groups of a cross
section of African American women were organized. The focus groups were designed to
ascertain what services should be offered, the demand for these services, pricing strategy,
and the most effective advertising/promotion strategy. The information gathered was then
used in the preparation of the marketing plan.
Someone other than the entrepreneur should lead the focus groups. Often this is a good
project for students at a college or university in a marketing research class.
Step Four: Analyzing and Interpreting the Results
Depending on the size of the sample, the entrepreneur can hand-tabulate the results or en-
ter them on a computer. In either case, the results should be evaluated and interpreted in
response to the research objectives that were specified in the first step of the research
process. Often, summarizing the answers to questions will give some preliminary insights.
Then data can be cross-tabulated to provide more focused results. For example, the entre-
preneur may want to compare the results to questions by different age groups, sex, occupation,
location, and so on. Continuing this fine-tuning can provide valuable insights, particularly
regarding the segmentation of the market, which is discussed later in this chapter.
UNDERSTANDING THE MARKETING PLAN
Once the entrepreneur has gathered all the necessary information, he or she can sit down
to prepare the marketing plan. The marketing plan represents a significant element in the
business plan for a new venture. It serves a number of important functions or purposes.
Primarily the marketing plan establishes how the entrepreneur will effectively compete
and operate in the marketplace and thus meet the business goals and objectives of the
new venture. Once the strategies of how the business will operate have been established,
the entrepreneur can assign costs to these strategies, which then serves the important pur-
pose of establishing budgets and making financial projections. The marketing plan, like any
other type of plan, may be compared to a road map used to guide a traveler. It is designed
to provide answers to three basic questions:5
1. Where have we been? When used as a stand-alone document (operational plan), this
would imply some background on the company, its strengths and weaknesses, some
background on the competition, and a discussion of the opportunities and threats in the
marketplace. When the marketing plan is integrated as part of the business plan, this
segment would focus on some history of the marketplace, marketing strengths and
weaknesses of the firm, and market opportunities and threats.
232 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
2. Where do we want to go (in the short term)? This question primarily addresses the
marketing objectives and goals of the new venture in the next 12 months. In the initial
business plan, the objectives and goals often go beyond the first year because of the
need to project profits and cash needs for the first three years.
3. How do we get there? This question discusses the specific marketing strategy that will
be implemented, when it will occur, and who will be responsible for the monitoring of
activities. The answers to these questions are generally determined from the marketing
research carried out before the planning process is begun. Budgets will also be deter-
mined and used in the income and cash flow projections.
Management should understand that the marketing plan is a guide for implementing
marketing decision making and not a generalized, superficial document. The mere or-
ganization of the thinking process involved in preparing a marketing plan can be help-
ful to the entrepreneur because to develop the plan, it is necessary to formally document
and describe as many marketing details as possible that will be part of the decision process
during the next year. This process will enable the entrepreneur not only to understand and
recognize the critical issues but also to be prepared in the event that any change in the
environment occurs.
Each year the entrepreneur should prepare an annual marketing plan before any decisions
are made regarding production or manufacturing, personnel changes, or financial resources
needed. This annual plan becomes the basis for planning other aspects of the business and
for developing budgets for the year. Table 8.5 provides a suggested outline for the marketing
plan. Variations of this outline will depend on the market and nature of the product or service,
as well as the general company mission. The remainder of this chapter focuses on the short-
term aspects of the marketing plan, while not ignoring the fact that the entrepreneur will also
need to provide market projections for years 2 and 3 as part of the business plan.
CHARACTERISTICS OF A MARKETING PLAN
The marketing plan should be designed to meet certain criteria. Some important character-
istics that must be incorporated in an effective marketing plan are as follows:
• It should provide a strategy for accomplishing the company mission or goal.
• It should be based on facts and valid assumptions. Some of the facts needed are illustrated in Table 8.6. It must provide for the use of existing resources.
C H A P T E R 8 THE MARKETING PLAN 233
TABLE 8.5 Outline for a Marketing Plan
Situation analysis
Background of venture
Strengths and weaknesses of venture
Market opportunities and threats
Competitor analysis
Marketing objectives and goals
Marketing strategy and action programs
Budgets
Controls
Allocation of all equipment, financial resources, and human resources must be
described.
• An appropriate organization must be described to implement the marketing plan.
• It should provide for continuity so that each annual marketing plan can build on it, successfully meeting longer-term goals and objectives.
• It should be simple and short. A voluminous plan will be placed in a desk drawer and likely never used. However, the plan should not be so short that details on how to
accomplish a goal are excluded.
• The success of the plan may depend on its flexibility. Changes, if necessary, should be incorporated by including what-if scenarios and appropriate responding
strategies.
• It should specify performance criteria that will be monitored and controlled. For example, the entrepreneur may establish an annual performance criterion
of 10 percent of market share in a designated geographic area. To attain this
goal, certain expectations should be made at given time periods (e.g., at the end
of three months we should have a 5 percent share of market). If not attained,
then new strategy or performance standards may be established.
It is clear from the preceding discussion that the market plan is not intended to be writ-
ten and then put aside. It is intended to be a valuable document that is referred to often and
a guideline for the entrepreneur during the next time period.
Since the term marketing plan denotes the significance of marketing, it is important to
understand the marketing system. The marketing system identifies the major interacting
components, both internal and external to the firm, that enable the firm to successfully pro-
vide products and/or services to the marketplace. Figure 8.1 provides a summary of the
components that constitute the marketing system.6
As can be seen from Figure 8.1, the environment (external and internal) plays a very
important role in developing the market plan. These factors should be identified and
discussed in the industry analysis section of the business plan discussed earlier in this
234 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
TABLE 8.6 Facts Needed for Market Planning
• Who are the users, where are they located, how much do they buy, from whom do they
buy, and why?
• How have promotion and advertising been employed and which approach has been most
effective?
• What are the pricing changes in the market, who has initiated these changes, and why?
• What are the market’s attitudes concerning competitive products?
• What channels of distribution supply consumers, and how do they function?
• Who are the competitors, where are they located, and what advantages/disadvantages
do they have?
• What marketing techniques are used by the most successful competitors? By the least
successful?
• What are the overall objectives of the company for the next year and five years hence?
• What are the company’s strengths? Weaknesses?
• What are one’s production capabilities by product?
marketing plan Written
statement of marketing
objectives, strategies, and
activities to be followed
in business plan
marketing system
Interacting internal and
external factors that affect
venture’s ability to provide
goods and services to
meet customer needs
chapter. It should also be noted that these factors are typically uncontrollable but need to be
recognized as part of the marketing plan.
In addition to the external environmental factors, there are internal environmental fac-
tors which, although more controllable by the entrepreneur, can also affect the preparation
of the marketing plan and implementation of an effective marketing strategy. Some of the
major internal variables are as follows:
• Financial resources. The financial plan, discussed in Chapter 10, should outline the financial needs for the new venture. Any marketing plan or strategy should consider
the availability of financial resources as well as the amount of funds needed to meet
the goals and objectives stated in the plan.
• Management team. It is extremely important in any organization to make appropriate assignments of responsibility for the implementation of the marketing plan. In some
cases the availability of a certain expertise may be uncontrollable (e.g., a shortage
of certain types of technical managers). In any event, the entrepreneur must build
an effective management team and assign the responsibilities to implement the
marketing plan.
• Suppliers. The suppliers used are generally based on a number of factors such as price, delivery time, quality, and management assistance. In some cases, where raw materials
are scarce or there are only a few suppliers of a particular raw material or part, the
entrepreneur has little control over the decision. Since the price of supplies, delivery
time, and so on, are likely to impact many marketing decisions, it is important to
incorporate these factors into the marketing plan.
C H A P T E R 8 THE MARKETING PLAN 235
FIGURE 8.1 The Marketing System
External environment
Economy Culture Technology Demand Legal considerations Raw materials Competition
Internal environment
Financial resources Suppliers Goals and objectives Management team
Entrepreneur Market- planning decisions
Marketing strategies directed to customers
Purchase decisions of customers
Marketing-mix decisions
Feedback
236
DEVIL’S ADVOCATE
Do your sales reps know how far is too far when it
comes to landing that sale? Ethics in sales may not be
the quickest route to success—cutting corners is al-
most always a more expeditious, if short-lived, route
to riches. But, in addition to the morality of adhering
to ethical business practices, entrepreneurs know
that selling with a conscience makes good balance-
sheet sense over time. Here are a few reasons to en-
courage your sales force to behave honorably in a
frequently shameful world:
• Reputation rules. Every business owner under-
stands that an impaired reputation is death to
trade. Selling ethically translates into treating
customers, suppliers, and employees with
integrity.
• Reps are your brand’s emissaries. If a salesperson
crosses the ethical line—whether by lowballing a
price or by making unrealizable promises—the
client will not trust your product or service in the
future.
• Cynicism is nipped in the bud. Having been
burned by companies ranging from telecommuni-
cations to financial services, consumers are warier
than ever. Working with clients in an aboveboard
way helps you surpass less trustworthy competi-
tors and make your company a safe place to do
business.
• Repeat customers are a bargain. Smart entrepre-
neurs know that honorable and ethical business
practices not only boost your reputation, but also
act as affordable advertising vehicles.
• A culture that rewards doing the right thing is
good for business. Dell Computer, for instance,
encourages its employees to report integrity is-
sues. It thus sets high standards for employee
conduct and gives employees a forum for report-
ing unethical behavior.
• In establishing your ethics parameters, be clear
about which behaviors are acceptable and which
cross the line, and then hold your employees ac-
countable. There will be times when an employee
will need to be disciplined or even fired.
• You must practice what you preach. Keep tabs on
employees by investigating credible ethics viola-
tions claims from co-workers and customers. The
problem may be easily corrected by a sit-down
with the employee and by taking time to reiter-
ate company ethics policies.
By requiring your reps to sell with class, you’ll prove
to your staff you do more than just lip-sync empty
dogmas about values.
Source: Adapted from Kimberly L. McCall, “Devil’s Advocate,” Entrepreneur magazine (May 3, 2003), p. 75.
E T H I C S
• Company mission. As indicated in Chapter 7, every new venture should define the nature of its business. This statement helps to define the company’s mission and
basically describes the nature of the business and what the entrepreneur hopes to
accomplish with that business. This mission statement or business definition will guide
the firm through long-term decision making.
THE MARKETING MIX
The preceding environmental variables will provide much important information in deciding
what will be the most effective marketing strategy to be outlined in the marketing plan. The
actual short-term marketing decisions in the marketing plan will consist of four important
marketing variables: product or service, pricing, distribution, and promotion. These four
factors are referred to as the marketing mix. Each variable will be described in detail in the
strategy or action plan section of the marketing plan discussed later in this chapter.
Although flexibility may be an important consideration, the entrepreneur needs a strong
marketing mix
Combination of product,
price, promotion, and
distribution and other
marketing activities
needed to meet marketing
objectives
C H A P T E R 8 THE MARKETING PLAN 237
base to provide direction for the day-to-day marketing decisions. Some of the critical decisions
in each area are described in Table 8.7.
STEPS IN PREPARING THE MARKETING PLAN
Figure 8.2 illustrates the various stages involved in preparing the marketing plan. Each
of these stages, when completed, will provide the necessary information to formally pre-
pare the marketing plan. Each of the steps is outlined and discussed, using examples to
assist the reader in fully understanding the necessary information and procedure for
preparing the marketing plan.7
Defining the Business Situation
The situation analysis is a review of where we have been. It responds to the first of the
three questions mentioned earlier in this chapter. It also considers many of the factors that
were defined in both the environmental analysis section of the business plan (see Chap-
ter 7) and the industry analysis section discussed earlier in this chapter.
To fully respond to this question, the entrepreneur should provide a review of past
performance of the product and the company. If this is a new venture, the background will
be more personal, describing how the product or service was developed and why it was de-
veloped (e.g., to satisfy consumer needs). If the plan is being written after the new venture
has started up, it would contain information on present market conditions and performance
of the company’s goods and services. Any future opportunities or prospects should also be
included in this section of the plan.
The industry and competitive environment has already been discussed in an earlier sec-
tion of the business plan. Thus, at this point the entrepreneur should simply review some of
the key elements of this section to help provide a context for the marketing segmentation
and actions that will be stated in this section of the business plan.
Defining the Target Market: Opportunities and Threats
Either from the industry analysis or from the marketing research done earlier, the entrepre-
neur should have a good idea of who the customer or target market will be. Knowledge of the
target market provides a basis for determining the appropriate marketing action strategy that
will effectively meet its needs. The defined target market will usually represent one or more
TABLE 8.7 Critical Decisions for Marketing Mix
Marketing Mix Variable Critical Decisions
Product Quality of components or materials, style, features, options,
brand name, packaging, sizes, service availability, and warranties
Price Quality image, list price, quantity, discounts, allowances for
quick payment, credit terms, and payment period
Channels of distribution Use of wholesalers and/or retailers, type of wholesalers or
retailers, how many, length of channel, geographic coverage,
inventory, and transportation
Promotion Media alternatives, message, media budget, role of personal
selling, sales promotion (displays, coupons, etc.), and media
interest in publicity
situation analysis
Describes past and present
business achievements of
new venture
target market Specific
group of potential
customers toward
which venture aims its
marketing plan
segments of the entire market. Thus, it is important even before beginning the research to un-
derstand what market segmentation is before determining the appropriate target market.
Market segmentation is the process of dividing the market into small homogeneous
groups. Market segmentation allows the entrepreneur to more effectively respond to the
needs of more homogeneous consumers. Otherwise the entrepreneur would have to iden-
tify a product or service that would meet the needs of everyone in the marketplace.
Henry Ford’s vision was to manufacture a single product (one color, one style, one size,
etc.) for the mass market. His Model T was produced in large numbers on assembly lines,
enabling the firm to reduce costs through specialization of labor and materials. Although
238 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
Critically examine present and prospective product/ market situation
Take into account company goals and restraints
Determine marketing strategies and prepare action programs with assigned responsibilities and dates for accomplishment
Set marketing objectives that are specific and measurable
Reevaluate programs against objectives
Objectives not attainable
Objectives attainable
Draft marketing plan, with steps to monitor progress of programs
Match feasibility of programs against available resources or restraints
Feasible Not feasible
Submit marketing plan for approval
FIGURE 8.2 Sample Flowchart of a Marketing Plan
Source: Adapted from David S. Hopkins, The Marketing Plan (New York: The Conference Board, 1981), p. 17.
market segmentation
Process of dividing a
market into definable and
measurable groups for
purposes of targeting
marketing strategy
his strategy was unique, any successful mass-market strategy employed today would be
unlikely.
In 1986, Paul Firestone of Reebok discovered that many consumers who bought running
shoes were not athletes. They bought the shoes for comfort and style. Firestone then devel-
oped a marketing plan that was targeted directly to this segment.
The process of segmenting and targeting customers by the entrepreneur should proceed
as follows:8
I. Decide what general market or industry you wish to pursue.
II. Divide the market into smaller groups based on characteristics of the customer or
buying situations.
A. Characteristics of the customer
1. Geographic (e.g., state, country, city, region)
2. Demographic (e.g., age, sex, occupation, education, income, and race)
3. Psychographic (e.g., personality and lifestyle)
B. Buying situation
1. Desired benefits (e.g., product features)
2. Usage (e.g., rate of use)
3. Buying conditions (e.g., time available and product purpose)
4. Awareness of buying intention (e.g., familiarity of product and willingness
to buy)
III. Select segment or segments to target.
IV. Develop a marketing plan integrating product, price, distribution, and promotion.
Let’s assume that an entrepreneur is considering offering an after-school student shuttle
service in a local community in the suburbs of Boston. The service will be marketed to
households that have high income, both spouses working (most likely professionals), and
young children typically between 10 and 15 years old. The shuttle service is designed to
taxi children (10 to 15 years old) using a minivan or similar vehicle to medical or other
related appointments and after-school activities. These activities would be non-school-related
activities since schools would most likely offer bus service for their students.
The first decision to be made, since we know the target market, is to identify candidate
communities that would match the user profile. Town census research and any other available
secondary sources are a logical starting place and will reveal demographic data on income,
ages of children, and employment. Once this step is complete and a few towns have been
identified, the entrepreneur can then conduct marketing research in the identified towns that
seem to match the target market profile. This would help the entrepreneur understand the
needs and buying intentions of any potential target market. The analysis from this research
would then assist the entrepreneur in selecting the community in which to launch the service.
The buying situation is dependent on the venture’s establishing credibility in the com-
munity. Even if specific households can be targeted, the marketing strategy (particularly
sales strategy) will need to concentrate on first establishing credibility and community
trust. This can be accomplished in a number of ways but will likely begin with an effort to
gain the support of the key townspeople, such as school administrators, PTA members, or
other local agencies. In addition, marketing actions will need to focus on getting the target
market’s attention and creating an awareness of the benefits that this service can provide.
For example, the venture might choose to sponsor school events and activities, appoint
local respected community members to its board, place advertisements in local newspapers,
or send company information through direct mail.
The major issues initially involve careful targeting, using the approach mentioned ear-
lier, as well as understanding the needs of this target market. With a clear understanding of
C H A P T E R 8 THE MARKETING PLAN 239
who the customer is and a combined sales effort and marketing program, the entrepreneur
can be more assured of sales growth and increased revenue. A continued presence in the
community may also allow the entrepreneur to expand this shuttle service to include other
segments of the market, such as senior citizens. Once credibility has been established in
one community, it will be easier to expand to other communities.
Considering Strengths and Weaknesses
It is important for the entrepreneur to consider strengths and weaknesses in the target mar-
ket. For example, to refer back to the student shuttle service venture, its primary strengths
in its market are: there is no existing competition, the company has the support of local
schools, and its usage base in the selected community is an excellent match for the pro-
jected target market. In addition, the experience gained from initiating this service in one
community will be a major factor in soliciting new business in other communities.
Weaknesses could relate to the venture’s inability to gain complete credibility in the
town—given such widespread concern regarding the abduction and molestation of children.
Credibility could be easily—and negatively—affected by any bad publicity. Also the success
of the venture will depend heavily on the reliability of its drivers, who may not be sensitive to
consumer needs. Thus, it will be important to carefully select and train all drivers.
Establishing Goals and Objectives
Before any marketing strategy decisions can be outlined, the entrepreneur must establish re-
alistic and specific goals and objectives. These marketing goals and objectives respond to
the question: “Where do we want to go?” and should specify things such as market share,
profits, sales (by territory and region), market penetration, number of distributors, awareness
level, new product launching, pricing policy, sales promotion, and advertising support.
For example, the entrepreneur of a new frozen diet product may determine the following
objectives for the first year: 10 percent market penetration, 60 percent of market sampled,
distribution in 75 percent of the market. All these objectives must be considered reasonable
and feasible given the business situation described earlier.
All the preceding goals and objectives are quantifiable and can be measured for control
purposes. However, not all goals and objectives must be quantified. It is possible for a firm
to establish such goals or objectives as: research customer attitudes toward a product, set
up a sales training program, improve packaging, change name of product, or find new dis-
tributor. It is a good idea to limit the number of goals or objectives to between six and eight.
Too many goals make control and monitoring difficult. Obviously, these goals should rep-
resent key areas to ensure marketing success.
Defining Marketing Strategy and Action Programs
Once the marketing goals and objectives have been established, the entrepreneur can begin
to develop the marketing strategy and action plan to achieve them. These strategy and
action decisions respond to the question: “How do we get there?” As indicated earlier, these
decisions reflect on the marketing mix variables. Some possible decisions that might be
made for each variable are discussed next.
Product or Service This element of the marketing mix indicates a description of the product or service to be marketed in the new venture. This product or service definition
may consider more than the physical characteristics. For example, Dell Computer’s
240 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
marketing goals and
objectives Statements of
level of performance
desired by new venture
marketing strategy and
action plan Specific
activities outlined to meet
the venture’s business
plan goals and objectives
product is computers, which is not distinctive from many other existing competitors.
What makes the products distinctive is the fact that they are assembled from off-the-
shelf components and are marketed with direct-marketing and Internet techniques prom-
ising quick delivery and low prices. Dell also provides extensive customer service with
e-mail and telephone available to the customer to ask technical or nontechnical ques-
tions. Thus, the product is more than its physical components. It involves packaging, the
brand name, price, warranty, image, service, delivery time, features, style, and even the
Web site that will be seen by most customers. When considering market strategy, the en-
trepreneur will need to consider all or some of these issues, keeping in mind the goal of
satisfying customer needs.
Pricing Prior to setting the price, the entrepreneur, in the majority of situations, will need to consider three important elements: costs, margins or markups, and competition. There
are some exceptions, which are discussed at the end of this section on pricing. Also
explained is the interaction of these elements in the pricing process. Appropriate examples
involving the use of each element are also discussed in the next few paragraphs.
Costs. One of the important initial considerations in any pricing decision is to
ascertain the costs directly related to the product or service. For a manufacturer this
would involve determining the material and labor costs inherent in the production of
the product. For a nonmanufacturer, such as a clothing retailer, this would involve
determining the cost of the goods from the suppliers. For a service venture, such as our
student shuttle service, there are no manufacturing costs or costs of goods such as those
that exist for a clothing retailer. Instead, the service venture’s costs relate entirely to
labor and overhead expenses.
Whether a manufacturer, retailer, or service venture, the entrepreneur would need to ascer-
tain the approximate costs for overhead (some examples would be utilities, rent, promotion,
insurance, and salaries). Let’s assume a manufacturer of a special oxygen-based rug cleaner
incurs a materials and labor cost of $2.20 per unit (24 ounces). Estimated sales are 500,000
units, with overhead at this level of sales at $1 million or $2.00 per unit. Total costs would add
to $4.20, and a unit profit of 30 percent of cost or $1.26 would mean a final price of $5.46.
For a retail example of pricing let’s consider a clothing store that sells T-shirts. Let’s
assume the company buys the T-shirts for $5.00 (cost of goods) from a supplier. Overhead
costs are estimated to be $10,000, and the entrepreneur expects to sell 5,000 units for a unit
overhead cost of $2.00 per shirt. An additional $2.00 is added for profit, resulting in a final
price of $9.00.
For our shuttle service example, the entrepreneur estimates that the cost per mile is ap-
proximately $6.00. This includes the depreciation of the vehicle, insurance, driver salary,
utilities, advertising, and all other operating costs. Each vehicle is expected to travel about
60 miles per day and service about 30 students. Thus total cost per day would be $360, or
$12 per student. Adding a profit of $3.00 would set the final price for this service at
$15.00 per student or ride.
In each of these examples the entrepreneur may find it necessary to consider the role of
competition and markups (discussed later) as well as an overall positioning strategy before
finalizing price.
Markups or margins. In many industries, such as jewelry, beauty supplies, furniture,
and clothing, the retailers of the products use a standard markup to price goods in their
stores. For example, a standard markup for beauty supplies is 100 percent on cost.
Thus, if the retailer buys nail polish for $1.50 per unit, the markup would be $1.50 and
C H A P T E R 8 THE MARKETING PLAN 241
the final price to the consumer would be $3.00. Given that the retailer maintains costs
equivalent to the industry standards, this markup would be expected to cover overhead
costs and some profit. Standard markups can be ascertained from trade publications
or by asking suppliers. A retailer may look at the $3.00 price and decide that, since
competition offers the same product for $2.99, he or she would like to offer the item at
$2.89. The lower markup and hence lower profit accepted by the entrepreneur in this
case is a strategy used to increase demand in the short term (market penetration
strategy) but could influence the competition to also lower its price, thus eventually
reducing the profit margins for everyone.
Competition. Often, when products cannot be easily differentiated (see the earlier
T-shirt example), the entrepreneur is forced to charge the same price as the competition.
For the oxygen-based rug cleaner, the entrepreneur may find it possible to justify a
higher price (say $6.50) than the competition’s price of $5.75 because the product has
unique benefits (oxygen and other ingredients). The clothing retailer may be able to
charge more than $9.00 for the T-shirt if it is unique enough. If competitors’ T-shirts
are $9.00 but the quality of our clothing retailer’s shirts is graphically superior, then a
higher than $9.00 price may be charged. Otherwise, if consumers are unable to discern
any difference, the price will need to be equivalent to that of the competition. In our
student shuttle example, it is more difficult to compare prices with competitors since
the competition is more indirect. Here we might compare taxicab prices or bus prices.
However, this service is more likely to be considered a convenience by the target
market, and as such, price may not be a concern. The target market is also in the
upper-income category, and therefore convenience may be more important than the
cost of the service.
A higher price may also be supported by market research data. Innovations such as
technology products (LCD televisions or interactive games such as those for the Wii)
or new drug products may warrant a higher price or skimming strategy for the new
venture to recover some of its high development costs. In a nondifferentiated product
market (such as clothing or a portable radio), marketing research may reveal that
consumers are willing to pay more if you offer service benefits such as free home
delivery, guarantees on the life of the item, or free long-term repair. Although these
services would increase the costs to the entrepreneur, they would establish a distinctive
image for the product in a nondifferentiated product category, allowing a higher price
and, potentially, a higher quality image than that of the competition.
Generally, in a nondifferentiated product market there is little room for price variations
from the competition. Any attempt to increase profits in this situation would have to come
from reduced costs. For those situations where the product or service is unique in the mar-
ketplace, the entrepreneur has more flexibility and should have a clear understanding of the
inherent costs. The important thing to remember is that there is a total cost and profit mar-
gin to get to the final price. Changing one of these items will impact the other two factors
in some manner.
Distribution This factor provides utility to the consumer; that is, it makes a product con-
venient to purchase when it is needed. This variable must also be consistent with other mar-
keting mix variables. Thus, a high-quality product will not only carry a high price but
should also be distributed in outlets that have a quality image.
Channel of distribution strategy considerations are summarized in Table 8.8. If the market
for a new venture is highly concentrated, such as a major metropolitan area, the entrepreneur
may consider direct sales to the customer or to a retailer rather than using a wholesaler. If the
242 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
market is dispersed across a wide geographic area, the cost of direct sales may be prohibitive
and the use of a longer channel with wholesalers and retailers may be necessary.
Attributes of the product also affect the channel decision. If the product is very expen-
sive, perishable, or bulky, a more direct channel would make sense because the costs of
handling and shipping would drive the costs up to a prohibitive level.
Middlemen such as wholesalers and retailers can add important value to the product.
Their costs for providing these benefits are much lower than the costs for a small, single-
product start-up because they operate with economies of scale by representing many other
businesses. They can provide functions such as storage, delivery, a sales staff, promotion or
advertising, and maintenance that would not be feasible for a start-up venture. Middlemen
also have important experience in the marketplace that can support and assist the entrepre-
neur in his or her marketing strategy.
Environmental issues may also be important in channel strategy. Special considerations
and regulations regarding such products as chemicals or food and drug products, to name a
few, are too costly for a small start-up to absorb. Competitor strategy is also important to
consider since alternative choices may help to differentiate the product. For example, Dell
Computer initially chose to use direct mail and the Internet to distribute its products, creat-
ing a major differentiation from its direct competitors. Once it became established in the
market, it then sought other channels such as electronics retailers.
A new venture may also consider brokers’ or manufacturers’ representatives to reach re-
tailers or end users. Manufacturers’ representatives do not take title or physical possession of
any products. Their role is to act on behalf of a number of noncompeting companies that will
share the cost of their services. In our oxygen-based rug cleaner example, the entrepreneur
C H A P T E R 8 THE MARKETING PLAN 243
TABLE 8.8 Major Considerations in Channel Selection
Degree of Directness of Channel
• Market conditions—Concerned whether end users are concentrated (direct) or dispersed
(indirect) in market.
• Product attributes—Concerned with whether product is large (direct) or small (indirect),
bulky (direct), perishable (direct), hazardous (direct), expensive (direct).
• Cost benefits—Considers the cost benefits in selection of channel members; many benefits
(indirect) minimal or no benefit (direct).
• Venture attributes—Considers financial strength, size, channel experience, and marketing
strategy of venture.
Number of Channel Members
• Intensive—Selection of as many retailers and/or wholesalers as possible.
• Selective—Choose only small number of channel members based on some set of criteria
or requirements.
• Exclusive—Select only one wholesaler and/or retailer.
Criteria in Selection of Channel Members
• Reputation
• Services provided
Number of Channels
• One channel for one target market or multiple target markets.
• Multiple channels for one target market or multiple target markets.
may consider contracting with manufacturers’ representatives that sell commercial products
(such as cleaning supplies, furniture, or carpeting) that would add the rug cleaner as a com-
plement to their other products. They would be paid a commission only when a product was
sold (usually 6 to 8 percent depending on the product). Manufacturers’ representatives could
also be used to market to the consumer or household market. In this case the entrepreneur
may look for those representatives that are presently marketing household cleaners or other
similar products to retail outlets. Orders then would be sent directly to the new venture and
would be shipped from there to the end user. This saves on the costs of a sales staff, storage,
and multiple shipping points. Brokers are similar to manufacturers’ representatives and are
common in food or dry goods businesses.
In selecting the channel, the entrepreneur should look at all the preceding factors. In
some instances it may be necessary to use more than one channel to service customers
more efficiently as well as increase sales potential. Clothing retailers such as Sports Au-
thority, L. L. Bean, Macy’s, Wal-Mart, and Target, to name a few, all sell their products
using multiple channels such as retail stores, Web sites, catalogs, and newspapers. Each
of these may require a different communications channel to enable the customer to buy
the desired products. Channel decisions will also change over time. As the venture grows,
the entrepreneur may find that hiring its own sales force is more efficient and is no longer
cost prohibitive.
Promotion It is usually necessary for the entrepreneur to inform potential consumers about the product’s availability or to educate the consumer, using advertising media
such as print, radio, or television. Usually television is too expensive unless the entre-
preneur considers cable television a viable outlet. A local service or retail company such
as a pet store may find that using community cable stations is the most cost-effective
method to reach customers. Larger markets can be reached using the Internet, direct
mail, trade magazines, or newspapers. The entrepreneur should carefully evaluate each
alternative medium, considering not just costs but the effectiveness of the medium in
meeting the market objectives mentioned earlier in the marketing plan. As stated earlier,
a Web site may also be valuable to create awareness and to promote the products and
services of the new venture.
Sometimes the entrepreneur has to be creative with the existing budget and costs of buy-
ing major media space or time.
Tom First is not new to being creative, as he learned as one of the founders of Nantucket
Nectars. Tom recently launched a new venture Owater, a nutrient-enhanced water. Not
able to compete with larger companies in this market, Tom has chosen to promote his
product through an intensive sampling campaign. Owater may do as many as six or seven sam-
pling events a day in key markets such as Boston, Chicago, Denver, Los Angeles, New York,
and Philadelphia. The ability to focus on specific large markets has enhanced sales at a
rate that would have been much more costly using more traditional mass media.9
Marketing Strategy: Consumer versus Business-to-Business Markets
Marketing strategy decisions for a consumer product may be very different from the deci-
sions for a business-to-business product. In business-to-business markets the entrepreneur
sells the product or service to another business that uses the product or service as part of
its operations. Dell Computer markets its products to both consumers and businesses. In
marketing to consumers, the company uses direct mail and the Internet, and to businesses
it uses its own sales force. This sales force calls on businesses with the intent of selling a
large volume of PCs or accessories in one transaction. The consumer marketing effort,
244 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
however, does support the business marketing effort since the advertising and promotions
will be seen or read by both markets. Consumer markets involve sales to households for
personal consumption. Food, beverages, household products, furniture, and computers
would be a few examples.
Usually business-to-business marketing strategy involves a more direct channel of distribu-
tion because of the volume of each transaction and the need to relate product knowledge to
the business buyers. Advertising and promotion for the business-to-business market involve
more trade magazine advertising, direct sales, and trade shows. For a start-up venture,
attendance at a trade show can be one of the most effective means to reach many potential
buyers in one location. At trade shows it is important to distribute material on the venture’s
products and services and to keep a log of all interested visitors to the trade show booth.
A S S E E N I N ENTREPRENEUR M A G A Z I N E
PROVIDE ADVICE TO AN ENTREPRENEUR ABOUT WEB SITES
It’s easy to educate prospects about your product or
service once they’re on your Web site, but how do
you get them there? One way is by getting your com-
pany’s name and URL out on the Web. You can do
that by writing content for online newsletters, trad-
ing links, and posting messages on chat sites. Com-
municating through other Web sites attracts quality
visitors to your site—and it can be done for free.
Content may still be king, but it’s an expensive
kingdom to maintain. Many organizations can’t af-
ford webmasters whose only job is to develop new
site content. But because you’re an expert in your
field, many companies will be more than thrilled if
you give them content in exchange for a link to your
site. Your content can be posted on Web sites or sent
out in their e-mail. The “publisher” benefits by offer-
ing relevant information to its site visitors. When you
teach these visitors something new, you also create a
“soft sell” marketing opportunity. Don’t pitch your
business. Rather, share some educational information
to establish trust and brand awareness.
Just what is “educational information”? It’s content
that addresses your prospects’ problems. For example,
if your company sells exercise equipment, you can pro-
vide tips, case studies, or statistics about fitness. Your
readers will want to know how you, the fitness expert,
can help them achieve their goals. With a simple click
on your URL, prospects can travel to your site and dis-
cover your company’s line of fitness products.
Of course, you aren’t limited to providing articles
to Web sites. Try asking for a link to your site or a link
trade. Just don’t put someone else’s link on your
home page—that encourages people to leave your
site as soon as they arrive! Links from sites related to
yours provide another benefit: They boost your site’s
position in search engines that rank sites according to
“link popularity.” If you would like feedback in addi-
tion to getting free exposure, try hanging out in chat
rooms. As a fitness expert, for example, you can ask
people what prevents them from exercising consis-
tently. Let people know you are doing market re-
search. Chat room participants may happily share
their thoughts with you online.
Find your target audience by starting with the in-
dustry Web sites you frequent. Also, run a keyword
query in search engines. Tell Web site managers what
your company does and how your information can
help their visitors. You may be offered a link or a
writing opportunity. In addition, try posting chat
room messages that reveal valuable information. You’ll
be greatly rewarded with free PR opportunities that
can lead to immediate and long-term sales.
ADVICE TO AN ENTREPRENEUR
An entrepreneur who has a Web site for his business
has read the above article and comes to you for advice:
1. Seems like a lot of work in writing articles and
spending time in chat rooms. Although it might
be a way of getting people to my Web site with
only a small expense, do you think that this ap-
proach is worth the investment of time?
2. What are the other benefits of this approach over
and above simply a cost saving?
3. Are there particular businesses and products
more suitable for this approach?
Source: Reprinted with permission of Entrepreneur Media, Inc., “Attention, Please. Yell Out ‘Look at Me!’ for Free by Using Other Websites to Your Advantage,” by Catherine Seda, March 2003, Entrepreneur magazine: www.entrepreneur.com.
245
Have visitors sign in or leave their business cards. From the log or business cards, a list
can then be prepared and used as a prospect list for sales reps. It is also important that, right
after the trade show, a follow-up letter be sent to all visitors thanking them for their interest
and explaining how they might be contacted.
Overall, the marketing mix for the consumer or business markets is the same. However,
the techniques and strategies within the mix of these factors will often vary significantly.
All these marketing mix variables will be described in detail in the marketing strategy
or action plan section of the marketing plan. As indicated earlier, it is important that the
marketing strategy and action programs be specific and detailed enough to guide the entre-
preneur through the next year.
Budgeting the Marketing Strategy
Effective planning decisions must also consider the costs involved in the implementation of
these decisions. If the entrepreneur has followed the procedure of detailing the strategy and
action programs to meet the desired goals and objectives, costs should be reasonably clear.
If assumptions are necessary, they should be clearly stated so that anyone else who reviews
the written marketing plan (e.g., a venture-capital firm) will understand these implications.
This budgeting of marketing action and strategy decisions will also be useful in
preparing the financial plan. Details of how to develop a financial plan are discussed in
Chapter 10.
Implementation of the Market Plan
The marketing plan is meant to be a commitment by the entrepreneur to a specific strategy.
It is not a formality that serves as a superficial document to outside financial supporters or
suppliers. It is meant to be a formal vehicle for answering the three questions posed earlier
in this chapter and a commitment to make adjustments as needed or dictated by market
conditions. Someone in the venture should be assigned the responsibility of coordinating
and implementing the plan.
Monitoring the Progress of Marketing Actions
Generally, monitoring of the plan involves tracking specific results of the marketing effort.
Sales data by product, territory, sales rep, and outlet are a few of the specific results that
should be monitored. What is monitored is dependent on the specific goals and objectives
outlined earlier in the marketing plan. Any “weak” signals from the monitoring process will
provide the entrepreneur with the opportunity to redirect or modify the existing marketing
effort to allow the firm to achieve its initial goals and objectives.
In addition to monitoring the progress of the existing plan, the entrepreneur should also
be prepared for contingencies. For example, reliance on a single supplier in a geographic
area that is vulnerable to hurricanes could be disastrous if that supplier were to be shut
down as a result of a hurricane. Adjustments in marketing actions are usually minor if the
plan has been effectively developed and implemented. If the entrepreneur is constantly
faced with significant changes in the marketing strategy, then it is likely that the plan was
not prepared properly. Weaknesses in market planning are usually the result of poor analy-
sis of the market and competitive strategy, unrealistic goals and objectives, or poor imple-
mentation of the outlined plan actions. There are also acts of God—such as weather
or war—that can affect a marketing plan. These are usually difficult to predict but may be
considered in a contingency plan.
246 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
IN REVIEW
S U M M A R Y
Before beginning the marketing plan section of the business plan, the entrepreneur
should provide a comprehensive review and assessment of the industry and market
trends at the national and local levels. In addition, a comprehensive assessment of
competitor strategies and their strengths and weaknesses should be documented.
From this analysis the entrepreneur can begin to formulate the marketing plan section
of the business plan. The marketing plan designates the response to three questions:
Where have we been? Where are we going? and How do we get there?
To be able to respond effectively to these questions, it is generally necessary for the
entrepreneur to conduct some marketing research. This research may involve second-
ary sources or a primary data collection process. Information from the research will be
very important in determining the marketing mix factors or the marketing strategy to
be implemented in the marketing plan.
The marketing plan entails a number of major steps. First, it is important to conduct
a situation analysis to assess the question, “Where have we been?” Market segments
must be defined and opportunities identified. This will help the entrepreneur deter-
mine a profile of the customer. Goals and objectives must be established. These goals
and objectives must be realistic and detailed (quantified if possible). Next, the market-
ing strategy and action programs must be defined. Again, these should be detailed so
that the entrepreneur clearly understands how the venture is going to get where it
wants to go.
The marketing strategy section or action plan describes how to achieve the goals
and objectives already defined. There may be alternative marketing approaches that
could be used to achieve these defined goals. The use of creative strategies such as In-
ternet marketing may give the entrepreneur a more effective entry into the market.
The action programs should also be assigned to someone to ensure their implemen-
tation. If the plan has been detailed, the entrepreneur should be able to assign some
costs and budgets for implementing the marketing plan. During the year, the market-
ing plan will be monitored to discern the success of the action programs. Any “weak”
signals will provide the entrepreneur with the opportunity to modify the plan and/or
develop a contingency plan.
Careful scrutiny of the marketing plan can enhance its success. However, many plans
fail, not because of poor management or a poor product but because the plan was not
specific or had an inadequate situation analysis, unrealistic goals, or did not anticipate
competitive moves, product deficiencies, and acts of God.
R E S E A R C H T A S K S
1. Participate in an online focus group. Then conduct research on the advantages
and disadvantages of conducting a focus group online versus a “face-to-face”
focus group.
2. Choose an industry and then use the library or the Internet to find data from
secondary sources that will be highly useful in developing a marketing plan.
3. Find five examples of product advertising (e.g., advertisements cut out of a
magazine or recorded on videotape). Bring them to class and be prepared to
C H A P T E R 8 THE MARKETING PLAN 247
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explain how they fit in with the rest of the marketing mix and which group of
customers is being targeted.
4. Find a marketing strategy that is being used now that you believe will be
ineffective. Be prepared to justify your answer.
C L A S S D I S C U S S I O N
1. What are the three most effective advertisements on television? Why are they
effective? What are the three least effective advertisements on television? Why are
they ineffective? Are they really ineffective if you have been able to recall them?
2. Define a customer group and then invent a product and come up with a price,
promotion, and distribution strategy. Have some fun in coming up with a
particularly creative marketing mix.
3. Segment the class into groups, label those groups, and determine a specific
demand that is unique to each group. You may be asked to reveal your market
(class) segmentation to the rest of the class, and people will have a chance to
respond to your classification.
4. Is market segmentation just a nice way of using “stereotypes” to sell your
products? Can people really be classified so easily into groups that share common
needs, wants, and demands?
S E L E C T E D R E A D I N G S
Baker, Stephen. (February 16, 2009). Will Work for Praise. BusinessWeek, Issue 4119, pp. 46–49.
This article illustrates how an online social Web site, ThisNext, allows entrepreneurs to build their image and enhance sales through social interaction. Customers log their satisfactions or experience with a product on this platform that is seen by other interested shoppers. The site attracts advertisers and with increased popular- ity provides a means of enhancing the reputation of firms that have satisfied cus- tomers willing to praise their transactions.
Cardamone, Joseph R. (January 26, 2009). Open a New Business Now. Accounting To- day, vol. 23, no. 2, pp. 10–11.
The author offers tips for entrepreneurs who are trying to start a business during an economic crisis. Emphasis is placed on launching businesses with products and services that are needed or a necessity during economic decline. Guerrilla marketing techniques are also mentioned as strategies to keep costs at a minimum.
Cooper, Marjorie J.; Nancy Upton; and Samuel Seaman. (July 2005). Customer Relation- ship Management: A Comparative Analysis of Family and Nonfamily Business Practices. Journal of Small Business Management, vol. 43, no. 3, pp. 242–56.
The importance of customer relationship management implementation among family and nonfamily businesses is analyzed. Results indicate that both types of organiza- tions show similar attitudes toward the implementation of customer relationship management. However, the study found that actual implementation strategies differ significantly between these two types of firms.
Dibb, Sally. (2002). Marketing Planning Best Practice. The Marketing Review, Summer 2002, vol. 2, no. 4, p. 1.
This paper explains the role that marketing planning plays and shows how it is used by organizations. Each stage of the marketing planning process is described in
248 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
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detail, and the role and format of the marketing plan document are explored. The marketing planning process is then illustrated using a detailed case example from the construction equipment industry, and guidance on best marketing planning practice is offered.
Goldsborough, Reid. (November 2008). Social Networks vs. Blogs vs. Discussion Groups. Tech Directions, vol. 68, no. 4, pp. 14–15.
This article presents an excellent explanation of the differences between the three main Internet-based media: social networks, discussion groups, and blogs. These di- alog Internet-based media have become important tools for entrepreneurs.
Gupta, Sumeet; Xu Heng; and Vimal Sahu. (February 2009). Impact of Store Size on Im- pulse Purchase. ICFAI Journal of Marketing Management, vol. 8, no. 1, pp. 7–22.
This article reports on a study comparing the effect of the size of a store on im- pulse purchases. Since stores spend money on in-store stimuli such as displays, price discounts, variety, and other variables, it is significant to understand their implication on impulse buying. Research indicates that the impulse purchase as a ratio of total spending is high for midsized stores when compared to small- and large-sized stores.
Lehmann, Donald R.; and Russell S. Winer. (2008). Analysis for Marketing Planning, 7th ed. (Burr Ridge, IL: McGraw-Hill/Irwin).
This paperback book focuses on the process of developing a marketing plan. In particular, it discusses the analysis of information pertaining to a product or ser- vice’s environment, customers, and competitors. The first chapter is particularly relevant to an entrepreneur as it provides a good overview of an operating mar- keting plan.
Lerch, Renata L. (January/February 2009). International Marketing Planning for Home Business Entrepreneurs. Home Business Magazine, vol. 16, no. 1, pp. 36–39.
In an economic crisis it is very important for the entrepreneur to focus on market planning. The author advises the entrepreneur to develop marketing objectives that are examined regularly and to adjust these objectives if necessary. Diversification during economic downturns is usually necessary to maintain some success in inter- national markets.
Pilmar, John. (July 2005). Small Business? Small Budget? How to Measure for Success. Public Relations Tactics, vol. 12, no. 7, p. 23.
This article suggests that public relations is one of the most effective means that small businesses can use to gain a strong foothold in their industry and also become more competitive with much larger firms. It describes the public relations process of research, planning, implementation, and measurement.
Schindehutte, Minet; Michael Morris; and Akin Kocak. (January 2008). Understanding Market-Driving Behavior: The Role of Entrepreneurship. Journal of Small Business Management, vol. 46, no. 1, pp. 4–26.
Marketing literature has long maintained the importance of market-driven behav- ior. These authors contend that market-driving behavior is distinct from a firm’s market orientation and instead is the essence of entrepreneurial action that deter- mines how strategic actions are manifested. An integrative model illustrates the dy- namics of the interface between marketing and entrepreneurship. Two case studies provide good illustrations.
Song, Jaeki; and Fatemeh Mariam Zahedi. (2006). Internet Market Strategies: An- tecedents and Implications. Information & Management, vol. 43, no. 2, pp. 222–38.
In this paper the authors differentiate between the Internet and traditional market channels and define two fundamental strategies for operating on the Internet. They develop a conceptual model for selection of the appropriate channel.
C H A P T E R 8 THE MARKETING PLAN 249
Taylor, Steven A.; Stephen Goodwin; and Kevin Celuch. (2005). An Exploratory Investi- gation into the Question of Direct Selling via the Internet in Industrial Equipment Mar- kets. Journal of Business-to-Business Marketing, vol. 12, no. 2, pp. 37–70.
This study seeks to provide exploratory insight into considerations of Internet-based direct marketing strategies aimed at industrial consumers. The research provides managerial and research implications regarding the use of the Internet in industrial markets.
Williams, David. (2001). Writing a Marketing Report. The Marketing Review, vol. 1, pp. 363–72.
This article looks at the process of constructing a basic marketing report, an area where there has hitherto been very little written guidance. Although often taken for granted, constructing the marketing report can consume a substantial amount of the marketer’s time and effort.
E N D N O T E S
1. “Making It,” Black Enterprise (July 1975), p. 6; Wendy Beech, “Keeping It in the Family,” Black Enterprise (November 1998), pp. 98–104: Agency Profile, Circula- tion Expertí, Ltd. (2005), pp. 1–16; and www.experti.com. Discussions with Garrison Jackson, president and CEO, also contributed to this profile.
2. Joseph F. Hair, Jr., Robert P. Bush, and David J. Ortinau, Marketing Research, 4th ed. (Burr Ridge, IL: McGraw-Hill/Irwin, 2009), pp. 42–51.
3. M. P. Peters and C. Brush, “Market Information Scanning Activities and Growth in New Ventures: A Comparison of Service and Manufacturing Businesses,” Journal of Business Research (May 1996), pp. 81–89.
4. Hair et al., Marketing Research, pp. 236–66. 5. R. D. Hisrich and M. P. Peters, Marketing Decisions for New and Mature
Products, 2nd ed. (Upper Saddle River, NJ: Prentice-Hall, 1991), pp. 63–78. 6. R. Kerin, S. Hartley, and W. Rudelius, Marketing, 9th ed. (Burr Ridge, IL:
McGraw-Hill/Irwin, 2009), pp. 5–50. 7. D. R. Lehman and R. S. Winer, Analysis for Marketing Planning, 7th ed. (Burr
Ridge, IL: McGraw-Hill/Irwin, 2008), pp. 10–11. 8. Kerin et al., Marketing, pp. 230–42. 9. Gwen Moran, “Try Sampling,” Entrepreneur (October 2008), p. 84.
APPENDIX 8A: MARKETING PLAN OUTLINES
Exhibit 1. Marketing Plan for a Consumer Products Company.
Exhibit 2. Marketing Plan for a Business-to-Business Company.
Exhibit 3. Marketing Plan for a Service Company.
250 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
251
EXHIBIT 1 Marketing Plan for a Consumer Products Company
I. ANALYZE AND DEFINE THE BUSINESS SITUATION—past, present, and future
An analysis of where we are, perhaps how we got there. Data and trend lines should go back three to five years.
Suggested items to cover:
A. The scope of the market (class of trade)
B. Sales history by products, by class of trade, by regions
C. Market potential, major trends anticipated
D. Distribution channels
1. Identification of principal channels (dealer or class of trade), sales history through each type
2. Buying habits and attitudes of these channels
3. Our selling policies and practices
E. The customer or end user
1. Identification of customers making the buying decision, classified by age, income level, occupation, geographical
location, etc.
2. Customer attitudes on product or services, quality, price, etc. Purchase or use habits that contribute to attitudes
3. Advertising history: expenditures, media and copy strategy, measurements of effectiveness
4. Publicity and other educational influences
F. The product or services:
1. Story of the product line, quality development, delivery and service
2. Comparison with other approaches to serve the customers’ needs
3. Product research; product improvements planned
II. IDENTIFY PROBLEMS AND OPPORTUNITIES
A. In view of the facts cited in (I) above, what are the major problems that are restricting or impeding our growth?
B. What opportunities do we have for
—Overcoming the above problems?
—Modifying or improving the product line or adding new products?
—Serving the needs of more customers in our market or developing new markets?
—Improving the efficiency of our operation?
III. DEFINE SPECIFIC AND REALISTIC BUSINESS OBJECTIVES
A. Assumptions regarding future conditions
—Level of economic activity
—Level of industry activity
—Changes in customer needs
—Changes in distribution channels
—Changes beyond our control, increased costs, etc.
B. Primary marketing objectives (the establishment of aim points and goals). Consider where you are going and how you
will get there. Objectives are the necessary base of any plan since a plan must have precise direction.
C. Overall strategy for achievement of primary objectives. The division’s overall strategy to accomplish its primary objective—
sample: shifting of sales emphasis, products, or classes of trade; changes for improvement of sales coverage, etc.
D. Functional (departmental) objectives. (In this section “explode” your primary objectives into subobjectives, or goals, for
each department. Show the interrelation vertically, by marketing project. Show time schedule on objectives below.)
1. Advertising and promotion objectives
2. Customer service objectives
3. Product modification objectives
4. New product objectives
5. Expense control objectives
6. Workforce objectives
7. Personnel training objectives
8. Market research objectives
IV. DEFINE MARKETING STRATEGY AND ACTION PROGRAMS—to accomplish the objectives
A. Here, detail the action steps, priorities, and schedules relating to each of the functional objectives above. If, for
example, one of your estimates was “an increase in sales of product X from 10,000 to 20,000 units,” now is the time
to pinpoint specific customers. In order to explain who must do what, and when, you can show the interaction of the
departments listed above (III-D) and how their objectives serve to meet this increased demand.
B. If one of your objectives was to introduce a new product by “x” date, now show the details and deadlines, production
schedule, market introduction plans, advertising and merchandising support, sales and service training needed, etc.
Define responsibility and dates for each step.
C. Alternatives—In the event of a delay in a project or program, what alternative plans are available?
V. CONTROL AND REVIEW PROCEDURES
How will the execution of the plan be monitored?
A. What kinds of “feedback” information will be needed?
B. When and how will reviews be scheduled (departments, regions, etc.)?
C. Date for full-scale review of progress vs. plan.
Source: David S. Hopkins, The Marketing Plan (New York: The Conference Board, 1981). Reprinted with permission of The Conference Board.
252 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
Marketing Plan Outline
For each major product/product category: Time Period—One, Three, and Five-Plus Years
I. MANAGEMENT SUMMARY
What is our marketing plan for this product in brief?
This is a one-page summary of the basic factors involving the marketing of the product in the plan period, along
with the results expected from implementing the plan. It is intended as a brief guide for management.
II. ECONOMIC OUTLOOK
What factors in the overall economy and industry will affect the marketing of the product in the plan period,
and how?
This section will contain a summary of the specific economic and industry factors that will affect the marketing
of this product during the plan period.
III. THE MARKET—qualitative
Who or what kinds of market segments constitute the major prospects for this product?
This section will define the qualitative nature of our market segments. It will include definitive descriptions and
profiles of major distributors, specifiers, users, and/or consumers of the product.
IV. THE MARKET—quantitative
What is the potential market for this product?
This section will apply specific quantitative measures to this product. Here we want to include numbers of
potential customers, dollar volume of business, our current share of the market—any specific measures that will
outline our total target for the product and where we stand competitively now.
V. TREND ANALYSIS
Based on the history of this product, where do we appear to be headed?
This section is a review of the past history of this product. Ideally, we should include annual figures for the last
five years showing dollar volume, accounts opened, accounts closed, share of market, and all other applicable
historical data.
VI. COMPETITION
Who are our competitors for this product, and how do we stand competitively?
This section should define our current competition. It should be a thoughtful analysis outlining who our
competitors are, how successful they are, and what actions they might be expected to take regarding this
product during the coming year.
VII. PROBLEMS AND OPPORTUNITIES
Internally and externally, are there problems inhibiting the marketing of this product, or are there opportunities
we have not taken advantage of?
This section will include a frank commentary on both inhibiting problems and unrealized opportunities. It
should include a discussion of the internal and external problems we can control, for example, by changes in
policies or operational programs. It should also point to areas of opportunity regarding this product that we
are not now exploring.
VIII. OBJECTIVES AND GOALS
Where do we want to go with this product?
This section will outline the immediate short- and long-range objectives for this product. Short-range goals
should be specific and will apply to next year. Intermediate to long-range goals will necessarily be less specific
and should project for the next three to five years and beyond. Objectives should be stated in two forms.
(1) Qualitative—reasoning behind the offering of this product and what modifications or other changes we
expect to make.
(2) Quantitative—number of accounts, dollar volume, share of market, and profit goals.
IX. ACTION PROGRAMS
Given past history, the economy, the market, competition, etc., what must we do to reach the goals we have set
for this product or service?
This section will be a description of the specific actions we plan to take during the coming plan period to ensure
reaching the objectives we have set for the product in VIII. These would include the full range of factors
comprising our marketing mix. The discussion should cover what is to be done, schedules for completion,
methods of evaluation, and assignment of accountability for executing the program and measuring results.
Source: David S. Hopkins, The Marketing Plan (New York: The Conference Board, 1981). Reprinted with permission of The Conference Board.
EXHIBIT 2 Marketing Plan for a Business-to-Business Company
C H A P T E R 8 THE MARKETING PLAN 253
Marketing Plan Outline
For each major bank service:
I. MANAGEMENT SUMMARY
What is our marketing plan for this service in brief?
This is a one-page summary of the basic factors involving the marketing of the service next year along with the
results expected from implementing the plan. It is intended as a brief guide for management.
II. ECONOMIC PROJECTIONS
What factors in the overall economy will affect the marketing of this service next year, and how?
This section will include a summary of the specific economic factors that will affect the marketing of this service
during the coming year. These might include employment, personal income, business expectations, inflationary
(or deflationary) pressures, etc.
III. THE MARKET—quantitative
Who or what kinds of organizations could conceivably be considered prospects for this service?
This section will define the qualitative nature of our market. It will include demographic information, industrial
profiles, business profiles, and so on, for all people or organizations that could be customers for this service.
IV. THE MARKET—quantitative
What is the potential market for this service?
This section will apply specific quantitative measures to this bank service. Here we want to include numbers of
potential customers, dollar volume of business, our current share of the market—any specific measures that will
outline our total target for the service and where we stand competitively now.
V. TREND ANALYSIS
Based on the history of this service, where do we appear to be headed?
This section is a review of the past history of this service. Ideally, we should include quarterly figures for the last
five years showing dollar volume, accounts opened, accounts closed, share of market, and all other applicable
historical data.
VI. COMPETITION
Who are our competitors for this service, and how do we stand competitively?
This section should define our current competition, both bank and nonbank. It should be a thoughtful analysis
outlining who our competitors are, how successful they are, why they have (or have not) been successful, and
what actions they might be expected to take regarding this service during the coming year.
VII. PROBLEMS AND OPPORTUNITIES
Internally and externally, are there problems inhibiting the marketing of this service, or are there opportunities
we have not taken advantage of?
This section will contain a frank commentary on both inhibiting problems and unrealized opportunities. It should
include a discussion of the internal and external problems we can control, for example, changes in policies or
operational procedures. It should also point to areas of opportunity regarding this service that we are not now
exploiting.
VIII. OBJECTIVES AND GOALS
Where do we want to go with this service?
This section will outline the immediate short- and long-range objectives for this service. Short-range goals should
be specific and will apply to next year. Long-range goals will necessarily be less specific and should project for the
next five years. Objectives should be stated in two forms:
(1) Qualitative—reasoning behind the offering of this service and what modifications or other changes we expect
to make.
(2) Quantitative—number of accounts, dollar volume, share of market, profit goals.
IX. ACTION PROGRAMS
Given past history, the economy, the market, competition, and so on, what must we do to reach the goals we have
set for this service?
This section will be a description of the specific actions we plan to take during the coming year to ensure reaching
the objectives we have set for the service in VIII. These would include advertising and promotion, direct mail, and
brochure development. It would also include programs to be designed and implemented by line officers. The
discussion should cover what is to be done, schedules for completion, methods of evaluation, and officers in
charge of executing the program and measuring results.
Source: David S. Hopkins, The Marketing Plan (New York: The Conference Board, 1981). Reprinted with permission of The Conference Board.
EXHIBIT 3 Marketing Plan for a Service Company
1
To understand the importance of the management team in launching a new venture.
2
To understand the advantages and disadvantages of the alternative legal forms for organizing a new venture.
3
To explain and compare the S corporation and limited liability company as alternative forms of incorporation.
4
To learn the importance of both the formal and the informal organization.
5
To illustrate how the board of directors or board of advisors can be used to support the management of a new venture.
9 T H E O R G A N I Z AT I O N A L P L A N
L E A R N I N G O B J E C T I V E S
255
O P E N I N G P R O F I L E
JIM SINEGAL
Building a strong and lasting organization requires careful planning and strategy. No
one knows this better than Jim Sinegal, the founder and CEO of Costco Wholesale
Corporation, a successful warehouse chain store. Jim’s philosophy is that a successful
organization depends heavily on its employees and that happy employees are loyal
and stable and can help generate successful sales and rev-
enue growth.
Jim Sinegal has had a long history with the warehouse
concept. It began appropriately when he was a student at
San Diego State University. In 1954, a classmate and good friend asked him if he would
be willing to help unload mattresses for the day at a newly opened discount store
called Fed-Mart. Jim didn’t realize at that time how significant this would be as an
introduction to the more modern warehouse concept. He not only went to work for
Fed-Mart but he made it a career, rising eventually to executive vice president. More
importantly, as part of this career at Fed-Mart, Jim was able to learn a great deal about
this business from Fed-Mart’s chairman, Sol Price, who is credited with being the inven-
tor of the concept of high-volume warehouse stores.
After many successful years working at Fed-Mart, Jim left the company in 1975 when
Sol Price was fired, having sold Fed-Mart to a German retailer. Both he and Sol then
teamed up to start a new warehouse company, Price Club. The success of Price Club
attracted competition from Wal-Mart, which launched Sam’s Club, and Zayre’s, which
started BJ’s Wholesale Club. Noting the potential for these warehouse stores, Jim left
Price Club and, with the help of a Seattle entrepreneur, launched Costco. Sol Price and
Jim Sinegal became partners again in 1993 when Costco and Price Club merged to form
the largest membership chain in the United States.
In 1995, Sol Price and Jim Sinegal again parted ways, mainly because they could
not agree on a strategy for building the business. Sol maintained some of the real
estate and concentrated his efforts on licensing PriceSmart warehouse stores in for-
eign markets. Jim retained control of all the warehouse stores in the United States
and has since built the business to be the number one warehouse club operator in
the country.
www.costco.com
Jim Sinegal would emphatically summarize the successful strategy of Costco in two
simple statements. First, build a strong organization with loyal, hardworking employees
by paying them above-average salaries (the average salary is $17/hour), providing
excellent benefits (90 percent of health insurance costs for both full-timers and part-
timers are paid by the company), and giving them the feeling that you care about
their welfare. Second, maintain the business model of a warehouse store by limiting
the product offerings, allowing fledgling companies to supply inventory, and main-
taining low prices.
In addition to the high wages and health insurance coverage, the company also
contributes between 3 and 9 percent of each employee’s pay to a 401(k). With this
policy Jim brags about the astoundingly low first-year employee turnover rate of
5.5 percent.
Wall Street, however, has been very critical of Costco’s industry-high labor cost of
70 percent of total cost of operations. Analysts argue that Costco treats its employees
and cardholders better than its stockholders. Sinegal’s response is clear and undaunted.
He argues that one of the most important aspects of a successful organization is its
people. It’s important to hire the best people you can and then keep them long term so
they in turn will have some job security. He states, “It’s not altruism. In the final analy-
sis, it’s good business.”
Even with its high labor costs and low revenue-to-sales ratio (in 2008 this figure
was 1.8 cents for every sales dollar, compared to almost twice that amount for Wal-
Mart), Costco established itself as the number-one-ranked warehouse club in the
United States. From 2006 to 2008 Costco’s sales revenue increased from $60.2 billion
to $72.5 billion. In 2008 Costco’s profits rose about 15 percent to $1.28 billion.
Although economic conditions have been poor, Costco did manage to achieve a
sales increase of 4 percent in the first quarter of fiscal 2009 compared to the same
period in 2008. Beginning with the single store in 1983, Costco now has more than
530 stores mostly in the United States, but with some in Canada, the U.K., South
Korea, Taiwan, Mexico, and Japan. The company has plans to open its first store in
Australia in 2009.
It’s impossible to argue with the huge success that Jim Sinegal has achieved. His
combination of a quality, loyal labor force and his relentless attention to maintain-
ing the warehouse store concept by offering a bare-bones, cement-floor retail space,
charging a membership fee for the right to shop, and maintaining a limited product
offering at low prices with high inventory turnover has proven to be a successful
business model.
Jim Sinegal takes only a modest salary, spends a lot of time traveling to many stores,
and works with a lot of fledgling supplier enterprises, giving them an opportunity that
would not be likely with other giant retailers. He also continues to maintain his policy
of marking up retail prices no more than 14 percent. The success of the firm has recently
continued, albeit at a slower pace, because of the economic conditions affecting retail
sales. However, Sinegal expects that the bargain pricing position of Costco will be an
advantage in a weakened economy.1
256 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
257
DEVELOPING THE MANAGEMENT TEAM
We can see from the Costco example the importance of employees and their loyalty and
commitment to the organization. Also significant to potential investors is the management
team and its ability and commitment to the new venture.
Investors will usually demand that the management team not attempt to operate the busi-
ness as a sideline or part-time venture while employed full time elsewhere. It is assumed
that the management team is prepared to operate the business full time and at a modest
salary. It is unacceptable for the entrepreneurs to try to draw a large salary out of the new
venture, and investors may perceive any attempt to do so as a lack of psychological
commitment to the business. Later in this chapter, the roles of various team members are
discussed, particularly as the firm evolves into a legitimate ongoing concern. In addition, the
entrepreneur should consider the role of the board of directors and/or a board of advisors in
supporting the management of the new venture. At this point, however, the entrepreneur
needs to consider the alternatives regarding the legal form of the organization. Each of
these forms has important implications for taxes, liability, continuity, and financing the new
venture.
A S S E E N I N E N T R E P R E N E U R M A G A Z I N E
PROVIDE ADVICE TO AN ENTREPRENEUR ABOUT SOME LEGAL ASPECTS
OF STARTING A BUSINESS
You just started your business—who has time to
think about an exit strategy? If you’re putting off
making such plans, you’ve committed a very com-
mon legal mistake, says Alan S. Kopit, partner at
Hahn Loeser & Parks LLP in Cleveland and advisor
to Lawyers.com. “Now is the time to decide those
issues—not after a problem develops,” he says.
Here, Kopit runs down a few more common legal
blunders to avoid:
1. Failing to get good advice. Don’t ever go it alone.
Instead, Kopit suggests entrepreneurs enlist the
services and counsel of a good lawyer, an
accountant, and an insurance agent at the very
beginning of their start-up ventures. “Younger
[entrepreneurs] particularly need people to
bounce their ideas off of,” he says.
2. Neglecting important employment
considerations. Hiring issues are a major legal
consideration for start-ups. Consider whether you
need a written non-compete contract with
employees, whether you’ll use independent
contractors, and so on.
3. Selecting the wrong business structure. Should
you classify your business as a sole proprietorship,
an LLC, an LLP, or a corporation? “There are tax
implications that go along with [each choice],”
cautions Kopit. Be sure to weigh each option with
the help of your advisors to determine which
form will best serve your business plan.
ADVICE TO AN ENTREPRENEUR
An entrepreneur who is looking to create a new busi-
ness has read the above article and comes to you for
advice:
1. It is not surprising that a lawyer should say that
an entrepreneur needs a lawyer to start a
business. I certainly do not have money to burn
on unnecessary legal fees. Which things do I need
a lawyer for now, which things need a lawyer but
can be delayed, and finally which things can I do
myself?
2. Other than the costs, are there any disadvantages
to “bouncing ideas” off a lawyer?
3. I certainly don’t want to pay more taxes than I
must. What are the tax implications of the differ-
ent legal structures for the business?
Source: Reprinted with permission of Entrepreneur Media, Inc., “Laying Down the Law. Don’t Be Legally Blind—Watch for These Common Start-Up Blunders,” by Nichole L. Torres, March 2003, Entrepreneur magazine: www.entrepreneur.com.
LEGAL FORMS OF BUSINESS
There are three basic legal forms of business formation with some variations available
depending on the entrepreneurs’ needs. The three basic legal forms are (1) proprietorship,
(2) partnership, and (3) corporation, with variations particularly in partnerships and corpo-
rations. The newest form of business formation is the limited liability company (LLC),
which is now possible in all 50 states and the District of Columbia. The typical corporation
form is known as a C corporation. Table 9.1 describes the legal factors involved in each of
these forms with the differences in the limited liability partnership (LLP) and S corporation
noted where appropriate. These three basic legal forms are compared with regard to own-
ership, liability, start-up costs, continuity, transferability of interest, capital requirements,
management control, distribution of profits, and attractiveness for raising capital. Later in
the chapter, the S corporation and the LLC are compared and discussed as alternative forms
of business, especially for the new venture.
It is very important that the entrepreneur carefully evaluate the pros and cons of the var-
ious legal forms of organizing the new venture. This decision must be made before the
submission of a business plan and request for venture capital.
The evaluation process requires the entrepreneur to determine the priority of each of the
factors mentioned in Table 9.1, as well as tax factors discussed later in this chapter. These
factors will vary in importance, depending on the type of new business.
The variations of organizational structure as well as the advantages and disadvantages
are numerous and can be quite confusing to the entrepreneur. In the next section of this
chapter, some of these differences are clarified to assist the entrepreneur in making the best
decision regarding organizational structure.
Ownership
In the proprietorship, the owner is the individual who starts the business. He or she has full
responsibility for the operations. In a partnership, there may be some general partnership
owners and some limited partnership owners. There are also limited liability partnerships
(LLPs) in which the partnership is treated as a legal entity. In the corporation, ownership is
reflected by ownership of shares of stock. Unlike the S corporation, where the maximum
number of shareholders is 100, there is no limit as to the number of shareholders who may
own stock in a corporation.
Liability of Owners
Liability is one of the most critical reasons for establishing a corporation rather than any
other form of business. The proprietor and general partners are liable for all aspects of
the business. Since the corporation is an entity or legal “person,” which is taxable and ab-
sorbs liability, the owners are liable only for the amount of their investment unless there is
negligence or fraud involved. In the case of a proprietorship or regular partnership, no dis-
tinction is made between the business entity and the owner(s). Then, to satisfy any out-
standing debts of the business, creditors may seize any assets the owners have outside the
business.
In a partnership, the general partners usually share the amount of personal liability
equally, regardless of their capital contributions, unless there is a specific agreement to the
contrary. The only protection for the partners is insurance against liability suits and each
partner putting his or her assets in someone else’s name. The government may disallow the
latter action if it feels this was done to defraud creditors.
258 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
proprietorship Form of
business with single
owner who has unlimited
liability, controls all
decisions, and receives all
profits
partnership Two or
more individuals having
unlimited liability who
have pooled resources to
own a business
corporation Separate
legal entity that is run by
stockholders having
limited liability
C corporation Most
common form of
corporation, regulated by
statute and treated as a
separate legal entity for
liability and tax purposes
C H A P T E R 9 THE ORGANIZATIONAL PLAN 259
Ownership
Liability of
owners
Costs of starting
business
Continuity of
business
Transferability of
interest
Capital
requirements
Management
control
Distribution of
profits and losses
Attractiveness for
raising capital
Individual.
Individual liable for
business liabilities.
None, other than filing
fees for trade name.
Death dissolves the
business.
Complete freedom to
sell or transfer any part
of business.
Capital raised only by
loan or increased
contribution by
proprietor.
Proprietor makes all
decisions and can act
immediately.
Proprietor responsible
and receives all profits
and losses.
Depends on capability
of proprietor and
success of business.
No limitation on number of
partners.
In general partnership, all
individuals liable for business
liabilities. Limited partners are
liable for amount of capital
contribution. In limited liability
partnership (LLP), there is no
liability except when negligence
exists.
Partnership agreement, legal
costs, and minor filing fees for
trade name.
Death or withdrawal of one
partner terminates partnership
unless partnership agreement
stipulates otherwise. Death or
withdrawal of one of limited
partners has no effect on
continuity.
General partner can transfer
his/her interest only with consent
of all other general partners.
Limited partner can sell interest
without consent of general
partners. No transfer of interest
in an LLP.
Loans or new contributions by
partners require a change in
partnership agreement. In LLP
partnership, entity raises money.
All general partners have equal
control, and majority rules.
Limited partners have limited
control. Can vary in an LLP.
Depends on partnership
agreement and investment by
partners.
Depends on capability of
partners and success of business.
No limitation on number of
stockholders.
Amount of capital contribution is
limit of shareholder liability.
Created only by statute. Articles
of incorporation, filing fees,
taxes, and fees for states in which
corporation registers to do
business.
Greatest form of continuity.
Death or withdrawal of owner(s)
will not affect legal existence of
business.
Most flexible. Stockholders can
sell or buy stock at will. Some
stock transfers may be restricted
by agreement. In S corporation,
stock may be transferred only to
an individual.
New capital raised by sale of
stock or bonds or by borrowing
(debt) in name of corporation.
In S corporation, only one class
of stock and limited to
100 shareholders.
Majority stockholder(s) have
most control from legal point of
view. Day-to-day control in hands
of management, who may or may
not be major stockholders.
Shareholders can share in profits
by receipt of dividends.
With limited liability for owners,
more attractive as an investment
opportunity.
TABLE 9.1 Factors in Three Forms of Business Formation
Factors Proprietorship Partnership Corporation
In a general partnership there also may be limited partners. These limited partners are
liable for only what they contribute to the partnership. This amount, by law, must be regis-
tered at a local courthouse, thus making this information public. The LLP has become very
popular among larger law firms and accounting CPA firms. It is actually a form of limited
liability company (LLC), where the firm elects this status when filing its entity classifica-
tion with the IRS on Form 8832. Thus the advantages of the LLP are the same as the LLC,
allowing the partners to protect their personal assets from liability risk. The LLP will be
distinguished from the general partnership as appropriate in our comparison of the various
forms of organization that follows.2
Costs of Starting a Business
The more complex the organization, the more expensive it is to start. The least expensive is
the proprietorship, where the only costs incurred may be for filing for a business or trade
name. In a partnership, in addition to filing a trade name, a partnership agreement is
needed. This agreement requires legal advice and should explicitly convey all the respon-
sibilities, rights, and duties of the parties involved. A limited partnership may be somewhat
more complex than a general partnership because it must comply strictly with statutory
requirements.
The corporation can be created only by statute. This generally means that before the
corporation may be legally formed, the owners are required to (1) register the name and
articles of incorporation and (2) meet the state statutory requirements (some states are more
lenient than others). In complying with these requirements, the corporation will likely incur
filing fees, an organization tax, and fees for doing business in each state. Legal advice is
necessary to meet all the statutory requirements.
Continuity of Business
One of the main concerns of a new venture is what happens if one of the entrepreneurs (or
the only entrepreneur) dies or withdraws from the business. Continuity differs significantly
for each of the forms of business. In a sole proprietorship, the death of the owner results in
the termination of the business. Sole proprietorships are thus not perpetual, and there is no
time limit on how long they may exist.
The partnership varies, depending on whether it is a general partnership or a limited
liability partnership (LLP). In a general partnership, the death or withdrawal of one of the
partners results in termination of the partnership unless the partnership agreement stipulates
otherwise. Thus, the partnership agreement may contain stipulations that allow for a buy-
out of the deceased or withdrawn partner’s share, based on some mechanism or predeter-
mined value. It also may be possible to have a member of the deceased partner’s family
take over as a partner and share in the profits accordingly. Life insurance owned by the
partnership can be valuable protection for the partnership, often providing the funds neces-
sary to buy out the deceased partner’s share.
If there are limited liability partners in a general partnership, their death or withdrawal
has no effect on the continuity of the business. A limited partner also may be replaced
depending on the partnership agreement.
In a limited liability partnership (LLP), the death or withdrawal of a partner has no
effect on the partnership. The deceased or withdrawn partner may be replaced much like
any employee of a corporation.
The corporation has the most continuity of all the forms of business. Death or with-
drawal has no impact on the continuation of the business. Only in a closely held corpo-
ration, where a few people hold all the shares, may there be some problems trying to
find a market for the shares. Usually, the corporate charter requires that the corporation or
the remaining shareholders purchase the shares. In a public corporation this, of course,
would not be an issue.
260 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
Transferability of Interest
There can be mixed feelings as to whether the transfer of interest in a business is desirable.
In some cases the entrepreneur(s) may prefer to evaluate and assess any new owners
before giving them a share of the business. On the other hand, it is also desirable to be able
to sell one’s interest whenever one wishes. This may be of particular significance when
there is the need to consider a succession plan or strategy. This is discussed in more detail
in Chapter 15. Each form of business offers different advantages as to the transferability
of interest.
In the sole proprietorship, the entrepreneur has the right to sell or transfer any assets in
the business. Limited partners, if existing in a general partnership organization, have more
flexibility and may typically sell their interest at any time without consent of the general
partners. The new limited partner’s rights will remain the same as those of the prior part-
ner. However, this may vary depending on the partnership agreement. General partners usu-
ally cannot sell their interest without first refusal from the remaining general partners, even
if the partnership agreement allows for the transfer of interest.
In an LLP, the transfer of interest of one limited partner is typically not allowable. As
stated previously, the LLP has become popular among law and CPA firms. Limited partners
also may vary in distinction (e.g., there may be associate partners or junior partners), in
which case they also may not share the same profit percentages as full partners. Full part-
ners in law or CPA firms may elect to sell the business, but such a decision usually requires
the approval of all or a majority.
The corporation has the most freedom in terms of selling one’s interest in the business.
Shareholders may transfer their shares at any time without consent from the other share-
holders. The disadvantage of the right is that it can affect the ownership control of a corpo-
ration through election of a board of directors. Shareholders’ agreements may provide some
limitations on the ease of transferring interest, usually by giving the existing shareholders
or corporation the option of purchasing the stock at a specific price or at the agreed-on
price. Thus, they sometimes can have the right of first refusal. In the S corporation, the
transfer of interest can occur only as long as the buyer is an individual.
Capital Requirements
The need for capital during the early months of the new venture can become one of the
most critical factors in keeping a new venture alive. The opportunities and ability of the
new venture to raise capital will vary, depending on the form of business.
For a proprietorship, any new capital can come only from loans by any number of
sources or by additional personal contributions by the entrepreneur. In borrowing
money from a bank, the entrepreneur in this form of business may need collateral to
support the loan. Often, an entrepreneur will take a second mortgage on his or her home
as a source of capital. Any borrowing from an outside investor may require giving up
some of the equity in the proprietorship. Whatever the source, the responsibility for pay-
ment is in the hands of the entrepreneur, and failure to make payments can result in
foreclosure and liquidation of the business. However, even with these risks the propri-
etorship is not likely to need large sums of money, as might be the case for a partnership
or corporation.
In the partnership, loans may be obtained from banks but will likely require a change in
the partnership agreement. Additional funds contributed by each of the partners will also
require a new partnership agreement. As in the proprietorship, the entrepreneurs are liable
for payment of any new bank loans.
C H A P T E R 9 THE ORGANIZATIONAL PLAN 261
In the corporation, new capital can be raised in a number of ways. The alternatives are
greater than in any of the other legal forms of business. Stock may be sold as either voting
or nonvoting. Nonvoting stock will of course protect the power of the existing major stock-
holders. Bonds also may be sold by the corporation. This alternative would be more diffi-
cult for the new venture since a high bond rating will likely occur only after the business
has been successful over time. Money also may be borrowed in the name of the corpora-
tion. As stated earlier, this protects the personal liability of the entrepreneur(s).
Management Control
In any new venture, the entrepreneur(s) will want to retain as much control as possible over
the business. Each of the forms of business offers different opportunities and problems as
to control and responsibility for making business decisions.
In the proprietorship, the entrepreneur has the most control and flexibility in making
business decisions. Since the entrepreneur is the single owner of the venture, he or she will
be responsible for and have sole authority over all business decisions.
The partnership can present problems over control of business decisions if the partner-
ship agreement is not concise regarding this issue. Usually, in a partnership the majority
rules unless the partnership agreement states otherwise. It is quite important that the part-
ners be friendly toward one another and that delicate or sensitive decision areas of the busi-
ness be spelled out in the partnership agreement.
The existence of limited partners in a general partnership offers a compromise be-
tween the partnership and the corporation. In this type of organization, we can see some
of the separation of ownership and control. The limited partners in the venture have no
control over business decisions. As soon as the limited partner is given some control over
business decisions, he or she then assumes personal liability and can no longer be con-
sidered a limited partner. In the LLP, the rights of all partners are clearly defined in the
partnership agreement. As mentioned earlier, these types of organizations use titles such
as junior partner, associate partner, and so on as a means of designating management
responsibilities.
Control of day-to-day business in a corporation is in the hands of management, who may
or may not be major stockholders. Control over major long-term decisions, however, may
require a vote of the major stockholders. Thus, control is separated based on the types of busi-
ness decisions. In a new venture, there is a strong likelihood that the entrepreneurs who are
major stockholders will be managing the day-to-day activities of the business. As the corpo-
ration increases in size, the separation of management and control becomes more probable.
Stockholders in the corporation can indirectly affect the operation of the business by
electing someone to the board of directors who reflects their personal business philosophies.
These board members, through appointment of top management, then affect the operation
and control of the day-to-day management of the business.
Distribution of Profits and Losses
Proprietors receive all distributions of profits from the business. As discussed earlier, they
are also personally responsible for all losses. Some of the profits may be used to pay back
the entrepreneur for any personal capital contributions that are made to keep the business
operating.
In the partnership, the distribution of profits and losses depends on the partnership
agreement. It is likely that the sharing of profits and losses will be a function of the partners’
262 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
investments. However, this can vary depending on the agreement. As in the proprietorship,
the partners may assume liability. Limited partners in a general partnership, or the forma-
tion of an LLP, are alternatives that protect those limited partners against personal liability
but that may also reduce their share in any profits.
Corporations distribute profits through dividends to stockholders. These distributions
are not likely to absorb all the profits that may be retained by the corporation for future in-
vestment or capital needs of the business. Losses by the corporation will often result in no
dividends. These losses will then be covered by retained earnings or through other finan-
cial means discussed earlier.
Attractiveness for Raising Capital
In both the proprietorship and the partnership, the ability of the entrepreneurs to raise cap-
ital depends on the success of the business and the personal capability of the entrepreneur.
These two forms are the least attractive for raising capital, primarily because of the prob-
lem of personal liability. Any large amounts of capital needed in these forms of business
should be given serious consideration.
The corporation, because of its advantages regarding personal liability, is the most
attractive form of business for raising capital. Shares of stock, bonds, and/or debt are all
opportunities for raising capital with limited liability. The more attractive the corporation,
the easier it will be to raise capital.
TAX ATTRIBUTES OF FORMS OF BUSINESS
The tax advantages and disadvantages of each of the forms of business differ significantly.
Some of the major differences are discussed next. There are many minor differences that,
in total, can be important to the entrepreneur. If the entrepreneur has any doubt about these
advantages, he or she should get outside advice. Table 9.2 provides a summary of the major
tax advantages of these forms of business.
Tax Issues for Proprietorship
For the proprietorship, the IRS treats the business as the individual owner. All income
appears on the owner’s return as personal income. Thus, the proprietorship is not regarded
by the IRS as a separate tax entity. As can be seen in Table 9.2, this treatment of taxes
affects the taxable year, distribution of profits to owners, organization costs, capital gains,
capital losses, and medical benefits. Each of these is treated as if it were incurred by the
individual owner and not the business.
The proprietorship has some tax advantages when compared with the corporation. First,
there is no double tax when profits are distributed to the owner. Another advantage is that
there is no capital stock tax or penalty for retained earnings in the business. Again, these
advantages exist because the proprietorship is not recognized as a separate tax entity; all
profits and losses are part of the entrepreneur’s tax return.
Tax Issues for Partnership
The partnership’s tax advantages and disadvantages are similar to those of the proprietor-
ship, especially regarding income distributions, dividends, and capital gains and losses.
C H A P T E R 9 THE ORGANIZATIONAL PLAN 263
Limited partners in a traditional general partnership have the advantage of limited liability
(they are liable only for the amount of their investment), but they can share in the profits at
a percentage stipulated in the partnership agreement. The LLP is treated the same as the
LLC for tax purposes, and all profits are distributed through the partners in some designated
fashion as personal income.
264 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
TABLE 9.2 Tax Attributes of Various Legal Forms of Business
Taxable year
Distribution of
profits to owners
Organization
costs
Dividends
received
Capital gains
Capital losses
Initial
organization
Limitations on
losses deductible
by owners
Medical benefits
Retirement
benefits
Usually a calendar year.
All income appears on owner’s return.
Not amortizable.
$100 dividend exclusion for single return and $200 on joint return.
Taxed at individual level. A deduction is allowed for long-term capital gains.
Carried forward indefinitely.
Commencement of business results in no additional tax for individual.
Amount at risk may be deducted except for real estate activities.
Itemized deductions for medical expenses in excess of percentage of adjusted gross income on individual’s return. No deduction for insurance premium.
Limitations and restrictions basically same as regular corporation.
Usually calendar year, but other dates may be used.
Partnership agreement may have special allocation of income. Partners pay tax on their pro rata shares of income on individual return even if income not immediately distributed.
Amortizable over 60 months.
Dividend exclusion of partnership passes to partner (conduit).
Capital gain to partnership will be taxed as a capital gain to the partner (conduit).
Capital losses can be used to offset other income. Carried forward indefinitely (conduit).
Contributions of property to a partnership not taxed.
Partnership investment plus share of recourse liability if any. At-risk rules may apply except for real estate partnership.
Cost of partner’s benefits not deductible to business as an expense. Possible deduction at partner level.
Same as for corporations.
Any year-end can be used at beginning. Any changes require changes in incorporation.
No income is allocated to stockholders.
Amortizable over 60 months.
80% or more of dividend received may be deducted.
Taxed at corporate level.
Carry back three years and carry over five years as short-term capital loss offsetting only capital gains.
Acquisition of stock for cash entails no immediate taxes. Transfer of property in exchange for stock may be taxable if stock value greater than contributed property.
No losses allowed except on sale of stock or liquidation of corporation. In S corporation, shareholder’s investment in corporation is deductible.
Cost of employee-shareholder coverage deductible as business expense if designed for benefit of employee.
Limitations on the benefits that can be derived and on the benefits that can be contributed to a defined contribution plan.
Attributes Proprietorship Partnership Corporation
Both the partnership and proprietorship are organizational forms that serve as nontax-
able conduits of income and deductions. These forms of business do have a legal identity
distinct from the partners or owners, but this identity is only for accounting reporting.
It is especially important for partnerships to report income since this serves as the basis
for determining the share of each partner. The income is distributed based on the partner-
ship agreement. The owners then report their share as personal income and pay taxes based
on this amount.
Tax Issues for Corporation
Since the IRS recognizes the corporation as a separate tax entity, it has the advantage of
being able to take many deductions and expenses that are not available to the proprietorship
or partnership. The disadvantage is that the distribution of dividends is taxed twice, as in-
come of the corporation and as income of the stockholder. This double taxation can be
avoided if the income is distributed to the entrepreneur(s) in the form of salary. Bonuses,
incentives, profit sharing, and so on, are thus allowable ways to distribute income of the
corporation as long as the compensation is reasonable in amount and payment was for ser-
vices rendered.
The corporate tax may be lower than the individual rate. The entrepreneur is best
advised to consider the tax pros and cons and decide on that basis. Projected earnings may
be used to calculate the actual taxes under each form of business to identify the one that
provides the best tax advantage. Remember, tax advantages should be balanced by liability
responsibility in the respective form of business.
THE LIMITED LIABILITY COMPANY VERSUS THE S CORPORATION
Although the perception among entrepreneurs is that the C corporation is the entity desired
by investors, the actual entity desired by venture capitalists is the limited liability company
(LLC), which is similar to the S corporation. The emergence of the LLC as a more popular
alternative has resulted from the finalization of new regulation. This new regulation now
allows an LLC to be automatically taxed as a partnership, unless the entrepreneur actively
makes another choice (taxed as a corporation). This easing of election is one important fac-
tor that has enhanced the LLC’s popularity.
The S corporation (the S refers to Subchapter S of the Internal Revenue Code) had been
the most popular choice of organization structure by new ventures and small businesses.
However, the growth rate of the formation of S corporations has actually declined in the last
few years primarily because of acceptance of the LLC in all states and amendments in sev-
eral states making the LLC more attractive.3
S CORPORATION
The S corporation combines the tax advantages of the partnership and the corporation. It is
designed so that venture income is declared as personal income on a pro rata basis by the
shareholders. In fact, the shareholders benefit from all the income and the deductions of the
business. Before the passing of the Small Business Job Protection Act of 1996, the rules
governing the S corporation were considered too rigid. The passage of the 1996 law loos-
ened some of the restrictions that existed in regard to number of shareholders, ownership of
stock of another corporation, role of trusts as stockholders, classes of stock, and a number
of other changes. In 2004, Congress again responded to some of the criticisms of the re-
strictions on S corporations as compared to LLCs. As a result a number of changes were
C H A P T E R 9 THE ORGANIZATIONAL PLAN 265
S corporation Special
type of corporation where
profits are distributed to
stockholders and taxed as
personal income
made, such as an increase in the number of shareholders to 100, allowing family members
to be treated as one stockholder, allowing IRAs to own shares in banks that are declared
S corporations, as well as some modifications regarding the transfer of stock in a divorce.
The intent was to make the S corporation as advantageous as the LLC since it is difficult
to change status once a firm has declared itself an S corporation. It is anticipated that
Congress may revisit the S corporation again in the future.4
One of the issues with the S corporation is that its status must be carefully monitored
and maintained. For example, its tax status as a pass-through entity (with its income taxed
as personal income of shareholders) still requires an affirmative election of shareholders. If
the S corporation status is ever lost, it usually cannot be reelected for five years and with
some costs. As stated earlier, the differences between the S corporation and the LLC are
generally minimal but should be evaluated on a case-by-case basis because of the existing
company and shareholder circumstances.
Advantages of an S Corporation
The S corporation offers the entrepreneur some distinct advantages over the typical corpo-
ration, or C corporation. However, there are also disadvantages. In those instances when the
disadvantages are great, the entrepreneur should elect the C corporation form. Some of the
advantages of the S corporation are as follows:
• Capital gains or losses from the corporation are treated as personal income or losses by the shareholders on a pro rata basis (determined by number of shares of stock held).
The corporation is thus not taxed.
• Shareholders retain the same limited liability protection as the C corporation.
• The S corporation is not subject to a minimum tax, as is the C corporation.
• Stock may be transferred to low-income-bracket family members (children must be 14 years or older).
• Stock may be voting or nonvoting.
• This form of business may use the cash method of accounting.
• Corporate long-term capital gains and losses are deductible directly by the shareholders to offset other personal capital gains or losses.
Disadvantages of an S Corporation
Although the advantages appear to be favorable for the entrepreneur, this form of business
is not appropriate for everyone. The disadvantages of the S corporation are as follows:
• Even with the regulations passed in 1996 and 2004, there are still some restrictions regarding qualification for this form of business.
• Depending on the actual amount of the net income, there may be a tax advantage to the C corporation. This will depend on the company payout ratio, the corporate tax
rate, the capital gains tax rate for the investor, and the personal income tax rate of the
investor.5
• The S corporation may not deduct most fringe benefits for shareholders.
• The S corporation must adopt a calendar year for tax purposes.
• Only one class of stock (common stock) is permitted for this form of business.
• The net loss of the S corporation is limited to the shareholder’s stock plus loans to the business.
• S corporations cannot have more than 100 shareholders.
266 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
267
LAWYERS EXPLAIN THE STEPS TO TAKE IF YOUR BUSINESS PARTNER
VIOLATES HIS OR HER OBLIGATIONS TO THE BUSINESS
My business partner and I have owned a technology company
for six years. It’s an S-Corporation and we are 50-50 share-
holders, each with a board position. Our bylaws are boilerplate
and our stockholder agreement is pretty weak, focusing on
when we can or can’t sell the business. Recently I found out
that for the first four years, my partner was getting paid by one
of the corporation’s customers through a local university to
work in the same technology we do in the company. Is this a
conflict of interest on his part? What should I do?
C. G. (Rome, NY)
Yes, this is a conflict of interest. In legal terms it’s
called “a diversion of corporate opportunity.” This
means your partner took work for himself that the cor-
poration could have done. This is most likely a breach of
your partner’s fiduciary obligations and his duty of loy-
alty to the corporation, says Stuart Blake, co-founder
and chief executive officer of the General Counsel, a
law firm based in Newport Beach, Calif. It’s also a seri-
ous breach of trust between the two of you as partners.
Relying on boilerplate documents and a weak
shareholder agreement may make this dilemma more
serious. “This is the pitfall of not having an attorney
help draft your corporate documents when you set
up your S-corp. With a more detailed agreement,
including buy/sell provisions, noncompete clauses, and
conflict-of-interest provisions, you could extricate your-
self from this situation much more easily,” Blake says.
PUT THE EVIDENCE IN BLACK
AND WHITE
What you should do depends largely on what you
want from your partner and from the corporation,
says Rubin Ferziger, a business attorney based in New
York. Do you want to continue with the corporation,
but recover the lost profits and perhaps other dam-
ages? Are you considering dissolving the corporation
and going off on your own? Does your business de-
pend on your partner or could you carry on alone?
“Take your shareholder agreement to an attorney
and explain what has happened,” Ferziger suggests.
“You should also discuss the situation with your fam-
ily and with an accountant who is not affiliated with
your partner.”
Make sure you have documentary evidence about
the competing work your partner did, says Ray Gallo,
a Los Angeles attorney with Gallo & Associates. “Hav-
ing it in black and white minimizes the possibilities
for arguments and litigation. Present the evidence to
a lawyer you engage to act as counsel to the corpora-
tion to make this determination,” Gallo says.
If the lawyer concludes your partner has violated his
duties, sit down with your partner promptly, Gallo says.
If you want to continue working together, both of you
should agree that he won’t do this again and—ideally—
that he’ll put the money he made into the corporation.
“Hopefully it’ll go well,” he says. “If not, you’ll have to
choose whether the money at issue is worth fighting
over. Either way, you’ll have to decide whether this is
a guy you should continue in business with. If your
gut reaction is that he cheated you, the answer is no.”
Source: Reprinted from June 26, 2008 issue of BusinessWeek by special permission, copyright © 2008 by The McGraw-Hill Companies, Inc., Karen E. Klein, “Resolving a Conflict of Interest,” BusinessWeek Online, p. 16.
E T H I C S
THE LIMITED LIABILITY COMPANY
As stated earlier, the new flexibility offered by LLC status has enhanced its choice by en-
trepreneurs. The tax rules for an LLC fall under Subchapter K, and this business form is
considered a partnership-corporation hybrid with the following characteristics:
• Whereas the corporation has shareholders and partnerships have partners, the LLC has members.
• No shares of stock are issued, and each member owns an interest in the business as designated by the articles of organization, which is similar to the articles of
incorporation or certificates of partnership.
• Liability does not extend beyond the member’s capital contribution to the business. Thus, there is no unlimited liability, which can be detrimental in a proprietorship or
general partnership.
• Members may transfer their interest only with the unanimous written consent of the remaining members.
• The Internal Revenue Service now automatically treats LLCs as partnerships for tax purposes, unless another option is elected. Thus, as mentioned earlier in this chapter,
members may elect to designate the firm as a partnership or a corporation.
• The standard acceptable term of an LLC is 30 years. Dissolution is also likely when one of the members dies, the business goes bankrupt, or all members choose to
dissolve the business. Some states allow continuity with majority or unanimous
consent of the members. One of the important characteristics of the LLC is that the
laws governing its formation differ from state to state. Thus, a firm that is operating
in more than one state may be subject to different treatment. An analysis of these
differences should be considered before choosing this form of organization.
Advantages of an LLC
A number of advantages of an LLC over an S corporation are described here.6
• In a highly leveraged enterprise, the LLC offers the partnership a distinct advantage over an S corporation in that the partners can add their proportionate shares of the
LLC liabilities to their partnership interests.
• With the exception of Texas and Pennsylvania, states do not tax LLCs.
• One or more (without limit) individuals, corporations, partnerships, trusts, or other entities can join to organize or form an LLC. This is not feasible in an S corporation.
• Members are allowed to share income, profit, expense, deduction, loss and credit, and equity of the LLC among themselves. This is the only form of organization that offers
all these features.
The one major concern with the LLC is in international business, where the context of
unlimited liability is still unclear. Otherwise the LLC offers all the distinct advantages
of a C corporation but with a pass-through tax to the members. Owners of an LLC can
neither be paid as employees nor participate in certain employee benefits. Instead they
are paid in the form of guaranteed payments with no federal or state withholding involved.
Thus, members are responsible for filing estimated taxes on a regular basis.7 The LLC
appears to be the favorite choice for venture capitalists since it offers more flexibility
based on the advantages already discussed. However, entrepreneurs should compare all
the alternative forms of organization before election. This should be done with the advice
of a tax attorney, since once a decision is made, it may be difficult to change without
some penalty.
DESIGNING THE ORGANIZATION
Generally, the design of the initial organization will be simple. In fact, the entrepreneur
may find that he or she performs all the functions of the organization alone. This is a com-
mon problem and a significant reason for many failures. The entrepreneur sometimes
thinks that he or she can do everything and is unwilling to give up responsibility to others
or even include others in the management team. In most cases when this occurs, the entre-
preneur will have difficulty making the transition from a start-up to a growing, well-managed
business that maintains its success over a long period of time. Regardless of whether one or
more individuals are involved in the start-up, as the workload increases, the organizational
structure will need to expand to include additional employees with defined roles in the
268 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
organization. Effective interviewing and hiring procedures will need to be implemented to
ensure that new employees will effectively grow and mature with the new venture. All the
design decisions involving personnel and their roles and responsibilities reflect the formal
structure of the organization. In addition to this formal structure there is an informal struc-
ture or organization culture that evolves over time that also needs to be addressed by the en-
trepreneur. Although we are speaking of an organization culture rather than an organization
design, the entrepreneur can have some control over how it evolves. Since issues related to
this culture can be just as critical as the formal design of the organization for ensuring a
successful and profitable enterprise, they will be discussed in more detail in the next
section of this chapter.
For many new ventures, predominantly part-time employees may be hired, raising im-
portant issues of commitment and loyalty that Jim Sinegal was able to successfully over-
come with some creativity in his organization. However, regardless of the number of actual
personnel involved in running the venture, the organization must identify the major activi-
ties required to operate it effectively.
The design of the organization will be the entrepreneur’s formal and explicit indication
to the members of the organization as to what is expected of them. Typically these expec-
tations can be grouped into the following five areas:8
• Organization structure. This defines members’ jobs and the communication and relationship these jobs have with each other. These relationships are depicted in an
organization chart.
• Planning, measurement, and evaluation schemes. All organization activities should reflect the goals and objectives that underlie the venture’s existence. The entrepreneur
must spell out how these goals will be achieved (plans), how they will be measured,
and how they will be evaluated.
• Rewards. Members of an organization will require rewards in the form of promotions, bonuses, praise, and so on. The entrepreneur or other key managers will need to be
responsible for these rewards.
• Selection criteria. The entrepreneur will need to determine a set of guidelines for selecting individuals for each position.
• Training. Training, on or off the job, must be specified. This training may be in the form of formal education or learning skills.
The organization’s design can be very simple—that is, one in which the entrepreneur
performs all the tasks (usually indicative of a start-up)—or more complex, in which other
employees are hired to perform specific tasks. As the organization becomes larger and more
complex, the preceding areas of expectation become more relevant and necessary.
Figure 9.1 illustrates two stages of development in an organization. In stage 1, the
new venture is operated by basically one person, the entrepreneur. This organizational
chart reflects the activities of the firm in production, marketing/sales, and administra-
tion. Initially, the entrepreneur may manage all these functions. At this stage, there is no
need for submanagers; the owner deals with everyone involved in the business and all
aspects of the operation. In this example, the president manages production, which may
be subcontracted; marketing and sales (possible use of agents or reps); and all adminis-
trative tasks such as bookkeeping, purchasing, and shipping. Planning, measurement
and evaluation, rewards selection criteria, and training would not yet be critical in the
organization.
As the business expands, the organization may be more appropriately described by
stage 2. Here, submanagers are hired to coordinate, organize, and control various aspects
C H A P T E R 9 THE ORGANIZATIONAL PLAN 269
of the business. In the example in Figure 9.1, the production manager is responsible for
quality control and assembly of the finished product by the subcontractor. The marketing
manager develops promotion and advertising strategy and coordinates the efforts of the
expanding rep organization. The administrative manager then assumes the responsibility
for all administrative tasks in the business operation. Here the elements of measurement,
evaluation, reward, selection, and training become apparent.
A third stage may exist when the firm achieves a much larger size (i.e., 1,000 employ-
ees). The activities below each manager in stage 2 would then be represented by a third
level of managers (i.e., quality control managers).
As the organization evolves, the manager or entrepreneur’s decision roles also become
critical for an effective organization. As an entrepreneur, the manager’s primary concern is
to adapt to changes in the environment and seek new ideas. When a new idea is found, the
entrepreneur will need to initiate development either under his or her own supervision
(stage 1 in Figure 9.1) or by delegating the responsibility to someone else in the organiza-
tion (stage 2 in Figure 9.1). In addition to the role of adaptor, the manager will also need to
respond to pressures such as an unsatisfied customer, a supplier reneging on a contract, or
a key employee threatening to quit. Much of the entrepreneur’s time in the start-up will be
spent “putting out fires.”
Another role for the entrepreneur is that of allocator of resources. The manager must de-
cide who gets what. This involves the delegation of budgets and responsibilities. The allo-
cation of resources can be a very complex and difficult process for the entrepreneur since
one decision can significantly affect other decisions. The final decision role is that of nego-
tiator. Negotiations of contracts, salaries, prices of raw materials, and so on, are an integral
part of the manager’s job, and since he or she can be the only person with the appropriate
authority, it is a necessary area of decision making.
270 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
FIGURE 9.1 Stages in Organizational Design
President
President
Marketing/SalesProduction
Stage 2
Stage 1
Administration
Administrative manager
Marketing manager
Production manager
Quality control
Assembly Sales Purchasing Promotion advertising
Finance accounting
Shipping/ receiving
C H A P T E R 9 THE ORGANIZATIONAL PLAN 271
BUILDING THE MANAGEMENT TEAM AND A SUCCESSFUL
ORGANIZATION CULTURE
In conjunction with the design of the organization the entrepreneur will need to assemble
the right mix of people to assume the responsibilities outlined in the organization structure.
Some of the issues identified in the organization design will be revisited here since they are
not only critical to the building of the team but are just as important in establishing a posi-
tive and successful organization culture. This strategy must be maintained through the
stages of start-up and growth of the enterprise. There are some important issues to address
before assembling and building the management team. In essence the team must be able to
accomplish three functions:
• Execute the business plan.
• Identify fundamental changes in the business as they occur.
• Make adjustments to the plan based on changes in the environment and market that will maintain profitability.
Although these functions may seem simple and easy to achieve, the people engaged
and the culture promoted by the entrepreneur are critical in accomplishing these func-
tions. As we discussed in the organization design section previously, the entrepreneur
will first need to assume the responsibility of determining what skills and abilities are
needed to meet the goals in the business plan. Not only are the skills and abilities impor-
tant, but the entrepreneur also will need to consider the personality and character of each
individual to create a viable organization culture. The organization culture will be a blend
of attitudes, behaviors, dress, and communication styles that make one business different
from another. There is no specific technique for accomplishing this since every organiza-
tion will be different. However, we will explore some of the important considerations and
strategies in recruiting and assembling an effective team and hence in creating an effec-
tive and positive organization culture.
First, the entrepreneur’s desired culture must match the business strategy outlined in the
business plan. For example, Fran Bigelow, founder of Fran’s Chocolates in Seattle, has
been able to get her team to consider themselves artisans, focus on detail, and strive for per-
fection. Fran feels that this strategy is effective for her venture because of her premium
product line but might result in disaster for someone marketing a high-volume, low-cost
manufactured product.9
Second, the leader of the organization must create a workplace where employees are
motivated and rewarded for good work. There are many different ways to motivate and re-
ward employees, as evidenced by Brad Nierenberg, cofounder of RedPeg Marketing, who
turned to unusual perks as incentives for employees. Trophies are handed out for good per-
formance, breakfast is provided at meetings, and the company even rents a house on the
beach that employees can sign up for year round. Nierenberg one time gave 38 employees
$1,000 each in cash because the company reached its planning goals. Besides the many
other perks that are provided, Brad has also eliminated some of these incentives when
things are not going well. However, Brad understands the difference between these perks
and life-altering incentives such as insurance, day care, or flextime. He understands that
taking away any of these significant incentives is what creates employee discontent and that
the fun perks are what keep his employees happy.10
Third, the entrepreneur should be flexible enough to try different things. This is not al-
ways possible in a very small organization but has been the successful strategy in the growth
of Google. The leadership of this company has an abundance of talent, and the attitude of
management is that this talent needs to be given enough flexibility to make decisions, as
long as they do so within the model established by the company. Founders Larry Page and
Sergey Brin have chosen a very flat organizational structure that they believe provides more
flexibility and in the long run provides the customer with a better product and better ser-
vice.11 Steven Jobs also believed in this approach. He moved key personnel to a separate
building and allowed them to spend all their working hours developing the new-generation
computer of that time, the Macintosh.
Fourth, it is necessary to spend extra time in the hiring process. There is sometimes
a tendency to want to hurry the process of finding the appropriate skills to fill the orga-
nization’s needs. As stated earlier, there is more to a person than his or her skills. Char-
acter is also an important factor in building an effective organization culture. One thing
that can be implemented is a hiring plan that establishes the procedure for screening,
interviewing, and assessing all candidates. Job descriptions, along with specifications of
the type of person who will match the desired culture, should be documented for this
process.
Next, the entrepreneur needs to understand the significance of leadership in the organi-
zation. Leadership should help to establish core values and provide the appropriate tools so
that employees can effectively complete their jobs. An approach such as, “We’re all in this
together, no one is bigger than anyone else, and here are the rules we live by,” can lead to
greater challenges and job satisfaction. A reward system, even to the extent offered by Brad
Nierenberg’s firm discussed earlier, can play an important role in providing consistent and
positive behavior patterns.
Finding the most effective team and creating a positive organization culture is a chal-
lenge for the entrepreneur but is just as critical as having an innovative, marketable prod-
uct. It is an important ingredient in an organization’s success.
272
A S S E E N I N BUSINESSWEEK
ELEVATOR PITCH FOR 20ⴛ200 WEB SITE
A friend of yours who loves to collect art has asked
you to find new Web-based businesses that she can
invest in that relate to the art industry. After reading
the following pitch, you think that your friend may
be interested in investing in this start-up. Would you
consider introducing Jen to your friend? How can she
address the issue regarding artists’ fear that their
work will be commoditized?
Her Web site is officially called 20x200, but founder
Jen Bekman calls her online mart the gateway drug to
the art world. The Manhattan gallery owner launched
the site in September 2007 to sell limited-edition
prints and photography at prices low enough to at-
tract first-time collectors, starting at $20 for a print
from a run of 200. Bekman, 39, worked for Internet
companies including Meetup before opening Jen
Bekman Gallery, where prices range from $1,000 to
$20,000. She bootstrapped the now-profitable Net
venture for less than $1,000, with the help of contacts
who donated time to get the site running. She now
runs it with a staff of five (plus contractors), who also
operate her gallery and a third venture, photo com-
petition Hey, Hot Shot! that leads her to many of the
photographers for 20x200. She splits profits 50-50 with
the artists, and her art-world cred assuages artists’
fears that their work will be commoditized. People
know that I am not just moving product, she says. But
the product moves nonetheless. The e-gallery has
shipped more than 40,000 prints, with $1.2 million in
revenue in 2008.*
*Source: Reprinted from April 28, 2009 issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Compa- nies, Inc., www.businessweek.com. “America’s Most Promising Startups,” www.businessweekonline.com/smallbiz by Nick Leiber.
C H A P T E R 9 THE ORGANIZATIONAL PLAN 273
THE ROLE OF A BOARD OF DIRECTORS
An entrepreneur may find it necessary in his or her organization plan to establish a board
of directors or board of advisors. The board of advisors is discussed in the next section. The
board of directors may serve a number of functions: (1) reviewing operating and capital
budgets, (2) developing longer-term strategic plans for growth and expansion, (3) support-
ing day-to-day activities, (4) resolving conflicts among owners or shareholders, (5) ensuring
the proper use of assets, or (6) developing a network of information sources for the entre-
preneurs. These functions may be a formal part of the organization, with responsibilities
assigned to the directors depending on the needs of the new venture.
Most important in establishing these responsibilities is the consideration of the impact of
the Sarbanes-Oxley Act passed in 2002. Passage of this act resulted because of accounting
irregularities, fraud, bankruptcy, insider trading, excessive management compensation, and
other illegal or unethical actions that have become newsworthy in the years leading up to 2002
(see Chapter 6 for more discussion of the Sarbanes-Oxley Act). Although there is still some
concern about the effectiveness of the new law, its intent is to establish a more independent
functioning board. This is particularly relevant in public companies where the board mem-
bers must represent all shareholders and are responsible for “blowing the whistle” on any
discrepancies that may be suspected. In spite of its intent, this act has come under criticism
in light of the economic crisis that led to the demise of a number of large financial services
companies. However, many feel that it is not the law that is the problem but more the issues
of having the right mix of board members. It is expected that because of the economic crisis
there will be a greater demand on boards to master the reforms of Sarbanes-Oxley and to be
more attentive to the expertise of appointed board members.12
Many start-up ventures do not plan to have a formal board of directors. However, if there
are equity investors, they will usually insist on the formation of a board and at least one
board seat. Julia Stamberger and Pam Jelaca, cofounders of GoPicnic, a company that sells
snack boxes and packaged meals to airlines, corporations, hotels, and event planners, did
not have a board in place and realized after their infusion of equity financing that they
would need to establish one. They found that the experience of the board was very positive
because it forced them into a discipline of financial reporting that they tended to avoid in
the past. This financial focus has helped them to prioritize things that are essential to their
fast-growing business.13
As we can see from the preceding example, the purpose of the board of directors is to
provide important leadership and direction for the new venture, and it should be carefully
chosen to meet the requirements of the Sarbanes-Oxley Act and also the following criteria:14
• Select individuals who can work with a diverse group and will commit to the venture’s mission.
• Select candidates who understand the market environment or can contribute important skills to the new venture’s achievement of planning goals.
• Select candidates who will show good judgment in business decision making.
Candidates should be identified using referrals of business associates or from any of the
external advisors such as banks, investors, lawyers, accountants, or consultants. Ideally, the
board should consist of 3, 5, 7, or some odd number of members to avoid deadlock and
with limited terms to allow for continuous infusion of new ideas from different people.
Board of director performance needs to be regularly evaluated by the entrepreneurs. It is
the chair’s responsibility to provide an appraisal of each board member. To provide this
appraisal, the chairperson (and/or founders) should have a written description of the re-
sponsibilities and expectations of each member.
Compensation for board members can be shares of stock, stock options, or dollar pay-
ment. Often the new venture will tie compensation to the performance of the new venture.
Compensation is important since it reinforces the obligation of board members. If board
members were only volunteers, they would tend to take the role lightly and not provide any
value to the entrepreneur.
THE BOARD OF ADVISORS
Compared to a board of directors, a board of advisors would be more loosely tied to the or-
ganization and would serve the venture only in an advisory capacity for some of the func-
tions or activities mentioned before. It has no legal status, unlike the board of directors, and
hence is not subject to the regulations stipulated in the Sarbanes-Oxley Act. These boards
are likely to meet less frequently or depending on the need to discuss important venture de-
cisions. A board of advisors is very useful in a family business where the board of directors
may consist entirely of family members.
The selection process for advisors can be similar to the process for selecting a board of
directors, including determining desired skills and interviewing potential candidates. Advi-
sors may be compensated on a per-meeting basis or with stock or stock options. Just as in
the case of the board of directors, the members should be evaluated as to their contribution
to meeting the mission of the new venture.
Boards of advisors can provide an important reality check for the entrepreneur or owner
of any noncorporate type of business. Robin Chase, the founder of Zipcar, a self-service car
rental business, regularly calls on a group of advisors to help her hash out ideas, provide
recommendations for advancing her company, or just get a sanity check.15 Agiliance Inc.,
a leading provider of IT risk and governance solutions, recently added five members to its
board of advisors. Having had great success with the concept, the company still felt that it
needed additional expertise in key areas of its growth strategies. The five new members all
represent significant expertise in the defined areas of growth.16 As we can see from these
two examples, the board of advisors represents an alternative or complementary option to
the entrepreneur in providing expertise in needed areas. The flexibility in size, background
requirements, number of meetings, and compensation makes these boards a very desirable
alternative to the more formal boards of directors.
THE ORGANIZATION AND USE OF ADVISORS
The entrepreneur will usually use outside advisors such as accountants, bankers, lawyers,
advertising agencies, and market researchers on an as-needed basis. These advisors, who
are separate from the more formal board of advisors, can also become an important part of
the organization and thus will need to be managed just like any other permanent part of the
new venture.
The relationship of the entrepreneur and outside advisors can be enhanced by seeking
out the best advisors and involving them thoroughly and at an early stage. Advisors should
be assessed or interviewed just as if they were being hired for a permanent position. Refer-
ences should be checked and questions asked to ascertain the quality of service as well as
compatibility with the management team.
Hiring and managing outside experts can be effectively accomplished by considering
these advisors as advice suppliers. Just as no manager would buy raw materials or supplies
without knowledge of their cost and quality, the same approval can apply for advisors.
Entrepreneurs should ask these advisors about fees, credentials, references, and so on,
before hiring them.
274 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
C H A P T E R 9 THE ORGANIZATIONAL PLAN 275
Even after the advisors have been hired, the entrepreneur should question their advice.
Why is the advice being given? Make sure you understand the decision and its potential im-
plications. There are many good sources of advisors, such as the Small Business Adminis-
tration, other small businesses, chambers of commerce, universities, friends, and relatives.
Careful evaluation of the entrepreneur’s needs and the competency of the advisor can make
advisors a valuable asset to the organization of a new venture.
IN REVIEW
S U M M A R Y
One of the most important decisions the entrepreneur(s) must make in the business plan
is the legal form of business. The three major legal forms of business are the proprietor-
ship, partnership, and corporation. Each differs significantly and should be evaluated
carefully before a decision is made. This chapter provides considerable insight and com-
parisons regarding these forms of business to assist the entrepreneur in this decision.
The S corporation and the limited liability company are alternative forms of business
that are gaining popularity. Each of these allows the entrepreneur to retain the protec-
tion from personal liability provided by a corporation as well as the tax advantages pro-
vided by a partnership. There are important advantages as well as disadvantages to
these forms of business, and entrepreneurs should carefully weigh both before deciding.
The organization plan for the entrepreneur also requires some major decisions that
could affect long-term effectiveness and profitability. It is important to begin the new
venture with a strong management team that is committed to the goals of the new
venture. The management team must be able to work together effectively toward
these ends.
The design of the organization requires the entrepreneur to specify the types of
skills needed and the roles that must be filled. These would be considered part of the
formal organization. In addition to the formal organization, the entrepreneur must
consider the informal organization or culture that is desired to match the strategy stip-
ulated in the business plan. This organization culture represents the attitudes, behav-
iors, dress, and communication styles that can differentiate one company from another.
Both of these are important in establishing an effective and profitable organization.
A board of directors or board of advisors can provide important management sup-
port for an entrepreneur starting and managing a new venture. Boards of directors are
now governed by the Sarbanes-Oxley Act, which was passed because of a rash of ille-
gal and unethical behaviors that were newsworthy. The intent of this new law is to
make the board of directors more independent and to make its members accountable
to the shareholders. The law is particularly relevant to public companies and has less
impact on privately held companies. The board of advisors is a good alternative to a
board of directors when the stock is held privately or in a family business.
In spite of the new regulations, a board of directors or advisors can still provide ex-
cellent support for an organization. Either one can be formed in the initial business
planning phase or after the business has been formed and financed. In either case the
selection of board members should be made carefully, so that members will take their
roles seriously and will be committed to their roles and responsibilities.
276 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
Advisors will also be necessary in the new venture. Outside advisors should be eval-
uated as if they were being hired as permanent members of the organization. Infor-
mation on their fees and referrals can help determine the best choices.
R E S E A R C H T A S K S
1. In this country, what proportion of all businesses are (a) proprietorships,
(b) partnerships, (c) private companies, and (d) public companies? Provide an
example of an industry that has a large share of proprietorships. Why is this the
case? Provide an example of an industry that has a large share of partnerships.
Why is this the case? Provide an example of an industry that has a large share of
private companies. Why is this the case? Provide an example of an industry that
has a large share of public companies. Why is this the case?
2. How much does it cost to set up a private company? What are the ongoing costs?
3. Study the local newspaper and choose three good examples and three poor
examples of job advertisements. Be prepared to explain your choices.
4. Interview five entrepreneurs about their use of a board of advisors. Ask who is on
the board, how the members were selected, how they were encouraged to join
the board, how useful the board has been, and so on.
C L A S S D I S C U S S I O N
1. Why would entrepreneurs open themselves up to personal financial losses by
choosing a proprietorship rather than a company form of organization?
2. Why do suppliers sometimes ask entrepreneurs of small companies to provide
personal guarantees for a line of business credit? If an entrepreneur is asked
(forced) to provide personal guarantees, then what personal protection does a
company as a legal form really provide?
3. Does the old saying “You get what you pay for” apply to a board of directors or a
board of advisors?
4. Design a structure for the following organization, and detail the changes that you
would make (if any) to that structure as the company develops.
a. Stage 1. You are the CEO of a company (“Party On”) that specializes in the sale
of party merchandise (e.g., paper cups, plates, and streamers). You have a retail
store and three employees, and you serve the local area. A differentiation
strategy is used. What structure (configuration, prime coordinating
mechanisms, and type of decentralization) are you going to implement and
why? Which is the key part of the organization?
b. Stage 2. After five years, Party On has expanded to 150 stores throughout the
United States. The company is still following a differentiation strategy, selling
primarily the same range of products in each store. What structure (configuration,
prime coordinating mechanisms, and type of decentralization) are you going to
implement and why? Which is the key part of the organization?
c. Stage 3. After a further seven years, Party On has expanded to 225 stores in the
United States, 57 stores in the U.K., 30 stores in Sweden, 10 stores in France,
8 stores in Mexico, and 5 stores in Germany. The company’s strategy is to sell its
range of products through company-owned stores at a premium price. What
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structure (configuration, prime coordinating mechanisms, and type of
decentralization) are you going to implement and why? Which is the key part
of the organization?
d. Stage 4. Not long after the new structure has been put in place, a consortium of
department stores offers you a very lucrative contract to sell Party On’s products
in its stores worldwide. Its requirement is that Party On’s current retail stores
must be closed over a five-year period (it doesn’t want to compete with Party
On), and it wants to offer the products at lower prices. You accept the terms
and conditions of the deal. What structure (configuration, prime coordinating
mechanisms, and type of decentralization) are you going to implement and
why? Which is the key part of the organization?
e. Stage 5. The contract has been enormously successful. Further, a number of
other opportunities have arisen. First, the founder and CEO of your major
supplier of party merchandise died and you were able to purchase the company
at a very reasonable price. Second, rather than close your outlet stores, which
are in excellent positions, you decided to sell sporting collectibles (e.g., baseball
cards, signed photographs, and jerseys) at a very nice mark-up indeed. However,
while U.S. sporting collectibles are somewhat popular outside the United
States, each country is quite different. What structure (configuration, prime
coordinating mechanisms, and type of decentralization) are you going to
implement and why? Which is the key part of the organization?
S E L E C T E D R E A D I N G S
Cooney, Thomas M. (June 2005). Editorial: What Is an Entrepreneurial Team? Interna- tional Small Business Journal, vol. 23, no. 3, pp. 226–35.
This article focuses on the role of the entrepreneurial team in industrial success. It argues that it is typically a myth to assume that the entrepreneur is a lone hero battling the storms of economic, government, social, and other environmental forces. These individuals play an important role in helping the venture through these external forces.
Ellentuck, Albert B. (October 2005). Converting a Sole Proprietorship into an LLC. Tax Adviser, vol. 36, no. 10, pp. 648–49.
This article presents a case study on the conversion of a sole proprietorship company to a limited liability company (LLC). It describes the filing information necessary and tax implications in the conversion.
Ellentuck, Albert B. (February 2009). Using a Limited Liability Partnership as the Entity of Choice. Tax Adviser, vol. 40, no. 2, pp. 124–25.
A case study regarding liability protection is presented in this article. The author notes that the limited liability partnership (LLP) or the registered limited liability partnership (RLLP) are very similar to the limited liability company (LLC). LLPs evolved because of the personal liability issues faced by partners in law and accounting firms. The article also lists the states where the LLP liability protection is similar to that afforded to LLC members.
Feltham, Tammi S.; Glenn Feltham; and James J. Barnett. (January 2005). The Depen- dence of Family Businesses on a Single Decision-Maker. Journal of Small Business Man- agement, vol. 43, no. 1, pp. 1–15.
This study focuses on the implications of dependence on a single individual in fam- ily businesses. It suggests that family businesses are highly dependent on a single
C H A P T E R 9 THE ORGANIZATIONAL PLAN 277
individual and that this dependence decreases with the age of the owner/manager and is significantly greater when the owner/manager’s family has voting control. In addition, a number of other factors are noted as related to the degree of depen- dence on a single individual.
Fiegener, Mark K. (September 2005). Determinants of Board Participation in the Strate- gic Decisions of Small Corporations. Entrepreneurship: Theory & Practice, vol. 29, no. 5, pp. 627–50.
Agency, strategic choice, and cognitive perspectives are used to identify the condi- tions under which chief executive officers of small private corporations involve the board of directors in strategic decisions. Boards are more likely to participate in strategic decisions when the firm is larger, the board has a critical mass of outside directors, or CEO power is low.
Gesiko, Agnes. (November 2008). Structure Counts! The Tax Implications Arising from the Formation, Operation and Liquidation of C Corporations, S Corporations, Partner- ships and Limited Liability Companies. Corporate Business Taxation Monthly, vol.10, no. 2, pp. 39–49.
This is a very comprehensive article that describes the differences in each of the organization legal structures available to an entrepreneur. The article focuses on both the tax and nontax implications of each of these legal business entities. Included are also advantages and disadvantages of each.
Goold, Michael; and Andrew Campbell. (March 2002). Do You Have a Well-Designed Organization? Harvard Business Review, pp. 117–24.
Creating a new organizational structure is one of the toughest—and most politically explosive—challenges that an executive faces. This article provides nine tests of organization design, which can be used either to evaluate an existing structure or to create a new one. Using this framework will help make the process more rational, shifting it away from issues of personality and toward strategy and effectiveness.
Hilzenrath, David S. (August 23, 2008). Sarbanes-Oxley Upheld by Court as Constitu- tional. Washington Post, p. D1.
This article describes the recent case challenging the heart of the Sarbanes-Oxley Act. The court dismissed the attempt to eliminate the nonprofit board that is set up to audit and police the accounting firms that audit public companies. The chal- lengers argued that the accounting oversight is a drag on the economy and they plan to appeal the decision. The article also provides more insight regarding the purpose of Sarbanes-Oxley.
O’Brien, Jeffrey M. (February 2, 2009). Zappos Knows How to Kick It. Fortune, vol. 159, no. 2, pp. 54–60.
Tony Hsieh, CEO of Zappos, an Internet footwear retailer, promotes an upbeat cor- porate culture that emphasizes having fun and even acting weird. As the founder of a company that has become one of the best places to work, he stresses core val- ues that includes such tenets as be humble, create fun, and deliver service, to name a few. Even though he had to lay off 124 workers, he still managed a 5 percent mar- gin on net sales and has also been able to maintain a high level of enthusiasm among existing employees because of his corporate culture approach.
Sonnenfeld, Jeffrey A. (September 2002). What Makes Great Boards Great. Harvard Business Review, pp. 106–13.
In light of the recent meltdowns of many once-great companies, enormous atten- tion has been focused on the companies’ boards. And yet a close examination of those boards reveals no broad pattern of incompetence or corruption. They passed the test that would normally be applied to ascertain whether a board of directors was likely to do a good job. This article argues that it is time for fundamentally new
278 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
thinking about how corporate boards should operate and be evaluated and that it is important to consider not only how the work of the board is structured but also how the board is managed.
Ward, John L.; and Corey Hansen. (July 2008). How To: Assemble a Board of Advisors, Inc., pp. 61–64.
This article provides some guidelines when there is a need to assemble a board of ad- visors. It begins with a determination of the venture’s key success factors. The board members should be considered only if they fulfill the need to build the business. Thus, the experience should be consistent with the long-term goals of the venture.
E N D N O T E S
1. See S. Greenhouse, “How Costco Became the Anti-Wal-Mart,” New York Times (July 17, 2005), Section BU, p. 1; Jeff Chu, “Thinking Outside the Big Box,” Fast Company (November 2008), pp. 128–32; “Costco Wholesale Corp—First Quarter Operating Results for Fiscal 2009,” Market News Publishing Online (December 11, 2008); Mark Hamstra, “Jim Sinegal,” Supermarket News (July 21, 2008), p. 56.
2. Daniel S. Kleinberger, “The Closely Held Business through the Entity-Aggregate Prism,” Wake Forest Law Review (Fall 2005), pp. 827–81.
3. Agnes Gesiko, “Structure Counts! The Tax Implications Arising from the Forma- tion, Operation and Liquidation of C Corporations, S Corporations, Partner- ships and Limited Liability Companies,” Corporate Business Taxation Monthly (November 2008), pp. 39–49.
4. Zev Landau, “Recent Reform and Simplifications for S Corporations,” CPA Journal (November 2005), pp. 46–50.
5. Gesiko, “Structure Counts!”, pp. 39–42. 6. See Albert B. Ellentuck, “Using a Limited Liability Partnership as the Entity of
Choice,” Tax Advisor (February 2009), pp. 124–25; and Andrew Rinn, “S Corpo- ration Planning Opportunities: More Than Meets the Eye,” National Under- writer (October 6, 2008), pp. 32–33.
7. Robert M. DiGiantommaso, “LLC and LLP Issues for Small Privately Owned Busi- nesses,” Tax Advisor (January 2005), pp. 24–25.
8. J. W. Lorsch, “Organization Design: A Situational Perspective,” in J. R. Hackman, E. E. Lawler III, and L. W. Porter (eds.), Perspectives on Behavior in Organizations, 2nd ed. (Burr Ridge IL: McGraw-Hill/Irwin, 1983), pp. 439–47.
9. Steven T. Barnett, “Culture Is Critical to a Company’s Success,” Seattle Post- Intelligencer (April 14, 2003), p. C1.
10. Chris Penttila, “Employee Benefits in Today’s Economy,” Entrepreneur (January 2009), pp. 51–55.
11. David LaGesse, “Engine of Fun and Profit,” U.S. News and World Report (October 31, 2005), p. 26.
12. Michael P. Kelly and Dona E. Roche-Tarry, “Reshaping Your Board for Hard Times,” Corporate Board ( March 9, 2009), p. 6.
13. David Worrell, “Board Relations,” Entrepreneur (November 2008), p. 56. 14. Nicole Gull, “Assemble a Board of Directors,” Inc. (October 2004), p. 102. 15. Stephanie N. Mehta, “Experts for Hire,” Fortune Small Business (May 1, 2002), p. 67. 16. “Agiliance, Inc. Expands Board of Advisors,” Business Wire (April 1, 2008).
C H A P T E R 9 THE ORGANIZATIONAL PLAN 279
1
To understand the role of budgets in preparing pro forma statements.
2
To understand why positive profits can still result in a negative cash flow.
3
To learn how to prepare monthly pro forma cash flow, income, balance sheet, and sources and applications of funds statements for the first year of operation.
4
To explain the application and calculation of the break-even point for the new venture.
5
To illustrate the alternative software packages that can be used for preparing financial statements.
10 T H E F I N A N C I A L P L A N
L E A R N I N G O B J E C T I V E S
281
O P E N I N G P R O F I L E
TONY HSIEH
Not too many entrepreneurs have the goal of reaching a billion dollars in sales. At the
age of 35, Tony Hsieh (pronounced “Shay”) has reached this goal as the CEO and en-
trepreneurial brain behind Zappos.com. His serious entrepreneurial endeavors began
after graduation from Harvard University at the age of 23. He and classmate Sanjay
Madan saw opportunities for advertisers who wanted to con-
solidate large ad buys into a single package and subsequently
launched LinkExchange in the early 1990s. LinkExchange of-
fered small sites free advertising on a 2-to-1 basis. What this
meant was that for every two ads a member displayed on their site, they would be
granted one free ad on another member’s site. The excess ad credits not used were then
sold by LinkExchange to nonmembers, resulting in a substantial revenue stream. After
getting investment capital in 1997, the company was seen as a serious player in the Inter-
net advertising market and was subsequently purchased by Microsoft for $265 million in
1998. After this success Tony co-founded Venture Frogs, which invested in Internet start-
ups such as Ask Jeeves, Tellme Networks, and Zappos.com. In 1999, as an investor he be-
gan to look more seriously at the long-term potential of Zappos.com. Initially, he was an
advisor and consultant to Zappos.com, but eventually he joined the company full time in
2000 as co-CEO. He later took over the reins completely and moved the operation to Las
Vegas because of the lower real estate rates and abundance of call-center workers. Under
his leadership the company grew from $1.6 million in sales in 2000 to more than $1 billion
in sales in 2008. In fact the company doubled its sales every year from 1999 to 2008.
Tony realized when he joined Zappos.com that the Internet had not become a major
player as a shopping choice for consumers. He discovered that the footwear industry,
at $40 billion per year, was mostly a result of retail store sales and that only 5 percent
of the sales came from mail-order catalogs. He saw this as a huge opportunity for the
company, particularly since he believed that the Web would surpass mail-order busi-
ness as a percentage of total sales. Thus, he saw 5 percent of $40 billion as a reason-
able goal for his business.
Tony’s business model was unique and to some retailers costly, yet it has been ex-
tremely successful. Part of Hsieh’s approach is to focus on customer service. Zappos
offers free shipping, fast delivery, and a 365-day return policy. He even relocated his
www.zappos.com
warehouse to Kentucky to be nearer the UPS hub and to ensure the fast delivery of the
products offered, which has recently expanded to clothing, handbags, and accessories.
The company’s focus on customer service is designed to make sure the customer has a
quality experience from beginning to end. In addition, all employees once hired must
complete a four-week customer loyalty training program to make sure they under-
stand the culture that has made the company so successful. To ensure that the hires are
serious, Tony makes a visit during the second week and offers anyone $2,000 if they
would like to drop out and quit the program. Only 1 percent of the hires have taken
him up on the offer. The unique culture of the company also includes such things as
happy hours, a nap room, fully paid health insurance, and life-related issue support
that Tony pays for out of his own pocket. His philosophy regarding these strategies is
that only a happy employee can provide great service.
Once Zappos wins over a customer (75 percent of the customers are repeaters), the
company tries to ensure their continued interest by keeping them engaged in various
online and social media outlets. Customers are invited to submit reviews and to share
their experience with others. This not only enhances each customer’s loyalty but also
attracts new customers.
Although these services, both at the employee and customer level, are costly to the
company, Tony believes that they are crucial in maintaining a competitive edge and
were important in achieving the $1 billion in sales. Good budgeting and financial plan-
ning are also significant factors in helping to reach these lofty goals.1
282 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
The financial plan provides the entrepreneur with a complete picture of how much and
when funds are coming into the organization, where funds are going, how much cash is avail-
able, and the projected financial position of the firm. It provides the short-term basis for bud-
geting control and helps prevent one of the most common problems for new ventures—lack of
cash. We can see from the preceding example how important it is to understand the role of the
financial plan. Without careful financial planning, especially in light of the costly customer
services, Zappos.com could have suffered serious cash flow problems. The financial plan
must explain to any potential investor how the entrepreneur plans to meet all financial obliga-
tions and maintain the venture’s liquidity in order to either pay off debt or provide a good re-
turn on investment. In general, the financial plan will need three years of projected financial
data to satisfy any outside investors. The first year should reflect monthly data.
This chapter discusses each of the major financial items that should be included in the fi-
nancial plan: pro forma income statements, pro forma cash flow, pro forma balance sheets,
and break-even analysis. As we saw in the Zappos.com example, Internet start-ups have
some unique financial characteristics, which are included in the discussion that follows.
OPERATING AND CAPITAL BUDGETS
Before developing the pro forma income statement, the entrepreneur should prepare oper-
ating and capital budgets. If the entrepreneur is a sole proprietor, then he or she is respon-
sible for the budgeting decisions. In the case of a partnership, or where employees exist, the
initial budgeting process may begin with one of these individuals, depending on his or her
role in the venture. For example, a sales budget may be prepared by a sales manager, a
manufacturing budget by the production manager, and so on. Final determination of these
budgets will ultimately rest with the owners or entrepreneurs.
As can be seen in the following, in the preparation of the pro forma income statement, the
entrepreneur must first develop a sales budget that is an estimate of the expected volume of
sales by month. Methods of projecting sales are discussed next. From the sales forecasts the
entrepreneur will then determine the cost of these sales. In a manufacturing venture the
entrepreneur could compare the costs of producing these internally or subcontracting them to
another manufacturer. Also included will be the estimated ending inventory needed as a buffer
against possible fluctuations in demand and the costs of direct labor and materials.
Table 10.1 illustrates a simple format for a production or manufacturing budget for the
first three months of operation. This provides an important basis for projecting cash flows
for the cost of goods produced, which includes units in inventory. The important informa-
tion from this budget is the actual production required each month and the inventory that is
necessary to allow for sudden changes in demand. As can be seen, the production required
in the month of January is greater than the projected sales because of the need to retain
100 units in inventory. In February the actual production will take into consideration the in-
ventory from January as well as the desired number of units needed in inventory for that
month. This continues for each month, with inventory needs likely increasing as sales in-
crease. Thus, this budget reflects seasonal demand or marketing programs that can increase
demand and inventory. The pro forma income statement will only reflect the actual cost of
goods sold as a direct expense. Thus, in those ventures in which high levels of inventory are
necessary or where demand fluctuates significantly because of seasonality, this budget can
be a very valuable tool to assess cash needs.
After completing the sales budget, the entrepreneur can then focus on operating costs. First
a list of fixed expenses (incurred regardless of sales volume) such as rent, utilities, salaries, ad-
vertising, depreciation, and insurance should be completed. Estimated costs for many of these
items can be ascertained from personal experience or industry benchmarks, or through direct
contact with real estate brokers, insurance agents, and consultants. Industry benchmarks for
preparing financial pro forma statements were discussed in the financial plan section of
Chapter 7 (see Table 7.2 for a list of financial benchmark sources). Anticipation of the addition
of space, new employees, and increased advertising can also be inserted in these projections as
deemed appropriate. These variable expenses must be linked to strategy in the business plan.
Table 10.2 provides an example of an operating budget. In this example, we can see that
salaries increase in month 3 because of the addition of a shipper, advertising increases because
the primary season for this product is approaching, and payroll taxes increase because of
the additional employee. This budget, along with the manufacturing budget illustrated in
Table 10.1, provides the basis for the pro forma statements discussed in this chapter.
TABLE 10.1 A Sample Manufacturing Budget for First Three Months
Jan. Feb. Mar.
Projected sales (units) 5,000 8,000 12,000
Desired ending inventory 100 200 300
Available for sale 5,100 8,200 12,300
Less: beginning inventory 0 100 200
Total production required 5,100 8,100 12,100
C H A P T E R 10 THE FINANCIAL PLAN 283
284
TABLE 10.2 A Sample Operating Budget for First Three Months ($000s)
Expense Jan. Feb. Mar.
Salaries $23.2 $23.2 $26.2
Rent 2 2 2
Utilities 0.9 0.9 0.9
Advertising 13.5 13.5 17
Selling expenses 1 1 1
Insurance 2 2 2
Payroll taxes 2.1 2.1 2.5
Depreciation 1.2 1.2 1.2
Office expenses 1.5 1.5 1.5
Total expenses $47.4 $47.4 $54.3
ARE YOU A GOOD LEADER?
You will be if you draw on key ethical principles.
Here’s how to do it, whether you’re a CEO, a banker,
an entrepreneur, or anyone else in business.
I propose the following leadership guidelines for
C-level executives, investment bankers, entrepreneurs,
and everyone else whose decisions can affect the
financial well being of other people.
1. What’s Good for the Gander Is Good for the
Goose.
At a time when companies are slashing their la-
bor forces and freezing salary increases, and
when some employees are being asked to take
lower-paying positions, it is deeply unethical for
leaders to retain their sky-high compensation
and to expect enormous bonuses.
2. Know Your Product.
According to a recent three-part story in The
Wall Street Journal, the willingness of investors
to buy and sell financial products whose com-
plexity they didn’t fully understand was one of
the primary catalysts of the bust.
Because money was being made in these deals,
no one thought to question what was going on
or had the strength of character to speak up
about any suspicions. However, knowing your
product isn’t a nicety of doing business. It is an
ethical obligation—to your company, your
clients, and yourself.
3. Winning [at All Costs] Is for Losers.
Most of us were taught that we should treat peo-
ple the way we’d like to be treated ourselves.
However, too many business leaders have failed
to take this seriously. Instead, the guideline seems
to be, “Get all you can by any means necessary.”
4. Tell the Truth.
A leader has an ethical obligation to be honest
with stakeholders about issues that directly con-
cern them.
5. Prevent Harm.
When you can reasonably foresee that a deci-
sion is likely to hurt people and you make that
decision anyway, you’re being both irrespon-
sible and stupid. For example, subprime
mortgage lenders and brokers who lend money
to people likely to default are enriching them-
selves at the expense of the rest of us, since the
federal government may be called upon for
financial rescue.
6. Don’t Exploit.
It is easy to take advantage of a situation for
financial gain, but doing so isn’t consistent with
E T H I C S
Capital budgets are intended to provide a basis for evaluating expenditures that will
impact the business for more than one year. For example, a capital budget may project
expenditures for new equipment, vehicles, computers, or even a new facility. It may also
consider evaluating the costs of make or buy decisions in manufacturing or a comparison
of leasing, buying used, or buying new equipment. Because of the complexity of these
decisions, which can include the computation of the cost of capital and the anticipated
return on the investment using present value methods, it is recommended that the entrepre-
neur enlist the assistance of an accountant.
PRO FORMA INCOME STATEMENTS
The marketing plan discussed in Chapter 8 provides an estimate of sales for the next
12 months. Since sales are the major source of revenue and since other operational activi-
ties and expenses relate to sales volume, it is usually the first item that must be defined.
Table 10.3 summarizes all the profit data during the first year of operations for
MPP Plastics. This company makes plastic moldings for such customers as hard goods
285
good leadership. After Hurricane Ike hit last
year, the wholesale price of gasoline shot up,
which was nothing more than price gouging.
In the short run, companies that exploited a nat-
ural tragedy may have profited financially, but
the long-term negative consequences are real
and significant: In New York State, for example,
more than a dozen companies were fined more
than $60,000 for unfair business practices fol-
lowing Hurricane Katrina.
7. Don’t Make Promises You Can’t Keep . . .
. . . and keep the promises you make. There are
rare circumstances in which we not only have a
right but an ethical obligation to break a prom-
ise, but generally speaking, we have a strong
duty to be true to our word.
8. Take Responsibility for Your Mistakes.
Transparency and accountability should be the
new buzzwords. This means, in part, that busi-
ness leaders who make mistakes should apolo-
gize to those they have let down and do what-
ever is necessary to make amends. In the wake
of the toy industry’s lead-paint scare in 2007,
Mattel CEO Robert Eckert took the high road
and told a Senate subcommittee that the com-
pany failed “by not closely overseeing subcon-
tractors in China whose toys didn’t meet U.S.
safety standards,” and that Mattel was
working with the Consumer Product Safety
Commission to ensure that these products
would be safer.
9. People, Not Profits.
Money has no intrinsic value; it is good only for
what it can get us. For the good leader, this
means that the ultimate goal in business—and
life—is not hoarding riches but making things
better for all, especially the neediest.
10. Be Kind, Not King.
The relentless quest to be No.1 can blind us to
what’s really valuable in life: being a decent hu-
man being. Yes, good leaders are enthusiasti-
cally devoted to accomplishing their mission, but
this pursuit cannot be at the expense of the well
being of others.
It should be obvious by now that the above rules
apply not just to those in the financial sector but to
everyone else, too. They are, after all, based on the
five fundamental principles of ethics: Do No Harm,
Make Things Better, Respect Others, Be Fair, and Be
Loving. As Peter Drucker pointed out, it is not enough
to do things right; we must also do the right things.
The good leader today is concerned not only with get-
ting from A to B, but with deciding whether B is worth
getting to in the first place.
Source: Reprinted from February 2, 2009 issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Compa- nies, Inc., “Are You a Good Leader?” by Bruce Weinstein, BusinessWeek Online, p. 13.
manufacturers, toy manufacturers, and appliance manufacturers. As can be seen from the
pro forma income statement in Table 10.3, the company begins to earn a profit in the
eleventh month. Cost of goods sold remains consistent at 50 percent of sales revenue.
In preparation of the pro forma income statement, sales by month must be calculated
first. Marketing research, industry sales, and some trial experience might provide the basis
for these figures. Forecasting techniques such as survey of buyers’ intentions, composite of
sales force opinions, expert opinions, or time series may be used to project sales.2 It may
also be possible to find financial data on similar start-ups to assist with these projections.
As would be expected, it will take a while for any new venture to build up sales. The costs
for achieving these increases can be disproportionately higher in some months, depending
on the given situation in any particular period.
Sales revenue for an Internet start-up is often more difficult to project since extensive
advertising will be necessary to attract customers to the Web site. For example, a giftware
Internet company can anticipate no sales in the first few months until awareness of the Web
site has been created. Heavy advertising expenditures (discussed subsequently) also will be
incurred to create this awareness. Given existing data on the number of “hits” by a similar
type of Web site, a giftware Internet start-up could project the number of average hits ex-
pected per day or month. From the number of hits, it is possible to project the number of
consumers who will actually buy products from the Web site and the average dollar amount
per transaction. Using a reasonable percentage of these “hits” times the average transaction
will provide an estimate of sales revenue for the Internet start-up.
The pro forma income statements also provide projections of all operating expenses for
each of the months during the first year. As discussed earlier and illustrated in Table 10.2,
286 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
TABLE 10.3 MPP Plastics Inc., Pro Forma Income Statement, First Year by Month ($000s)
Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. Totals
Sales 20.0 32.0 48.0 70.0 90.0 100.0 100.0 100.0 80.0 80.0 120.0 130.0 970.0
Less: Cost of goods sold 10.0 16.0 24.0 35.0 45.0 50.0 50.0 50.0 40.0 40.0 60.0 65.0 485.0
Gross profit 10.0 16.0 24.0 35.0 45.0 50.0 50.0 50.0 40.0 40.0 60.0 65.0 485.0
Operating expenses
Salaries* 23.2 23.2 26.2 26.2 26.2 26.2 26.2 26.2 26.2 26.2 26.2 26.2 308.4
Rent 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 24.0
Utilities 0.9 0.9 0.9 0.8 0.8 0.8 0.9 0.9 0.9 0.8 0.8 0.9 10.3
Advertising 13.5 13.5 17.0 17.0 17.0 17.0 14.0 14.0 14.0 21.0† 17.0 17.0 192.0
Sales expenses 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 12.0
Insurance 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 24.0
Payroll taxes 2.1 2.1 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 29.2
Depreciation‡ 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 14.4
Office expenses 1.5 1.5 1.5 1.7 1.8 2.0 2.0 2.0 1.8 1.8 2.2 2.2 22.0
Total operating expenses 47.4 47.4 54.3 54.4 54.5 54.7 51.8 51.8 51.6 58.5 54.9 55.0 636.3
Gross profit (37.4) (31.4) (30.3) (19.4) (9.5) (4.7) (1.8) (1.8) (11.6) (18.5) 5.1 10.0 (151.3)
*Added shipper in month 3. †Trade show ‡Plant and equipment of $72,000 depreciated straight line for five years.
pro forma income
Projected net profit
calculated from projected
revenue minus projected
costs and expenses
each of the expenses should be listed and carefully assessed to make sure that any increases
in expenses are added in the appropriate month.3 For example, selling expenses such as
travel, commissions, and entertainment should be expected to increase somewhat as terri-
tories are expanded and as new salespeople or representatives are hired by the firm. Selling
expenses as a percentage of sales also may be expected to be higher initially since more
sales calls will have to be made to generate each sale, particularly when the firm is an un-
known. The cost of goods sold expense can be determined either by directly computing the
variable cost of producing a unit times the number of units sold or by using an industry
standard percentage of sales. For example, for a restaurant, the National Restaurant Asso-
ciation or Food Marketing Institute publishes standard cost of goods as a percentage of sales.
These percentages are determined from members and studies completed on the restaurant
industry. Other industries also publish standard cost ratios, which can be found in sources
such as those listed in Table 7.2. Trade associations and trade magazines will also often
quote these ratios in industry newsletters or trade articles.
Salaries and wages for the company should reflect the number of personnel employed
as well as their role in the organization (see the organization plan in Chapter 9). As new
personnel are hired to support the increased business, the costs will need to be included
in the pro forma statement. In March, for example, a shipper is added to the staff. Other
increases in salaries and wages may also reflect raises in salary.
The entrepreneur should also consider increasing selling expenses as sales increase, ad-
justing taxes because of the addition of new personnel or raises in salary, increasing office
expenses relative to the increase in sales, and modifying the advertising budget as a result
of seasonality or simply because in the early months of start-up the budget may need to be
higher to increase visibility. These adjustments actually occur in our MPP Plastics example
(Table 10.3) and are reflected in the month-by-month pro forma income statement for year 1.
Any noteworthy changes that are made in the pro forma income statement are also labeled,
with explanations provided.
In addition to the monthly pro forma income statement for the first year, projections
should be made for years 2 and 3. Generally, investors prefer to see three years of income
projections. Year 1 totals have already been calculated in Table 10.3. Table 10.4 illustrates
the yearly totals of income statement items for each of the three years. Calculation of the
percent of sales of each of the expense items for year 1 can be used by the entrepreneur as
a guide for determining projected sales and expenses for year 2; those percentages then can
be considered in making the projections for year 3. In addition, the calculation of percent
of sales for each year is useful as a means of financial control so that the entrepreneur can
ascertain whether any costs are too high relative to sales revenue. In year 3, the firm expects
to significantly increase its profits as compared with the first and second years. In some in-
stances, the entrepreneur may find that the new venture does not begin to earn a profit un-
til sometime in year 2 or 3. This often depends on the nature of the business and start-up
costs. For example, a service-oriented business may take less time to reach a profitable
stage than a high-tech company or one that requires a large investment in capital goods and
equipment, which will take longer to recover.
In the pro forma statements for MPP Plastics (Tables 10.3 and 10.4), we can see that the
venture begins to earn a profit in the eleventh month of year 1. In the second year, the company
does not need to spend as much money on advertising and, with the sales increase, shows a
modest profit of $16,300. However, in year 3 we see that the venture adds an additional em-
ployee and also incurs a 26 percent increase in sales, resulting in a net profit of $127,900.
In projecting the operating expenses for years 2 and 3, it is helpful to first look at those
expenses that will likely remain stable over time. Items like depreciation, utilities, rent, in-
surance, and interest are likely to remain steady unless new equipment or additional space
is purchased. Some utility expenses such as heat and power can be computed by using
C H A P T E R 10 THE FINANCIAL PLAN 287
industry standard costs per square foot of space that is utilized by the new venture. Selling
expenses, advertising, salaries and wages, and taxes may be represented as a percentage of
the projected net sales. When calculating the projected operating expenses, it is most im-
portant to be conservative for initial planning purposes. A reasonable profit that is earned
with conservative estimates lends credibility to the potential success of the new venture.
For the Internet start-up, capital budgeting and operating expenses will tend to be consumed
by equipment purchasing or leasing, inventory, and advertising expenses. For example, the gift-
ware Internet company introduced earlier would need to purchase or lease an extensive amount
of computer equipment to accommodate the potential buyers from the Web site. Inventory
costs would be based on the projected sales revenue just as would be the case for any retail
store. Advertising costs, however, would need to be extensive to create awareness for the gift-
ware Web site. These expenses would typically involve a selection of search engines such as
Yahoo!, Lycos, MSN, and Google; links from the Web sites of magazines such as Woman’s
Day, Family Circle, and Better Homes and Gardens; and extensive media advertising in maga-
zines, television, radio, and print—all selected because of their link to the target market.
PRO FORMA CASH FLOW
Cash flow is not the same as profit. Profit is the result of subtracting expenses from sales,
whereas cash flow results from the difference between actual cash receipts and cash pay-
ments. Cash flows only when actual payments are received or made. Sales may not be re-
garded as cash because a sale may be incurred but payment may not be made for 30 days. In
288 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
TABLE 10.4 MPP Plastics Inc., Pro Forma Income Statement, Three-Year Summary ($000s)
Percent Year 1 Percent Year 2 Percent Year 3
Sales 100.0 970.0 100.0 1,264.0 100.0 1,596.0
Less: Cost of goods sold 50.0 485.0 50.0 632.0 50.0 798.0
Gross profit 50.0 485.0 50.0 632.0 50.0 798.0
Operating expenses
Salaries 31.8 308.4 24.4 308.4 21.8 348.4
Rent 2.5 24.0 1.9 24.0 1.5 24.0
Utilities 1.1 10.3 0.8 10.3 0.7 10.3
Advertising 19.8 192.0 13.5 170.0 11.3 180.0
Sales expenses 1.2 12.0 1.0 12.5 0.8 13.5
Insurance 2.4 24.0 1.9 24.0 1.5 24.0
Payroll & misc. taxes 3.0 29.2 2.3 29.2 2.0 32.0
Depreciation 1.5 14.4 1.1 14.4 0.9 14.4
Office expenses 2.3 22.0 1.8 22.5 1.5 23.5
Total operating expenses 65.6 636.3 48.7 615.3 42.0 670.1
Gross profit (loss) (15.6) (151.3) 1.3 16.3* 8.0 127.9*
Taxes 0.0 0.0 0.0 0.0 0.0 0.0
Net profit (15.6) (151.3) 1.3 16.3 8.0 127.9
*No taxes are incurred in profitable years 2 and 3 because of the carryover of losses in year 1.
addition, not all bills are paid immediately. On the other hand, cash payments to reduce the
principal on a loan do not constitute a business expense but do constitute a reduction of cash.
Also, depreciation on capital assets is an expense, which reduces profits, not a cash outlay.
For an Internet start-up such as our giftware company discussed earlier, the sales trans-
action would involve the use of a credit card in which a percentage of the sale would be
paid as a fee to the credit card company. This is usually between 1 and 3 percent depend-
ing on the credit card. Thus, for each sale only 97 to 99 percent of the revenue would be net
revenue because of this fee.
As stated at the beginning of this chapter, one of the major problems that new ventures
face is cash flow. On many occasions, profitable firms fail because of lack of cash. Thus,
using profit as a measure of success for a new venture may be deceiving if there is a signif-
icant negative cash flow.
For strict accounting purposes there are two standard methods used to project cash flow,
the indirect and the direct method. The most popular of these is the indirect method, which
is illustrated in Table 10.5. In this method the objective is not to repeat what is in the in-
come statement but to understand there are some adjustments that need to be made to the
net income based on the fact that actual cash may or may not have actually been received
or disbursed. For example, a sales transaction of $1,000 may be included in net income, but
if the amount has not yet been paid, no cash has been received. Thus, for cash flow pur-
poses there is no cash available from the sales transaction. For simplification and internal
monitoring of cash flow purposes, many entrepreneurs prefer a simple determination of
cash in less cash out. This method provides a fast indication of the cash position of the new
venture at a point in time and is sometimes easier to understand.
It is important for the entrepreneur to make monthly projections of cash like the monthly
projections made for profits. The numbers in the cash flow projections are constituted from
C H A P T E R 10 THE FINANCIAL PLAN 289
TABLE 10.5 Statement of Cash Flows: The Indirect Method
Cash Flow from Operating Activities (ⴙ or ⴚ Reflects Addition or Subtraction from Net Income)
Net income XXX
Adjustments to net income:
Noncash nonoperating items
depreciation and amortization XXX
Cash provided by changes in current assets or liabilities:
Increase( ) or decrease( ) in accounts receivable XXX
Increase( ) or decrease( ) in inventory XXX
Increase( ) or decrease( ) in prepaid expenses XXX
Increase( ) or decrease( ) in accounts payable XXX
Net cash provided by operating activities XX,XXX
Cash Flow from Other Activities
Capital expenditures ( ) (XXX)
Payments of debt ( ) (XXX)
Dividends paid ( ) (XXX)
Sale of stock ( ) XXX
Net cash provided by other activities (XXX)
Increase (Decrease) in Cash XXX
290
A S S E E N I N BUSINESSWEEK
PROVIDE ADVICE TO AN ENTREPRENEUR ABOUT SOLVING THEIR
CASH-FLOW PROBLEM TO STAY IN BUSINESS
Hot & Cold Inc., a plumbing and heating supply com-
pany in the heart of Virginia’s Shenandoah Valley, is
headed for the slaughterhouse. As the housing boom
grew, so did sales, from $7 million a year to $14 mil-
lion over four years. But as the company expanded,
its problems multiplied, and no amount of sales could
cover the warts. As the economy faltered and poor
management continued, revenue started dropping
by more than $2 million a year.
Crunching the numbers over the past five years
shows lost opportunity and bad financial manage-
ment have cost the company about $5 million in prof-
its. Overtime alone is about $250,000 a year. Today
Hot & Cold is at $6 million in sales and is running at a
loss in excess of $1 million. The bank is nervous, and
ready to pull the plug on its line of credit. The steady
supply of new business has dried up, and the three
owners’ lives are on the line. The old cash cow is
chopped meat.
To keep the company alive, they’ve mortgaged their
homes, maxed out their credit cards at usurious interest
rates, and cashed in their 401(k)s. Worker morale is
low, and employees are phoning it in because they are
convinced they’ll be out of a job tomorrow. As a result,
the few remaining clients are unhappy, and threaten-
ing to take their business elsewhere.
SOLUTION: CONTROL, CONTROL,
CONTROL The owners of Hot & Cold have three choices: Walk
away at great personal financial ruin; hope for a big
client to fly to their rescue and help them pay off
their huge debt; or take control of their own busi-
ness. They’re teetering on the verge of bankruptcy,
but it’s not too late.
The three guys who took over from the family
who founded Hot & Cold have no training as man-
agers. These are hard-working, talented contractors
and engineers with great knowledge of how to carry
plumbing and installation projects to completion.
But, for most of their careers, they worked for some-
body else.
First they need to sit down with each department
head and develop an adopting plan for cash manage-
ment. They need to be clear in their instructions, and
forceful in their insistence that there will be dire con-
sequences for failure to comply. Hold department
meetings at 8 a.m. on Monday, issue marching orders,
then meet again on Friday at 6 p.m. to see what did
and did not get done. Every job needs to be moni-
tored by microscope from start to finish.
It’ll hurt. Hot & Cold requires drastic internal over-
haul, including deep cuts in operating costs. They
can’t be “tepid” about this. At least 20% of their
workforce of 50 will have to be fired. This business
needs to get serious about collecting the cash that
clients owe them, even if they have to take a hit by
offering cash discounts or accepting partial payment
just to bring the money in.
I also recommend that they meet face to face with
their banker. If they’ve followed my advice so far,
they will be able to point to the cost measures al-
ready in place and forestall foreclosure on their loan.*
ADVICE TO AN ENTREPRENEUR An entrepreneur friend saw the above article and has
asked you for some advice:
1. My receivables are averaging about 75 days.
Should I be concerned that this will affect my
cash flow?
2. What can I do to get faster payments on my
billing?
3. My business is profitable, but I seem to always
run short of cash at the end of each month?
Why is that?
*Source: Reprinted from July 24, 2009 issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Compa- nies, Inc., www.businessweek.com, “Solve Your Cash-Flow Problem to Stay in Business,” by George Cloutier with Samantha Marshall.
the pro forma income statement with modifications made to account for the expected tim-
ing of the changes in cash. If disbursements are greater than receipts in any time period, the
entrepreneur must either borrow funds or have cash in a bank account to cover the higher
disbursements. Large positive cash flows in any time period may need to be invested in
short-term sources or deposited in a bank to cover future time periods when disbursements
are greater than receipts. Usually the first few months of the start-up will require external
cash (debt) to cover the cash outlays. As the business succeeds and cash receipts accumu-
late, the entrepreneur can support negative cash periods.
Table 10.6 illustrates the pro forma cash flow over the first 12 months for MPP Plastics.
As can be seen, there is a negative cash flow based on receipts less disbursements for the first
11 months of operation. The likelihood of incurring negative cash flows is very high for any
new venture, but the amount and length of time before cash flows become positive will vary,
depending on the nature of the business. In Chapter 13 we discuss how the entrepreneur can
manage cash flow in the early years of a new venture. For this chapter, we will focus on
how to project cash flow before the venture is launched.
The most difficult problem with projecting cash flows is determining the exact monthly
receipts and disbursements. Some assumptions are necessary and should be conservative so
that enough funds can be maintained to cover the negative cash months. In this firm, it is antic-
ipated that 60 percent of each month’s sales will be received in cash with the remaining 40 per-
cent paid in the subsequent month. Thus, in February we can see that the cash receipts from
sales totaled $27,200. This resulted from cash sales in February of 60 percent of $32,000, or
$19,200, plus the 40 percent of sales that occurred in January (.40 $20,000 $8,000) but
was not paid until February, thus resulting in the total cash received in February of $27,200.
This process continues throughout the remaining months in year 1.
Similar assumptions are made for the cost of goods disbursement. It is assumed in our
example that 80 percent of the cost of goods is paid in the month that it is incurred, with the
C H A P T E R 10 THE FINANCIAL PLAN 291
TABLE 10.6 MPP Plastics Inc., Pro Forma Cash Flow, First Year by Month ($000s)
Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.
Receipts
Sales 12.0 27.2 41.6 61.2 82.0 96.0 100.0 100.0 88.0 80.0 104.0 126.0
Disbursements
Equipment purchase 72.0 — — — — — — — — — — —
Cost of goods 8.0 14.8 22.4 37.6 43.0 49.0 50.0 50.0 42.0 40.0 56.0 60.0
Salaries 23.2 23.2 26.2 26.2 26.2 26.2 26.2 26.2 26.2 26.2 26.2 26.2
Rent 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0
Utilities 0.9 0.9 0.9 0.8 0.8 0.8 0.9 0.9 0.9 0.8 0.8 0.9
Advertising 13.5 13.5 17.0 17.0 17.0 17.0 14.0 14.0 14.0 21.0 17.0 17.0
Sales expense 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0
Insurance 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0
Payroll & misc. taxes 2.1 2.1 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
Office expenses 1.5 1.5 1.5 1.7 1.8 2.0 2.0 2.0 1.8 1.8 2.2 2.2
Inventory* 0.2 0.4 0.6 0.6 0.8 0.8 1.0 1.0 1.0 1.0 1.2 1.2
Total disbursements 126.4 61.4 76.1 91.4 97.1 103.3 101.6 101.6 93.4 98.3 110.9 115.0
Cash flow (114.4) (34.2) (34.5) (30.2) (15.1) (7.3) (1.6) (1.6) (5.4) (18.3) (6.9) 11.0
Beginning balance† 300.0 185.6 151.4 116.9 86.7 71.6 64.3 62.7 61.1 55.7 37.4 30.5
Ending balance 185.6 151.4 116.9 86.7 71.6 64.3 62.7 61.1 55.7 37.4 30.5 41.5
*Inventory is valued at cost or average of $2.00/unit. †Three founders put up $100,000 each for working capital through the first three years. After the third year the venture will need debt or equity financing for
expansion.
pro forma cash flow
Projected cash available
calculated from projected
cash accumulations
minus projected cash
disbursements
remainder paid in the following month. Thus, referring back to Table 10.3, we can note that
in February the actual cost of goods was $16,000. However, we actually pay only 80 percent
of this in the month incurred—but we also pay 20 percent of the cost of goods sold that
is still due from January. Thus, the actual cost of goods cash outflow in February is
.8 $16,000 .2 $10,000, or a total of $14,800.
Using conservative estimates, cash flows can be determined for each month. These cash
flow projections assist the entrepreneur in determining how much money he or she will
need to raise to meet the cash demands of the venture. In our example, the venture starts
with a total of $300,000, or $100,000 from each of the three founders. We can see that by
the twelfth month, the venture begins to turn a positive cash flow from operations, still
leaving enough cash available ($41,500) should the projections fall short of expectations.
If the entrepreneurs in our example had to use debt for the start-up, then they would need
to show the interest payments in the income statement as an operating expense and indicate
the principal payments to the bank as a cash disbursement, not as an operating expense.
This issue often creates cash flow problems for entrepreneurs when they do not realize that
debt is a cash disbursement only and that interest is an operating expense.
It is most important for the entrepreneur to remember that the pro forma cash flow, like
the income statement, is based on best estimates. A start-up venture in a weak economy
may find it necessary to revise cash flow projections frequently to ensure that their accu-
racy will protect the firm from any impending disaster. The estimates or projections should
include any assumptions so that potential investors will understand how and from where the
numbers were generated.4
In the case of both the pro forma income statement and the pro forma cash flow, it is
sometimes useful to provide several scenarios, each based on different levels of success of
the business. These scenarios and projections not only serve the purpose of generating pro
forma income and cash flow statements but, more importantly, familiarize the entrepreneur
with the factors affecting the operations.
PRO FORMA BALANCE SHEET
The entrepreneur should also prepare a projected balance sheet depicting the condition of
the business at the end of the first year. The balance sheet will require the use of the pro
forma income and cash flow statements to help justify some of the figures.5
The pro forma balance sheet reflects the position of the business at the end of the first
year. It summarizes the assets, liabilities, and net worth of the entrepreneurs.
Every business transaction affects the balance sheet, but because of the time and
expense, as well as need, it is common to prepare balance sheets at periodic intervals
(i.e., quarterly or annually). Thus, the balance sheet is a picture of the business at a certain
moment in time and does not cover a period of time.
Table 10.7 depicts the balance sheet for MPP Plastics. As can be seen, the total assets
equal the sum of the liabilities and owners’ equity. Each of the categories is explained here:
• Assets. These represent everything of value that is owned by the business. Value is not
necessarily meant to imply the cost of replacement or what its market value would
be but is the actual cost or amount expended for the asset. The assets are categorized
as current or fixed. Current assets include cash and anything else that is expected to be
converted into cash or consumed in the operation of the business during a period of
one year or less. Fixed assets are those that are tangible and will be used over a long
period of time. These current assets are often dominated by receivables or money that
is owed to the new venture from customers. Management of these receivables is
292 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
pro forma balance sheet
Summarizes the projected
assets, liabilities, and net
worth of the new venture
assets Items that are
owned or available to
be used in the venture
operations
important to the cash flow of the business since the longer it takes for customers to pay
their bills, the more stress is placed on the cash needs of the venture. A more detailed
discussion of the management of receivables is presented in Chapter 13.
• Liabilities. These accounts represent everything owed to creditors. Some of these
amounts may be due within a year (current liabilities), and others may be long-term
debts. There are no long-term liabilities in our MPP Plastics example because the
venture used funds from the founders to start the business. However, should the
entrepreneurs need to borrow money from a bank for the future purchase of equip-
ment or for additional growth capital, the balance sheet would show long-term lia-
bilities in the form of a note payable equal to the principal amount borrowed. As
stated earlier, any interest on this note would appear as an expense in the income
statement, and the payment of any principal would be shown in the cash flow state-
ment. Subsequent end-of-year balance sheets would show only the remaining
amount of principal due on the note payable. Although prompt payment of what is
owed (payables) establishes good credit ratings and a good relationship with suppli-
ers, it is often necessary to delay payments of bills to more effectively manage cash
flow. Ideally, any business owner wants bills to be paid on time by suppliers so that
he or she can pay any bills owed on time. Unfortunately, during recessions, many
C H A P T E R 10 THE FINANCIAL PLAN 293
TABLE 10.7 MPP Plastics Inc., Pro Forma Balance Sheet, End of First Year ($000s)
Assets
Current assets
Cash $41.5
Accounts receivable 52.0
Inventory 1.2
Total current assets $ 94.7
Fixed assets
Equipment 72.0
Less depreciation 14.4
Total fixed assets 57.6
Total assets $152.3
Liabilities and Owners’ Equity
Current liabilities
Accounts payable $13.0
Total liabilities $ 13.6
Owners’ equity
K. Peters 100.0
C. Peters 100.0
J. Welch 100.0
Retained earnings (160.7)
Total owners’ equity 148.7
Total liabilities and owners’ equity $152.3
liabilities Money that is
owed to creditors
firms hold back payment of their bills to better manage cash flow. The problem
with this strategy is that while the entrepreneur may think that slower payment of
bills will generate better cash flow, he or she may also find that customers are think-
ing the same thing, with the result that no one gains any cash advantage. More discus-
sion of this issue is also included in Chapter 13.
• Owner equity. This amount represents the excess of all assets over all liabilities. It
represents the net worth of the business. The $300,000 that was invested into the
business by MPP Plastics’ three entrepreneurs is included in the owners’ equity or net
worth section of the balance sheet. Any profit from the business will also be included
in the net worth as retained earnings. In our MPP Plastics example, retained earnings
is negative, based on the net loss incurred in year 1. Thus, revenue increases assets
and owners’ equity, and expenses decrease owners’ equity and either increase liabili-
ties or decrease assets.
BREAK-EVEN ANALYSIS
In the initial stages of the new venture, it is helpful for the entrepreneur to know when a
profit may be achieved. This will provide further insight into the financial potential for the
start-up business. Break-even analysis is a useful technique for determining how many
units must be sold or how much sales volume must be achieved to break even.
We already know from the projections in Table 10.3 that MPP Plastics will begin to earn
a profit in the eleventh month. However, this is not the break-even point since the firm has
obligations for the remainder of the year that must be met, regardless of the number of units
sold. These obligations, or fixed costs, must be covered by sales volume for a company to
break even. Thus, breakeven is that volume of sales at which the business will neither make
a profit nor incur a loss.
The break-even sales point indicates to the entrepreneur the volume of sales needed to
cover total variable and fixed expenses. Sales in excess of the break-even point will result
in a profit as long as the selling price remains above the costs necessary to produce each
unit (variable cost).6
The break-even formula is derived in Table 10.8 and is given as:
TFC B兾E(Q) ⫽ ————————————————
SP ⫺ VC兾Unit (marginal contribution)
where B兾E(Q) ⫽ break-even quantity
TFC ⫽ total fixed costs
SP ⫽ selling price
VC兾Unit ⫽ variable costs per unit
As long as the selling price is greater than the variable costs per unit, some contribution can
be made to cover fixed costs. Eventually, these contributions will be sufficient to pay all
fixed costs, at which point the firm has reached breakeven.
The major weakness in calculating the breakeven lies in determining whether a cost is
fixed or variable. For new ventures these determinations will require some judgment. How-
ever, it is reasonable to regard costs such as depreciation, salaries and wages, rent, and in-
surance as fixed. Materials, selling expenses such as commissions, and direct labor are
most likely to be variable costs. The variable costs per unit usually can be determined by
allocating the direct labor, materials, and other expenses that are incurred with the produc-
tion of a single unit.
294 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
breakeven Volume of
sales where the venture
neither makes a profit
nor incurs a loss
owner equity The
amount owners have
invested and/or retained
from the venture
operations
Recall that in our MPP Plastics example the venture produces plastic molded parts
for the toy industry and hard goods and appliance manufacturers. Since the company is
likely to be selling a large volume of these parts at various prices, it is necessary to
make an assumption regarding the average selling price based on production and sales
revenue. The entrepreneurs determine that the average selling price of all these compo-
nents is $4.00/unit. From the pro forma income statement (Table 10.4), we see that fixed
costs in year 1 are $636,300. We also know from our example that cost of goods sold is
50 percent of sales revenue, so we can assume a variable cost per unit of $2.00. Using
these calculations we can then determine the venture’s break-even point (B兾E) in units
as follows:
Any units beyond the 318,150 that are sold by the venture will result in a profit of $2.00 per
unit. Sales below this number will result in a loss for the company. In cases where the firm
produces more than one product and it is feasible to allocate fixed costs to each product,
then it is possible to calculate a break-even point for each product. Fixed costs are deter-
mined by weighting the costs as a function of the sales projections for each product. For ex-
ample, if it is assumed that 40 percent of the sales are for product X, then 40 percent of
fixed costs should be allocated to that product.
In our MPP Plastics example, the large number of different products and the size lots of
customer purchases prohibit any individual product break-even calculation. In this case we
estimate the average selling price of all components for use in our calculations.
⫽ 318,150 units
⫽ $636,300
$2.00
⫽ $636,300
$4.00 ⫺ $2.00
BⲐE ⫽ TFC
SP ⫺ VCⲐUnit
C H A P T E R 10 THE FINANCIAL PLAN 295
By definition, breakeven is
where Total Revenue (TR) ⫽ Total Costs (TC)
Also by definition:
(TR) ⫽ Selling Price (SP) ⫻ Quantity (Q)
and (TC) ⫽ Total Fixed Costs (TFC)* ⫹ Total Variable Costs (TVC)†
Thus: SP ⫻ Q ⫽ TFC ⫹ TVC
Where TVC ⫽ Variable Costs兾Unit (VC兾Unit)‡ ⫻ Quantity (Q)
Thus SP ⫻ Q ⫽ TFC ⫹ (VC兾Unit ⫻ Q )
(SP ⫻ Q ) ⫺ (VC兾Unit ⫻ Q ) ⫽ TFC
Q (SP ⫺ VC兾Unit) ⫽ TFC
Finally, Breakeven(Q ) ⫽ TFC
SP ⫺ VC兾Unit
TABLE 10.8 Determining the Break-Even Formula
*Fixed costs are those costs that, without change in present productive capacity, are not affected by changes in volume of output. †Variable costs are those that are affected in total by changes in volume of output. ‡The variable costs per unit is all those costs attributable to producing one unit. This cost is constant within defined ranges of
production.
One of the unique aspects of breakeven is that it can be graphically displayed, as in
Figure 10.1. In addition, the entrepreneur can try different states of nature (e.g., different
selling prices, different fixed costs and/or variable costs) to ascertain the impact on
breakeven and subsequent profits.
PRO FORMA SOURCES AND APPLICATIONS OF FUNDS
The pro forma sources and applications of funds statement illustrates the disposition of
earnings from operations and from other financing. Its purpose is to show how net income
and financing were used to increase assets or to pay off debt.
It is often difficult for the entrepreneur to understand how the net income for the year
was disposed of and the effect of the movement of cash through the business. Questions often
asked are, Where did the cash come from? How was the cash used? and What happened
to asset items during the period?
Table 10.9 shows the pro forma sources and applications of funds for MPP Plastics
Inc. after the first year of operation. Many of the funds were obtained from personal
funds or loans. Since at the end of the first year a profit was earned, it too would be
added to the sources of funds. Depreciation is added back because it does not represent
100 200 300 400 500
100
200
300
400
500
600
700
800
900
1,000
1,100
1,200
1,300
1,400
1,500
$ 000s TR at $4.00/unit FC
Units (000s)
B/E TC FIGURE 10.1 Graphic Illustration of Breakeven
pro forma sources and
applications of funds
Summarizes all the
projected sources of
funds available to the
venture and how these
funds will be disbursed
296 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
297
Source of funds
Personal funds of founders $ 300,000
Net income (loss) from operations (151,300)
Add depreciation 14,400
Total funds provided $163,100
Application of funds
Purchase of equipment $ 72,000
Inventory 1,200
Total funds expended 73,200
Net increase in working capital 89,900
$163,100
TABLE 10.9 MPP Plastics Inc., Pro Forma Sources and Applications of Funds, End of First Year
an out-of-pocket expense. Thus, typical sources of funds are from operations, new invest-
ments, long-term borrowing, and sale of assets. The major uses or applications of funds
are to increase assets, retire long-term liabilities, reduce owner or stockholders’ equity,
and pay dividends. The sources and applications of funds statement emphasizes the inter-
relationship of these items to working capital. The statement helps the entrepreneur as
well as investors to better understand the financial well-being of the company as well as
the effectiveness of the financial management policies of the company.
A S S E E N I N BUSINESSWEEK
ELEVATOR PITCH FOR BEER CHIPS
When Brett Stern sees a problem, he fixes it. A life-
long tinkerer, the 50-year-old inventor used his ex-
pertise in industrial design to market snack foods.
Unable to find a beer-flavored potato chip, Stern
whipped up his own batch. Within two years, he
was shipping packages of aptly named Beer Chips,
which retail from $1.39 to $3.60, to Whole Foods
(WFMI), SuperValu (SVU), and Publix grocery stores.
Stern used $11,200 of his own money to launch the
Portland (Ore.) company. He says he generated
$500,000 in revenue in 2007 and $1.3 million in
2008. He claims a profit margin of 11%, which he
credits to his virtual business model: He outsources
everything but the creativity. Controlling only the
design and direction of the product, he relies on
others to manufacture and distribute it. That keeps
his overhead low: His only employees—a book-
keeper and a marketer—both work part time from a
garage. Stern, who’s known to carry chip samples in
his car and give them to strangers, also keeps his eye
on the big picture. He hopes to create enough de-
mand for Beer Chips, with such new flavors as mar-
garita and Bloody Mary, that a snack-food company
will purchase it.*
A business associate has asked you to look for in-
teresting investment opportunities in the snack-food
market. He is willing to pay you a finder’s fee if you
provide a good investment opportunity. After learn-
ing about this start-up, you need to decide whether
to introduct Brett to your business associate. What
would you do? Why would this be a good long-term
investment, and what would be the risks?
*Source: Reprinted from June 9, 2009 issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Companies, Inc., “America’s Most Promising Startups: Beer Chips.” by Emily Schmitt, posted on June 9, 2009, www.businessweek.com/smallbiz/
298 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
SOFTWARE PACKAGES
There are a number of financial software packages available for the entrepreneur that can
track financial data and generate any important financial statement. For purposes of com-
pleting the pro forma statements, at least in the business planning stage, it is probably eas-
iest to use a spreadsheet program, since numbers may change often as the entrepreneur
begins to develop budgets for the pro forma statements. Microsoft Excel is the most widely
used spreadsheet software and is available in Macintosh and PC formats.
The value of using a spreadsheet in the start-up phase for financial projections is simply be-
ing able to present different scenarios and assess their impact on the pro forma statements. It
helps to answer such questions as, What would be the effect of a price decrease of 10 percent
on my pro forma income statement? What would be the impact of an increase of 10 percent in
operating expenses? and How would the lease versus purchase of equipment affect my cash
flow? This type of analysis, using the computer spreadsheet software, will provide a quick
assessment of the likely financial projections given different scenarios.
It is recommended in the start-up stage, where the venture is very small and limited in
time and resources, that the software selected be very simple and easy to use. The entrepre-
neur will need software to maintain the books and to generate financial statements. Most of
these software packages allow for check writing, payroll, invoicing, inventory manage-
ment, bill paying, credit management, and taxes.
The software packages vary in price and complexity. The simplest to use and least expen-
sive ($79 to $140) software products are QuickBooks (Intuit Inc.), Peachtree (Sage Software),
Microsoft Office Accounting, and CheckMark Software Inc. These packages offer basic pay-
roll and general ledger accounting software for the start-up venture. They typically offer
tutorials and support geared toward the successful implementation of these packages, partic-
ularly for new users. All these firms offer more comprehensive accounting software, as do
many other companies. Prices for these packages can range from $199 to $999 (and up)
depending on the comprehensiveness of the software. A simple Internet search will identify
hundreds of accounting software companies. The most basic and most popular comprehen-
sive packages are mentioned in the preceding, and these usually can be purchased online or
at a local computer store. If a more comprehensive package is needed, the entrepreneur
should discuss the options with a business associate, friend, or consultant who can
assess his or her needs, evaluate the benefits of the most appropriate options, and assist the
entrepreneur in selecting the package that will best fit the venture’s needs.
IN REVIEW
S U M M A R Y
This chapter introduces several financial projection techniques. A single fictitious ex-
ample of a new venture (MPP Plastics Inc.) is used to illustrate how to prepare each pro
forma statement. Each of the planning tools is designed to provide the entrepreneur
with a clear picture of where funds come from, how they are disbursed, the amount of
cash available, and the general financial well-being of the new venture.
The pro forma income statement provides a sales estimate in the first year (monthly
basis) and projects operating expenses each month. These estimates are determined
from the appropriate budgets, which are based on marketing plan projections and
objectives.
C H A P T E R 10 THE FINANCIAL PLAN 299
Cash flow is not the same as profit. It reflects the difference between cash actually
received and cash disbursements. Some cash disbursements are not operating expenses
(e.g., repayment of loan principal); likewise, some operating expenses are not a cash
disbursement (e.g., depreciation expense). Many new ventures have failed because of
a lack of cash, even when the venture is profitable.
The pro forma balance sheet reflects the condition of the business at the end of a
particular period. It summarizes the assets, liabilities, and net worth of the firm.
The break-even point can be determined from projected income. This measures the
point where total revenue equals total cost.
The pro forma sources and applications of funds statement helps the entrepreneur
to understand how the net income for the year was disposed of and the effect of the
movement of cash through the business. It emphasizes the interrelationship of assets,
liabilities, and stockholders’ equity to working capital.
Software packages to assist the entrepreneur in accounting, payroll, inventory,
billing, and so on are readily available. The cost of these packages will vary depending
on the size and type of business.
R E S E A R C H T A S K S
1. Research the software packages available to help entrepreneurs with the
financials for a business plan. Which do you believe is the best? Why?
2. Companies planning to make an initial public offering (IPO) must submit a
financial plan as part of their prospectus. From the Internet, collect a prospectus
from three different companies and analyze their financial plans. What were the
major assumptions made in constructing these financial plans? Compare and
contrast these financial plans with what we would expect of a financial plan as
part of a business plan.
3. Find an initial public offering prospectus for three companies. What items are
listed as assets? As liabilities? How much is the owners’ equity? For what purpose
do they say they are going to use the additional funds raised from the initial
public offering?
C L A S S D I S C U S S I O N
1. Is it more important for an entrepreneur to track cash or profits? Does it depend
on the type of business and/or industry? What troubles will an entrepreneur face if
she or he tracks only profits and ignores cash? What troubles will an entrepreneur
face if she or he tracks only cash and ignores profits?
2. What volume of sales is required to reach breakeven for the following business:
The variable cost of producing one unit of the product is $5, the fixed costs of
plant and labor are $500,000, and the selling price of a single product is $50. It
is not always easy to classify a cost as fixed or variable. What happens to the
breakeven calculated above if some of the fixed costs are reclassified as variable
costs? What happens if the reverse is the case (i.e., some of the variable costs are
reclassified as fixed costs)?
3. How useful is a financial plan when it is based on assumptions of the future and
we are confident that these assumptions are not going to be 100 percent correct?
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300 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
S E L E C T E D R E A D I N G S
Adelman, Philip J.; and Alan M. Marks. (2007). Entrepreneurial Finance—Finance for Small Businesses, 4th ed. Upper Saddle River, NJ: Prentice-Hall.
A practical-oriented text that focuses specifically on the needs of individuals start- ing their own businesses. Its emphasis is on financial issues for proprietorships, partnerships, limited liability companies, and S corporations. A unique chapter on personal finance has been added in this edition.
Bogoslaw, David. (November 11, 2008). How to Fix Financial Reporting, Business Week Online, p. 14.
Twenty of the wealthiest countries sent their finance ministers to a conference to discuss how to overhaul the global financial system. Basically, there needs to be a change in how companies think about capital markets, and they need to work more closely with customers, employees, and their supply chains. In addition, the author argues that changes are needed in the U.S. Generally Accepted Accounting Princi- ples (GAAP).
Carter, Richard B.; and Howard Van Auken. (2005). Bootstrap Financing and Owners’ Perceptions of Their Business Constraints and Opportunities. Entrepreneurship and Re- gional Development, vol. 17, no. 2, pp. 129–44.
The results of a regional survey of small-business entrepreneurs are presented. These entrepreneurs were queried regarding their use of and their motivation to use bootstrap financing. Extending the work of Winborg and Landstrom, these results indicate that perceived risk is highly associated with the owners’ assess- ment of the importance of bootstrap financing techniques. The results should be helpful to consultants and agencies that assist small firms with funding alternatives.
Gahagan, Jim. (2004). Reaching for Financial Success. Strategic Finance, vol. 20, no. 7, pp. 12–13.
This article discusses the importance of reaching financial success for a business en- terprise. As market conditions change dramatically within a single planning period, budgeting and planning forecasts and the financial plans they produce are critical to the business owner.
Jones, Craig. (February 2008). Reducing Operating Costs through Innovation. Conve- nience Store Decisions, pp. 6–8.
A small-business owner of a service center and car wash discusses how he was able to reduce costs through the integration of energy-cost-saving strategies. Not only were costs reduced, but profits and convenience to the employees and customers were increased.
Jordan, Charles E.; and Marilyn A. Waldron. (2001). Predicting Cash Flow from Opera- tions: Evidence on the Comparative Abilities for a Continuum of Measures. Journal of Applied Business Research, vol. 17, no. 3, pp. 87–94.
Prior studies have attempted to confirm or reject the assertion that accrual accounting measures provide better information for predicting cash flows than do cash basis measures. However, their results have proved largely inconclusive and contradictory. This study identifies research constructs that may have driven these inconsistent findings and makes adjustments to mitigate their effects.
Rappaport, Alfred. (2005). The Economics of Short-Term Performance Obsession. Finan- cial Analysts Journal, vol. 61, no. 3, pp. 65–79.
This article focuses on a three-pronged program for reducing short-term corpo- rate performance obsession. The author argues that short-term performance is
C H A P T E R 10 THE FINANCIAL PLAN 301
particularly important to young companies. However, it is important to recognize that because there is such flexibility in estimating the timing of accruals, these short-term performance predictions may not accurately picture the cash flow forecasts.
Rezaee, Zabihollah. (February 2003). High-Quality Financial Reporting: The Six-Legged Stool. Strategic Finance, pp. 26–30.
This article argues that quality financial reports can be achieved when there is a well-balanced, functioning system of corporate governance. For good corporate governance, companies should develop a “six-legged stool” model that supports re- sponsible and reliable reports. The model is based on the active participation of all parties, which are: the board of directors, the audit committee, the top manage- ment team, internal auditors, external auditors, and governing bodies.
Rhodes, David; and Daniel Stelter. (February 2009). Seize Advantage in a Downturn. Harvard Business Review, pp. 50–58.
The authors offer recommendations to stabilize business during a downturn. First, companies should monitor and maximize cash flow by managing customer credit and reducing working capital. Second, firms need to protect their existing business by reducing costs, managing the product line, and divesting noncore business. Third, firms need to maximize the business value relative to rivals by being proactive in investor relations.
Salzman, Jessica Reagan. (November/December 2008). Time for an End of Year Finan- cial Tune-Up. Home Business Magazine, pp. 64–67.
The article offers suggestions on how small businesses can increase revenue to meet financial needs for 2009. Business owners should bill customers promptly to en- hance receivables. Bills should be paid on time to avoid late fees. Also suggestions are provided on where to find excess expenses.
Tarantino, David. (September/October 2001). Understanding Financial Statements. Physician Executive, pp. 72–76.
This article describes the critical “financials” that can make or break a business. It explains each financial statement, how it differs from other financial statements, and what useful information about the business can be obtained from each statement.
Taylor, Mandie. (June 2008). How to Identify Short and Long-Term Liquidity Needs Accurately. Journal of Corporate Treasury Management, pp. 291–96.
The author describes the need to manage cash effectively to ensure that funding is secured at an early date. These strategies involve producing a reliable cash projection with the appropriate cash budget. This forecast or projection of cash needs is a work in progress and should be monitored regularly to ensure reliability.
E N D N O T E S
1. See Sara Wilson, “Build a Billion-Dollar Business,” Entrepreneur (March 2009), pp. 45–47; Jeffrey M. O’Brien, “Zappos Knows How to Kick It,” Fortune (February 2, 2009), pp. 54–60; Paula Andruss, “Delivering Wow through Service,” Marketing News (October 10, 2008), p. 10; and Brian Morrissey, “Zappos Launches Insights Service,” Adweek (December 15, 2008), p. 6.
2. R. Kerin, S. W. Hartley, and W. Rudelius, Marketing, 9th ed. (Burr Ridge, IL: McGraw-Hill/Irwin, 2009), pp. 245–47.
302 PA RT 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
3. E. A. Helfert, Techniques of Financial Analysis, 11th ed. (Burr Ridge, IL: McGraw-Hill/Irwin, 2003), pp. 152–78.
4. Norman Brodsky, “Learning from Mistakes,” Inc. (June 2003), pp. 55–57. 5. Clyde P. Stickney, Paul Brown, and James Whalen, Financial Reporting and
Statement Analysis: A Strategic Approach, 6th ed. (Florence, KY: South- Western/Cengage Learning, 2007), pp. 443–79.
6. Kerin et al., Marketing, pp. 346–50.
4 F R O M T H E B U S I N E S S P L A N T O
F U N D I N G T H E V E N T U R E
C H A P T E R 1 1
Sources of Capital
C H A P T E R 1 2
Informal Risk Capital, Venture Capital, and Going Public
1
To identify the types of financing available.
2
To understand the role of commercial banks in financing new ventures, the types of loans available, and bank lending decisions.
3
To discuss Small Business Administration (SBA) loans.
4
To understand the aspects of research and development limited partnerships.
5
To discuss government grants, particularly Small Business Innovation Research grants.
6
To understand the role of private placement as a source of funds.
11 S O U R C E S O F C A P I TA L
L E A R N I N G O B J E C T I V E S
305
O P E N I N G P R O F I L E
SCOTT WALKER
Some entrepreneurs are born and others are created through focus, energy, and de-
sire. Scott Walker is the latter style, developing his own lifelong learning curriculum in
creating opportunities and taking risks.
Walker was born an Air Force brat; his family was posted at stations across the coun-
try throughout his childhood. This training, including six
different grade schools and three high schools in three
different states, gave him the ability to get along any-
where, to be comfortable with different types of people,
and to be self-sufficient. Walker brought these capabilities to a series of start-up com-
panies, including one very successful financial technology firm.
After receiving a BA from Utah State University in 1977, Walker selected a graduate
school that would initiate his career as an entrepreneur. Thunderbird, the Garvin
School of International Management, provided an environment for learning how an
interesting idea can become a business—as well as exposure to the broader world as
represented by students and faculty from around the globe. Walker graduated in 1981
with an MBA.
The banking world and its activity in mergers and acquisitions was the first profes-
sional stop for Walker. Based in Dallas, he centered much of his effort on the oil and
gas industry, including working with T. Boone Pickens, the notorious corporate raider
of the 1980s, and his Mesa Petroleum Co. Pickens prided himself on being able to see
undervalued assets and subsequently make a profit when outside parties and the mar-
ket recognized that value. That lesson was not lost on Walker. Nor was the idea that
businesses need to be responsive to their shareholders and stakeholders, even if they
have to be dragged to that realization—as Pickens did to staid management teams
with his hostile takeover bids.
After a number of years in banking with such firms as Lloyd’s Bank and GE Capital,
Walker noticed that many of the people he respected in this industry were leaving to
work on riskier, more nontraditional and stimulating ventures. This appealed to
Walker, playing to his strengths and providing a new channel for his energy. However,
he did not feel that he understood all the details of how to successfully build a new
venture, so he searched for an established entrepreneur who could show him the basics.
www.BillMatrix.com
That person was William Conley, a friend and successful serial business builder, who
was starting an Internet backbone infrastructure company to provide Internet points
of presence, or POPs. Walker was the second employee and CFO of the fledgling tech-
nology firm in 1995. After one year of hard work with few paychecks, the firm was sold
to GTE. It remains a portion of the Internet backbone today.
While that first taste of risk taking was exhilarating, Walker returned to the corpo-
rate world as CFO of Precept Business Services, a $200 million company. He gathered
useful experience in the process of taking a company public, as he was instrumental in
achieving that status for Precept through an S-4 registration, where securities are
issued in a business combination transaction.
When Conley again touched base with Walker in 1998, he was ready for a new chal-
lenge. This opportunity was [the establishment of] a not-for-profit [educational assis-
tance] company. This company, one2one Learning Foundation, provided individualized
curriculum programs for children not enrolled in traditional public or private institu-
tions. While serving as CFO of the foundation, Walker was approached by Clint Norton,
another friend, to assist with the sale of a small company Norton’s father had invested
in three years earlier.
After a short time, it became clear to Walker that the ongoing talks were not going
to lead to a transaction with the buyer and he requested a 30-day leave from his cur-
rent responsibilities to clean up the company and find someone else to buy it. Once in-
side, he discovered that there was a great concept hiding inside this poorly managed
company, which was called TelePay. The firm provided large recurring billers with a
way to have their consumers pay their bills using an automated telephone service
known as interactive voice response, or IVR (the “press 1 for . . .” technology). A wide
range of payment choices, including credit cards, ATM debit cards, and ACH or elec-
tronic checks, was offered to provide not only speed but also great flexibility for the
consumer. The revenue model for TelePay reflected the “many small slices” nature of
the transaction industry—the consumers paid a small incremental fee above the
amount owed for the convenience of not writing a check or visiting an office. The
biller did not pay for the setup or ongoing maintenance of the service.
Walker recognized the potential and joined it as president and CEO in early 1999,
when there were only four employees. This was the chance to put all that he had
learned as an apprentice into his own company. He saw that TelePay had very loyal
clients despite a number of nagging technical glitches, so his first decision was to com-
pletely rebuild the system on a single software platform. The key to success was to
ensure that the resulting architecture would scale up from 1,000 transactions to 10 mil-
lion transactions. His second act was to bring on a senior sales executive who could
leverage the loyalty of the existing customers into references for new prospects. This
expensive investment required trusting that the person could deliver new clients
quickly. On advice from Conley, Walker hired the right person. Both early decisions
proved correct: the company’s infrastructure has readily grown with the client base,
and two of its initial four employees, as well as the sales executive, remain with the
company today.
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C H A P T E R 11 SOURCES OF CAPITAL 307
After renaming the company BillMatrix Corporation, the team started to develop
a stellar client list. Walker built out the senior executive staff, adding a COO, CFO,
and both client and consumer support personnel. The company has been cash flow
positive since the first month of his tenure and revenue has grown over 100 percent
year after year, every year. Because of its cash flow, the company has not required
venture capital for growth, thereby keeping the majority control of the company
and all of the decision-making processes in the hands of the senior executives.
Walker’s ability to make skillful choices, based upon what is good for the business
and good for the clients (but not necessarily those with the least risk), has created a
strong organization.
The company has been at the forefront in applying new technology to electronic
bill payments since its restart by Walker in 1999. Internet-based payments were added
to the telephone service as use of that channel is now expected by consumers.
Multiple technologies are used for real-time connectivity to client systems for data ver-
ification and immediate posting of payments. A self-service client information portal
delivers real-time payment data to client personnel. The company continually looks to
add other innovations to its service as they become available.
BillMatrix serves a diverse client base of over 125 companies today, including
those in the utilities, telecom, insurance, and consumer finance industries. Walker’s
organization has over 175 employees and a strong reputation for operational excel-
lence and exceptional client service in the electronic payments industry. His mantra
to the employees is: “We handle two of the most important things for our clients—
their money and their customers. We must always act with the highest ethics and
integrity.”
In 2005, the electronic payments industry was considered a hot area and the time
was ripe for maximizing the value of an acquisition. Walker led the company in a buy-
out process with a large number of interested parties. The resulting transaction was an
acquisition of BillMatrix by Fiserv Inc. (NASDAQ: FISV) of Brookfield, Wisconsin, for
$350 million in August 2005. This was the second largest acquisition in dollar value for
Fiserv, which has built itself primarily by acquisition into a $3.4 billion company with
over 16,000 clients worldwide and 22,000 employees. BillMatrix is serving as the cor-
nerstone of Fiserv’s greater role in the overall payment business, a growth engine for
its core business of financial technology and services.
In early 2006, Walker was meeting with an old friend, Jim Tehan. Jim was com-
plaining about all of the problems he had with contract fillers. Jim owned a sun care
line, Aloe Gator. After listening to his problems, Walker concluded that all these prob-
lems were correctible, and he and Tehan decided at that time to acquire an existing
contract filler. They looked at a company—Nature’s Formula (about $16⫹ million
revenues)—one of the largest operations in North Texas. The company’s largest cus-
tomer was Victoria’s Secret ($12 million contract). Since the deal could not be closed in
August 2006, over dinner that night with three other individuals, Walker made the de-
cision to build a contract filler company from scratch. In November, a lease was signed
on 90,000 square feet of empty warehouse space. Offices, mechanical and production
rooms, and a warehouse were built utilizing both new and used equipment. The com-
pany, ProCore Laboratories, was open for business in early March 2007, and the first
official product batch was filled in early April. Positive cash flow was achieved by De-
cember that year. The major difference between ProCore and all the rest of the indus-
try was that the company employed an internal operating system to manage and
monitor by batch.
The focus of ProCore is on quality and partnership. The company has quality stan-
dards that will not be compromised. The company proved that if it could provide
consistent product quality in every batch, customer sales will increase. First year
(2007) revenues were around $1.26 million and in 2008, $8.5 million; projected rev-
enues in 2009 are $25⫹ million. Tehan’s goal is to build the company to $500⫹ million
in revenues. Some of Walker’s “must have” basic principles applied in this start-up:
integrity, no debt, ethics, above-standard quality, a solid management team (espe-
cially the entrepreneur in charge), and the ability to pay bills on time. ProCore’s rep-
utation spread quickly throughout the industry. As a result, the company rarely
needs to seek out new customers as many come directly to the company. ProCore is
now the largest contract filler in North Texas. In this time of economic turmoil, the
company is flourishing while many of its competitors have shut down operations.
With ProCore, Walker proved that it is more about the philosophy of running a com-
pany versus having direct experience in the industry. Since ProCore is now up and
running and the foundation has been built, Walker is now taking the next step—
jumping into a new industry: distribution.
Today, Walker is dedicated to being an “entrepreneurial philanthropist.” While he
is a generous monetary donor to his alma mater—Thunderbird School of Global
Management—he also provides the more important gift of time with students who are
looking for the same knowledge he needed early in his career. His goal is to help the next
generation get a quicker start on their ventures by sharing his knowledge about how to
build a strong business around a good idea. Among his many talents, Scott Walker under-
stands how to successfully finance and capitalize a venture, the focus of this chapter.
308 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
AN OVERVIEW
One of the most difficult problems in the new venture creation process is obtaining financ-
ing. For the entrepreneur, available financing needs to be considered from the perspective
of debt versus equity and using internal versus external funds.
Debt or Equity Financing
Two types of financing need to be considered: debt financing and equity financing. Debt
financing is a financing method involving an interest-bearing instrument, usually a loan,
the payment of which is only indirectly related to the sales and profits of the venture.
debt financing
Obtaining borrowed
funds for the company
Typically, debt financing (also called asset-based financing) requires that some asset (such
as a car, house, plant, machine, or land) be used as collateral.
Debt financing requires the entrepreneur to pay back the amount of funds borrowed as
well as a fee expressed in terms of the interest rate. There can also be an additional fee,
sometimes referred to as points, for using or being able to borrow the money. If the financ-
ing is short term (less than one year), the money is usually used to provide working capital
to finance inventory, accounts receivable, or the operation of the business. The funds are
typically repaid from the resulting sales and profits during the year. Long-term debt (last-
ing more than one year) is frequently used to purchase some asset such as a piece of
machinery, land, or a building, with part of the value of the asset (usually from 50 to 80 per-
cent of the total value) being used as collateral for the long-term loan. Particularly when
interest rates are low, debt (as opposed to equity) financing allows the entrepreneur to re-
tain a larger ownership portion in the venture and have a greater return on the equity. The
entrepreneur needs to be careful that the debt is not so large that regular interest payments
become difficult if not impossible to make, a situation that will inhibit growth and develop-
ment and possibly end in bankruptcy.
Equity financing does not require collateral and offers the investor some form of owner-
ship position in the venture. The investor shares in the profits of the venture, as well as any
disposition of its assets on a pro rata basis based on the percentage of the business owned.
Key factors favoring the use of one type of financing over another are the availability of
funds, the assets of the venture, and the prevailing interest rates. Usually, an entrepreneur
meets financial needs by employing a combination of debt and equity financing.
All ventures will have some equity, as all ventures are owned by some person or institu-
tion. Although the owner may sometimes not be directly involved in the day-to-day manage-
ment of the venture, there is always equity funding involved that is provided by the owner.
The amount of equity involved will of course vary by the nature and size of the venture. In
some cases, the equity may be entirely provided by the owner, such as in a small ice cream
stand or pushcart in the mall or at a sporting event. Larger ventures may require multiple
owners, including private investors and venture capitalists. This equity funding provides the
basis for debt funding, which together make up the capital structure of the venture.
Internal or External Funds
Financing is also available from both internal and external funds. The funds most frequently
employed are internally generated funds. Internally generated funds can come from several
sources within the company: profits, sale of assets, reduction in working capital, extended
payment terms, and accounts receivable. In every new venture, the start-up years involve
putting all the profits back into the venture; even outside equity investors do not expect any
payback in these early years. The needed funds can sometimes be obtained by selling little-
used assets. Assets, whenever possible, should be on a rental basis (preferably on a lease
with an option to buy), not an ownership basis, as long as there is not a high level of infla-
tion and the rental terms are favorable. This will help the entrepreneur conserve cash, a prac-
tice that is particularly critical during the start-up phase of the company’s operation.
A short-term, internal source of funds can be obtained by reducing short-term assets:
inventory, cash, and other working-capital items. Sometimes an entrepreneur can generate
the needed cash for a period of 30 to 60 days through extended payment terms from
suppliers. Although care must be taken to ensure good supplier relations and continuous
sources of supply, taking a few extra days to pay can generate needed short-term funds. A
final method of internally generating funds is collecting bills (accounts receivable) more
quickly. Key account holders should not be irritated by implementation of this practice, as
C H A P T E R 11 SOURCES OF CAPITAL 309
equity financing
Obtaining funds for the
company in exchange for
ownership
certain customers have established payment practices. Mass merchandisers, for example,
pay their bills to supplying companies in 60 to 90 days, regardless of a supplying company’s
accounts receivable policy, the size of the company, or the discount offered for prompt
payment. If a company wants this mass merchandiser to carry its product, it will have to
abide by this payment schedule.
One entrepreneur who is very successful at leveraging the discounts from vendors is
home product distributor Jeff Schreiber. Schreiber always tries to take advantage of any dis-
counts for prompt payments, and he obtained over $15,000 in early payment savings in
2002 alone.1
The other general source of funds is external to the venture. Alternative sources of exter-
nal financing need to be evaluated on three bases: the length of time the funds are available,
the costs involved, and the amount of company control lost. In selecting the best source of
funds, each of the sources indicated in Table 11.1 needs to be evaluated along these three di-
mensions. The more frequently used sources of funds (self, family and friends, commercial
banks, R&D limited partnerships, government loan programs and grants, venture capital, and
private placement) indicated in the table are discussed at length in the following pages. The
firms in the “Entrepreneur 2003 Hot 100” list got start-up capital from savings (61 percent),
private investors (31 percent), friends and family (18 percent), home equity lines of credit
(17 percent), bank loans (16 percent), credit cards (10 percent), the sale of another business
(1 percent), SBA loans (1 percent), and other sources (2 percent).
Whenever an entrepreneur deals with items external to the firm, particularly with peo-
ple and institutions that could become stakeholders, ethical dilemmas can sometimes occur.
PERSONAL FUNDS
Few, if any, new ventures are started without the personal funds of the entrepreneur. Not
only are these the least expensive funds in terms of cost and control, but they are absolutely
essential in attracting outside funding, particularly from banks, private investors, and
venture capitalists. The typical sources of personal funds include savings, life insurance, or
TABLE 11.1 Guide for Alternative Sources of Financing
Length of Time Cost Control
Fixed Floating Percent
Short Long Rate Rate of Voting
Source of Financing Term Term Debt Debt Profits Equity Covenants Rights
Self
Family and friends
Suppliers and trade credit
Commercial banks
Government loan programs
R&D limited partnerships
Private investors (angels)
Venture capital
Private equity placements
Public equity offerings
Other government programs
310 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
311
mortgage on a house or car. These outside providers of capital feel that the entrepreneur
may not be sufficiently committed to the venture if he or she does not have money invested.
As one venture capitalist succinctly said, “I want the entrepreneurs so financially commit-
ted that when the going gets tough, they will work through the problems and not throw the
keys to the company on my desk.”
A S S E E N I N B U S I N E S S W E E K
SHOW ME THE MONEYMEN
Adeo Ressi has long had a problem with authority
figures. When he was in college, at the University of
Pennsylvania, he ran an environmental newspaper
called The Green Times. He tried to turn in copies of
the paper as his senior thesis, but his professor
wouldn’t accept them. Ressi dug in his heels and re-
fused to submit a traditional thesis. He never did get
a degree. “He’s always done his own thing,” says
younger brother Alex Ressi.
With his latest venture, Adeo Ressi is taking on the
Establishment once again. A year ago, the 35-year-
old New Yorker started up TheFunded.com, a Web
site that lets entrepreneurs anonymously rank, re-
view, and post comments about venture capital firms.
As an entrepreneur who has started numerous com-
panies, Ressi saw a need to shine a spotlight on the
previously secretive industry. “Venture capital defi-
nitely needed a kick in the pants,” he says.
It’s certainly getting one. TheFunded has become
the talk of Silicon Valley, as venture firms have come
in for increasing scrutiny and in many cases harsh crit-
icism. One recent winter day, in a cramped confer-
ence room in his Greenwich Village office, Ressi
pecked his way through the site, waving his long
arms and poking at the computer screen. “They stole
as much information as they could about my business,”
reads one recent post. “It was a very unfriendly at-
mosphere,” reads another. Ressi points to a third com-
ment about a venture employee who was 40 minutes
late for an appointment, didn’t apologize, and then
was obnoxious. “How much you wanna bet that guy
gets fired in a few months?” he says.
The idea for TheFunded was born out of Ressi’s ex-
perience at Game Trust, the developer of online
games he founded in 2002. Ressi says he had lined up
a $10 million investment from Softbank Capital for a
second round of funding. But in February, 2005, on
the day the deal was supposed to close, Softbank
pulled its offer. The withdrawal set in motion a chain
of events that ended 18 months later with one of
Game Trust’s new investors trying to boot Ressi out of
the company.
The coup failed, but Ressi knew he had to do
something. So over the winter in 2006, he built
TheFunded.com. The idea was to create a place to
help him evaluate venture capitalists in case he
needed to raise money in the future. The site struck a
chord with other entrepreneurs, and Ressi quickly
signed up hundreds of members, who began posting
juicy stories under titles such as “The Truth about
Matrix Partners.”
TheFunded.com isn’t a big money maker. Ressi pulls
in revenue by selling advertising, as well as $400-a-year
subscriptions, typically to the institutional investors
who put money into venture funds. To date, Ressi
claims 450 subscribers. He says the site is profitable and
revenue “will easily hit seven figures” this year.
Venture firms are pressuring Ressi for more in-
volvement and influence. George Zachary, a partner
at Charles River Ventures who counts himself as a
friend of Ressi’s, says TheFunded should forbid anony-
mous posts. “There should be more transparency,” he
says. “Anonymous comments allow people to make
up stuff.”
Ressi retorts: “Anonymity provides entrepreneurs
with a comfortable environment to speak their minds
freely.”
TheFunded could create long-term challenges for
Ressi. As a frenetic entrepreneur, he likely will try to
raise venture money for one of his future startups.
But it may be tough to persuade VCs to cut him a
check after he has so publicly taken on the industry
Establishment. “Yes,” he says with a smile, “it will be
difficult.”
Source: Reprinted from the January 21, 2008 issue of BusinessWeek by special permission, copyright © 2008 by The McGraw-Hill Companies, Inc., “Show Me the Moneymen,” by Spencer E. Ante, BusinessWeek, Issue 4067, pp. 54–58.
This level of commitment is reflected in the percentage of total assets available that the
entrepreneur has committed, not necessarily in the amount of money committed. An out-
side investor wants an entrepreneur to have committed all available assets, an indication
that he or she truly believes in the venture and will work all the hours necessary to ensure
success. Whether this is $1,000, $100,000, or $250,000 depends on the assets available. En-
trepreneurs should always remember that it is not the amount but rather the fact that all
monies available are committed that makes outside investors feel comfortable with their
commitment level and therefore more willing to invest.
FAMILY AND FRIENDS
After the entrepreneur, family and friends are a common source of capital for a new venture.
They are most likely to invest due to their relationship with the entrepreneur. This helps
overcome one portion of uncertainty felt by impersonal investors—knowledge of the entre-
preneur. Family and friends provide a small amount of equity funding for new ventures,
reflecting in part the small amount of capital needed for most new ventures. Although it is
relatively easy to obtain money from family and friends, like all sources of capital, there are
positive and negative aspects. Although the amount of money provided may be small, if it is
in the form of equity financing, the family members or friends then have an ownership
position in the venture and all rights and privileges of that position. This may make them feel
they have a direct input into the operations of the venture, which may have a negative effect
on employees, facilities, or sales and profits. Although this possibility must be guarded
against as much as possible, frequently family and friends are not problem investors and in
fact are more patient than other investors in desiring a return on their investment.
To avoid problems in the future, the entrepreneur must present the positive and negative
aspects and the nature of the risks of the investment opportunity to try to minimize the neg-
ative impact on the relationships with family and friends should problems occur. One thing
that helps to minimize possible difficulties is to keep the business arrangements strictly
business. Any loans or investments from family or friends should be treated in the same
businesslike manner as if the financing were from an impersonal investor. Any loan should
specify the rate of interest and the proposed repayment schedule of interest and principal.
The timing of any future dividends must be disclosed in terms of an equity investment. If
the family or friend is treated the same as any investor, potential future conflicts can be
avoided. It is also beneficial to the entrepreneur to settle everything up front and in writing.
It is amazing how short memories become when money is involved. All the details of the
financing must be agreed upon before the money is put into the venture. Such things as
the amount of money involved, the terms of the money, the rights and responsibilities of the
investor, and what happens if the business fails must all be agreed upon and written down.
A formal agreement with all these items helps avoid future problems.
Finally, the entrepreneur should carefully consider the impact of the investment on the
family member or friend before it is accepted. Particular concern should be paid to any
hardships that might result should the business fail. Each family member or friend should
be investing in the venture because they think it is a good investment, not because they feel
obligated.
COMMERCIAL BANKS
Commercial banks are by far the source of short-term funds most frequently used by the
entrepreneur when collateral is available. The funds provided are in the form of debt fi-
nancing and, as such, require some tangible guaranty or collateral—some asset with value.
312 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
This collateral can be in the form of business assets (land, equipment, or the building of the
venture), personal assets (the entrepreneur’s house, car, land, stock, or bonds), or the assets
of the cosigner of the note.
Types of Bank Loans
There are several types of bank loans available. To ensure repayment, these loans are based
on the assets or the cash flow of the venture. The asset base for loans is usually accounts
receivable, inventory, equipment, or real estate.
Accounts Receivable Loans Accounts receivable provide a good basis for a loan, espe- cially if the customer base is well known and creditworthy. For those creditworthy cus-
tomers, a bank may finance up to 80 percent of the value of their accounts receivable. When
customers such as the government are involved, an entrepreneur can develop a factoring
arrangement whereby the factor (the bank) actually “buys” the accounts receivable at a
value below the face value of the sale and collects the money directly from the account. In
this case, if any of the receivables is not collectible, the factor (the bank) sustains the loss,
not the business. The cost of factoring the accounts receivable is of course higher than the
cost of securing a loan against the accounts receivable without factoring being involved,
since the bank has more risk when factoring. The costs of factoring involve the interest
charge on the amount of money advanced until the time the accounts receivable are col-
lected, the commission covering the actual collection, and protection against possible
uncollectible accounts.
Inventory Loans Inventory is another of the firm’s assets that is often a basis for a loan, particularly when the inventory is liquid and can be easily sold. Usually, the finished goods
inventory can be financed for up to 50 percent of its value. Trust receipts are a unique type
of inventory loan used to finance floor plans of retailers, such as automobile and appliance
dealers. In trust receipts, the bank advances a large percentage of the invoice price of the
goods and is paid on a pro rata basis as the inventory is sold.
Equipment Loans Equipment can be used to secure longer-term financing, usually on a 3- to 10-year basis. Equipment financing can fall into any of several categories: fi-
nancing the purchase of new equipment, financing used equipment already owned by
the company, sale-leaseback financing, or lease financing. When new equipment is be-
ing purchased or presently owned equipment is used as collateral, usually 50 to 80 per-
cent of the value of the equipment can be financed depending on its salability. Given
the entrepreneur’s tendency to rent rather than own, sale-leaseback or lease financing
of equipment is widely used. In the sale-leaseback arrangement, the entrepreneur
“sells” the equipment to a lender and then leases it back for the life of the equipment to
ensure its continued use. In lease financing, the company acquires the use of the equip-
ment through a small down payment and a guarantee to make a specified number of
payments over a period of time. The total amount paid is the selling price plus the
finance charges.
Real Estate Loans Real estate is also frequently used in asset-based financing. This mortgage financing is usually easily obtained to finance a company’s land, plant, or another
building, often up to 75 percent of its value.
C H A P T E R 11 SOURCES OF CAPITAL 313
asset base for loans
Tangible collateral valued
at more than the amount
of money borrowed
Cash Flow Financing
The other type of debt financing frequently provided by commercial banks and other fi-
nancial institutions is cash flow financing. These conventional bank loans include lines
of credit, installment loans, straight commercial loans, long-term loans, and character
loans. Lines of credit financing is perhaps the form of cash flow financing most fre-
quently used by entrepreneurs. In arranging for a line of credit to be used as needed, the
company pays a “commitment fee” to ensure that the commercial bank will make the loan
when requested and then pays interest on any outstanding funds borrowed from the
bank. Frequently, the loan must be repaid or reduced to a certain agreed-upon level on a
periodic basis.
Installment Loans Installment loans can also be obtained by a venture with a track record of sales and profits. These short-term funds are frequently used to cover working
capital needs for a period of time, such as when seasonal financing is needed. These loans
are usually for 30 to 40 days.
Straight Commercial Loans A hybrid of the installment loan is the straight com- mercial loan, by which funds are advanced to the company for 30 to 90 days. These
self-liquidating loans are frequently used for seasonal financing and for building up
inventories.
Long-Term Loans When a longer time period for use of the money is required, long-term loans are used. These loans (usually available only to strong, mature compa-
nies) can make funds available for up to 10 years. The debt incurred is usually repaid
according to a fixed interest and principal schedule. The principal, however, can some-
times start being repaid in the second or third year of the loan, with only interest paid
the first year.
Character Loans When the business itself does not have the assets to support a loan, the entrepreneur may need a character (personal) loan. These loans frequently must
have the assets of the entrepreneur or other individual pledged as collateral or the loan
cosigned by another individual. Assets that are frequently pledged include cars, homes,
land, and securities. One entrepreneur’s father pledged a $50,000 certificate of deposit
as collateral for his son’s $40,000 loan. In extremely rare instances, the entrepreneur can
obtain money on an unsecured basis for a short time when a high credit standing has
been established.
Bank Lending Decisions
One problem for the entrepreneur is determining how to successfully secure a loan from the
bank. Banks are generally cautious in lending money, particularly to new ventures, since
they do not want to incur bad loans. Regardless of geographic location, commercial loan
decisions are made only after the loan officer and loan committee do a careful review of the
borrower and the financial track record of the business. These decisions are based on both
quantifiable information and subjective judgments.2
The bank lending decisions are made according to the five Cs of lending: character,
capacity, capital, collateral, and conditions. Past financial statements (balance sheets and
income statements) are reviewed in terms of key profitability and credit ratios, inventory
turnover, aging of accounts receivable, the entrepreneur’s capital invested, and commitment
314 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
conventional bank loan
Standard way banks lend
money to companies
to the business. Future projections on market size, sales, and profitability are also evalu-
ated to determine the ability to repay the loan. Several questions are usually raised re-
garding this ability. Does the entrepreneur expect to be carried by the loan for an ex-
tended period of time? If problems occur, is the entrepreneur committed enough to spend
the effort necessary to make the business a success? Does the business have a unique dif-
ferential advantage in a growth market? What are the downside risks? Is there protection
(such as life insurance on key personnel and insurance on the plant and equipment)
against disasters?
Although the answers to these questions and the analysis of the company’s records al-
low the loan officer to assess the quantitative aspects of the loan decision, the intuitive fac-
tors, particularly the first two Cs—character and capacity—are also taken into account.
This part of the loan decision—the gut feeling—is the most difficult part to assess. The en-
trepreneur must present his or her capabilities and the prospects for the company in a way
that elicits a positive response from the lender. This intuitive part of the loan decision be-
comes even more important when there is little or no track record, limited experience in
financial management, a nonproprietary product or service (one not protected by a patent
or license), or few assets available.
Some of the concerns of the loan officer and the loan committee can be reduced by pro-
viding a good loan application. While the specific loan application format of each bank dif-
fers to some extent, generally the application format is a “mini” business plan that consists
of an executive summary, business description, owner/manager profiles, business projec-
tions, financial statements, amount and use of the loan, and repayment schedule. This
information provides the loan officer and loan committee with insight into the creditworthi-
ness of the individual and the venture as well as the ability of the venture to make enough
sales and profit to repay the loan and the interest. The entrepreneur should evaluate several
alternative banks, select the one that has had positive loan experience in the particular busi-
ness area, call for an appointment, and then carefully present the case for the loan to the
loan officer. Presenting a positive business image and following the established protocol are
necessary to obtain a loan from a commercial bank.
Generally, the entrepreneur should borrow the maximum amount that can possibly be
repaid as long as the prevailing interest rates and the terms, conditions, and restrictions of
the loan are satisfactory. It is essential that the venture generate enough cash flow to repay
the interest and principal on the loan in a timely manner. The entrepreneur should evaluate
the track record and lending procedures of several banks to secure the money needed on the
most favorable terms available. This “bank shopping procedure” will provide the needed
funds at the most favorable rates.
ROLE OF THE SBA IN SMALL-BUSINESS FINANCING
Frequently, an entrepreneur is missing the necessary track record, assets, or some other
ingredient to obtain a commercial bank loan. When the entrepreneur is unable to secure a
regular commercial bank loan, an alternative is a guaranty from the Small Business Admin-
istration (SBA). The SBA offers numerous loan programs to assist small businesses. In
each of these, the SBA is primarily a guarantor of loans made by private and other institu-
tions. The Basic 7(a) Loan Guaranty is the SBA’s primary business loan program. This pro-
gram helps qualified small businesses obtain financing when they cannot obtain business
loans through regular lending channels. The proceeds from such a loan can be used for a
variety of business purposes, such as working capital; machinery and equipment; furniture
and fixtures; land and building; leasehold improvements; and even, under some conditions,
debt refinancing.
C H A P T E R 11 SOURCES OF CAPITAL 315
To get a 7(a) loan, the entrepreneur must be eligible. While repayment ability from the
cash flow of the business is of course essential, other criteria include good character, manage-
ment capability, collateral, and owner’s equity contribution. Eligibility factors for all 7(a)
loans include size, type of business, use of proceeds, and the availability of funds from other
sources. All owners of 20 percent or more are required to personally guarantee SBA loans.
The SBA 7(a) loan program has a maximum loan amount of $2 million with the SBA’s
maximum exposure of $1 million. In the case of a $2 million loan, the maximum guaran-
tee to the lender by the SBA will be $1 million or 50 percent. Though the interest rates on
the loan are negotiated between the borrower and the lender, they are subject to SBA
316
E T H I C S
Energy Czar. Health Reform Czar. Technology Czar.
Green Czar. President Barack Obama continues to line
up an impressive array of policy leaders to tackle our
ever-mounting social and economic problems. Tough
times call for creative solutions, and the President is
right to look for the best and the brightest to heal
our battered economy and bruised infrastructure.
But there is one kind of problem the Obama Ad-
ministration has yet to tackle, even though it may be
the most pervasive one of all. It is a distressing issue
about which everyone complains but no one has
been able to address effectively: The widespread fail-
ure of our leaders—and the rest of us—to take ethics
seriously.
WHAT WE NEED IS AN ETHICS CZAR According to the annual USA Today/Gallup Poll, less
than one American in four rates highly the ethical
standards of business executives, attorneys, members
of Congress, or stockbrokers. Bankers had it espe-
cially rough in the latest poll: Their approval rating
fell from 35% to 23%. Even before the Blagojevich
scandal hit the news, only 22% of Americans held
state governors in high esteem.
A contempt for ethics lies at the heart of almost
every top story of the day: Yankee hitter Alex
Rodriguez admitting to steroid use, investor Bernard
L. Madoff confessing to running the largest Ponzi
scheme in history, a report by the Josephson Institute
stating that 64% of high school students cheat and
30% steal. As I have argued repeatedly in this column,
however, striving to live an ethical life isn’t just the
right thing to do; it’s the smart thing to do, too.
I THEREFORE PROPOSE MY TOP NOMINEE FOR ETHICS CZAR: YOU That’s right. Whether you’re the CEO of a global cor-
poration, a midlevel manager, or an entrepreneur
striking out in this difficult economy, you are the one
who should set high standards in your organization
and do your level best to live up to them.
In fact, being the ethics czar applies not just to
how you lead your organization, but also to how you
lead your life. I hereby offer six simple rules for ethi-
cal leadership at work, with your family and friends,
and in your community.
A CODE OF CONDUCT FOR ETHICS CZARS 1. Lead by Example. The most effective way to pro-
mote ethical behavior is to demonstrate it in all
that you do. When members of your team see
that you tell the truth when it would be easier to
be dishonest, or react to a stressful situation with
compassion rather than hostility, or own up to
your mistakes rather than blaming someone else,
they not only have a model for making the right
choices—they have the motivation to do it, too.
Anyone can take the low road, but it takes a per-
son of character to take the high road consis-
tently, or at least attempt to do so. Show your
team that you are such a person.
2. Praise Generously. When was the last time you
told someone she was doing a good job? Yes, it’s
important for managers to let employees know
when they’ve gotten off track. But it may be even
more important to tell people when they’ve done
WE NEED AN ETHICS CZAR
maximums, which are pegged to the prime rate and may be fixed or variable. For example,
a fixed-rate loan of $50,000 or more must not exceed prime plus 2.25 percent if the matu-
rity is less than seven years.
Most of the loans have the same guarantee features. The SBA can guarantee 85 percent
of the loan for loans of $150,000 or less and 75 percent for loans between $150,000 and
$1 million. Some differences occur in SBA Express loans (maximum guarantee of 50 per-
cent) and export working capital loans (maximum guarantee of 90 percent). To help offset
the costs of the SBA loan programs, lenders are charged a guaranty and servicing fee for
each approved loan. These fees can be passed on to the borrower and vary depending on the
amount of the loan.
317
something right. After all, people will give you
their best if they feel appreciated. One of the
many useful lessons I picked up at the Gallup Insti-
tute for Leadership is the value of writing brief
notes to those who have done something benefi-
cial for me. Even a one-line e-mail saying some-
thing like, “You handled that situation brilliantly,”
will make someone’s day. As long as it comes from
the heart, a little praise goes a long way.
3. Criticize to Build Up, Not Break Down. Many of us
view criticism as something we’d rather not give or
receive. But this misses its real aim, which is to bring
out the best in others and not merely instill feel-
ings of guilt or remorse. It is appropriate for peo-
ple to feel bad when they have done something
wrong. Good managers know, however, that criti-
cism is most effective when it leaves someone in-
spired to do better rather than stuck in feelings of
inadequacy. It’s in your own interest to take mean-
ingful criticism seriously when you receive it, too.
4. Be Kind, Unwind. The better angels of our nature
are often the first casualties in the war of eco-
nomic survival we’re all fighting now. More than
ever, it makes sense for managers to build stress-
busters into the work week. Take the group out
to lunch or have a brown-bag day for your team
in the conference room with no work allowed.
Let the staff go home early from time to time or
celebrate their birthdays away from the office for
the full day. Encourage team members to use, not
hoard, their vacation days.
5. Punish Fairly. One measure of good managers is
the extent to which anger influences the way
they punish employees. It is human to be upset
when a person you manage and trust lets you
down, but you can and should rise above that
anger, look objectively at what has occurred, and
decide what the appropriate response should be.
It’s especially important to put aside whatever
emotional turmoil you’re going through that is
unrelated to the problem at hand.
It’s also critical to avoid favoritism when met-
ing out punishment. There is no surer way to
lower your team’s morale than to give one errant
employee a free pass after you have punished
another employee who made the same mistake.
6. If It Is to Be, It’s Up to Thee. When you see people
doing things they shouldn’t, take action. For ex-
ample, when employees come to work with the
flu, sending them home is fair, it prevents harm,
and it demonstrates that you care. Avoiding the
matter helps no one, including you. If you over-
hear colleagues discussing confidential informa-
tion in a public place, mention your concerns
rather than ignoring the situation. If you get bad
customer service, telling the manager instead of
quietly seething about it means you at least have
a shot at getting a positive result.
Don’t assume problems will take care of themselves.
They won’t. It often takes very little effort to make a
big difference. It does, however, take courage, and
this is where you come in, since others may not step
up to the plate.
You can’t solve every problem in the world, but
living by the above guidelines will make your own
corner of the world a more dignified place to be.
You just may end up being the most effective czar
of them all.
Source: Reprinted from March 13, 2009 issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Companies, Inc., “We Need an Ethics Czar to Battle a Wide- spread Breakdown in Standards,” by Bruce Weinstein, PhD, BusinessWeek magazine: www.businessweek.com/managing/ content/mar2009/ca20090313_869103.htm.
In addition to the 7(a) loan program, the SBA has several other programs. The 504 loan
program provides fixed-rate financing to enable small businesses to acquire machinery,
equipment, or even real estate in order to expand or modernize. The maximum of the pro-
gram is usually $1 million, and the loan can take a variety of forms, including a loan from
a Community Development Company (CDC) backed by a 100 percent SBA-guaranteed
debenture.
Another more recent SBA loan program that many entrepreneurs have used is the
SBA Microloan, a 7(m) loan program. This program provides short-term loans of up to
$35,000 to small businesses for working capital or the purchase of inventory, supplies,
furniture, fixtures, machinery, or equipment. The loan cannot be used to pay existing
debts. The small business receives the loan from a bank or other organization, with the
loan being guaranteed in full by the SBA. The SBA also provides such loans as Home
and Personal Property Disaster Loans, Physical Disaster Business Loans, and Military
Reservist Economic Injury Disaster Loans. The entrepreneur should check with the SBA
to see whether a loan program is available, if a loan cannot be obtained without the SBA
guarantee.
RESEARCH AND DEVELOPMENT LIMITED PARTNERSHIPS
Research and development limited partnerships are another possible source of funds
for entrepreneurs in high-technology areas. This method of financing provides funds
from investors looking for tax shelters. A typical R&D partnership arrangement involves
a sponsoring company developing the technology with funds being provided by a
limited partnership of individual investors. R&D limited partnerships are particularly
good when the project involves a high degree of risk and significant expense in doing
the basic research and development, since the risks, as well as the ensuing rewards,
are shared.
Major Elements
The three major components of any R&D limited partnership are the contract, the sponsor-
ing company, and the limited partnership. The contract specifies the agreement between the
sponsoring company and the limited partnership, whereby the sponsoring company agrees
to use the funds provided to conduct the proposed research and development that hopefully
will result in a marketable technology for the partnership. The sponsoring company does
not guarantee results but rather performs the work on a best-effort basis, being compen-
sated by the partnership on either a fixed-fee or a cost-plus arrangement. The typical con-
tract has several key features. The first is that the liability for any loss incurred is borne by
the limited partners. Second, there are some tax advantages to both the limited partnership
and the sponsoring company.
The second component involved in this contract is the limited partners. Similar to the
stockholders of a corporation, the limited partners have limited liability but are not a
total taxable entity. Consequently, any tax benefits of the losses in the early stages of the
R&D limited partnership are passed directly to the limited partners, offsetting other in-
come and reducing the partners’ total taxable incomes. When the technology is success-
fully developed in later years, the partners share in the profits. In some instances, these
profits for tax purposes are at the lower capital gains tax rate as opposed to the ordinary
income rate.
The final component, the sponsoring company, acts as the general partner developing
the technology. The sponsoring company usually has the base technology but needs funds
318 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
research and development
limited partnerships
Money given to a firm for
developing a technology
that involves a tax shelter
limited partner A
party in a partnership
agreement that usually
supplies money and has
a few responsibilities
general partner The
overall coordinating party
in a partnership agreement
to further develop and modify it for commercial success. It is this base technology that the
company is offering to the partnership in exchange for money. The sponsoring company
usually retains the rights to use this base technology to develop other products and to use
the developed technology in the future for a license fee. Sometimes, a cross-licensing
agreement is established whereby the partnership allows the company to use the technology
for developing other products.
Procedure
An R&D limited partnership generally progresses through three stages: the funding stage,
the development stage, and the exit stage. In the funding stage, a contract is established
between the sponsoring company and limited partners, and the money is invested for the
proposed R&D effort. All the terms and conditions of ownership, as well as the scope of
the research, are carefully documented.
In the development stage, the sponsoring company performs the actual research, using
the funds from the limited partners. If the technology is subsequently successfully devel-
oped, the exit stage commences, in which the sponsoring company and the limited partners
commercially reap the benefits of the effort. There are three basic types of arrangements for
doing this: equity partnerships, royalty partnerships, and joint ventures.
In the typical equity partnership arrangement, the sponsoring company and the limited
partners form a new, jointly owned corporation. On the basis of the formula established
in the original agreement, the limited partners’ interest can be transferred to equity in
the new corporation on a tax-free basis. An alternative is to incorporate the R&D limited
partnership itself and then either merge it into the sponsoring company or continue as a
new entity.
A possible alternative to the equity partnership arrangement is a royalty partnership. In
this situation, a royalty based on the sale of the products developed from the technology is
paid by the sponsoring company to the R&D limited partnership. The royalty rates typi-
cally range from 6 to 10 percent of gross sales and often decrease at certain established
sales levels. Frequently, an upper limit, or cap, is placed on the cumulative royalties paid.
A final exit arrangement is through a joint venture. Here the sponsoring company and
the partners form a joint venture to manufacture and market the products developed from
the technology. Usually, the agreement allows the company to buy out the partnership in-
terest in the joint venture at a specified time or when a specified volume of sales and profit
has been reached.
Benefits and Costs
As with any financing arrangement, the entrepreneur must carefully assess the appropriate-
ness of establishing an R&D limited partnership in terms of the benefits and costs involved.
Among the several benefits is that an R&D limited partnership provides the funds needed
with a minimum amount of equity dilution while reducing the risks involved. In addition,
the sponsoring company’s financial statements are strengthened through the attraction of
outside capital.
There are some costs involved in this financial arrangement. Typically, it is more ex-
pensive to establish than conventional financing. First, time and money are expended. An
R&D limited partnership frequently takes a minimum of six months to establish and
$50,000 in professional fees. These can increase to a year and $400,000 in costs for a major
effort. And the track record is not as good, as most R&D limited partnerships are unsuc-
cessful. Second, the restrictions placed on the technology can be substantial. To give up
C H A P T E R 11 SOURCES OF CAPITAL 319
the technology developed as a by-product of the primary effort may be too high a price to
pay for the funds. Third, the exit from the partnership may be too complex and involve too
much fiduciary responsibility. These costs and benefits need to be evaluated in light of
other financial alternatives available before an R&D limited partnership is chosen as the
funding vehicle.
Examples
In spite of the many costs involved, there are numerous examples of successful R&D
limited partnerships. Syntex Corporation raised $23.5 million in an R&D limited partner-
ship to develop five medical diagnostic products. Genentech was so successful in devel-
oping human growth hormone and gamma interferon products from its first $55 million
R&D limited partnership that it raised $32 million through a second partnership six
months later to develop a tissue-type plasminogen activator. Trilogy Limited raised
$55 million to develop a high-performance computer. And the list goes on. Indeed, R&D lim-
ited partnerships offer one financial alternative to fund the development of a venture’s
technology.
GOVERNMENT GRANTS
The entrepreneur can sometimes obtain federal grant money to develop and launch an in-
novative idea. The Small Business Innovation Research (SBIR) program, designed for the
small business, was created as part of the Small Business Innovation Development Act. The
act requires that all federal agencies with R&D budgets in excess of $100 million award
a portion of their R&D funds to small businesses through the SBIR grants program. This
act not only provides an opportunity for small businesses to obtain research and develop-
ment money but also offers a uniform method by which each participating agency solicits,
evaluates, and selects the research proposals for funding.
Eleven federal agencies are involved in the program (see Table 11.2). Each agency devel-
ops topics and publishes solicitations describing the R&D topic it will fund. Small businesses
320 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
SBIR grants program
Grants from the U.S.
government to small
technology-based
businesses
• Department of Defense (DOD)
• National Aeronautics and Space Administration (NASA)
• Department of Energy (DOE)
• Department of Health and Human Services (DHHS)
• National Science Foundation (NSF)
• U.S. Department of Agriculture (USDA)
• Department of Transportation (DOT)
• Nuclear Regulatory Commission (NRC)
• Environmental Protection Agency (EPA)
• Department of Education (DOED)
• Department of Commerce (DOC)
TABLE 11.2 Federal Agencies Participating in Small Business Innovation Research Program
A S S E E N I N BUSINESSWEEK
FROM 401(k) NEST EGG TO SEED MONEY
Michael Amstein decided to strike out on his own
last year, leaving behind his job as an executive at
an ambulance company. The 43-year-old Denver
native carefully weighed the pros and cons of var-
ious franchise options and eventually decided to
open a Nestlé Toll House Café at a local mall. But
when he applied for loans, Amstein couldn’t come
up with enough collateral and was rejected. Un-
daunted, he turned to BeneTrends, a firm that
helps entrepreneurs tap into their 401(k)s without
incurring a tax penalty. After paying $4,500,
Amstein unlocked $100,000 from his account and
bought the cookie shop. “I was nervous about
starting something,” says Amstein. ”But I took a
leap of faith, and it has worked out.”
With banks tightening lending, small busi-
nesses, which can’t borrow from the bond market
like larger corporations, have lost one of their best
sources of funding. To fill the void, a cottage in-
dustry, made up of a few small companies and a
bevy of independent contractors, has sprung up to
help entrepreneurs turn their 401(k)s and other
tax-deferred accounts into capital. The firms, which
generally charge $4,500 to $7,500 for their services,
are taking advantage of an unpublicized tax law
that allows individuals to invest their retirement
funds in a company.
Here’s how it works. An entrepreneur, aided
by the outside adviser, creates a corporation. The
newly formed entity starts a 401(k) plan, and an
individual rolls over existing retirement funds into
the account. Under 401(k) rules, the plan can pur-
chase shares in the corporation—money that can
be plowed into a small business that sells a product
or service. Those deals are considered investments,
which is the key. By investing the money rather
than withdrawing it, entrepreneurs avoid trigger-
ing a penalty that amounts to 10% of the assets.
The funding method has been around for years.
But the credit crisis has turned this once sleepy
niche into a booming business. Industry leaders
BeneTrends in North Wales, Pa., and Guidant Finan-
cial Group in Bellevue, Wash., say customer volume
is up 30% to 35% over the past year. By compari-
son, small-business loans from traditional lenders
fell 30%. “There’s not any kind of underwriting re-
quirement,” says David Nilssen, CEO of Guidant,
which has helped customers unlock $1.5 billion in
401(k) funds since its start in 2003. “You either have
the capital or you don’t.”
Such strategies can make the difference be-
tween a small business getting off the ground or
not. But they come with a big risk. If the com-
pany goes belly up, the nest egg will be wiped
out. And the possibility of failure is great. A
study at Case Western Reserve University found
that more than half of startups fold within five
years. “I know small business owners are in
tough situations,” says Alice Bredin, a small-
business consultant who works with American
Express. But utilizing retirement funds ”is a really
bad idea.”
Tim and Terry Madden considered taking out a
traditional loan to buy three franchises of Assist-
ing Hands, which provides in-home help to the
elderly and disabled. They qualified, but the
Fountain Hills (Ariz.) couple didn’t want to rack
up huge piles of debt in a turbulent economy.
Instead, the Maddens used $175,000 of their re-
tirement assets, paying Guidant $5,000 to steer
them through the process. “Everybody worries
about taking money out of an account you’ve
grown over the years,” says Terry Madden,
whose franchises are slated to open in January.
“But we felt it was a calculated risk. We sleep at
night.”
Source: Reprinted from the December 22, 2008 issue of Business- Week by special permission, copyright © 2008 by The McGraw- Hill Companies, Inc., “From 401(k) Nest Egg to Seed Money,” by Brian Burnsed, BusinessWeek, Issue 4113, p. 64.
321
submit proposals directly to each agency using the required format, which is somewhat
standardized, regardless of the agency. Each agency, using its established evaluation criteria,
evaluates each proposal on a competitive basis and makes awards through a contract, grant,
or cooperative agreement.
The SBIR grant program has three phases. Phase I awards are up to $100,000 for six
months of feasibility-related experimental or theoretical research. The objective here is to
determine the technical feasibility of the research effort and assess the quality of the com-
pany’s performance through a relatively small monetary commitment. Successful projects
are then considered for further federal funding support in Phase II.
Phase II is the principal R&D effort for those projects showing the most promise at the
end of Phase I. Phase II awards are up to $750,000 for 24 months of further research and
development. The money is to be used to develop prototype products or services. A small
business receiving a Phase II award has demonstrated good research results in Phase I, de-
veloped a proposal of sound scientific and technical merit, and obtained a commitment for
follow-on private-sector financing in Phase III for commercialization.
Phase III does not involve any direct funding from the SBIR program. Funds from the
private sector or regular government procurement contracts are needed to commercialize
the developed technologies in Phase III.
Procedure
Applying for an SBIR grant is a straightforward process. The government agencies partic-
ipating (indicated in Table 11.2) publish solicitations describing the areas of research they
will fund. Each of these annual solicitations contains documentation on the agency’s R&D
objectives, proposal format, due dates, deadlines, and selection and evaluation criteria. The
second step involves the submission of the proposal by a company or individual. The pro-
posal, which is 25 pages maximum, follows the standard proposal format. Each agency
screens the proposals it receives. Knowledgeable scientists or engineers then evaluate those
that pass the screening on a technological basis. Finally, awards are granted to those proj-
ects that have the best potential for commercialization. Any patent rights, research data,
technical data, and software generated in the research are owned by the company or indi-
vidual, not by the government.
The SBIR grant program is one viable method of obtaining funds for a technology-
based entrepreneurial company that is independently owned and operated, employs 500 or
fewer individuals, and has any organizational structure (corporation, partnership, sole
proprietorship).
Another grant program available to the entrepreneur is the Small Business Technology
Transfer (STTR) program, which was established by the Small Business Technology
Transfer Act of 1992. Federal agencies with budgets over $1 billion are required to set
aside 0.3 percent for small businesses. Five agencies participate in the STTR program—
the Department of Defense (DOD), the Department of Energy (DOE), the Department of
Health and Human Services (DHHS), the National Aeronautics and Space Administration
(NASA), and the National Science Foundation (NSF). All these, except DHHS, also par-
ticipate in the SBIR program. While a comparison of the SBIR and STTR programs is
found in Table 11.3, the two programs differ in two major ways: First, while in the SBIR
program, the principal investigator must have his or her primary employment with the
small business receiving the award. In contrast, for the duration of the project, there is no
employment stipulation in the STTR program. Second, the STTR program requires re-
search partners at universities or other nonprofit institutions, with at least 40 percent of the
research conducted by the small business and at least 30 percent conducted by the partnering
322 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
nonprofit institution. The SBIR program has a maximum of 33 percent [Phase I] and
50 percent [Phase II] in consulting costs. The procedure for obtaining an STTR award is the
same as for the SBIR award.
Other Government Grants
There are other grants available to the entrepreneur at the federal, state, and local levels.
These take many different forms and vary greatly depending on the objectives of the level
of government involved and the geographic area. Sometimes the federal and some state
governments provide training grants to companies locating in and/or hiring in what has
been determined to be a labor surplus area. These training grants often take the form of
paying 50 percent of the salary of the employee for up to the first year, at which time the
employee should be fully productive. Companies locating in these areas often get some tax
reductions at the state and federal levels for a period of time.
Many of the states and cities in the United States also have grant incentive programs
for developing technology and technology companies located in the particular state
and/or providing jobs in labor surplus areas. Often in terms of locating or building a
facility in the state or city, these incentives take the form of a tax reduction for a period
of time.
Grants are also available in many countries and cities throughout the world. The entre-
preneur should investigate all possible grants available, particularly in deciding where to
locate his or her company.
C H A P T E R 11 SOURCES OF CAPITAL 323
TABLE 11.3 Comparison of SBIR and STTR Programs
Requirements SBIR STTR
Applicant organization
Award period
Award dollar guidelines
Principal investigator (PI)
Subcontract/consultant costs
Performance site
Small-business concern (SBC)
Phase I—6 months, normally
Phase II—2 years, normally
Phase I—$100,000, normally
Phase II—$750,000, normally
Employed by company more than 50% of her or his time during award.
Minimum level of effort on the project not stipulated.
Phase I—Total amount of contractual and consultant costs normally may not exceed 33% of total amount requested.
Phase II—Total amount of contractual and consultant costs normally may not exceed 50% of total amount requested.
Must be entirely in United States.
Part of research must take place in company-controlled research space.
Small-business concern (SBC)
Phase I—1 year, normally
Phase II—2 years, normally
Phase I—$100,000, normally
Phase II—$750,000, normally
Employment not stipulated.
The PI must spend a minimum of 10% effort on the project and have a formal appointment with or commitment to the SBC.
Phase I and Phase II—SBC must perform at least 40% of work, and the single, partnering U.S. nonprofit research institution (RI) must perform at least 30% of the work.
Must be entirely in United States.
Part of research must take place in company-controlled research space and part in that of partnering U.S. research institution.
324 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
PRIVATE PLACEMENT
Another source of funds for the entrepreneur is private investors, also called angels, who
may be family and friends or wealthy individuals. Individuals who handle their own sizable
investments frequently use advisors such as accountants, technical experts, financial plan-
ners, or lawyers in making their investment decisions. Business angels are discussed in
more detail in Chapter 12.
Types of Investors
An investor usually takes an equity position in the company, can influence the nature and
direction of the business to some extent, and may even be involved to some degree in the
business operation. The degree of involvement in the day-to-day operations of the venture
is an important point for the entrepreneur to consider in selecting an investor. Some in-
vestors want to be actively involved in the business; others desire at least an advisory role
in the direction and operation of the venture. Still others are more passive in nature, desir-
ing no active involvement in the venture at all. Each investor is primarily interested in re-
covering his or her investment plus a good rate of return.
Private Offerings
A formalized approach for obtaining funds from private investors is through a private
offering. A private offering is different from a public offering or going public (as dis-
cussed in Chapter 12) in several ways. Public offerings involve a great deal of time and
expense, in large part due to the numerous regulations and requirements involved. The
process of registering the securities with the Securities and Exchange Commission
(SEC) is an arduous task requiring a significant number of reporting procedures once
the firm has gone public. Since this process was established primarily to protect unso-
phisticated investors, a private offering is faster and less costly when a limited number
of sophisticated investors are involved who have the necessary business acumen and
ability to absorb risk. These sophisticated investors still need access to material infor-
mation about the company and its management. What constitutes material information?
Who is a sophisticated investor? How many is a limited number? Answers to these ques-
tions are provided in Regulation D.
Regulation D
Regulation D contains (1) broad provisions designed to simplify private offerings,
(2) general definitions of what constitutes a private offering, and (3) specific operating
rules—Rule 504, Rule 505, and Rule 506. Regulation D requires the issuer of a private
offering to file five copies of Form D with the Securities and Exchange Commission
(SEC) 15 days after the first sale, every 6 months thereafter, and 30 days after the final
sale. It also provides rules governing the notices of sale and the payment of any commis-
sions involved.
The entrepreneur issuing the private offering carries the burden of proving that the
exemptions granted have been met. This involves completing the necessary documenta-
tion on the degree of sophistication of each potential investor. Each offering memoran-
dum presented to an investor needs to be numbered and must contain instructions that
the document should not be reproduced or disclosed to any other individual. The date
Regulation D Laws
governing a private
offering
private offering A
formalized method for
obtaining funds from
private investors
that the investor (or the designated representative) reviews the company’s information—
that is, its books and records—as well as the date(s) of any discussion between the company
and the investor need to be recorded. At the close of the offering, the offering company
needs to verify and note that no persons other than those recorded were contacted re-
garding the offering. The book documenting all the specifics of the offering needs to be
placed in the company’s permanent file. The general procedures of Regulation D are
further broadened by the three rules—504, 505, and 506. Rule 504 provides the first ex-
emption to a company seeking to raise a small amount of capital from numerous investors.
Under Rule 504, a company can sell up to $500,000 of securities to any number of in-
vestors, regardless of their sophistication, in any 12-month period. While there is no
specific form of disclosure required, the issuing company cannot engage in any general
solicitation or advertising. Some states do not allow investors to resell their shares unless
the security is registered.
Rule 505 changes both the investors and the dollar amount of the offering. This rule per-
mits the sale of $5 million of unregistered securities in the private offering in any 12-month
period. These securities can be sold to any 35 investors and to an unlimited number of ac-
credited investors. This eliminates the need for the sophistication test and disclosure re-
quirements called for by Rule 504. What constitutes an “accredited investor”? Accredited
investors include (1) institutional investors, like banks, insurance companies, investment
companies, employee benefit plans containing over $5 million in assets, tax-exempt organ-
izations with endowment funds of over $25 million, and private business development
companies; (2) investors who purchase over $150,000 of the issuer’s securities; (3) investors
whose net worth is $1 million or more at the time of sale; (4) investors with incomes in
excess of $200,000 in each of the last two years; and (5) directors, executive officers, and
general partners of the issuing company.
Like Rule 504, Rule 505 permits no general advertising or solicitation through pub-
lic media. When only accredited investors are involved, no disclosure is required under
Rule 505 (similar to the issuance under Rule 504). However, if the issuance involves any
unaccredited investors, additional information must be disclosed. Regardless of the
amount of the offering, two-year financial statements for the two most recent years must
be available unless such a disclosure requires “undue effort and expense.” When this oc-
curs for any issuing company other than a limited partnership, a balance sheet as of
120 days before the offering can be used instead. All companies selling private-placement
securities to both accredited and unaccredited investors must furnish appropriate com-
pany information to both and allow any questions to be asked before the sale. Rule 506
goes one step further than Rule 505 by allowing an issuing company to sell an unlimited
number of securities to 35 investors and an unlimited number of accredited investors
and relatives of issuers. Still, no general advertising or solicitation through public me-
dia can be involved.
In securing any outside funding, the entrepreneur must take great care to disclose all
information as accurately as possible. Investors generally have no problem with the
company as long as its operations continue successfully and this success is reflected in
the valuation. But if the business turns sour, both investors and regulators scrutinize the
company’s disclosures in minute detail to determine if any technical or securities law vi-
olations occurred. When any violation of securities law is discovered, management and
sometimes the company’s principal equity holders can be held liable as a corporation
and as individuals. When this occurs, the individual is no longer shielded by the corpo-
ration and is open to significant liability and potential lawsuits. Lawsuits under securi-
ties law by damaged investors have almost no statute of limitations, as the time does not
C H A P T E R 11 SOURCES OF CAPITAL 325
326 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
begin until the person harmed discovers or should reasonably be expected to discover
the improper disclosure. The suit may be brought in federal court in any jurisdiction in
which the defendant is found or lives or transacts business. An individual can file suit as
a single plaintiff or as a class action on behalf of all persons similarly affected. Courts
have awarded large attorney’s fees as well as settlements when any securities law viola-
tion occurs. Given the number of lawsuits and the litigious nature of U.S. society, the
entrepreneur needs to be extremely careful to make sure that any and all disclosures are
accurate. If this is not enough of an incentive, it should be kept in mind that the SEC can
take administrative, civil, or criminal action as well, without any individual lawsuit in-
volved. This action can result in fines, imprisonment, or the restoration of the monies
involved.
BOOTSTRAP FINANCING
One alternative to acquiring outside capital that should be considered is bootstrap financ-
ing.3 This approach is particularly important at start-up and in the early years of the venture
when capital from debt financing (i.e., in terms of higher interest rates) or from equity fi-
nancing (i.e., in terms of loss of ownership) is more expensive.
In addition to the monetary costs, outside capital has other costs as well. First, it usu-
ally takes between three and six months to raise outside capital or to find out that there
is no outside capital available. During this time, the entrepreneur may not be paying
enough attention to the important areas of marketing, sales, product development, and
operating costs. A business usually needs capital when it can least afford the time to
raise it. One company’s CEO spent so much time raising capital that sales and market-
ing were neglected to such an extent that the forecasted sales and profit figures on the
pro forma income statements were not met for the first three years after the capital in-
fusion. This led to investor concern and irritation that, in turn, required more of the
CEO’s time.
Second, outside capital often decreases a firm’s drive for sales and profits. One success-
ful manager would never hire a person as one of his commission salespeople if he or she
“looked too prosperous.” He felt that if a person was not hungry, he or she would not push
hard to sell. The same concept could apply to outside funded companies that may have the
tendency to substitute outside capital for income.
Third, the availability of capital increases the impulse to spend. It can cause a company
to hire more staff before they are needed and to move into more costly facilities. A company
can easily forget the basic axiom of venture creation: staying lean and mean.
Fourth, outside capital can decrease the company’s flexibility. This can hamper the di-
rection, drive, and creativity of the entrepreneur. Unsophisticated investors are particularly
a problem as they often object to a company’s moving away from the focus and direction
outlined in the business plan that attracted their investment. This attitude can encumber a
company to such an extent that the needed change cannot be implemented or else is imple-
mented very slowly after a great deal of time and effort has been spent in consensus building.
This can substantially demoralize the entrepreneur who likes the freedom of not working
for someone else.
Finally, outside capital may cause disruption and problems in the venture. Capital is not
provided without the expectation of a return, sometimes before the business should be giv-
ing one. Also, particularly if certain equity investors are involved, the entrepreneur is under
pressure to continuously grow the company so that an initial public offering can occur as
soon as possible. This emphasis on short-term performance can be at the expense of the
long-term success of the company.
Bootstrap financing involves using any possible method for conserving cash. While
some entrepreneurs can take advantage of any supplier discounts available, entrepreneurs
with restricted cash flow need to take as long as possible to pay without incurring interest
or late payment fees or being cut off from any future items from the supplier. The entrepre-
neur should always ask about discounts for volume, frequent customer discounts, promo-
tional discounts for featuring the vendor’s product, and even “obsolescence money,” which
allows for upgrading to an enhanced product at no additional cost.
Savings can also be obtained by asking for bulk packaging instead of paying more for
individually wrapped items as well as using co-op advertising with a channel member so
that the cost of the advertisement is shared.
Consignment financing can also be used to help conserve cash. Some vendors allow en-
trepreneurs to place a standing order for the entire amount of goods to be used over a pe-
riod of time but take shipment and make payment only as needed, therefore securing the
lower price of a larger order without having to carry the cost of the inventory. These are just
some examples. The only possible limitation in bootstrap financing is the imagination of
the entrepreneur.
In spite of the potential problems, an entrepreneur at times needs some capital to finance
growth, which would be too slow or nonexistent if internal sources of funds were used.
Outside capital should be sought only after all possible internal sources of funds have been
explored. And when outside funds are needed and obtained, the entrepreneur should not
forget to stay intimately involved with the basics of the business.
C H A P T E R 11 SOURCES OF CAPITAL 327
IN REVIEW
S U M M A R Y
All business ventures require capital. While capital is needed throughout the life of a
business, the new entrepreneur faces significant difficulties in acquiring capital at
start-up. Before seeking outside financing, an entrepreneur should first explore all
methods of internal financing, such as using profits, selling unused assets, reducing
working capital, obtaining credit from suppliers, and collecting accounts receivable
promptly. After all internal sources have been exhausted, the entrepreneur may find it
necessary to seek additional funds through external financing. External financing can
be in the form of debt or equity. When considering external financing, the entrepre-
neur needs to consider the length of time, cost, and amount of control of each alter-
native financial arrangement.
Commercial bank loans are the most frequently used source of short-term external
debt financing. This source of funding requires collateral, which may be asset-based or
may take the form of cash flow financing. In either case, banks tend to be cautious
about lending and carefully weigh the five Cs: character, capacity, capital, collateral,
and condition. Not every entrepreneur will qualify under the bank’s careful scrutiny.
When this occurs, an alternative for an entrepreneur is the Small Business Administra-
tion Guaranty Loan. The SBA guarantees a percentage of the loan, allowing banks to
lend money to businesses that might otherwise be refused.
A special method of raising capital for high-technology firms is a research and de-
velopment (R&D) limited partnership. A contract is formed between a sponsoring
company and a limited partnership. The partnership bears the risk of the research,
receiving some tax advantages and sharing in future profits, including a fee to use the
328 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
research in developing any future products. The entrepreneur has the advantage of ac-
quiring needed funds for a minimum amount of equity dilution while reducing his or
her own risk in the venture.
Government grants are another alternative available to small businesses through
the Small Business Innovation Research (SBIR) program. Businesses can apply for grants
from 11 agencies. Other federal, state, and local (city) grants are often available.
Finally, the entrepreneur can seek private funding. Individual investors frequently
require an equity position in the company and some degree of control. A less expensive
and less complicated alternative to a public offering of stock is a private offering. By
following the procedures of Regulation D and three of its specific rules—504, 505, and
506—an entrepreneur can sell private securities. When making a private offering, the
entrepreneur must exercise care in accurately disclosing information and adhering
precisely to the requirements of the SEC. Securities violations can lead to lawsuits
against individuals as well as the corporation.
The entrepreneur needs to consider all possible sources of capital and select the one
that will provide the needed funds with minimal cost and loss of control. Usually, dif-
ferent sources of funds are used at various stages in the growth and development of
the venture, as occurred in the case of Scott Walker, a successful entrepreneur indeed.
R E S E A R C H T A S K S
1. Interview a business loan officer at a bank to determine the bank’s lending criteria
for small businesses and new businesses. Does it use the five Cs? Which of the five
Cs appears to be the most important?
2. Obtain a loan application from the local bank and categorize each question in
terms of which of the five Cs it is attempting to assess.
3. Choose a type of business you would like to run. Then search the Internet for
government grants that might be applicable for you and your business.
4. Interview three small-business owners about things they do (or have done) to
bootstrap the financing of their business. How effective were these techniques? Be
prepared to present this list to the class and describe how the techniques work.
C L A S S D I S C U S S I O N
1. What is the cheapest source of funds? When all other sources turn down your
request for funding, what source is most likely to say yes? Why is this the case?
Is the entrepreneur exploiting a personal relationship with this potential source of
capital? What are the consequences of using this source of capital if the business
goes bankrupt?
2. Should the government provide grants for entrepreneurs starting new businesses?
Should the government guarantee loans for small businesses that are missing the
necessary track record, assets, or other ingredients to obtain a commercial bank
loan? What benefit do we, as a nation of taxpayers, receive from such grants and
loan guarantees?
3. Why don’t all firms use bootstrap financing? Are there any dangers with this
approach? What are the benefits of having some financial slack (e.g., some extra
cash in reserve)? What are the costs of that financial slack?
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S E L E C T E D R E A D I N G S
Barr, Kate. (January 2, 2009). Guidance for Building a Social Enterprise. Fedgazette, vol. 21, no. 1, p. 6.
Published by the Federal Reserve Bank of Minnesota, the Fedgazette includes edu- cational commentary for the general public about the economy and investing. This article, positioned in the Community Dividend section, defines social enterprise as a fundraising strategy put in place by nonprofit organizations (e.g., Girl Scouts of America cookie sales). Kate Barr, who heads Minnesota’s Nonprofits Assistance Fund, suggests helpful hints for nonprofit organizations seeking commercial fund- ing for their benevolent works. Advice such as “achieving a double bottom line” and properly assessing the organization’s readiness are invaluable tips for the non- profit entrepreneur.
Cruickshank, Nancy. (January 1, 2009). Instil [sic] Confidence in Your Brand If You Want to Secure Venture Capital Funds. Revolution, p. 24.
The dot.com boom of the 1990s has convinced young entrepreneurs that whatever the gadget, discovery, innovation, or gizmo, some soul exists who will front the money. From venture capitalists to angel investors to strategic business competitors, someone out there has a nickel for you. However, with economic crunches on the horizon, the land of plenty is no longer a promised land. This article, published in a British periodical, confirms that in times of duress, if any funding is circulating, the venture capitalists are the ones who’ll set the stage. The author of this opinion piece cites the coveted criteria.
Dahl, Darren. (February 2006). Facing the Capital Gap. Inc., vol. 28, no. 2, pp. 25–27.
This article highlights the ever-changing climate of venture capital funding: who’s en vogue, who’s déclassé, and which start-up firms do venture capital firms love to hate. While recognizing the volatility in investor temperaments, the author of this article chronicles the prevalent trends in venture capital deals at the start of the new millennium, and why raising $200,000 can be more difficult than raising $5 million.
Farrell, Christopher. (April 28, 2008). How Angel Investors Get Their Wings. Business- Week, no. 112.
Angel investors invest in promising start-ups too young and raw to attract the attention and money of professional venture capitalists. The credit crunch and economic downturn have some angels feeling skittish. But others see opportu- nity. Studies show that the best time to start a business is when the economy is down. That’s because entrepreneurs with good ideas will find cheaper land, labor, supplier contracts, and other ingredients that go into starting a business. Angels who back such ventures can earn impressive long-term returns—one study cites a rate of return of about 27 percent, on average, or 2.6 times the investment in 3.5 years. The risks, of course, are steep. Still, 258,200 angels pumped $26 billion into 57,120 ventures last year, according to the University of New Hampshire’s Center for Venture Research. While many angels are current or former entrepre- neurs, and that background can prove invaluable, they also need to develop investing skills.
Gimmon, Eli. (2008). Entrepreneurial Team-starts and Teamwork: Taking the Investors’ Perspective. Team Performance Management, vol. 14, no. 7/8, pp. 327–39.
This article includes the results of a research project, which evaluates the impor- tance of entrepreneurial teamwork in venture capitalists’ decisions to fund a ven- ture. The entrepreneurial teams examined in this research are exclusively involved in high-technology pursuits, such as information technology and electronics. The author of this research is an Israeli business professor who bases his hypothesis on
C H A P T E R 11 SOURCES OF CAPITAL 329
330 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
previous evidence that teamwork has a favorable effect on the success of entrepre- neurial undertakings. The author’s conclusions examine the habits of venture capitalists and angel investors from different geographical regions: U.S. investors, for example, do not value entrepreneurial teamwork as much as do British and Israeli investors.
Kushnirovich, Nonna; Heilbrunn, Sibylle. (June 2008). Financial Funding of Immigrant Businesses. Journal of Developmental Entrepreneurship, vol. 13, no. 2, pp. 167–84.
This 2008 article includes the results of a study conducted among Israeli businesses between the years 2000 and 2005. One-hundred fifty-three of the responding businesses were owned by immigrants from the former Soviet Union, while 214 were owned by native Israelis. The authors of this study, faculty of Israel’s Ruppin Academic Center, compare the borrowing tendencies between these two groups: immigrant- and non-immigrant-owned businesses. According to the results of the study, Israel’s non-immigrant-owned businesses had more access to capital from the Israeli government, banks, and other financial institutions. Yet, the immigrant businesses tended to assume less debt and had unique sources of capital at their disposal.
Pineda, Yovanna. (June 2006). Sources of Finance and Reputation: Merchant Finance Groups in Argentine Industrialization, 1890–1930. Latin American Research Review, vol. 41, no. 2, pp. 3–30.
The author of this article is a Latin American history and economics professor at St. Michael’s College in Vermont. Her research paper describes the importance of personal relationships and social status in securing business funding in turn-of-the- century Argentina. While the capitalist economies of Europe and North America were swelling with the boom of industry, Latin America, namely Argentina, was devoid of even an established banking system. The author’s thesis explores how five small-business lenders managed to fund Argentina’s industrial revolution, in the absence of equity and credit markets.
Rayasam, Renuka. (August 1, 2008). Who Needs Silicon Valley? Thanks to New State Programs, Companies Are Finding Funds Outside of Traditional VC Hubs. Inc., vol. 30, no. 8, pp. 10, 43–44.
California’s Silicon Valley is considered the mecca of venture capital firms: progres- sive, forward-thinking individuals who recognize the importance of providing seed funds. Obviously, in times of economic downturn, these once well-recognized fonts of wealth dehydrate and inventors are left with nowhere to turn. According to this article, U.S. state governments are creating training programs that coach wealthy individuals on the benefits of assisting start-ups. The Wisconsin Angel Network, for example, has secured tax incentives for the state’s wealthy individuals who choose to invest in fledgling enterprises.
Westerman, James W.; Geiger, Scott W.; Cyr, Linda A. (December 2008). Employee Eq- uity Incentives and Venture Capitalist Involvement: Examining the Effects on IPO Per- formance. Journal of Developmental Entrepreneurship, vol. 13, no. 4, pp. 409–23.
Many times entrepreneurs are hesitant to operate within the confines of other peo- ple’s money. While the additional influx of cash is often welcome, seasoned entre- preneurs realize these handouts come at a price: independence. This article, for such naysayers, offers proof that accepting venture capital funding can ensure the suc- cess of a business, should it choose to go public. Also, the employees of these poten- tial initial public offering firms are in better stead if their company has received venture capital funding.
C H A P T E R 11 SOURCES OF CAPITAL 331
E N D N O T E S
1. Crystal Detamore-Rodman, “Cash In, Cash Out,” Entrepreneur (June 2003), pp. 53–54.
2. For a discussion of bank lending decisions, see A. D. Jankowicz and R. D. Hisrich, “Intuition in Small Business Lending Decisions,” Journal of Small Business Management (July 1987), pp. 45–52; N. C. Churchill and V. L. Lewis, “Bank Lending to New and Growing Enterprises,” Journal of Business Venturing (Spring 1986), pp. 193–206; R. T. Justis, “Starting a Small Business: An Investiga- tion of the Borrowing Procedure,” Journal of Small Business Management (October 1982), pp. 22–32; and L. Fertuck, “Survey of Small Business Lending Practices,” Journal of Small Business Management (October 1982), pp. 42–48.
3. Bootstrap financing is discussed in Anne Murphy, “Capital Punishment,” Inc. (November 1993), pp. 38–42; and Michael P. Cronin, “Paradise Lost,” Inc. (November 1993), pp. 48–53.
1
To explain the basic stages of venture funding.
2
To discuss the informal risk-capital market.
3
To discuss the nature of the venture-capital industry and the venture-capital decision process.
4
To explain all aspects of valuing a company.
5
To identify several valuation approaches.
6
To explain the process of going public.
12 I N F O R M A L R I S K C A P I TA L , V E N T U R E
C A P I TA L , A N D G O I N G P U B L I C
L E A R N I N G O B J E C T I V E S
333
O P E N I N G P R O F I L E
MARK ZUCKERBERG
According to Portfolio Research, it took 89 years for the telephone to reach 150 million
users and 38 years for television to do the same. Facebook, however, became 150 mil-
lion users strong after a mere five years.
It all started with Harvard student Mark Zuckerberg, who had a passion for program-
ming. He began building programs in middle school,
and by high school he had developed an application
aimed at helping the employees in his father’s office
communicate. A few years later, he created an online
version of the game Risk (a game of world domination), followed by a program called
Synapse (a music player). Driven by his passion, he learned his coding knowledge
through C⫹⫹ for Dummies and discussions with friends, and in 2001 he went on to
study computer science at Harvard. By 2006, he was a Harvard dropout.
Zuckerberg’s first online program attempt at Harvard, Facemash, got him into seri-
ous trouble with school administrators. Facemash allowed users to rank photos of their
classmates according to their attractiveness. Even though the site had over 450 users
who voted more than 22,000 times within just a few days, Zuckerberg was accused of
violating individual privacy, violating copyright laws, and breaching security and was
obliged to take down the site. His second programming attempt, however, made him
the youngest self-made billionaire in history.
Entering Harvard, Zuckerberg was looking for a way to meet and get to know his
classmates. So in February 2004, with Harvard roommates Dustin Moskovitz, Eduardo
Saverin, and Chris Hughes, Zuckerberg developed a program that allowed his class-
mates to share as much or as little information about themselves as they wanted and
originally named it “TheFacebook.com.” Users could share information about them-
selves such as their favorite bands, their relationship status, and class notes and could
change any of their content at any time they wanted. Zuckerberg’s main concern with
creating the site was not to make millions or to reach unprecedented fame, but to al-
low the free sharing and transfer of information among members. He also wanted the
site to be a replica of human life: joining clubs, creating albums, finding out what
other people are doing with their lives. Zuckerberg knew that as long as he made it
easy to use, peer pressure and the network effect would ensure its growth.
www.facebook.com
Zuckerberg originally targeted the site to 18- to 24-year-olds, and it was at first
limited to Harvard students. In March of that year, TheFacebook.com expanded to
other Ivy League schools, and by May 2005 was serving 800 colleges across the coun-
try. At that time, the site operated upon exclusivity; a corresponding college e-mail
address was required to sign up to become a member. In August 2005, the company
name was officially changed to “Facebook,” and later that year it was opened up to
high school networks and a few companies, including Apple and Microsoft. By the
end of 2005, the site had grown to 5.5 million active users compared to 1 million
exactly a year before.
In September 2006, Zuckerberg removed all registration restrictions on Facebook and
opened up the site to the general public. Having anticipated a negative reaction from
the college students who made the site so popular, he, along with the other founders,
had proactively taken action to prepare and inform existing members of new privacy
features. For example, users could not only block other Facebook members from viewing
their profiles, but they could also avoid even being found on the site when their name
was searched. Opening Facebook to the public helped to more than double the site’s
membership within one year; by December 2006 Facebook had 12 million active users.
In anticipation of growing the site to 200 million users, Zuckerberg began looking
outside the confines of the United States, and in March 2007 two million Canadians
and one million British joined Facebook. In early 2008, Facebook was launched in
French, Spanish, and German, and by April 2008 it was translated and launched in 21
additional languages. August 2008 saw a Facebook membership of 100 million active
users; five months later, in January 2009, this number reached 150 million, and February
2009’s count revealed 175 million active users. By early 2009, five million new people
were joining Mark Zuckerberg’s social network site every week, with the most common
new members being women over the age of 55.
As the site grew in membership, its platform blossomed as well. In September 2004,
the Groups application and Wall features were added, followed by the Photos applica-
tion in October 2005. The Photo feature allowed users to tag everyone appearing in
the picture so the picture shows up on the corresponding members’ profiles as well.
This helped the application quickly gain popularity; in February 2008, 250 million pho-
tos were uploaded every month, and a year later, February 2009, the number had risen
to 850 million monthly uploads. In April 2006, Facebook added the Mobile feature, al-
lowing users to upload Facebook onto their mobile phones and access the site any-
where, anytime. September 2006 saw the addition of the News and Mini-Feeds, which
created some backlash from members. The News feed informed users of all recent
activity taken on the profiles of all their friends, including potentially embarrassing
changes such as breakups or professional demotions. Though such information was
already accessible (since the member chose to change it on his or her profile), users
felt Facebook was spreading the news and informing those who would otherwise not
have noticed. A Facebook group entitled “Students Against Facebook News Feed”
was created and within 24 hours, 290,000 members had joined. Zuckerberg heard
334 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 335
and listened to the outcry and reacted by creating and promoting additional privacy
settings enabling users to decide what profile changes could and could not be included
on the feed.
In 2007, another backlash occurred when Facebook launched a feature called
Beacon, informing users which Web sites their friends had visited, including informa-
tion on products they were purchasing. The user protest was overwhelming and even
included a filed lawsuit. This resulted in the allowance for users to disable Beacon on
their profile, and an apology from Zuckerberg, admitting, “We simply did a bad job
with this release, and I apologize for it.”
In April 2008, a Chat feature was added, furthering the communication capabilities
of the users among each other, and by 2009, Facebook had grown to become more
than just a communication tool among friends. It has become the hub for users to
store their pictures, organize parties, chat, play games, and find jobs. From a profes-
sional standpoint, companies such as Ernst & Young and Dell use the site to recruit new
hires, and governmental parties, such as the Democratic Party in Maine, use it to
organize meetings.
In 2008, Mark Zuckerberg was named one of “The World’s Most Influential People
of 2008” by Time magazine, and Forbes calls him the youngest self-made billionaire.
Many investors had recognized Facebook’s value and potential early on; in 2005 Face-
book received $12.7 million in venture-capital money from Accel Partners and $27.5 mil-
lion from Greylock Partners in 2006. Also in 2006, Facebook and Microsoft formed a
strategic relationship, and by October 2007, Microsoft took a $240 million equity stake
in Facebook.
However, Facebook is not lacking challenges. Although the site is worth $3.7 billion
(in 2008), it has a unique financial predicament; its revenues reached a mere $280 mil-
lion in 2008, which did not even reach the break-even point. To bring the company to
a position where it financially makes the most of its soaring attractiveness to mar-
keters, Zuckerberg brought Sheryl Sandberg (who built Google’s AdWords program)
on board as the chief operating officer. Because each user on the site has his or her
own unique story, the wealth of personal information allows advertisers to effectively
promote themselves to their target markets, based on each individual’s profile. It also
gives marketers a better sense of new trends and popular activities. For example, if a
particular Facebook group has hundreds of thousands of members, it is vital for adver-
tisers to join the group and stay aligned with current and upcoming trends and societal
interests.
Facebook also faces the challenge of “staying on top.” The world has seen compa-
nies such as AOL and Yahoo!, who were each well positioned to become the ultimate
leader in communication platforms, fail. Zuckerberg and Facebook are working on
coming up with ways to continue growing and expanding to remain the leading social
network while making sure not to alienate its early adopters. Luckily, Zuckerberg’s
vision for the future is well aligned with the needs for Facebook; he wants his site to
reach every person and every computer in the world.1
336 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
Unlike Mark Zuckerberg, many entrepreneurs find it difficult both to manage and expand
the ventures they have created. To successfully start and especially grow a venture, an
entrepreneur must understand venture financing and obtain the necessary funding from a
variety of sources.
FINANCING THE BUSINESS
In evaluating the appropriateness of financing alternatives, particularly angel versus
venture-capital financing, an entrepreneur must determine the amount and the timing of
the funds required, as well as the projected company sales and growth. Conventional small
businesses and privately held middle-market companies tend to have a difficult time
obtaining external equity capital, especially from the venture-capital industry. Most ven-
ture capitalists like to invest in software, biotechnology, or high-potential ventures like
Mark Zuckerberg’s Facebook. The three types of funding as the business develops are
indicated in Table 12.1. The funding problems, as well as the cost of the funds, differ for
each type. Early-stage financing is usually the most difficult and costly to obtain. Two
types of financing are available during this stage: seed capital and start-up capital. Seed
capital, the most difficult financing to obtain through outside funds, is usually a relatively
small amount of funds needed to prove concepts and finance feasibility studies. Since
early-stage financing
One of the first financings
obtained by a company
TABLE 12.1 Stages of Business Development Funding
Early-Stage Financing
• Seed capital Relatively small amounts to prove concepts and
finance feasibility studies
• Start-up Product development and initial marketing, but with
no commercial sales yet; funding to actually get com-
pany operations started
Expansion or Development Financing
• Second stage Working capital for initial growth phase, but no clear
profitability or cash flow yet
• Third stage Major expansion for company with rapid sales growth;
company is at breakeven or positive profit levels but is
still private
• Fourth stage Bridge financing to prepare company for public
offering
Acquisition and Leveraged Buyout Financing
• Traditional acquisitions Assuming ownership and control of another company
• Leveraged buyouts (LBOs) Management of a company acquiring company con-
trol by buying out the present owners
• Going private Some of the owners/managers of a company buying
all the outstanding stock, making the company
privately held again
venture capitalists usually have a minimum funding level of above $500,000, they are
rarely involved in this type of funding, except in the case of high-technology ventures of
entrepreneurs who have a successful track record and need a significant amount of capi-
tal. The second type of funding is start-up financing. As the name implies, start-up financ-
ing is involved in developing and selling some initial products to determine if commercial
sales are feasible. These funds are also difficult to obtain. Angel investors are active in
these two types of financing.
Expansion or development financing (the second basic financing type) is easier to obtain
than early-stage financing. Venture capitalists play an active role in providing funds here.
As the firm develops in each stage, the funds for expansion are less costly. Generally, funds
in the second stage are used as working capital to support initial growth. In the third stage,
the company is at breakeven or a positive profit level and uses the funds for major sales ex-
pansion. Funds in the fourth stage are usually used as bridge financing in the interim period
as the company prepares to go public.
Acquisition financing or leveraged buyout financing (the third type) is more specific in
nature. It is issued for such activities as traditional acquisitions, leveraged buyouts (man-
agement buying out the present owners), and going private (a publicly held firm buying out
existing stockholders, thereby becoming a private company).
There are three risk-capital markets that can be involved in financing a firm’s growth:
the informal risk-capital market, the venture-capital market, and the public-equity market.
Although all three risk-capital markets can be a source of funds for stage-one financing, the
public-equity market is available only for high-potential ventures, particularly when high
technology is involved. Recently, some biotechnology companies raised their first-stage
financing through the public-equity market since investors were excited about the potential
prospects and returns in this high-interest area. This also occurred in the areas of oceanog-
raphy and fuel alternatives when there was a high level of interest. Although venture-
capital firms also provide some first-stage funding, the venture must require the minimum
level of capital ($500,000). A venture-capital company establishes this minimum level of
investment due to the high costs in evaluating and monitoring a deal. By far the best source
of funds for first-stage financing is the informal risk-capital market—the third type of
risk-capital market.
INFORMAL RISK-CAPITAL MARKET
The informal risk-capital market is the most misunderstood type of risk capital. It consists
of a virtually invisible group of wealthy investors, often called business angels, who are
looking for equity-type investment opportunities in a wide variety of entrepreneurial ven-
tures. Typically investing anywhere from $10,000 to $500,000, these angels provide the
funds needed in all stages of financing, but particularly in start-up (first-stage) financing.
Firms funded from the informal risk-capital market frequently raise second-and third-
round financing from professional venture-capital firms or the public-equity market.
Despite being misunderstood by, and virtually inaccessible to, many entrepreneurs, the
informal investment market contains the largest pool of risk capital in the United States.
Although there is no verification of the size of this pool or the total amount of financing
provided by these business angels, related statistics provide some indication. A 1980 sur-
vey of a sample of issuers of private placements by corporations, reported to the Securities
and Exchange Commission under Rule 146, found that 87 percent of those buying these is-
sues were individual investors or personal trusts, investing an average of $74,000.2 Private
placements filed under Rule 145 average over $1 billion per year. Another indication
becomes apparent on examination of the filings under Regulation D—the regulation
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 337
business angels
A name for individuals in
the informal risk-capital
market
development financing
Financing to rapidly
expand the business
acquisition financing
Financing to buy another
company
risk-capital markets
Markets providing debt
and equity to nonsecure
financing situations
informal risk-capital
market Area of risk-
capital markets consisting
mainly of individuals
venture-capital market
One of the risk-capital
markets consisting of
formal firms
public-equity market
One of the risk-capital
markets consisting of
publicly owned stocks of
companies
338
A S S E E N I N BUSINESSWEEK
OLD BANKS, NEW LENDING TRICKS
That didn’t take long. The economy hasn’t yet recov-
ered from the implosion of risky investments that led
to the worst recession in decades—and already some
of the world’s biggest banks are peddling a new gen-
eration of dicey products to corporations, consumers,
and investors.
In recent months such big banks as Bank of America,
Citigroup, and JPMorgan Chase have rolled out new-
fangled corporate credit lines tied to complicated and
volatile derivatives. Others, including Wells Fargo
and Fifth Third, are offering payday-loan programs
aimed at cash-strapped consumers. Still others are
marketing new, potentially risky ”structured notes”
to small investors.
There’s no indication that the loans and instru-
ments are doomed to fail. If the economy keeps mov-
ing toward recovery, as many measures suggest, then
the new products might well work out for buyers and
sellers alike.
But it’s another scenario that worries regulators,
lawmakers, and consumer advocates: that banks once
again are making dangerous loans to borrowers
who can’t repay them and selling toxic investments
to investors who don’t understand the risks—all of
which could cause blowups in the banking sector and
weigh on the economy.
Some of Wall Street’s latest innovations give rea-
son for pause. Consider a trend in business loans.
Lenders typically tie corporate credit lines to short-
term interest rates. But now Citi, JPMorgan Chase,
and BofA, among others, are linking credit lines both
to short-term rates and credit default swaps (CDSs),
the volatile and complicated derivatives that are sup-
posed to act as “insurance” by paying off the owners
if a company defaults on its debt. JPMorgan, BofA,
and Citi declined to comment.
In these new arrangements, when the price of the
CDS rises—generally a sign the market thinks the com-
pany’s health is deteriorating—the cost of the loan
increases, too. The result: The weaker the company,
the higher the interest rates it must pay, which hurts
the company further.
The lenders stress that the new products give them
extra protection against default. But for companies,
the opposite may be true. Managers now must deal
with two layers of volatility—both short-term interest
rates and credit default swaps, whose prices can spike
for reasons outside their control.
At the other end of the borrower spectrum, big
banks are entering another controversial arena: pay-
day loans, whose interest rates can run as high as
400%. Historically the market has been dominated by
small nonbank lenders, which mainly operate in poor
urban centers and offer customers an advance on
their paychecks. But big lenders Fifth Third and U.S.
Bancorp started offering the loans, while Wells Fargo
continues to boost its payday-loan program, which it
began in 1994.
More big banks are getting into the market just as
a recent flurry of usury laws has crippled smaller play-
ers. In the past two years lawmakers in 15 states have
capped interest rates on short-term loans or kicked
out payday lenders altogether. The state of Ohio, for
example, has imposed a 28% interest rate limit. But
thanks to interstate commerce rules, nationally char-
tered banks don’t have to follow local rules. After
Ohio limited rates, Cincinnati-based Fifth Third, which
has 400 branches in the state but also operates in
11 others, introduced its Early Access Loan, with an
annual interest rate of 120%. “These banks are skirting
state laws,” says Kathleen Day of advocacy group
Center for Responsible Lending. Says a spokeswoman
for Fifth Third: “Our Early Access product fully com-
plies with federal regulations and applicable state
regulations.”
Lenders argue they offer a valuable service for
those who need emergency cash. Wells Fargo says it
warns customers using its Direct Deposit Advance that
the loan is expensive and tries to offer alternatives.
“We have policies in place to prevent long-term usage
of the services,” says a spokeswoman. U.S. Bancorp
didn’t return calls.
National regulators are taking notice, however. The
Office of Thrift Supervision says it is “looking into”
two institutions that are offering the high-interest
loans. “We need to make sure there’s no predatory
lending and also ensure that there are no risks to the
institutions,” says an OTS spokesman.
Source: Reprinted from August 17, 2009 issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Companies, Inc., “Old Banks, New Lending Tricks,” by Jessica Silver-Greenberg, Theo Francis, and Ben Levisohn, pp. 20–23.
exempting certain private and limited offerings from the registration requirements of the
Securities Act of 1933, discussed in Chapter 11. In its first year, over 7,200 filings, worth
$15.5 billion, were made under Regulation D. Corporations accounted for 43 percent of the
value ($6.7 billion), or 32 percent of the total number of offerings (2,304). Corporations fil-
ing limited offerings (under $500,000) raised $220 million, an average of $200,000 per
firm. The typical corporate issuers tended to be small, with fewer than 10 stockholders,
revenues and assets less than $500,000, stockholders’ equity of $50,000 or less, and five or
fewer employees.3
Similar results were found in an examination of the funds raised by small technology-
based firms prior to their initial public offerings. The study revealed that unaffiliated indi-
viduals (the informal investment market) accounted for 15 percent of these funds, while
venture capitalists accounted for only 12 to 15 percent. During the start-up year, unaffili-
ated individuals provided 17 percent of the external capital.4
A study of angels in New England again yielded similar results. The 133 individual in-
vestors studied reported risk-capital investments totaling over $16 million in 320 ventures
between 1976 and 1980. These investors averaged one deal every two years, with an aver-
age size of $50,000. Although 36 percent of these investments averaged less than $10,000,
24 percent averaged over $50,000. While 40 percent of these investments were start-ups,
80 percent involved ventures less than five years old.5
The size and number of these investors have increased dramatically, due in part to the
rapid accumulation of wealth in various sectors of the economy. One study of consumer
finances found that the net worth of 1.3 million U.S. families was over $1 million.6 These
families, representing about 2 percent of the population, accumulated most of their wealth
from earnings, not inheritance, and invested over $151 billion in nonpublic businesses in
which they have no management interest. Each year, over 100,000 individual investors
finance between 30,000 and 50,000 firms, with a total dollar investment of between $7 bil-
lion and $10 billion. Given their investment capability, it is important to know the charac-
teristics of these angels.
One article determined that the angel money available for investment each year was
about $20 billion.7 This amount was confirmed by another study indicating that there are
about 250,000 angel investors who invest an amount of $10 billion to $20 billion annually
in about 30,000 firms.8 A recent study found that only about 20 percent of the angel in-
vestors surveyed tended to specialize in a particular industry, with the typical investment in
the first round being between $29,000 to over $100,000.9
The characteristics of these informal investors, or angels, are indicated in Table 12.2.
They tend to be well educated; many have graduate degrees. Although they will finance
firms anywhere in the United States (and a few in other parts of the world), most of the
firms that receive funding are within one day’s travel. Business angels will make one to two
deals each year, with individual firm investments ranging from $100,000 to $500,000 and
the average being $340,000. If the opportunity is right, angels might invest from $500,000
to $1 million. In some cases, angels will join with other angels, usually from a common
circle of friends, to finance larger deals.
Is there a preference for the type of ventures in which they invest? While angels in-
vest in every type of investment opportunity, from small retail stores to large oil explo-
ration operations, some prefer manufacturing of both industrial and consumer products,
energy, service, and the retail/wholesale trade. The returns expected decrease as the
number of years the firm has been in business increases, from a median five-year capi-
tal gain of 10 times for start-ups to 3 times for established firms over five years old.
These investing angels are more patient in their investment horizons and do not have a
problem waiting for a period of 7 to 10 years before cashing out. This is in contrast to
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 339
the more predominant five-year time horizon in the formal venture-capital industry.
Investment opportunities are rejected when there is an inadequate risk/return ratio, a
subpar management team, a lack of interest in the business area, or insufficient commit-
ment to the venture from the principals.
The angel investor market averages about $20 billion each year, which is about the same
level of yearly investment of the venture-capital industry. The angel investment is in about
eight times the number of companies. In normal economic conditions, the number of active
340 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
TABLE 12.2 Characteristics of Informal Investors
Demographic Patterns and Relationships
• Well educated, with many having graduate degrees.
• Will finance firms anywhere, particularly in the United States.
• Most firms financed within one day’s travel.
• Majority expect to play an active role in ventures financed.
• Many belong to angel clubs.
Investment Record
• Range of investment: $100,000–$500,000
• Average investment: $340,000
• One to two deals each year
Venture Preference
• Most financings in start-ups or ventures less than 5 years old
• Most interest in financing:
• Manufacturing—industrial/commercial products
• Manufacturing—consumer products
• Energy/natural resources
• Services
• Software
Risk/Reward Expectations
• Median 5-year capital gain of 10 times for start-ups
• Median 5-year capital gain of 6 times for firms under 1 year old
• Median 5-year capital gain of 5 times for firms 1–5 years old
• Median 5-year capital gain of 3 times for established firms over 5 years old
Reasons for Rejecting Proposals
• Risk/return ratio not adequate
• Inadequate management team
• Not interested in proposed business area
• Unable to agree on price
• Principals not sufficiently committed
• Unfamiliar with area of business
investors is around 250,000 individuals in the United States, with five or six investors typ-
ically being involved in an investment.
Where do these angel investors generally find their deals? Deals are found through re-
ferrals by business associates, friends, active personal research, investment bankers, and
business brokers. However, even though these referral sources provide some deals, most
angel investors are not satisfied with the number and type of investment referrals. Fifty-one
percent of the investors surveyed were either partially or totally dissatisfied with their re-
ferral systems and indicated that at least moderate improvement is needed.
A phenomenon that is spreading throughout the United States is “brands” of angels or
organized angel investor groups. Each angel group or club usually has a meeting for about
two to three hours about 8 to 10 times each year. Some groups are now starting to co-invest
with other groups. The group as a whole does not have any money but serves as a conven-
ing and screening device for the presentations. The individual members of the group make
the investment either individually or with others interested if any investment is made.
The typical club process is that you send the required form to the designated club mem-
ber. Following initial screening, if the entrepreneur is chosen, then follow-up meetings with
several club members occur. If the entrepreneur is selected to present at a future meeting,
then the entrepreneur is provided guidance in terms of business plan refinement and the
presentation. Usually 30 minutes is allocated for a presentation and questions, and then any
interested club members meet with the entrepreneur to discuss further steps in the invest-
ment decision process. The approximately 200 organized angel investor groups are identi-
fied by the Kauffman Foundation (www.kauffman.org).
In several cases, these organized clubs have spawned an angel fund, which is a pool of
money dedicated to a specific region and several industries. The fund size is between
$5 and $10 million. The few angel funds in existence operate very much like university-
sponsored venture-capital funds, which will be discussed later in this chapter.
VENTURE CAPITAL
The important and little understood area of venture capital will be discussed in terms of its
nature, the venture-capital industry in the United States, and the venture-capital process.
Nature of Venture Capital
Venture capital is one of the least understood areas in entrepreneurship. Some think that
venture capitalists do the early-stage financing of relatively small, rapidly growing technol-
ogy companies. It is more accurate to view venture capital broadly as a professionally man-
aged pool of equity capital. Frequently, the equity pool is formed from the resources of
wealthy limited partners. Other principal investors in venture-capital limited partnerships
are pension funds, endowment funds, and other institutions, including foreign investors.
The pool is managed by a general partner—that is, the venture-capital firm—in exchange
for a percentage of the gain realized on the investment and a fee. The investments are in
early-stage deals as well as second- and third-stage deals and leveraged buyouts. In fact,
venture capital can best be characterized as a long-term investment discipline, usually oc-
curring over a five-year period, that is found in the creation of early-stage companies, the
expansion and revitalization of existing businesses, and the financing of leveraged buyouts
of existing divisions of major corporations or privately owned businesses. In each invest-
ment, the venture capitalist takes an equity participation through stock, warrants, and/or
convertible securities and has an active involvement in the monitoring of each portfolio
company, bringing investment, financing planning, and business skills to the firm.
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 341
referral sources Ways
individual investors find
out about potential deals
equity pool Money
raised by venture
capitalists to invest
equity participation
Taking an ownership
position
Overview of the Venture-Capital Industry
Although the role of venture capital was instrumental throughout the industrialization of
the United States, it did not become institutionalized until after World War II. Before World
War II, venture-capital investment activity was a monopoly led by wealthy individuals,
investment banking syndicates, and a few family organizations with a professional manager.
The first step toward institutionalizing the venture-capital industry took place in 1946 with
the formation of the American Research and Development Corporation (ARD) in Boston.
The ARD was a small pool of capital from individuals and institutions put together by Gen-
eral Georges Doriot to make active investments in selected emerging businesses.
The next major development, the Small Business Investment Act of 1958, married pri-
vate capital with government funds to be used by professionally managed small-business
342
A S S E E N I N BUSINESSWEEK
SHE’S AN ANGEL
Barbara Boxer, a practicing attorney in Milwaukee,
knows just how difficult it can be for women entre-
preneurs to raise money. She ran her own mail-order
medical supply company for 20 years before selling it
in 1990, and now many of her clients are women who
own businesses. After participating in a conference
for women trying to raise funding, the 56-year-old
decided to take matters into her own hands. Last sum-
mer, Boxer started Women Angels, a group of women
investors that focuses on women-owned businesses in
the Midwest. Now the group’s 22 members are get-
ting ready to make their first investments. They will
put $150,000 to $500,000 in each of two companies,
one in biotech and one in transportation.
Boxer is part of a small but growing legion of
women angel investors, who are using their own
money to back young companies. Often, those are
companies led by women. “We’re seeing more women
entrepreneurs who are cashing out of their busi-
nesses,” says Jeffrey Sohl, a professor of entrepreneur-
ship at the University of New Hampshire. “The more
women who are successful in business, particularly in
entrepreneurship, the more women angels we’re likely
to see.” That’s because the prime candidates to be
angel investors are former entrepreneurs. There are at
least six women-focused angel groups in the U.S., with
an additional dozen or so just getting started, accord-
ing to a recent report from the Kauffman Foundation.
Angels are a rich source of capital for entrepre-
neurs. Last year, 225,000 angels invested $23.1 billion
in roughly 49,500 deals, according to the Center for
Venture Research. Women represented 9% of that
group, up from 5% in 2004. Part of that increase is
coming from new women-led investment groups, but
there’s still plenty of room for growth. Women
not only control 50% of the country’s wealth, but
they also represent an increasing percentage of en-
trepreneurs. About half of private companies are
majority-owned by women, according to the Center
for Women’s Business Research.
Why aren’t there more women angel groups?
There are plenty of reasons. For one, only about
15%–20% of angels are organized into groups at all,
with the rest investing on their own. Angel investors
tend to be serial entrepreneurs, and serial entrepre-
neurs tend to be men. Social networks also play a role,
since angel groups usually form around investors’
social circles. “Men tend to socialize and affiliate with
people they do business with,” says Maggie Kenefake,
manager of growth entrepreneurship for the Kauffman
Foundation. “If you look at women, their networks
are more social, philanthropic, or family-based.”
Just because many women are newer to the
investment game doesn’t mean they’re any less dis-
cerning than men. Although women angels actively
seek out, and tend to attract, more women entrepre-
neurs, the groups conduct the same amount of due
diligence and ultimately fund companies at the same
rate as men do, roughly 10% of the proposals they
see. And while many of these new groups have every
intention of helping other women entrepreneurs,
being an angel is, in the end, still an investment deci-
sion. Says Boxer: “This isn’t about altruism. It’s about
making money.”
Source: Reprinted from Summer 2006 Small Biz Supplement issue of BusinessWeek by special permission, copyright © 2006 by The McGraw-Hill Companies, Inc., “She’s an Angel,” by Adrienne Carter, p. 34.
investment companies (SBIC firms) to infuse capital into start-ups and growing small busi-
nesses. With their tax advantages, government funds for leverage, and status as a private-
capital company, SBICs were the start of the now formal venture-capital industry. The
1960s saw a significant expansion of SBICs with the approval of approximately 585 SBIC
licenses that involved more than $205 million in private capital. Many of these early SBICs
failed due to inexperienced portfolio managers, unreasonable expectations, a focus on
short-term profitability, and an excess of government regulations. These early failures
caused the SBIC program to be restructured, which in turn eliminated some of the unnec-
essary government regulations and increased the amount of capitalization needed. There
are approximately 360 SBICs operating today, of which 130 are minority small-business
investment companies (MESBICs) funding minority enterprises.
During the late 1960s, small private venture-capital firms emerged.10 These were usually
formed as limited partnerships, with the venture-capital company acting as the general part-
ner that received a management fee and a percentage of the profits earned on a deal. The
limited partners, who supplied the funding, were frequently institutional investors such as
insurance companies, endowment funds, bank trust departments, pension funds, and
wealthy individuals and families. There are over 900 of this type of venture-capital estab-
lishment in the United States.
Another type of venture-capital firm was also developed during this time: the venture-
capital division of major corporations. These firms, of which there are approximately 100,
are usually associated with banks and insurance companies, although companies such as
3M, Monsanto, Xerox, Intel, and Unilever house such firms as well. Corporate venture-
capital firms are more prone to invest in windows on technology or new market acquisi-
tions than are private venture-capital firms or SBICs. Some of these corporate venture-
capital firms have not had strong results.
In response to the need for economic development, a fourth type of venture-capital
firm has emerged in the form of the state-sponsored venture-capital fund. These state-
sponsored funds have a variety of formats. While the size and investment focus and industry
orientation vary from state to state, each fund typically is required to invest a certain per-
centage of its capital in the particular state. Generally, the funds that are professionally
managed by the private sector, outside the state’s bureaucracy and political processes,
have performed better.
An overview of the types of venture-capital firms is indicated in Figure 12.1. Besides the
four types previously discussed, there are now emerging university-sponsored venture-capital
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 343
state-sponsored
venture-capital fund
A fund containing state
government money that
invests primarily in
companies in the state
SBIC firms Small
companies with some
government money that
invest in other companies
private venture-capital
firms A type of venture-
capital firm having general
and limited partners
FIGURE 12.1 Types of Venture-Capital Firms
Types of venture-capital firms
Industry sponsored: • Banks and other financial institutions • Nonfinancial companies
Private venture- capital firms
(general partners and limited partners)
Small-business investment company (SBIC)
State/ government sponsored
University sponsored
funds. These funds, usually managed as separate entities, invest in the technology of the par-
ticular university. At such schools as Stanford, Columbia, and MIT, students assist professors
and other students in creating business plans for funding as well as assisting the fund manager
in his or her due diligence, thereby learning more about the venture-funding process.
The venture-capital industry has not returned to the highest level of dollars invested
in 1999, 2000, and 2001. While the total amount of venture-capital dollars invested in-
creased steadily from $7.8 billion in 1995 to a high of $104.7 billion in 2000
(see Table 12.3),11 the total dollars invested declined to $40.7 billion in 2001, $21.7 bil-
lion in 2002, and $19.6 billion in 2003. There was a slight increase to $21.6 billion in
2004 and $21.7 billion in 2005. The total amount invested increased again in 2006
($26.7 billion) and 2007 ($30.9 billion) before declining with the economic downturn to
$28.3 billion in 2008.
The total amount of venture-capital dollars invested, disseminated across the number of
deals, is indicated in column 3 of Table 12.3. The number of venture-capital deals went from
1,773 in 1995 to a high of 7,809 in 2000. In 2003, 2004, and 2005, the number of deals
stayed fairly steady, at 2,865, 2,966, and 2,939, respectively. The number of deals increased
in 2006 (3,675) and again in 2007 (3,952) before declining in 2008 to 3,808 deals.
These deals concentrated in three primary areas in 2008: software—$4,919 million
(17 percent), industrial/energy—$4,651 million (16 percent), and biotechnology—$4,500 mil-
lion (16 percent). This investment has significantly impacted the growth and development
of these three industry sectors. As indicated in Figure 12.2, other industry areas receiving
venture-capital investment include the following: medical devices and equipment—
$3,460 million (12 percent), media and entertainment—$2,039 million (7 percent), IT
services—$1,832 million (6 percent), telecommunications—$1,688 million (6 percent),
and semiconductors—$1,651 million (6 percent).
At what stage of the business development is this money invested? The percentage of
venture-capital money raised by stage of the venture in 2008 is indicated in Figure 12.3.
344 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
Year Total # of Deals
1995 $ 7,879,331,900 1,773
1996 11,014,332,900 2,471
1997 14,612,026,900 3,084
1998 20,810,583,100 3,553
1999 53,475,711,500 5,396
2000 104,700,717,300 7,809
2001 40,703,455,300 4,456
2002 21,697,809,100 3,057
2003 19,585,475,700 2,865
2004 21,635,323,900 2,966
2005 23,173,465,300 3,155
2006 26,740,603,400 3,675
2007 30,885,861,100 3,952
2008 28,298,040,600 3,808
TABLE 12.3 Total Venture Dollars Invested and Number of Deals
Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association Money Tree™ Survey.
Numbers rounded to the nearest whole percent.
Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association Money Tree™ Survey.
FIGURE 12.2 Percentage of Venture Dollars Invested in 2008 by Industry Sector
Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association Money Tree™ Survey.
FIGURE 12.3 Percentage of Venture Dollars Raised by Stage in 2008
Other, 0.5%
Health care services, 0.69%
Retailing/distribution, 0.95%
Computers and peripherals, 1.45%
Consumer products and services, 1.54%
Business products and services, 1.70%
Financial services, 1.89%
Electronics/instrumentation, 2.02%
Industrial/energy, 16.44% Medical device and
equipment, 12.23%
Biotechnology, 15.90%
Software, 17.38%
Media and entertainment,
7.21%
IT services, 6.47%
Telecommunications, 5.97%
Semiconductors, 5.83%
Networking and equipment,
2.28%
Later stage 38%
Early stage 19%
Start-up/seed 5%
Expansion 38%
The largest amount of money raised was for later-stage and expansion-stage investments
(38 percent), followed by early-stage (19 percent), and start-up/seed stage (5 percent). Tra-
ditionally the largest amount of money raised is for expansion-stage investment. In 2002,
for example, 57 percent of the venture money raised was for expansion, followed by early
stage (23 percent), later stage (18 percent), and start-up (2 percent).
The money invested by stage and year from 1995 to 2008 is broken down in Table 12.4.
Venture-capital money invested at the start-up/seed stage (for seed capital) went from
$1,704 million in 1995 to a high of $6,605 million in 1999, before declining to a low of
$335 million in 2002. The amount invested in this early-stage area increased to $1,268 million
in 2007 and again to $1,510 million in 2008. Venture capitalists in 2008 showed a significant
interest in funding start-up/seed capital deals, despite the economic downturn.
Where do these deals take place? Table 12.5 shows the amount of money invested in
2008 ($28.2 billion) by region of the country. It should come as no surprise that the areas
receiving the largest amount of venture capital were the Silicon Valley—$111.7 billion in
TABLE 12.4 Venture Investment Stages
Stage
Year Start-Up/Seed Early Stage Expansion Later Stage Total
1995 $ 1,704,471,700 $ 2,541,970,600 $ 1,712,698,300 $ 2,036,641,700 $ 7,995,782,300 21.32% 31.79% 21.42% 25.47% 100.00%
1996 $ 2,412,661,100 $ 3,106,571,800 $ 2,555,789,700 $ 3,190,091,200 $ 11,265,113,800 21.42% 27.58% 22.69% 28.32% 100.00%
1997 $ 3,047,368,500 $ 3,674,240,600 $ 3,669,504,700 $ 4,479,777,100 $ 14,870,890,900 20.49% 24.71% 24.68% 30.12% 100.00%
1998 $ 4,113,597,500 $ 5,652,693,500 $ 5,321,257,600 $ 5,991,717,200 $ 21,079,265,800 19.51% 26.82% 25.24% 28.42% 100.00%
1999 $ 6,605,334,400 $ 10,993,285,200 $ 13,130,681,200 $ 23,318,742,800 $ 54,048,043,600 12.22% 20.34% 24.29% 43.14% 100.00%
2000 $ 3,223,304,800 $ 25,406,580,700 $ 59,710,151,000 $ 16,427,731,000 $ 104,767,767,500 3.08% 24.25% 56.99% 15.68% 100.00%
2001 $ 778,015,300 $ 8,602,168,900 $ 23,008,875,900 $ 8,188,266,600 $ 40,577,326,700 1.92% 21.20% 56.70% 20.18% 100.00%
2002 $ 335,810,200 $ 3,835,175,200 $ 12,434,571,800 $ 5,404,111,000 $ 22,009,668,200 1.53% 17.42% 56.50% 24.55% 100.00%
2003 $ 347,769,000 $ 3,559,772,100 $ 10,100,836,400 $ 5,768,505,400 $ 19,776,882,900 1.76% 18.00% 51.07% 29.17% 100.00%
2004 $ 470,124,200 $ 4,011,236,300 $ 9,165,044,300 $ 8,821,753,200 $ 22,468,158,000 2.09% 17.85% 40.79% 39.26% 100.00%
2005 $ 897,707,300 $ 3,819,745,600 $ 8,663,870,300 $ 9,792,142,100 $ 23,173,465,300 3.87% 16.48% 37.39% 42.26% 100.00%
2006 $ 1,177,319,200 $ 4,172,001,400 $ 11,521,031,400 $ 9,870,251,400 $ 26,740,603,400 4.40% 15.60% 43.08% 36.91% 100.00%
2007 $ 1,267,968,200 $ 5,486,760,800 $ 11,677,215,200 $ 12,453,916,900 $ 30,885,861,100 4.11% 17.76% 37.81% 40.32% 100.00%
2008 $ 1,509,963,800 $ 5,339,272,800 $ 10,604,468,700 $ 10,844,335,300 $ 28,298,040,600 5.34% 18.87% 37.47% 38.32% 100.00%
Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association Money Tree™ Survey.
346 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
1,170 companies (31 percent), and New England—$3.3 billion in 460 companies (12 per-
cent). Other areas receiving funding were metro New York—$1.9 billion in 308 companies
(8 percent), Los Angeles/Orange County—$1.9 billion in 237 companies (6 percent), and
the Midwest—$1.3 billion in 267 companies (7 percent).
Venture-Capital Process
To be in a position to secure the funds needed, an entrepreneur must understand the philos-
ophy and objectives of a venture-capital firm, as well as the venture-capital process. The
objective of a venture-capital firm is to generate long-term capital appreciation through
debt and equity investments. To achieve this objective, the venture capitalist is willing to
make any changes or modifications necessary in the business investment. Since the objec-
tive of the entrepreneur is the survival of the business, the objectives of the two are fre-
quently at odds, particularly when problems occur.
A typical portfolio objective of venture-capital firms in terms of return criteria and risk
involved is shown in Figure 12.4. Since there is more risk involved in financing a business
earlier in its development, more return is expected from early-stage financing (50 percent
ROI) than from acquisitions or leveraged buyouts (30 percent ROI), which are later stages
of development. The significant risk involved and the pressure that venture-capital firms
feel from their investors (limited partners) to make safer investments with higher rates of
return have caused these firms to invest even greater amounts of their funds in later stages
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 347
Region # of Companies % $ Invested (in millions) %
Silicon Valley 1,170 30.72% $10,980 38.80%
New England 460 12.08 $ 3,260 11.52
LA/Orange County 237 6.22 $ 1,994 7.05
NY Metro 308 8.09 $ 1,879 6.64
Midwest 267 7.01 $ 1,348 4.76
Texas 146 3.83 $ 1,283 4.53
Southeast 207 5.44 $ 1,240 4.38
San Diego 126 3.31 $ 1,217 4.30
Northwest 208 5.46 $ 1,160 4.10
DC/Metroplex 190 4.99 $ 1,015 3.59
Colorado 100 2.63 $ 813 2.87
Philadelphia Metro 140 3.68 $ 750 2.65
North Central 77 2.02 $ 623 2.20
Southwest 78 2.05 $ 484 1.71
Upstate NY 29 0.76 $ 88 0.31
Sacramento/N.Cal 19 0.50 $ 73 0.26
South Central 38 1.00 $ 71 0.25
AK/HI/PR 8 0.21 $ 21 0.07
Grand Total 3,808 100.0 % $28,299 100.0 %
TABLE 12.5 Venture-Capital Investments by Region (2008)
venture-capital process
The decision procedure of
a venture-capital firm
Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association Money Tree™ Survey.
of financing. In these late-stage investments, there are lower risks, faster returns, less man-
agerial assistance needed, and fewer deals to be evaluated.
The venture capitalist does not necessarily seek control of a company, but would rather
have the firm and the entrepreneur at the most risk. The venture capitalist will want at least
one seat on the board of directors. Once the decision to invest is made, the venture capital-
ist will do anything necessary to support the management team so that the business and the
investment prosper. Whereas the venture capitalist expects to provide guidance as a mem-
ber of the board of directors, the management team is expected to direct and run the daily
operations of the company. A venture capitalist will support the management team with in-
vestment dollars, financial skills, planning, and expertise in any area needed.
Since the venture capitalist provides long-term investment (typically five years or more),
it is important that there be mutual trust and understanding between the entrepreneur and
the venture capitalist. There should be no surprises in the firm’s performance. Both good
and bad news should be shared, with the objective of taking the necessary action to allow
the company to grow and develop in the long run. The venture capitalist should be available
to the entrepreneur to discuss problems and develop strategic plans.
The venture capitalist expects a company to satisfy three general criteria before he or
she will commit to the venture. First, the company must have a strong management team
that consists of individuals with solid experience and backgrounds, a strong commitment
to the company, capabilities in their specific areas of expertise, the ability to meet chal-
lenges, and the flexibility to scramble wherever necessary. A venture capitalist would
rather invest in a first-rate management team and a second-rate product than the reverse.
The management team’s commitment should be reflected in dollars invested in the com-
pany. Although the amount of the investment is important, more telling is the size of this
investment relative to the management team’s ability to invest. The commitment of the
management team should be backed by the support of the family, particularly the spouse,
of each key team player. A positive family environment and spousal support allow team
members to spend the 60 to 70 hours per week necessary to start and grow the company.
348 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
Source: © 1992, American Economic Development Council (AEDC). All rights reserved. Reprinted from the Economic
Development Review, vol. 10, no. 2, Spring 1992, p. 44, with the permission of AEDC.
FIGURE 12.4 Venture-Capital Financing: Risk and Return Criteria
Development financingEarly stage
40% ROI
30% ROI
50% ROI
Acquisitions and leveraged buyouts
Lowest risk
Lowest return expected
Highest risk
Highest return expected
One successful venture capitalist makes it a point to have dinner with the entrepreneur and
spouse, and even to visit the entrepreneur’s home, before making an investment decision.
According to the venture capitalist, “I find it difficult to believe an entrepreneur can suc-
cessfully run and manage a business and put in the necessary time when the home envi-
ronment is out of control.”
The second criterion is that the product and/or market opportunity must be unique, hav-
ing a differential advantage in a growing market. Securing a unique market niche is essen-
tial since the product or service must be able to compete and grow during the investment
period. This uniqueness needs to be carefully spelled out in the marketing portion of the
business plan and is even better when it is protected by a patent or a trade secret.
The final criterion for investment is that the business opportunity must have significant
capital appreciation. The exact amount of capital appreciation varies, depending on such
factors as the size of the deal, the stage of development of the company, the upside poten-
tial, the downside risks, and the available exits. The venture capitalist typically expects a 40
to 60 percent return on investment in most investment situations.
The venture-capital process that implements these criteria is both an art and a science.12
The element of art is illustrated in the venture capitalist’s intuition, gut feeling, and creative
thinking that guide the process. The process is scientific due to the systematic approach and
data-gathering techniques involved in the assessment.
The process starts with the venture-capital firm establishing its philosophy and invest-
ment objectives. The firm must decide on the following: the composition of its portfolio
mix, including the number of start-ups, expansion companies, and management buyouts;
the types of industries; the geographic region for investment; and any product or industry
specializations.
The venture-capital process can be broken down into four primary stages: preliminary
screening, agreement on principal terms, due diligence, and final approval. The preliminary
screening begins with the receipt of the business plan. A good business plan is essential in
the venture-capital process. Most venture capitalists will not even talk to an entrepreneur
who doesn’t have one. As the starting point, the business plan must have a clear-cut mission
and clearly stated objectives that are supported by an in-depth industry and market analy-
sis and pro forma income statements. The executive summary is an important part of
this business plan, as it is used for initial screening in this preliminary evaluation. Many
business plans are never evaluated beyond the executive summary. When evaluating the
business, the venture capitalist first determines if the deal or similar deals have been seen
previously. The investor then determines if the proposal fits his or her long-term policy and
short-term needs in developing a portfolio balance. In this preliminary screening, the ven-
ture capitalist investigates the economy of the industry and evaluates whether he or she has
the appropriate knowledge and ability to invest in that industry. The investor reviews the
numbers presented to determine whether the business can reasonably deliver the ROI re-
quired. In addition, the credentials and capability of the management team are evaluated to
determine if they can carry out the plan presented.
The second stage is the agreement on principal terms between the entrepreneur and the
venture capitalist. The venture capitalist wants a basic understanding of the principal terms
of the deal at this stage of the process before making the major commitment of time and ef-
fort involved in the formal due diligence process.
The third stage, detailed review and due diligence, is the longest stage, involving any-
where from one to three months. There is a detailed review of the company’s history, the
business plan, the resumes of the individuals, their financial history, and target market cus-
tomers. The upside potential and downside risks are assessed, and there is a thorough eval-
uation of the markets, industry, finances, suppliers, customers, and management.
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 349
significant capital
appreciation
Significant capital
appreciation is the
increase in value of the
organization during a
specific period of time
preliminary screening
Initial evaluation of a deal
due diligence The
process of deal evaluation
In the last stage, final approval, a comprehensive, internal investment memorandum is
prepared. This document reviews the venture capitalist’s findings and details the investment
terms and conditions of the investment transaction. This information is used to prepare the
formal legal documents that both the entrepreneur and venture capitalist will sign to final-
ize the deal.13
Locating Venture Capitalists
One of the most important decisions for the entrepreneur lies in selecting which venture-
capital firm to approach. Since venture capitalists tend to specialize either geographically
by industry (manufacturing industrial products or consumer products, high technology,
or service) or by size and type of investment, the entrepreneur should approach only
those that may have an interest in the investment opportunity. Where do you find this
venture capitalist?
Although venture capitalists are located throughout the United States, the traditional ar-
eas of concentration are found in Los Angeles, New York, Chicago, Boston, and San
Francisco. Most venture capital firms belong to the National Venture Capital Association
and are listed on its Web site (www.nvca.org). An entrepreneur should carefully research
the names and addresses of prospective venture-capital firms that might have an interest in
the particular investment opportunity. There are also regional and national venture-capital
associations. For a nominal fee or none at all, these associations will frequently send the
entrepreneur a directory that lists their members, the types of businesses their members
invest in, and any investment restrictions. Whenever possible, the entrepreneur should be
introduced to the venture capitalist. Bankers, accountants, lawyers, and professors are good
sources for introductions.
Approaching a Venture Capitalist
The entrepreneur should approach a venture capitalist in a professional business manner.
Since venture capitalists receive hundreds of inquiries and are frequently out of the office
working with portfolio companies or investigating potential investment opportunities, it is
important to begin the relationship positively. The entrepreneur should call any potential
venture capitalist to ensure that the business is in an area of investment interest. Then the
business plan should be sent, accompanied by a short professional letter.
Since venture capitalists receive many more plans than they are capable of funding,
many plans are screened out as soon as possible. Venture capitalists tend to focus and put
more time and effort on those plans that are referred. In fact, one venture-capital group said
that 80 percent of its investments over the last five years were in referred companies. Con-
sequently, it is well worth the entrepreneur’s time to seek out an introduction to the venture
capitalist. Typically this can be obtained from an executive of a portfolio company, an ac-
countant, a lawyer, a banker, or a business school professor.
The entrepreneur should be aware of some basic rules of thumb before implementing
the actual approach and should follow the detailed guidelines presented in Table 12.6. First,
great care should be taken in selecting the right venture capitalist to approach. Venture cap-
italists tend to specialize in certain industries and will rarely invest in a business outside
those areas, regardless of the merits of the business proposal and plan. Second, recognize
that venture capitalists know each other, particularly in a specific region of the country.
When a large amount of money is involved, they will invest in the deal together, with one
venture-capital firm taking the lead. Since this degree of familiarity is present, a venture-
capital firm will probably find out if others have seen your business plan. Do not shop
350 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
final approval A
document showing the
final terms of the deal
among venture capitalists, as even a good business plan can quickly become “shopworn.”
Third, when meeting the venture capitalist, particularly for the first time, bring only one or
two key members of the management team. A venture capitalist is investing in you and
your management team and its track record, not in outside consultants and experts. Any
experts can be called in as needed.
Finally, be sure to develop a succinct, well-thought-out oral presentation. This should
cover the company’s business, the uniqueness of the product or service, the prospects for
growth, the major factors behind achieving the sales and profits indicated, the backgrounds
and track records of the key managers, the amount of financing required, and the returns
anticipated. This first presentation is critical, as is indicated in the comment of one venture
capitalist: “I need to sense a competency, a capability, a chemistry within the first half hour
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 351
• Carefully determine the venture capitalist to approach for funding the particular type of
deal. Screen and target the approach. Venture capitalists do not like deals that have been
excessively “shopped.”
• Once a discussion is started with a venture capitalist, do not discuss the deal with other
venture capitalists. Working several deals in parallel can create problems unless the
venture capitalists are working together. Time and resource limitations may require a
cautious simultaneous approach to several funding sources.
• It is better to approach a venture capitalist through an intermediary who is respected and
has a preexisting relationship with the venture capitalist. Limit and carefully define the
role and compensation of the intermediary.
• The entrepreneur or manager, not an intermediary, should lead the discussions with the
venture capitalist. Do not bring a lawyer, accountant, or other advisors to the first
meeting. Since there are no negotiations during this first meeting, it is a chance for the
venture capitalist to get to know the entrepreneur without interference from others.
• Be very careful about what is projected or promised. The entrepreneur will probably be
held accountable for these projections in the pricing, deal structure, or compensation.
• Disclose any significant problems or negative situations in this initial meeting. Trust is a
fundamental part of the long-term relationship with the venture capitalist; subsequent
discovery by the venture capitalist of an undisclosed problem will cause a loss of
confidence and probably prevent a deal.
• Reach a flexible, reasonable understanding with the venture capitalist regarding the
timing of a response to the proposal and the accomplishment of the various steps in the
financing transaction. Patience is needed, as the process is complex and time consuming.
Too much pressure for a rapid decision can cause problems with the venture capitalist.
• Do not sell the project on the basis that other venture capitalists have committed them-
selves. Most venture capitalists are independent and take pride in their own decision
making.
• Be careful about glib statements such as, “There is no competition for this product” or
“There is nothing like this technology available today.” These statements can reveal a
failure to do one’s homework or can indicate that a perfect product has been designed
for a nonexistent market.
• Do not indicate an inordinate concern for salary, benefits, or other forms of current
compensation. Dollars are precious in a new venture. The venture capitalist wants the
entrepreneur committed to an equity appreciation similar to that of the venture capitalist.
• Eliminate to the extent possible any use of new dollars to take care of past problems,
such as payment of past debts or deferred salaries of management. New dollars of the
venture capitalist are for growth, to move the business forward.
TABLE 12.6 Guidelines for Dealing with Venture Capitalists
of our initial meeting. The entrepreneur needs to look me in the eye and present his story
clearly and logically. If a chemistry does not start to develop, I start looking for reasons not
to do the deal.”
Following a favorable initial meeting, the venture capitalist will do some preliminary in-
vestigation of the plan. If favorable, another meeting between the management team and
the venture capitalist will be scheduled so that both parties can assess the other and deter-
mine if a good working relationship can be established and if a feeling of trust and confi-
dence is evolving. During this mutual evaluation, the entrepreneur should be careful not to
be too inflexible about the amount of company equity he or she is willing to share. If the
entrepreneur is too inflexible, the venture capitalist might end negotiations. During this
meeting, initial agreement of terms is established. If you are turned down by one venture
capitalist, do not become discouraged. Instead, select several other nonrelated venture-
capitalist candidates and repeat the procedure. A significant number of companies denied
funding by one venture capitalist are able to obtain funds from other outside sources,
including other venture capitalists.
VALUING YOUR COMPANY
A problem confronting the entrepreneur in obtaining outside equity funds, whether from
the informal investor market (the angels) or from the formal venture-capital industry, is de-
termining the value of the company. This valuation is at the core of determining how much
ownership an investor is entitled to for funding the venture. This is determined by consid-
ering the factors in valuation. This, as well as other aspects of securing funding, has a po-
tential for ethical conflict that must be carefully handled.
Factors in Valuation
There are eight factors that, although they vary by situation, the entrepreneur should con-
sider when valuing the venture. The first factor, and the starting point in any valuation, is
the nature and history of the business. The characteristics of the venture and the industry in
which it operates are fundamental to every evaluation process. The history of the company
from its inception provides information on the strength and diversity of the company’s op-
erations, the risks involved, and the company’s ability to withstand any adverse conditions.
The valuation process must also consider the outlook of the economy in general as well
as the outlook for the particular industry. This, the second factor, involves an examination
of the financial data of the venture compared with those of other companies in the industry.
Management’s capability now and in the future is assessed, as well as the future market for
the company’s products. Will these markets grow, decline, or stabilize, and in what eco-
nomic conditions?
The third factor is the book value (net value) of the stock of the company and the over-
all financial condition of the business. The book value (often called owner’s equity) is the
acquisition cost (less accumulated depreciation) minus liabilities. Frequently, the book
value is not a good indication of fair market value, as balance sheet items are almost always
carried at cost, not market value. The value of plant and equipment, for example, carried on
the books at cost less depreciation may be low due to the use of an accelerated depreciation
method or other market factors, making the assets more valuable than indicated in the book
value figures. Land, particularly, is usually reflected lower than fair market value. For val-
uation, the balance sheet must be adjusted to reflect the higher values of the assets, partic-
ularly land, so that a more realistic company worth is determined. A good valuation should
also value operating and nonoperating assets separately and then combine the two into the
352 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
factors in valuation
Nonmonetary aspects that
affect the fund valuation
of a company
total fair market value. A thorough valuation involves comparing balance sheets and profit
and loss statements for the past three years when available.
While book value develops the benchmark, the future earning capacity of the company,
the fourth factor, is the most important factor in valuation. Previous years’ earnings are gen-
erally not simply averaged but weighted, with the most recent earnings receiving the high-
est weighting. Income by product line should be analyzed to judge future profitability and
value. Special attention should be paid to depreciation, nonrecurring expense, officers’
salaries, rental expense, and historical trends.
The fifth valuation factor is the dividend-paying capacity of the venture. Since the entre-
preneur in a new venture typically pays little if any in dividends, it is the future capacity to
pay dividends rather than actual dividend payments made that is important. The dividend-
paying capacity should be capitalized.
An assessment of goodwill and other intangibles of the venture is the sixth valuation
factor. These intangible assets usually cannot be valued without reference to the tangible
assets of the venture.
The seventh factor in valuation involves assessing any previous sale of stock. Previous
stock sales accurately represent future sales if the stock sales are recent. Motives regarding
the new sale (if other than arriving at a fair price) and any change in economic or financial
conditions during the intermittent period should be considered.
The final valuation factor is the market price of the stocks of companies engaged in the
same or similar lines of business. This factor is used in the specific valuation method dis-
cussed later in this section. The critical issue is the degree of similarity between the pub-
licly traded company and the company being valued.
Ratio Analysis
Calculations of financial ratios can also be extremely valuable as an analytical and control
mechanism to test the financial well-being of a new venture during its early stages. These
ratios serve as a measure of the financial strengths and weaknesses of the venture, but
should be used with caution since they are only one control measure for interpreting the fi-
nancial success of the venture. There is no single set of ratios that must be used, nor are
there standard definitions for all ratios. However, there are industry rules of thumb that the
entrepreneur can use to interpret the financial data. Ratio analysis is typically used on
actual financial results but can also provide the entrepreneur with some sense of where
problems exist in the pro forma statements as well. Throughout this section we will use
information taken from the financial statements of MPP Plastics (Chapter 10) to illustrate.
Liquidity Ratios
Current Ratio This ratio is commonly used to measure the short-term solvency of the venture or its ability to meet its short-term debts. The current liabilities must be covered
from cash or its equivalent; otherwise the entrepreneur will need to borrow money to meet
these obligations. The formula and calculation of this ratio when current assets are
$108,050 and current liabilities are $40,500 is:
While a ratio of 2:1 is generally considered favorable, the entrepreneur should also com-
pare this ratio with any industry standards. One interpretation of this result is that for every
dollar of current debt, the company has $2.67 of current assets to cover it. This ratio
Current assets
Current liabilities ⫽
108,050
40,500 ⫽ 2.67 times
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 353
financial ratios
Control mechanisms to
test the financial strength
of the new venture
indicates that MPP Plastics is liquid and can likely meet any of its obligations even if there
were a sudden emergency that would drain existing cash.
Acid Test Ratio This is a more rigorous test of the short-term liquidity of the venture be- cause it eliminates inventory, which is the least liquid current asset. The formula given the
same current assets and liabilities and inventory of $10,450 is:
The result from this ratio suggests that the venture is very liquid since it has assets con-
vertible to cash of $2.40 for every dollar of short-term obligations. Usually a 1:1 ratio
would be considered favorable in most industries.
Activity Ratios
Average Collection Period This ratio indicates the average number of days it takes to convert accounts receivable into cash. This ratio helps the entrepreneur to gauge the liquid-
ity of accounts receivable or the ability of the venture to collect from its customers. Using
the formula with accounts receivable of $46,400 and sales of $995,000 results in:
This particular result needs to be compared with industry standards since collection will
vary considerably. However, if the invoices indicate a 20-day payment required, then one
could conclude that most customers pay on time.
Inventory Turnover This ratio measures the efficiency of the venture in managing and selling its inventory. A high turnover is a favorable sign indicating that the venture is able
to sell its inventory quickly. There could be a danger with a very high turnover that the
venture is understocked, which could result in lost orders. Managing inventory is very im-
portant to the cash flow and profitability of a new venture. The calculation of this ratio
when the cost of goods sold is $645,000 and the inventory is $10,450 is:
This would appear to be an excellent turnover as long as the entrepreneur feels that he
or she is not losing sales because of understocking inventory.
Leverage Ratios
Debt Ratio Many new ventures will incur debt as a means of financing the start-up. The debt ratio helps the entrepreneur to assess the firm’s ability to meet all its obligations (short
and long term). It is also a measure of risk because debt also consists of a fixed commit-
ment in the form of interest and principal repayments. With total liabilities of $249,700 and
total assets of $308,450, the debt ratio is calculated as:
This result indicates that the venture has financed about 81 percent of its assets with debt.
On paper this looks very reasonable, but it would also need to be compared with industry data.
Total liabilities
Total assets ⫽
249,700
308,450 ⫽ 81%
Cost of goods sold
Inventory ⫽
645,000
10,450 ⫽ 61.7 times
Accounts receivable
Average daily sales ⫽
46,000
995,000Ⲑ360 ⫽ 17 days
Current assets ⫺ Inventory
Current liabilities ⫽
108,050 ⫺ 10,450
40,500 ⫽ 2.40 times
354 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
Debt to Equity This ratio assesses the firm’s capital structure. It provides a measure of risk to creditors by considering the funds invested by creditors (debt) and investors (equity).
The higher the percentage of debt, the greater the degree of risk to any of the creditors. The
calculation of this ratio using the same total liabilities, with stockholder’s equity being
$58,750, is:
This result indicates that this venture has been financed mostly from debt. The actual in-
vestment of the entrepreneurs or the equity base is about one-fourth of what is owed. Thus,
the equity portion represents a cushion to the creditors. For MPP Plastics this is not a seri-
ous problem because of its short-term cash position.
Profitability Ratios
Net Profit Margin This ratio represents the venture’s ability to translate sales into prof- its. You can also use gross profit instead of net profit to provide another measure of prof-
itability. In either case it is important to know what is reasonable in your industry as well
as to measure these ratios over time. The ratio and calculation when net profit is $8,750 and
net sales are $995,000 is:
The net profit margin for MPP Plastics, although low for an established firm, would not
be of great concern for a new venture. Many new ventures do not incur profits until the sec-
ond or third year. In this case we have a favorable profit situation.
Return on Investment The return on investment measures the ability of the venture to manage its total investment in assets. You can also calculate a return on equity, which sub-
stitutes stockholders’ equity for total assets in the following formula and indicates the abil-
ity of the venture in generating a return to the stockholders. The formula and calculation of
the return on investment when total assets are $200,400 and net profit is $8,750 is:
The result of this calculation will also need to be compared with industry data. However,
the positive conclusion is that the firm has earned a profit in its first year and has returned
4.4 percent on its asset investment.
There are many other ratios that could also be calculated. However, for a start-up these
would probably suffice for an entrepreneur in assessing the venture’s financial strengths
and weaknesses. As the firm grows, it will be important to use these ratios in conjunction
with all other financial statements to provide an understanding of how the firm is perform-
ing financially.
General Valuation Approaches
There are several general valuation approaches that can be used in valuing the venture.
One of the most widely used approaches assesses comparable publicly held companies
and the prices of these companies’ securities. This search for a similar company is both
an art and a science. First, the company must be classified in a certain industry, since
Net profit
Total assets ⫽
8,750
200,400 ⫽ 4.4%
Net profit
Net sales ⫽
8,750
995,000 ⫽ 0.88%
Total liabilities
Stockholder , s equity ⫽ 249,70058,750 ⫽ 4.25 times
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 355
general valuation
approaches Methods
for determining the worth
of a company
companies in the same industry share similar markets, problems, economies, and poten-
tial of sales and earnings. The review of all publicly traded companies in this industry
classification should evaluate size, amount of diversity, dividends, leverage, and growth
potential until the most similar company is identified. This method is inaccurate when a
truly comparable company is not found.
A second widely used valuation approach is the present value of future cash flow. This
method adjusts the value of the cash flow of the business for the time value of money and
the business and economic risks. Since only cash (or cash equivalents) can be used in
reinvestment, this valuation approach generally gives more accurate results than profits.
With this method, the sales and earnings are projected back to the time of the valuation
decision when shares of the company are offered for sale. The period between the valu-
ation and sale dates is determined, and the potential dividend payout and expected
price-earnings ratio or liquidation value at the end of the period are calculated. Finally, a
rate of return desired by investors is established, less a discount rate for failure to meet
those expectations.
Another valuation method, used only for insurance purposes or in very unique circum-
stances, is known as replacement value. This method is used when, for example, there is a
unique asset involved that the buyer really wants. The valuation of the venture is based on
the amount of money it would take to replace (or reproduce) that asset or another important
asset or system of the venture.
The book value approach uses the adjusted book value, or net tangible asset value, to de-
termine the firm’s worth. Adjusted book value is obtained by making the necessary adjust-
ments to the stated book value by taking into account any depreciation (or appreciation) of
plant and equipment and real estate, as well as necessary inventory adjustments that result
from the accounting methods employed. The following basic procedure can be used:
356 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
replacement value The
cost of replacing all
assets of a company
present value of future
cash flow Valuing a
company based on its
future sales and profits
Book value $__________
Add (or subtract) any adjustments such as appreciation or depreciation to arrive at figure on next line—the fair market value $__________
Fair market value (the sale value of the company’s assets) $__________
Subtract all intangibles that cannot be sold, such as goodwill $__________
Adjusted book value $__________
Since the book valuation approach involves simple calculations, its use is particularly
good in relatively new businesses, in businesses where the sole owner has died or is disabled,
and in businesses with speculative or highly unstable earnings.
The earnings approach is the most widely used method of valuing a company since it
provides the potential investor with the best estimate of the probable return on investment.
The potential earnings are calculated by weighting the most recent operating year’s earn-
ings after they have been adjusted for any extraordinary expenses that would not have
normally occurred in the operations of a publicly traded company. An appropriate price-
earnings multiple is then selected based on norms of the industry and the investment risk.
A higher multiple will be used for a high-risk business and a lower multiple for a low-risk
business. For example, a low-risk business in an industry with a seven-times-earnings mul-
tiple would be valued at $4.2 million if the weighted average earnings over the past three
years were $0.6 million (7 ⫻ $0.6 million).
An extension of this method is the factor approach, wherein the following three major
factors are used to determine value: earnings, dividend-paying capacity, and book value.
book value The
indicated worth of the
assets of a company
earnings approach
Determining the worth of
a company by looking at
its present and future
earnings
factor approach Using
the major aspects of a
company to determine its
worth
Appropriate weights for the particular company being valued are developed and multi-
plied by the capitalized value, resulting in an overall weighted valuation. An example is
indicated here:
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 357
Approach (in 000s) Capitalized Value Weight Weighted Value
Earnings: $40 ⫻ 10 $400 0.4 $160
Dividends: $15 ⫻ 20 $300 0.4 $120
Book value: $600 ⫻ 0.4 $240 0.2 $ 48
Average: $328
10% discount: $33
Per-share value: $295
A company needs $500,000 of venture-capital money.
The company is anticipating profits of $650,000.
The venture capitalist wants an investment multiple of 5 times.
The price-earnings multiple of a similar company is 12.
According to the following calculations, the company would have to give up 32 percent
ownership to obtain the needed funds:
A more accurate method for determining this percentage is given in Table 12.7. The step-
by-step approach takes into account the time value of money in determining the appropri-
ate investor’s share. The following hypothetical example uses this step-by-step procedure.
H&B Associates, a start-up manufacturing company, estimates it will earn $1 million after
taxes on sales of $10 million. The company needs $800,000 now to reach that goal in five
years. A similar company in the same industry is selling at 15 times earnings. A venture-
capital firm, Davis Venture Partners, is interested in investing in the deal and requires a
$500,000 ⫻ 5
$650,000 ⫻ 12 ⫽ 32%
A final valuation approach that gives the lowest value of the business is liquidation value.
Liquidation value is often difficult to obtain, particularly when costs and losses must be es-
timated for selling the inventory, terminating employees, collecting accounts receivable,
selling assets, and performing other closing-down activities. Nevertheless, it is also good for
an investor to obtain a downside risk value in appraising a company.
General Valuation Method
One approach an entrepreneur can use to determine how much of the company a venture
capitalist will want for a given amount of investment is indicated here:
Consider the following example:
Venture-capitalist
ownership 1% 2 ⫽
VC $ investment ⫻ VC investment multiple desired
Company’s projected profits in year 5 ⫻ Price-earnings multiple of comparable company
liquidation value Worth
of a company if
everything was sold today
50 percent compound rate of return on investment. What percentage of the company will
have to be given up to obtain the needed capital?
Evaluation of an Internet Company
The valuation process for early-stage Internet companies is quite different from the tradi-
tional valuation process. Traditionally, private-equity companies would examine historical
financials and operations as part of a very quantitative process using such things as dis-
counted cash flow (DCF), comparables, and/or multiples of EBITDA (earnings before in-
terest, taxes, depreciation, and amortization). Following this, the culture and management
are examined in a more qualitative way. When institutional investors focus on earlier-stage
companies—in particular Internet companies that have little or no history, no historical
financials, and no comparables—a different approach has to be taken in the valuation
process.
For these companies, the qualitative portion of due diligence carries much more
weight than in other evaluations. The focus is more on the market itself. How big is it?
How is it segmented? Who are the players? How will it evolve? Once these questions are
resolved, the potential entrepreneurial company’s financial projections are compared
with the future market in terms of fit, realism, and opportunity. After getting comfortable
with the market size and potential revenue of a company, the investor examines the man-
agement team. Is this a management team that will take the company “all the way”? Who
will they need to bring in? How much should be set aside for an employee stock ownership
$800,000
$1,975,000 ⫽ 41% will have to be given up
⫽ $1,975,000
Present value ⫽ $1,000,000 ⫻ 15 times earning multiple
11 ⫹ 0.5025
358 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
TABLE 12.7 Steps in Valuing Your Business and Determining Investors’ Share
1. Estimate the earnings after taxes based on sales in the fifth year.
2. Determine an appropriate earnings multiple based on what similar companies are selling
for in terms of their current earnings.
3. Determine the required rate of return.
4. Determine the funding needed.
5. Calculate, using the following formulas:
where:
Investors’ share ⫽ Initial funding
Present value
n ⫽ Number of years
i ⫽ Required rate of return
Future valuation ⫽ Total estimated value of company in 5 years
Present value ⫽ Future valuation
11 ⫹ i2n
plan (ESOP)? The more complete the management team is, the higher the valuation. If
the management team is still thin, then a substantial portion of the company’s assets
needs to be set aside to attract and retain good employees. Different industries require
different valuations. For example, an infrastructure business is viewed differently from a
business-to-business firm.
After going through the process of deriving a value, the investor looks at all the opportuni-
ties available in the investor market. Generally, the value in early-stage technology companies
is driven by a combination of market structure and management team maturity, modified by
the supply and demand forces that exist in a market that is highly competitive for good,
solid companies.
An entrepreneur seeking financing should keep in mind that markets are changing and
traditional systems are being turned upside down. Investors and entrepreneurs who have a
sense of how this is going to occur and can predict the impact new technologies will have
on traditional and newly formed markets are the ones who will be more highly rewarded.
DEAL STRUCTURE
In addition to valuing the company and determining the percentage of the company that
may have to be given up to obtain funding, a critical concern for the entrepreneur is the deal
structure, or the terms of the transaction between the entrepreneur and the funding source.
To make the venture look as attractive as possible to potential sources of funds, the entre-
preneur must understand the needs of the investors as well as his or her own needs. The
needs of the funding sources include the rate of return required, the timing and form of re-
turn, the amount of control desired, and the perception of the risks involved in the particu-
lar funding opportunity. While some investors are willing to bear a significant amount of
risk to obtain a significant rate of return, others want less risk and less return. Other in-
vestors are more concerned about their amount of influence and control once the invest-
ment has been made.
The entrepreneur’s needs revolve around similar concerns, such as the degree and mech-
anisms of control, the amount of financing needed, and the goals for the particular firm.
Before negotiating the terms and the structure of the deal with the venture capitalist, the
entrepreneur should assess the relative importance of these concerns to negotiate most
strategically. Both the venture capitalist and the entrepreneur should feel comfortable with
the final deal structure, and a good working relationship needs to be established to deal
with any future problems that may arise.
GOING PUBLIC
Going public occurs when the entrepreneur and other equity owners of the venture offer
and sell some part of the company to the public through a registration statement filed with
the securities commission of the country. In the United States, this is the Securities and Ex-
change Commission (SEC) pursuant to the Securities Act of 1933. The resulting capital in-
fusion to the company from the increased number of stockholders and outstanding shares
of stock provides the company with financial resources and generally with a relatively liq-
uid investment vehicle. Consequently, the company will have greater access to capital mar-
kets in the future and a more objective picture of the public’s perception of the value of the
business. However, given the reporting requirements, the increased number of stockholders
(owners), and the costs involved, the entrepreneur must carefully evaluate the advantages
and disadvantages of going public before initiating the process. A list of these advantages
and disadvantages is given in Table 12.8.
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 359
going public Selling
some part of the company
by registering with the
SEC
deal structure The form
of the transaction when
money is obtained by a
company
360
TABLE 12.8 Advantages and Disadvantages of Going Public
Advantages Disadvantages
• Ability to obtain equity capital
• Enhanced ability to borrow
• Enhanced ability to raise equity
• Liquidity and valuation
• Prestige
• Personal wealth
• Increased risk of liability
• Expense
• Regulation of corporate governance policies and
procedures
• Disclosure of information
• Pressures to maintain growth pattern
• Loss of control
E T H I C S
Money is like water: It’s best when clear, and it needs
to flow freely or it can stagnate. In order to flow, the
money system must be trusted by everyone around
the world. Today, that most vital trust is broken. A
short while ago money flowed freely, and investors
asked few questions other than what their returns
would be. Now, it is exceptionally difficult for even
rock-solid businesses to finance their daily opera-
tions. A lack of transparency led us into this situation,
and only an abundance of transparency can deliver
us to better times.
Many of the economic challenges we face are the
function of a global crisis in confidence. Investors,
employees, and analysts have good reason to pause
and consider where their efforts and investments
will be safe. This lack of confidence is preventing
basic, sound business from thriving and is ultimately
prolonging the downturn. The complex inventions
of investment banks and hedge funds allowed clever
financial engineers to hide bad business fundamen-
tals and allowed risk to be spread and distanced
from its original creators. A lack of transparency
hid the true exposure of giants like AIG and to the
detriment of international stakeholders and the
American public.
Nontransparent Financial Tools: Too many in the corporate community have lost their focus on transparency. Nearly every corporation that violated basic governance principles did so by creating a web of complex and confusing rules. Blinded by outsize returns, investors and employees opted for faith over verification. If nontransparent financial tools were the workhorses of the economic downturn, fraud- sters rode dressage horses that demonstrated how far blind trust can mislead. The leadership failure at Satyam (SAY) confirms that the problem is global and demonstrates another shortcoming in corporate governance. When auditors and boards fail to get to details of the financials, shareholders lose out.
Capitalism is not broken, but history shows that it
cannot be run on autopilot either. The Great Depres-
sion of the 1930s was triggered by corporate misman-
agement that led the Supreme Court to condemn
corporations as “Frankenstein monsters, capable of
doing evil.” In 1934, public outcry in the U.S. gave rise
to the Securities & Exchange Commission, which for-
mally defined corporate ownership and control. But
regulators failed to clearly address responsibilities
relating to “acceptable behavior” and levels of dis-
closure for corporations.
FINANCIAL TRANSPARENCY A MUST
Advantages
The three primary advantages of going public are obtaining new equity capital, realizing an
enhanced valuation due to the greater liquidity of an equity investment in the company, and
enhancing the company’s ability to obtain future funds. Whether it is first-stage, second-stage,
or third-stage financing that is desired, a venture is in constant need of capital. The new
capital provides the needed working capital, plant and equipment, or inventories and sup-
plies necessary for the venture’s growth and survival. Going public is often the best way to
obtain capital on the best possible terms.
Going public generally results in a public trading market and provides a mechanism for
valuing the company and allowing this value to be easily transferred among parties. Many
family-owned or other privately held companies may need to go public so that the value of
the company can be disseminated among the second and third generations. Venture capital-
ists view going public as one of the most beneficial ways to attain the liquidity necessary
to exit a company with the best possible return on their investment. Other investors benefit
as well due to easier liquidation of their investment when the company’s stock takes on
value and transferability. Because of this liquidity, the value of a publicly traded security is
sometimes higher than shares of one that is not publicly traded. In addition, publicly traded
companies often find it easier to acquire other companies by using their securities in the
transactions.
As noted earlier, the third primary advantage is that publicly traded companies usually
find it easier to raise additional capital, particularly debt. Money can often be borrowed more
easily and on more favorable terms, the company’s balance sheet is strengthened by the new
equity capital, and the company has better prospects for raising future equity capital.
361
These loopholes proved a fertile breeding ground
for much corporate malfeasance. During the 1970s,
SEC investigations revealed widespread illegal con-
tracting practices, insider trading, deceptive advertis-
ing, and savings-and-loan scandals. Over 500 public
American companies—including 117 of the then For-
tune 500 companies—were charged by the SEC or
confessed to corporate misconduct. The governance
failures sent regulators back to the drawing board
and blue ribbon panels worked to create frame-
works for enhancing corporate accountability. The
result was a surfeit of good governance codes issued
across the globe by securities exchange commissions,
stock exchanges, and investor associations.
Sarbanes-Oxley Reforms: Unfortunately, these prescriptions were also short-lived and failed to curb financial mismanagement and corporate fraud around the turn of the millennium. Instead, creative accounting and significantly large CEO pay packages resulted. Lessons from Enron, Worldcom, and Tyco resulted in the passage of Sarbanes-Oxley reforms that significantly increased rules and regulations and enforcement.
One common theme throughout the evolution of
corporate governance is increased transparency. But
there is only so much regulators can do, and trying
to regulate for every possibility surely will stifle
growth. Corporate leaders must seize this opportu-
nity to prioritize openness in their organizations.
Promoting transparency not only covers greater dis-
closure to regulators or the investing public; it also
means that risk should be in plain sight to the insti-
tution’s own management. If exposure to “hidden”
risk must exist, there should be good, quantitative
estimates of that risk and an acknowledgement of
what is unknowable.
Infosys (INFY) has staked its past and future
success on being as transparent as possible, publish-
ing metrics that go well beyond those required by
law. One of our corporate policies is “when in doubt,
disclose.” In 1999 we became the first company
on Nasdaq to produce its balance sheet and income
statement according to the generally accepted
accounting principles of eight countries. Reminding
stakeholders of sound business fundamentals and
providing as much information as possible are the
best antidotes for fear and uncertainty in the mar-
ket. Corporations that recognize and embrace the
principles of transparency will benefit from a lower
cost of capital, the ability to attract talent, and bet-
ter client relationships. The financial waters are
backed up now, but responsible corporate leaders
and regulators that prioritize transparency will have
the best chance of reassuring skeptical investors and
returning prosperity.
Source: Reprinted from February 27, 2009 issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Companies, Inc., from “Infosys CEO: Financial Transparency a Must,” by Kris Gopalakrishnan. BusinessWeek magazine: www.businessweek.com/ globalbiz/content/feb2009/gb20090226_803741.htm.
Disadvantages
Although the advantages of going public are significant for a new venture, they must be
carefully weighed against the numerous disadvantages. Some entrepreneurs want to keep
their companies private, even in times of a hot stock market. Why do entrepreneurs avoid
an initial public offering (IPO)?
Two major reasons are the increased reporting and the potential loss of control that can
occur in a publicly traded company. Yet, to stay on the cutting edge of technology, compa-
nies frequently need to sacrifice short-term profits for long-term innovation. This can
require reinvesting in technology that in itself may not produce any bottom-line results,
particularly in the short run. Making long-term decisions can be difficult in publicly traded
companies where sales and profit results indicate the capability of management via stock
values.
Some of the most troublesome aspects of being public are the resulting loss of autonomy
as well as increased duties to public stockholders and administrative burdens. The company
must make decisions with respect to the fiduciary duties owed to the public shareholder,
and it needs to disclose to the public all material information regarding the company, its op-
erations, and its management. One publicly traded company had to retain a more expensive
investment banker than would have been required by a privately held company to obtain an
“appropriate” fairness opinion in a desired merger. The investment banker increased the ex-
penses of the merger by $150,000, in addition to causing a three-month delay in the merger
proceedings. Management of a publicly traded company also spends a significant amount
of additional time and expense addressing queries from shareholders, press, and financial
analysts and ensuring compliance with the complicated accessing, reporting, and securities
trading regulations. CEOs of most publicly traded companies set aside one day per week
for this.
Finally, when enough shares are sold to the public, the company can lose control of de-
cision making, which can even result in the venture being acquired through an unfriendly
tender offer.
With the enactment of the Sarbanes-Oxley Act in 2002, corporate governance and dis-
closure requirements of public companies and the practices and conduct of accountants and
lawyers engaged by public companies became subject to significantly greater regulation
enforcement by the Securities and Exchange Commission and the stock exchanges. As a re-
sult, the expense and administrative responsibilities of being a public company, as well as
the liability risks of officers and directors, are greater than ever. Among the other conse-
quences of the new regulation, the recruitment of qualified independent directors has
become a much more difficult challenge for most public companies.
If all these disadvantages themselves have not caused the entrepreneur to look for alter-
native financing rather than an IPO, the expenses involved may. The major expenses of go-
ing public include accounting fees, legal fees, underwriter’s fees, registration and blue-sky
filing fees, and printing costs. The accounting fees involved in going public vary greatly,
depending in part on the size of the company, the availability of previously audited financial
statements, and the complexity of the company’s operations. Generally, the costs of going
public average $700,000, although they can be much greater when significant complexities
are involved. Additional reporting, accounting, legal, and printing expenses can run any-
where from $50,000 to $250,000 per year, depending on the company’s past practices in
the areas of accounting and shareholder communications. In addition to the SEC reports
that must be filed, a proxy statement and other materials must be submitted to the SEC for
review before distribution to the stockholders. These materials contain certain disclosures
concerning management, its compensation, and transactions with the company, as well as
362 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
initial public offering
(IPO) The first public
registration and sale of a
company’s stock
the items to be voted on at the meeting. Public companies must also submit an annual re-
port to the shareholders containing the audited financial information for the prior fiscal year
and a discussion of any business developments. The preparation and distribution of the
proxy materials and annual report are some of the more significant items of additional ex-
pense incurred by a company after it is public.
Accounting fees for an initial public offering fluctuate widely but typically average
$200,000. Fees are at the lower end of this range if the accounting firm has regularly au-
dited the company over the past several years. They are at the higher end of the range if the
company has no prior audits or if it engages a new accounting firm. The accounting fee
covers the preparation of financial statements, the response to SEC queries, and the prepa-
ration of “cold comfort” letters for the underwriters described later in this chapter. The fees
can be affected by the quality and reputation of the accounting firm used in the last three
years before going public. Sometimes it becomes necessary to redo these last three years at
additional cost if an appropriate firm had not been used.
Legal fees will vary significantly, typically ranging from $150,000 to $350,000. These
fees generally cover preparation of corporate documents, preparation and clearing of the
registration statement, negotiation of the final underwriting agreement, and closing of the
sale of the securities to these underwriters. Additional legal fees may also be assessed and
can be extensive, particularly if a major organization is involved. A public company also
pays legal fees for the work involved with the Financial Industry Regulatory Authority
(FINRA) and state blue-sky filings. The legal fees for FINRA and state blue-sky filings
range from $8,000 to $30,000, depending on the size of the offering and the number of
states in which the securities will be offered.
In most of the more significant public offerings, the company technically sells the shares
to the underwriters, who then resell the shares to the public investors. The difference in the
per-share price at which the underwriters purchase the shares from the company and the
price at which they sell them to the public is the underwriters’ discount, which usually
ranges from 7 to 10 percent of the public offering price of the new issue. In some IPOs, the
underwriters can also require additional compensation, such as warrants to purchase stock,
reimbursement for expenses, and the right of first refusal on any future offerings. The
FINRA regulates the maximum amount of the underwriters’ compensation and reviews the
actual amount for fairness before the offering can take place.
There are other expenses in the form of SEC, FINRA, and state blue-sky registration
fees. Of these, the SEC registration fee is quite small: one-fiftieth of 1 percent of the max-
imum aggregate public offering price of the security. For example, the SEC fee would be
$4,000 on a $20 million offering. The minimum fee is $100. The SEC fee must be paid by
certified or cashier’s check. The FINRA filing fee is also small in relation to the size of the
offering: $100 plus one-hundredth of 1 percent of the maximum public offering price. In
the preceding example of a $20 million offering, this would be $2,100, with the FINRA
fee being $5,100.
The final major expense, printing costs, typically ranges from $50,000 to $200,000. The
registration statement and prospectus discussed later in this chapter account for the largest
portion of these expenses. The exact amount of expenses varies, depending on the length of
the prospectus, the use of color or black and white photographs, the number of proofs and
corrections, and the number printed. It is important for the company to use a good printer
because accuracy and speed are required in the printing of the prospectus and other offer-
ing documents.
Some help in stemming these rapidly increasing costs could come from more significant
use of the Internet in the publication and distribution of prospectuses, as well as from other
stockholder communications such as proxy statements and annual reports. However, use of
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 363
this medium is still somewhat in its infancy state. The SEC is continually refining its rules
in this regard in an effort to allow companies to take advantage of this technology while
maintaining the disclosure principles originally developed in the 1930s.
Not only can going public be a costly event, but also the process leading up to it can be
exasperating. Just ask Bing Yeh, who went through some trying circumstances starting
when he decided to go public in July 1995 and ending when his company, Silicon Storage
Technology (SST), issued its IPO on November 22 of that same year.14 While the exact
process varies with each company, the goal is the same as it was for SST—make sure the
company is well received by Wall Street. For some companies, getting ready to go public
can involve eliminating members of the management team and board, dropping marginal
products, eliminating treasured perks such as the corporate jet, hiring a new accounting
firm, subduing some personality traits, dressing up the senior management, or hiring new
members of the management team. For Bing Yeh and SST, the makeover centered around
four primary tasks: (1) hiring a chief financial officer, (2) reorganizing the financials,
(3) writing a company biography, and (4) preparing for the road show (this is the time when
management will present the company to potential investors).
Regardless of how much reading is done, like Bing Yeh, almost every entrepreneur is
unprepared and wants to halt the preparation process at some point. Yet for a successful
IPO, each entrepreneur must follow Yeh’s example by listening to the advice being given
and making any recommended changes.
TIMING OF GOING PUBLIC AND UNDERWRITER SELECTION
Two of the most critical issues in a successful public offering are the timing of the offering
and the underwriting team. An entrepreneur should seek advice from several financial ad-
visors as well as other entrepreneurs who are familiar with the process in making decisions
in these two areas.
Timing
The critical question each entrepreneur must ask is, “Is the company ready to go public?”
Some criteria to help answer this question are indicated in the following section.
First, is the company large enough? While it is not possible to establish rigid
minimum-size standards that must be met before an entrepreneur can go public, New
York investment banking firms prefer at least a 100,000 share offering at a minimum of
$20 per share. This means that the company would have to have a post offering value of
at least $50 million to support this $20 million offering, given that the company is will-
ing to sell shares representing not more than 40 percent of the total number of shares
outstanding after the offering is completed. This size of offering will occur only with
past significant sales and earnings performance or a solid prospect for future growth and
earnings.
Second, what is the amount of the company’s earnings, and how strong is its financial
performance? Not only is this performance the basis of the company valuation, but it also
determines if a company can successfully go public and the type of firm willing to under-
write the offering. While the exact criteria vary from year to year, thereby reflecting mar-
ket conditions, generally a company must have at least one year of good earnings and sales
before its stock offering will be acceptable to the market. Larger underwriting firms have
more stringent criteria, such as sales as high as $15 million to $20 million, a $1 million or
more net income, and a 30 to 50 percent annual growth rate.
364 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
Third, are the market conditions favorable for an initial public offering? Underlying the
sales and earnings, as well as the size of the offering, is the prevailing general market con-
dition. Market conditions affect both the initial price that the entrepreneur will receive for
the stock and the aftermarket, or the price performance of the stock after its initial sale.
Some market conditions are more favorable for IPOs than others. Unless the need for
money is so urgent that delay is impossible, the entrepreneur should attempt to take his or
her company public in the most favorable market conditions.
Fourth, how urgently is the money needed? The entrepreneur must carefully appraise
both the urgency of the need for new money and the availability of outside capital from
other sources. Since the sale of common stock decreases the ownership position of the en-
trepreneur and other equity owners, the longer the time before going public, given that
profits and sales growth occur, the less percentage of equity the entrepreneur will have to
give up per dollar invested.
Finally, what are the needs and desires of the present owners? Sometimes the present
owners lack confidence in the future viability and growth prospects of the business, or they
have a need for liquidity. Going public is frequently the only method by which present
stockholders may obtain the cash needed.
Underwriter Selection
Once the entrepreneur has determined that the timing for going public is favorable, he or
she must carefully select a managing underwriter that will then take the lead in forming the
underwriting syndicate. The underwriter is of critical importance in establishing the initial
price for the stock of the company, supporting the stock in the aftermarket, and creating a
strong following among security analysts.
Although most public offerings are conducted by a syndicate of underwriters, the
entrepreneur needs to select the lead or managing underwriter(s). The managing under-
writer will then develop the syndicate of underwriters for the initial public offering. An
entrepreneur should ideally develop a relationship with several potential managing
underwriters (investment bankers) at least one year before going public. Frequently, this
occurs during the first- or second-round financing, when the advice of an investment
banker helps structure the initial financial arrangements to position the company to go
public later.
Since selecting the investment banker is a major factor in the success of the public of-
fering, the entrepreneur should approach one through a mutual contact. Commercial banks,
attorneys specializing in securities work, major accounting firms, providers of the initial
financing, or prominent members of the company’s board of directors can usually provide
the needed suggestions and introductions. Also, because the relationship will be ongoing
and will not end with the completion of the offering, the entrepreneur should employ sev-
eral criteria in the selection process, such as reputation, distribution capability, advisory
services, experience, and cost.
Since an initial public offering rarely involves a well-known company, the managing un-
derwriter needs a good reputation to develop a strong syndicate team and provide confi-
dence to potential investors. This reputation helps sell the public offering and supports the
stock in the aftermarket. The ethics of the potential underwriter is an aspect that must be
carefully evaluated.
The success of the offering also depends on the underwriter’s distribution capability. An
entrepreneur wants the stock of his or her company distributed to as wide and varied a base
as possible. Since each investment banking firm has a different client base, the entrepreneur
should compare client bases of possible managing underwriters. Is the client base strongly
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 365
underwriting syndicate
Group of firms involved
in selling stock to the
public
managing underwriter
Lead financial firm in
selling stock to the public
institutional or is it composed of individual investors? Or is it balanced between the two?
Is the base more internationally or domestically oriented? Are the investors long term or
speculators? What is the geographic distribution—local, regional, or nationwide? A strong
managing underwriter and syndicate with a quality client base will help the stock sell and
perform well in the aftermarket.
Some underwriters are better able than others to provide financial advisory services.
Although this factor is not as important as the previous two in selecting an underwriter,
financial counsel is frequently needed before and after the IPO. An entrepreneur should
pose such questions as the following: Can the underwriter provide sound financial advice?
Has the underwriter given good financial counsel to previous clients? Can the underwriter
render assistance in obtaining future public or private financing? The answers to these
questions will indicate the degree of ability among prospective underwriters.
As reflected in the previous questions, the experience of the investment banking firm is
important. The firm should have experience in underwriting issues of companies in the
same or at least similar industries. This experience will give the managing underwriter
credibility, the capability to explain the company to the investing public, and the ability to
price the IPO accurately.
The final factor to be considered in the choice of a managing underwriter is cost. Going
public is a very costly proposition, and costs can vary significantly among underwriters.
Costs associated with various possible managing underwriters must be carefully weighed
against the other four factors. The key is to obtain the best possible underwriter and not try
to cut corners, given the stakes involved in a successful initial public offering.
REGISTRATION STATEMENT AND TIMETABLE
Once the managing underwriter has been selected, a planning meeting should be held
among those company officials responsible for preparing the registration statement, the
company’s independent accountants and lawyers, and the underwriters and their counsel.
At this important meeting, frequently called the “all hands” meeting, a timetable is pre-
pared that indicates dates for each step in the registration process. This timetable estab-
lishes the effective date of the registration, which determines the date of the final financial
statements to be included. The timetable should indicate the individual(s) responsible for
preparing the various parts of the registration and offering statement. Problems may arise
in an initial public offering due to the timetable not being carefully developed and agreed
to by all parties involved.
After the completion of the preliminary preparation, the first public offering normally
requires six to eight weeks to prepare, print, and file the registration statement with the
SEC. Once the registration statement has been filed, the SEC generally takes 6 to 12 weeks
to declare the registration effective. Delays frequently occur in this process, especially
(1) during heavy periods of market activity; (2) during peak seasons such as March,
when the SEC is reviewing a large number of proxy statements; (3) when the company’s
attorney is not familiar with federal or state regulations regarding the registration process;
(4) when issues arise over requirements of the SEC resulting from its review of the filing;
or (5) when the managing underwriter is inexperienced.
In reviewing the registration statement, the SEC attempts to ensure that the document
makes a full and fair disclosure of the material reported. The SEC has no authority to with-
hold approval of or require any changes in the terms of an offering that it deems unfair or
inequitable, as long as all material information concerning the company and the offering
is fully disclosed. However, the Financial Industry Regulatory Authority (FINRA) will
366 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
full and fair disclosure
The nature of all material
submitted to the SEC for
approval
review each offering, principally to determine the fairness of the underwriting compensa-
tion and its compliance with FINRA bylaw requirements.
The registration statement itself consists primarily of two parts: the prospectus (a legal
offering document normally prepared as a brochure or booklet for distribution to prospec-
tive buyers) and the registration statement (supplemental information to the prospectus,
which is available for public inspection at the office of the SEC and EDGAR). Both parts
of the registration statement are governed principally by the Securities and Exchange Act
of 1933 (the “1933 Act”), a federal statute requiring the registration of securities to be of-
fered to the public. This act also requires that the prospectus be furnished to the purchaser
at or before the making of any written offer or the actual confirmation of a sale. Specific
SEC forms set forth the informational requirements for a registration. Most initial public
offerings will use a Form S-1 registration statement. Smaller offerings may be able to use
the shorter forms SB-1 or SB-2.
The Prospectus
The prospectus portion of the registration statement is almost always written in a highly
stylized narrative form, since it is the selling document of the company. While the exact
format is decided by the company, the information must be presented in an organized, log-
ical sequence and in an easy-to-read, understandable manner to obtain SEC approval. Some
of the most common sections of a prospectus include the cover page; prospectus summary;
description of the company; risk factors; use of proceeds; dividend policy; capitalization;
dilution; selected financial data; the business, management, and owners; type of stock; un-
derwriter information; and the actual financial statements.
The cover page includes information such as company name, type and number of shares to
be sold, a distribution table, date of prospectus, managing underwriter(s), and syndicate of
underwriters involved. There is a preliminary prospectus and then a final prospectus once it has
been approved by the SEC. The preliminary prospectus is used by the underwriters to solicit
investor interest in the offering while the registration is pending. The final prospectus contains
all the changes and additions required by the SEC and the information concerning the price at
which the securities will be sold. The final prospectus must be delivered with or prior to the
written confirmation of purchase orders from investors participating in the offering.
The prospectus starts with a table of contents and summary. The prospectus summary
highlights the important features of the offering, similar to the executive summary of a
business plan that was discussed previously in Chapter 7.
A brief introduction of the company follows, which describes the nature of the business,
the company’s history, major products, and location.
Then a discussion of the risk factors involved is presented. Such issues as a history of
operating losses, a short track record, the importance of certain key individuals, depen-
dence on certain customers, significant level of competition, or market uncertainty are the
typical risk factors revealed to ensure that the purchaser is aware of the speculative nature
of the offering and the degree of risk involved in purchasing.
The next section, use of proceeds, needs to be carefully prepared since the actual use of
the proceeds must be reported to the SEC after the offering. This section is of great interest
to potential purchasers as it indicates the reason(s) the company is going public and its
future direction.
The dividend policy section details the company’s dividend history and any restrictions
on future dividends. Most entrepreneurial companies have not paid any dividends but have
retained their earnings to finance future growth.
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 367
prospectus Document
for distribution to
prospective buyers of a
public offering
registration statement
Materials submitted to the
SEC for approval to sell
stock to the public
Form S-1 Form for
registration for most
initial public offerings of
stock
The capitalization section indicates the overall capital structure of the company both
before and after the public offering.
Whenever there is significant disparity between the offering price of the shares and the
price paid for shares by officers, directors, or founding stockholders, a dilution section is
necessary in the prospectus. This section describes the dilution, or difference between the
share price paid by the public investors and the weighted average price at which all shares
have been issued, including the pre-IPO shares sold to officers, directors, and founding
stakeholders.
Form S-1 requires that the prospectus contain selected financial data for each of the last
five years of company operation to highlight significant trends in the company’s financial
condition. There must also be a discussion of management’s analysis of the company’s fi-
nancial condition and results of operations. This analysis should cover at least the last three
years of operation.
The next section, the business, is the largest part of the prospectus. It provides informa-
tion on the company, its industry, and its products, and includes the following: the histori-
cal development of the company; principal products, markets, and distribution methods;
new products being developed; sources and availability of raw materials; backlog orders;
export sales; number of employees; and nature of any patents, trademarks, licenses, fran-
chises, and physical property owned; competition; and effects of governmental regulations.
Following the business section is a discussion of management and security holders. This
section covers background information, ages, business experience, total remuneration, and
stock holdings of directors, nominated directors, and executive officers. Also, any other
stockholder (not in the preceding categories) who beneficially owns more than 5 percent of
the company must be indicated.
The description of the capital stock section, as the name implies, indicates the par and
stated value of the stock being offered, dividend rights, voting rights, liquidity, and trans-
ferability if more than one class of stock exists.
Following this, the underwriter information section explains the plans for distributing
the securities, such as the amount of securities to be purchased by each underwriting par-
ticipant involved.
The prospectus part of the registration statement concludes with the actual financial
statements. Form S-1 normally requires audited balance sheets for the last two fiscal years,
audited income statements and statements of retained earnings for the last three fiscal
years, and unaudited interim financial statements as of 135 days prior to the date when the
registration statement becomes effective. It is this requirement that makes it so important to
pick a date for going public in light of year-end operations and to develop a good timetable.
This will help avoid the time and costs of preparing additional interim statements.
The Registration Statement
This section of Form S-1 contains certain information regarding the offering, the past unreg-
istered securities offering of the company, and any other undertakings by the company. The
registration statement also includes exhibits such as the articles of incorporation, the under-
writing agreement, company bylaws, stock option and pension plans, and initial contracts.
Procedure
Once the preliminary prospectus is filed as a part of the registration statement, it can be dis-
tributed to the underwriting group. This preliminary prospectus is called a red herring, be-
cause a statement printed in red ink appears on the front cover. The registration statement
368 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
red herring Preliminary
prospectus of a potential
public offering
is then reviewed by the SEC to determine the adequacy of the disclosure. Some deficien-
cies are almost always found and are communicated to the company via either telephone or
a comment letter. This preliminary prospectus contains all the information that will appear
in the final prospectus except that which is not known until shortly before the effective
date: offering price, underwriters’ commission, and amount of proceeds. These items are
filed through a pricing amendment and appear in the final prospectus. The time between the
initial filing of the registration statement and its effective date, usually around 2 to 10
months, is called the waiting period. During this time the underwriting syndicate is formed
and briefed. Any company publicity regarding the proposed offering cannot be released
during this period.
LEGAL ISSUES AND BLUE-SKY QUALIFICATIONS
Legal Issues
In addition to all the legal issues surrounding the actual preparation and filing of the
prospectus, there are several other important legal concerns. Perhaps the one that is of the
most concern to the entrepreneur is the quiet period, the period of time from when the de-
cision to go public is made to 90 days following the date the prospectus becomes effective.
Care must be taken during this period regarding any new information about the company
or key personnel. Any publicity effort creating a favorable attitude about the securities to
be offered is illegal. The guidelines established by the SEC regarding the information that
can and cannot be released should be understood not only by the entrepreneur but by every-
one else in the company as well. All press releases and other printed material should be
cleared with the attorneys involved as well as the underwriter. The entrepreneur and key
personnel must curtail speaking engagements and television appearances to avoid any pos-
sible problematic response to interviewer or audience questions. For example, one entre-
preneur whose company was in the process of going public had to postpone a TV guest
appearance on The Today Show with one of the authors of this textbook, where she was to
discuss women entrepreneurs, not her company.
Blue-Sky Qualifications
The securities of certain smaller companies going public must also be qualified under the
blue-sky laws of each state in which the securities will be offered. This is true unless the
state has an exemption from the qualification requirements. These blue-sky laws may
cause additional delays and costs to the company going public. Offerings of securities that
will be traded on the more prominent stock exchanges or listed on the NASDAQ Global
Market have been preempted from most state registration requirements by the National
Securities Markets Improvement Act of 1996. Many states allow their state securities ad-
ministrators to prevent an offering from being sold in their state on such substantive
grounds as past stock issuances, too much dilution, or too much compensation to the un-
derwriter, even though all required disclosures have been met and clearance has been
granted by the SEC.
AFTER GOING PUBLIC
After the initial public offering has been sold, there are still some areas of concern to the
entrepreneur. These include aftermarket support, relationship with the financial commu-
nity, and reporting requirements.
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 369
comment letter A letter
from the SEC to a
company indicating
corrections that need to
be made in the submitted
prospectus
pricing amendment
Additional information on
price and distribution
submitted to the SEC to
develop the final
prospectus
quiet period 90-day
period in going public
when no new company
information should be
released
blue-sky laws Laws of
each state regulating
public sale of stock
aftermarket support
Actions of underwriters
to help support the price
of stock following the
public offering
370
A S S E E N I N BUSINESSWEEK
WHERE VENTURE CAPITAL NEVER VENTURED BEFORE
The fishermen from the Indian village of Chidambaram
live a hard life. They sleep most of the day, then
spend the night out on the water. For light during
those dark hours, they have long depended on wob-
bly kerosene lamps that were easily blown out or,
worse, toppled by the wind, risking a deadly fire
on their boats. But these days, the kerosene lamps
have been replaced with MightyLights, $50 solar-
powered fixtures. “I save 100 rupees [$2.50] a month
on kerosene alone,” says K Kanimuri, a fisherman’s
wife who also uses the MightyLight in her makeshift
kitchen.
Kanimuri and her fellow villagers may not know it,
but the change in their fortunes is rooted in global
finance. MightyLights are the brainchild of New Delhi-
based Cosmos Ignite Innovations, a startup that aims
to provide simple products for the world’s poorest
people. And Cosmos got its start with backing from
Vinod Khosla, a veteran Silicon Valley venture capital-
ist. Now Cosmos is in talks with other groups includ-
ing London-based 3i and eBay Inc. founder Pierre
M. Omidyar for a second round of funding. “For us,
it’s not just the light, but using a sustainable model to
effect social change,” says Matthew Scott, chief exec-
utive of Cosmos.
Just a few years ago, most venture capital funds
focused on pure technology companies operating in
industrialized countries. But now, VCs are starting to
look for opportunities in the developing world. “The
base of the pyramid is often ignored but offers a
tremendous opportunity,” says Katie Hill, the India
representative of Acumen Fund, an $8 million fund
backed by the Cisco Systems Foundation and the
Rockefeller Foundation. Acumen has put $1.5 million
into Ziqitza, a Mumbai-based ambulance company
that offers deep discounts on its service for residents
of the city’s vast slums.
The trend is due in part to the amount of money
chasing deals. VCs these days are forced to “invest in
less fished areas,” says Sumir Chadha, managing
director of Sequoia Capital India, an arm of the
Silicon Valley VC firm. But don’t mistake such invest-
ments as charity. Santa Monica (Calif.)-based Clear-
stone Venture Partners has put $5 million into DigiBee
Microsystems, which expects to pocket handsome
profits by selling low-end mobile phones to poor
Indians. And two California VC funds are considering
a $5 million investment in Novatium, a Chennai com-
pany that has developed a $100 PC and expects to sell
3 million of them by 2010. Says Novatium CEO Alok
Singh: “We have always been market-driven and
make money.”
Source: Reprinted from July 9, 2007 issue of BusinessWeek by spe- cial permission, copyright © 2007 by The McGraw-Hill Companies, Inc., “Where Venture Capital Never Ventured Before,” by Nandini Lakshman, p. 97.
Aftermarket Support
Once issued, the price of the stock is typically monitored, particularly in the initial weeks
after its offering. Usually the managing underwriting firm will be the principal market
maker in the company’s stock and will be ready to purchase or sell stock in the interdealer
market. To stabilize the market, and prevent the price from going below the initial public
offering price, the underwriter will usually enter bids to buy the stock in the early stages af-
ter the offers, thereby giving aftermarket support. This support is important in allowing the
stock not to be adversely affected by an initial drop in price.
Relationship with the Financial Community
Once a company has gone public, the financial community usually takes a greater interest.
An entrepreneur will need an increasing portion of time to develop a good relationship with
this community. The relationship established has a significant effect on the market interest
and the price of the company’s stock. Since many investors rely on analysts and brokers for
investment advice, the entrepreneur should attempt to meet as many of these individuals as
possible. Regular appearances before societies of security analysts should be a part of
establishing this relationship, as well as public disclosures through formal press releases.
Frequently, it is best to designate one person in the company to be the information officer,
ensuring that the press, public, and security analysts are dealt with in a friendly, efficient
manner. There is nothing worse than a company not responding in a timely manner to
information requests.
Reporting Requirements
The company must file annual reports on Form 10-K, quarterly reports on Form 10-Q, and
specific transaction or event reports on Form 8-K. The information in Form 10-K on the
business, management, and company assets is similar to that in Form S-1 of the registration
statement. Of course, audited financial statements are required.
The quarterly report on Form 10-Q primarily contains the unaudited financial informa-
tion for the most recently completed fiscal quarter. No Form 10-Q is required for the fourth
fiscal quarter.
A Form 8-K report must be filed within two to five days of such events as the acquisi-
tion or disposition of significant assets by the company outside the ordinary course of the
business, the resignation or dismissal of the company’s independent public accountants, or
a change in control of the company.
Under the Sarbanes-Oxley Act, the due dates for reports have been accelerated. In addi-
tion, by adopting its Regulation FD, the Securities and Exchange Commission has tried to
minimize selective disclosures of important corporate developments and information. Un-
der this regulation, public companies are required to make immediate and broad public dis-
closures of important information at the same time they release the information to anyone
outside the company.
The company must follow the proxy solicitation requirements in connection with hold-
ing a meeting or obtaining the written consent of security holders. The timing and type of
materials involved are detailed in Regulation 14A under the Securities Exchange Act of
1934. These are but a few of the reporting requirements of public companies that must be
carefully observed, since even inadvertent mistakes can have negative consequences for the
company. The reports required must be filed on time.
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 371
IN REVIEW
S U M M A R Y
In financing a business, the entrepreneur determines the amount and timing of funds
needed. Seed or start-up capital is the most difficult to obtain, with the most likely
source being the informal risk-capital market (angels). These investors, who are
wealthy individuals, average one or two deals per year, ranging from $100,000 to
$500,000, and generally find their deals through referrals.
Although venture capital may be used in the first stage, it is primarily used in the sec-
ond or third stage to provide working capital for growth or expansion. Venture capital
is broadly defined as a professionally managed pool of equity capital. Since 1958, small-
business investment companies (SBICs) have combined private capital and government
372 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
funds to finance the growth and start-up of small businesses. Private venture-capital
firms have developed since the 1960s, with limited partners supplying the funding. At
the same time, venture-capital divisions operating within major corporations began
appearing. States also sponsor venture-capital funds to foster economic development.
To achieve the venture capitalist’s primary goal of generating long-term capital appre-
ciation through investments in business, three criteria are used: The company must have
strong management; the product/market opportunity must be unique; and the capital
appreciation must be significant, offering a 40 to 60 percent return on investment. The
process of obtaining venture capital includes a preliminary screening, agreement on prin-
cipal terms, due diligence, and final approval. Entrepreneurs need to approach a poten-
tial venture capitalist with a professional business plan and a good oral presentation.
Valuing the company is of concern to the entrepreneur. Eight factors can be used as
a basis for valuation: the nature and history of the business, the economic outlook,
book value, future earnings, dividend-paying capacity, intangible assets, sales of stock,
and the market price of stocks of similar companies. Numerous valuation approaches
that can be used were discussed.
In the end, the entrepreneur and investor must agree on the terms of the transac-
tion, known as the deal. When care is taken in structuring the deal, the entrepreneur
and the investor will maintain a good relationship while achieving their goals through
the growth and profitability of the business.
Going public—transforming a closely held corporation into one in which the gen-
eral public has proprietary interest—is indeed arduous. An entrepreneur must carefully
assess whether the company is ready to go public as well as whether the advantages
outweigh the disadvantages of doing so.
Once the decision is made to proceed, a managing investment banking firm must be
selected and the registration statement prepared. The expertise of the investment
banker is a major factor in the success of the public offering. In selecting an investment
banker, the entrepreneur should consider reputation, distribution capability, advisory
services, experience, and cost. To prepare for the registration date, the entrepreneur
must organize an “all hands” meeting of company officials, the company’s independ-
ent accountants and lawyers, and the underwriters and their counsel. A timetable must
be established for the effective date of registration and for the preparation of neces-
sary financial documents, including the preliminary and final prospectuses. Following
the initial public offering, the entrepreneur should strive to maintain a good relation-
ship with the financial community and adhere strictly to the reporting requirements of
public companies.
R E S E A R C H T A S K S
1. Go to a directory of venture capitalists and ascertain what percentage of funds
for a typical venture-capital firm are invested in seed, start-up, expansion or
development, and acquisitions or leveraged buyouts. What criteria do venture
capitalists report using in their initial screening of business proposals?
2. Obtain an initial public offering prospectus for three companies. Use at least two
different approaches for valuing each company.
3. Search the Internet for services that provide access to business angels or informal
investors. How do these sites work? If you were an entrepreneur looking for
funding, how much would it cost to use this service? How many business angels
are registered on the typical database? How many entrepreneurs are registered on
�
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 373
the typical database? How effective do you believe these services are? (Use data
where possible to back up your answer.)
4. How many companies went public per year over the last 10-year period? How do
you explain this variation in the “popularity” of going public?
5. Analyze the prospectuses of 10 companies that went public in 2005. In your
opinion, which companies are likely to do well in the public offering, and
which are less likely to do well? Conduct the following calculation to test your
propositions: Stock price after 1 week ⫺ Offering price ⫼ Offering price. Compare
this price with the original IPO price.
6. Analyze the prospectuses of five companies going public. What are the reasons
they state for going public? How are they going to use the proceeds? What are
the major risk factors presented?
C L A S S D I S C U S S I O N
1. An investor provides an entrepreneurial firm with the capital that it needs to
grow. Over and above providing the capital, in what other ways can the investor
add value to the firm? What are the possible downsides of having a venture
capitalist as an investor in the business?
2. Assume that you have been very lucky and have been given a considerable
fortune. You want to become a business angel (straight after graduation). How
would you go about setting up and running your “business angel” business? Be
specific about generating deal flow, selection criteria, the desired level of control
and involvement in the investee, etc.
3. What drives the market for IPOs? Why is it so volatile?
4. If you were an entrepreneur in a “hot” market, would you invest the substantial
amount of time, energy, and other resources necessary to try and go public before
the bubble bursts? Or would you prefer to utilize those resources to build your
business and create value for customers?
S E L E C T E D R E A D I N G S
Betros, Chris. (September 2008). From Startup to IPO: New Zealand’s Most Successful Entrepreneur. J@pan Inc., no. 80, pp. 37–39.
This article profiles an entrepreneur—Ted Williams—from New Zealand who has had great success launching an Internet business in Japan. During this interview, Mr. Williams recounts his first days in Japan from being a tourist to trading whisky for office furniture to reorganizing the management structure of his company in preparation for an IPO. ValueCommerce, Mr. Williams’s company, is Japan’s first in- teractive Internet marketing site.
Delaney, Laurel. (April 2007). Howdy, Partner. Entrepreneur, vol. 35, no. 4, p. 87.
This very brief editorial column illustrates another tactic for boosting capital: forming strategic global alliances (SGAs). The author, Laurel Delaney, owns a consultancy advising entrepreneurs on international endeavors. In her column, Ms. Delaney asserts that strategic global alliances can offer successful avenues for defraying informal risk. The anecdote includes Ms. Delaney’s experience exporting food to Japan. Ms. Delaney also highlights the three telltale qualities of a poten- tially auspicious SGA partner: good chemistry, internal trust, and charted perfor- mance results.
�
374 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
Duffner, Stefan; Markus M. Schmid; and Heinz Zimmermann. (February 2009). Trust and Success in Venture Capital Financing—An Empirical Analysis with German Survey Data.” Kyklos, vol. 62, no. 1, pp. 15–43.
This research paper is the collaborative effort of a Goldman Sachs analyst (Duffner) and two Swiss finance experts (Schmid and Zimmermann). Leaving nothing to chance or to opinion, these authors have designed a research study to scrutinize the importance of trust in venture-capital funding decisions. The authors con- ducted a survey of German venture capitalists in 2003 and again in 2006, the data from which suggest that mutual trust between the venture-capital firm and the en- trepreneur is an indicator of the venture’s successful performance. Also relevant to these results, the more trust a venture capitalist had in an entrepreneur, the less vigilance he tended to impose on the entrepreneur in the formative stages of the venture.
Kaplan, Steven N.; Berk A. Sensoy; and Per Strömberg. (February 2009). Should In- vestors Bet on the Jockey or the Horse? Evidence from the Evolution of Firms from Early Business Plans to Public Companies. Journal of Finance, vol. 64, no. 1, pp. 75–115.
This study includes evidence-based research on the behavioral development of the venture-capital–backed firm. From the start-up phase to the search for funding and finally to the IPO, the authors have based their research on 50 firms that received seed funding from venture-capital groups and eventually went public. The study de- sign is formidable, accounting for all sorts of variations in company dynamics. The hypothesized results suggest that venture capitalists, when assessing start-up ven- tures, should focus their attention on the viability of the start-ups’ core business idea, rather than on the chemistry of the management team; as companies evolve, so typically will the leadership structure.
Patrick, Darren. (June 1, 2008). Going Private. Benefits Canada, vol. 32, no. 6, p. 63.
The author of this article is an investment analyst at a Vancouver, Canada, consult- ing firm. In an effort to expand the firm’s net worth, the author recommends investors increase their odds by betting on companies that are not listed in the public domain. Funding from private-equity firms, the author suggests, is an attractive alternative to ambiguous capital markets. In this article, the author specifies the many ways in which one can invest in private equity, underscoring the relaxed pricing models and return conditions promised by the current trends in private-equity deals.
Spindler, James C. (May 2007). IPO Liability and Entrepreneurial Response. University of Pennsylvania Law Review, vol. 155, no. 5, pp. 1187–1228.
This scholarly article, authored by a University of Southern California (USC) law pro- fessor, details the legal implications of taking a private company public by issuing an initial public offering (IPO) on the stock market. In addition to the heightened level of scrutiny and the redoubled number of shareholders to please, a newly public company may find that its option performance also takes a hit. The author explores some of the more technical ramifications of becoming a publicly traded entity, citing the Securities Act of 1933 as a virtual insurance policy for shareholders against a company’s potential missteps. Entrepreneurs, or company owners, may shy away from going public because of the increased risk thrust on them by the Securities Act liability, opines the author.
Taulli, Tom. (February 2009). When to Postpone Efforts to Raise Capital. BusinessWeek Online, www.businessweek.com/smallbiz/content/feb2009/sb2009025_538531.htm.
This article deals with raising equity capital for an early-stage company and the cur- rent state of the early-stage investing marketplace. Getting a meeting with a VC or angel investor is not easy. This article discusses things to keep in mind when dealing with VCs and angel investors.
C H A P T E R 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC 375
Zhang, Jing; Vangelis Souitaris; Pek-hooi Soh; and Poh-kam Wong. (July 2008). A Con- tingent Model of Network Utilization in Early Financing of Technology Ventures. Entre- preneurship: Theory & Practice, vol. 32, no. 4, pp. 593–613.
A U.S. business professor, a British entrepreneurship professor, and two Singaporean policy professors joined forces to conduct this study on international habits of solic- iting start-up funding. Westerners tend to emphasize social networks when direct- ing their search for funding. Asian entrepreneurs, on the other hand, typically employ a different modus operandi. The authors of this study suggest that while the Western tendency may be familiar and easy, it can also be limiting and risky. Asian entrepreneurs don’t normally abdicate their companies’ marketing or sales functions to their personal contacts; why should they rely on friends and family for seed capital? Entrepreneurs, according to this study, should cast a wider net in the canvassing stage, so as not to exhaust personal relationships or recurring sources of funding. The study includes data from over 200 high-tech start-up firms in both Singapore and Beijing, China.
E N D N O T E S
1. See Jessi Hempel, “How Facebook Is Taking Over Our Lives,” Fortune (March 2, 2009); “Inspiring Stories from Famous Entrepreneurs—Mark Zuckerberg,” www.yousaytoo.com/amerazone/inspiring-stories-from-famous-entrepreneurs- mark-zuckerberg/27452; Simon Garfield, “So How Many Friends Do You Have, Mark?” The Observer (November 16, 2008), www.guardian.co.uk/media/2008/ nov/16/mark-zuckerberg-facebook-social-networking; Katharine A. Kaplan, “Facemash Creator Survives Ad Board,” The Harvard Crimson Online Edition (November 19, 2003), www.thecrimson.com/article.aspx?ref=350143; Michael Arrington, “Facebook Just Launched Open Registrations,” TechCrunch (September 26, 2006), www.techcrunch.com/2006/09/26/facebook-just-launched- open-registrations/; and Erik Sass, “Users Throw Book at Facebook,” MediaPost News (September 7, 2006), www.mediapost.com/publications/index.cfm? fuseaction=Articles.showArticle@art_aid=47811&art_type=13.
2. Report of the Use of the Rule 146 Exemption in Capital Formation (Washington, DC: Directorate of Economic Policy Analysis, Securities and Exchange Commission, 1983).
3. An Analysis of Regulation D (Washington, DC: Directorate of Economic Policy Analysis, Securities and Exchange Commission, 1984).
4. Charles River Associates, Inc., An Analysis of Capital Market Imperfections (Washington, DC: National Bureau of Standards, February 1976).
5. W. E. Wetzel, Jr., “Entrepreneurs, Angels, and Economic Renaissance,” in R. D. Hisrich (ed.), Entrepreneurship, Intrapreneurship, and Venture Capital (Lexington, MA: Lexington Books, 1986), pp. 119–40. Other information on angels and their investments can be found in W. E. Wetzel, Jr., “Angels and Infor- mal Risk Capital,” Sloan Management Review 24 (Summer 1983), pp. 23–24; and W. E. Wetzel, Jr., “The Informal Venture Capital Market: Aspects of Scale and Market Efficiency,” Journal of Business Venturing (Fall 1987), pp. 299–314.
6. R. B. Avery and G. E. Elliehausen, “Financial Characteristics of High-Income Families,” Federal Reserve Bulletin, Washington, DC (March 1986).
7. M. Gannon, “Financing Purgatory: An Emerging Class of Investors Is Beginning to Fill the Nether Regions of Start-Up Financing—The Murky World between the Angels and the Venture Capitalists,” Venture Capital Journal (May 1999), pp. 40–42.
8. S. Prowse, “Angel Investors and the Market for Angel Investments,” Journal of Banking and Finance 23 (1998), pp. 785–92.
376 PA RT 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
9. Joseph Bell, Kenneth Huggins, and Christine McClatchey, “Profiling the Angel Investor,” Proceedings, Small Business Institute Directors Association 2002 Con- ference, February 7–9, 2002, San Diego, CA, pp. 1–3.
10. For the role of SBICs, see Farrell K. Slower, “Growth Looms for SBICs,” Venture (October 1985), pp. 46–47; and M. H. Fleischer, “The SBIC 100—More Deals for the Bucks,” Venture (October 1985), pp. 50–54.
11. Most of the information on the venture-capital industry in this section as well as other information can be found in the PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association Money TreeTM Survey.
12. For a thorough discussion of the venture-capital process, see B. Davis, “Role of Venture Capital in the Economic Renaissance of an Area,” in R. D. Hisrich (ed.), Entrepreneurship, Intrapreneurship, and Venture Capital (Lexington, MA: Lexington Books, 1986), pp. 107–18; Robert D. Hisrich and A. D. Jankowicz, “Intuition in Venture Capital Decisions: An Exploratory Study Using a New Technique,” Journal of Business Venturing 5 (January 1990), pp. 49–63; Robert D. Hisrich and Vance H. Fried, “The Role of the Venture Capitalist in the Man- agement of Entrepreneurial Enterprises,” Journal of International Business and Entrepreneurship 1, no. 1 (June 1992), pp. 75–106; Vance H. Fried, Robert D. Hisrich, and Amy Polonchek, “Research Note: Venture Capitalists’ Investment Criteria: A Replication,” Journal of Small Business Finance 3, no. 1 (Fall 1993), pp. 37–42; and Vance H. Fried and Robert D. Hisrich, “The Venture Capitalist: A Relationship Investor,” California Management Review 37, no. 2 (Winter 1995), pp. 101–13.
13. A discussion of some of the important sectors in this decision process can be found in I. MacMillan, L. Zemann, and Subba Narasimba, “Criteria Distinguish- ing Successful from Unsuccessful Ventures in the Venture Screening Process,” Journal of Business Venturing 2 (Spring 1987), pp. 123–38; Robert D. Hisrich and Vance H. Fried, “Towards a Model of Venture Capital Investment Decision- Making,” Financial Management 23, no. 3 (Fall 1994), pp. 28–37; and Vance H. Fried, B. Elonso, and Robert D. Hisrich, “How Venture Capital Firms Differ,” Journal of Business Venturing 10, no. 2 (March 1995), pp. 157–79.
14. For the full details of this story, see John Kerr, “The 100-Day Makeover,” Inc. (May 1996), pp. 54–63.
5 F R O M F U N D I N G T H E V E N T U R E T O
L A U N C H I N G , G R O W I N G , A N D
E N D I N G T H E N E W V E N T U R E
C H A P T E R 1 3
Strategies for Growth and Managing the Implications of Growth
C H A P T E R 1 4
Accessing Resources for Growth from External Sources
C H A P T E R 1 5
Succession Planning and Strategies for Harvesting and Ending the Venture
1
To know where to look for (or how to create) possible growth opportunities.
2
To understand the implications of business growth for a national economy.
3
To understand the primary challenges for managing business growth and to be prepared to effectively manage those challenges.
4
To recognize that people differ and to understand how these differences impact their intentions to grow a business.
13 S T R AT E G I E S F O R G R O W T H A N D
M A N A G I N G T H E I M P L I C AT I O N S O F
G R O W T H
L E A R N I N G O B J E C T I V E S
379
O P E N I N G P R O F I L E
BRIAN AND JENNIFER MAXWELL
Brian Maxwell, an internationally ranked marathon runner and coach at the University of
California, Berkeley, was leading a marathon race in England when at the 21-mile mark
he began to experience dizziness and tunnel vision, which forced him to quit the race. His
consumption of energy drinks on the day of the race had failed and motivated him to
find a solution for a better energy source. He teamed
up with Jennifer Biddulph, a student studying nutrition
and food science (now a PhD chemist), and they began
the quest for an energy bar that would taste good, be
healthy and nutritious, and provide the appropriate ingredients to optimize perfor-
mance. With $50,000 gathered from savings, they were determined to find a solution.1
During their three years of research, experts indicated to them that it would be im-
possible to produce a healthy product because of the large amounts of saturated fats
necessary for lubricating machinery in the food bar manufacturing process. However,
after many failures, they found the solution. They understood that their efforts re-
quired developing a food bar manufacturing process that would not require adding
fats for lubrication of machinery and would produce a product that would meet the
desired attributes. The product needed to provide a balance of simple carbohydrates
for quick energy, complex carbohydrates for longer lasting energy, and low fat for easy
digestion. Hundreds of recipes were tested with athletes until the most effective and
best-tasting product was found. Continued requests among these athletes to have
more of those “power bars” led to the final brand name, and in 1986 they officially
formed the company, PowerBar Inc.
Initially the company was operated from Brian and Jennifer’s basement. The first
products, which went on sale in 1987, were the Malt-Nut and Chocolate flavors. After
their marriage in 1988, they moved to a new facility and began hiring employees to
meet the growing demand.
Their vision of finding a solution to a serious runner’s energy source wasn’t the only
factor in forming this new venture. Both Brian and Jennifer were determined to create
a work environment where employees would feel important and have a strong sense
of pride in the company. They wanted a company that did not have all the things that
they hated about jobs they had held previously. Thus, they created a work environment
olympics.powerbar.com
where employees are called team members, the dress is casual, and the focus is on
sports. To Brian and Jennifer, it was important that their employees enjoyed the work-
place and developed an important loyalty and commitment to the company’s mission.
In the early part of the 1990s, sales for the new venture increased by 50 to 60 per-
cent. In 1997 sales began to slow and increased by only 23 percent. In 1995 Brian and
Jennifer turned down an opportunity to purchase Balance Bar, a producer of an energy
bar that targeted the more casual athlete and those who were looking for a nutritious
snack. They had believed that their company did not need to add any new products and
could continue to grow with the one product. In retrospect, they realized this was a mis-
take in strategy and that the venture could not survive on the one product, especially
when they saw sales begin to stall in 1995. At that time there were many new competi-
tors who recognized the opportunities in a larger market by introducing energy bars
for casual exercisers and snackers. So in 1997 Brian and Jennifer began efforts to find
new products. In 1998 they launched PowerBar Harvest, a crunchy, textured energy bar
available in a number of flavors that would target casual athletes and consumers look-
ing for a nutritious snack. In 1999 a new creamy bar called Essentials and a new line of
sports drinks were launched.
Today PowerBar is still the leader in the serious athlete market, and Harvest has just
passed Clif bar to become the number three brand in this category. Sales in 1999 reached
$135 million. The company also opened a state-of-the-art manufacturing facility in
Idaho and two distribution centers in Idaho and North Carolina. It also established two
subsidiaries in Canada and Germany as opportunities for sales growth in international
markets occurred.
Brian still runs 40 to 50 miles per week. Jennifer was recently recognized in the first
annual Working Women Entrepreneurial Excellence Awards competition by winning
for Harvest in the Best Innovation category. In 2000, PowerBar was purchased by Nestlé
USA, which intends to grow and expand it globally. Brian Maxwell will continue to play
an integral role in the company.
In this chapter, important management decision areas are reviewed and discussed.
Building a solid management team and a loyal employee base, recognized by entre-
preneurs like Brian and Jennifer Maxwell as being very important during the early
years, is discussed in detail, along with financial and marketing control decisions.
380 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
GROWTH STRATEGIES: WHERE TO LOOK
FOR GROWTH OPPORTUNITIES
In Chapter 3 we discussed new entry as an essential act of entrepreneurship. A successful
new entry provides the opportunity for the entrepreneur to grow his or her business. For ex-
ample, introducing a new product into an existing market provides the opportunity to take
market share from competitors; entry into a new market provides the opportunity to service
a new group of customers; and a new organization has a chance to make, and build upon,
its first sales. Although it is difficult to provide direct guidance to entrepreneurs on a step-
by-step process for generating a highly attractive opportunity, in this chapter we provide a
model that offers suggestions on where to look for growth opportunities in which the firm
may already have a basis for a sustainable competitive advantage. We then investigate the
implications of that growth for an economy, for the firm, and for the entrepreneur, as well
as the possible need to negotiate for resources from external sources to sustain firm growth.
We know from Chapter 3 that opportunities for new entry are generated by the knowl-
edge of the entrepreneur and from organizational knowledge. We use this as a basis for
deciding on the best place to look for opportunities to grow the business. From a simple
perspective, we can assume that the entrepreneur and the firm have knowledge about
the product that they are currently producing and selling (the existing product) and have
knowledge about the group of customers to which they are currently selling that product
(the existing market).
Different combinations of different levels of these types of knowledge are represented
in Figure 13.1 and provide a model of different growth strategies.2 Most of these growth
strategies can lead to a competitive advantage because they capitalize on some aspect of the
entrepreneur’s, and the firm’s, knowledge base. These growth strategies are: (1) penetration
strategies, (2) market development strategies, (3) product development strategies, and
(4) diversification strategies.
Penetration Strategies
A penetration strategy focuses on the firm’s existing product in its existing market. The
entrepreneur attempts to penetrate this product or market further by encouraging existing
customers to buy more of the firm’s current products. Marketing can be effective in encour-
aging more frequent repeat purchases. For example, a pizza company engages in an exten-
sive marketing campaign to encourage its existing customer base of university students to
eat its pizza three nights a week rather than only twice a week. This growth strategy does not
involve anything new for the firm and relies on taking market share from competitors
and/or expanding the size of the existing market. Therefore, this growth strategy attempts
to better exploit its original entry.
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 381
FIGURE 13.1 Growth Strategies Based upon Knowledge of Product and/or Market
Source: H. I. Ansoff, Corporate Strategy: An Analytical Approach to Business Policy for Growth and Expansion (New York:
McGraw-Hill, 1965).
penetration strategy
A strategy to grow by
encouraging existing
customers to buy more
of the firm’s current
products
Penetration
strategies
Product
development
strategies
Market
development
strategies
Diversification
strategies
Existing
New
Existing New
Product
Market
Market Development Strategies
Growth also can occur through market development strategies. Market development strate-
gies involve selling the firm’s existing products to new groups of customers. New groups
of customers can be categorized in terms of geographics or demographics and/or on the
basis of new product use.
New Geographical Market This simply refers to selling the existing product in new lo- cations. For example, a firm selling its products in Singapore could start selling its products
in Malaysia, Thailand, and Indonesia. This has the potential of increasing sales by offering
products to customers who have not previously had the chance to purchase them. The entre-
preneur must be aware of possible regional differences in customer preferences, language,
and legal requirements that may necessitate a slight change in the product (or packaging).
New Demographic Market Demographics are used to characterize (potential) customers based upon their income; where they live; their education, age, and sex; and so on. For an
entrepreneur who is currently selling the firm’s existing product to a specific demographic
group, the business could grow by offering the same product to a different demographic
group. For example, a studio currently produces and sells computer games (specializing
in games on baseball and soccer) to males between the ages of 13 and 17. However, there is
an opportunity for this company to expand its sales by also targeting males between the ages
of 24 and 32 who are university educated, have high disposable incomes, and would likely
enjoy the escapism of these computer game products.
New Product Use An entrepreneurial firm might find out that people use its product in a way that was not intended or expected. This new knowledge of product use provides in-
sight into how the product may be valuable to new groups of buyers. For example, when I
moved from Australia to Chicago, I bought a baseball bat. I did not use the bat to play base-
ball; rather, I kept it beside my bed for security against anyone who might break into my
apartment. Fortunately, I never had to use it, but I did sleep better knowing it was there.
Recognition of this new product use could open up a whole new market for the manufac-
turers of baseball bats. Another example is four-wheel-drive vehicles. The original produc-
ers of this product thought that it would be used primarily for off-road recreational driving
but found that the vehicle was also popular among housewives because it was big enough
to take the children to school and carry all their bags and sporting equipment. Knowledge
of this new use allowed the producers to modify their product slightly to better satisfy cus-
tomers who use the product in this way. An advantage from using a market development
strategy is that it capitalizes on existing knowledge and expertise in a particular technology
and production process.
Product Development Strategies
Product development strategies for growth involve developing and selling new products to
people who are already purchasing the firm’s existing products. Experience with a particu-
lar customer group is a source of knowledge on the problems customers have with existing
technology and ways in which customers can be better served. This knowledge is an impor-
tant resource in coming up with a new product. For example, Disney Corporation built on
its existing customer base of Disney movie viewers and developed merchandising products
specifically aimed at this audience. A further advantage of using a product development
strategy is the chance to capitalize on existing distribution systems and on the corporate
reputation the firm has with these customers.
382 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
market development
strategy Strategy to
grow by selling the firm’s
existing products to new
groups of customers
product development
strategy A strategy to
grow by developing and
selling new products to
people who are already
purchasing the firm’s
existing products
Diversification Strategies
Diversification strategies involve selling a new product to a new market. Even though both
knowledge bases appear to be new, some diversification strategies are related to the entre-
preneur’s (and the firm’s) knowledge. In fact there are three types of related diversification
that are best explained through a discussion of the value-added chain.
As illustrated in Figure 13.2, a value-added chain captures the steps it takes to develop
raw materials into a product and get it into the hands of the customers. Value is added at
every stage of the chain. For the value added, each firm makes some profit. If we focus on
the manufacturer, opportunities for growth arise from backward integration, forward inte-
gration, and horizontal integration. Backward integration refers to taking a step back (up)
on the value-added chain toward the raw materials, which in this case means that the man-
ufacturer also becomes a raw materials wholesaler. In essence the firm becomes its own
supplier. Forward integration is taking a step forward (down) on the value-added chain to-
ward the customers, which in this case means that the firm also becomes a finished goods
wholesaler. In essence the firm becomes its own buyer.
Backward or forward integration provides an entrepreneur with a potentially attractive
opportunity to grow his or her business. First, these growth opportunities are related to the
firm’s existing knowledge base, and the entrepreneur could therefore have some advantage
over others with no such experience or knowledge. Second, being one’s own supplier
and/or buyer provides synergistic opportunities to conduct these transactions more effi-
ciently than they are conducted with independent firms fulfilling these roles. Third, operat-
ing as a supplier and/or a buyer of the original business provides learning opportunities that
could lead to new processes and/or new product improvements that would not have been
available if this integration had not taken place.
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 383
diversification strategy
A strategy to grow by
selling a new product to
a new market
FIGURE 13.2 Example of a Value-Added Chain and Types of Related Diversification
backward integration
A step back (up) in the
value-added chain toward
the raw materials
forward integration
A step forward (down) on
the value-added chain
toward the customers
Value-added chain for product 1 Value-added chain for product 2
Backward
integration
Horizontal
Forward
integration
Raw materials producer
Raw materials wholesaler
Manufacturer
Finished goods wholesaler
Retailer
Customer
Raw materials producer
Raw materials wholesaler
Manufacturer
Finished goods wholesaler
Retailer
Customer
$
$
$
$
$
A third type of related diversification is horizontal integration. The growth opportunity
occurs at the same level of the value-added chain but simply involves a different, but com-
plementary, value-added chain. For example, a firm that manufactures washing machines
may go into the manufacture of detergent. These products are complementary in that they
need each other to work. Again the relatedness of the new product to the firm’s existing
product means that the firm will likely have some competencies in this new product and
384
horizontal integration
Occurs at the same level
of the value-added chain
but simply involves a
different, but
complementary, value-
added chain
Dot-com mania may have ended, but selling products
and services online has scarcely begun. In fact, esti-
mates from a variety of sources have total online retail
sales increasing approximately 30 percent in 2002. And
after years of similarly rapid growth, the absolute num-
bers aren’t tiny either: Projections based on the U.S.
Department of Commerce’s conservative data reports
indicate that online sales of goods and services topped
$42 billion in 2002. And the Department of Commerce
doesn’t include online travel sales, which typically ac-
count for 40 percent or more of online revenue.
One thing driving online sales growth is the still-
increasing number of people going online. Market
trackers at Jupiter Media Metrix forecast the num-
ber of online Americans will double in five years to
132 million. Because about half of Internet users buy
something online during any particular year, that
translates to solid growth for online commerce.
The online market isn’t just growing; it’s also
changing. To begin with, the shoppers themselves
are transforming. Once mostly men, they’re now
mostly women. Though the Net is seen as a youthful
medium, seniors are the fastest-growing age group.
And though ethnic groups have lagged behind the
mainstream in embracing online, they are catching up
fast. “While the general market is tending to flatten
out a little bit, the ethnic market continues to have
rapid growth,” says Derene Allen, vice president of
The Santiago Solutions Group, a San Francisco multi-
cultural marketing consulting firm.
These groups all have their own reasons for shop-
ping online, their own styles, and their own favored
purchases. They’re buying a broader range of prod-
ucts and services as well. Once, goods were divided
into those suitable for sale on the Internet and those
not suitable. Supposedly, items such as furniture were
not online-ready, for instance. But increasingly, nearly
everything is being sold online. Furniture makes up
most of the volume at PoshTots, a 16-person Glen
Allen, Virginia, online seller of high-end children’s
products. “Our customers are buying cribs and beds,”
says Karen Booth Adams, 33-year-old co-founder,
“and we sell a lot of playhouses.”
Continuing growth of the online market calls for
evolving business strategies as well. The frenzy to
achieve the first-mover advantage that characterized
the early years of online retail has subsided. Today, sell-
ing online is less about having the latest technology
and more about having the best insight into customers.
“It’s back to tried-and-true principles of marketing,”
says Keith Tudor, professor of marketing at Kennesaw
State University in Kennesaw, Georgia. “Look at your
customers’ wants, needs, and motivations.”
ADVICE TO AN ENTREPRENEUR
An entrepreneur who runs a “bricks and mortar” re-
tail business comes to you for advice:
1. With all the failures associated with dot-com busi-
nesses, do you think it is safe now for me to start
advertising and selling my products online?
2. If I can’t enter this market and rely on first-mover
advantages or on a technological advantage,
then how can I develop a competitive advantage
in the proposed online division of my retail busi-
ness? Do I need to enter just to keep up with my
competitors and maintain market share?
3. If it reverts back to the basic principles of market-
ing, then how do you target your product at a
particular audience when everyone is using the
Internet?
Source: Reprinted with permission of Entrepreneur Media, Inc., “Net Meeting. Let Us Introduce You to the Most Important People on the Internet. If You Think You Know E-Commerce Consumers, This Might Surprise You,” by Mark Henricks, February 2003, Entrepreneur magazine: www.entrepreneur.com.
PROVIDE ADVICE TO AN ENTREPRENEUR ABOUT GROWING INTO NEW
MARKETS USING THE INTERNET
A S S E E N I N ENTREPRENEUR M A G A Z I N E
may provide learning opportunities. Further, horizontal integration provides the opportu-
nity to increase sales of the existing product. For example, the existing product and the new
product may be bundled and sold together, which may provide increased value to cus-
tomers and increase sales. Examples of bundled products include computer hardware and
software, televisions and video recorders, and telephones and answering machines.
What about introducing a new product into a new market that is not related to the ex-
isting business (i.e., not forward, backward, or horizontal integration)? The short answer
is, “Don’t do it.” If it is not related to the current business, then what possible advantage
can this firm have over competitors? Ego and the mistaken belief in the benefits of a
firm’s diversifying its risk lead some entrepreneurs to pursue unrelated diversification to
their own peril.
Example of Growth Strategies
To illustrate the use of the preceding model to explore possibilities for firm growth, we con-
sider the early days of the Head Ski Company, which, at that time, only produced and sold
high-tech skis in the U.S. market. A penetration strategy for Head could be achieved
through an increase in its marketing budget focused on encouraging existing customers to
“upgrade” their skis more often. This could involve some sort of performance imperative
that encourages customers to desire the most up-to-date skis with the newest technological
features.
A market development strategy could involve Head’s selling its skis in Europe,
Argentina, and New Zealand. The advantage of moving into Argentina and New Zealand is
that these markets are in the Southern Hemisphere and therefore sales are counterseasonal
to those in the United States (and other Northern Hemisphere markets). Head could also
start selling its skis to the mass market—those less affluent skiers who want a good-
performance ski at a “reasonable” price.
To pursue a product development strategy, Head could develop and sell new products,
such as hats, gloves, boots, and other ski accessories, to people who buy its skis. Head
could also manufacture tennis racquets or mountain bikes—equipment that is used by its
existing customer group when not skiing. These new products would build on its customer
reputation for high-tech, high-quality products and could capitalize on existing distribution
systems. For example, ski shops could sell Head tennis racquets and mountain bikes dur-
ing the summer months, which would also smooth out seasonal variability in sales.
Diversification strategies also offer opportunities for growth. For example, backward
integration could involve the design and manufacture of equipment used to make skis, for-
ward integration could involve control of a chain of retail ski shops, and horizontal integra-
tion could involve ownership of ski mountains (lifts, lodges, etc.).
As this example demonstrates, the model offers a tool for entrepreneurs, to force them
to think and look in different directions for growth opportunities where the firm may al-
ready have a basis for a sustainable competitive advantage. The pursuit and achievement of
growth have an impact on the economy, the firm, and the entrepreneur.
ECONOMIC IMPLICATIONS OF GROWTH
In 1996 Inc. magazine conducted a study of its 500 fastest-growing ventures in 1984 to as-
certain what happens to those ventures that are entering a growth phase.3 In 1984 these 500
fastest-growing ventures had aggregate sales of $7.4 billion and 64,000 full-time employ-
ees and were all experiencing the beginning of the rapid growth described earlier. By 1995,
among the original 500 ventures, there had been 95 failures or shutdowns and 135 had been
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 385
sold to new owners. The 233 companies that were willing to report earnings, however,
more than made up for the failures in jobs created and revenue generated. These 233 com-
panies had reached sales of $29 billion and employed 127,000 people full time. Thus, these
233 firms represented revenue and total numbers of employees that were significantly
larger than the original list of 500 ventures.
Figure 13.3 compares the 1984 results with the reported 1994 revenue and number of
full-time employees. You can see how significant the growth has been when you compare
the 1994 sales and numbers of employees of the 233 companies that participated with the
1984 sales and numbers of employees of the same 233 companies.
386 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
Source: Martha E. Mangelsdorf, “The Startling Truth about Growth Companies,” Inc. (May 21, 1996), p. 85. Copyright © 1996 by Mansueto Ventures LLC. Reproduced with permission of Mansueto Ventures LLC via Copyright Clearance Center.
FIGURE 13.3 A Follow-Up of Inc. Magazine’s 1984 Fastest-Growing Ventures
3.5
0
A g g re
g a te
s a le
s (
in $
b ill
io n s )
1984
Figures for all 500 companies
1994
5
010
15
20
25
30
35
Revenue generated by the 1985 Inc. 500
in 1984 and 1994
64
127
35
0
A g g re
g a te
n u m
b e r
o f fu
ll- ti m
e e m
p lo
y e e s (
in t h o u s a n d s )
1984 1994
30
60
90
120
150
Full-time jobs generated by the 1985 Inc. 500
in 1984 and 1994
Figures for 233 companies for which we have 1994 data
My, How They've Grown
29
7.4
In addition to the sales and employees, it was reported that 48 percent were still pri-
vately held under the same ownership and only 6 percent had actually gone public. The fact
that there were so few ventures that had gone public probably defies conventional thinking
in entrepreneurship that becoming a big business requires you to go public to finance the
growth. A comparison of the ventures that did go public, however, revealed that they had
achieved much larger growth than those that did not go public. These 32 companies from
the 1984 list grew by $18.9 billion in revenue, which was an average growth rate of 32 per-
cent. As a group these 32 firms included some of the top entrepreneurial performers in the
United States, such as Microsoft, Merisel, and Tech Data. Many of these companies had
also retained the original founder of the company as CEO.
The sample of Inc. magazine ventures does not capture those businesses that grow more
modestly, especially small businesses. However, modest levels of growth by small businesses
can still have a dramatic impact on an economy. For example, the majority of new jobs in most
industrialized economies are created by small business.4 This does not necessarily mean that
most small firms do grow; rather, the population of small firms is so large that even when a
small percentage of them do grow, the impact on an economy is still significant and important.5
The sample of Inc. magazine ventures does capture some businesses that were at one
stage growing rapidly but later failed. We should not consider business failure a negative
outcome for an economy. On the contrary, entrepreneurs who pursue growth opportunities,
even if such pursuit increases the potential for failure, generate knowledge that stimulates
improvements in technologies and increases economic resilience.6
For example, an entrepreneur who “goes for it” and develops a new technology could hit
the jackpot, which obviously provides benefits to the economy in terms of tax revenue, em-
ployment, reduction of the trade deficit, and so on. But what if the new technology does not
work as expected and the business is bankrupted? How does this improve the economy? A
failed attempt provides information for that entrepreneur and other entrepreneurs. Although
the new technology itself did not work, another entrepreneur may have learned from the at-
tempt, which may have provided an important piece of the puzzle and, ultimately, success
(and the associated economic benefits).
An economy made up of entrepreneurs that do not fail is likely a poorly performing
economy. Such an economy does not have entrepreneurs willing to pursue high-risk–high-
potential-growth opportunities and therefore does not benefit from the rewards of technolo-
gies that “hit” and does not learn from those that are pursued but fail. Next we address the
implications of firm growth for the firm and then for the entrepreneur.
IMPLICATIONS OF GROWTH FOR THE FIRM
Because growth makes a firm bigger, the firm begins to benefit from the advantages of size.
For example, higher volume increases production efficiency, makes the firm more attractive
to suppliers, and therefore increases its bargaining power. Size also enhances the legitimacy
of the firm, because firms that are larger are often perceived by customers, financiers, and
other stakeholders as being more stable and prestigious. Therefore, the growing of a busi-
ness can provide the entrepreneur more power to influence firm performance. But as the firm
grows, it changes. These changes introduce a number of managerial challenges. These chal-
lenges arise from the following pressures.
Pressures on Existing Financial Resources
Growth has a large appetite for cash. Investing in growth means that the firm’s resources
can become stretched quite thin. With financial resources highly stretched, the firm is more
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 387
vulnerable to unexpected expenses that could push the firm over the edge and into bank-
ruptcy. Resource slack (resources in reserve) is required to ensure against most environ-
mental shocks and to foster further innovation.
Pressures on Human Resources
Growth is also fueled by the work of employees. If employees are spread too thin by the
pursuit of growth, then the firm will face problems of employee morale, employee burnout,
and an increase in employee turnover. These employee issues could also have a negative
impact on the firm’s corporate culture. For example, an influx of a large number of new
employees (necessitated by an increase in the number of tasks and to replace those that
leave) will likely dilute the corporate culture, which is a concern, especially if the firm
relies on its corporate culture as a source of competitive advantage.
Pressures on the Management of Employees
Many entrepreneurs find that as the venture grows, they need to change their management
style, that is, change the way they deal with employees. Management decision making that
is the exclusive domain of the entrepreneur can be dangerous to the success of a growing
venture. This is sometimes difficult for the entrepreneur to realize since he or she has been
so involved in all important decisions since the business was created. However, to survive,
the entrepreneur will need to consider some managerial changes.
Pressures on the Entrepreneur’s Time
One of the biggest problems in growing a firm is encapsulated in the phrase “If I only had
more time.” While this is a common problem for all managers, it is particularly applicable
to entrepreneurs who are growing their businesses. Time is the entrepreneur’s most pre-
cious yet limited resource. It is a unique quantity: The entrepreneur cannot store it, rent it,
hire it, or buy it. It is also totally perishable and irreplaceable. No matter what an entrepre-
neur does, today’s ration is 24 hours, and yesterday’s time is already history. Growth is de-
manding of the entrepreneur’s time, but as the entrepreneur allocates time to growth, it must
be diverted from other activities, and this can cause problems.
There are actions the entrepreneur can take to better manage these issues and more
effectively grow his or her business. We will now discuss some of these actions.
OVERCOMING PRESSURES ON EXISTING
FINANCIAL RESOURCES
To overcome pressures on existing financial resources, the entrepreneur could acquire new
resources. The acquisition of new resources is expensive, whether in terms of the equity
sold or the interest payments from debt. The need or the magnitude of the new resources re-
quired can be reduced through better management of existing resources. Such important
management activities include applying effective financial control, managing inventory,
and maintaining good records.
FINANCIAL CONTROL
The financial plan, as an inherent part of the business plan, was discussed in Chapter 10. Just
as we outlined how to prepare pro forma income and cash flow statements for the first three
years, the entrepreneur will need some knowledge of how to provide appropriate controls to
ensure that projections and goals are met. Some financial skills are thus necessary for the
388 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
entrepreneur to manage the venture during these early years. Cash flows, the income state-
ment, and the balance sheet are the key financial areas that will need careful management
and control. Since Chapter 10 explains how to prepare these pro forma statements, the focus
in this section will be controls and the management of these elements to alleviate financial
“growing” pains.
389
E T H I C S
EVEN THE SMALLEST BUSINESS CAN
LEARN WHAT NOT TO DO FROM THIS
GIANT COMPANY
Q: What can a business owner learn from the mis-
takes of Enron?
A: So you wanted to own a multibillion-dollar corpo-
ration and fly around the world in the latest Lear jet.
Then along comes Enron, the seventh largest company
in the United States, a firm most folks probably never
even heard of, and it ruins your dreams. And perhaps
your 401(k), too. The excesses that caused this disinte-
gration will be thoroughly examined by lawmakers
and regulators. When their work is completed, even
the innocent will find new government-mandated
rules and regulations to make doing business more
difficult. Well, don’t despair—“mistakes were made,”
but lessons can be learned.
And don’t think for a minute the Enron problem is
something that only giant corporations face. Although
the magnitude of its collapse won’t be matched by the
local print shop or pizza parlor, the collapse of even
the smallest of businesses impacts many people. The
failure of your business will greatly and negatively im-
pact you, your partners, your employees, customers,
and vendors as well as the families of each of those
groups. As business owners, we have a duty to operate
in a prudent, lawful, and ethical manner.
So what can we do? Every good business has a solid
business plan and a realistic design for implementing
that plan. While Enron is fresh in our minds, we think
the first thing to do is to examine our business plan
from the perspective of its fidelity to the prudence,
legality, and ethics mentioned above, and then com-
pare the business plan to the reality. Have business
“necessities” caused us to step over the line? How will
the deviations from the plan come back to bite us and
those who depend on us? Try to recall your first day in
business—it wasn’t about bending the rules, it wasn’t
about living high on the hog (or as they say today,
living large), and it had nothing to do with cheating
others—that first day was all about launching a dream
and bringing others along. It’s time to relight the flame.
As we said, on a local scale, the collapse of a small
business will match the collapse of an Enron for those
involved. If we get caught playing the business game
dirty, we won’t see ourselves on national TV, but our
next-door neighbor will know that side of our charac-
ter we’ve tried to hide. So will our families and close
friends.
Let’s think about the things we may be doing now,
things that were never in our plan and were never a
part of our dreams. And let’s purge them from our
business practices. A few of the common legal and
ethical missteps some business owners take, which
must be ended today, are:
• Paying personal expenses out of business funds
and writing them off
• Not reporting all cash receipts
• Cheating customers on price, quality, delivery, or
warranty
• Using misleading advertising
• Failing to pay our business bills on time
• Lying to employees, customers, and vendors
Some may think these lapses pale in comparison to
the allegations against Enron. They don’t. If you act
illegally or unethically in your business, given the
opportunity, you’d do so if your canvas were larger.
Take a good look at the list above and ask yourself,
“What is the penalty if I get caught?” Then ask your-
self a more important question: “Is this who I really
am?” Finally, fix it.
We may yet get to fly in that Lear jet, but we’ll
only deserve to if we’re honest, hard-working busi-
ness owners.
Source: Reprinted with permission of Entrepreneur Media, Inc., “Even the Smallest Business Can Learn What Not to Do from This Giant Company,” by Rod Walsh and Dan Carrison, February 2002, Entrepreneur magazine: www.entrepreneur.com.
LESSONS FROM ENRON
Managing Cash Flow
Since cash outflow may exceed cash inflow when growing a business, the entrepreneur
should try to have an up-to-date assessment of his or her cash position. This can be accom-
plished by preparing monthly cash flow statements, such as that found in Table 13.1, and
comparing the budgeted or pro forma statements with the actual results. The July budgeted
amounts are taken from the pro forma cash flow statement of MPP Plastics. The entrepre-
neur can indicate the actual amounts next to the budgeted amounts. This will be useful for
adjusting the pro forma for the remaining months, as well as for providing some indication
as to where cash flow problems may exist.
Table 13.1 shows a few potential problem areas. First, sales receipts were less than
anticipated. Management needs to assess whether this was due to nonpayment by some
customers or to an increase in credit sales. If the lower amount is due to nonpayment by
customers, the entrepreneur may need to try enforcing faster payment by sending re-
minder letters or making telephone calls to delinquent customers. Bounced checks from
customers can also affect cash flow since the entrepreneur has likely credited the
amount to the account and assumed that the cash is readily available. If the lower re-
ceipts are resulting from higher credit sales, the entrepreneur may need to either con-
sider short-term financing from a bank or try to extend the terms of payment to his or
her suppliers.7
Cash disbursements for some items were greater than budgeted and may indicate a
need for tighter cost controls. For example, cost of goods was $22,500, which was $1,700
390 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
TABLE 13.1 MPP Plastics Inc. (Statement of Cash Flow) July, Year 1 (000s)
July
Budgeted Actual
Receipts
Sales $ 24.0 $ 22.0
Disbursements
Equipment 100.0 100.0
Cost of goods 20.8 22.5
Selling expenses 1.5 2.5
Salaries 6.5 6.5
Advertising 1.5 1.5
Office supplies 0.3 0.3
Rent 2.0 2.0
Utilities 0.3 0.5
Insurance 0.8 0.8
Taxes 0.8 0.8
Loan principal and interest 2.6 2.6
Total disbursements $137.1 $140.0
Cash flow (113.1) (118.0)
Beginning balance 275.0 275.0
Ending balance 161.9 157.0
more than budgeted. The entrepreneur may find that suppliers increased their prices,
which may require a search for alternative sources or even raising the prices of the
products/services offered by the new venture. If the higher cost of goods resulted from
the purchase of more supplies, then the entrepreneur should assess the inventory costs
from the income statement. It is possible that the increased cost of goods resulted from the
purchase of more supplies because sales were higher than expected. However, if these
additional sales resulted in more credit sales, the entrepreneur may need to plan to borrow
money to meet short-term cash needs. Conclusions can be made once the credit sales and
inventory costs are evaluated.
The higher selling expenses also may need to be assessed. If the additional selling ex-
penses were incurred to support increased sales (even if they were credit sales), then there
is no immediate concern. However, if no additional sales were generated, the entrepreneur
may need to review all these expenses and perhaps institute tighter controls.
Projecting cash flow in the early stages can also benefit by conducting sensitivity
analysis. For each monthly expected cash flow, the entrepreneur can use 1 plus and minus 5
for an optimistic and pessimistic cash estimate, respectively. Thus, our MPP Plastics ex-
ample (Table 13.1) might have projected in the prior month sales receipts of $24,000 and,
using the 1 plus and minus 5 percent, would have a column indicating a pessimistic
amount of $22,800 and an optimistic amount of $25,200. This sensitivity analysis would
then be computed for all disbursements as well. In this manner the entrepreneur would be
able to ascertain the maximum cash needs given a pessimistic outcome and could prepare
for any cash needs.
For the very new venture it may be necessary to prepare a daily cash sheet. This
might be particularly beneficial to a retail store, restaurant, or service business. Table 13.2
provides an illustration of the cash available at the beginning of the day with additions
and deletions of cash recorded as indicated. This would provide an effective indication
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 391
TABLE 13.2 Daily Cash Activity (Date)
Beginning day’s cash balance: $XXX
Add:
Day’s cash sales (cash, charges, checks) $XXX
Collection of receivables $XXX
Total $XXX
Less:
Charge account sales (from day’s cash sales) $XXX
Total cash collected $XXX
Cash disbursed:
Cash refunds $XXX
Cash returns $XXX
Petty cash expenses (such as postage, travel, supplies, or repairs) $XXX
Total cash disbursed (subtract from total cash collected) $XXX
Amount of cash that should be on hand $XXX
Actual count of cash on hand $XXX
Difference between what should be on hand and actual $XXX
Note: If the final number is negative or positive, then an error has occurred in collections or payments.
of any daily shortfall and give a clear sense of where problems exist or where errors
have occurred.
Comparison of budgeted or expected cash flows with actual cash flows can provide the
entrepreneur with an important assessment of potential immediate cash needs and indicate
possible problems in the management of assets or control of costs. These items are discussed
further in the next sections.
Managing Inventory
During the growth of a new venture, the management of inventory is an important task. Too
much inventory can be a drain on cash flow since manufacturing, transportation, and stor-
age costs must be borne by the venture. On the other hand, too little inventory to meet cus-
tomer demands can also cost the venture in lost sales, or it can create unhappy customers
who may choose another firm if their needs are not met in a timely manner.
Growing ventures typically tie up more cash in their inventory than in any other part
of the business. Skolnik Industries, a $10 million manufacturer of steel containers
for storage and disposal of hazardous materials, developed an inventory control
system that allowed it to ship products to its customers within 24 to 48 hours. This was
accomplished with a very lean inventory, thanks to the installation of a computerized
inventory-control system that allows the firm to maintain records of inventory on a
product-by-product basis. In addition to this capability, the system allows the com-
pany to monitor gross margin return on investment, inventory turnover, percentage
of orders shipped on time, length of time to fill back orders, and percentage of cus-
tomer complaints to shipped orders. Software to accomplish these goals is readily avail-
able and in many cases can even be modified to meet the exact needs of the business.
The reports from this system are generated every two to four weeks in normal sales pe-
riods and weekly in heavy sales periods. This system not only provides Skolnik with an
early warning system but also frees up cash normally invested in inventory and im-
proves the overall profitability of the firm.8 Perpetual inventory systems can be struc-
tured using computers or a manual system. As items are sold, inventory should be re-
duced. To check the inventory balance, it may be necessary to physically count
inventory periodically.
Efficient electronic data interchanges (EDIs) among producers, wholesalers, and retailers
can enable these firms to communicate with one another. Linking the needs of a retailer with
the wholesaler and producer allows for a fast order entry and response. These systems also al-
low the firm to track shipments internationally.9 The linking of firms in a computerized sys-
tem has also been developed by the grocery and pharmaceutical industries using a software
system called efficient consumer response (ECR). Supply chain members work together in
this system to manage demand, distribution, and marketing such that minimum inventory lev-
els are necessary to meet consumer demands. Computerized checkout machines are usually
part of these systems so that linked members are able to anticipate inventory needs before
stock-outs occur.10
Transport mode selection can also be important in inventory management. Some
transportation modes, such as air transport, are very expensive. Rail and truck are
the most often used methods of transportation when a next-day delivery for a customer
is not necessary. Careful management of inventory through a computerized system
and by working with customers and other channel members can minimize transporta-
tion costs. Anticipating customer needs can avoid stock-outs and the unexpected cost of
having to meet a customer’s immediate need by shipping a product by next-day air.
392 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
These mistakes can be costly and are likely to significantly reduce the margins on any
transaction.
Managing Fixed Assets
Fixed assets generally involve long-term commitments and large investments for the new
venture. These fixed assets, such as the equipment appearing in Table 13.3, will have
certain costs related to them. Equipment will require servicing and insurance and will af-
fect utility costs. The equipment also will be depreciated over time, which will be reflected
in the value of the asset over time.
If the entrepreneur cannot afford to buy equipment or fixed assets, leasing could
be considered as an alternative. Leasing may be a good alternative to buying, depending
on the terms of the lease, the type of asset to be leased, and the usage demand on the
asset. For example, leases for automobiles may contain a large down payment and pos-
sible usage or mileage fees that can make the lease much more expensive than a pur-
chase. On the other hand, lease payments represent an expense to the venture and can
be used as a tax deduction. Leases are also valuable for equipment that becomes obso-
lete quickly. The entrepreneur can take a lease for short periods, reducing the long-term
obligation to any specific asset. As with any other make or buy decision, the entrepre-
neur should consider all costs associated with the decision as well as its impact on
cash flows.
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 393
Actual (%) Standard (%)
Net sales $150.0 100.0% 100.0%
Less cost of goods sold 100.0 66.7 60.0
Gross margin 50.0 33.3 40.0
Operating expenses
Selling expenses 11.7 7.8 8.0
Salaries 19.8 13.2 12.0
Advertising 5.2 3.5 4.0
Office supplies 1.9 1.3 1.0
Rent 6.0 4.0 3.0
Utilities 1.3 0.9 1.0
Insurance 0.6 0.4 0.5
Taxes 3.4 2.3 2.0
Interest 3.6 2.4 2.0
Depreciation 9.9 6.6 5.0
Miscellaneous 0.3 0.2 0.2
Total operating expenses $ 66.3 42.5 38.7
Net profit (loss) (13.7) (9.1) 1.3
TABLE 13.3 MPP Plastics Inc., Income Statement, First Quarter Year 1 (000s)
Managing Costs and Profits
Although the cash flow analysis discussed earlier in the chapter can assist the entrepreneur
in assessing and controlling costs, it is also useful to compute the net income for interim
periods during the year. The most effective use of the interim income statement is to estab-
lish cost standards and compare the actual with the budgeted amount for that time period.
Costs are budgeted based on percentages of net sales. These percentages can then be com-
pared with actual percentages and can be assessed over time to ascertain where tighter cost
controls may be necessary.
Table 13.3 compares actual and expected (standard) percentages on MPP Plastic’s in-
come statement for its first quarter of operation. This analysis gives the entrepreneur the
opportunity to manage and control costs before it is too late. Table 13.4 shows that cost of
goods sold is higher than standard. Part of this may result from the initial small purchases
394 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
Assets
Current assets
Cash $ 13,350
Accounts receivable (40% of $60,000 in sales the previous month) 24,000
Merchandise inventory 12,850
Supplies 2,100
Current assets $ 52,300
Fixed assets
Equipment $240,000
Less depreciation 9,900
Total fixed assets $230,100
Total assets 282,400
Liabilities and Owners’ Equity
Current liabilities
Accounts payable (20% of 40 CGS) $ 8,000
Current portion of L-T debt 13,600
Total current liabilities $ 21,600
Long-term liabilities
Notes payable 223,200
Total liabilities 244,800
Owners’ equity
C. Peter’s capital $ 25,000
K. Peter’s capital 25,000
Retained earnings (13,400)
Total owners’ equity $ 37,600
Total liabilities and owners’ equity $282,400
TABLE 14.4 MPP Plastics Inc., Balance Sheet, First Quarter Year 1TABLE 13.4 MPP Plastics Inc., Balance Sheet, First Quarter Year 1
of inventory, which did not provide any quantity discounts. If this is not the case, the entre-
preneur should consider finding other sources or raising prices.
Most of the expenses appear to be reasonably close to standard or expected percentages.
The entrepreneur should assess each item to determine whether these costs can be reduced
or whether it will be necessary to raise prices to ensure future positive profits (although the
effectiveness of raising prices is determined by the market and could substantially lower the
number of items sold and reduce market share). As the venture begins to evolve into the
second and third years of operation, the entrepreneur should also compare current actual
costs with prior incurred costs. For example, in the second year of operation, the entrepre-
neur may find it useful to look back at the selling expenses incurred in the first year of
operation. Such comparisons can be done on a month-to-month basis (i.e., January, year 1, to
January, year 2) or even quarterly or yearly, depending on the volatility of the costs in the
particular business.
Where expenses or costs have been much higher than budgeted, it may be necessary for
the entrepreneur to carefully analyze the account to determine what is the exact cause of
the overrun. For example, utilities represent a single expense account yet may include a
number of specific payments for such things as heat, electricity, gas, and hot water. Thus,
the entrepreneur should retain a running balance of all these payments to ascertain the
cause of an unusually large utility expense. In Table 13.1 we see that the utility expense
was $500, which was $200 over the budgeted amount, or a 67 percent increase. What
caused the increase? Was any particular utility responsible for the overrun, or was it a re-
sult of higher oil costs, which affected all the utility expenses? These questions need to be
resolved before the entrepreneur accepts the results and makes any needed adjustments for
the next period.
Comparisons of the actual and budgeted expenses in the income statement can be mis-
leading for those new ventures where there are multiple products or services. For financial
reporting purposes to shareholders, bankers, or other investors, the income statement would
summarize expenses across all products and services. This information, although helpful to
provide an overview of the success of the venture, does not indicate the marketing cost for
each product, the performance of particular managers in controlling costs, or the most prof-
itable product(s). For example, selling expenses for MPP Plastics Inc. (Table 13.3) were
$11,700. These selling expenses may apply to more than one product, in which case the en-
trepreneur would need to ascertain the amount of selling expense for each product. He or
she may be tempted to prorate the expense across each product, which would not provide a
realistic picture of the relative success of each product. Thus, if MPP Plastics Inc. produced
three different products, the selling expense for each might be assumed to be $3,900 per
product, when the actual selling expenses could be much more or less.
Some products may require more advertising, insurance, administrative time, transporta-
tion, storage, and so on, which could be misleading if the entrepreneur chooses to allocate
these expenses equally across all products. In response to this problem, it is recommended
that the entrepreneur allocate expenses as effectively as possible, by product. Not only is it
important to evaluate these costs across each product, but also it is important to evaluate
them by region, customer, distribution channel, department, and so on. Arbitrary allocation
of costs should be avoided to get a real profit perspective of every product marketed by the
new venture.
Taxes
Don’t forget the tax agent! The entrepreneur will be required to withhold federal and
state taxes for his or her employees. Each month or quarter (depending on the size of the
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 395
payroll), deposits or payments will need to be made to the appropriate agency for funds
withheld from wages. Generally, federal taxes, state taxes, Social Security, and Medicare
are withheld from employees’ salaries and are deposited later. The entrepreneur should be
careful not to use these funds since, if payments are late, there will be high interest and
penalties assessed. In addition to withholding taxes, the new venture may be required to
pay a number of taxes, such as state and federal unemployment taxes, a matching FICA and
Medicare tax, and other business taxes. These taxes will need to be part of any budget since
they will affect cash flow and profits. To determine the exact amount, dates due, and pro-
cedures, the unemployment agency for the federal government and the appropriate state or
the tax department can be contacted.
The federal and state governments will also require the entrepreneur to file end-of-
year returns of the business. If the venture is incorporated, there may be state corpora-
tion taxes to be paid regardless of whether the venture earned a profit. The filing peri-
ods and tax responsibilities will vary for other types of organizations. Chapter 10
provides some insights into the tax responsibilities of proprietorships, partnerships, and
corporations. As stated earlier, use of a tax accountant should also be considered to
avoid any errors and provide advice in handling these expenses. The accountant can also
assist the entrepreneur in planning or budgeting appropriate funds to meet any of these
expenses.
Record Keeping
To support this effort toward financial control, it is helpful to consider using a software
package to enhance the flow of this type of information. With a growing venture it may also
be necessary to enlist the support and services of an accountant or a consultant to support
record keeping and financial control. These external service firms can also help train em-
ployees using the latest and most appropriate technology to meet the needs of the venture.
A system for storing and using customer information becomes vitally important for a
growing firm. Growth typically involves marketing to new customers, and a large influx of
new customers can overwhelm more primitive systems. For example, previously customer
information may have been stored in the memory of the different salespeople. However, as
the sheer number of customers increases, the memory capacity of a salesperson may be ex-
ceeded and important information (and new and existing sales) could be lost.
Not only will a database increase the capacity to hold and process information, it begins
to accumulate bits of knowledge contained within different individuals into an organiza-
tional knowledge that is accessible to everyone within the firm. By building organizational
knowledge the entrepreneur is less dependent upon any one individual. For example, if the
top salesperson were to die or otherwise leave the organization, then a considerable amount
of important information could be lost to the firm. Specifically, customer information
should be retained in a database that includes information on a contact person (including
telephone number and address), as well as important data on the number of units and dol-
lars of business transacted by each account. New accounts should also be designated for
follow-up, such as welcoming customers and providing them with important information
about the company and its products and services.
OVERCOMING PRESSURES ON EXISTING HUMAN RESOURCES
Generally, the new venture does not have the luxury of a human resource department that
can interview, hire, and evaluate employees. Most of these decisions will be the responsi-
bility of the entrepreneur and perhaps one or two other key employees. The process of
396 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
human resource management should not be any different from what was previously dis-
cussed in Chapter 9, where we outline some of the important procedures for preparing job
descriptions and specifications for new employees.
Some entrepreneurs are using professional employer organizations (PEOs). One such
company is TriNet Employer Group Inc., which came to the rescue of Robert Teal,
cofounder of a Silicon Valley start-up, Quinta Corporation. Robert had found it time con-
suming and costly to hire and retain employees. His banker suggested he consider TriNet.
After an assessment of TriNet’s services, he hired the firm to assume most of the human
resource tasks of the new venture. This involved such things as recruiting, hiring, setting
up benefit programs, payroll, and even firing decisions. This has given Robert more time to
devote to other aspects of his growing venture.11
In growing the workforce, entrepreneurs face the decision of what proportion of the
workforce should be permanent and what proportion should be part time, and this decision
involves a number of trade-offs. On the one hand, a greater percentage of part-time work-
ers represents a lower fixed cost, which provides the firm greater flexibility in dealing with
changes in the external environment. On the other hand, personnel instability is more likely
with part-time workers because turnover is typically higher12 and part-time workers are less
committed to the firm because they have less of a personal stake in its performance. There-
fore, building a functional organizational culture is more difficult when the workforce has
a greater proportion of part-time workers.
Regardless of the composition of the firm’s workforce, mistakes will be made in
the selection and hiring of some people. This leads to one of the most difficult decisions
for an entrepreneur to make—the firing of incompetent employees. Having a fair em-
ployee evaluation process is essential in justifying the firing of an employee. Employ-
ees should be given feedback on a regular basis, and any problems should be identified
with a proposed solution agreeable to the employee and the entrepreneur. In this man-
ner, continued problems with the employee that necessitate a firing decision will be well
documented.
An integral part of the firm’s human resource strategy for effectively growing the
business must take into consideration how to maintain the corporate culture despite
the influx of new employees. New employees can be inculcated through early training
sessions that perpetuate the stories and rituals that form the basis of the culture. But
the majority of this responsibility falls on the shoulders of the entrepreneur. The entre-
preneur must be the walking, talking embodiment of the culture, although in cases of
rapid growth the work of the entrepreneur can be complemented by the work of a cul-
tural ambassador. For example, as IKEA expanded internationally, Ingvar Kamprad
took a number of steps to ensure that the corporate culture would still have an impact
in foreign stores. For example, he documented the “IKEA way” and used cultural
ambassadors and training sessions to inculcate new employees of new stores in foreign
locations.
OVERCOMING PRESSURES ON THE MANAGEMENT
OF EMPLOYEES
As the venture grows, it changes. Managing change is often a complex task, one that is
better undertaken with a participative style of management. A participative style of
management is one in which the entrepreneur involves others in the decision-making
process. There are a number of advantages to using a participative management style
when a firm is growing. First, the complexity of growing a business and managing
change increases the information-processing demands on the entrepreneur. Involving
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 397
participative style of
management The
manager involves others
in the decision-making
process
A S S E E N I N E N T R E P R E N E U R M A G A Z I N E
ELEVATOR PITCH FOR eVEST
A wealthy friend has asked you to keep your eye out
for attractive businesses in which she can invest. Your
wealthy friend is very busy, and you only want to
introduce those businesses that are genuinely attrac-
tive. After hearing the following pitch, would you
introduce Scott to your wealthy friend?
Entrepreneur: Scott Jordan, 38, founder and CEO of
Scott eVest LLC.
Company: Clothing and licensing company featuring
a line of vests/jackets with 16 to 22 pockets that
discreetly hold tech gadgets.
Sales Projections for the Current Year: $5 million.
Weighed Down: “I was practicing law and commut-
ing back and forth, carrying the things that
most businesspeople carry with them
nowadays—PDA, cell phone, an expandable
keyboard. Working in a business casual environ-
ment, I would wear sports jackets just to have
the extra pockets to put my stuff in. I started
asking around and found the need for more
pockets was common.”
(Un) orderly Fashion: Now selling through www.
scottevest.com, Jordan was initially wary of
e-commerce when he started the company in
2001. “On the day [the site] went live, a Web
site referred to it, and I got 50,000 hits and
more than 100 orders. I didn’t even have a
manufacturer lined up. I had six samples. I
had to juggle between sending them to
retailers, catalog companies, and Asia for
production pricing. Each one was like gold
to me.”
Apparel Appeal: On exhibit at Disneyland’s Tomor-
rowland, the Scott eVest has appeared on ER
and HBO’s The Wire. “Every other day, I get a
call from a branch of the military, CIA, Secret
Service, INS. I’m told the president got one with
the presidential seal on it.”
Source: Reprinted with permission of Entrepreneur Media, Inc., “This Entrepreneur Will Never Find His Pockets Empty—No Matter How Many of Them He Has,” by April Y. Pennington, February 2003, Entrepreneur magazine: www.entrepreneur.com.
others in the decision-making process is a way of reducing these demands. Second,
highly qualified managers and employees are an important resource for coming up with
new ways to tackle current problems. Third, if employees are involved in the decision-
making process, they are more prepared and more motivated to implement the decided
course of action. Finally, in most cultures employees enjoy the added responsibility of
making decisions and taking initiative. In such a case, a participative management style
will enhance job satisfaction. The following captures some of the activities the entrepre-
neur can do to institute a more participative style of management and successfully grow
the business.
Establish a Team Spirit A team spirit involves the belief by everyone in the organiza- tion that they are “in this thing together” and by working together great things can be
achieved. Small but important actions by the entrepreneur can create this team spirit. For
example, the entrepreneur should establish a “we” spirit—not a “me” spirit—in meetings
and memoranda to employees as well as to other stakeholders.
Communicate with Employees Open and frequent communication with employees builds trust and diminishes fear. Often the fear of change associated with firm growth is
worse than the reality of change, and communication will alleviate some of that anxiety.
Open and frequent communication is a two-way street. The entrepreneur must listen to
what is on the minds of his or her employees. The entrepreneur should solicit suggestions
on how a department or the firm as a whole can more effectively manage growth and
improve its performance.
398
Provide Feedback The entrepreneur should frequently provide feedback to employees. Feedback needs to be constructive such that it enables the employee to improve the quality
of a particular task but does not attack the person and create a fear of failure. The entrepre-
neur should also seek feedback from others. For this feedback to be valuable it must be
honest, which requires a culture that values open and honest communication. An entrepre-
neur confident in his or her own abilities, and with a desire to effectively grow the business,
should be open to, and should encourage, this type of feedback.
Delegate Some Responsibility to Others With an increasing number of tasks for the entrepreneur, he or she cannot be available to make every management decision. Key em-
ployees must be given the flexibility to take the initiative and make decisions without the
fear of failure. This requires the entrepreneur to create a culture that values and rewards
employees for taking initiative and sees failure as a positive attempt rather than a nega-
tive outcome.
Provide Continuous Training for Employees By training employees, the entrepre- neur increases employees’ ability and capacity to improve their own performance at a
particular task and, as a result, improves the chance of successfully growing the firm.
Training should reflect the new management style by involving employees in deciding
upon training session topics.
OVERCOMING PRESSURES ON ENTREPRENEURS’ TIME
Entrepreneurs can always make better use of their time, and the more they strive to do so,
the more it will enrich their venture as well as their personal lives. How does one more ef-
fectively manage time? Time management is the process of improving an individual’s pro-
ductivity through more efficient use of time. The entrepreneur reaps numerous benefits
from effectively managing his or her time, some of which follow.
Increased Productivity Time management helps the entrepreneur determine the tasks of greatest importance and focuses his or her attention on successfully completing those tasks.
This means that there will always be sufficient time to accomplish the most important
things.
Increased Job Satisfaction Increased productivity means that more of the important tasks are successfully completed, which in turn enhances the entrepreneur’s job satisfac-
tion. The entrepreneur is less likely to feel “swamped” and overwhelmed by the increasing
number of tasks generated from firm growth. Getting more important things done and be-
ing more successful in growing and developing the venture will give the entrepreneur more
job satisfaction.
Improved Interpersonal Relationships Although the total time an entrepreneur spends with other individuals in the company may in fact decrease through better time manage-
ment, the time spent will be of a higher quality (quality time), allowing him or her to im-
prove relationships with others inside and outside the firm (including family). Furthermore,
as others in the company experience less time pressure, better results, and greater job sat-
isfaction, relationships within the firm become more harmonious and the firm can build an
esprit de corps.
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 399
time management The
process of improving an
individual’s productivity
through more efficient
use of time
Reduced Time Anxiety and Tension Worry, guilt, and other emotions tend to reduce the entrepreneur’s information-processing capacity, which can lead to less effective as-
sessments and decisions. Effective time management reduces concerns and anxieties,
which “frees up” information processing and improves the quality of the entrepreneur’s
decisions.
Better Health By reducing anxiety and tension and improving productivity, job satisfac- tion, and relationships with others, there is less psychological and physiological strain on
the mind and body, resulting in improved health. Time management can also include sched-
uling time to eat well and exercise. Good health, and the energy that it brings, is vital for an
entrepreneur growing his or her business.
Basic Principles of Time Management
Time management provides a process by which the entrepreneur can become a time saver,
not a time server. This efficient use of time enables the entrepreneur to expand and grow the
venture properly, increase personal and firm productivity, and lessen the encroachment of
the business into his or her private life. An entrepreneur develops good time management
by adhering to six basic principles, as follows.
Principle of Desire The principle of desire requires that the entrepreneur recognize that he or she is a time waster, that time is an important resource, and that there is a need to
change personal attitudes and habits regarding the allocation of time. Therefore, effective
time management depends on the entrepreneur’s willpower, self-discipline, and motivation
to optimize his or her time.
Principle of Effectiveness The principle of effectiveness requires the entrepreneur to focus on the most important issues, even when under pressure. Whenever possible, an
entrepreneur should try to complete each task in a single session, which requires that
enough time be set aside to accomplish that task. This eliminates time wasted in catch-
ing up to where one left off. Although quality is of course important, perfectionism is
not and often leads only to procrastination. The entrepreneur must not spend excessive
time on trying to make a small improvement in one area when time would be better
spent in another area.
Principle of Analysis The principle of analysis provides information to the entrepreneur about how time is currently being allocated, which will also highlight inefficient or inap-
propriate investments of time. The entrepreneur should track his or her time over a two-
week period, using a time sheet with 15-minute intervals, and then analyze how time has
been spent, where time has been wasted, and how these “time traps” can be avoided in the
future (using the other principles). For example, the entrepreneur should not “reinvent the
wheel” in solving similar problems; rather, standardized forms and procedures should
be developed for all recurring events and operations.
Principle of Teamwork Analysis of time will likely reveal to the entrepreneur that only a small amount of time is actually under his or her control—most of his or her time
is taken up by others. The principle of teamwork acknowledges the increasing impor-
tance of delegation for an entrepreneur of a growing firm; that is, the entrepreneur must
require others to take responsibility for the completion of tasks previously undertaken by
400 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
principle of desire A
recognition of the need to
change personal attitudes
and habits regarding the
allocation of time
principle of effectiveness
A focus on the most
important issues
principle of analysis
Understanding how
time is currently being
allocated, and where it is
being inefficiently invested
principle of teamwork
Acknowledgment that
only a small amount of
time is actually under
one’s control and that
most of one’s time is
taken up by others
the entrepreneur. The entrepreneur must also help members of the management team be-
come more sensitive to the time management concept when dealing with others in the
company, especially in dealing with the entrepreneur. Note that managing one’s time
does not mean that the entrepreneur must make himself or herself inaccessible to others;
rather, accessibility is increased because the time that is spent with others can now be
fully focused on them.
Principle of Prioritized Planning The principle of prioritized planning requires the en- trepreneur to categorize his or her tasks by their degree of importance and then to allocate
time to tasks based on this categorization. For example, each day, an entrepreneur should
list all tasks to be accomplished and indicate their degree of importance using a scale from
1 to 3, with 1 being most important, 2 somewhat important, and 3 moderately important. The
entrepreneur can then focus on those tasks of most importance (those with a number 1).
Furthermore, the entrepreneur can prioritize his or her time. For example, some entrepre-
neurs are most efficient in the morning, some during the afternoon, and some at night. The
most efficient period of the day should be used to address the most important issues.
Principle of Reanalysis The principle of reanalysis requires the entrepreneur to period- ically review his or her time management process. In this reanalysis, entrepreneurs can of-
ten improve their time management by investigating more systemic (systemwide) issues
and revisiting potential opportunities for delegation. For example, the clerical staff and
close assistants should be well trained and encouraged to take the initiative, including sort-
ing correspondence and returning phone calls based on importance, dealing with issues of
low importance to the entrepreneur, and instituting routines such as standard letters for the
entrepreneur to sign, a daily diary, reminder lists, operations board, and an efficient “pend-
ing” file. All meetings should be analyzed to ensure that they are being run effectively.
If not, the person who runs the meeting should be trained to do so. The purpose of all
committees should also be reanalyzed to ensure that they still provide value.
IMPLICATIONS OF FIRM GROWTH FOR THE ENTREPRENEUR
Firm growth introduces a number of managerial challenges for the entrepreneur; challenges
with which they may be unfamiliar and ill equipped to deal. In the preceding, we have offered
a number of tools that entrepreneurs can develop to more effectively cope with, and man-
age, the growth process. Some entrepreneurs lack the ability to make the transition to this
more professional management approach. Another group of entrepreneurs may be able but
unwilling to focus their attention on achieving those tasks necessary to successfully achieve
firm growth.
For example, Pearce Jones, founder and president of Design Edge, controlled growth by
putting a halt on all growth for one full year. The company realized that if it did not get control
over growth, serious problems were likely. At this decision point, the company had quadrupled
its number of employees and had invested in a new building. Even though each new employee
was contributing an increase of $150,000 in sales, the margins were small. The additional debt
from the new facility and the additional costs for employees led to this abrupt decision to cease
hiring, deactivate marketing and sales, refuse any new business, and basically focus only on ex-
isting customers. Although Pearce admits this decision was emotionally painful, it led to dra-
matic changes as profits actually doubled and no employee turnover was experienced.13
Another example of a reluctance to grow is illustrated by this quote from the founder
and CEO of Southwest Airlines (at the time), Herb Kelleher: “Southwest has had more op-
portunities for growth than it has airplanes. Yet, unlike other airlines, it has avoided the trap
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 401
principle of reanalysis
Periodic review of one’s
time management process
principle of prioritized
planning Categorization
of tasks by their degree of
importance and then the
allocation of time to tasks
based on this categorization
of growing beyond its means. . . . Employees just don’t seem to be enamored of the idea
that bigger is better.”14 Growth may not be pursued because there is a belief that in doing
so firm profitability and/or the firm’s chances of survival will be sacrificed.
Even if there is a belief that the pursuit of growth will improve firm performance and en-
hance personal wealth, some entrepreneurs will still avoid growing their business. These
entrepreneurs are not necessarily motivated by financial gain. Consider an individual who
chooses to start a business because she or he is tired of being controlled by others—this
person wants the independence that comes from being one’s own boss. Growth may not be
an attractive option for this entrepreneur, because acquiring the necessary resources for
growth will mean selling equity (for example, to a venture capitalist) or raising debt capi-
tal (for example, from a bank). Both sources of resources place limits on the entrepreneur’s
ability to make strategic decisions for the firm. In this case the entrepreneur may prefer to
have full ownership, be debt free, and remain small.
Evan Douglas is a professor of entrepreneurship and dean of the University of the
Sunshine Coast in Australia. His dream is to create and manage a business that rents a small
number of yachts to tourists. The office (preferably a shack) would be on the beach some-
where on the Great Barrier Reef. When he achieves this dream, the last thing that he wants
to do is to grow the business such that his task moves to one of professional manager and
away from the task of “beach bum.” His dream business is an example of a lifestyle busi-
ness. Growth can be perceived by such lifestyle entrepreneurs as threatening the very rea-
son for becoming an entrepreneur in the first place.
A Categorization of Entrepreneurs and Their Firms’ Growth
Based on the preceding arguments, Figure 13.4 categorizes entrepreneurs in terms of two
dimensions: The first dimension represents an entrepreneur’s abilities to successfully make
the transition to more professional management practices, and the second dimension repre-
sents an entrepreneur’s growth aspirations. Depending on the entrepreneur’s position along
these two dimensions, four types of firm growth outcomes are identified.
Actual Growth of the Firm Entrepreneurs in the upper-right quadrant possess both the necessary abilities to make the transition to a more professional management approach and
402 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
FIGURE 13.4 Four Types of Entrepreneurs* and Firm Growth
Unused potential
Actual growth
Little potential
Constrained
High
Low
No Yes
Entrepreneur's growth aspirations
Entrepreneur's
ability to
institute
professional
management
practices
*Based on ability to make a transition to professional management and aspiration.
Source: Adapted from J. Wiklund and D. A. Shepherd, “Aspiring for and Achieving Growth: The Moderating Role of Resources
and Opportunities,” Journal of Management Studies (2003), vol. 40, no. 8, pp. 1919–42.
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 403
the aspiration to grow their businesses. These are the entrepreneurs who are the most likely
to achieve firm growth.
Unused Potential for Growth Entrepreneurs in the upper-left quadrant possess the nec-
essary abilities for transition but do not aspire to do so. These are the entrepreneurs of firms
that have unused potential. A relatively large proportion of all lifestyle firms are repre-
sented by this classification.
Constrained Growth Entrepreneurs in the lower-right quadrant aspire to grow their
businesses but do not possess sufficient abilities to successfully satisfy this aspiration.
These entrepreneurs are most likely to be frustrated by the firm’s lack of growth and are
in the most danger of failure because the firm may be pushed toward the pursuit of growth
opportunities and beyond the entrepreneur’s ability to cope. However, the entrepreneur
might replace himself or herself as the CEO with a professional manager. This will allow
the aspiration to be fulfilled (move to the upper-right quadrant). This does not necessarily
mean that the entrepreneur will leave the business; rather, the entrepreneur might manage
R&D, new products, and/or new markets where his or her strengths are highly valued and
enhance rather than constrain the growth of the firm.
Little Potential for Firm Growth Entrepreneurs in the lower-left quadrant possess nei-
ther the necessary abilities to make the transition to a more professional management ap-
proach nor the aspirations to grow their businesses. These businesses have little potential
for growth, and due to the limited abilities of the entrepreneur to manage growth, these
firms may actually perform better if they remain at a smaller scale.
Although the abilities of the entrepreneur and the existing resources of the firm can
limit the effective pursuit of growth opportunities, the resources necessary for growth
can be acquired externally—we refer to these sources as external growth mechanisms.
These external mechanisms for growth, which include joint ventures, acquisitions,
mergers, and so on, each offer a number of different advantages and disadvantages in
providing the resources for effective growth, but all require the entrepreneur to negoti-
ate a new relationship. For example, negotiation is a critical element to forming a joint
venture.
Chapter 14 introduces the basic concepts and skills required for an entrepreneur to ne-
gotiate the best agreement with these potential growth partners—an agreement that maxi-
mizes the entrepreneur’s interests. It then describes each external growth mechanism and
its advantages and disadvantages.
IN REVIEW
S U M M A R Y
This chapter provides a model that suggests where an entrepreneur can look for (or
create) opportunities to grow his or her business—opportunities that can provide a
basis for a sustainable competitive advantage. The relevant growth strategies are:
(1) penetration strategies—encouraging existing customers to buy more of the firm’s
products, (2) market development strategies—selling the firm’s existing products to
404 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
new groups of customers, (3) product development strategies—developing and selling
new products to people who are already purchasing the firm’s existing products, and
(4) diversification strategies—selling a new product to a new market. Most of these
growth strategies can lead to a competitive advantage because they capitalize on
some aspect of the entrepreneur’s, and the firm’s, knowledge base.
Business growth has important implications for the economy, the firm, and the en-
trepreneur. High-growth businesses can stimulate an economy, improve its interna-
tional competitiveness, and reduce unemployment. Even modest levels of growth by
small businesses can have a dramatic impact on an economy because the population
of small firms is so large. It is also important to acknowledge that growth strategies
often involve the entrepreneur’s taking some risk, which means that sometimes they
will not succeed. A failed attempt provides information for that entrepreneur and
other entrepreneurs, and learning from failure has an important positive impact on
an economy.
Because growth makes a firm bigger, the firm begins to benefit from the advan-
tages of size but also introduces a number of managerial challenges. It puts pressure
on existing financial resources, human resources, the management of employees, and
the entrepreneur’s time. There are actions the entrepreneur can take to better manage
these pressures and more effectively grow his or her business.
To overcome pressures on existing financial resources, the entrepreneur should
apply more effective financial control, record keeping, and inventory management
techniques. To overcome pressures on existing human resources, the entrepreneur
must address the question of what proportion of the workforce should be permanent
and what proportion should be part time, should be prepared to fire incompetent
employees, and, at the same time, should build and maintain a functional organiza-
tional culture. It is important that the entrepreneur interact with employees, so as to
establish a team spirit; effect open and frequent communication to build trust and
provide constructive feedback; provide key employees with the flexibility to take the
initiative and make decisions without the fear of failure; and provide continuous
training for employees.
Entrepreneurs can always make better use of their time, and the more they strive to
do so, the more it will enrich their venture as well as their personal lives. Better use of
time can lead to increased productivity, increased job satisfaction, improved interper-
sonal relationships with people inside and outside the business, reduced anxiety and
tension, and possibly even better health. Efficient use of time enables the entrepre-
neur to expand and grow the venture properly, increase personal and firm productiv-
ity, and lessen the encroachment of the business into his or her private life. Effective
time management requires adherence to six basic principles: desire, effectiveness,
analysis, teamwork, prioritized planning, and reanalysis.
Some entrepreneurs lack the ability to make the transition to this more profes-
sional management approach, while others may be unwilling to do so. Entrepreneurs
who possess both the necessary abilities and the aspiration are most likely to achieve
firm growth. Entrepreneurs who possess the necessary abilities but do not aspire to
do so will manage firms that have unused potential and/or lifestyle firms. Entrepre-
neurs who aspire to grow their business but do not possess sufficient abilities are
most likely to be frustrated by the firm’s lack of growth and are in the most danger
of business failure unless the entrepreneur replaces himself or herself. Finally, entre-
preneurs who possess neither the necessary abilities nor the aspirations to grow their
businesses may run businesses that provide a sufficient income if the businesses
remain at a smaller scale.
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 405
R E S E A R C H T A S K S
1. What different software packages are available to help entrepreneurs with their
different record-keeping and control activities? How effective do you believe
software can be for each of these tasks?
2. Which are the three fastest-growing companies in the country? What
opportunities have they pursued to achieve this level of growth? What
growth mechanism have they used (internal, joint venture, acquisitions,
franchising, etc.)?
3. Use research to come up with three examples of founding entrepreneurs who
stepped aside once their firms had grown to a certain size and brought in
“professional managers.” In each case, what relationship did the entrepreneur
continue to have with the firm after the transition? Provide an example of a
founding entrepreneur being forced out of the position of CEO to be replaced by
a professional manager.
4. Keep a record of how you use your time by documenting what you are doing
every 15 minutes over a two-day period. Then analyze these records to determine
where you waste time and what you could do to eliminate (or minimize) these
time wasters.
C L A S S D I S C U S S I O N
1. To what extent does the use of software help and hinder the entrepreneur’s
ability to perform the important tasks of record keeping and financial
control?
2. The firm needs to make sales. What is the best way to motivate salespeople
to make more sales and improve the performance of the firm? How would
you effectively monitor their performance under the proposed motivation
system? What are the pros and cons of your motivation and monitoring
system?
3. Categorize those people in the class who you believe would be well suited for
starting a business and managing initial growth but would be less effective at
conducting the professional management tasks when the firm became larger.
What can they do to improve their ability to successfully make the transition with
the firm? Categorize those people in your class who you believe would be well
suited to the role of professionally managing a larger (more established) firm but
less effective at starting a firm and managing early growth. What can they do to
improve their ability to manage a firm earlier in its development? Is there anybody
in the class (except maybe yourself) who you believe would be equally effective at
both tasks?
4. Think of a company that produces one product and sells it to one group of
customers (or make one up). Advise the entrepreneur of the many opportunities
there are for growth—opportunities for penetration strategies, market
development strategies, product development strategies, and diversification
strategies.
5. Are you a time waster or a time server? What time management techniques do
you use? How can you better manage your time?
�
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406 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
S E L E C T E D R E A D I N G S
Baum, J. Robert; Edwin A. Locke; and Ken G. Smith. (2001). A Multidimensional Model of Venture Growth. Academy of Management Journal, vol. 44, no. 2, pp. 292–304.
The authors formed an integrated model of venture growth. CEOs’ specific compe- tencies and motivations and firm competitive strategies were found to be direct predictors of venture growth. CEOs’ traits and general competencies and the envi- ronment had significant indirect effects.
Chrisman, James; Ed McMullan; and Jeremy Hall. (2005). The Influence of Guided Preparation on the Long-Term Performance of New Ventures. Journal of Business Ven- turing, vol. 20, no. 6, pp. 769–91.
In this article the authors further develop a theory of guided preparation and new venture performance and test its fundamental relationships on a sample of 159 new ventures that had received outsider assistance 5 to 9 years earlier and had been in business for 3 to 8 years. The results suggest that the long-term growth of the ventures since start-up is significantly related to guided preparation. However, a curvilinear model, rather than a linear model, was found to best capture the relationships of interest.
Danneels, Erwin. (2002). The Dynamics of Product Innovation and Firm Competences. Strategic Management Journal, vol. 23, no. 12, pp. 1095–1122.
This study examines how product innovation contributes to the renewal of the firm through its dynamic and reciprocal relation with the firm’s competences.
Davidsson, Per; Bruce Kirchhoff; Abdulnasser Hatemi-J.; and Helena Gustavsson. (2002). Empirical Analysis of Business Growth Factors Using Swedish Data. Journal of Small Business Management, vol. 40, no. 4, pp. 332–50.
Although business growth differs among industrial sectors, youth, ownership inde- pendence, and small size are found to be major factors that underlie growth across all industries.
Delmar, Frédéric; Per Davidsson; and William B. Gartner. (2003). Arriving at the High- Growth Firm. Journal of Business Venturing, vol. 18, no. 2, pp. 189–217.
Using 19 different measures of firm growth (such as relative and absolute sales growth, relative and absolute employee growth, organic growth versus acquisition growth, and the regularity and volatility of growth rates over the 10-year period), the authors identified seven different types of firm growth patterns. These patterns were related to firm age and size as well as industry affiliation. Implications for research and practice are offered.
Park, Choelsoon. (2003). Prior Performance Characteristics of Related and Unrelated Acquirers. Strategic Management Journal, vol. 24, no. 5, pp. 471–81.
This paper focuses on a single event of a large acquisition, which enables the au- thors to better identify the sequential relationships between prior firm profitability, prior industry profitability, and subsequent acquisition strategies. By doing so, this paper makes clearer the causal relationships between firm profitability, industry profitability, and acquisition strategies.
Penrose, Edith. (1959). The Theory of the Growth of the Business. Oxford: Oxford Uni- versity Press.
Pettus, Michael L. (2001). The Resource-Based View as a Developmental Growth Process: Evidence from the Deregulated Trucking Industry. Academy of Management Journal, vol. 44, no. 4, pp. 878–97.
This paper develops a resource-based perspective for predicting the sequencing of a firm’s resources that best provides for firm growth. The sequencing that generated
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 407
the highest firm growth combines a Penrosian (1959) perspective with the more recent resource-based literature.
Qian, Gongming. (2002). Multinationality, Product Diversification, and Profitability of Emerging U.S. Small- and Medium-Sized Enterprises. Journal of Business Venturing, vol. 17, no. 6, pp. 611–34.
This paper examines empirically individual and joint effects of multinationality and product diversification on profit performance for a sample of emerging small- and medium-sized enterprises (SMEs). The results suggest a curvilinear relationship be- tween them: that is, they are positively related up to a point, after which a further increase in multinationality and product diversification was associated with declin- ing performance.
Reuber, Rebecca A.; and Eileen Fischer. (2002). Foreign Sales and Small Firm Growth: The Moderating Role of the Management Team. Entrepreneurship: Theory & Practice, vol. 27, no. 1, pp. 29–46.
The premise of this article is that the management team of a small firm plays a key role in internationalization outcomes. Findings indicate that the behavioral integra- tion of the management team moderates the relationship between foreign sales growth and overall firm growth.
Rugman, Alan M.; and Alan Verbeke. (2002). Edith Penrose’s Contribution to the Resource-Based View of Strategic Management. Strategic Management Journal, vol. 28, no. 8, pp. 769–81.
Edith Penrose’s 1959 book, The Theory of the Growth of the Firm, is considered by many scholars in the strategy field to be the seminal work that provided the intel- lectual foundations for the modern, resource-based theory of the firm. However, the present paper suggests that Penrose’s direct or intended contribution to resource-based thinking has been misinterpreted.
Schulze, William S., Michael H. Lubatkin; and Richard N. Dino. (2003). A Social Capi- tal Model of High-Growth Ventures. Academy of Management Journal, vol. 46, no. 3, pp. 374–85.
In this article the authors use social capital theory to explain how human and social capital affect a venture’s ability to accumulate financial capital during its growth stages and its performance during the two-year period after going public. They found indications that social capital leverages the productivity of a venture’s resource base and provides the venture with a durable source of competitive advantage.
Shepherd, Dean A.; and Johan Wiklund (2009). Are We Comparing Apples with Apples or Apples with Oranges? Appropriateness of Knowledge Accumulation across Growth Studies. Entrepreneurship: Theory & Practice, vol. 33, no. 1, pp. 105–23.
In this paper the authors conduct analyses on all Swedish firms incorporated during the 1994 to 1998 period (68,830 firms) and track their growth (or demise) over their first 6 years of existence. Although they typically find low shared variance between different growth measures, there is variability such that some measures demon- strate high and/or moderate concurrent validity. These findings have implications for how we delineate the boundaries of firm growth research and accumulate knowledge—when we are comparing apples with apples and when we are compar- ing apples with oranges. [Abstract from author.]
Wiklund, Johan; and Dean A. Shepherd. (2003). Aspiring for, and Achieving Growth: The Moderating Role of Resources and Opportunities. Journal of Management Studies, vol. 40, no. 8, pp. 1919–42.
In this article, the authors find that small-business managers’ aspirations to expand their business activities are positively related to actual growth. However, the relationship between aspirations and growth appears more complex than stated.
408 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
Education, experience, and environmental dynamism magnify the effect of growth aspirations on the realization of growth.
Wiklund, Johan; Per Davidsson; and Frédéric Delmar. (2003). What Do They Think and Feel about Growth? An Expectancy-Value Approach to Small Business Managers’ Atti- tudes toward Growth. Entrepreneurship: Theory & Practice, vol. 27, no. 3, pp. 247–71.
This study focuses on small-business managers’ motivation to expand their firms. The results suggest that concern for employee well-being comes out strongly in de- termining the overall attitude toward growth. The authors interpret this as reflect- ing a concern that the positive atmosphere of the small organization may be lost in growth, which might cause recurrent conflict for small-business managers when deciding about the future route for their firms.
Wiklund, Johan; Holger Patzelt; and Dean A. Shepherd. (2009). Building an Integrative Model of Small Business Growth. Small Business Economics, vol. 32, no. 4, pp. 351–74.
The purpose of this article is to develop an integrative model of small-business growth that is both broad in scope and parsimonious in nature. Based on an analysis of data from 413 small businesses, the authors derive a set of propositions that sug- gest how entrepreneurial orientation, environmental characteristics, firm resources, and managers’ personal attitudes directly and/or indirectly influence the growth of small businesses. [Abstract from authors.]
Zimmerman, Monica A.; and Gerald J. Zeitz. (2002). Beyond Survival: Achieving New Venture Growth by Building Legitimacy. Academy of Management Review, vol. 27, no. 3, pp. 414–32.
In this article the authors argue that (1) legitimacy is an important resource for gain- ing other resources, (2) such resources are crucial for new venture growth, and (3) legitimacy can be enhanced by the strategic actions of new ventures. They review the impact of legitimacy on new ventures as well as sources of legitimacy for new ventures, present strategies for new ventures to acquire legitimacy, explore the process of building legitimacy in the new venture, and examine the concept of the legitimacy threshold.
E N D N O T E S
1. See, “PowerBar Reaps Bounty with New Harvest Bar; Crunched for Time, Americans Devour Energy Bars,” Business Wire (August 4, 1998), p. 1; C. Adams, “A Lesson from PowerBar’s Slow Start to Diversity,” The Wall Street Journal (June 14, 1999), p. 4; and “The PowerBar Story,” Company Web site www.powerbar.com.
2. H. I. Ansoff, Corporate Strategy: An Analytical Approach to Business Policy for Growth and Expansion (New York: McGraw-Hill, 1965).
3. Martha E. Mangelsdorf, “Growth Companies,” Inc. (May 21, 1996), pp. 85–92. 4. P. Davidsson, L. Lindmark, and C. Olofsson, Dynamiken i svenskt näringsliv
(Business Dynamics in Sweden) (Lund, Sweden: Studentlitteratur, 1994). 5. J. Wiklund, Small Firm Growth and Performance: Entrepreneurship and
Beyond, Doctoral Dissertation (Jönköping: Jönköping International Business School, 1998).
6. R. Gunther McGrath, “Falling Forward: Real Options Reasoning and Entrepre- neurial Failure,” Academy of Management Review 24 (1999), pp. 13–30; F. A. Hayek, “The Use of Knowledge in Society,” American Economic Review 5 (1945), pp. 519–30.
7. E. Pofeldt, “Collect Calls,” Success (March 1998), pp. 22–23. 8. J. Fraser, “Hidden Cash,” Inc. (February 1991), pp. 81–82.
C H A P T E R 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH 409
9. Ivan T. Hoffman, “Current Trends in Small Package Shipping,” International Business (March 1994), p. 33.
10. “Unlocking the Secrets of ECR,” Progressive Grocer (January 1994), p. 3. 11. “You Do the Work, They Do the Paperwork,” BusinessWeek (November 17,
1997), p. 54. 12. K. Carley, “Organizational Learning and Personnel Turnover,” Organization
Science 3, no. 1 (1992), pp. 20–47. 13. I. Mochari, “Too Much, Too Soon,” Inc. (November 1999), p. 119. 14. M. A. Hitt, R. D. Ireland, and R. E. Hoskisson, Strategic Management: Competitive-
ness and Globalization, 3rd ed. (London: South-Western College Publishing, 1999).
1
To understand franchising from the perspective of both the entrepreneur looking to reduce the risk of new entry and the entrepreneur looking
for a way to grow his or her business.
2
To understand how joint ventures can help an entrepreneur grow his or her business and acknowledge the challenges of finding, and maintaining,
an effective joint venture relationship.
3
To be aware of the pros and cons of using acquisitions to grow a business and to know what to look for in an acquisition candidate.
4
To understand the possibilities of achieving growth through mergers and leveraged buyouts and the challenges associated with each.
5
To understand the tasks of negotiation and develop the skills to more effectively conduct these tasks.
14 A C C E S S I N G R E S O U R C E S F O R G R O W T H
F R O M E X T E R N A L S O U R C E S
L E A R N I N G O B J E C T I V E S
411
O P E N I N G P R O F I L E
BILL GROSS
How does a start-up company take advantage of the seemingly endless opportunities
of the Internet by using the creative talents of one person and then letting other se-
lected entrepreneurs take over the responsibility of running these businesses? It
sounds like a repeat of history when Thomas Edison made invention a business. But the
new kid on the block is Bill Gross, whose vision is to grow
his Idealab by nurturing and monitoring other Internet
businesses that have resulted because of his ingenuity. He
refers to Idealab as Internet start-ups in a box. Basically the
concept is simple. Bill comes up with an idea for an Internet start-up. He locates some-
one, either a former executive or even an engineering student, who he thinks is right
for the job. That person is then given the reins to start this venture all under the roof
of an incubator-like operation, where Bill provides the structure and services necessary
to make these start-ups rapidly grow into successful enterprises.
Bill describes Idealab as a combination of incubator, venture capitalist, and creative
think tank. Like an incubator, it provides shared space and administrative services, it of-
fers seed financing for a minority equity position (up to 49 percent), and it uses every-
one to brainstorm on the most opportune technology applications. Started in 1996 in
Pasadena, California, to date the company has created 30 Internet ventures, all at var-
ious stages of development. Each idea came from Gross or one of his Idealab staff man-
agers. For each firm a CEO was found and hired using Bill’s networking skills in the
Internet industry and at Caltech, his alma mater. Then the core expert staff becomes
involved to get these ventures up and running as quickly as possible. This involves de-
veloping the technology, conducting marketing research, preparing a business plan,
hiring management, launching the venture, and finally either going public or selling
the business. The seed financing that Idealab provides to these start-ups does not ex-
ceed $250,000. Bill believes that Internet start-ups do not need large amounts of capi-
tal to get started but, more importantly, do need knowledge, intelligence, and speed.
Knowledge and intelligence are provided by Bill and the Idealab’s staff experts, and
speed focuses on the ability to quickly grow a start-up, but with few mistakes. Accord-
ing to Bill, these two elements are much more important in the successful launch and
growth of an Internet company than money.
www.idealab.com
412 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
Bill Gross personifies the real meaning of an entrepreneur. He probably holds
the unique distinction in the field of entrepreneurship of not only starting many
businesses but also turning all of them into successful enterprises. As an enterprising
12-year-old he noticed that the corner drugstore was selling candy at 9 cents, and at
the Sav-On nearby it was selling for 7 cents. He quickly figured out that with no over-
head he could make an easy profit on the price spread. Bill then moved on to his next
successful enterprise by placing ads in Popular Mechanics, where he sold $25,000 worth
of solar devices and plans. The proceeds from this effort were used to finance his fresh-
man year’s tuition at Caltech. While at Caltech he proceeded to launch GNP Inc., a
stereo equipment maker. This enterprise not only was very successful but was recog-
nized as one of Inc. magazine’s top 500 growth ventures in 1982 and 1985. His next en-
terprise was created when Bill and his brother found a way to make Lotus 1-2-3 obey
simple commands. Mitch Kapor, the founder of Lotus, was impressed with their soft-
ware and purchased their business for $10 million.
The success streak continued with the launch of Knowledge Adventure in 1991. This
venture developed and marketed educational software and was considered to be his
most successful venture to date. He sold the business in 1997 for $100 million. Idealab
actually was created in 1996 when Bill was stepping down from Knowledge Adventure
and negotiating the sale.
A sample of some of the companies launched by Idealab includes CitySearch, which
competes with Microsoft and provides online services for urban communities; Entertain-
Net, an Internet broadcaster that provides news and related information; and
Answer.com, a Web site that will answer any question you might have and which has al-
ready been acquired by another company. Last year Bill expanded his operations into
Silicon Valley. He wanted to be close to the action and take advantage of Idealab’s abil-
ity to quickly transform some of these Internet opportunities into successful ventures.
Growing these start-ups is a challenge to Bill Gross, and although there is high
risk in the Internet industry, Bill feels that Idealab will continue to stay focused on
its mission.1
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USING EXTERNAL PARTIES TO HELP GROW A BUSINESS
In Chapter 3, we introduced franchising as a means of new entry that can reduce the risk
of downside loss for the franchisee. Franchising is also an alternative means by which an
entrepreneur may expand his or her business by having others pay for the use of the
name, process, product, service, and so on. Using franchising as a growth mechanism is
the primary focus of this chapter. Given the importance of franchising for both new en-
try and growth, the first section explores franchising from the perspective of the entrepre-
neur looking to use franchising to reduce the risks of new entry and from the perspective
of the entrepreneur looking to use franchising as a way to grow his or her business. The
second section explores other external mechanisms for growing a business, namely, joint
ventures, acquisitions, and mergers. Finally, this chapter provides some useful advice for
those entrepreneurs who need to negotiate to obtain the human and financial resources
necessary to fuel business growth.
FRANCHISING
Franchising is “an arrangement whereby the manufacturer or sole distributor of a trade-
marked product or service gives exclusive rights of local distribution to independent retailers
in return for their payment of royalties and conformance to standardized operating proce-
dures.”2 The person offering the franchise is known as the franchisor. The franchisee is the
person who purchases the franchise and is given the opportunity to enter a new business with
a better chance to succeed than if he or she were to start a new business from scratch.
Advantages of Franchising—to the Franchisee
One of the most important advantages of buying a franchise is that the entrepreneur does
not have to incur all the risks associated with creating a new business. Table 14.1 summa-
rizes the important advantages of a franchise. Typically, the areas that entrepreneurs have
problems with in starting a new venture are product acceptance, management expertise,
meeting capital requirements, knowledge of the market, and operating and structural con-
trols. In franchising, the risks associated with each are minimized through the franchise re-
lationship, as discussed in the following.
Product Acceptance The franchisee usually enters into a business that has an accepted name, product, or service. In the case of Subway, any person buying a franchise will be us-
ing the Subway name, which is well known and established throughout the United States.
The franchisee does not have to spend resources trying to establish the credibility of the
business. That credibility already exists based on the years the franchise has existed. Sub-
way has also spent millions of dollars in advertising, thus building a favorable image of the
products and services offered. An entrepreneur who tries to start a sandwich shop would be
unknown to the potential customers and would require significant effort and resources to
build credibility and a reputation in the market.
Management Expertise Another important advantage to the franchisee is the manage- rial assistance provided by the franchisor. Each new franchisee is often required to take a
training program on all aspects of operating the franchise. This training could include
classes in accounting, personnel management, marketing, and production. McDonald’s, for
C H A P T E R 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES 413
franchising An
arrangement whereby a
franchisor gives exclusive
rights of local distribution
to a franchisee in return
for payment of royalties
and conformance to
standardized operating
procedures
franchisor The person
offering the franchise
franchisee The person
who purchases the
franchise
TABLE 14.1 What You May Buy in a Franchise
1. A product or service with an established market and favorable image.
2. A patented formula or design.
3. Trade names or trademarks.
4. A financial management system for controlling the financial revenue.
5. Managerial advice from experts in the field.
6. Economies of scale for advertising and purchasing.
7. Head office services.
8. A tested business concept.
example, requires all its franchisees to spend time at its school, where everyone takes
classes in these areas. In addition, some franchisors require their new franchisees to
actually work with an existing franchise owner or at a company-owned store or facility
to get on-the-job training. Once the franchise has been started, most franchisors will
offer managerial assistance on the basis of need. Toll-free numbers are also available so
that the franchisee can ask questions anytime. Local offices for the larger franchises
continually visit the local franchisees to offer advice and keep owners informed of new
developments.
The training and education offered is actually an important criterion that the entrepre-
neur should consider in evaluating any franchise opportunity. If the assistance in start-up is
not good, the entrepreneur should probably look elsewhere for opportunities unless he or
she already has extensive experience in the field.
Capital Requirements As we’ve seen in previous chapters, starting a new venture can be costly in terms of both time and money. The franchise offers an opportunity to
start a new venture with up-front support that could save the entrepreneur significant
time and possibly capital. Some franchisors conduct location analysis and market re-
search of the area that might include an assessment of traffic, demographics, business
conditions, and competition. In some cases, the franchisor will also finance the initial
investment to start the franchise operation. The initial capital required to purchase a
franchise generally reflects a fee for the franchise, construction costs, and the purchase
of equipment.
The layout of the facility, control of stock and inventory, and the potential buying power
of the entire franchise operation can save the entrepreneur significant funds. The size of the
parent company can be advantageous in the purchase of health care and business insurance,
since the entrepreneur would be considered a participant in the entire franchise organiza-
tion. Savings in start-up are also reflected in the pooling of monies by individual fran-
chisees for advertising and sales promotion. The contribution by each franchisee is usually
a function of the volume and the number of franchises owned. This allows advertising on
both a local and a national scale to enhance the image and credibility of the business, some-
thing that would be impossible for a single operation.
Knowledge of the Market Any established franchise business offers the entrepreneur years of experience in the business and knowledge of the market. This knowledge is usu-
ally reflected in a plan offered to the franchisee that details the profile of the target cus-
tomer and the strategies that should be implemented once the operation has begun. This is
particularly important because of regional and local differences in markets. Competition,
media effectiveness, and tastes can vary widely from one market to another. Given their
experience, franchisors can provide advice and assistance in accommodating any of these
differences.
Most franchisors will be constantly evaluating market conditions and determining the
most effective strategies to be communicated to the franchisees. Newsletters and other pub-
lications that reflect new ideas and developments in the overall market are continually sent
to franchisees.
Operating and Structural Controls Two problems that many entrepreneurs have in starting a new venture are maintaining quality control of products and services and estab-
lishing effective managerial controls. The franchisor, particularly in the food business, will
identify suppliers that meet the quality standards established. In some instances, the sup-
plies are actually provided by the franchisor. Standardization in the supplies, products, and
414 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
services provided helps ensure that the entrepreneur will maintain quality standards that are
so important. Standardization also supports a consistent image on which the franchise busi-
ness depends for expansion.
Administrative controls usually involve financial decisions relating to costs, inventory,
and cash flow, and personnel issues such as criteria for hiring and firing, scheduling, and
training to ensure consistent service to the customer. These controls will usually be outlined
in a manual supplied to the franchisee upon completion of the franchise deal.
Although all the preceding are advantages to the franchisee, they also represent impor-
tant strategic considerations for an entrepreneur who is considering growing the business
by selling franchises. Since there are so many franchise options for an entrepreneur, the
franchisor will need to offer all the preceding services to succeed in the sale of franchises.
One of the reasons for the success of such franchises as McDonald’s, Burger King, KFC,
Boston Market, Subway, Midas, Jiffy Lube, Holiday Inn, Mail Boxes Etc., and Merry
Maids is that all these firms have established an excellent franchise system that effectively
provides the necessary services to the franchisee.
Advantages of Franchising—to the Franchisor
The advantages a franchisor gains through franchising are related to expansion risk, capi-
tal requirements, and cost advantages that result from extensive buying power. Consider the
success of the Subway chain. Clearly, Fred DeLuca would not have been able to achieve
the size and scope of his business without franchising it. To use franchising as an expansion
method, the franchisor must have established value and credibility that someone else is
willing to buy.
Expansion Risk The most obvious advantage of franchising for an entrepreneur is that it allows the venture to expand quickly using little capital. This advantage is signif-
icant when we reflect on the problems and issues that an entrepreneur faces in trying to
manage and grow a new venture (see Chapter 13). A franchisor can expand a business
nationally and even internationally by authorizing and selling franchises in selected lo-
cations. The capital necessary for this expansion is much less than it would be without
franchising. Just think of the capital that DeLuca would require to build 8,300 Subway
sandwich shops.
The value of the franchise depends on the to-date track record of the franchisor and
on the services offered to the entrepreneur or franchisee. Subway’s low franchise fee has
enhanced expansion opportunities, as more people can afford it.
Operating a franchised business requires fewer employees than a nonfranchised busi-
ness. Headquarters and regional offices can be lightly staffed, primarily to support the
needs of the franchisees. This allows the franchisor to maintain low payrolls and minimizes
personnel issues and problems.
Cost Advantages The mere size of a franchised company offers many advantages to the franchisees. The franchisor can purchase supplies in large quantities, thus achieving
economies of scale that would not have been possible otherwise. Many franchise busi-
nesses produce parts, accessories, packaging, and raw materials in large quantities, and
then in turn sell these to the franchisees. Franchisees are usually required to purchase
these items as part of the franchise agreement, and they usually benefit from lower
prices.
One of the biggest cost advantages of franchising a business is the ability to commit
larger sums of money to advertising. Each franchisee contributes a percentage of sales
C H A P T E R 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES 415
416
A S S E E N I N BUSINESSWEEK
VENTURE CAPITAL’S FAVORITE STARTUPS
Over the past four quarters—even as the depths of the na-
tion’s economic problems became evident—venture capital-
ists invested more than $7 billion in seed and early-stage
companies in more than 1,400 deals, according to the
MoneyTree Report from the National Venture Capital Assn.
That’s more money raised by young companies than in any
calendar year since the dot-com bubble burst in 2001.
In the largest deals of the past year, venture capital firms
poured money into companies tackling the global problems
of climate change and disease. The challenges are great—and
investors bet that the payoffs will be, too—for the startups
that successfully commercialize ideas like solar power, low-
emission cars, and new medications.
Who are these hot startups? To find out, we followed the
money, looking at deals that took place in the four most re-
cent quarters available, from October 2007 to September
2008, based on the MoneyTree report, which uses data from
Thomson Reuters. We then reached out to a selection of the
seed and early-stage companies that raised the most money
and profiled them in a slide show.
At the top of the list are some veteran entrepreneurs
who have already proven themselves to investors by found-
ing companies that led to acquisitions. The team behind
Relypsa, a Santa Clara (Calif.) drug development company
working on a treatment for life-threatening hyperkalemia
in heart and kidney patients, sold their last company to
Amgen (AMGN) for $420 million in 2007. Relypsa, founded
months after the acquisition, raised $33 million in late 2007.
But even for well-capitalized startups with proven track
records, the uncertain funding outlook means they have to
make every dollar count. Gerrit Klaerner, Relypsa’s chief op-
erating officer, says startups that are only now thinking of
ways to trim may be in trouble. “Operating a small company,
I think you have to be lean and mean. If you start thinking
about capital efficiency today, it’s too late,” he says.
For other businesses, the downturn carries the scent of
opportunity. Ron Gonen, co-founder and chief executive offi-
cer of RecycleBank, says the sudden need for cities and house-
holds to conserve cash puts his company in a position to
grow. The 85-employee New York firm runs recycling systems
for cities that let residents earn points, based on the amount
they recycle, that they can redeem at retailers. “Now that
cities really need to save money and people are really looking
for a way to get disposable income, we’re at a unique time in
our growth curve,” Gonen says. He says families can earn up
to $400 a year in RecycleBank points. RecycleBank, which
raised $30 million last year on top of $15 million in an earlier
round, takes a cut of the savings that the cities get from re-
ducing how much trash they send to landfills.
Venture capitalists see other companies that focus on
conservation, renewable power, and reducing the emissions
that cause global warming as strong bets even in bad times.
“No matter how much worse the economy could get
over the next six to 12 months, there are many who believe
that clean tech kind of rides above the economic uncer-
tainty,” says Mark Heesen, president of the National Venture
Capital Assn. Demand for clean power from governments
around the globe, along with renewed attention to cutting
emissions from the incoming Obama Administration, has
convinced investors to bet on solar and wind power, as well
as hybrid cars.
Likewise, Heesen says, biotechnology and medical device
companies will continue to draw investors because the
promise of their products to extend lives is so important.
“We all are living longer, and we want to live longer, more
productive lives, and biotech is at the cusp of that,” he says.
The startups Heesen predicts will suffer most from the down-
turn are IT firms that ultimately sell their products to con-
sumers or businesses, because both are cutting spending.
Still, developing drugs or clean technology takes a lot of
money, with long time frames for exits potentially made
longer by an IPO drought and a tough market for acquisi-
tions. One drug development company, IRX Therapeutics in
New York, has raised more than $60 million since its found-
ing more than a decade ago, mostly from high-net-worth
individuals and some VCs, to develop treatments to restore
immune function in head and neck cancer patients. “We’re
obviously a company without revenue in a business that
eats capital,” says Chief Financial Officer Jeffrey Hwang. He
says the firm has had to cut staff by a third and delay clinical
trials it planned for 2009, because he’s not sure whether the
funding will be there to complete them. “We’re not going
to start anything we can’t finish,” he says.
Heesen says many startups may face the same problem
next year. He expects fewer companies to get funded. Those
entrepreneurs that do will have to prove the value of their
ideas and their ability to execute them even in a downturn.*
ADVICE TO AN ENTREPRENEUR
An individual who is looking to start and grow a business
approaches you and asks you the following questions:
1. If I don’t have the track record of starting and running
a successful business, then what else can I do to enhance
my likelihood of raising funds to start up and grow a
new business?
2. Why are “green opportunities” so attractive during an
economic downturn? Will they “disappear” when the
economy “heats up”?
3. Biotech requires scientific knowledge and considerable
money. Given the trends that make biotech attractive,
what other businesses are also likely to be high growth?
*Source: Reprinted from December 19, 2008 issue of BusinessWeek by special
permission, copyright © 2008 by The McGraw-Hill Companies, Inc., “Venture
Capital’s Favorite Startups,” by John Tozzi, http://www.businessweek.com/
smallbiz/content/dec2008/sb20081218_856857.htm.
(1 to 2 percent) to an advertising pool. This pooling of resources allows the franchisor to
conduct advertising in major media across a wide geographic area. If the business were not
franchised, the company would have to provide funds for the entire advertising budget.
Disadvantages of Franchising
Franchising is not always the best option for an entrepreneur. Anyone investing in a fran-
chise should investigate the opportunity thoroughly. Problems between the franchisor
and the franchisee are common and have recently begun to receive more attention from the
government and trade associations.
The disadvantages to the franchisee usually center on the inability of the franchisor
to provide services, advertising, and location. When promises made in the franchise
agreement are not kept, the franchisee may be left without any support in important ar-
eas. For example, Curtis Bean bought a dozen franchises in Checkers of America Inc.,
a firm that provides auto inspection services. After losing $200,000, Bean and other
franchisees filed a lawsuit claiming that the franchisor had misrepresented advertising
costs and had made false claims—including that no experience was necessary to own a
franchise.3
The franchisee may also face the problem of a franchisor’s failing or being bought out
by another company. No one knows this better than Vincent Niagra, an owner of three Win-
dow Works franchises. Niagra had invested about $1 million in these franchises when the
franchise was sold to Apogee Enterprises and then resold four years later to a group of in-
vestors. This caused many franchises to fail. The failure of these franchises has made it dif-
ficult for Niagra to continue because customers are apprehensive about doing business with
him for fear that he will also go out of business. None of the support services that had been
promised were available.4
The franchisor also incurs certain risks and disadvantages in choosing this expansion
alternative. In some cases, the franchisor may find it very difficult to find quality fran-
chisees. Poor management, in spite of all the training and controls, can still cause individ-
ual franchise failures and, therefore, can reflect negatively on the entire franchise system.
As the number of franchises increases, the ability to maintain tight controls becomes more
difficult.
Types of Franchises
There are three available types of franchises.5 The first type is the dealership, a form com-
monly found in the automobile industry. Here, manufacturers use franchises to distribute
their product lines. These dealerships act as the retail stores for the manufacturer. In some
instances, they are required to meet quotas established by the manufacturers, but as is the
case for any franchise, they benefit from the advertising and management support provided
by the franchisor.
The most common type of franchise is the type that offers a name, image, and method
of doing business, such as McDonald’s, Subway, KFC, Midas, Dunkin’ Donuts, and Holiday
Inn. There are many of these types of franchises, and their listings, with pertinent information,
can be found in various sources.6
A third type of franchise offers services. These include personnel agencies, income tax
preparation companies, and real estate agencies. These franchises have established names
and reputations and methods of doing business. In some instances, such as real estate, the
franchisee has actually been operating a business and then applies to become a member of
the franchise.
C H A P T E R 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES 417
Franchising opportunities have often evolved from changes in the environment as well
as important social trends. Several of these are discussed in the following.7
• Good health. Today people are eating healthier food and spending more time keeping fit. Many franchises have developed in response to this trend. For example, Bassett’s
Original Turkey was created in response to consumer interest in eating foods lower in
cholesterol, and Booster Juice was created to provide fresh juice and smoothies as a
healthy alternative to other snacks and drinks. Peter Taunton founded Snap Fitness Inc.
in 2003 to offer patrons a convenient and affordable place to work out, and Gary
Heavin created Curves for Women —a women-only fitness center.
• Time saving or convenience. More and more consumers prefer to have things delivered to them as opposed to going out of their way to buy them. In fact, many food stores
now offer home delivery services. In 1990, Auto Critic of America Inc. was started as
a mobile car inspection service. About the same time, Ronald Tosh started Tubs To Go,
a company that delivers Jacuzzis to almost any location for an average of $100 to $200
per night.
• Health care. There is an increasing number of opportunities in health care for aging people. For example, Senior Helpers was founded in 2001 and started franchising in
2005 to offer care for seniors so that they can live independently in the comfort of their
own home. HealthSource Chiropractic and Progressive Rehab started franchising in
2006 and offers chiropractic care with “Progressive Rehabilitation” where chiropractors
work side by side with therapists, massage therapists, and athletic trainers.
• The second baby boom. Today’s baby boomers have had babies themselves, which has resulted in the need for a number of child-related service franchises. Child care
franchises such as KinderCare and Living and Learning are thriving. In 1989, two
attorneys, David Pickus and Lee Sandoloski, opened Jungle Jim’s Playland. This is an
indoor amusement park with small-scale rides in a 20,000- to 27,000-square-foot
facility. One franchise, Computertots, teaches classes on computers to preschoolers.
This franchise has spread to 25 locations in 15 states.
INVESTING IN A FRANCHISE
Franchising involves many risks to an entrepreneur. Although we read about the success of
McDonald’s or Burger King, for every one of these successes there are many failures. Fran-
chising, like any other venture, is not for the passive person. It requires effort and long
hours, as any business does, since duties such as hiring, scheduling, buying, and account-
ing are still the franchisee’s responsibility.
Not every franchise is right for every entrepreneur. He or she must evaluate the franchise
alternatives to decide which one is most appropriate. A number of factors should be as-
sessed before making the final decision.
1. Unproven versus proven franchise. There are some trade-offs in investing in a proven
or unproven franchise business. Whereas an unproven franchise will be a less expen-
sive investment, the lower investment is offset by more risk. In an unproven franchise,
the franchisor is likely to make mistakes as the business grows. These mistakes could
inevitably lead to failure. Constant reorganization of a new franchise can result in con-
fusion and mismanagement. Yet, a new and unproven franchise can offer more excite-
ment and challenge and can lead to significant opportunities for large profits should
the business grow rapidly. A proven franchise offers lower risk but requires more
financial investment.
418 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
419
2. Financial stability of franchise. The purchase of a franchise should entail an assess-
ment of the financial stability of the franchisor. A potential franchisee should seek
answers to the following questions:
• How many franchises are in the organization?
• How successful is each of the members of the franchise organization?
• Are most of the profits of the franchise a function of fees from the sale of franchises or from royalties based on profits of franchisees?
• Does the franchisor have management expertise in production, finance, and marketing?
Some of the preceding information can be obtained from the profit-and-loss statements
of the franchise organization. Face-to-face contact with the franchisor can also indicate
the success of the organization. It is also worthwhile to contact some of the franchisees
directly to determine their success and to identify any problems that have occurred. If
financial information about the franchisor is unavailable, the entrepreneur may purchase a
E T H I C S
To Be a Better Negotiator, Learn to Tell the Difference between a Lie and a Lie No one really likes to think about how much lying
goes on at the bargaining table. Of course not—it’s
troubling. On the one hand, we aspire to principled
negotiation, win-win solutions, and civility with our
opponents. On the other, our whole notion of nego-
tiation is built on ethical quicksand: To succeed, you
must deceive.
I’m not talking about the obvious cases, such as the
bald lie. Those we all condemn, and in fact, our courts
provide remedies for them—albeit slow, aggravating,
inconsistent, and expensive ones. To me, it’s the little
lies, the omissions and evasions, that are more curious.
In negotiation, exaggerating benefits, ignoring
flaws, or saying “I don’t know” when in reality you
do is not considered lying. Rather, it’s sales ability. De-
claring your bottom line to be non-negotiable (even
when you’re posturing) is not lying. It’s a show of
strength. Pretending to bend over backward to make
meaningless concessions is not lying. It’s applied psy-
chology. Savvy businesspeople accept these rituals
without undue introspection. Of course, the patho-
logically honest among us find them disturbing. But
we have a place for those people . . . in the back room,
far away from any bargaining table.
Still, some evasiveness and deception we consider
out of bounds. Following are some tips for staying in
bounds without getting clobbered.
On defense, vigilant skepticism is a tremendous as-
set. Reflect on everything you hear. Reflect on every-
thing you don’t. If you’re suspicious, ask questions,
especially ones that require more than just a simple
yes or no answer. Keep probing until you’re satisfied.
J. P. Morgan used to say, “A man always has two rea-
sons for the things he does—a good one and the real
one.” So after you get the good ones, ask for the real
ones by saying, “And why else?” Also, get important
promises in writing, and scrutinize their wording
with and without your lawyer. To discourage dishon-
esty, tell your opponent you will independently verify
the important stuff. If you can, do it. By the way, ex-
perts say it’s easier to detect lying on the phone than
in person. The voice all by itself (without distracting
visual cues) is more of a giveaway.
To the terminally honest, I say: Negotiation is not
group therapy. Generally, if you bare your soul, you
will be fleeced. Respect the rules—or have someone
else do your bargaining for you. If you’re a liar (and
you know who you are), I hope you get nailed big
time. And if you’re morally sturdy and find yourself
unsure of what to say or omit, just keep Richard
Nixon’s comments about Watergate in mind: “I was
not lying. I said things that later on seemed to be
untrue.”
Source: Reprinted with permission of Entrepreneur Media, Inc., “To Be a Better Negotiator, Learn to Tell the Difference between a Lie and a Lie,” by Marc Diener, January 2002, Entrepreneur magazine: www.entrepreneur.com.
FAIR ENOUGH
financial rating from a source such as Dun & Bradstreet. Generally, the following are
good external sources of information:
• Franchise association
• Other franchisees
• Government
• Accountants and lawyers
• Libraries
• Franchise directories and journals
• Business exhibitions
3. Potential market for the new franchise. It is important for the entrepreneur to
evaluate the market that the franchise will attract. A starting point is evaluating the
traffic flow and demographics of the residents from a map of the area. Traffic flow
information may be observed by visiting the area. Direction of traffic flow, ease of
entry to the business, and the amount of traffic (pedestrian and automobile) can be
estimated by observation. The demographics of the area can be determined from
census data, which can be obtained from local libraries or the town hall. It can also
be advantageous to locate competitors on the map to determine their potential effect
on the franchise business. Marketing research in the market area is helpful. Attitudes
about and interest in the new business can be assessed in the market research. In
some instances, the franchisor will conduct a market study as a selling point to the
franchisee.
4. Profit potential for a new franchise. As in any start-up business, it is important to
develop pro forma income and cash flow statements. The franchisor should provide
projections to calculate the needed information.
In general, most of the preceding information should be provided in the disclosure state-
ment or the prospectus. The Federal Trade Commission’s Franchise Rule requires fran-
chisors to make full presale disclosure in a document that provides information about 20
separate aspects of a franchise offering.8 The information required in this disclosure is sum-
marized in Table 14.2. Some of the information will be comprehensive and some will be
sketchy. There are always weaknesses that must be evaluated before making a commitment.
The disclosure statement represents a good resource, but it is also important to evaluate the
other services mentioned earlier in this chapter.
Front-end procedure fees, royalty payments, expenses, and other information should be
compared with those of franchises in the same field, as well as in different business areas.
If a franchise looks good as an investment, the entrepreneur may request a franchise package
from the franchisor, which usually contains a draft franchise agreement or contract. Generally,
this package will require a deposit of $400 to $600, which should be fully refundable.
The contract or franchise agreement is the final step in establishing a franchise arrange-
ment. Here a lawyer experienced in franchising should be used. The franchise agreement
contains all the specific requirements and obligations of the franchisee. Things such as the
exclusivity of territory coverage will protect against the franchisor’s granting another fran-
chise within a certain radius of the business. The renewable terms will indicate the length
of the contract and the requirements. Financial requirements will stipulate the initial price
for the franchise, the schedule of payments, and the royalties to be paid. Termination of
franchise requirements should indicate what will happen if the franchisee becomes disabled or
dies and what provisions are made for the family. Terminating a franchise generally results in
more lawsuits than any other issue in franchising. These terms should also allow the franchisee
to obtain fair market value should the franchise be sold. Even though the agreement may be
standard, the franchisee should try to negotiate important items to reduce the investment risk.
420 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
JOINT VENTURES
With the increase in business risks, hypercompetition, and failures, joint ventures have oc-
curred with increased regularity and often involve a wide variety of players.9 Joint ventures
are not a new concept, but rather have been used as a means of expansion by entrepreneur-
ial firms for a long time.
What is a joint venture? A joint venture is a separate entity that involves a partnership be-
tween two or more active participants. Sometimes called strategic alliances, joint ventures
can involve a wide variety of partners that include universities, not-for-profit organizations,
C H A P T E R 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES 421
TABLE 14.2 Information Required in Disclosure Statement
1. Identification of the franchisor and its affiliates and their business experience.
2. The business experience of each of the franchisor’s officers, directors, and management
personnel responsible for franchise services, training, and other aspects of the franchise
programs.
3. The lawsuits in which the franchisor and its officers, directors, and management personnel
have been involved.
4. Any previous bankruptcies in which the franchisor and its officers, directors, and
management personnel have been involved.
5. The initial franchise fee and other initial payments that are required to obtain the
franchise.
6. The continuing payments that franchisees are required to make after the franchise
opens.
7. Any restrictions on the quality of goods and services used in the franchise and where
they may be purchased, including restrictions requiring purchases from the franchisor or
its affiliates.
8. Any assistance available from the franchisor or its affiliates in financing the purchase of
the franchise.
9. Restrictions on the goods or services franchises are permitted to sell.
10. Any restrictions on the customers with whom franchises may deal.
11. Any territorial protection that will be granted to the franchisee.
12. The conditions under which the franchise may be repurchased or refused renewal by the
franchisor, transferred to a third party by the franchisee, and terminated or modified by
either party.
13. The training programs provided to franchisees.
14. The involvement of any celebrities or public figures in the franchise.
15. Any assistance in selecting a site for the franchise that will be provided by the franchisor.
16. Statistical information about the present number of franchises; the number of franchises
projected for the future; and the number of franchises terminated, the number the
franchisor has decided not to renew, and the number repurchased in the past.
17. The financial statements of the franchisor.
18. The extent to which the franchisees must personally participate in the operation of the
franchise.
19. A complete statement of the basis of any earnings claims made to the franchisee,
including the percentage of existing franchises that have actually achieved the results
that are claimed.
20. A list of the names and addresses of other franchises.
joint venture Two or
more companies forming
a new company
businesses, and the public sector.10 Joint ventures have occurred between such rivals as
General Motors and Toyota as well as General Electric and Westinghouse. They have oc-
curred between the United States and foreign concerns to penetrate an international market,
and they have been a good conduit by which an entrepreneur can enter an international market.
Whenever close relationships between two companies are being developed, concerns
about the ethics and ethical behavior of the potential partner may arise.
Types of Joint Ventures
Although there are many different types of joint venture arrangements, the most common
is still between two or more private-sector companies. For example, Boeing, Mitsubishi,
Fuji, and Kawasaki entered into a joint venture for the production of small aircraft to share
technology and cut costs. Microsoft and NBC Universal formed a partnership to create a
cable news channel (MSNBC). There is an elaborate cost-sharing arrangement between the
different entities of the partnership.
Other private-sector joint ventures have had different objectives, such as entering new mar-
kets (Corning and Ciba-Geigy as well as Kodak and Cetus), entering foreign markets (AT&T
and Olivetti), and raising capital and expanding markets (U.S. Steel and Phong Iron and Steel).
Some joint ventures are formed to do cooperative research. Probably the best known of
these is the Microelectronics and Computer Technology Corporation (MCC). Supported by
13 major U.S. companies, this for-profit venture does long-range research with scientists
who are loaned to MCC for up to four years before returning to their competing companies
to apply the results of their research activities. MCC retains title to all the resulting knowl-
edge and patents, making them available for license to the companies participating in the
program. Another type of joint venture for research development is the Semiconductor
Research Corporation, located in Triangle Park, North Carolina. A not-for-profit research
organization, it began with the participation of 11 U.S. chip manufacturers and computer
companies. The goal of the corporation is to sponsor basic research and train professional
scientists and engineers to be future industry leaders. Members of SRC programs have in-
vested $1.1 billion in cutting-edge semiconductor research supporting over 7,000 students
and 1,598 faculty members at 237 universities worldwide.11
Industry–university agreements created for the purpose of doing research are another
type of joint venture that has seen increasing usage. However, two major problems have
kept these types of joint ventures from proliferating even faster. A profit corporation has the
objective of obtaining tangible results, such as a patent, from its research investment and
wants all proprietary rights. Universities want to share in the possible financial returns from
the patent, but the university researchers want to make the knowledge available through re-
search papers. In spite of these problems, numerous industry–university teams have been
established. In one joint venture agreement in robotics, for example, Westinghouse retains
patent rights while Carnegie-Mellon receives a percentage of any license royalties. The uni-
versity also has the right to publish the research results as long as it withholds from publi-
cation any critical information that might adversely affect the patent.
The joint venture agreement between Celanese Corporation and Yale University, created
for researching the composition and synthesis of enzymes, took a somewhat different
form—cost sharing. Although Celanese assumes the expense of any needed supplies and
equipment for the research, as well as the salaries of the postdoctoral researchers, Yale pays
the salaries of the professors involved. The research results can be published only after a
45-day waiting period.
International joint ventures, discussed in Chapter 5, are rapidly increasing in number
due to their relative advantages. Not only can both companies share in the earnings and
growth, but the joint venture can have a low cash requirement if the knowledge or patents are
422 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
capitalized as a contribution to the venture. Also, the joint venture provides ready access to
new international markets that otherwise may not be easily attained. Finally, since talent and
financing come from all parties involved, an international joint venture causes less drain on
a company’s managerial and financial resources than a wholly owned subsidiary.
There are several drawbacks to establishing an international joint venture. First, the
business objectives of the joint venture partners can be quite different, which can result in
problems in the direction and growth of the new entity. In addition, cultural differences in
each company can create managerial difficulties in the new joint venture. Finally, govern-
ment policies can sometimes have a negative impact on the direction and operation of the
international joint venture.
In spite of these problems, the benefits usually outweigh the drawbacks, as evidenced by
the frequency rate of establishing international joint ventures. For example, an international
joint venture was established between Dow Chemical (United States) and Asaki Chemicals
(Japan) to develop and market chemicals on an international basis. While Asaki provided the
raw materials and was a sole distributor, Dow provided the technology and obtained distri-
bution in the Japanese market. The arrangement eventually dissolved because of the con-
cerns of the Japanese government and the fundamental difference in motives between the
two partners: Dow was primarily concerned with the profits of the joint venture, whereas
Asaki was primarily concerned with having a purchaser for its basic petrochemicals.
Factors in Joint Venture Success
Clearly, not all joint ventures succeed. An entrepreneur needs to assess this method of
growth carefully and understand the factors that help ensure success as well as the prob-
lems involved before using it. The most critical factors for success are:
1. The accurate assessment of the parties involved to best manage the new entity in light
of the ensuing relationships. The joint venture will be more effective if the managers
can work well together. Without this chemistry, the joint venture has a low likelihood
of success and may even fail.
2. The degree of symmetry between the partners. This symmetry goes beyond chemistry
to objectives and resource capabilities. When one partner feels that he or she is bring-
ing more to the table, or when one partner wants profits and the other desires product
outlet (as in the case of the Asaki-Dow international joint venture), problems arise. For
a joint venture to be successful, the managers in each parent company, as well as those
in the new entity, must concur on the objectives of the joint venture and the level of re-
sources that will be provided. Good relationships must be nurtured between the man-
agers in the joint venture and those in each parent company.
3. The expectations of the results of the joint venture must be reasonable. Far too often,
at least one of the partners feels that a joint venture will be the cure-all for other corpo-
rate problems. Expectations of a joint venture must be realistic.
4. The timing must be right. With environments constantly changing, industrial condi-
tions being modified, and markets evolving, a particular joint venture could be a suc-
cess one year and a failure the next. Intense competition leads to a hostile environment
and increases the risks of establishing a joint venture. Some environments are just not
conducive to success. An entrepreneur must determine whether the joint venture will
offer opportunities for growth or will penalize the company, for example, by prevent-
ing it from entering certain markets.
A joint venture is not a panacea for expanding the entrepreneurial venture. Rather, it
should be considered one of many options for supplementing the resources of the firm and
responding more quickly to competitive challenges and market opportunities. The effective
C H A P T E R 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES 423
use of joint ventures as a strategy for expansion requires the entrepreneur to carefully appraise
the situation and the potential partner(s). Other strategic alternatives to the joint venture—
such as acquisitions, mergers, and leveraged buyouts—should also be considered.
ACQUISITIONS
Another way the entrepreneur can expand the venture is by acquiring an existing business.
Acquisitions provide an excellent means of expanding a business by entering new markets
or new product areas. One entrepreneur acquired a chemical manufacturing company after
becoming familiar with its problems and operations as a supplier of the entrepreneur’s
company. An acquisition is the purchase of an entire company, or part of a company; by
definition, the company is completely absorbed and no longer exists independently. An ac-
quisition can take many forms, depending on the goals and position of the parties involved
in the transaction, the amount of money involved, and the type of company.
Although one of the key issues in buying a business is agreeing on a price, successful
acquisition of a business actually involves much, much more. In fact, often the structure of
the deal can be more important to the resultant success of the transaction than the actual
price. One radio station was successful after being acquired by a company primarily be-
cause the previous owner loaned the money and took no principal payment (only interest)
on the loan until the third year of operation.
From a strategic viewpoint, a prime concern of the entrepreneurial firm is maintaining
the focus of the new venture as a whole. Whether the acquisition will become the core of
the new business or rather represents a needed capability—such as a distribution outlet,
sales force, or production facility—the entrepreneur must ensure that it fits into the overall
direction and structure of the strategic plan of the present venture.
Advantages of an Acquisition
For an entrepreneur, there are many advantages to acquiring an existing business:
1. Established business. The most significant advantage is that the acquired firm has an
established image and track record. If the firm has been profitable, the entrepreneur
need only continue its current strategy to be successful with the existing customer
base.
2. Location. New customers are already familiar with the location.
3. Established marketing structure. An acquired firm has its existing channel and sales
structure. Known suppliers, wholesalers, retailers, and manufacturers’ reps are impor-
tant assets to an entrepreneur. With this structure already in place, the entrepreneur can
concentrate on improving or expanding the acquired business.
4. Cost. The actual cost of acquiring a business can be lower than other methods of
expansion.
5. Existing employees. The employees of an existing business can be an important asset
to the acquisition process. They know how to run the business and can help ensure that
the business will continue in its successful mode. They already have established rela-
tionships with customers, suppliers, and channel members and can reassure these
groups when a new owner takes over the business.
6. More opportunity to be creative. Since the entrepreneur does not have to be concerned
with finding suppliers, channel members, hiring new employees, or creating customer
awareness, more time can be spent assessing opportunities to expand or strengthen the
existing business and tapping into potential synergies between the businesses.
424 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
acquisition Purchasing
all or part of a company
Disadvantages of an Acquisition
Although we can see that there are many advantages to acquiring an existing business, there
are also disadvantages. The importance of each of the advantages and disadvantages should
be weighed carefully with other expansion options.
1. Marginal success record. Most ventures that are for sale have an erratic, marginally
successful, or even unprofitable track record. It is important to review the records
and meet with important constituents to assess that record in terms of the business’s
future potential. For example, if the store layout is poor, this factor can be rectified;
but if the location is poor, the entrepreneur might do better using some other expan-
sion method.
2. Overconfidence in ability. Sometimes an entrepreneur may assume that he or she can
succeed where others have failed. This is why a self-evaluation is so important before
entering into any purchase agreement. Even though the entrepreneur brings new ideas
and management qualities, the venture may never be successful for reasons that are
not possible to correct. Often managers are overconfident in their ability to overcome
cultural differences between their current business and the one being acquired.
3. Key employee loss. Often, when a business changes hands, key employees also leave.
Key employee loss can be devastating to an entrepreneur who is acquiring a business
since the value of the business is often a reflection of the efforts of the employees.
This is particularly evident in a service business, where it is difficult to separate the
actual service from the person who performs it. In the acquisition negotiations, it is
helpful for the entrepreneur to speak to all employees individually to obtain some
assurance of their intentions as well as to inform them of how important they will be
to the future of the business. Incentives can sometimes be used to ensure that key
employees will remain with the business.
4. Overvaluation. It is possible that the actual purchase price is inflated due to the
established image, customer base, channel members, or suppliers. If the entrepre-
neur has to pay too much for a business, it is possible that the return on investment
will be unacceptable. It is important to look at the investment required in purchasing
a business and at the potential profit and establish a reasonable payback to justify
the investment.
After balancing the pros and cons of the acquisition, the entrepreneur needs to determine
a fair price for the business.
Synergy
The concept that “the whole is greater than the sum of its parts” applies to the integration
of an acquisition into the entrepreneur’s venture. The synergy should occur in both the busi-
ness concept, with the acquisition functioning as a vehicle to move toward overall goals,
and the financial performance. The acquisition should positively impact the bottom line, af-
fecting both long-term gains and future growth. Lack of synergy is one of the most frequent
causes of an acquisition’s failure to meet its objectives.
Structuring the Deal
Once the entrepreneur has identified a good candidate for acquisition, an appropriate deal
must be structured. Many techniques are available for acquiring a firm, each having a dis-
tinct set of advantages to both the buyer and seller. The deal structure involves the parties,
C H A P T E R 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES 425
the assets, the payment form, and the timing of the payment. For example, all or part of the
assets of one firm can be acquired by another for some combination of cash, notes, stock,
and/or employment contract. This payment can be made at the time of acquisition, through-
out the first year, or extended over several years.
The two most common means of acquisition are the entrepreneur’s direct purchase of
the firm’s entire stock or assets or the bootstrap purchase of these assets. In the direct pur-
chase of the firm, the entrepreneur often obtains funds from an outside lender or the seller
of the company being purchased. The money is repaid over time from the cash flow gener-
ated from the operations. Although this is a relatively simple and clear transaction, it usu-
ally results in a long-term capital gain to the seller and double taxation on the funds used to
repay the money borrowed to acquire the company.
426
A S S E E N I N E N T R E P R E N E U R M A G A Z I N E
PROVIDE ADVICE TO AN ENTREPRENEUR ABOUT ENTERING INTO AGREEMENTS
Entrepreneurs: James Tiscione, 49, and Anthony
Tiscione, 79, founders of ACM Enterprises in
Tucson, Arizona.
Product Description: The Auto Card Manager (ACM),
a thin metal case that holds a driver’s license
and up to five credit cards. When users push one
of the six buttons on the case, the selected
credit card is dispensed.
Start-Up: $50,000 in 2000 and 2001, to pay for the
first production run of 25,000 units.
Sales: $1.8 million in 2002.
The Challenge: Bringing a new product to market
with a limited marketing budget.
James Tiscione didn’t have a lot of money when he
launched his business, but that didn’t stop him from
finding a way to bring his unusual product to market.
Here are the steps he followed:
1. Obtain a patent. Tiscione started by visiting
www.uspto.gov, the official Web site of the U.S.
Patent and Trademark Office, to look for similar
patents. “I looked at over 1,000 patents and
found only two that were even remotely similar
to mine,” he says. “Only after completing the
search did I go to a patent attorney.” Doing some
research on his own did more than just save
Tiscione money: “I was trying to hedge my bets
before investing dollars in attorney fees, engi-
neering design, and prototypes. I also wanted to
see what other ideas were out there. I was sur-
prised no one else ever had the idea.” Before
long, Tiscione applied for a provisional patent,
which doesn’t give inventors patent protection,
but does allow them to show their ideas to peo-
ple. “It is an inexpensive way of protection that
allows inventors one year for research and devel-
opment,” Tiscione says. In 2001, he applied for his
utility patent.
2. Decide what help you need. Because Tiscione had
never developed a product before, he felt he
lacked the experience he needed to launch the
idea. He asked his father, Anthony, an inventor,
for help in finalizing his product design. Tiscione
also approached Steve Pagac, a marketing whiz
who owned a real estate and investment firm.
Says Tiscione, “Steve invested sweat equity in our
venture, and he is responsible for lining up all our
customers.”
3. Make a prototype. Tiscione knew people wouldn’t
understand the ACM without trying it, so he
made a prototype. Tiscione ended up choosing
a prototype supplier in California. Once he
began using the prototype, people started
asking where they could buy one. The positive
feedback played a major role in moving the
business ahead.
4. Locate a production source. Tiscione’s first stop
was the Hong Kong Chamber of Commerce, which
has an office in San Francisco. “They sent me a list
of companies I e-mailed,” he says. He narrowed
it down to one—but only signed the final agree-
ment after visiting the company several times and
viewing a few trial production pieces.
To avoid these problems, the entrepreneur can make a bootstrap purchase, acquiring a
small amount of the firm, such as 20 to 30 percent, for cash. He or she then purchases
the remainder of the company with a long-term note that is paid off over time out of the
acquired company’s earnings. This type of deal often results in more favorable tax advan-
tages to both the buyer and the seller.
Locating Acquisition Candidates
If an entrepreneur is seriously planning to buy a business, there are some sources of assis-
tance. There are professional business brokers who operate in a fashion similar to a real es-
tate broker. They represent the seller and will sometimes aggressively find buyers through
either referrals, advertising, or direct sales. Since these brokers are paid a commission on
the sale, they often expend more effort on their best deals.
427
brokers People who sell
companies
5. Explore all possibilities to find distribution out-
lets. Tiscione and Pagac weren’t sure which retail-
ers would want to buy their product, so they
started by approaching catalogs and stores such
as Brookstone, The Sharper Image, and Things
Remembered. “While the stores didn’t bite, one
promotional company did—AMG of Plymouth,
Wisconsin,” Tiscione says. “AMG signed an exclu-
sive agreement with us for the promotional prod-
ucts market in 2001.” Tiscione and Pagac also
approached SkyMall, a specialty retailer that pro-
duces a cost-sharing catalog targeting in-flight
airline passengers. “After two quarters ending in
September,” says Tiscione, “SkyMall reported that
the ACM was the No. 1–selling product in [the
catalog], and they agreed to carry the product
through March.” Tiscione and Pagac also con-
tacted MJ Media, a TV marketer in Phoenix that
signed a nonexclusive agreement to sell the ACM
through TV ads. “We revamped our original
agreement with MJ Media to include a broader
base of distribution,” Tiscione says. “Originally,
the contract was for TV advertising only. Since
then, MJ Media has expanded into Internet sales
and master distribution to small distributors.”
Now, Tiscione has a broad range of customers
selling his products. As a bonus, Taylor Gifts, a
major consumer catalog, picked up the ACM for
the 2002 Christmas season.
6. Sign deals that maximize marketing exposure
but limit financial risk. Advertising and market-
ing expenses can kill a product—but Tiscione
avoided these expenses by signing contracts
with limited risk. Both AMG and MJ Media
signed agreements to purchase the product
from ACM and promote it themselves. Also,
Tiscione’s deal with SkyMall was cooperative.
Tiscione paid nothing to be listed in SkyMall, but
all the sales went to SkyMall up to a certain sales
level. Once that level was reached, sales were
split equally between SkyMall and ACM. At press
time, ACM switched to a standard contract,
which requires them to pay for the ad but allows
them to retain all sales.
ADVICE TO AN ENTREPRENEUR
An inventor has read the preceding article and comes
to you for advice. “This is exactly what I want to do,”
he says, “I don’t have the expertise or the money to
manufacture the product myself or to market and sell
it. What I need is for someone else to do that for me.
Here are my questions:
1. Is it really that simple to find and then establish a
relationship with someone to produce my prod-
uct? Should the producer have a manufacturing
license or should I enter into a joint venture?
2. Same sorts of issues on the marketing end, but I
also want to know how much control I can main-
tain over how the product is marketed and sold.
Or should I not worry about that and let the
experts do their thing?
3. One dilemma for me is how much money I should
invest in the prototypes. The more money I invest,
the better the prototype looks, but I don’t want
to waste money either.
Source: Reprinted with permission of Entrepreneur Media, Inc., “Play Your Cards Right. Presenting a Case Study in Striking the Best Deals to Launch Your Own Great Product on a Limited Budget,” by Don Debelak, March 2003, Entrepreneur magazine: www.entrepreneur.com.
Accountants, attorneys, bankers, business associates, and consultants may also know of
good acquisition candidates. Many of these professionals have a good working knowledge
of the business, which can be helpful in the negotiations.
It is also possible to find business opportunities in the classified sections of the newspa-
per or in a trade magazine. Since these listings are usually completely unknown, they may
involve more risk but can be purchased at a lower price.
Determining the best option for an entrepreneur involves significant time and effort.
The entrepreneur should gather as much information as possible, read it carefully, consult
with advisors and experts, consider his or her own situation, and then make a construc-
tive decision.
MERGERS
A merger—or a transaction involving two, or possibly more, companies in which only one
company survives—is another method of expanding a venture. Acquisitions are so similar
to mergers that at times the two terms are used interchangeably. A key concern in any
merger (or acquisition) is the legality of the purchase. The Department of Justice frequently
issues guidelines for horizontal, vertical, and conglomerate mergers which further define
the interpretation that will be made in enforcing the Sherman Act and Clayton Act. Since
the guidelines are extensive and technical, the entrepreneur should secure adequate legal
advice when any issues arise.
Why should an entrepreneur merge? There are both defensive and offensive strategies
for a merger, as indicated in Figure 14.1. Merger motivations range from survival to protec-
tion to diversification to growth. When some technical obsolescence, market or raw mate-
rial loss, or deterioration of the capital structure has occurred in the entrepreneur’s venture,
a merger may be the only means for survival. The merger can also protect against market
encroachment, product innovation, or an unwarranted takeover. A merger can provide a
great deal of diversification as well as growth in market, technology, and financial and
managerial strength.
How does a merger take place? It requires sound planning by the entrepreneur. The
merger objectives, particularly those dealing with earnings, must be spelled out with the
428 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
merger Joining two or
more companies
Source: F. T. Haner, Business Policy, Planning, and Strategy (Cambridge, MA: Winthrop, 1976), p. 399.
FIGURE 14.1 Merger Motivations
Survival requirement
Capital structure deterioration
Technological obsolescence
Loss of raw materials
Market loss to superior products
Protection against...
Market infringement
Lower cost position of a competitor
Product innovations by others
An unwanted takeover
Diversification
Countercyclical
Counterseasonal
International operations
Multiple strategic plans
Gains in...
Market position
Technological edge
Financial strength
Managerial talent
DEFENSIVE (Passive)
OFFENSIVE (Active)
resulting gains for the owners of both companies delineated. Also, the entrepreneur must
carefully evaluate the other company’s management to ensure that, if retained, it would be
competent in developing the growth and future of the combined entity. The value and ap-
propriateness of the existing resources should also be determined. In essence, this involves
a careful analysis of both companies to ensure that the weaknesses of one do not compound
those of the other. Finally, the entrepreneur should work toward establishing a climate of
mutual trust to help minimize any possible management threat or turbulence.
The same methods for valuing an acquisition candidate can be used to determine the
value of a merger candidate. The process involves the entrepreneur looking at the syner-
gistic product/market position, the new domestic or international market position, any un-
dervalued financial strength, whether or not the company is skilled in a related industry,
and any underexploited company asset. A common procedure for determining value is
to estimate the present value of discounted cash flows and the expected after-tax earnings
attributable to the merger. This should be done on optimistic, pessimistic, and probable
scenarios of cash flows and earnings using various acceptable rates of return.
LEVERAGED BUYOUTS
A leveraged buyout (LBO) occurs when an entrepreneur (or any employee group) uses
borrowed funds to purchase an existing venture for cash. Most LBOs occur because the
entrepreneur purchasing the venture believes that he or she could run the company more
efficiently than the current owners. The current owner is frequently an entrepreneur or other
owner who wants to retire. The owner may also be a large corporation desiring to divest
itself of a subsidiary that is too small or that does not fit its long-term strategic plans.
The purchaser needs a great amount of external funding since the personal financial re-
sources needed to acquire the firm directly are frequently limited. Since the issuance of
additional equity as a means of funding is usually not possible, capital is acquired in the
form of long-term debt financing (five years or more), and the assets of the firm being ac-
quired serve as collateral. Who usually provides this long-term debt financing? Banks,
venture capitalists, and insurance companies have been the most active providers of the
debt needed in LBOs.
The actual financial package used in an LBO reflects the lender’s risk-reward profile.
Whereas banks tend to use senior-debt issues, venture capitalists usually use subordinated
debt issues with warrants or options. Regardless of the instrument used, the repayment plan
established must be in line with the pro forma cash flows that the company expects to be
generated. The interest rates are usually variable and are consistent with the current yields
of comparable risk investment.
In most LBOs, the debt capital usually exceeds the equity by a ratio of 5 to 1, with some
ratios as high as 10 to 1. This is significantly more debt relative to equity than in a typical
firm’s capital structure. Although this makes the financial risk great, the key to a success-
ful LBO is not the relative debt-equity ratio but rather the ability of the entrepreneur taking
over to cover the principal and interest payments through increased sales and profits. The
ability depends on the skills of the entrepreneur and the strength and stability of the firm.
How does the entrepreneur determine whether a specific company is a good candidate
for an LBO? This determination can be made through the following evaluation procedure:
1. The entrepreneur must determine whether the present owner’s asking price is reason-
able. Many subjective and quantitative techniques can be used in this determination.
Subjective evaluations need to be made of the following: the competitiveness of the
industry and the competitive position of the firm in that industry, the uniqueness of the
C H A P T E R 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES 429
leveraged buyout (LBO)
Purchasing an existing
venture by any employee
group
offering of the firm and its stage in the product life cycle, and the abilities of management
and other key personnel remaining with the firm. Quantitative techniques are used to
evaluate the fairness of the asking price. The price-earnings ratio of the LBO prospect
should be calculated and compared with those of comparable companies, as well as
the present value of future earnings of the prospect and its book value.
2. The entrepreneur must assess the firm’s debt capacity. This is particularly critical since
the entrepreneur wants to raise as much of the capital needed as possible in the form of
long-term debt. The amount of long-term debt a prospective LBO can carry depends
on the prospect’s business risk and the stability of its future cash flows. The cash flow
must cover the long-term debt required to finance the LBO. Any financial amount that
cannot be secured by long-term debt, due to the inadequacy of the cash flow, will need
to be in the form of equity from the entrepreneur or other investors.
3. The entrepreneur must develop the appropriate financial package. The financial pack-
age must meet the needs and objectives of the providers of the funds as well as the
company’s and the entrepreneur’s situation. Although each LBO financial package is
tailored to the specific situation, there are usually some restrictions, such as no pay-
ment of dividends. Frequently, an LBO agreement with venture capitalists has war-
rants that are convertible into common stock at a later date. A sinking fund repayment
of the long-term debt is frequently required.
There are many instances of both successful and unsuccessful LBOs. One of the most pub-
licized involved R. H. Macy and Co., a well-known department store chain. Macy’s was not
in bad condition in terms of the traditional measures of sales per square foot, profitability, and
return on assets. However, it had experienced a significant drop in profits and was losing tal-
ented middle executives. The LBO was accomplished by some 345 executives participating
and sharing a 20 percent ownership in the $4.7 billion retailer. Ultimately, the LBO provided
the following benefits: a new entrepreneurial spirit in management that fostered more loyalty
in the employees; increased motivation among employees, with middle managers actually
selling and earning sales floor bonuses during slack time; and a long-term planning direction
for the board of directors that meets five times a year instead of once a month.
OVERCOMING CONSTRAINTS BY NEGOTIATING
FOR MORE RESOURCES
There are two primary tasks for an entrepreneur negotiating with another party for access
to an external growth mechanism. The distribution task is the first—how the benefits of the
relationship are distributed between the parties. That is, given a certain sized pie, the par-
ties work out who gets what proportion of that pie. Second is the integration task, in which
mutual benefits from the relationship are explored. This requires a collaborative mind-set
so that the “size of the pie” can be increased.
Often people focus on the first task and ignore the second. However, making the pie big-
ger before distribution provides the opportunity to generate greater benefits for both parties
and increases the likelihood of an agreement being reached. Besides, the collaborative and
creative aspects of working together to find ways to increase the size of the pie are more
enjoyable and more beneficial than a conflict resolution approach, which involves simply
allocating outcomes under a purely distributive approach.
To negotiate in a way that maximizes benefits requires the entrepreneur to use informa-
tion about one’s own preferences and those of the other party to create an outcome that is
mutually beneficial. This requires an initial assessment of oneself and the other party and
the use of strategies to elicit more information during the negotiation interactions to better
430 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
distribution task
Negotiating how the
benefits of the relationship
will be allocated between
the parties
integration task
Exploring possible
mutual benefits from the
relationship so that the
“size of the pie” can be
increased
inform those initial assessments. Based on the work of Max Bazerman and Margaret Neale,
two leading experts on negotiation, there are a number of assessments that an entrepreneur
should make when negotiating with a growth partner.12
Assessment 1: What Will You Do If an Agreement Is Not Reached? The answer to such a question provides an important basis for any negotiation strategy. The answer
represents the entrepreneur’s “best alternative to a negotiated agreement.” This best alter-
native helps to determine a reservation price for the negotiation. The reservation price is
the price (the bundle of resources from the agreement) at which the entrepreneur is indif-
ferent about whether to accept the agreement or choose the alternative. For example, the
best alternative to a negotiated agreement with a joint venture partner would be the ben-
efits from pursuing growth at a slower rate using existing resources (knowledge, money,
network, etc.). Recognizing that there is an alternative to this joint venture relationship,
albeit a slower route, provides a minimum acceptable level of benefits that the negotiated
outcome must reach.
Assessment 2: What Will the Other Party to the Negotiation Do If an Agreement Is Not Reached? It can be difficult for the entrepreneur to assess his or her own reservation prices, and it is even more difficult to assess those of the negotiation partner. If these prices
can be determined, the entrepreneur has a good idea of the bargaining zone, or the range of
outcomes between the entrepreneur’s reservation price and the reservation price of the
other party. Consideration of the bargaining zone encourages the entrepreneur not to focus
prematurely on a settlement price but rather to consider the range of possible outcomes
within the bargaining zone. If the bargaining zone can be determined by the entrepreneur
while keeping his or her reservation price hidden from the other party, then the entrepre-
neur is in a position to negotiate an outcome that is largely beneficial to the entrepreneur
and only marginally beneficial to the other party (i.e., just above the other party’s reserva-
tion price). Of course, such an approach focuses on the distribution stage and not the inte-
grative stage.
Assessment 3: What Are the Underlying Issues of This Negotiation? How Important Is Each Issue to You? Answers to these questions focus the negotiation toward achieving aspects of the relationship that are most desirable for the entrepreneur by
trading off aspects of less importance for those of greater importance. For example, an
entrepreneur might be more concerned about having control over a joint venture than
about his or her share of the profits generated by the joint venture. Recognizing the relative
importance of these aspects of the relationship allows the entrepreneur to “sacrifice” equity
(maybe through nonvoting shares) but obtain control (e.g., to have 51 percent of the
stock and/or one more seat on the board of directors and the position of chairman of the
board).
Assessment 4: What Are the Underlying Issues of This Negotiation? How Important Is Each Issue to the Other Party? By understanding more about the other party, the entrepreneur has a greater opportunity to achieve integration (i.e., make the size of the pie
bigger). This information provides the opportunity for the entrepreneur to sacrifice aspects
that are of less importance to him or her but of high importance to the other party. Similarly,
the entrepreneur can obtain from the other party aspects of high importance to him or her
but of low importance to the other party. If this information is known to both parties, then
it is likely that the outcome will be mutually beneficial (because the size of the pie has
been increased).
C H A P T E R 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES 431
reservation price The
price (the bundle of
resources from the
agreement) at which the
entrepreneur is indifferent
about whether to accept
the agreement or choose
the alternative
bargaining zone The
range of outcomes
between the
entrepreneur’s reservation
price and the reservation
price of the other party
Being aware of the assessments that need to be made is an important step toward a success-
ful negotiation but requires strategies for eliciting information from the other party that can
benefit the distributive and/or integrative elements of a negotiation. Again based on the work
of Bazerman and Neale (1992),13 we offer a number of these strategies. These strategies should
be thought of as tools. No one tool is perfect for every job. Some jobs require that a number of
different tools be used simultaneously, while other jobs require that the tools be used sequen-
tially. The entrepreneur needs to make his or her own decision as to which strategies should be
used and when. This may not be known in advance, and the entrepreneur might experiment
with different strategies to get an idea of which ones will work best for the current negotiation.
Strategy 1: Build Trust and Share Information As has been discussed, the best nego- tiated outcome likely arises from integration, where the parties find mutually beneficial
trade-offs. To find them requires both parties to have information about each other’s under-
lying issues and the relative importance of those issues. Although providing information is
beneficial to integration, it can be detrimental to the entrepreneur in distributing benefits if
the other party has kept hidden his or her own preferences (e.g., the other party is aware of
the entrepreneur’s reservation price but the entrepreneur is unaware of the other party’s
reservation price). Therefore, releasing information requires trust—a belief that the other
party will not act opportunistically to the detriment of the entrepreneur.
Building trust is an important aspect of negotiation and is important for the ongoing re-
lationship if an agreement is reached. One way to start this process is to share some infor-
mation with the other party, such as the relative importance of a particular issue (not one’s
reservation price). The other party may reciprocate by also sharing information, as part
of an incremental process of building trust. If possible, the entrepreneur should assess
the other party’s trustworthiness (maybe by investigating the other party’s previous rela-
tionships). If the other party appears to be untrustworthy, then the worst outcome for the
entrepreneur would be that an agreement is reached, because a relationship with an untrust-
worthy partner can be detrimental to the long-run performance of the firm.
Strategy 2: Ask Lots of Questions Asking questions provides an opportunity to learn more about the preferences of the other party, because this information is the foundation for
finding the trade-offs necessary for integrative agreements. Even if the other party does not
answer certain questions, the nonanswer itself might provide some information. For exam-
ple, an entrepreneur negotiating an exclusive license agreement could ask the potential
licensee, “How much would it cost you to get out of your current contract with firm YY to
free yourself up to license our technology?”
Strategy 3: Make Multiple Offers Simultaneously Relationships are rarely defined by one dimension, and therefore there can be numerous possible offers based on combinations
of different levels on different dimensions. Recognizing this, the entrepreneur can simulta-
neously make multiple offers. By determining which offer is the closest to being accept-
able, the entrepreneur can infer which issues are of greatest importance to the other party.
This information is valuable in reaching an integrative agreement. It also sends a signal to
the other party that the entrepreneur is flexible.
Strategy 4: Use Differences to Create Trade-Offs That Are a Source of Mutually Beneficial Outcomes Differences between the entrepreneur and the other party in ex- pectations, risk preferences, and time preferences all provide opportunities to reach an in-
tegrative agreement. We can investigate these differences in the context of an entrepreneur
negotiating a license agreement. One difference could be in expectation—the entrepreneur
432 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
expects the introduction of the licensed technology into the other party’s product to in-
crease sales more substantially than the other party expects. This difference in expectation
could be the basis for an integrative agreement. For example, both parties would prefer
to have a lower “up-front” fee for the technology and a greater royalty percentage. Both
parties perceive that they do better based on their expectations of sales.
A similar license agreement would be mutually beneficial when the entrepreneur has
less risk aversion than the other party—that is, when the entrepreneur is more willing to
give up a certain gain from the up-front fee for a greater, but uncertain, stream of revenue
from an increased royalty payment. Alternatively, differences in time preference could lead
to the preceding negotiated license agreement. The entrepreneur prefers to accept less now
for more later, whereas the licensee is prepared to pay more later, when the income from
the license is generated.
C H A P T E R 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES 433
IN REVIEW
S U M M A R Y
In this chapter we explored alternate means by which an entrepreneur can grow his or
her business. Franchising was discussed as a means of new entry that can reduce the
risk of downside loss for the franchisee and also as a way that an entrepreneur can ex-
pand his or her business by having others pay for the use of the business formula. For
the franchisee, the advantages of franchising are that he or she enters into a business
with an accepted name, product, or service; has access to managerial assistance pro-
vided by the franchisor; receives up-front support that could save the entrepreneur sig-
nificant time and possibly capital; has access to extensive information about the market;
and has other operating and structural controls to assist in the effective management
of the business. However, there are a number of potential disadvantages, which usually
center on the inability of the franchisor to provide the services, advertising, and location
that were promised.
For the franchisor, the primary advantage of franchising is that he or she can ex-
pand the business quickly, using little personal capital. But the franchisor also incurs
certain risks in choosing this expansion alternative. In some cases, the franchisor may
find it very difficult to locate quality franchisees. Poor management, in spite of all the
training and controls, can still cause individual franchise failures, and these can reflect
negatively on the entire franchise system. As the number of franchises increases, the
ability to maintain tight controls becomes more difficult.
Entrepreneurs can also achieve growth through joint ventures. The effective use of
joint ventures as a strategy for expansion requires the entrepreneur to carefully appraise
the situation and the potential partner(s). First, the entrepreneur needs an accurate
assessment of the other party to best manage the new entity in light of the ensuing re-
lationship. Second, there needs to be symmetry between the two (or more) firms in
terms of “chemistry” and the combination of their resources. Third, expectations of
the results of the joint venture must be reasonable. Far too often, at least one of the
partners feels that a joint venture will be the cure-all for other corporate problems.
Expectations of a joint venture must be realistic. Finally, the timing must be right.
Another way the entrepreneur can expand the venture is by acquiring an existing
business. For an entrepreneur, there are many advantages to acquiring an existing
business, such as gaining access to an established image and track record, familiar
location, established distribution and resource channels, and knowledgeable and
skilled employees. Besides, the cost of an acquisition can be cheaper than other mech-
anisms for growth. However, history suggests that acquisitions have only a marginal
success record. Entrepreneurs seem to be overly confident about their ability to
achieve envisioned synergies, integrate organizational cultures, and retain key employ-
ees. After balancing the pros and cons of the acquisition, the entrepreneur needs to
determine a fair price for the business.
Mergers and leveraged buyouts are other ways that entrepreneurs can grow their
businesses. An essential skill for all these alternatives is the ability of the entrepreneur
to negotiate. Good negotiation involves two tasks. The first task involves determining
how the benefits of the relationship are going to be distributed between the parties.
The second task is exploring the mutual benefits that can be gained from the relation-
ship. To negotiate in a way that maximizes benefits requires the entrepreneur to use
information about one’s own preferences and those of the other party to create an
outcome that is mutually beneficial. This requires an initial assessment of oneself and
the other party and the use of strategies to elicit more information during the negoti-
ation interactions to better inform those initial assessments. To these ends, this chapter
offered four important assessments an entrepreneur should make and four strategies
that can be used to achieve a successful negotiation.
R E S E A R C H T A S K S
1. Find information about three joint ventures that were failures, and be prepared to
discuss the underlying reasons for the failure in each case.
2. Search on the Internet for franchises for sale. Choose three. What commonalities are
there across the businesses and the information provided? What differences are
there? For one of these businesses, obtain all franchise information. For this business,
what are the benefits of being a franchisee rather than setting up an independent
business? What are all the associated costs of being a franchisee for this business?
3. Interview three franchisees to better understand their relationship with the
franchisor.
4. Find three types of business license agreements (only one of these should be a
software license agreement). In what ways are these license agreements the same
and in what ways are they different? Why have these companies decided to
license their product or technology rather than simply sell it?
5. Find three reports of acquisitions that were unsuccessful. Why were these
acquisitions deemed unsuccessful?
C L A S S D I S C U S S I O N
1. Being a franchisor seems to be a mechanism for growth, but what are the growth
prospects for entrepreneurs who are franchisees? Isn’t the entrepreneur limited
in his or her ability to pursue all the different types of growth strategies? Is being
a franchisee simply substituting one type of employment for another type of
employment? How can a franchisee grow his or her business(es)?
2. Recently the Chinese government has been encouraging foreign firms to enter
into joint venture relationships with local (Chinese) firms. What are the benefits
to the Chinese economy from these joint venture relationships? What are the
benefits to the local Chinese firm? What are the benefits to the foreign firm?
What is the impact of the joint venture on the foreign firm’s domestic economy?
434 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
�
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3. Identify a local franchise in your area, and determine where the competitors are
located and where other franchises from the same organization are located.
Evaluate the existing potential for the franchise.
4. Why are there so many different techniques for determining the worth of a firm? In
any given situation, is there one “right answer” for a company’s value? What effects
do your answers to these questions have on the entrepreneur making an acquisition?
S E L E C T E D R E A D I N G S
Bazerman, Max H.; and Jared R. Curhan. (2000). Negotiation. Annual Review of Psychology, vol. 51, no. 1, pp. 279–315.
This article focuses on the psychological study of negotiation, including the history of the negotiation game; the development of mental models on negotiation; the definition of negotiation rules based on concerns of ethics, fairness, and values; the impact of the selection of communication medium on the negotiation game; and the impact of cross-cultural issues on perception and of behavior on negotiation.
Chang, Sea Jin. (2004). Venture Capital Financing, Strategic Alliances, and the Initial Pub- lic Offerings of Internet Startups. Journal of Business Venturing, vol. 19, no. 5, pp. 721–41.
In this study the author examines how Internet start-ups’ venture-capital financing and strategic alliances affect these start-ups’ ability to acquire the resources neces- sary for growth. Using the initial public offering (IPO) event as an early-stage measure for an Internet start-ups’ performance and controlling for the IPO market environ- ment, this study found that three factors positively influence a start-up’s time to IPO: (1) the reputations of participating venture-capital firms and strategic alliance partners, (2) the amount of money the start-up raised, and (3) the size of the start- up’s network of strategic alliances.
Dietmeyer, Brian J.; and Max H. Bazerman. (2001). Value Negotiation. Executive Excel- lence, vol. 18, no. 4, p. 7.
This article advises executives on value negotiation, including developing wise trades in value creation, building trust and sharing information in an open and truthful manner, asking questions, making multiple offers simultaneously, and searching for postsettlement settlements.
George, Gerard; Shaker A. Zahra; and D. Robley Wood, Jr. (2002). The Effects of Business–University Alliances on Innovative Output and Financial Performance: A Study of Publicly Traded Biotechnology Companies. Journal of Business Venturing, vol. 17, no. 6, pp. 557–90.
Analysis of 2,457 alliances undertaken by 147 biotechnology firms shows that com- panies with university linkages have lower R&D expenses and higher levels of inno- vative output. However, the results do not support the proposition that companies with university linkages achieve higher financial performance than similar firms without such linkages.
Gulati, Ranjay; and Monica C. Higgins. (2003). Which Ties Matter When? The Contin- gent Effects of Interorganizational Partnerships on IPO Success. Strategic Management Journal, vol. 24, no. 2, pp. 127–45.
This paper investigates the contingent value of interorganizational relationships at the time of a young firm’s initial public offering (IPO). Results show that ties to prominent venture-capital firms are particularly beneficial to IPO success during cold markets, while ties to prominent investment banks are particularly beneficial to IPO success during hot markets; a firm’s strategic alliances with major pharmaceu- tical and health-care firms did not have such contingent effects.
C H A P T E R 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES 435
Holmberg, Stevan R.; and Kathryn Boe Morgan. (2003). Franchise Turnover and Failure: New Research and Perspectives. Journal of Business Venturing, vol. 18, no. 3, pp. 403–19.
This paper’s new franchise failure concept reconciles many prior, seemingly inconsis- tent study results based largely on franchisors’ surveys. Overall franchisee turnover rates are significant and appear to have increased over time.
Katila, Riitta; Jeff Rosenberger; and Kathleen Eisenhardt. (2008). Swimming with Sharks: Technology Ventures, Defense Mechanisms and Corporate Relationships. Ad- ministrative Science Quarterly, vol. 53, no. 2, pp. 295–332.
This paper focuses on the tension that firms face between the need for resources from partners and the potentially damaging misappropriation of their own re- sources by corporate “sharks.” The findings show that entrepreneurs take a risk when they need resources that established firms uniquely provide (i.e., financial and manufacturing) and when they have effective defense mechanisms to protect their own resources (i.e., secrecy and timing). [Abstract from authors.]
Kenis, Patrick; and David Knoke. (2002). How Organizational Field Networks Shape Interorganizational Tie-Formation Rates. Academy of Management Review, vol. 27, no. 2, pp. 275–94.
The authors investigate the impact of communication in field-level networks on rates of formation of interorganizational collaborative ties, such as strategic alliances and joint ventures.
Marino, Louis; Karen Strandholm; Kevin H. Steensma; and Mark K. Weaver. (2002). The Moderating Effect of National Culture on the Relationship between Entrepreneurial Orientation and Strategic Alliance Portfolio Extensiveness. Entrepreneurship: Theory & Practice, vol. 26, no. 4, pp. 145–61.
This article examines the moderating effect of national culture on the relationship between entrepreneurial orientation and strategic alliance portfolio extensiveness.
Michael, Steven C. (2003). First Mover Advantage through Franchising. Journal of Busi- ness Venturing, vol. 18, no. 1, pp. 61–81.
Franchising has been argued to be a technique used by entrepreneurs in service in- dustries to assemble resources to rapidly create large chains and gain first-mover ad- vantage. Whether and how such first-mover advantage is created is the subject of this paper. A structural equations model is specified, and empirical results from the restaurant industry support the model’s predictions that the first-mover advantage initially takes the form of a lead in the number of retail outlets, followed by a mar- ket share lead and, finally, superior profitability.
Michael, Steven C. (2000). Investment to Create Bargaining Power: The Case of Fran- chising. Strategic Management Journal, vol. 21, no. 4, pp. 497–517.
In this article the author argues that the franchisor can make investments in activities to increase its bargaining power and decrease conflict and litigation in a franchise system. Includes tapered integration, ownership of some units with franchisement of others, selection of inexperienced franchisees, and employment of a long training program.
Park, Seung H.; Roger R. Chen; and Scott Gallagher. (2002). Firm Resources as Modera- tors of the Relationship between Market Growth and Strategic Alliances in Semicon- ductor Start-Ups. Academy of Management Journal, vol. 45, no. 3, pp. 527–46.
The results of this study indicate that, in volatile markets, resource-rich firms access external resources through alliances whereas resource-poor firms are less likely to do so. However, in relatively stable markets, this relationship reverses, and resource- poor firms become more active in alliance formation.
Pearce II, John A.; and Louise Hatfield. (2002). Performance Effects of Alternative Joint Venture Resource Responsibility Structures. Journal of Business Venturing, vol. 17, no. 4, pp. 343–65.
436 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
The authors examine the relationship between the acquirers of a joint venture’s (JV’s) resources and the JV’s performance in achieving its partners’ goals in the United States. Topics covered include the impact of alternative resource responsibil- ity structures on JV performance, variation in resources received by JVs, and implica- tions for business theory development and practicing managers.
Sarkar, M. B.; R. A. J. Echambadi; and Jeffrey S. Harrison. (2001). Alliance Entrepreneurship and Firm Market Performance. Strategic Management Journal, vol. 22, no. 6/7, pp. 701–12.
This article extends entrepreneurship into the domain of alliances and examines the effect of alliance proactiveness on market-based firm performance, including the higher performance of firms that are proactive in forming alliances, and the mod- erating influences of firm size and environmental uncertainty on the relationship between alliance proactiveness and performance.
Wiklund, Johan; and Dean A. Shepherd. (2009). The Effectiveness of Alliances and Ac- quisitions: The Role of Resource Combination Activities. Entrepreneurship: Theory & Practice, vol. 33, no. 1, pp. 193–212.
Resource complementarity increases the potential value of alliances and acquisitions, but the extent to which the value potential of an alliance or an acquisition becomes re- alized depends on the ability of the firm to discover and conduct productive resource combinations. Using a sample of 319 small firms, the authors separate domestic from international alliances and acquisitions and show that alliances and acquisitions bring limited benefits to firms unless a deliberate effort is devoted to resource combination.
E N D N O T E S
1. See J. Useem, “The Start-up Factory,” Inc. (February 9, 1997), pp. 40–52; E. Matson, “He Turns Ideas into Companies—at Net Speed,” Fast Company (December 1996), p. 34; and Idealab Web site, www.idealab.com.
2. D. D. Seltz, The Complete Handbook of Franchising (Reading, MA: Addison- Wesley Publishing, 1982), p. 1.
3. L. Bongiorno, “Franchise Fracas,” BusinessWeek (March 22, 1993), pp. 68–71. 4. F. Huffman, “Under New Ownership,” Entrepreneur (January 1993), pp. 101–5. 5. W. Siegel, Franchising (New York: John Wiley & Sons, 1983), p. 9. 6. Directory of Franchising Organizations (Babylon, NY: Pilot Industries, 1985). 7. K. Rosenburg, “Franchising, American Style,” Entrepreneur (January 1991),
pp. 86–93. 8. D. J. Kaufmann and D. E. Robbins, “Now Read This,” Entrepreneur (January
1991), pp. 100–105. 9. For some different perspectives on joint ventures, see R. D. Hisrich, “Joint
Ventures: Research Base and Use in International Methods,” in Donald L. Sexton and John D. Kasarda (eds.), The State of the Art of Entrepreneurship (Boston: PWS-Kent Publishing, 1992), pp. 520–79; and J. McConnell and T. J. Nantell, “Corporate Combinations and Common Stock Returns: The Case of Joint Ventures,” Journal of Finance 40 (June 1985), pp. 519–36.
10. For a discussion of some different types of joint ventures, see R. M. Cyert, “Establishing University–Industry Joint Ventures,” Research Management 28 (January–February 1985), pp. 27–28; F. K. Berlew, “The Joint Venturer—A Way into Foreign Markets,” Harvard Business Review (July–August 1984), pp. 48–49 and 54; and Kathryn Rudie Harrigan, Strategies for Joint Ventures (Lexington, MA: Lexington Books, 1985).
11. Semiconductor Research Corporation, www.src.org/member/about/src.asp. 12. Max H. Bazerman and Margaret A. Neale, Negotiating Rationally (New York:
Free Press, 1992). 13. Ibid.
C H A P T E R 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES 437
1
To understand the planning that is necessary to allow for the effective succession of ownership or leadership in a business.
2
To examine the options in providing for an exit strategy, such as the sale of the business to employees (ESOP) or to an external source.
3
To illustrate differences in alternative types of bankruptcy under the Bankruptcy Act of 1978 (amended in 1984 and again in 2005).
4
To illustrate the rights of creditors and entrepreneurs in different cases of bankruptcy.
5
To provide the entrepreneur with an understanding of the typical warning signs of bankruptcy.
6
To illustrate how some entrepreneurs can turn bankruptcy into a successful business.
15 S U C C E S S I O N P L A N N I N G A N D S T R AT E G I E S
F O R H A RV E S T I N G A N D E N D I N G T H E
V E N T U R E
L E A R N I N G O B J E C T I V E S
439
O P E N I N G P R O F I L E
TERESA CASCIOLI
It is not often that a bankrupt small business is able to successfully recover from bank-
ruptcy. However, one such case involves Teresa Cascioli, the first woman in Canada to
become president of a major brewery. Teresa not only led Lakeport Brewing out
of bankruptcy but launched the venture into one of the more successful Canadian
microbreweries.
In 1999 Teresa was getting ready to enter law
school. She had spent 12 years with the city of
Hamilton in Ontario, Canada, as finance manager
and another two years with Philip Services Corporation. Born of immigrant Italian
parents, she had spent her entire life in the city. Before she reached law school, a group of
private investors approached her to see if she could help out at an ailing company for the
summer. The company, Lakeport Brewing, was in trouble. The beer market is extremely
competitive and had seen companies like Amstel come and go during this period.
Lakeport was now in bankruptcy with little chance of being revitalized unless it could find
a new marketing niche in a very competitive market. Teresa was a bit concerned that her
only knowledge of beer was being able to tell a good brew from a bad one. However, she
not only took on the challenge but six months later actually took control of Lakeport
after Alphacorp Holdings invested $3.1 million in equity and working capital.
Teresa describes the first years of managing the bankrupt brewery as “hell.” She had
many ups and downs during those first few years that took a great deal of energy, tena-
city, and a vision of success that would not be deterred. She had to work without senior
managers and often was in the plant seven days a week trying to learn the business. At
one point she actually spent time at night inside the bottling plant learning the business
from employees who had been working there for 20 years or more. In the early years, she
dedicated Lakeport’s excess capacity to contract manufacturing of beer, near beer, and
coolers for brand names and private labels. This was the beginning of the turnaround and
kept the company in a positive cash flow until a major relaunch strategy could be devised.
In the summer of 2002, Teresa Cascioli was beginning to develop this new strategy
for the relaunch of Lakeport’s beer products. It was time to find a profitable niche for
the Ontario-based brewery. She became aware of how many of her competitors were
constantly saturating newspapers with ads of $5.00 off. Her response to these ads was
www.lakeportbrewing.ca
always, “$5.00 off what?” As far as she was concerned, none of the beer ads had a
clear message. It seemed that they were all trying to do the same thing—outprice one
another with heavy advertising. Her response to this was a simple genius marketing
strategy in her ads: A case of 24 for $24.00. At the time, this strategy amounted to a $5
to $10 savings from what her competitors were charging. More importantly, it pro-
vided a clear message to the customer.
This low-price strategy was successful because the company had extended serious
time and effort redesigning and restructuring its infrastructure to allow for more effec-
tive cost controls. As a result, the low prices still allowed the company enough margin
to earn a profit. This strategy made Lakeport a significant player in the Ontario market.
Market share of the take-home beer market, one of the company’s primary targets,
grew from a 0.5 percent share to more than a 6 percent share by the end of 2004.
In 2004 Teresa took complete control of the company. With financing from Ven-
Growth Capital Partners and National Bank, she was able to purchase 100 percent of
the 200-employee company. Her effort in these early years was rewarded not only by
the success of the company but also by the recognition of her peers. In 2005 she was
ranked eighth in the annual list of the top 100 successful women business owners in
Canada, and she was a finalist for the Ernst & Young turnaround entrepreneur of the
year; in 2007 she was named entrepreneur of the year by Canada’s Venture Capital
and Private Equity Association. In addition to successful labels such as Brava, Steeler
Lager, and Lakeport Honey Lager, the company also kept its production lines busy by
aggressively seeking deals to pack products such as hard lemonade and ready-to-drink
mixes for other makers. In 2007 Lakeport had nine proprietary brands and was ranked
the third largest producer of beer in the very competitive Ontario market.
In June of 2005 Lakeport went public on the Toronto Stock Exchange. The result was
a successful IPO as investors responded favorably to the company and Teresa’s leader-
ship. The company’s gross revenue after the IPO continued to grow and at the end of
the third quarter of 2005 reached $39.2 million, up 86 percent from the previous year.
Market share in the take-home market from early 2005 to the end of 2006 increased
from 9 percent to more than 12 percent. This remarkable growth created such pressure
in this market that Labatt Brewing Company Ltd. decided that the only way to com-
pete was to tender an offer to buy Lakeport. In March 2007 Lakeport Brewing was sold
to Labatt for $201 million. At the time of the sale Teresa held 21.6 percent ownership
of Lakeport Brewing.
After the sale Teresa continued as a consultant to Labatt until early 2008 but has now
moved on to a new endeavor. With her substantial financial reward from the sale of
the company, Teresa, in wanting to give back to the community, established the Teresa
Cascioli Charitable Foundation. As manager of this foundation, Teresa has given back to
the community through a number of important endeavors such as an endowed chair in
entrepreneurial leadership at McMaster University (she graduated from there in 1983),
and with a $1 million donation to St. Joseph’s Hospital where she was born in 1961. She
will continue to be active in these endeavors, and given her strong entrepreneurial spirit
it is very likely that we will find Teresa in some new venture in the near future.1
440 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
A S S E E N I N BUSINESSWEEK
PROVIDE ADVICE TO AN ENTREPRENEUR ON HOW TO BEAT
FAILURE AND BE THE BOSS AGAIN
A Maryland-based company that provides installations
for conventions and special events around the country
is about to be forced into liquidation by its bank.
Meanwhile, the $30 million business, which we’ll call
”Shows ’R Us Inc.,” is facing a leadership vacuum. The
owner is in a state of denial and won’t confront just
how desperate his financial situation is. He also failed
to provide accurate financial information to his lender,
and now the bank is on the warpath. As a result, the
owner is about to lose the home he mortgaged for his
loan. Three decades’ worth of sweat and tears are
heading down the drain.
It didn’t have to get to this point. For years the
ownership has allowed the Shows ’R Us ”team” of 30
managers around the country to run their own re-
gional operations. These managers have not been an-
swerable to anyone in the chain of command, because
there is no chain of command. Each office acts as a
separate unit, responsible for its own hiring and ex-
penses, and with no requirement to get out there and
find new clients to justify its existence. Instead they de-
pend on a short burst of activity during the convention
season and put their feet up for the rest of the year.
The result has been an egregious waste of resources.
There are too many people on the payroll. Roles are
duplicated, and offices that handle events in one state
could just as easily cover two or three states with the
amount of business that’s coming in.
This was fine before the recession hit, when busi-
ness was steady and there was always income from
regular clients to cover operational and budget leaks.
Today, lousy sales are unmasking a host of problems,
and it’s entirely the owner’s fault.
SOLUTION: END DENIAL AND TAKE
BACK CONTROL
Now is the time for the owner to step up and lead.
The CEO needs to conduct a major overhaul of oper-
ations and install a chain of command where every
regional department head must be answerable only
to him. He should take a look at where each office is
located on the map, where business is coming in, and
where it isn’t. Decide which offices can be closed and
which can be merged. Slash the workforce in half.
Leadership must call an emergency meeting of all
the regional office managers, fly them to headquarters
in Maryland, and communicate the plan. The owner
needs to meet face to face with the people he
wants to keep and let them know that it’s do or die
this time. They can either comply with a new system
of accountability and accept compensation that is
tied to performance, sales, and operating within or
under a tight budget, or be out of a job in a matter
of weeks when the bank shuts down the whole
business.
I predict that morale will improve despite the fact
that some employees will face drastic pay cuts and
layoffs. Until now, employees in the regional offices
have been working without direction, with no con-
nection to headquarters, and little sense that they’re
part of a larger organization. With no performance
targets in place, ambitious workers have been flail-
ing. As it is, there is zero opportunity or motivation
to work hard. If Shows ’R Us survives this crisis, the
star performers who remain will have a chance to
make more money by bringing in more sales because
their pay will be tied strictly to productivity.
The good news is that we have already bought
Shows ’R Us some extra time with the bank, which
will continue to work with the company as long as it
sees that the business is taking serious steps to imple-
ment these changes. It won’t be easy, but it sure
beats losing everything.*
ADVICE TO AN ENTREPRENEUR
An entrepreneur friend sees the above article and
comes to you for advice:
1. I recently hired four regional managers to run my
business and have given them a lot of flexibility
to make decisions without constantly asking me.
Is this a mistake?
2. How should I communicate with these regional
managers without letting them know that I am
concerned about their decision making?
3. Isn’t the fact that these regional managers have
flexibility enough to motivate them to make
good decisions?
*Source: Reprinted from the August 4, 2009, issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Companies, Inc., “To Beat Failure, Be the Boss Again,” by George Cloutier with Samantha Marshall, www.businessweek.com/smallbiz.
441
This book has taken an in-depth view of the entire entrepreneurial process, from the idea
to a business plan and then successful funding and growth strategies. However, the entre-
preneur should also be prepared for a number of important issues that he or she may face
in later years of the operations of the venture. Just as Teresa felt it was time to move on
when a great offer was made, the entrepreneur should always be considering the future and
possible exit strategies or scenerios that may involve ending the venture. Exit strategies
consist of three important issues: planning for succession, harvesting the business, or bank-
ruptcy which will be discussed in this chapter.
EXIT STRATEGY
Every entrepreneur who starts a new venture should think about an exit strategy. A number
of possible exit strategies will be discussed in the following paragraphs. Exit strategies in-
clude an initial public offering (IPO), private sale of stock, succession by a family member
or a nonfamily member, merger with another company, or liquidation of the company. The
sale of the company could be to employees (an ESOP) or to an external source (a person or
persons, or a company). The IPO, private sale of stock, and merger options are discussed
elsewhere in this book (see Chapters 12 and 14).
Each of these exit strategies has its advantages and disadvantages, which are discussed
in the following and in Chapters 12 and 14. The most important issue is that the entrepre-
neurs have an exit strategy or plan in place at the start-up stage, instead of waiting until it
may be too late to effectively implement a desirable option.
SUCCESSION OF BUSINESS
By 2015 millions of baby boomers will be retired, causing a significant gap in the work-
force. This will be a critical issue for small businesses that are looking to find successors.
One study suggests that only about 35 percent of small and mid-size businesses have a suc-
cession plan ready to be implemented. This problem can be serious when there is a sudden
need to replace a key executive or owner of a successful company.2 In the next sections we
will focus on important issues that can help the entrepreneur plan for the succession of the
business to either a family member, an employee, or an external party. Table 15.1 provides
a summary of important tips that should be considered in any succession plan.
If there is no one in the family interested in the business, it is important for the entrepre-
neur to either sell the business or train someone within the organization to take over. Each
of these transfer possibilities is discussed in the following sections.
442 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
TABLE 15.1 Succession Planning Tips
• Allow sufficient time for the process by starting early.
• Estimate the firm’s value or hire a consultant to do it for you.
• Evaluate potential successors on their merit—not on whether they remind you of yourself.
• If family members are being considered, make sure they have the skills and motivation
necessary to carry on the business.
• Provide a transition period so that the successor can learn the business.
• Consider options such as employee stock option plans (ESOPs) for a management
succession.
• Set a date for completion of the transition and stick to it.
Transfer to Family Members
Successfully passing a business down to a family member faces tough odds. Experts esti-
mate that half such attempts fail in the transition from first- to second-generation owner-
ship. Only about 14 percent make it to the third generation. In addition, a 2007 survey of
1,000 family-owned businesses by the Family Firm Institute found that the leading causes
of failure were insufficient estate planning, failure to plan for the transition, and lack of
funds to pay estate taxes.3 An effective succession plan should also be communicated
clearly to all employees. This is particularly relevant to key personnel who may be affected
by the succession transition. The solution to minimize the emotional and financial turmoil
that can often be created during a transfer to family members is a good succession plan.
An effective succession plan needs to consider the following critical factors:
• The role of the owner in the transition stage: Will he or she continue to work full time? Part time? Or will the owner retire?
• Family dynamics: Are some family members unable to work together?
• Income for working family members and shareholders.
• The current business environment during the transition.
• Treatment of loyal employees.
• Tax consequences.
The transfer of a business to a family member can also create internal problems with
employees. This often results when a son or daughter is handed the responsibility of run-
ning the business without sufficient training. A young family member’s chances of success
in taking over the business are improved if he or she assumes various operational responsi-
bilities early on. It is beneficial for the family member to rotate to different areas of the
business to get a good perspective on the total operation. Other employees in these depart-
ments or areas will be able to assist in the training and get to know their future leader.
It is also helpful if the entrepreneur stays around for a while to act as an advisor to the suc-
cessor. As stated in Table 15.1, however, there should be a set date for when this transition
will end. Although having the entrepreneur act as an advisor during the transition stage can
be helpful to the successor in making business decisions, it is also possible that this can result
in major conflicts if the personalities involved are not compatible. In addition, employees who
have been with the firm since start-up may resent the younger family member’s assuming
control of the venture. However, if the successor works in the organization during this transi-
tion period, he or she can justify assumption of the future role by proving his or her abilities.
Transfer to Nonfamily Members
Often, family members are not interested in assuming responsibility for the business. When
this occurs, the entrepreneur has three choices: train a key employee and retain some eq-
uity, retain control and hire a manager, or sell the business outright.
Passing the business on to an employee ensures that the successor (or principal) is famil-
iar with the business and the market. The employee’s experience minimizes transitional
problems. In addition, the entrepreneur can take some time to make the transition smoother.
The key issue in passing the business on to an employee is ownership. If the entrepreneur
plans to retain some ownership, the question of how much becomes an important area of
negotiation. The new principal may prefer to have control, with the original entrepreneur
remaining as a minority owner, stockholder, or consultant. The financial capacity and mana-
gerial ability of the employee will be important factors in deciding how much ownership is
transferred. In many cases the transfer or succession of a venture can take many years to meet
C H A P T E R 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 443
all the requirements of the parties involved. Since evidence indicates that most entrepreneurs
wait until it is too late, it is important to begin the process long before there is a need to sell
or transfer the ownership of the business. The U.S. Department of Commerce indicates that
about 70 percent of successful ventures never make it to the second generation of ownership.
Ron Norelli was one of the exceptions because he realized the importance of a succes-
sion plan and hired a search firm to help him find a successor. Unfortunately, even though
he was able to hire someone who was to be groomed as his successor, the individual
decided that he did not want to take the risk. Norelli had to start the process all over again,
and this time conducted the search personally by using his network of trusted business as-
sociates. After a number of candidates were evaluated and interviewed by the staff, they
settled on a successor who would, over a number of years, buy Norelli out. Norelli went
even further by promoting one of his staff to vice president with the intent that this individ-
ual would be a good candidate to succeed his successor. The entire process took about five
years, and since he began the process early enough, it gave him the opportunity to leave the
business gradually with the confidence that it would successfully continue in the future.4
If the business has been in the family for some time and the succession to a family mem-
ber may become more likely in the future, the entrepreneur may hire a manager to run the
business. However, finding someone to manage the business in the same manner and with
the same expertise as the entrepreneur may be difficult. If someone is found to manage the
business, the likely problems are compatibility with the owners and willingness of this per-
son to manage for any length of time without a promise of equity in the business. Execu-
tive search firms can help in the search process. It will be necessary to have a well-defined
job description to assist in identifying the right person.
In nonfamily business situations, succession planning may take on a slightly different
approach. In these businesses a key senior manager or group of managers may be stepping
down or leaving the company. Since there are no family members involved, there may be a
need to consider replacements from either external or internal sources. For a partnership the
process may be clearly outlined in the partnership agreement and could simply involve a
predetermined choice. However, there could also be a need to go outside the partnership
and find a successor for the partnership. In this instance, as well as in an S corporation or
an LLC, where there may be only a small number of shareholders, the succession plan
should consider the following important issues:5
• Senior management of the company must be committed to any succession plan. The strategy must be one that everyone shares.
• It is important to have well-defined job descriptions and a clear designation of skills necessary to fulfill any and all positions.
• The process needs to be an open one. All employees should be invited to participate so that they will feel comfortable with the transition and thus minimize the possibility of
their leaving the company.
The last option is to sell the business outright to either an employee or an outsider. The
major considerations in this option are financial, which will likely necessitate the help of
an accountant and/or lawyer. This alternative also requires that the value of the business be
determined (see Chapter 12).
OPTIONS FOR SELLING THE BUSINESS
There are a number of alternatives available to the entrepreneur in selling the venture.
Some of these are straightforward, and others involve more complex financial strategy.
Each of these methods should be carefully considered and one selected, depending on the
goals of the entrepreneur.
444 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
Direct Sale
This is probably the most common method for selling the venture. The entrepreneur may
decide to sell the business because he or she wants to move on to some new endeavor or
simply decides that it is time to retire. A sale to a larger company that can infuse much-
needed capital may also provide opportunities for the company to grow and reach larger
markets. If the entrepreneur has decided to sell the business but does not need to sell imme-
diately, there are a number of strategies that should be considered early in the process.6
• A business can be more valuable if it is focused on a narrow, well-defined segment. In other words, a larger share in a small market niche can be more valuable than a smaller
share in a large market.
• The entrepreneur should concentrate on keeping costs under control and focus on higher margins and profits.
• Get all financial statements in order, including budgets and cash flow projections.
• Prepare a management documentation of the business explaining how the business is organized and how it operates.
• Assess the condition of capital equipment. Up-to-date or state-of-the-art equipment can enhance the value of a company.
• Get tax advice, since the sale of a corporation will involve different tax considerations than those for a partnership, LLC, or S corporation.
• Get nondisclosures from key employees.
• Try to maintain a good management team, allowing them to have day-to-day contact with key customers to lessen the firm’s dependence on owner–customer relations.
• There is no substitute for advance preparation and planning.
One of the important considerations of any business sale is the type of payment the
buyer will use. Often, buyers will purchase a business using notes based on future profits.
If the new owners fail in the business, the seller may receive no cash payment and possibly
may have to take back the company, which is struggling to survive.
Business brokers in some instances may be helpful, since trying to actually sell a busi-
ness will take time away from running it. Brokers can be discreet about a sale and may have
an established network to get the word around. Brokers earn a commission from the sale of
a business. Generally, these commissions are based on a sliding scale starting at about
10 percent for the first $200,000. The best way to communicate the business to potential
buyers is through the business plan. A five-year comprehensive plan can provide buyers of
the business with a future perspective and accountability of the value of the company (see
Chapters 7 and 8).
As indicated earlier, an entrepreneur may find that selling out to a larger company can
provide much-needed resources to achieve important market goals. It has also become a
more common exit strategy given that IPOs, the more traditional growth funding option,
have become more rare given the current economic environment.
Frederick Schilling, the founder of Dagoba Organic Chocolate, realized that selling his com-
pany to The Hershey Company would allow him to continue operations independent of the
parent company and, more importantly, would allow him to grow Dagoba to reach more peo-
ple. More and more organic-food entrepreneurs like Schilling are selling out to larger compa-
nies to take advantage of their strong distribution networks to reach broader audiences.7
Unlike Schilling, who remains as CEO, the role of an entrepreneur who sells to an em-
ployee or passes the business on to a family member may vary depending on the sale agree-
ment or contract with the new owner(s). Many buyers will want the seller to stay on for a
short time to provide a smooth transition. Under these circumstances, the seller (entrepreneur)
C H A P T E R 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 445
should negotiate an employment contract that specifies time, salary, and responsibility. If the
entrepreneur is not needed in the business, it is likely that the new owner(s) will request that
the entrepreneur sign an agreement not to engage in the same business for a specified number
of years. These agreements vary in scope and may require a lawyer to clarify details.
An entrepreneur may also plan to retain a business for only a specified period of time,
with the intent to sell it to the employees. This may be achieved using an employee stock
option plan (ESOP) or through a management buyout, which allows the sale to occur to
only certain managers of the venture.
Employee Stock Option Plan
Under an employee stock option plan (ESOP), the business is sold to employees over a period
of time. The ESOP establishes a new legal entity, called an employee stock ownership trust,
that borrows the money against future profits. The borrowed money then buys the owner’s
shares and allocates them to individual employees’ retirement accounts as the loan is paid off.
The ESOP has the obligation to repay the loan plus interest out of the cash flow of the busi-
ness. Typically, these ESOPs are a way to reward employees and clarify the succession
process. In addition, ESOPs result in significant stock values for employees, provided that the
company continues to succeed.
Presently there are about 11,500 ESOP companies in the United States, of which
approximately 2,500 are wholly owned by the ESOP. ESOPs account for about 50 percent
of the nation’s 10 million employees (about 10 percent of the private sector workforce). In
addition, about 330 (or 3 percent) are publicly traded companies.8
The ESOP has a number of advantages. First, it offers a unique incentive to employees
that can enhance their motivation to put in extra time or effort. Employees recognize that
they are working for themselves and hence will focus their efforts on innovations that con-
tribute to the long-term success of the venture. Second, it provides a mechanism to pay
back those employees who have been loyal to the venture, particularly during more diffi-
cult times. Third, it allows the transfer of the business under a carefully planned written
agreement. Finally, the company can reap the advantage of deducting the contributions to
the ESOP or any dividends paid on the stock.
ESOPs, due to a new law passed in 1996, are now possible for S corporations. However,
there are some important differences in the tax treatment between the C corporation and the
S corporation because of the pass-through feature of the S corporation (see Chapter 9). Be-
cause of the new tax law, the S corporation pays no income tax on the portion of the stock
owned by the ESOP.
However, in spite of its favorable attributes, the ESOP has some disadvantages. This
type of stock option plan is usually quite complex to establish. It requires a complete valu-
ation of the venture to establish the amount of the ESOP package. In addition, it raises is-
sues such as taxes, payout ratios, amount of equity to be transferred per year, and the
amount actually invested by the employees. The agreement also must specify if the em-
ployees can buy or sell additional shares of stock once the plan has been completed.
Clearly, because of the complexity of this type of plan, the entrepreneur will need the ad-
vice of experts if this type of plan is selected. A simpler method may be a more direct buy-
out by key employees of the venture.
Management Buyout
It is conceivable that the entrepreneur only wants to sell or transfer the venture to loyal, key
employees. Since the ESOP described earlier can be rather complicated and expensive, the
entrepreneur may find that a direct sale would be simpler to accomplish.
446 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
employee stock option
plan (ESOP) A two- to
three-year plan to sell the
business to employees
Management buyouts usually involve a direct sale of the venture for some predetermined
price. This would be similar to selling one’s house. To establish a price, the entrepreneur
would have an appraisal of all the assets and then determine the goodwill value established
from past revenue.
Sale of a venture to key employees can be for cash, or it can be financed in any number
of ways. A cash sale is unlikely if the value of the business is substantial. Financing the sale
of the venture can be accomplished through a bank, or the entrepreneur could also agree to
carry the note. This may be desirable to the entrepreneur in that the stream of income from
the sale would be spread out over a determined period of time, enhancing cash flow and
lessening the tax impact. Another method of selling the venture would be to use stock as
the method of transfer. The managers buying the business may sell nonvoting or voting
stock to other investors. These funds would then be used as a full or partial payment for the
venture. The reason that other investors would be interested in buying stock or that a bank
would lend the managers money is that the business is continuing with the same manage-
ment team and with its established track record.
Other methods of transferring or selling a business are through a public offering or even
a merger with another business. These topics are discussed in Chapter 14. Before determin-
ing the appropriate selling strategy, the entrepreneur should seek the advice of outsiders.
Every circumstance is different, and the actual decision will depend on the entrepreneur’s
goals. Case histories of each of the preceding methods can also be reviewed to be able to
effectively determine which option is best for the given circumstances.
BANKRUPTCY—AN OVERVIEW
Failure is not uncommon in many new ventures, especially in light of the poor global eco-
nomic environment, the wars in Iraq and Afghanistan, and the continued battle against ter-
rorism. According to the Small Business Administration, about half of all new start-ups fail
447
E T H I C S
Who should be made aware when a venture is in
trouble? How much responsibility does the entrepre-
neur have to his or her employees? How much should
you tell your banker? Should clients be made aware
of your problems? These are all legitimate yet difficult
questions that an entrepreneur may struggle with
when the business is on the verge of bankruptcy.
Some may feel that their only responsibility is to
their family and themselves. Trying to get out of the
dilemma with the least effect on your personal repu-
tation and financial well-being could in fact make
matters worse. Ethically and morally the entrepre-
neur is the leader of the organization, and trying to
avoid responsibility will not rectify the situation.
In fact, there is evidence to indicate that involving
your employees, banker, or other business associates
can actually improve matters. Employees may take
pay cuts or stock options to stay on with the company
and try to turn the business around. Bankers can be
your financial best friend and can recommend ways to
save money and generate more cash flow. Your clients
and suppliers can also support turnaround efforts by
helping to provide needed cash during the crisis. One
example was an entrepreneur who ran out of cash to
produce a product being sold by a large supermarket
chain. A meeting with the important client that re-
vealed the situation (brought on by a competitor’s
lawsuit that was settled) led to a simple solution. The
supermarket appreciated the honesty of the entrepre-
neur and agreed to prepay for all orders so that there
would be sufficient cash to produce the product.
The entrepreneur needs to consider the past ef-
forts of employees who made him or her successful in
the first place. Thus, the best solution is participation.
Get help rather than taking the selfish and perhaps
immoral alternative. Honesty is the best strategy.
INVOLVING EMPLOYEES, BANKERS, AND BUSINESS ASSOCIATES
IN THE PROBLEM
in their first years. The failures are personally painful for the entrepreneur and too often
could have been prevented if the entrepreneur had paid more attention to certain critical
factors in the business operation. It is important to understand the issues involved in bank-
ruptcy since it does occur and there may even be an opportunity to use the bankruptcy op-
tions to get the company back on solid financial ground.
Prior to a recent tightening of the bankruptcy laws by Congress in 2005, bankruptcies
were running at about 1.6 million per year. In 2006 total filings dropped to about 618,000,
a definite reflection of the new laws. Business filings represented about 20,000 of this to-
tal. However, it should be noted that many of the nonbusiness filings could be failed pro-
prietorships, partnerships, or home businesses. Since the recent economic crisis in 2008
and 2009, total filings have again jumped to more than 1.1 million, of which about 44,000
were business filings. It is also important to understand that both business and nonbusiness
bankruptcy filings are divided by chapter filings, which will be explained in more detail later.
The most common type of business bankruptcy is Chapter 7, or liquidation, which ac-
counted for about 69 percent of the total in 2008. Chapter 11 bankruptcy provides an op-
portunity for a business to reorganize, prepare a new business plan (acceptable to the
courts), and then, with time and achievement of new goals, to return to normal business op-
eration. These bankruptcies represented about 19 percent of all business filings in 2008.
The remaining business bankruptcies (about 12 percent) are Chapter 13 filings, which
allow creditors to be repaid in an agreed-upon installment plan.9
Bankruptcy is a term that has been on the minds of many entrepreneurs in the past cou-
ple of years, as businesses face a weak economy, increased competition, and rising costs of
doing business. As stated before, bankruptcy may not always mean the end of a business
since it can offer the entrepreneur an opportunity to reorganize under Chapter 11 or merge
with another company. The results of each bankruptcy filing can be quite distinct because of
the nature of the business or the uniqueness of an industry. Some of the following examples
describe the possible mix of results or experiences that can occur from a bankruptcy filing.
Although a Chapter 11 filing is designed to allow a company to reorganize and then
emerge with its operations again, there have been some serious concerns given the new
restrictions signed into law in 2005. The Sharper Image filed for Chapter 11 bankruptcy in
February 2008. Its intent was to close 90 of its 184 stores to save significant operating
costs. However, because the new law has lessened the time that Chapter 11 firms can
remain under court control, the management of The Sharper Image felt that there was not
enough time to finance the restocking of the remaining stores, so the company instead
chose liquidation to retain some value in the assets. Other retailers such as Wickes Furni-
ture, Whitehall Jewelers, Levitz, and Bombay Company have had similar experiences. It is
apparent that the new time restrictions have been particularly harsh to retailers.
In 2005 Jeff Yarbrough filed for Chapter 13 bankruptcy after his restaurants in Dallas
failed. In wanting to share his experiences and to explain that there was no shame in bank-
ruptcy, Jeff described how he survived. Since filing for bankruptcy he worked three jobs to
provide for his family as well as pay off the debt. He is now running his own public rela-
tions firm and also brokering commercial leases, which has allowed him to pay off the debts
from his failed restaurants. His biggest lesson and response to entrepreneurs is to avoid ex-
tensive debt at any cost.10
In February 2004 disaster struck for 72 franchise stores when Ground Round Grill & Bar
announced that it was filing for bankruptcy. The franchise stores were owned by local propri-
etors under a license from the chain. The company also owned 59 restaurants. Founded in
1969, the restaurant had been a pioneer in the casual dining industry but now was faced with
debt to unsecured creditors of between $10 million and $50 million. Sell-offs of a number of
the restaurants had provided some funds, but any ability to survive the bankruptcy hit a snag
448 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
when financing was delayed and the company defaulted on its loan payments. The franchisees,
however, made some quick and innovative decisions and decided to organize themselves into
a cooperative. With this new organization they were able to raise some internal and external
funds to buy the brand from the bankruptcy court. As of early 2009 the cooperative operates 46
of the remaining restaurants from the original 72 that existed at the time of the declared bank-
ruptcy. The new business model of a cooperative seems to be working as a number of the orig-
inal franchise owners have now opened new restaurants.11
Bankrate is one of a few Internet stocks that were able to survive the dot-com bubble
burst. After an IPO at $13 per share in May 1999, the stock reached a low of $1 per share
in August 2002. Since that low point, the company has made a complete turnaround, pri-
marily due to the leadership of Elizabeth DeMarse. The company Web site lists compara-
tive rate tables and fee information on 100 financial products such as mortgages, credit
cards, auto loans, and money markets. Most of its revenue, however, is accumulated from
advertising on the site. Now under new leadership, the company has reached new profit
milestones in 2008 (reported net income of over $20 million). It has also enhanced its prod-
uct line with a network of companies such as Interest.com, Mortgage-calc.com, Nation-
wide Card Services, and Savingforcollege.com.12
Some lessons that can be learned from those who have experienced bankruptcy are as
follows:
• Many entrepreneurs spend too much time and effort trying to diversify in markets where they lack knowledge. They should focus only on known markets.
• Bankruptcy protects entrepreneurs only from creditors, not from competitors.
• It’s difficult to separate the entrepreneur from the business. Entrepreneurs put everything into the company, including worrying about the future of their employees.
• Many entrepreneurs do not think their businesses are going to fail until it’s too late. They should file early.
• Bankruptcy is emotionally painful. Going into hiding after bankruptcy is a big mistake. Bankruptcy needs to be shared with employees and everybody else involved.
As the preceding examples indicate, bankruptcy is serious business and requires some im-
portant understanding of its applications. The Bankruptcy Act of 1978 (with amendments
added in 1984 and 2005) was designed to ensure a fair distribution of assets to creditors, to
protect debtors from unfair depletion of assets, and to protect debtors from unfair demands
by creditors. The Bankruptcy Act provides three alternative provisions for a firm near or at a
position of insolvency. The three alternative positions are (1) reorganization, or Chapter 11
bankruptcy; (2) extended time payment, or Chapter 13 bankruptcy; and (3) liquidation, or
Chapter 7 bankruptcy. All attempt to protect the troubled entrepreneur as well as provide a
reasonable way to organize payments to debtors or to end the venture.
CHAPTER 11—REORGANIZATION
This is the least severe alternative to bankruptcy. In this situation the courts try to give the ven-
ture “breathing room” to pay its debts. Usually, this situation results when a venture has cash
flow problems, and creditors begin to pressure the firm with lawsuits. The entrepreneur feels
that, with some time, the business can become more solvent and liquid to meet its debt require-
ments. However, as we have seen in the preceding example, the new time restrictions regard-
ing how long a Chapter 11 firm may continue under court control have made it particularly
difficult for firms in retailing to reorganize effectively. However, it is still in the best interests
of a company that has a chance to become solvent to seek protection under this option.
C H A P T E R 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 449
Chapter 11 bankruptcy
Provides the opportunity
to reorganize and make
the venture more solvent
Chapter 13 bankruptcy
Voluntarily allows
individuals with regular
income the opportunity
to make extended time
payments
Chapter 7 bankruptcy
Requires the venture
to liquidate, either
voluntarily or
involuntarily
A major creditor, any party who has an interest, or a group of creditors will usually pre-
sent the case to the court. Then a plan for reorganization will be prepared to indicate how the
business will be turned around. The plan will divide the debt and ownership interests into
two groups: those who will be affected by the plan and those who will not. It will then spec-
ify whose interests will be affected and how payments will be made.
Once the plan is completed, it must be approved by the court. All bankruptcies are
now handled by the U.S. Bankruptcy Court, whose powers were restructured under the
Bankruptcy Amendments and Federal Judgeship Act of 1984. Approval of the plan also
requires that all creditors and owners agree to comply with the reorganization plan as
presented to the courts. The decisions made in the reorganization plan generally reflect
one or a combination of the following:13
1. Extension. This occurs when two or more of the largest creditors agree to postpone any
claims. This acts as a stimulus for smaller creditors to also agree to the plan.
2. Substitution. If the future potential of the venture looks promising enough, it may be
possible to exchange stock or something else for the existing debt.
3. Composition settlement. The debt is prorated to the creditors as a settlement for any debt.
Even though only 20 to 25 percent of those firms that file for Chapter 11 bankruptcy will
make it through the process, it does present an opportunity to find a cure for any business
problems. Some of these problems are resolvable, and without the Chapter 11 protection
even these 20 to 25 percent that file would never have the opportunity to succeed. It should
also be noted that some firms that make it through the process often find that they cannot
succeed and thus either must liquidate or find a buyer.
It is generally believed by experts that one of the primary reasons companies do not suc-
cessfully come out of Chapter 11 bankruptcy is that they wait too long before filing for pro-
tection. In May 2005, Heather Antonelli filed for Chapter 7 bankruptcy. She and her mother
JoAnn had opened a furniture wholesaling business, Eminence Style, in 1996 and had
achieved steady growth in sales, reaching $3 million in 2000. Then in 2001 a buyer from
Sears ordered $2 million worth of tables. The production of this large order necessitated fi-
nancing, which Heather secured from the SBA, the Bank of America, and friends and fam-
ily. She found a manufacturer in Hungary and made the one-third deposit and budgeted the
rest of the money for the final payment. Unfortunately, the value of the dollar took a dive
and her cost increased by one-third. Only a minimal profit was made, and then the buyer at
Sears was replaced by someone who had no interest in reordering. Competitors found
cheaper manufacturing in China, and Antonelli found she could no longer compete on
price. Customers then switched to the lower-price competitors and, as sales declined, the
Bank of America demanded payment of the full amount of the debt. All during this period
Heather still felt compelled to avoid bankruptcy and get things back on track. However, af-
ter much deliberation and with advice from a business consultant, she finally decided to shut
down the company and file for Chapter 7 bankruptcy. She now agrees that she waited too
long but, on a positive note, feels she learned some important lessons that will help her to
make better decisions in the future.14
As in Heather’s case, entrepreneurs have a tendency to ignore the warning signs of bank-
ruptcy and hold on until there is an emergency, such as running out of cash. Recognizing
the signals may give an entrepreneur the opportunity to develop a strategy or plan.
Surviving Bankruptcy
The most obvious way to survive bankruptcy is to avoid it altogether. However, since bank-
ruptcy is becoming such a common occurrence, it may be helpful for the entrepreneur to
450 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
have a plan should he or she find it necessary to declare bankruptcy. Some suggestions for
survival are listed here:
• Bankruptcy can be used as a bargaining chip to allow the entrepreneur to voluntarily restructure and reorganize the venture.
• File before the venture runs out of cash or has no incoming revenue so that expenses not protected by bankruptcy can be paid.
• Don’t file for Chapter 11 protection unless the venture has a legitimate chance of recovery.
• Be prepared to have creditors examine all financial transactions for the last 12 months, seeking possible debtor fraud.
• Maintain good records.
• Understand completely how the protection against creditors works and what is necessary to keep it in place.
• If there is any litigation in existence, transfer it to the bankruptcy court, which may be a more favorable forum for the entrepreneur.
• Focus efforts on preparing a realistic financial reorganization plan.
Following some of these suggestions and being prepared should bankruptcy be neces-
sary is the best advice that anyone could give to an entrepreneur. Preparation will prevent
unfavorable conditions and could increase the likelihood of successfully coming out of
bankruptcy.
451
A S S E E N I N BUSINESSWEEK
ELEVATOR PITCH FOR nPOWER PERSONAL ENERGY GENERATOR
Your former partner, who has been a very successful
investor in start-ups, has called you to ask if you are
aware of any good investments. He just cashed out
of a very profitable sale of one of his companies and
has funds to reinvest. You know he likes to hike and
thought that after learning about the following start-
up, this may be a good option to propose to his for-
mer partner. What do you think?
Lugging a stash of fresh batteries isn’t something
Aaron LeMieux wanted to do while hiking the Ap-
palachian Trail. He had no alternative back in 1996,
but he hopes he’s got one for hikers, runners, and
even walkers. It’s called the nPower Personal Energy
Generator. The 9-oz., 9-in.-long cylinder harvests ki-
netic energy from the human stride and turns it into
2.5 watts of electricity, enough for an iPod, cell phone,
or other gadgets. LeMieux invented the generator af-
ter convincing his wife that he should quit his job as a
management consultant in Cleveland. He then “emp-
tied out the savings account,” netting $20,000. After
three days of tinkering in his basement, the mechanical
engineering graduate finished a prototype. In 2007,
he formed Tremont Electric, in Tremont, Ohio, with
himself as CEO. He’s now selling the product for
$149 through Tremont’s Web site, greennpower.com.
LeMieux, 34, didn’t get this far on his savings alone:
He’s raised $135,000 from friends and family and a
$55,000 loan from Cuyahoga County. And he’s trying
to bring in $1.5 million from government agencies
and venture capitalists. He and his one full-time and
seven part-time employees aren’t paid. The gen-
erator, which is manufactured in Cleveland, may be
pricey. But it means no more batteries to throw out
or dead devices while you're away from a recharger
too long.*
*Source: Reprinted from the July 21, 2009, issue of BusinessWeek by special permission, copyright © 2009 by The McGraw-Hill Companies, Inc., “America’s Most Promising Startups: Tremont Electric,” by Rachel Z. Arndt, www.businessweek.com/smallbiz.
CHAPTER 13—EXTENDED TIME PAYMENT PLANS
As of October 17, 2005, the ability of an entrepreneur to file for a Chapter 7 bankruptcy is
now more difficult. The reforms in the Bankruptcy Code that were signed into law in April
2005 are based on the argument that a person should be obligated to repay some of his or
her debt (Chapter 13 bankruptcy); therefore, these reforms make it more difficult to walk
away from all debt by filing for Chapter 7 bankruptcy. Under this new law, individuals are
required to obtain credit counseling within six months of filing and to take a means test to
ascertain if they are eligible for either Chapter 7 or Chapter 13 bankruptcy. The means test
states that individuals may not file for Chapter 7 bankruptcy if their income is at or above
the state income median.
Under Chapter 13 bankruptcy, the individual creates a five-year repayment plan under
court supervision. In each case, a court-appointed trustee receives money from the debtor
and then is responsible for making scheduled payments to all creditors. This reform is more
favorable to creditors than the old law. The only problem is that, according to the Bank-
ruptcy Institute, about two of every three Chapter 13 filers ultimately fail to meet their
planned obligations, thus resulting in a Chapter 7 filing.
The future effects of these reforms are still unknown. There are some who argue that this
new law will stifle entrepreneurial activity. On the other hand, creditors have long been the
losers under the old law since it was so easy for individuals to file a Chapter 7 bankruptcy
and eliminate all their debt.15
CHAPTER 7—LIQUIDATION
The most extreme case of bankruptcy requires the entrepreneur to liquidate, either volun-
tarily or involuntarily, all nonexempt assets of the business.
If the entrepreneur files a voluntary bankruptcy petition under Chapter 7, it constitutes
a determination that his or her venture is bankrupt. Usually, the courts will also require a
current income and expense statement.
Table 15.2 summarizes some of the key issues and requirements under the involuntary
bankruptcy petition. As the table indicates, an involuntary bankruptcy can be very complicated
and can take a long time to resolve. However, liquidation is in the best interests of the entrepre-
neur if there is no hope of recovering from the situation.
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Number and Claims Rights and Duties
Requirements of Creditors of Entrepreneur Trustee
Debts are not being paid as they become due.
Custodian appointed within 120 days of filing petition.
Considered insolvent when fair value of all assets is less than debts. Called a balance sheet test.
Elected by creditors. Interim trustee appointed by court.
Becomes by law owner of all property considered nonexempt for liquidation.
Can set aside petitions; transfer of property to a creditor under certain conditions.
Damages may be recovered if creditor files in bad faith.
If involuntary petition is dismissed by court, costs, fees, or damages may be awarded.
Must file a list of creditors with courts. Must file a current income and expense statement.
If 12 or more creditors, at least 3 with unsecured claims totaling $5,000 must sign petition.
If fewer than 12 creditors, 1 creditor whose unsecured claim is at least $5,000 must sign the petition.
A proof of claim must be filed within 90 days of first meeting of creditors.
TABLE 15.2 Liquidation under Chapter 7 Involuntary Bankruptcy
voluntary bankruptcy
Entrepreneur’s decision to
file for bankruptcy
involuntary bankruptcy
Petition of bankruptcy
filed by creditors without
consent of entrepreneur
STRATEGY DURING REORGANIZATION
Normally, reorganization under Chapter 11 or an extended payment plan under Chapter 13
takes a significant amount of time. During this period, the entrepreneur can speed up
the process by taking the initiative in preparing a plan, selling the plan to secured cred-
itors, communicating with groups of creditors, and not writing checks that cannot be
covered.
The key to enhancing the bankruptcy process is keeping creditors abreast of how the
business is doing and stressing the significance of their support during the process.
Improving the entrepreneur’s credibility with creditors will help the venture emerge
from financial difficulties without the stigma of failure. But trying to meet face to face
with groups of creditors usually results in turmoil and ill will, so these meetings should
be avoided.
Bankruptcy should be a last resort for the entrepreneur. Every effort should be made to
avoid it and keep the business operating.
KEEPING THE VENTURE GOING
We’ve already noted in this chapter’s opening profile that not all bankruptcies have unfa-
vorable endings. Teresa Cascioli, CEO of Lakeport Brewing, has led the emergence of her
company from Chapter 11 bankruptcy to its current position as a formidable player in the
Canadian beer market.
Any entrepreneur who starts a business should pay attention to, as well as learn from,
the mistakes of others. There are certain requirements that can help keep a new venture go-
ing and reduce the risk of failure. We can never guarantee success, but we can learn how to
avoid failure.
Table 15.3 summarizes some of the key factors that can reduce the risk of business fail-
ure. The entrepreneur should be sensitive to each of these issues regardless of the size or
type of business.
Many entrepreneurs have confidence in their abilities, which is necessary for them to
be successful in their field. This confidence allows them to meet changing market condi-
tions by implementing new strategies and directions for their firms to achieve future suc-
cess where others may have failed. Two examples of this approach are Eli and Sheri
Gurock and Nathaniel Bernier. Eli and Sheri Gurock saw two big-name toy stores close
their doors in their Massachusetts community. They believed that they could be success-
ful with a community toy store by including a baby section that offered a wide variety of
baby clothes and necessities. Their strategy was that expectant parents who shopped the
store (named Magic Beans) would leave with the idea that this was also a great place to
buy toys. In addition, even though toy sales tended to be very seasonal, sales of the baby
necessities would create a good business environment all year long. Emphasizing them-
selves as a community business that had excellent follow-through service during and
C H A P T E R 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 453
TABLE 15.3 Requirements for Keeping a New Venture Afloat
• Avoid excess optimism when the business appears to be successful.
• Always prepare good marketing plans with clear objectives.
• Make good cash projections and avoid capitalization.
• Keep abreast of the marketplace.
• Identify stress points that can put the business in jeopardy.
after the sale has led to an expansion to three stores, an effective Web site, and sales in
the seven figures.16
Nathaniel Bernier was the owner of Wild Rufus Records in the seaside town of Camden,
Maine. He found that CD sales were declining rapidly not only in his store but nationally.
A local Wal-Mart added to the problem by increasing its music section. Bernier decided,
rather than try to compete in CD sales, he needed to change his strategy before he found
himself bankrupt. His solution was to focus on selling old technology—vinyl records—
bundled with pass codes allowing customers to download MP3 versions of the same song.
He believed that this offered customers the best of both worlds, a rich analog sound of vinyl
for home use and a digital version they could take anywhere. His unique strategy has re-
sulted in an increase of sales of 100 percent over the last year.17
Both entrepreneurs in these examples recognized the need to develop different strategies
or face failure. In the first case we see the need to develop a unique mix of products that
would help build a strong store image. In the second case the entrepreneur was faced with
ultimate failure unless he could find a unique marketing strategy to increase sales and prof-
its. We saw in Chapter 8 of this textbook the importance of market planning to help prepare
for situations such as those described.
Good cash projections are also a serious consideration for the entrepreneur. Cash flow is
one of the major causes for an entrepreneur to have to declare bankruptcy. Thus, in preparing
cash projections, entrepreneurs should seek assistance from accountants, lawyers, or a federal
agency such as the Small Business Administration. This may prevent the situation from
reaching the point where it is too late for any hope of recovery.
Many entrepreneurs avoid gathering sufficient information about the market (see Chap-
ter 7 of this textbook). Information is an important asset to any entrepreneur, especially
regarding future market potential and forecasting the size of the immediate attainable mar-
ket. Entrepreneurs will often try to guess what is happening in the market and ignore the
changing marketplace. This could spell disaster, especially if competitors are reacting more
positively to the market changes.
In the early stages of a new venture, it is helpful for the entrepreneur to be aware of
stress points, that is, those points when the venture is changing in size, requiring new sur-
vival strategies. Early rapid rises in sales can be interpreted incorrectly so that the venture
finds itself adding plant capacity, signing new contracts with suppliers, or increasing inven-
tories, resulting in shrinking margins and being overleveraged. To offset this situation,
prices are increased or quality weakened, leading to lower sales. This becomes a vicious
circle that can lead to bankruptcy.
Stress points can be identified based on the amount of sales. For example, it may be pos-
sible to recognize that sales of $1 million, $5 million, and $25 million may represent key
decision marks in terms of major capital investment and operational expenses such as hir-
ing new key personnel. Entrepreneurs should be aware of the burden of sales levels on
capital investment and operational expenses.
WARNING SIGNS OF BANKRUPTCY
Entrepreneurs should be sensitive to signals in the business and the environment that may
be early warning signs of trouble. Often, the entrepreneur is not aware of what is going on
or is not willing to accept the inevitable. Table 15.4 lists some of the key early warning
signs of bankruptcy. Generally, they are interrelated, and one can often lead to another.
For example, when management of the financial affairs becomes lax, there is a tendency
to do anything to generate cash, such as reducing prices, cutting back on supplies to meet
orders, or releasing important personnel such as sales representatives. A new office
454 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
furniture business catering to small or medium-sized businesses illustrates how this can
happen. Top management of the firm decided that moving merchandise was its top priority.
Sales representatives earned standard commission on each sale and were free to reduce
prices where necessary to make the sale. Hence, without any cost or break-even awareness,
sales representatives often reduced prices below direct costs. They still received their com-
missions when the price charged was below cost. Thus, the venture eventually lost substan-
tial amounts of money and had to declare bankruptcy.
When an entrepreneur sees any of the warning signs in Table 15.4, he or she should im-
mediately seek the advice of a CPA or an attorney. It may be possible to prevent bankruptcy
by making immediate changes in the operation to improve the cash flow and profitability
of the business. Turnaround strategies are discussed later in this chapter.
STARTING OVER
Bankruptcy and liquidation do not have to be the end for the entrepreneur. History is full of
examples of entrepreneurs who have failed many times before finally succeeding.
Gail Borden’s tombstone reads, “I tried and failed, and I tried again and succeeded.”
One of his first inventions was the Terraqueous Wagon, which was designed to travel on
land or water. The invention sank on its first try. Borden also had three other inventions that
failed to get patents. A fourth invention was patented but eventually wiped him out because
of lack of capital and poor sales. However, Borden was persistent and convinced that his
vacuum condensation process, giving milk a long shelf life, would be successful. At 56,
Borden had his first success with condensed milk.
Over the years, other famous entrepreneurs have also endured many failures before
finally achieving success. Rowland Hussey Macy (of Macy’s retail stores), Ron Berger (of
National Video), and Thomas Edison are other examples of struggling entrepreneurs who
lived through many failures.
The characteristics of entrepreneurs were discussed in Chapter 3. From that chapter we
know that entrepreneurs are likely to continue starting new ventures even after failing.
There is evidence that they learn from their mistakes, and investors often look favorably on
someone who has failed previously, assuming that he or she will not make the same mis-
take again.18
Generally, entrepreneurs who have failed in their endeavors tend to have a better under-
standing and appreciation for the need for market research, more initial capitalization, and
C H A P T E R 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 455
TABLE 15.4 Warning Signs of Bankruptcy
• Management of finances becomes lax, so no one can explain how money is being spent.
• Directors cannot document or explain major transactions.
• Customers are given large discounts to enhance payments because of poor cash flow.
• Contracts are accepted below standard amounts to generate cash.
• Bank requests subordination of its loans.
• Key personnel leave the company.
• Materials to meet orders are lacking.
• Payroll taxes are not paid.
• Suppliers demand payment in cash.
• Customers’ complaints regarding service and product quality increase.
stronger business skills. Unfortunately, not all entrepreneurs learn these skills from their
experiences; many tend to fail over and over again.
However, business failure does not have to be a stigma when it comes time to seek ven-
ture capital. Past records will be revealed during subsequent start-ups, but the careful entre-
preneur can explain why the failure occurred and how he or she will prevent it in the future,
restoring investors’ confidence. As discussed in Chapter 7, the business plan will help sell
the business concept to investors. It is in the business plan that the entrepreneur, even after
many failures, can illustrate how this venture will be successful.
THE REALITY OF FAILURE
Unfortunately, failure does happen, but it isn’t necessarily the end. Many entrepreneurs are
able to successfully turn failure into success. It is one of the important historical character-
istics of entrepreneurs that we have continually identified throughout this text. Since fail-
ure can happen, there are also some important considerations that should be mentioned if
it should occur.
First and foremost, the entrepreneur should consult with his or her family. As difficult as
it is for the entrepreneur to deal with bankruptcy, it is even more so for spouses. Problems
occur because the spouse usually has no control over the venture’s operations unless it is a
family-operated business. As a result, he or she may not even be aware of any bankruptcy
threats. Thus, the first thing the entrepreneur should do is sit down with his or her spouse
and explain what is happening. This discussion will also help alleviate some of the stress of
dealing with bankruptcy.
Second, the entrepreneur should seek outside assistance from professionals, friends,
and business associates. Although not all of these people may be sympathetic, it is
usually not difficult to find individuals among these groups who will be supportive. Pro-
fessional support is also available from the Small Business Administration (SBA),
universities, the Senior Corps of Retired Executives (SCORE), and small-business de-
velopment centers.
Third, it is important to not try to hang on to a venture that will continually drain re-
sources if the end is inevitable. It is better to consider the time spent trying to save a dying
business as an opportunity cost. The time spent could be more effectively and profitably
used to either start over or do something else. If a turnaround is considered possible (see
the following discussion), it is wise to set a time frame and, if it is not accomplished in that
time frame, to simply end the venture.
BUSINESS TURNAROUNDS
We have discussed a number of turnaround examples throughout this chapter, such as the
opening profile on Lakeport Brewing, Bankrate, and Wild Rufus Records. All were faced
with declining sales and earnings that either resulted in bankruptcy or threatened bank-
ruptcy. What we have learned from successful examples of turnarounds is summarized and
discussed in the next few paragraphs.19
During a business’s life cycle it is likely that an entrepreneur will face adversity, perhaps
because of external factors (the economy; competition; changes in consumer needs; tech-
nology; or unpredictable acts such as war, terrorism, or weather); or the adversity may be
self-inflicted (that is, due to poor management). The severity of the adversity can result in
bankruptcy or in a need to refocus the business and strive for a turnaround. The process of
turnaround can take many directions, but there are some basic principles and support that
can be considered to help the entrepreneur.
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First and foremost it is important for the entrepreneur to recognize the warning signs of
bankruptcy discussed earlier and listed in Table 15.4. However, recognition of the warning
signs does not solve the problem; instead, it is the point at which the principles discussed
next should be considered. If the entrepreneur feels inadequate in dealing with any of these
warning signs, then it is recommended that he or she consult with a CPA or an attorney.
There are also a number of turnaround management consulting firms that support businesses
of all sizes. They can be identified with a simple search on the Internet. The Business
Finance and Turnaround Association can also provide support in this situation.
The first principle in any successful turnaround (reflected in all our earlier examples) is
aggressive hands-on management. Leadership in all these cases focused initial efforts on
getting out among, meeting, and communicating with all employees. This high-visibility
strategy is significant to identify the roots of any issues that are contributing to the threat of
bankruptcy or to the need to successfully resurface from bankruptcy. The entrepreneur
needs to keep all the employees energized and focused on bringing the company back to a
position of market and financial stability and then, it is hoped, moving it toward managed
growth. The entrepreneur needs to be honest and up-front with all the employees regarding
the situation to get them involved in identifying the issues that need to be addressed.
Historically, at this stage neither an absentee management nor a bunker mentality in which
management works long hours is sufficient.
The second principle is that management must have a plan. We’ve discussed many times
in this text that there are three questions that need to be addressed in any planning process
(see Chapter 8). The same questions are applicable here as part of a turnaround plan.
Step 1 in this plan is getting out into the business and trying to understand the problem, as
described in the preceding paragraph. This addresses the situation analysis, or the question,
“Where are we now?” The second question in any plan is, “Where are we going?” This is
when the plan becomes important, since goals and objectives will need to be developed to
get the company turned around. Again it is important to get everyone in the organization in-
volved in looking for opportunities to improve the company’s existing market and financial
position by cutting costs, increasing efficiencies, and improving customer service and loyalty,
as well as by pursuing strategies to increase sales.
The third and last step, or principle, in the turnaround process is action. This relates to
the third question in the planning process, which is, “How do we get there?” The plan
should involve aggressive corrective action. Time is of the essence here, either to avoid
bankruptcy or to prove to the creditors or the bankruptcy court that you can get the com-
pany back on track. At this point, a turnaround consultant may be called in to support these
actions if the entrepreneur feels inadequate.
C H A P T E R 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 457
IN REVIEW
S U M M A R Y
This chapter of the textbook deals with exit strategies that the entrepreneur will need to
consider. These decisions can involve finding a successor to the venture, selling the busi-
ness either totally or partially, or ending the venture because of bankruptcy. All of these
likely scenarios are real and common among small businesses. Thus, to be prepared the
entrepreneur should understand each of these issues and be prepared with an exit plan
before it is too late. One of the venture-ending decisions that an entrepreneur may face
is succession of the business. If the business is family owned, the entrepreneur would
likely seek a family member to succeed. Other options, if no family member is available
or interested, include transferring some or all of the business to an employee or outsider
or hiring an external person to manage the business. Direct sale of the business, em-
ployee stock option plans, and management buyouts are alternatives for the entrepre-
neur in selling the venture. These are all exit strategy options for the entrepreneur and
need to be planned for early so that crises are minimized.
Even though the intent of all entrepreneurs is to establish a business for a long
time, many problems can cause these plans to fail. Since about one-half of all new ven-
tures fail in their first four years of business, it is important for the entrepreneur to un-
derstand the options for either ending or salvaging a venture.
Bankruptcy offers three options for the entrepreneur. Under Chapter 11 of the Bank-
ruptcy Act of 1978 (amended in 1984 and again in 2005), the venture will be reorganized
under a plan approved by the courts. With this plan the entrepreneur strives to revital-
ize the financial condition of the venture and return to the market with new strategies.
Chapter 13 of the Bankruptcy Act provides for an extended time payment plan to
cover outstanding debts. The 2005 amendment to the Bankruptcy Act has made this
particular choice a more likely first option—and an option that must be exhausted be-
fore the entrepreneur is allowed to file for Chapter 7 liquidation. The courts feel that
individuals should be required to pay back some of their debt, and therefore this
amendment makes it more difficult to file for Chapter 7 liquidation. If the individual is
unable to make extended payments, then liquidation, either voluntarily or involuntar-
ily, is the final option.
Keeping the business going is the primary intent of all entrepreneurs. Avoiding ex-
cessive optimism, preparing good marketing plans, making good cash projections,
keeping familiar with the market, and being sensitive to stress points in the business
can help keep the business operating.
Entrepreneurs can also be sensitive to key warning signs of potential problems. Lax
management of finances, discounting to generate cash, loss of key personnel, lack of
raw materials, nonpayment of payroll taxes, demands of suppliers to be paid in cash,
and increased customer complaints about service and product quality are some of the
key warning signs that a firm is headed for bankruptcy. If the business does fail, how-
ever, the entrepreneur should always consider starting over. Failure can be a learning
process, as evidenced by the many famous inventors who succeeded after many failures.
R E S E A R C H T A S K S
1. Find three accounts by entrepreneurs in which they describe their experience with
poorly performing firms and the process of going through bankruptcy. In what ways
were their experiences similar? In what ways were they different? Did emotions play
a role? Did the entrepreneurs learn from the experience?
2. Interview a member of a family business and gain a deeper understanding of the
issues surrounding the management of such a business, especially those related to
succession.
3. Write an account of the emotions that you felt when someone or something
close to you was lost forever (you will not be required to present this to the class).
How did these emotions impact your ability to perform other tasks? How did
you overcome these negative emotions? To what extent do you believe that
entrepreneurs go through a similar process when their businesses fail?
458 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
�
C L A S S D I S C U S S I O N
1. If your family had a highly successful business, would succession to the next
generation (you and/or your siblings) likely be smooth, or would there be the
potential for conflict and hurt feelings? What would be a “fair” way to set up
succession?
2. Do you believe the laws should be changed to make it easier for entrepreneurs to
go into, and recover from, bankruptcy? What are the implications of your answer
for the entrepreneur, creditors, and the national economy?
3. What are the issues facing an entrepreneur in deciding whether or not the
business needs to be put into bankruptcy today?
4. The following role-plays require you to think and act as if you were the person
being described in each situation.
a. Role-play 1. One student prepares and presents a speech as if she or he is an
entrepreneur informing employees that her or his business has failed and will
not be operating from tomorrow on. The rest of the class can respond and ask
questions as if they are devoted employees upset about losing their jobs.
b. Role-play 2. In small groups, role-play the interchange between an entrepreneur
of a failed business expressing his or her negative emotions and a friend providing
advice on how to best cope with the situation.
S E L E C T E D R E A D I N G S
Avila, Stephen M.; Ramon A. Avila; and Douglas W. Naffziger. (May 2003). A Compari- son of Family-Owned Businesses: Succession Planners and Nonplanners. Journal of Financial Service Professionals, vol. 57, no. 3, pp. 85–92.
This study compares family-owned businesses that had a business succession plan with those that did not have a plan. Survey results indicate that a succession plan can affect business transition, tax planning, and the ownership structure.
Baird, Douglas G.; and Edward R. Morrison. (December 2005). Serial Entrepreneurs and Small Business Bankruptcies. Columbia Law Review, vol. 105, no. 8, pp. 2310–68.
Chapter 11 is thought to preserve the going-concern surplus of a financially dis- tressed business. However, the typical Chapter 11 debtor is a small business whose assets are rarely enough to pay tax claims. This article discusses the implications of Chapter 11 bankruptcy to those entrepreneurs who do not wish to stay with their business but instead are more interested in other opportunities.
Brodzinski, Carrie. (June 13, 2005). ESOP’s Fables Can Make Coverage Risky. National Underwriter/Property Casualty Risks & Benefits Management, vol. 109, no. 23, pp. 16, 44.
This article focuses on employee stock ownership plans (ESOPs) that invest solely in employer stock. These plans can be risky for employers and employees and are often misunderstood. Important issues related to these plans are discussed.
Davis, James. (May 2003). Staking Your Life on a Betting Future. Accountancy, vol. 131, no. 1317, pp. 54–56.
The author in this article provides a discussion of the factors that need to be con- sidered before implementing a management buyout. The article includes a discus- sion of the role of the board of directors, management presentations, and due diligence.
Hoffman, John. (Summer 2008). Planning Early Will Maximize Return from a Liquidity Event. Family Business, pp. 32–37.
C H A P T E R 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 459
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Timely planning is important during a buyout by private-equity firms, strategic buy- ers, financial buyers, or publicly traded firms. To be prepared for such an event, the author recommends including financial advisors, business associates, and a trusted network of friends to coordinate the process so that specific goals can be met in the sale negotiations.
Jackson, Kirk. (July 2005). Case Study of a Succession Plan. Journal of Financial Plan- ning, vol. 18, no. 7, pp. 39–42.
This article relates the experiences of the author in succession planning. It is a case study of the author’s family business and how various conflict situations led to deci- sions for succession of the business.
Latham, Scott. (April 2009). Contrasting Strategic Response to Economic Recession in Start-Up versus Established Software Firms. Journal of Small Business Management, vol. 47, no. 2, pp. 180–201.
Economic recession, especially among small firms, can be a significant factor in sur- vival. This study surveyed 137 software executives regarding their strategic response to the recent economic downturn. The results suggest that small firms tend to use revenue-producing strategies to combat economic recession whereas larger firms tend to pursue cost-cutting strategies.
Maddy, Monique. (2000). Dream Deferred: The Story of a High-Tech Entrepreneur in a Low-Tech World. Harvard Business Review, vol. 78, no. 3, pp. 56–69.
Monique Maddy discusses the important lessons that the failure of her start-up, Adesemi, taught her about starting a business in an emerging-market country.
Phillips, Edward A. (Winter 2006). Bankruptcy Law: Changes in Protection Make Plan- ning Critical. CPA Journal, vol. 76, no. 4, pp. 1–4.
This paper provides in-depth discussion and analysis of the impact of the new bankruptcy laws on accounting issues. The author discusses the importance of planning in the process. Each area that needs to be considered in this plan is discussed.
Shepherd, Dean A.; Evan J. Douglas; and Mark Shanley. (2000). New Venture Survival: Ignorance, External Shocks, and Risk Reduction Strategies. Journal of Business Ventur- ing, vol. 15, no. 5–6, pp. 393–410.
The authors develop a model to explain new venture failure. The theoretical model argues that risk of failure is largely dependent on the degree of novelty (ignorance) associated with a new venture—novelty to the market, novelty to the technology of production, and novelty (experience) to management.
Shepherd, Dean A.; and Andrew Zackarakis. (2000). Structuring Family Business Succes- sion: An Analysis of the Future Leader’s Decision Making. Entrepreneurship: Theory & Practice, vol. 24, no. 4, pp. 25–39.
This article examines the perception of potential family business leaders from a be- havioral economics theory perspective. The authors argue that founders should structure succession so that the future leader incurs both financial and behavioral sunk costs as well as hold the future leader to stringent performance requirements prior to the succession.
Warren, Elizabeth; and Jay Lawrence Westbrook. (February 2009). The Success of Chapter 11: A Challenge to the Critics. Michigan Law Review, vol. 107, no. 4, pp. 603–41.
Nearly all troubled companies choose Chapter 11 over Chapter 7 liquidation. Many of these firms are eliminated in the early screening and are forced into liquidation. The new regulation that shortens the time under court control has prevented many small businesses from being able to reorganize. Data indicate that small businesses were more successful in reorganizing under the old regulations than under the new stricter regulations.
460 PA RT 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
E N D N O T E S
1. See Chris Daniels, “Small-Town Beer, Big Impact,” Marketing Magazine (De- cember 19, 2005), pp. 22–24; Jennifer Morrison, “Lakeport’s Lady Boss Has That Steel City Drive,” Hamilton Spectator (October 4, 2004), p. AO1; “Lakeport Brewing Financial Results,” LexisNexis Canadian News Wire (November 10, 2005); Paul Wildie, “A Soft Spot for Would Be Entrepreneurs,” LexisNexis Canadian Report on Business (December 29, 2007), p. B2; and Peter Koven, “Labatt Snaps up Lakeport: $201 M Offer Defensive Move against Discoun- ters,” Financial Post (February 2, 2007), p. FP3.
2. McLean Robbins, “Small Companies Have Big Shoes to Fill: Proper Succession Planning Safeguards SMB’s Future Success,” LexisNexis, Employee Benefit News (April 15, 2008), pp. 15–16.
3. Family Firm Institute, www.ffi.org. 4. C. Dannhauser, “Will My Beloved Survive Me?” BusinessWeek Frontier (January
21, 1999), www.businessweek.com. 5. M. Kindley, “Grooming Your Successor,” Network World (July 22, 2002), p. 7. 6. Clyde E. Witt, “Plan Ahead, Stay Ahead,” Material Handling Management
(January 2006), pp. 33–35. 7. Shelby Scarbrough, “Sell without Selling Out,” Entrepreneur (June 2008),
pp. 19–21. 8. The ESOP Association, www.esopassociation.org. 9. See American Bankruptcy Institute’s Web site, www.abiworld.org; and
www.uscourts.gov/bankruptcystats. 10. Jeffrey Yarbrough, “Back from the Brink,” FSB: Fortune Small Business
(October 2008), p. 94. 11. Carlye Adler, “The Grand Rebound,” FSB: Fortune Small Business (February
2005), pp. 56–60; and www.groundround.com. 12. www.bankrate.com. 13. David Twomey and Marianne Jennings, Anderson’s Business Law and Legal
Environment, Standard, 20th ed. (Mason, OH: West Legal Studies, 2008), pp. 752–73.
14. Nadine Heintz, “Anatomy of a Business Decision: A Case Study,” Inc. (December 2005), pp. 59–60.
15. Lawrence S. Clark, Randall Hanson, and James K. Smith, “Bankruptcy Reform Is Here,” Journal of Accountancy 200, no. 5, (November 2005), pp. 51–59.
16. Nichole L. Torres, “Underdog Days,” Entrepreneur (April 2008), p. 94. 17. Jonathan Blum, “New Spin on Vinyl,” FSB: Fortune Small Business (March
2009), p. 28. 18. L. M. Lament, “What Entrepreneurs Learn from Experience,” Journal of Small
Business Management (1972), p. 36. 19. See W. P. Schuppe, “Leading a Turnaround,” The Secured Lender (January
2003), pp. 8–14; and W. H. Fetterman, “The Team Approach to Turnarounds,” Journal of Private Equity (Summer 2003), pp. 9–10.
C H A P T E R 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 461
6 C A S E S
C A S E 1
Turner Test Prep Co.
C A S E 2
Jim Boothe, Inventor
C A S E 3
A. Monroe Lock and Security Systems
C A S E 4
Beijing Sammies
C A S E 5
“Mamma Mia!” The Little Show That Could!
C A S E 6
The Beach Carrier
C A S E 7
Gourmet to Go
C A S E 8
Intervela d.o.o. Koper—Victory Sailmakers
C A S E 9
The Gril-Kleen Corporation
C A S E 1 0
The Winslow Clock Company
C A S E 1 1
NeoMed Technologies
C A S E 1 2
Rug Bug Corporation
C A S E 1 3
Nature Bros. Ltd.
C A S E 1 4
Amy’s Bread
C A S E 1 5
Oklahoma National Bank
C A S E 1 6
Datavantage Corporation
C A S E 1 7
Dual Pane Company
464 PA RT 6 CASES
C A S E 1 TURNER TEST PREP CO. 465
C A S E 1
TURNER TEST PREP CO.
INTRODUCTION
In the Spring of 2003, Jessica Turner felt that she had
come to a crossroads with her business. As the founder
and CEO of Turner Test Prep, a California company
specializing in preparing people for the Certified Public
Accountant (CPA) exam, she felt that she was not achiev-
ing market share and growing in the right direction. After
three years of providing prep classes to both students
and professionals, Turner had about 10 percent of the
market and was facing fierce competition from her pri-
mary rival, National Testing Services. Uncertain about
which growth direction to take, Jessica contemplated
several options.
BACKGROUND
Jessica Turner started Turner Test Prep in the summer of
1997 after graduating from Case Western Reserve Uni-
versity’s Weatherhead School of Management with a
master’s degree in accounting. She passed the CPA exam
and began applying to Big Six accounting firms. Frus-
trated after receiving several rejections, Jessica began to
consider other employment options. Her undergraduate
degree was in business, and after graduation, Jessica
worked for several years in the business office of a small
test prep company based in San Francisco. The company
prepared students who wanted to take primarily the SAT,
GRE, GMAT, MCAT, and LSAT. Although her job was
to manage the company’s business affairs, she also began
teaching math to students several nights a week. Jessica
received training from the company in teaching basic
testing skills, and she applied those skills toward teach-
ing the math portion of the exams. She received positive
feedback from her students as a conscientious and inno-
vative teacher.
Jessica felt that her experience as a teacher for the test
prep company helped her when she began studying for
the CPA exam. She knew how to study efficiently, how to
organize her notes, and how to practice for the various
sections. Jessica was one of the 25 percent of students
who passed all sections of the CPA exam on the first try.1
When contemplating what to do next, Jessica was
struck by the fact that so many of her colleagues were
unable to pass the exam. Convinced that she was not
only skilled in the accounting and finance principles but
also in knowing how to study effectively, she decided to
start her own test prep business teaching specifically to
the CPA exam. She was confident that students and pro-
fessionals wishing to become CPAs would benefit from
a full-service program that gave students full classes and
individualized attention so that they could pass the exam.
Jessica returned to California, put together a business
plan, and secured financing from a local venture capital
firm specializing in small start-ups. She decided to focus
her business and marketing efforts in the San Francisco
Bay area. On the basis of her research and the Bay
area’s concentration of different types of businesses,
Jessica estimated that there was a market of about 1,000
students a year.
THE CPA EXAM
Although people with undergraduate or graduate degrees
in accounting or business may do accounting work for a
company, becoming a CPA provides an additional certi-
fication that employers prefer. Becoming a CPA can in-
crease an accountant’s salary by 10 to 15 percent2 and is
typically necessary to secure upper-level positions. In or-
der to be certified to become a CPA, people must fulfill
the following requirements:
• Have a college or master’s degree with 24 semester
units dedicated to business-related subjects, and at
least 24 credits in accounting (a minimum of three
credits), auditing (a minimum of three credits),
business law, finance, and tax subjects;
• Pass the CPA exam;
• Have two years of work experience with a
bachelor’s degree or one year of work experience
with 150 course credits.3
The exam is offered two times a year, in May and
November. It is a grueling two-day, 15-hour event com-
prised of multiple choice, essay questions, and problem
sets. The subjects tested are: Business Law and Profes-
sional Responsibility, Auditing, Accounting and Report-
ing, and Financial Accounting and Reporting.
CPA EXAM PREP SERVICES
The CPA exam varies only slightly from state to state. In
order to study for the exam, people typically purchase
books, software, or an online course to help them pre-
pare. The materials usually provide an overview of the
tested material, study guides, and practice questions.
The online tutorials often provide more practice ques-
tions and give students timed exams so that they can
simulate actual testing conditions. Due to the amount of
material covered on the exam as well as its level of dif-
ficulty, students are advised to give themselves four
months to study.
In the San Francisco Bay area, several community
colleges offer one-week review classes to help students
prepare. These classes give students a starting point, af-
ter which they could use supplemental materials to study
on their own.
NATIONAL TESTING SERVICES
National Testing Centers (NTC) is Turner’s primary com-
petition. NTC is a national test preparation company that
has been in existence since 1962. The company focuses on
virtually every standardized test that is offered and has
programs for high school students taking the SAT, under-
graduate students taking graduate school entrance tests
(such as the GMAT, LSAT, GRE, and MCAT), and gradu-
ate students taking certification tests like the bar and CPA
exams. In addition, the company has a program designed
for international students taking the Test of English as a
Foreign Language (TOEFL) exam.
NTC is a full-service program that offers a variety of
options for students taking any of these exams. Most
courses offer the opportunity to have classroom lectures,
home-study videotapes, books, software, online tests, or
a combination of any of these options.
The CPA course does not offer live classroom ses-
sions but gives students the option of books, software,
and online testing for one or all of the areas covered on
the exam. Students also have a toll-free number that they
can call if they have questions as well as online chats
with NTC instructors to answer questions. NTC offers
students a free repeat course if they do not pass the CPA
exam and boasts a 75 percent pass rate. The course is
priced from $1,000 to $1,500, depending on which of the
services the student chooses. Many of NTC’s students
are repeaters who initially chose to study on their own
and use a book or software package. Such students are
dedicated to passing the second time they take the exam
and want the structure that the courses provide. NTC
provides a study schedule, study techniques, and infor-
mation about how to take the exam that, it boasts, can not
be found in any other course on the market.
Many of NTC’s students have also taken an NTC
course for a previous entrance exam. NTC boasts a
higher overall pass rate for all its courses than any other
test prep center in the country. People who had taken a
course for the GMAT and had passed, for example, felt
confident that they would be equally prepared for pass-
ing the CPA exam. In a survey of undergraduate students
who had taken NTC for the SAT, 85 percent said they
would take another NTC course to prepare them for a
graduate school entrance exam.
THE TURNER TESTING ADVANTAGE
Despite NTC’s success, Jessica knew that with a pass
rate of only 25 percent for first-time takers, there was a
need to provide a comprehensive program to students so
that they could pass on their first try. She devised a full-
service program that lasted for six weeks and was three
to six hours per day. She worked with accounting, fi-
nance, and law professors to design a curriculum to give
students a comprehensive approach to studying for the
exam. She hired the professors to give three live, one-
hour lectures per day, and she taught the test-taking tech-
niques and organizing skills necessary to easily assimilate
the mountains of information that students needed to
know. Jessica also provided audiotapes for students so
that they could review the lectures at home and sug-
gested that they listen to them in their cars to maximize
the use of their time. The course also included several
timed minitests for each topic and four practice essay
questions, which Jessica and her professors graded. The
responses to essays included many comments and much
feedback to give students guidance on areas to improve.
Jessica also made herself completely available to her
students. She felt that one-on-one attention was critical
to their success, and she held biweekly meetings with
each student to gauge progress and answer questions. In
addition to the meetings, students could call Jessica or
e-mail her with questions, and she promised to get back
to them within 24 hours.
Jessica held two sessions a year in March and
September, three months prior to the exams, allowing
students to continue to study on their own before the ex-
ams. She also made herself available to students after the
course to answer their questions and help them in any
way she could. Pricing her course at $1,100 per student,
she felt that she was providing her students with more of
an advantage and better preparation than any of the NTC
options. She also offered a guarantee, allowing students
to repeat the course if they did not pass the exam.
Jessica had taken a year to develop the materials and
create a marketing plan for her company. She decided to
place ads in Bay area business schools to attract students
contemplating taking the exam after graduation. She
also created flyers to be placed in the schools and asked
466 PA RT 6 CASES
C A S E 2 JIM BOOTHE, INVENTOR 467
the school administrations if she could place them in
students’ mailboxes. She introduced herself to local
businesses and tried to alert them to her program so that
up-and-coming accountants would be encouraged to
take her class if they wanted to take the CPA exam.
The first year that she ran the program she had 10 stu-
dents. Despite the small class size, students felt that they
had been well prepared for the exam and appreciated the
individual attention they received. All students passed
the exam. The second course had 45 students, 70 percent
of whom passed. The last session that she held had 105
students, and 80 percent of those students passed. Jessica
did not feel comfortable advertising her pass rate, how-
ever, because many of her students had taken the CPA
exam one or two times before and failed. She wasn’t sure
whether they passed after taking her course because of
the quality of the program or because they were bound to
pass it at some point. Jessica did some cost and revenue
estimates indicated in Exhibit 1.
SPRING 2003
By the spring of 2003, Jessica had finished teaching the
course for the May exam and was looking forward to the
September class. Although she was pleased that the num-
ber of students in each session was rising, she felt con-
cerned that she was not making enough of an impact in
the market. With only 10 percent of the market tapped,
Jessica wanted to know how to improve her marketing
and gain market share. She also wondered if she needed
to format the course differently to attract students who
did not want to attend live lectures. She had initially be-
lieved that students would benefit from a structured pro-
gram that kept them on track, but now she was not so
sure. Many times students did not come to class but
opted to listen to the tapes at home. Finally, Jessica real-
ized that in her zeal to get her business up and running
she had neglected to calculate her break-even point. How
Professor salaries (about $75 per hour 1,200 hours per year)
Office space $2,000 per month
Utilities and insurance $1,000 per month
Materials $600 per student
Printing $500 per month
Marketing $400 per month
Travel $200 per month
EXHIBIT 1 Operating Costs for Turner Testing Services
many students did Jessica need to break even, and at
what point could she recognize a profit? She realized that
these were all critical questions that needed answers to
ensure the future success of her business.
E N D N O T E S
1. www.micromash.net.
2. www.cpazone.org.
3. www.picpa.org.
C A S E 2
JIM BOOTHE, INVENTOR
Jim Boothe has invented dozens of different products in
his 25 years as an engineer to a large research and devel-
opment lab. For some time, he has been thinking of
leaving his current company and starting his own but
has never seemed to have the nerve to do so. Jim feels
that with his children grown up and on their own, now
would be a good time to start his own business.
Having been an avid bicyclist for many years, Jim had
invented an automatic derailleur for a 15-speed bike. This
derailleur can be easily attached to any bicycle. The user
does no shifting as the bicycle shifts the gears of the bicy-
cle automatically (depending on terrain) much like the au-
tomatic transmission on an automobile. Jim feels that this
invention has significant market potential, particularly
since he has observed a rapid growth in the bicycling in-
dustry. This growth has been related to Lance Armstrong’s
success in the Tour de France, increased interest in physi-
cal fitness, and technological improvements in bicycles al-
lowing for off-road travel as well as more comfort for
longer-distance riding. In his cycling club alone, the mem-
bership has doubled in the past two years and to his
knowledge is consistent with a national trend.
Jim feels that all he needs to do is to write a business
plan and submit it to his bank to obtain the estimated
$100,000 needed to get started. He is willing to support
this by taking out a second mortgage as collateral. Jim
feels that he can subcontract the manufacturing of the
derailleur and the bicycle separately; then upon receiv-
ing the items, he can complete the final installation and
fabrication functions before shipping to customers.
Jim’s wife Nora is a little skeptical about him leaving
a good job for the purpose of fulfilling one of his many
fantasies or lifelong dreams. She is the more practical of
the two and is concerned about their financial future and
the commitment that will be required of Jim in the first
468 PA RT 6 CASES
few months of the start-up. Taking a second mortgage
on the house makes her uncomfortable. She is also not
sure Jim is the entrepreneurial type.
In spite of all the concerns, Jim has prepared a busi-
ness plan that he expects to submit to his banker in the
next few days. The business plan consists of six parts: a
one-page summary of the plan, a detailed description of
his invention, forecasts of growth for the bicycle market,
a one-year profit and loss statement, a plan for the man-
ufacturing and final fabrication of the derailleur and
bicycle, and an appendix which contains surveys with
some of his friends who own ten-speed bikes.
C A S E 3
A. MONROE LOCK AND
SECURITY SYSTEMS
Ray Monroe was sitting back in his chair in his home office
trying to understand why the new venture had not made
him the rich man he thought he would be. A. Monroe Lock
and Security Systems (AMLSS) had been established
about two years ago and offered locksmithing services to
residential and commercial customers as well as automo-
bile owners in the greater Boston area. These services in-
cluded lock rekeying, lock and deadbolt installation and
repair, master key systems, emergency residential lock-
outs, foreign and domestic automobile lockouts, and win-
dow security locks. In addition, AMLSS was certified by
the Commonwealth of Massachusetts to perform alarm in-
stallation and offered a full range of alarm products.
Financial results have been relatively poor, with losses
of $6,500 in the first year and a profit of only about
$3,500 in year 2. Currently, AMLSS’s target market is
three local communities in the Boston area with similar
demographics (see Exhibit 1).
BACKGROUND
Ray Monroe is the only child of parents who were both
successful entrepreneurs. His parents are now deceased,
and Monroe received a substantial inheritance that would
satisfy any of his financial needs for the rest of his life.
Ray had been educated at a local private high school and
then at a small liberal arts college in Vermont. He was not
a great student but always seemed to get by. His summers
were usually spent at the college, taking summer courses.
Upon graduation, his father had helped him get a
job with a friend who owned a security and alarm
manufacturing business in the western part of the state.
Ray worked in various areas of the business learning a
great deal about alarms and locks. After two years there,
Ray decided that he’d prefer to be his own boss and, using
some of his inheritance, entered a special program to
learn more about the locksmith business. His intent
upon completion of the program was to start his own
lock and security business. He felt from his experience
and education that this market offered tremendous oppor-
tunities. Increased crime and residential house sales that
often required new locks offered many opportunities to
succeed in this business.
Ray did not want to offer alarm installations as part of
his new venture since he felt that they were bothersome
to install. He also knew that there were many large com-
petitors already in the alarm market that would be able to
offer products and service at much lower prices.
INDUSTRY STRUCTURE/COMPETITION
The locksmith industry was dominated by small opera-
tors, 60 percent of which consisted of an owner and one
employee. Only about 20 percent of these firms had five
or more employees.
Because of the low entry barriers, the number of
small operators had grown dramatically in the past few
years. These businesses were often operated out of the
home with no storefront and concentrated mainly on the
residential market. There were also a large number of
family-owned businesses that usually had a retail store
serving their communities for several generations of
family members. The larger operators were the most so-
phisticated in terms of service and products and relied
primarily on commercial accounts.
The Boston area was densely populated, with 160
locksmiths all advertising in the area yellow pages. In the
three communities on which AMLSS concentrated, there
were 37 other locksmiths.
PRESENT STRATEGY
Excluding alarms, Ray offered just about every lock-
smith service. His company van was used to store these
products and any necessary tools for servicing his
clients. This company van was 10 years old with a few
minor dents, but it ran quite well.
Ray had a beeper system and a cellular phone in order
to respond to customer requests. After 5 p.m., however,
Ray turned off the system and refused to take calls. Dur-
ing his operating hours he was able to respond to all
C A S E 3 A. MONROE LOCK AND SECURITY SYSTEMS 469
requests fairly quickly even if he was not in the office,
primarily because of the beeper and cellular phone. He
had tried using an answering machine, but it did not allow
him to respond to a customer fast enough, especially if
he was at a job that kept him out of the office for a num-
ber of hours. He also knew that many job requests were
emergencies and required a quick response.
During the past year, Ray had decided to advertise in
the yellow pages. He felt that with all the locksmiths
listed in the yellow pages he needed to be at the top of
the list, so he decided to use his middle name initial (for
Arthur) to form A. Monroe Locksmith and Security Sys-
tems. The yellow pages ad seemed to help business and
contributed to the $4,000 profit (see Exhibits 2 and 3 for
billing and expenses).
Ray spent a lot of his time in the office thinking of ways
to increase his business, yet to this point nothing had been
very successful. His understanding was that many of his
competitors had found that the yellow pages were the most
likely place for customers to find a locksmith. His ad iden-
tified the three communities, the services he offered, and a
telephone number. In addition, he included that he was
bonded and insured and a member of the Massachusetts
Locksmith Association. Competitors typically stressed
products and services, 24-hour emergency service, follow-
up guarantee service, being bonded and insured, and mem-
bership in the locksmith association.
Time was running out for Ray, and he was trying to
think of other businesses that he could start up. He would
often question his decision to enter the locksmith busi-
ness, but then he would quickly decide that since he didn’t
really need the money, it wasn’t a big deal. However, at
some point he felt he should try to establish himself so
he could settle down to a more routine life.
Demographics Newton Needham Wellesley
Total population 83,829 28,911 26,613
Total number of households 31,201 19,612 8,594
Percent family 66.7 73.3 76.0
Percent nonfamily 34.3 26.8 24.0
Total number of families 20,486 7,782 6,537
Number of married-couple families 17,209 6,887 5,772
Number of female householder families 2,500 728 607
Average household income $86,025 $88,079 $113,686
Education
Percent high school educated 94.5 96.4 97.6%
Percent college or higher educated 68.0 64.9 75.9%
Labor force
Percent total population employed 66.1 64.9 63.0%
Percent female population employed 62.4 56.4 53.9%
Disability
Percent with mobility or self-care disability (21–64) 10.4 9.0 6.4%
Percent with mobility or self-care disability (65 ) 31.5 28.8 21.8%
Total number of housing units 32,112 10,846 8,861
Median number of rooms 6.4 6.9 7.6
Total number of owner-occupied housing units 21,692 8,587 7,139
Total number of renter-occupied housing units 9,509 2,025 1,455
Retail industry—number of establishments (2000) 595 168 187
Service industry—number of establishments (2000) 1,077 336 1,580
EXHIBIT 1 Demographic Profile of Present Market
470 PA RT 6 CASES
C A S E 4
BEIJING SAMMIES
When Sam Goodman opened a new Sammies café in
Beijing’s Motorola Building, he cut prices by 50 percent
for the first three months in order to attract customers.
The initial period was very successful, but when he re-
turned prices to normal, sales dropped dramatically and
fell short of targets. The local store manager, when pre-
senting the figures, suggested that Goodman simply
lower the sales targets. Goodman was frustrated; the
manager had failed to address any of the issues that
were keeping customers from returning. There were
countless orders that went out with missing utensils, in
the wrong bag, or [with items] simply left out. Delivery
orders were being sent hours late or to the wrong loca-
tion. This typified Goodman’s early experience; the
market was showing interest in Beijing Sammies’s prod-
ucts but he knew that without exceptional service, good
food would not be enough. Goodman questioned whether
he could find employees who were thinkers and prob-
lem solvers and he wondered how to improve upon the
business in order to turn Beijing Sammies into a sustain-
able and profitable enterprise.
According to Goodman, face and money were the
two most important subjects. With experience as a stu-
dent and businessman in China, he knew one must ob-
serve the cultural beliefs:
Face is a huge issue here, and as the economy develops,
so is money. If one is not relevant, the other is. Once you
recognize this is crucial, it was not hard to learn. The
difficult part is incorporating it into the business. We
need to offer a superior experience in order for cus-
tomers to justify paying more. This means providing a
quality product with excellent service. It sounds easy,
but in China the concept of service is not the same as in
the West. I just can’t seem to get my employees to un-
derstand that there is a way to serve the customer while
also keeping the company’s interest at heart. It is an, “all
for us” or “all for them” mentality here.
Throughout the company’s initial years Goodman
sought to teach a service-oriented approach to his em-
ployees. In doing so, he ironically learned that face was
as much of an important issue for Beijing Sammies’s
customers as it was for its employees.
BEIJING SAMMIES
Canadian native, Sam Goodman, started Beijing Sam-
mies1 in 1997. Aside from producing food for the every-
day, walk-in customer, Sammies provided fare for com-
pany meetings, presentations, picnics, and gifts. Sammies
was open for breakfast, lunch, and dinner and delivered
all products to its customers. The menu included a selec-
tion of sandwiches, salads, bagels, brownies, cookies,
coffee, soda, and tea (Exhibit 1).
Business expenses
Selling expenses $ 9,454
Memberships (chambers of commerce and Associated Locksmiths of America) 2,490
Telephone (includes beeper and cellular) 1,920
Office expenses (materials/supplies) 1,775
Yellow pages 4,200
Other promotional expenses 600
Total expenses $20,439
EXHIBIT 3 Year Two Expenses
Source: This case was prepared by Christopher Ferrarone under the supervision of Boston College Professor Gregory L. Stoller as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
Copyright © 2003, Gregory L. Stoller. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the author.
January $ 1,200.01
February 2,260.85
March 2,777.26
April 1,748.62
May 922.20
June 1,414.12
July 1,595.18
August 1,652.37
September 2,264.64
October 2,602.19
November 4,087.37
December 1,905.80
Total $24,430.61
EXHIBIT 2 A. Monroe Monthly Billings for Year Two
(C o n ti n u e d )
E X
H IB
IT 1
471
E X
H IB
IT 1
(C o n ti n u e d )
472
C A S E 4 BEIJING SAMMIES 473
Goodman started the company with personal savings
and money borrowed from family. He opened his first
café at the Beijing Language and Culture University with
the goal of providing people with a place to “hang out”
and enjoy homemade western food.
By 2003 Beijing Sammies had five outlets [composed]
of four “deli-style” cafés and one kiosk. The stores were
traditional in terms of layout and size for fast food restau-
rants. Two Sammies cafés were 1,200 square feet, and
the other two were roughly 800 square feet each, while
the kiosk was a stand-alone structure with open seating
inside the lobby of a corporate building. All of the café
locations had enclosed seating that was maximized, as
there was no need for self-contained kitchens.
The Central Kitchen
Goodman found that revenues of the first café were
driven as much by corporate delivery orders as they
were by the local walk-in customers. This motivated
Goodman to open more cafés and a centralized kitchen
in 1998. Located in Beijing’s Chao Yang District, the
kitchen ran from 10 p.m. to 5:30 a.m. each day making
the sandwiches and baked goods for all of Sammies’s
locations. Between 5:30 and 6 a.m., trucks delivered the
goods from the kitchen to each Sammies outlet. No
cooking was done at any of the Sammies locations.
Every sandwich, cookie, and muffin was prepared,
baked, and packaged centrally. Only coffee and smooth-
ies were prepared onsite at individual retail cafés.
While the central kitchen created a number of effi-
ciencies for Beijing Sammies, what Goodman liked even
more was the quality control that it provided:
It is much easier for me to teach the kitchen staff how to
make the food correctly than it is to teach all of the em-
ployees at each location. At the kitchen I can make sure
that the product going out to all of the stores is consistent.
In the end that’s what I am striving for, to offer a consis-
tently great product with superior service. Only having
one kitchen to manage makes this task much easier.
The central kitchen not only provided Beijing
Sammies with efficiencies with ingredients, machines,
and manpower, but also allowed for larger customer
capacity at each café location and enabled the em-
ployees to uniquely focus on customer service.
THE SAMMIE
The idea behind Beijing Sammies originated from
Goodman. Moving to Hong Kong after college and sub-
sequently moving to Beijing to attend Beijing Language
and Culture University, Goodman yearned for a place to
hang out and eat a traditional sandwich or “sammie”
that reminded him of home. Three years later Beijing
Sammies was named Beijing’s #1 western food delivery
service by City Weekend magazine.
Modeled after Goodman’s version of a New York
deli, Beijing Sammies’s staple is the “sammie.” Each
sammie started with homemade bread made every
night at Sammies’s kitchen. Customers could order
from a menu of standard sammies or could create their
own. Goodman found the pre-set menu best for the local
customers, while many foreigners frequently customized
their sandwich:
Having a menu of pre-crafted sandwiches is a necessity.
Many of the Chinese customers simply do not know
how to order. They do not understand the notion of se-
lecting different types of deli meats and condiments for
a sandwich. I didn’t even think about this at first. Per-
sonally, I know exactly what goes with roast beef and
what goes with turkey.
When we opened our first location many people
came in and left without ordering. They didn’t know
how, and did not want to look foolish ordering some-
thing inappropriate. Many times, and this still happens,
people come in and just order whatever the person in
front of them ordered. Putting complete sandwiches to-
gether allows the inexperienced customer to come in
and feel more comfortable about ordering.
Creating pre-made selections of sandwiches worked
so well for Sammies that Goodman put together an “Or-
dering Tips” section on the menu. The section not only
suggested what types of products to order for breakfast
and what products to buy for lunch, but also provided a
guide for corporate clients to ensure correct portions and
variety for meetings. In addition, Sammies trained sales
clerks to act as customer service representatives who
could assist both the walk-in client and a growing base of
corporate delivery clients with their orders.
Corporate Clients and Sammies Rewards
As Beijing Sammies realized a growing corporate delivery
base, Goodman adapted the model to provide the business
client with as much flexibility and customization as possi-
ble. Sammies set up corporate accounts, online ordering,
flexible payment options, and a rewards program.
Corporate customers who registered with Beijing
Sammies could choose weekly or monthly payment
terms whereby Beijing Sammies would send out item-
ized statements and invoices. Clients could choose to set
up a debit account as well. Under the debit account,
474 PA RT 6 CASES
clients prepaid a certain amount (usually a minimum
of RMB1000*) that was credited to an account and
deducted each time an order was placed.
Along with the flexible payment options, corporate
customers could become enrolled in the Bonus Points
program, which offered credits based on the frequency
and size of orders. Customers who spent between
RMB500 and 750 received an RMB50 credit, orders
between RMB750 and 1000 an RMB75 credit, and or-
ders over RMB1000 are given an RMB100 credit.
Furthermore, each time a client cumulatively spent over
RMB5000, they were rewarded with an RMB500
credit. All of this could be done over the Beijing Sammies
Web site, www.beijingsammies.com, where customers
could log in and manage their account (Exhibit 2).
The Bonus Points program was offered to the walk-in
customer as well. Customers who registered with Beijing
Sammies online could become enrolled in the program.
OUR NEW SILK ALLEY SAMMIES CAFE IS ALSO OPEN!
Drop on by to enjoy some of your Sammies favorites . . . and more!
• Enjoy our wider breakfast selection
• Choose from café beverages and goodies
• Select from smoothies, espresso, cappuccinos, and our selection of baked goods
• Warm, inviting café atmosphere—whether you’re networking, on a date, getting a meal-to-go or getting social,
Sammies Xiu Shui Jie café is the place to be!
Located at the Silk Alley/Xiu Shui Jie south entrance on Chang An Jie, in the Chaoyang District; open every day from
07:30 to 24:00.
**WHERE EAST EATS WEST**
*THANKS FOR REGISTERING! NOW YOU CAN ORDER ALL YOUR SAMMIES FAVORITES THROUGH THE WEB!
Browse online and order our delicious Sammies sandwiches, salads, baked goods including muffins, cookies, brownies,
biscotti, and bagels. Great for business meetings, social events, breakfast, lunch, or dinner! Registration allows you to
enjoy the following:
***SAVE TIME***
One-time registration of delivery information—no need to re-explain your contact info at every order. Just log in,
order, and then submit for successful delivery every time you come to the Web site.
***SAVE MONEY***
Bonus points for future discounts—sign up and receive bonus points based on every RMB you order, which you can
redeem for future discounts and Sammies products.
***IMPROVED EFFICIENCY***
Online ordering and delivery—order directly from our Web site menu and we’ll deliver to you!
***CUSTOM-MADE ORDERS***
Customize your Sammies, and track your orders with our new menu and online ordering interface.
***RE-ORDER YOUR FAVORITES***
Quick ordering of your favorite Sammies items—registered users can re-order from a recorded list of past favorite
orders.
***ORDER 24 HOURS A DAY***
Order hours or days in advance.
Questions? Please e-mail our helpful customer service staff at beijingsammies @yahoo.com. Tell a friend to visit us at
www.beijingsammies.com.
EXHIBIT 2 Beijing Sammies Introductory E-mail
*Note: Conversion rate is: RMB8.3 ⫽ $1.
C A S E 4 BEIJING SAMMIES 475
Every registered customer received a point for each RMB
they spent. Every 10 points could be redeemed for
1 RMB off the next order. Extra points could be re-
ceived for filling out surveys, referring new cus-
tomers, or attending selected special events. The point
system was well received by Beijing Sammies’s cus-
tomers and contributed to a solid base of returning
foreign clients (Exhibit 3).
Charity Sponsorship
Beijing Sammies served large numbers of foreigners,
and consequently, Goodman felt a strong responsibility
to sponsor charity, youth, and community events focused
around the ex-pat community in Beijing:
The Canadian community in Beijing and around China
in general is pretty strong. As a foreign student here I re-
ally appreciated the sense of kinship that I felt even
though I was far away from home. In addition, the for-
eign businesses and tourists have been very supporting
of Beijing Sammies so I really enjoy and feel compelled
to participate in the community’s events.
Along with providing snacks and food, Beijing
Sammies helped certain organizations by allowing
promotional and ticket sale efforts to be staged from
Sammies’s locations. Sammies’s sponsorship events
included:
• Special Olympics
• Canadian Day and Independence Day
• Sporting and school events held by the Western Academy of Beijing and The International School
of Beijing
• Annual Terry Fox Run for Cancer
• ACBC Baseball Events
SAMMIES’S EVOLUTION
Starting out with $25,000 borrowed from friends and
family back in Canada, Goodman opened Beijing’s
first sandwich shop. In order to more easily get past
the bureaucracy involved with opening the café,
Goodman located a Chinese partner. After an initial
four months of business, Beijing Sammies was a hit.
The store was so successful that the new partner at-
tempted to strong-arm Goodman out of the company
by locking him out. In response, Goodman rallied
some friends and broke into the shop one night and
removed the appliances and supplies. The partner agreed
to be bought out.
Soon after Goodman regained control, his landlord
disappeared. The government demanded the tenants
cover his back taxes. When they could not, it demolished
the whole row and left the tenants with the bricks. Good-
man was able to sell them for $25.
Goodman responded by opening a café at the Beijing
Language and Culture University. Again, Sammies opened
to a steady stream of customers, particularly from foreign
students and local corporations.
In 1998, after realizing success with the first café in
its newfound location, Goodman found another business
partner. Together they planned to invest $350,000 more
into Beijing Sammies. The next step was to build a cen-
tralized kitchen and add more café locations. Soon after
construction started, however, the funds supposedly
coming from the newfound business partner quickly
dried up and Goodman was left financing the new
kitchen on his own.
At the end of 1998, Sammies had a central kitchen
with great capacity but no new store locations to de-
liver to. Goodman was able to generate yet another
round of financing. With some western investment and
all of the profits from his previous two years in business,
• Nokia China Investment
• U.S.A. Embassy
• Canada Embassy
• Intel PRC, Corp.
• Boeing
• AEA SOS
• American Chamber of Commerce
• Agilent
• Andersen Consulting
• Australia Embassy
• APCO Associates Inc.
• Benz
• Ford Foundation
• Henkel
• Hewlett-Packard
• IBM China Ltd.
• Motorola China Electronics, Ltd.
• Western Academy of Beijing
• Reuters
EXHIBIT 3 Corporate Clients
E X
H IB
IT 4
476
Goodman was able to put $150,000 together and open
three new cafés.
In addition to the first café located at Beijing Language
and Culture University, Sammies cafés were opened
between 1998 and 2001 at the Silk Alley Market, 1/F
Exchange Beijing, and The Motorola Building. A Sam-
mies kiosk was also opened at the China Resource
Building (Exhibit 4). The expansion allowed Goodman
to more adequately serve the Beijing area while also
firmly establishing Beijing Sammies in an increasingly
competitive environment:
Overall, I see the expansion into multiple cafés as a suc-
cess. Two of the cafés are doing well while the two oth-
ers have not met sales targets yet. The kiosk, because of
less rent, is doing moderately well but is still not as busy
as I’d like it to be. 2002 looks to be our best year to date
with a revenue increase of 54%, and an operating profit
of $20,000. However, due to the fact that the central
kitchen is its own cost center, we will record a $24,000
loss (including depreciation). 2003 should show our first
profits.
By the end of 2001, Beijing Sammies was recording
monthly revenues over RMB500,000 and by 2003, the
company had recorded positive net income in certain
months (Exhibit 5).
COMPETITION
The economic expansion of the late 1990s dramatically
changed dining in Beijing. Private establishments that
catered to China’s emerging middle class replaced old
state-run restaurants. Most traditional meals were under
$5 per person. Peking duck and other local specialties
were the most popular, but new restaurants opened that
offered regional tastes from all around Asia. Addition-
ally, the number of western-style restaurants targeting
tourists, expatriates, and younger, trendy Chinese cus-
tomers increased.
Sam Goodman viewed all restaurants physically close
to Sammies as competitors:
As far as I’m concerned, everyone in Beijing who or-
ders lunch is a potential customer and every restaurant
serving it is a competitor. There are those who stick to
the traditional Chinese meal, but who is to say that they
will never try Sammies?
I do not want to restrict Sammies to serving just
western businesses or students. We are delivering not
only to western businesses but to traditional Chinese
companies as well. While we rely on western students
for our walk-in business, we do have Chinese cus-
tomers who come to Sammies every day. There are
others who only come once in a while. These people
go to the Chinese restaurants when they don’t come
here, so I must think broadly in terms of whom my
customers are and who my competition is. Of course
the western restaurants like McDonald’s, Subway,
Schlotzskys, and Starbucks are the most obvious
competitors. Competition in this business is day-to-day
as people rarely eat lunch at the same location each
afternoon.
Like most major cities, Beijing had an array of restau-
rant choices ranging from traditional Chinese to Mexi-
can, German, Scandinavian, Italian, Swiss, and English
Continental.
THE GREAT WALL OF CHINA
As Beijing Sammies adapted to the competitive envi-
ronment, Goodman increasingly turned to the delivery
business for revenue. But the model did not work as
planned, due to the lack of experience Goodman had
in delivery logistics. Corporate clients were more
demanding and lunch delivery complicated. Goodman
states:
We started out delivering from a central source. At
first, things did not go as planned. Quite frankly, I
was an inexperienced manager and made quite a few
mistakes. The delivery model here in China is very
different from the West. Clients have no understand-
ing of what goes on behind the scenes, and they do
not understand that it is nearly impossible for us to
take a large delivery order for a corporate luncheon
and bring it to them ten minutes later. I didn’t plan for
all of the possible problems that a different culture
would bring. I should have put more effort and time
into educating the customer about the product. This
definitely had a negative impact on the business at
first.
In addition to overcoming the existing perceptions
and expectations of the customer, Goodman learned
about the prevailing attitude of the employees. One of
his biggest challenges was not securing the hard-to-
come-by ingredients, dealing with the local government,
or raising capital, but rather teaching his employees
the concept of service. For many of Beijing Sam-
mies’s employees, service was little more than open-
ing the store in the morning and closing it at night. To
Goodman, service was much more. It was what he be-
lieved would differentiate Beijing Sammies from the
C A S E 4 BEIJING SAMMIES 477
478 PA RT 6 CASES
other western food establishments, and what would
cause the traditional Chinese consumer to pay more
money for lunch. Service was not only delivering the
product on time, with the correct number of forks and
knives, but was also helping the customer to under-
stand the product. According to Goodman:
For most of my employees it doesn’t matter “how” you
get things done—it just matters that you get the end
result. The concept of face for them manifests itself
with the feeling that appearance is much more impor-
tant than the service or quality of the product. While for
the customer, the service provided by us is part of the
final product.
Just as the client base did not understand the wait for a
delivery, the employee did not understand the product
that Beijing Sammies was trying to sell:
EXHIBIT 5 Income Statement
Beijing Sammies Kitchen Office Kitchen Production Kitchen Delivery Kitchen Café
Revenue 2,007,921.19
Cost of Goods Sold 17,886.73 641,106.51
Gross Profit 17,886.73 1,366,814.68
Gross Margin 68.07%
Taxes 8,983.00 99,884.24
Salary 583,260.12 308,911.56 267,225.53
Insurance 57,067.01 24,131.97
Rent Related 185,246.10 102,917.10 82,331.60 41,165.80
Utilities 38,075.39 41,237.04 22,891.23 2,531.10
Office Expenses 131,989.31 445.38 5,750.55
Marketing/Advertising 29,687.74 25,129.00
Transportation 37,798.57 256.75 20,545.85
Maintenance 68,965.65 6,357.00 1,560.00
Entertainment 16,660.54 1,033.50 2,388.10
Law & Other Expenses 47,623.29
Bank Charges 91.60
Others 1,238.08 5,987.22 10,414.69
HR 8,580.00
Legal/Gov’t Charge 33,566.00
Low-Cost and Short-Lived Articles 14,581.58 21,594.56 4,869.28
CK Service Fee 327,302.43 100,396.06
Total Expenses 935,928.34 512,872.07 643,386.13 43,696.90
Gross Income 953,815.07 512,872.07 723,428.55 43,696.90
Amortization Pre-Operating Costs 154,683.52
Amortization-Renovations 71,500.00
Depreciation Expense 49,392.72 144,283.10 2,296.71
Total 275,576.24 144,283.10 2,296.71 0.00
Net Income 1,229,391.31 657,155.17 721,131.84 43,696.90
*Note: Exhibit 5 amounts are in Chinese Renminbi.
C A S E 4 BEIJING SAMMIES 479
The staff does not understand the urgency needed in
running a service-oriented business. The whole concept
of service is new in China. The business traditions are
very strong here. I don’t know if it’s because of the issue
of face and pride, the political history, or something else,
but our employees have a very difficult time understand-
ing how we need to deliver service as much as we need
to deliver a sandwich.
For Sam Goodman, the initial years of operation
proved that Beijing Sammies could hold a niche. While
he was pleased to see Beijing Sammies growing toward
profitability, he was concerned about whether it could
ever become cash-flow positive, and if so, whether he
could sustain it. In addition, Goodman was no closer
to finding the type of employee who would adopt his
concept of service than he was when he started and
wondered if the answer lay in increased automation,
training, or somewhere else.
BY Café SA Café CR Café EB Café 2002YTD
RMB USD
0.120479942 conversion factor
1,562,707.90 2,413,590.26 253,667.83 308,161.39 6,546,048.56 788,667.55
458,643.00 660,387.10 85,284.58 116,182.07 1,979,489.98 238,488.84
1,104,064.90 1,753,203.15 168,383.25 191,979.32 4,566,558.58 550,178.71
70.65% 72.64% 66.38% 62.30% 69.76% 69.76%
26,129.18 126,258.34 8,716.06 15,408.20 285,379.02 34,382.45
295,125.60 280,945.80 43,670.25 90,302.94 1,869,441.80 225,230.24
12,160.29 6,641.12 2,151.96 0.00 102,152.34 12,307.31
104,000.00 585,000.00 28,199.80 85,322.84 1,214,183.23 146,284.73
45,492.79 7,103.90 7,587.91 6,598.31 171,517.66 20,664.44
4,298.84 14,296.32 3,451.76 17,737.90 177,970.07 21,441.82
18,306.60 41,151.07 17,203.88 43,155.50 174,633.78 21,039.87
4,286.23 743.60 0.00 237.90 63,868.90 7,694.92
12,139.01 21,128.90 1,843.40 1,625.00 113,618.96 13,688.81
6,477.25 1,123.20 0.00 789.10 28,471.69 3,430.27
0.00 0.00 0.00 47,623.29 5,737.65
103.48 7.15 39.00 148.93 17.94
6,236.88 4,112.19 250.76 43.63 28,283.44 3,407.59
0.00 0.00 0.00 8,580.00 1,033.72
533.00 0.00 0.00 34,099.00 4,108.25
5,411.90 2,859.58 0.00 13,277.94 62,594.84 7,541.42
78,135.40 120,679.51 12,683.40 15,408.07 0.00 0.00
618,199.96 1,212,473.04 125,766.30 289,946.32 4,382,269.07 527,975.52
485,864.94 540,730.11 42,616.95 97,967.00 184,289.51 22,203.19
15,468.34 154,683.36 18,636.24
16,300.87 92,852.02 11,186.81
16,088.84 10,502.70 11,881.35 24,125.41 241,254.13 29,066.28
16,088.84 10,502.70 11,881.35 55,894.62 488,789.51 58,889.33
469,776.10 530,227.41 30,735.60 153,861.62 304,500.00 36,686.14
480 PA RT 6 CASES
EXHIBIT 5 Income Statement (Continued)
Beijing Sammies Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02
Revenue 474,490.19 340,345.07 633,584.38 636,305.41 714,801.13 768,954.55
Cost of Goods Sold 116,310.43 112,891.03 209,662.56 221,218.57 185,420.17 221,374.62
Gross Profit 358,179.76 227,454.05 423,921.82 415,086.84 529,380.96 547,579.93
Gross Margin 75.49% 66.83% 66.91% 65.23% 74.06% 71.21%
Taxes 21,449.26 15,003.20 21,514.52 21,744.06 31,754.91 24,373.65
Salary 195,127.49 200,044.95 179,709.69 197,527.25 172,055.86 208,886.93
Insurance 9,027.64 8,697.01 10,910.74 10,991.92 7,642.39 10,484.72
Rent Related 118,045.59 118,045.53 118,045.66 118,045.92 118,046.11 112,665.80
Utilities 14,993.68 20,974.36 13,872.64 13,989.55 14,436.11 18,413.58
Office Expenses 7,002.19 9,775.81 10,184.63 15,715.78 23,112.66 15,346.73
Marketing/Advertising 2,080.00 8,476.00 5,473.00 7,670.00 17,500.60 24,986.00
Transportation 3,458.00 1,738.10 4,951.70 3,695.64 4,497.74 11,303.50
Maintenance 7,800.00 5,281.25 309.40 4,564.30 6,630.00 38,958.40
Entertainment 3,216.20 6,073.60 3,313.70 2,471.30 852.80 4,378.14
Law & Other Expenses 1,798.33 1,798.33 6,998.33 1,798.33 14,798.33 1,798.33
Bank Charges 104.00 78.00 379.54 13.17 163.15 425.63
Others 845.00 234.00 7,179.64 4,312.10 0.00 3,208.14
HR 650.00 975.00 4,615.00 0.00 975.00 0.00
Legal/Gov’t Charge 1,950.00 1,950.00 16,016.00 1,950.00 1,950.00 2,483.00
Low-Cost and Short-Lived
Articles 2,171.00 1,295.84 3,055.00 10,031.27 10,522.07 5,995.31
Total Expenses 389,718.38 400,440.96 405,770.11 414,494.24 424,937.72 482,856.60
Gross Income 31,538.62 172,986.92 18,151.72 592.60 104,443.24 64,723.33
Amortization
Pre-Operating Costs 15,468.34 15,468.34 15,468.34 15,468.34 15,468.34 15,468.34
Amortization-
Renovations 7,150.00 7,150.00 7,150.00 7,150.00 7,150.00 7,150.00
Depreciation Expense 24,125.41 24,125.41 24,125.41 24,125.41 24,125.41 24,125.41
Total 46,743.75 46,743.75 46,743.75 46,743.75 46,743.75 46,743.75
Net Income 78,282.37 219,730.67 28,592.03 46,151.14 57,699.49 17,979.58
Cumulative Net Income 78,282.37 298,013.04 326,605.07 372,756.22 315,056.73 297,077.14
C A S E 4 BEIJING SAMMIES 481
Jul-02 Aug-02 Sep-02 Oct-02 2002YTD
RMB USD
0.120479942 conversion factor
819,787.15 743,912.26 659,126.31 754,742.12 6,546,048.56 788,667.55
271,224.40 216,298.58 210,682.54 214,407.10 1,979,489.98 238,488.84
548,562.76 527,613.68 448,443.78 540,335.02 4,566,558.58 550,178.71
66.92% 70.92% 68.04% 71.59% 69.76% 69.76%
42,118.17 32,275.32 25,169.18 49,976.76 285,379.02 34,382.45
151,037.11 172,597.30 181,573.80 210,881.44 1,869,441.80 225,230.24
12,577.94 10,606.44 10,606.44 10,607.09 102,152.34 12,307.31
99,665.80 124,581.20 142,870.82 144,170.82 1,214,183.23 146,284.73
16,504.80 14,210.99 19,398.47 24,723.49 171,517.66 20,664.44
21,650.58 29,671.43 33,736.55 11,773.71 177,970.07 21,441.82
23,403.09 33,382.75 24,166.45 27,495.88 174,633.78 21,039.87
5,270.98 18,112.15 5,557.37 5,283.72 63,868.90 7,694.92
26,887.90 9,034.61 7,272.20 6,880.90 113,618.96 13,688.81
546.00 461.50 4,406.35 2,752.10 28,471.69 3,430.27
8,038.33 6,998.33 1,798.33 1,798.33 47,623.29 5,737.65
176.80 117.00 9.36 21.10 148.93 17.94
3,867.12 3,606.10 1,757.47 3,273.87 28,283.44 3,407.59
0.00 0.00 0.00 1,365.00 8,580.00 1,033.72
1,950.00 1,950.00 1,950.00 1,950.00 34,099.00 4,108.25
3,622.32 20,954.62 3,919.89 1,027.00 62,594.32 7,541.36
417,316.94 478,559.73 464,192.68 503,981.21 4,382,268.55 527,975.46
131,245.82 49,053.95 15,748.90 36,353.61 184,290.03 22,203.25
15,468.34 15,468.34 15,468.34 15,468.34 154,683.36 18,636.24
7,150.00 16,300.87 13,250.58 13,250.58 92,852.02 11,186.81
24,125.41 24,125.41 24,125.41 24,125.41 241,254.13 29,066.28
46,743.75 55,894.62 52,844.32 52,844.32 488,789.51 58,889.33
84,502.07 6,840.67 68,593.23 16,490.51 304,499.48 36,686.08
212,575.08 219,415.74 288,008.97 304,499.48
EXHIBIT 5 Income Statement (Continued)
2001–2002 Comparison
Beijing Sammies Jan Feb Mar Apr May Jun Jul Aug Sep
Revenues-Total
2002 474,490 340,345 633,584 636,305 714,801 768,955 819,787 743,912 659,126
2001 195,360 221,729 273,194 322,826 360,585 487,627 485,567 479,232 495,706
Revenues-CD
2002 125,663 101,290 209,557 173,213 226,170 269,890 360,783 338,797 92,303
2001 118,331 167,267 157,382 190,320 164,654 161,971 153,994 142,709 136,926
Revenues-BY
2002 150,800 55,375 173,870 202,190 213,181 245,040 86,393 20,944 191,542
2001 77,029 54,462 115,812 132,506 122,457 161,166 130,244 112,095 136,210
Revenues-SA
2002 171,306 166,733 221,391 231,774 255,840 229,739 286,696 260,326 273,640
2001 0 0 0 0 73,473 164,492 172,101 197,597 197,532
Revenues-CR
2002 26,722 16,949 28,768 29,128 19,612 24,287 28,860 26,354 27,414
2001 0 0 0 0 0 0 29,229 26,832 23,036
Gross Profit
2002 358,180 227,454 423,922 415,087 529,381 547,580 548,563 527,614 448,444
2001 136,161 155,046 181,279 216,507 243,420 334,135 340,288 353,393 340,074
Total Expenses
2002 389,718 400,442 405,770 414,495 424,938 482,856 415,874 478,560 439,563
2001 199,170 212,702 203,262 204,741 292,468 293,136 271,625 318,711 367,199
Salary
2002 195,127 200,045 179,710 197,527 172,056 208,887 151,037 172,597 181,574
2001 130,803 135,100 123,547 123,572 136,526 141,993 143,111 165,208 161,795
Rent Related
2002 118,046 118,046 118,046 118,046 118,046 112,666 99,666 124,581 142,871
2001 36,833 36,833 36,833 36,833 93,180 93,180 71,500 71,500 112,666
Insurance
2002 9,028 8,697 10,911 10,992 7,642 10,485 12,578 10,606 10,606
2001 0 0 0 260 0 3,894 5,203 6,003 4,694
Utilities
2002 14,994 20,974 13,873 13,990 14,436 18,414 16,505 14,211 19,398
2001 11,239 13,459 7,232 8,932 11,063 11,041 13,607 16,717 24,505
Office Expenses
2002 7,002 9,776 10,185 15,716 23,113 15,347 21,651 29,671 33,737
2001 5,437 4,486 5,652 7,899 9,877 9,994 8,281 12,463 9,611
Marketing/Advertising
2002 2,080 8,476 5,473 7,670 17,501 24,986 23,403 33,383 24,166
2001 1,950 7,150 2,842 3,900 19,682 17,508 6,838 14,598 9,460
Transportation
2002 3,458 1,738 4,952 3,696 4,498 11,304 5,271 18,112 5,557
2001 1,158 1,131 2,298 2,662 2,989 1,219 2,428 2,522 2,510
Maintenance
2002 7,800 5,281 309 4,564 6,630 38,958 26,888 9,035 7,272
2001 735 371 3,785 1,707 98 1,110 1,365 1,754 1,252
Entertainment
2002 3,216 6,074 3,314 2,471 853 4,378 546 462 4,406
2001 0 520 4,976 5,881 2,896 0 1,123 255 12,332
Law & Other Expenses
2002 3,748 3,748 23,014 3,748 16,748 4,281 9,988 8,948 3,748
2001 3,613 6,500 6,500 2,665 3,848 0 867 4,767 6,136
Taxes
2002 21,384 15,003 21,515 21,744 31,755 24,374 42,119 32,275 25,169
2001 6,871 5,950 8,639 8,813 6,360 6,163 13,657 15,219 16,592
Oct Nov Dec Total Average % Total USD Average USD
0.12048 conversion factor
754,742 0 0 6,546,049 654,605 32.94% 788,668 78,867
501,579 565,923 534,743 4,924,071 410,339 593,252 49,438
110,257 0 0 2,007,923 200,792 12.52% 241,914 24,191
111,007 146,241 131,628 1,784,429 148,702 214,988 17,916
223,374 0 0 1,562,708 156,271 1.18% 188,275 18,827
155,964 173,991 172,487 1,544,423 128,702 186,072 15,506
316,147 0 0 2,413,592 241,359 66.65% 290,789 29,079
216,702 221,035 205,347 1,448,279 193,104 174,489 23,265
25,579 0 0 253,672 25,367 72.63% 30,562 3,056
17,908 24,656 25,284 146,944 24,491 17,704 2,951
540,335 0 0 4,566,559 456,656 33.45% 550,179 55,018
360,762 406,459 354,387 3,421,909 285,159 412,271 34,356
503,981 0 0 4,356,196 435,620 25.44% 524,834 52,483
358,769 367,961 383,097 3,472,840 289,403 418,408 34,567
210,881 0 0 1,869,442 186,944 5.67% 225,230 22,523
163,081 169,485 174,984 1,769,204 147,434 213,154 17,763
144,171 0 0 1,214,183 121,418 28.69% 146,285 14,628
118,045 118,048 118,047 943,497 78,625 113,672 9,473
10,507 0 0 102,152 10,215 174.55% 12,307 1,231
6,516 5,049 5,589 37,207 3,101 4,483 374
24,723 0 0 171,518 17,152 0.10% 20,664 2,066
18,764 17,195 17,936 171,690 14,307 20,685 1,724
11,774 0 0 177,970 17,797 63.35% 21,442 2,144
10,245 10,773 14,229 108,948 9,079 13,126 1,094
27,496 0 0 174,634 17,463 42.87% 21,040 2,104
9,494 17,076 11,736 122,234 10,186 14,727 1,227
5,284 0 0 63,869 6,387 149.15% 7,695 769
2,626 1,651 2,439 25,635 2,136 3,088 257
6,881 0 0 113,619 11,362 588.67% 13,689 1,369
1,273 681 2,366 16,498 1,375 1,988 166
2,752 0 0 28,472 2,847 13.33% 3,430 343
372 759 3,738 32,852 2,738 3,958 330
3,748 0 0 81,718 8,172 123.09% 9,845 985
867 867 0 36,630 3,053 4,413 368
49,977 0 0 285,315 28,531 83.43% 34,375 3,437
25,346 16,892 25,046 155,546 12,962 18,740 1,562
E N D N O T E S
1. Beijing Sammies is the name of the entire company,
while “a Sammies” is a particular café.
C A S E 5 “MAMMA MIA!” THE LITTLE
SHOW THAT COULD!*
In the spring of 1988, Björn Ulvaeus, Benny Andersson,
and Judy Craymer agreed that poor Broadway reviews
marked the beginning of the end for “Chess.” As the
executive producer of the musical, Judy Craymer re-
flected on the recent failure and wondered what factors,
other than the reviews, had contributed to “Chess’s”
Broadway failure. More immediate however was the
question of how she was going to resurrect her career.
As she left the project behind in search of new work,
Craymer was convinced that there was a musical to be
created out of the ABBA songs.
Almost a decade later, and after numerous attempts,
Craymer finally received the approval of ABBA’s Ulvaeus
and Andersson to plan a musical based around their
songs. By 2001, Craymer had flourishing productions of
“Mamma Mia!” running in London, Toronto, and on tour
across the United States. But even with this success, both
Craymer and Ulvaeus were anxious about the show’s
fate once they decided to bring “Mamma Mia!” to Broad-
way in the fall of 2001. After all, bad reviews in New
York 13 years earlier had caused their production of
“Chess” to close after only 68 shows. Moreover, ABBA’s
music was more than 20 years old and consumer tastes
in theater had undoubtedly changed in the new millen-
nium. Another Broadway flop would likely wipe out the
momentum behind the productions in Canada and on the
road while also bringing 15 years of Craymer’s hard
work to an end. Was the idea of a show, surrounded and
484 PA RT 6 CASES
Source: This case was prepared by Christopher Ferrarone under the supervision of Boston College Professor Gregory L. Stoller as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. This case was prepared entirely from existing, publicly available sources.
Copyright © 2003, Gregory L. Stoller. No part of this publication may be reproduced, stored in a retrieval system, used in a spread- sheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the author.
*Note: The phrase “The Little Show That Could” was coined by a member of the Las Vegas company.
EXHIBIT 5 Income Statement (Continued)
Sammies Revenue Comparison
900,000
800,000
700,000
600,000
500,000
400,000
300,000
200,000
100,000
0 1 2 3 4 5 6 7 8 9 10 11 12
2001
2002
195,360
474,490
221,729
340,345
273,194
633,584
322,826
636,305
360,585
714,801
487,627
768,955
485,567
819,787
479,232
743,912
495,706
659,126
501,579
754,742
565,923 534,743
2001
2002
C A S E 5 “MAMMA MIA!” THE LITTLE SHOW THAT COULD! 485
hyped by already existing songs, a solid business propo-
sition? Would theater-going audiences find merit in such
a creation? Was risking the success of the other “Mamma
Mia!” productions a sound decision?
The initial fears quickly subsided when “Mamma
Mia!” tallied over $27 million in advance ticket sales prior
to the October 18th opening, the second highest advance
sale ever on Broadway.1 But even as ticket sales continued
to break records, Craymer and Ulvaeus could not help but
wonder why “Mamma Mia!” was having such great suc-
cess while “Chess” had done so poorly. Moreover, as
Craymer began to win awards and achieve recognition for
the production, she wondered to what extent it mattered
that she had not created anything “new.” She questioned
whether it was ABBA or she who deserved the accolades
and whether the production would ever be considered on
the same level as more traditional works such as “Les
Miserables” or “Cats,” the show that “Mamma Mia!” had
just replaced at the Winter Garden Theater.2
ABBA
The ABBA history began in 1966 when Björn Ulvaeus
and Benny Andersson first met. The two were singers in
different bands; Björn in a musical group named the
Hootenanny Singers and Benny in a group called the
Hepstars. After the two became more acquainted with
one another, they began co-writing songs. As the decade
progressed, they increased their collaborative efforts.
Three years later, in the spring of 1969, Björn and
Benny met Agnetha Fältskog and Anni-Frid Lyngstad. At
the time both women were mildly successful solo singers
in Sweden. Eventually, Benny would marry Fältskog and
Björn would marry Lyngstad and the quartet would be-
come ABBA, an acronym of their first names.
In the early 1970s the group performed together as a
cabaret act called “Festfolk.” Mostly, the four covered a
combination of existing music and humorous acts. It
was quickly evident that audiences did not particularly
enjoy the covered material; however, they did react pos-
itively to one of the group’s original songs, “Hej gamle
man.” The team quickly put their efforts into creating a
routine made up of their own material. In the spring of
1972 they recorded a song called “People Need Love,”
which was regarded as a moderate hit.
In 1974, the group changed their name to ABBA and
entered the Eurovision Song Contest with their song
“Waterloo.” The group won the contest and “Waterloo”
consequently reached number one on the music charts
across Europe, and attained a spot on the U.S. Top Ten.
Soon thereafter the group released the album entitled
Waterloo, which became a huge hit in Sweden. From
there, the group continued to work on their music, re-
leasing numerous albums. However, it took nearly a
year and a half before they obtained another worldwide
hit. It ended up being the song, “SOS,” taken off their
third album, entitled ABBA. After “SOS,” the group pro-
duced many hit singles throughout the 1970s:
Waterloo No. 1 in April 1974
Ring Ring No. 32 in July 1974
I Do I Do I Do I Do I Do No. 38 in July 1975
SOS No. 6 in September 1975
Mamma Mia No. 1 in December 1975
Fernando No. 1 in March 1976
Dancing Queen No. 1 in August 1976
Money, Money, Money No. 3 in November 1976
Knowing Me, No. 1 in February 1977
Knowing You
The Name of the Game No. 1 in October 1977
Take a Chance on Me No. 1 in February 1978
Summer Night City No. 5 in September 1978
Chiquitita No. 2 in February 1979
Does Your Mother Know No. 4 in May 1979
Angel Eyes/Voulez Vous No. 3 in July 1979
Gimme! Gimme! Gimme! No. 3 in October 1979
I Have a Dream No. 2 in December 1979
The Winner Takes It All No. 1 in August 1980
Super Trouper No. 1 in November 1980
“Mamma Mia,”i also taken from the album ABBA,
gave the group a number one spot on the British hit list,
a feat that they were able to accomplish nine times be-
tween 1974 and 1980 (behind only The Beatles and Elvis).
“Mamma Mia” was also a number one hit in Australia in
1975. Australia increasingly became one of ABBA’s
most successful regions where the group managed to re-
lease a total of six number one songs. An ABBA TV
show even ran in Australia, drawing more viewers than
the first moon landing.
As ABBA continued to rack up hit songs they began
to release compilation albums filled with their most
i“Mamma Mia” the song is separate from the musical “Mamma Mia!”
486 PA RT 6 CASES
popular music. In 1976, ABBA released Greatest Hits
and The Best of ABBA. These two albums contributed to
the group’s worldwide fame and helped them to achieve
a number one rating in the U.S. with “Dancing Queen”
in 1977 (which would be the only song ever reaching a
number one place on the U.S. charts). At one time dur-
ing the late 1970s, only the automaker Volvo surpassed
ABBA as Sweden’s top export.
In late 1976, ABBA released its fourth album, Arrival.
This was followed by concert tours in Europe the next
year. The tour completely sold out and was conse-
quently brought to Australia where the group decided to
begin working on a film entitled “ABBA—The Movie.”
In 1978 the group came to the United States on a pro-
motional tour that preceded the release of their sixth al-
bum, Voulez-Vous. However, earlier in the year, Björn
and Agnetha had announced their divorce. While the
group remained determined to continue their work as
ABBA, the news started rumors of the group’s breakup.
In late 1979, the group released a second compilation
album, Greatest Hits Vol. 2 that coincided with a major
tour of Canada, the United States, and Europe.
In March 1980, ABBA took their tour to Japan for
what turned out to be one of their last live concerts. For
the rest of the year, the group recorded the album Super
Trouper.
In February 1981 Benny and Frida also announced
their divorce. Many fans considered this the breakup of
the group. Yet, the event did not stop the foursome from
working together. At the end of the year, ABBA released
their eighth album, The Visitors.3
“CHESS”
At the end of 1982, the group decided to take a break.
Benny and Björn had tired of ABBA and were looking
to branch out into musical theater. At the same time,
Tim Rice was looking for someone to write the score for
his musical, “Chess.”
Working as a lyricist/producer, Rice reached fame by
collaborating with producer Andrew Lloyd Webber in
“Joseph and the Amazing Technicolor Dreamcoat” and
“Jesus Christ Superstar,” and was considered to be a
musical pioneer in theater. As Rice pointed out:
Doing shows on record first and without a bookii may
have been things that Andrew [Lloyd Webber] and I
pioneered, but we really did it by mistake. The only
reason we recorded “Jesus Christ Superstar” first was
because we couldn’t get a theater deal. It had no book
because we didn’t know anyone who could write one.
Geography had a lot to do with our success. Had we
been in America, we would have been subject to the
Broadway tradition. But because we were so far away
we felt there was no need to follow any rules. After the
Beatles, anybody with ambitions to write songs went
into records and performing. But since we weren’t
performers and since Andrew loved theater so much,
we took all our favorite rock things and used them in
our scores. As with the Beatles, it finally wasn’t bril-
liant thinking so much as luck that made us so suc-
cessful. We happened to be in the right place at the
right time.4
Rice’s reputation, and the work that he was doing (he
has since been a major part of productions such as “Evita,”
“Aladdin,” “Beauty and the Beast,” “The Lion King,” and
“Aida”) turned out to be an instant draw for Benny and
Björn. They immediately signed on to the project.
Using the world of international chess as a metaphor,
Tim Rice conceived to write a musical about how the
Cold War affected the lives of all those it touched. The
story follows an international chess match from Bangkok
to Budapest. The plot revolves around Florence, a
Hungarian-born woman who works as an assistant for
the upstart American challenger, Freddie. Freddie is
jointly modeled after Bobby Fischer and the tennis star
John McEnroe. In the middle of the match with the
Russian champion, Anatoly, the American precipitates a
dispute. As the match seems about to fall apart, Florence,
attempting to intercede, meets and falls in love with the
Russian, who promptly decides to defect to the West.
When the Russians pressure Anatoly to change his mind,
he becomes the focus of an international tug of war.
Rice originally approached Andrew Lloyd Webber to
write the score, but his former partner was already com-
mitted to other projects. Then, in 1981, producer Richard
Vos introduced Rice to Benny Andersson and Björn
Ulvaeus. The team immediately set about creating a con-
cept album. Two numbers did well in the charts. “One
Night in Bangkok” first appeared on the U.K. charts on
November 10, 1984, and stayed there for 13 weeks, at
one point reaching #12. In the U.S., it jumped to #9 in
April of 1985 and topped the charts in France, Australia,
Belgium, Austria, South Africa, Denmark, Israel, West
Germany, Switzerland, Holland, and Sweden. Another
single, “I Know Him So Well” followed, eventually
reaching #1 on the U.K. charts during its 16 week run.
With “Chess” already a worldwide phenomenon before
iiA “book” is the baseline story behind the production and is similar to a screenplay for a movie.
C A S E 5 “MAMMA MIA!” THE LITTLE SHOW THAT COULD! 487
it had even opened, expectations were high. The London
production team of Tim Rice, Judy Craymer, Andersson,
and Ulvaeus brought the show to the West Endiii on
May 14, 1986, where it ran for three years. However, the
high tech spectacle never garnered a lot of interest from
London’s theatergoers and failed to make back its initial
investment. The production team, still believing in the
project, decided to bring the show to Broadway.
The show was drastically altered before moving to
Broadway. Instead of having the performance com-
pletely sung-throughiv as it had been in London, director
Trevor Nunn chose to bring in playwright Richard
Nelson to write a book. Rice also added several new
songs including “Someone Else’s Story.”
The Broadway production opened at the Imperial
Theatre on April 28, 1988, with an entirely new cast.
With a poor review from The New York Times leading to
a series of unfavorable criticisms, the show proved even
less of a commercial success than its predecessor, losing
$6 million and closing after only 68 performances. A
later concert, however, which featured the Broadway
cast at Carnegie Hall, was a huge hit.5
The concert was a bittersweet end to the “Chess”
story for Björn Ulvaeus:
We weren’t surprised, in one sense that “Chess” failed
because the bad review in The New York Times came
right after our run in the West End and we were already
losing steam. The songs were hits four years earlier and
their popularity was not recent enough to carry us
through [the bad review]. But we were very proud of
it—the music and lyrics and everything.6
Where the “Chess” episode did succeed, however,
was in bringing Ulvaeus and Andersson into the world
of theater, offering the duo a unique platform for contin-
uing their love of composing while also offering them a
fresh start.
LONDON THEATER
London Theater falls into three broad and sometimes
overlapping categories—West End, National Repertory
Companies, and Off-West End/Fringe—terms analogous
to Broadway, Regional Theater, and Off-Broadway in
the United States.
Geographically, the West End encompasses a two
square mile section of London in the vicinity of
Leicester Square, Piccadilly, and Covent Garden, where
more than 40 “picture frame” theaters, most dating from
the Victorian and Edwardian eras, are clustered. These
are commercial theaters in which producers present
shows with the expectation of making a profit.
The most prestigious groups of British theater are the
two national repertory companies that enjoy the support
of government subsidies through the Arts Council, as
well as through their huge ticket sales.
The Royal National Theatre, located in a three-stage
complex on the South Bank, and the Royal Shakespeare
Company (RSC), with stages in London at the Barbican
Center and in Stratford-upon-Avon, are large companies
of actors, directors, and technicians who produce a formi-
dable number of plays in repertory throughout the year.
On these stages, audiences see performances of the
highest quality, made possible by conditions not often
met in commercial theater: longer rehearsal periods,
freedom to commit to new work and innovative ap-
proaches, support from expert voice coaches, the secu-
rity of a firmly scheduled run, and, most significantly,
the devotion of seasoned British actors who return to
these companies throughout their careers. In these ven-
ues, as well, audiences discover emerging actors, direc-
tors, and designers who are about to become the leading
figures of British theater, film, and television.
At any one time, there are around 70 small, so-called
Fringe theaters operating in pubs, warehouses, and a few
purpose-built theaters in and around London. They consti-
tute the breeding ground from which the rising generation
of British actors, directors, playwrights, and designers
emerge and to which seasoned theater artists occasionally
return in order to be able to see and do cutting-edge work.
Cross-fertilization from the subsidized companies
and the varied Off-West End and Fringe theaters to the
commercial West End accounts for the high productivity
of the entire British theater. Major productions from the
National or the RSC are sometimes picked up by a com-
mercial producer for long runs in the West End. The
repertory company benefits from extended royalties,
sometimes many years’ worth, as in the case of the RSC’s
“Les Miserables.” That show opened at the Barbican
Theatre in 1985 and soon transferred under commercial
sponsorship to the Palace, where it continued to run
through May 2003. The West End producer benefits
from getting a production that has already demonstrated
it “has legs” and will go on attracting audiences when its
limited repertory run is over.
The work of the Off-West End and Fringe sector is an
important aspect of British theater. These companies
iiiLondon’s version of Broadway. ivAll dialogue and character lines in musical verse.
488 PA RT 6 CASES
cultivate audiences for a wide range of new work and
new talent. As a result, in London, a high number of very
young directors and writers get opportunities for signifi-
cant careers. Productions from these theaters sometimes
transfer to the commercial West End, as in the case of the
1992 production “Medea,” which went on to a long run
in the West End and then played on Broadway.
Judy Craymer
With a pedigree in London theater including working
for the likes of Tim Rice, Cameron Mackintosh, and
Andrew Lloyd Webber on productions of “Cats,” “Les
Miserables,” “Phantom of the Opera,” and “Miss Saigon,”
Craymer was well known throughout the theater pro-
duction world. This reputation suffered with her work
on “Chess” but ultimately allowed her to continue on
her quest to produce an ABBA musical.
From the time “Chess” closed down in 1988, Craymer
worked to make her idea of an all-ABBA musical a real-
ity. She was convinced that there was a theatrical per-
formance behind the songs of ABBA and would toil for
10 years on the project, selling her house and eventually
squatting in her office in order to keep the project alive.7
It was her determination and passion that persuaded
ABBA’s Benny Andersson and Björn Ulvaeus to “take a
chance” and let her hire writer Catherine Johnson and
director Phyllida Lloyd and create “Mamma Mia!”
Johnson remarked:
Benny and Björn didn’t think it was such a great idea at
first, because they had really moved away from ABBA,
but Judy pursued this concept with them for 10 years.
Finally Björn told Judy that if she found a writer who
could come up with a story everyone is keen on, then
she could go ahead with the project.8
Catherine Johnson
In 1997, after finally getting the go-ahead from Benny
and Björn to create a story, Craymer found Catherine
Johnson, a single, nearly broke, mother of two. The two
women worked on a script from opposite ends of England,
each taking the train half way to save money in order to
conduct meetings with each other. There was a lot of col-
laboration and work on the book as it was the key to get-
ting ABBA’s consent on the whole project. As Johnson
pointed out:
Judy Craymer conceived the original idea in 1988 when
she was working on “Chess” with Björn and Benny, but
it took her ever so long to come up with a writer. I came
on board when she was working with a director that I
once worked with. She told him about the project and
he suggested me. It was very fortunate because I hadn’t
heard of it and it certainly wouldn’t have been some-
thing I would have thought of doing.9
For Ulvaeus and Andersson, the story was what
would either make or break the project. They had told
Craymer that they wanted the plot to be the first and
foremost priority, with the music coming in afterward to
help the narrative. As Ulvaeus pointed out:
I said to Catherine, “We have a catalog of 95 to 100
ABBA songs, and you can choose whatever you like, not
just the hits.” I told her, “The story is more important than
the songs.” I saw this as a challenge and an experiment,
and was ready to call it off at any point. In the end what
I saw was a seamless story, not something that would
make you say, “They’ve shoe-horned the songs in.”10
Johnson’s story follows a 20-year-old, Sophie, on the
eve of her wedding. Sophie has been raised by her mother,
Donna, on a Greek island without ever knowing her father.
Eager to have him walk her down the aisle, Sophie tracks
down the three probable candidates based on her mother’s
youthful indiscretions and secretly invites each of them to
the wedding. She confronts her potential dads but none of
them seems to be the right one. As the plot moves along,
complications arise among the characters, most notably
with her mother, who is forced to confront her past. There
are many other secondary characters that add to the stereo-
types and humorous situations that come about. All of the
action is carried along and highlighted by 22 ABBA songs
mixed throughout the performance.
Phyllida Lloyd
Once the story was completed, Craymer and Ulvaeus
brought director Phyllida Lloyd onto the project. Re-
nowned for her work at England’s Royal National The-
atre and on international opera productions, Lloyd
helped the project gather further momentum. She was
behind the assembly of the creative team of Mark
Thompson (design), Howard Harrison (lighting), An-
drew Bruce and Bobby Aitken (sound), Martin Koch
(musical supervisor), and Anthony Van Laast (choreog-
raphy) who were credited with making the show as
successful as it was. As Lloyd told the actors involved in
an early workshop: “ ‘Mamma Mia!’ is the musical
Benny and Björn wrote years ago. They just decided to
release the songs first.”11
THE ROAD SHOW
Traditionally, Broadway had been the proving ground
for most large-scale theatrical productions known as
equity productions, with the “equity” referring to the
large amounts of money needed to produce fancy, glam-
orous shows. These performances are a large draw for
audiences.
During the 1998–99 season more than 11.6 million
people attended a show on Broadway. This amounted to
over $588 million in gross ticket sales. Of those shows,
the ones that realized success then sent touring compa-
nies on the road. During the same season, these touring
companies brought shows to over 100 U.S. cities and
sold tickets to 14.6 million people, yielding $707 million
in “road grossed”12 receipts. That represents nearly
55 percent of the industry’s combined $1.3 billion take
in New York and on the road.
As such, road shows today are big business and have
a rather involved process. Every road show starts with
the producer who then hires a booking agent, whose job
it is to contact presenters at theaters across the country
and “book” the production into their theaters for specific
weeks during the season. Presenters range from entrepre-
neurs who rent theaters, to performing arts organizations
and municipalities who own and operate their own
locales and venues.
In many cases, production companies search for shows
that they are interested in booking. For the popular musi-
cals it is not uncommon for bidding wars to take place
among production companies looking to take the show on
the road. Sometimes the original Broadway producers
even take their own shows on the road themselves.
Once the decision to take a performance on the road
has been made, the booking agent, in concert with the
producer or production company, decides where to
take it and how long to stay at certain locations. For
the large productions, surveys and marketing data are
collected and analyzed to aid in this process of decid-
ing the best travel destinations. In some cases, the size
of the venue or city determines how long a run the
show will have.13
From there, producers negotiate guaranteesv with pre-
senters. This amount, coupled with the show’s capitaliza-
tion and weekly expenditure requirements, ultimately
determines how many weeks the production must be on
the road for. Of course, the producers always also get a
percentage of the box office receipts above and beyond
the guarantee.vi
Originally, road shows were non-equity or bus-and-
truckvii versions of the Broadway originals, and were
dramatically scaled down productions with fewer, less
known actors and simpler sets. This trend changed how-
ever in the late 1970s. Some credit English producer
Cameron Mackintosh with these changes. Mackintosh
produced “Miss Saigon,” “Cats,” “Les Miserables,” and
“Phantom of the Opera.” When he started, the “road”
was primarily made up of the bus-and-truck variety.
However, Mackintosh did not want to do that with “Les
Miserables”:
When I first put “Les Miz” out I was not going to cut
corners in any way. I wanted to give audiences the same
show that they would see on Broadway. And the combi-
nation of my four big shows completely changed the
standards of the road.14
These productions sent box-office receipts soaring
and resulted in theaters upgrading their facilities and
cities even building state-of-the-art performing arts
centers to take advantage of the blockbusters. In order
to be profitable, these productions required multi-
week stays at a minimum. However, in the absence of
blockbuster productions, and proportionally scaled
down ticket prices, few patrons ended up filling the
seats.15 As such, the manner in which road shows are
produced has tended to change as the popularity of
theater has cycled.
TAKING “MAMMA MIA!” ON THE ROAD
In total, Craymer was able to fund the first production of
“Mamma Mia!” with $4.8 million.16 In 1999, “Mamma
Mia!” debuted in London’s Prince Edward Theatre and
was met by rave reviews from fans. Once the show
opened, it took fewer than 27 weeks for Craymer to
make back the initial investment. The show has contin-
ued to have advance ticket sales of more than $6.5 mil-
lion through 2003.
Very little advertising was done as Craymer relied on
word-of-mouth advertising for nearly two years. As the
show proved capable of delivering a return for investors,
the decision for Craymer was not whether to take the act
C A S E 5 “MAMMA MIA!” THE LITTLE SHOW THAT COULD! 489
viThis percentage is typically around 40%. viiThe term “bus-and-truck” comes from the way in which sets, actors, musicians, etc., were carted around the country. Typically, these shows have runs at theaters for no more than a week or two.
vA “guarantee” is the weekly figure the presenter promises to pay the producer no matter what the box office intake happens to be.
490 PA RT 6 CASES
to North America, but rather how. The costs for a large-
scale production were immense, particularly if the group
was going to tour through Canada and the U.S. However,
a scaled down production could result in poor ticket sales
and reviews, and could stop a tour before it was able
to gain any momentum. Craymer was able to put this
decision off, at least for a few months.
In May of 2000, the group brought the show to
Toronto’s Princess of Wales Theatre where it planned a
6-month stay before going on the road across the U.S. A
full-scale production, Craymer believed, would draw au-
diences and positive reviews, while the extended stay
would serve as insurance if the production failed to live
up to expectations. In short, future road shows in the
U.S. could be cancelled without incurring the large up-
front costs of a full-scale tour. While Craymer believed
the strategy was sound, she ultimately altered the plans
to take advantage of the situation:
Our strategy was to see if it worked in London, and it
did. Then we had the opportunity to go to Toronto for
six months, and the bookings were so positive that they
suggested we stay in Toronto and create a new touring
company in the United States.17
In fact, two touring companies were created and
“Mamma Mia!” brought productions to Buffalo, Atlanta,
Cincinnati, Columbus, Charlotte, Louisville, Norfolk,
Pittsburgh, Providence, Memphis, Miami, Nashville,
Rochester, and Tampa.18
As the touring companies performed across the U.S.
and the Toronto and London productions continued to
sell out, Craymer and the production team slowly
edged closer to bringing the show to Broadway. Hype
for the musical was built slowly by word-of-mouth and
the producers continued to use little advertising.
Craymer explained:
After the first London preview, the audience came out of
the theater, got on their cell phones and called their
friends, saying, “You’ve just got to come see this.”
That’s the effect we wanted to create before we came to
Broadway.19
“Mamma Mia!” proved popular enough to sustain
multi-week runs on the road without the usual publicity
of a successful Broadway run. In its first 18 months,
“Mamma Mia!” had proved a hit at every major theatri-
cal level except Broadway.
With the four “Mamma Mia!” productions perform-
ing at once, three of which were in North America,
Benny, Björn, and Craymer decided to finally take the
plunge, and return ABBA to the world of Broadway.
BROADWAY
As soon as Ulvaeus and Andersson gave her the go-
ahead, Judy Craymer began planning for the “Mamma
Mia!” Broadway debut. It proved to be a long, hard
fought battle. Craymer recalls:
The whole thing started 12 years before we would bring
the show to New York. I used to go home and listen to
ABBA records, dreaming of songs as part of a Broad-
way musical. When we finally got the show together,
there was no way that Benny and Björn would let it go
straight to Broadway because of “Chess.”20
Because of Benny and Björn’s stance, Craymer began
devising alternative ways to bring the show to the U.S.:
London and Europe were never going to be problems;
everyone knew ABBA. It was getting the show to The
States that I worried about. We couldn’t bring it right to
Broadway and when I came up with the strategy of
building interest through a tour, people told me that it
would never be successful unless it was a Broadway-
branded production. Either way, the stakes were quite
high; I just kind of followed my heart and instincts.21
As skeptics quickly discovered, the tour was a huge
success and the word-of-mouth strategy had proved suc-
cessful as each new tour location routinely sold out prior to
opening night. The financial returns were further magni-
fied by the reduced need for advertising. Moreover, to the
delight of Craymer and Ulvaeus, as “Mamma Mia!” got
closer and closer to Broadway, advance sales began rack-
ing up. Officially, “Mamma Mia!” sold over $27 million
worth of tickets before opening night. The production team
could not have been happier; they had achieved all of their
goals and had the momentum to roll over any poor review.
This momentum, however, came to a violent stop a
little over a month before opening night, when the
World Trade Center was attacked. At first there was lit-
tle thought about her own problem as Craymer worried
for the actors who were rehearsing in studios close to
ground zero. As a few days passed and when it was de-
termined that everyone involved was safe, Ulvaeus and
Craymer asked themselves, “Can we really go on with
this?”22 They questioned whether or not it would be ap-
propriate to stage such an exuberant show amidst the in-
tense mourning of an entire city. Very quickly they made
the decision to carry on. Ulvaeus pointed out:
At first I did not know what to do. I did not know if our
feel-good music and text would strike the right chord.
But then what was said by many people and by Mayor
Giuliani especially made sense to me: [New Yorkers]
C A S E 5 “MAMMA MIA!” THE LITTLE SHOW THAT COULD! 491
needed to see people coming here from the outside and
doing things, moving ahead. This is how you fight
back; this is how you don’t give in. I thought: Maybe
we’re meant to be here to do this show for people, now
of all times.23
Judy Craymer agreed:
Many of the cast had seen it happen, because the re-
hearsal rooms are downtown. I was just off to the dentist
when I saw it on television. But to have withdrawn
would have been a huge psychological blow to New
York. Having seen a preview performance, I think the
show had come at exactly the right time. The audience
was on its feet dancing at the end.24
The recession and loss of tourists from September
11th cost most shows millions of dollars, closed a myr-
iad of productions, and threatened a number more.
“Mamma Mia!” however, proved to be somewhat im-
mune. The Broadway version cost $10 million to pro-
duce and was able to recoup its entire investment in just
six months. The show played to near sell-outs for the
first two years breaking all kinds of box-office records
along the way. The show not only gave a boost to Broad-
way but also to the community, and in addition raised
nearly $500,000 for the attack victims’ families.
“MAMMA MIA!” THE CORPORATION
The success on Broadway helped the production com-
pany expand its reach around the world. Before Broad-
way there were productions of “Mamma Mia!” running
in London, Toronto, and touring the United States. A
second U.S. tour opened in Providence, R.I., in February
of 2001, playing shorter runs in many cities. A third pro-
duction was opened in Melbourne, Australia.
With six productions of the show performing concur-
rently worldwide, Craymer began licensing the show to
production companies in other countries, where it was
translated into different languages. The first foreign
show to start was a German version in Hamburg, in
November 2002. A second production in Japanese began
in December 2002. A third and fourth opened shortly
thereafter in Moscow and Madrid. According to Craymer,
“’Mamma Mia!’ has become a corporation in a sense; it
had turned into a sizable organization running shows all
over the world.25
By the end of 2002, the globalwide phenomenon had
grossed more than $400 million with a one-day box of-
fice record in London of $831,000 in ticket sales. While
the numbers suggest a well thought out business plan
combined with experienced market-savvy, Craymer calls
the success “a sheer fluke,” and Ulvaeus agreed:
I thought when we split up in 1981, that it was the end
of it. I thought I would hardly hear ABBA again. I have
no idea why all this is happening and why the music is
so much [more present now].26
While Craymer’s realization of an ABBA-inspired
musical had exceeded her dreams, she and Ulvaeus were
still not certain as to why the results of “Chess” and
“Mamma Mia!” had differed to such a great extent. Un-
like “Chess,” “Mamma Mia!” had started with a loose
concept and ended up a worldwide sensation. Along the
way it had overcome skeptics, poor reviews which had
similarly sunk “Mamma Mia’s” predecessor, and even
September 11th. They wondered how their original, sim-
ple business plan had morphed into a 9-production
sensation employing over 700 people.
THE BUSINESS OF “MAMMA MIA!”
Critics from both inside and outside performing arts
circles have heavily debated the run of “Mamma
Mia!” While a great deal of criticism subsided when
the show became an unabashed success, some still con-
tinue to question whether the production team’s acco-
lades are warranted, since nothing “new” has really been
created with the exception of a story-line around some
old hit songs.
The question ultimately centers on how theater, and
its broader category of the performing arts, is classified
by business analysts and the world around them. Are
plays, musicals, and productions merely another avenue
through which to make money, or are other metrics such
as creative expression the true return-on-investment?
Are these types of ventures managed like “traditional
businesses,” with a projected profit motive, or is per-
formance quality emphasized above all else? Perhaps
it’s a combination of the two approaches that matters to
producers, directors and choreographers alike. . . .
Additionally, where does “Mamma Mia!” stand when
compared with Broadway classics like “Les Miserables,”
“Miss Saigon,” and “Cats”? Can those who come up
with something new in theater be considered entrepre-
neurs? What about people like Craymer, who simply
bring existing material into a new arena? Is she an entre-
preneur? Is the success of “Mamma Mia!” attributable to
skill and business acumen, or was it a “fluke”?
In the end, does it really matter to Craymer, her critics,
and the many fans?
492 PA RT 6 CASES
E N D N O T E S
1. Marcus Tustin, www.abbamail.com/
mamma_bwy_variety.htm (accessed
July 2003).
2. Ibid.
3. www.abbasite.com (accessed July 2003).
4. Stephen Holden, “ ‘Chess’ Seeks to Shed Its
Checkered Past,” The New York Times
(April 24, 1998).
5. www.abbasite.com, op. cit.
6. Roy Proctor, “ABBA Cadabra It’s ‘Mamma
Mia!’ ” Richmond Times Dispatch (February 9,
2003).
7. John Moore, “Viva ABBA! Three Women’s
Dream Changes Face of Theater,” Denver Post
(November 24, 2002).
8. Ibid.
9. Ibid.
10. Proctor, op. cit.
11. www.playbill.com (accessed July 2003).
12. Steven Winn, “Paying Big Bucks and Getting
Shortchanged,” San Francisco Chronicle
(January 23, 2000).
13. Bruce Lazarus, “Getting Your Act Together and
Taking It on the Road,” Producer’s Corner
(accessed July 2003).
14. “Looking Out on a Different Broadway”
(October 26, 2002), www.ctnow.com.
15. Ibid.
16. Tustin, op. cit.
17. Moore, op. cit.
18. Tom Buckhan, “‘Mamma Mia!’ Proves a
Record Crowd Pleaser,” Buffalo News
(January 18, 2003).
19. Frank Rizzo, “Mamma Mia!” Hartford Courant
(November 3, 2003).
20. Miriam Souccar, “Dancing Queen; ‘Mamma
Mia!’ Charms in Broadway Slump,” Crain’s
NY Business (December 17, 2001).
21. Ibid.
22. Janet Maslin, “Trying to Make ABBA’s
Oldies Young Again,” The New York Times
(October 14, 2001).
23. Ibid.
24. Ibid.
25. “Mamma Mia!” Associated Press (October 28,
2002).
26. www.playbill.com, op. cit.
C A S E 6
THE BEACH CARRIER
Mary Ricci has a new product concept, The Beach
Carrier, that she is ready to bring to market. Ricci is
creative, optimistic, enthusiastic, flexible, and motivated.
She is willing to put substantial time into developing
and bringing The Beach Carrier to market. Although
she lacks capital, Ricci is unwilling to license or sell
the pattern to a manufacturer; she is determined to
maintain control and ownership of the product through-
out the introduction and market penetration phases.
Ricci believes there is a significant amount of money to
be made and refuses to sell her product concept for a
flat fee.
THE PRODUCT
The Beach Carrier is a bag large enough to carry
everything needed for a day at the beach, including
a chair. When empty, the bag can be folded down to a
12-inch by 12-inch square for easy storage. The bag’s
36-inch by 36-inch size, adjustable padded shoulder
strap, and various-sized pockets make it ideal for
use in carrying chairs and other items to the beach
or other outdoor activities, such as concerts, picnics,
and barbecues. The bag can also be used to trans-
port items, such as ski boots, that are difficult to
carry. Manufactured in a lightweight, tear-resistant,
fade-proof fabric that dries quickly, the bag will be
available in a variety of fluorescent as well as conser-
vative colors.
COMPETITION
Currently there are two competitive products sold on-
line that Ricci felt would compete with The Beach
Carrier. The first one, found at www.shadeusa.com, is
the “Caddy Sack” and is advertised as a backpack-type
product that can hold a beach chair, an umbrella, a
boogie board, and even a small collapsing table. There
is also an outside pocket for a towel, a snorkel, or fins.
It is available in three colors and is priced at $16.95.
Ricci purchased one of these and felt that it would not
hold all the items advertised at one time. The chair had
to be very small, and room for extra beach accessories
C A S E 6 THE BEACH CARRIER 493
Segment Percentage of Total Users of Suntan/Sunscreen Products
Ages 18–44 66.9
High school graduate 40.2
Employed full time 60.5
No child in household 54.5
Household income of $30,000 55.3
EXHIBIT 1
was very limited. This item was ideal for someone bik-
ing or walking to the beach with gear for only himself
or herself.
The second item is called the “Wonder Wheeler”
and can be found at www.4thebeach.com. It looks sim-
ilar to a two-wheel shopping cart that might be used to
carry purchased groceries while walking home from
the store. This product is advertised as having over-
sized wheels; it weighs less than 10 pounds and folds
up easily. It can hold a significant amount of beach
gear, such as multiple chairs, an umbrella, a cooler,
beach towels, and toys. It has a list price of $59.99,
and Ricci felt that even with the advertised oversized
wheels it would be cumbersome to maneuver on the
sand. Its high price was also felt to be a negative for
many consumers.
MARKETING RESEARCH
Ricci commissioned a consulting company to perform a
feasibility study for the product, which included a de-
mographic profile, cost estimates, packaging recom-
mendations, and a patent search. The patent search re-
vealed the above-mentioned products and a chair that
could be folded and carried as a small tote bag that
could also hold a few small beach items. None of these
were felt to be a threat to Ricci’s product, and she was
optimistic that a patent could be obtained.
A focus group was used to determine potential
consumer response. Results of the focus group indi-
cated that several features of the product should be
modified. For example, the material was perceived
as durable; however, the fluorescent color was see-
through and considered “trendy,” lessening the per-
ceived quality of the bag. The size also represented an
issue, as the bag was perceived as much larger than
necessary.
MARKET POTENTIAL
People who use suntan and sunscreen products have
been identified as the primary target market for The
Beach Carrier. Research indicates that 43.9 percent of
the adult U.S. population, or 77,293,000 people, use sun-
tan and sunscreen products. Of these, 57.8 percent are
female. Assuming that women are the primary pur-
chasers of beach bags, the potential market is estimated
at 44,675,000. Beach bags are replaced every three years.
The primary market for suntan and sunscreen products is
described in Exhibit 1. The marketing share objectives
for the first year of The Beach Carrier’s sales have been
determined based on the following assumptions:
• People who use suntan and sunscreen products rep- resent the market for The Beach Carrier.
• Most men do not buy beach bags; consider women only (57.8 percent of population).
• Women buy new beach bags every three years on average; that is, one-third will buy a new bag this
year.
Based on these assumptions, the unit sales needed to
achieve market share objectives of 1 percent, 2 percent,
and 5 percent of the total market during the first year of
The Beach Carrier’s sales are shown in Exhibit 2. Ricci
is targeting 1 percent of this potential market. Regional
market share objectives can be developed from the same
data as seen in Exhibits 3A and 3B.
STRATEGY
Ricci investigated several methods of marketing The
Beach Carrier, including selling it in upscale (i.e.,
Bloomingdale’s) or discount (i.e., Wal-Mart) stores, li-
censing the product concept to a manufacturer, selling
the idea for a flat fee, selling the bag to corporations for
494 PA RT 6 CASES
use as a promotional item, selling it on the Internet, and
setting up a mail-order operation. Ricci believes that the
mail-order option, while requiring the most effort, will
provide higher margins, lower risk, and the overall best
fit with Ricci’s strengths and weaknesses, her market
penetration objectives, and her limited financial re-
sources. The Internet could also create opportunities, but
Ricci was unsure of this option.
The mail-order sales strategy will be implemented
nationally using a regional rollout and following a sea-
sonal demand pattern. With three-month intervals be-
tween rollout phases, national market exposure will be
achieved within 12 months. Ricci is also exploring how
to set up a Web site with a local university team of stu-
dent consultants.
PROMOTION
The product initially will be promoted in novelty and
general interest mail-order catalogs and special interest
magazines that appeal to beachgoers and boat owners.
PRICING
The costs of manufacturing have been estimated at
$6.50 per unit for material, zippers, Velcro, and so on. The
costs for assembly and packaging have been estimated
at $3.50 per unit, bringing the total manufacturing cost to
$10.00. After analysis of competitive products and focus
group results, a mail-order price in the $12.99 to $14.99
range has been established.
Market Share
1% 2% 5%
Northeast 33,071 66,142 165,356
Midwest 37,820 75,641 189,102
South 46,201 92,403 231,007
West 31,825 63,649 159,123
Total 148,917 297,835 744,588
EXHIBIT 3B
Population Sunscreen Users Replace Bag This Year
Total adults 176,251,000 77,293,000 25,764,333
Females 92,184,000 44,671,000 14,890,333
Market Share
1% 2% 5%
Total adults 257,643 515,287 1,288,217
Females 148,903 297,807 744,517
EXHIBIT 2
Population Sunscreen Users Women Replace Bag This Year
Northeast 37,366,000 17,165,000 9,921,370 3,307,123
Midwest 43,426,000 19,630,000 11,346,140 3,782,047
South 60,402,000 23,980,000 13,860,440 4,620,147
West 35,057,000 16,518,000 9,547,404 3,182,468
Total 176,251,000 77,293,000 44,675,354 14,891,785
EXHIBIT 3A
C A S E 7 GOURMET TO GO 495
DISTRIBUTION
The product will be manufactured at a local New England
factory, drop-shipped to a storage facility, and shipped via
UPS to the consumer. Initially, inventory can be carried at
no cost in Ricci’s house or garage. This same process
could also be used if the Web site is developed.
FINANCING
A $30,000 small-business loan is the minimum amount
Ricci needs to fund her fixed costs for the first phase
of the rollout for the mail-order program. Marketing the
product through traditional retail channels would require
approximately $250,000 for advertising and other selling
costs associated with a new product introduction.
BREAK-EVEN ANALYSIS
Break-even analysis was performed at three mail-order
prices, as seen in Exhibit 4. On the basis of this analysis,
Ricci must meet only one-fourth of her target sales goal,
or one-quarter of 1 percent of the total market, in order
to break even in the first year.
C A S E 7 GOURMET TO GO
INTRODUCTION
Today, many households have two incomes. At the end of
the day the questions arise, “Who will cook?” or “What do
I cook?” Time is limited. After a long day at work, few
people want to face the lines at the grocery store. Often the
choice is to eat out. But the expense of dining out or the
boredom of fast food soon becomes unappealing. Pizza
or fast-food delivery solves the problem of going out but
does not always satisfy the need for nutritious, high-
quality meals. Some people prefer a home-cooked meal,
especially without the hassle of grocery shopping, menu
planning, and time-consuming preparation.
Jan Jones is one of those people. She is a hardwork-
ing professional who would like to come home to a
home-cooked meal. She would not mind fixing it herself
but, once at home, making an extra trip to the store is a
major hassle. Jones thought it would be great to have the
meal planned and all the ingredients at her fingertips.
EXHIBIT 4
Unit Variable Cost per Unit Price Contribution
Materials $6.50 $12.99 $2.99
Assembly 3.00 $13.99 $3.99
Packaging 0.50 $14.99 $4.99
Total unit VC $10.00
Fixed Costs
Northeast Midwest South West Total
Advertising $25,000 $25,000 $25,000 $25,000 $100,000
Warehousing 266 305 372 256 1,199
General S&A 2,500 2,500 2,500 2,500 10,000
Total fixed costs $27,766 $27,805 $27,872 $27,756 $111,199
Break-Even Units
$12.99 9,286 9,299 9,322 9,283 37,190
Percent of total market 0.28 0.25 0.20 0.29 0.25
$13.99 6,959 6,969 6,985 6,956 27,869
Percent of total market 0.21 0.18 0.15 0.22 0.19
$14.99 5,564 5,572 5,586 5,562 22,284
Percent of total market 0.17 0.15 0.12 0.17 0.15
She thought of other people in her situation and realized
there might be a market need for this kind of service.
After thinking about the types of meals that could be
marketed, Jones discussed the plan with her colleagues
at work. The enthusiastic response led her to believe she
had a good idea. After months of marketing research,
menu planning, and financial projections, Jones was
ready to launch her new business. The following is the
business plan for Gourmet to Go.
EXECUTIVE SUMMARY
Gourmet to Go is a new concept in grocery marketing.
The product is a combination of menu planning and gro-
cery delivery; a complete package of groceries and recipes
for a week’s meals is delivered to a customer’s door. The
target market consists of young urban professionals living
in two-income households in which individuals have
limited leisure time, high disposable income, and a will-
ingness to pay for services.
The objective is to develop a customer base of 400
households by the end of the third year after start-up.
This level of operation will produce a new income of
about $120,000 per year and provide a solid base for
market penetration in the future.
The objective will be achieved by creating an
awareness of the product through an intense promo-
tional campaign at start-up and by providing customers
with first-class service and premium-quality goods.
The capital required to achieve objectives is $258,000.
Jones will invest $183,000 and will manage and own the
business. The remainder of the capital will be financed
through bank loans.
PRODUCT
The product consists of meal-planning and grocery shop-
ping services. It offers a limited selection of preplanned
five-dinner packages delivered directly to the customer.
The criteria for the meal packages will be balanced
nutrition, easy preparation, and premium quality. To en-
sure the nutritional requirements, Gourmet to Go will
hire a nutritionist as a consultant. Nutritional informa-
tion will be included with each order. The most efficient
method for preparing the overall meal will be presented.
Meals will be limited to recipes requiring no more than
20 minutes to prepare. Premium-quality ingredients will
be a selling feature. The customer should feel that he or
she is getting better-quality ingredients than could be
obtained from the grocery store.
MANUFACTURING AND PACKAGING
Since the customer will not be shopping on the prem-
ises, Gourmet to Go will require only a warehouse-type
space for the groceries. The store location or decor will
be unimportant in attracting business. There will be fewer
inventory expenses since the customer will not be choos-
ing among various brands. Only premium brands will be
offered.
It will be important to establish a reliable connection
with a distributor for high-quality produce and to main-
tain freshness for delivery to the customer.
As orders are processed, the dinners will be assembled.
Meats will be wrapped and ready for the home freezer. All
ingredients will be labeled according to the dinner to
which they belong. The groceries will be sorted and
bagged according to storage requirements: freezer, refrig-
erator, and shelf. Everything possible will be done to min-
imize the customer’s task. Included in the packaging will
be the nutritional information and preparation instructions.
Customers will be given the option of selecting their
own meals from the monthly menu list or opting for a
weekly selection from the company.
FUTURE GROWTH
Various options will be explored in order to expand the
business. Some customers may prefer a three- or four-
meal plan if they eat out more often or travel frequently.
Another possibility might be the “last-minute gourmet”;
that is, they can call any evening for one meal only.
Increasing the customer base will increase future
sales. Expansion of Gourmet to Go can include branches
in other locations or even future franchising in other
cities. With expansion and success, Gourmet to Go
might be a prime target for a larger food company to
buy out.
INDUSTRY
The Gourmet to Go concept is a new idea with its own
market niche. The closest competitors would be grocery
stores and restaurants with delivery services.
Of the 660 grocery stores in the Tulsa/Tulsa County
region, only two offer delivery service. They are higher-
priced stores and will deliver for $4, regardless of order
size. However, they offer no assistance in meal planning.
A number of pizza chains will deliver pizza as well as
fried chicken. There is also a new service that will pick
up and deliver orders from various restaurants. However,
496 PA RT 6 CASES
C A S E 7 GOURMET TO GO 497
Gourmet to Go would not be in direct competition with
these services because the meals available from them are
either of a fast-food type or far more expensive than a
Gourmet to Go meal.
SALES PREDICTION
The market segment will be households with an in-
come of at least $65,000 per year. In Tulsa/Tulsa
County, this will cover an area including over 16,600
households that meet the target requirements of income
with an age range of 24 to 50 years. By the end of the
third year, a customer base of 400 households will be
developed (2.3 percent of the target market). At a
growth rate of 2.73 percent a year, the target market
of households should increase over three years to
18,000.
FINANCIAL
Various financial statements are included in Exhibits 1
through 8.
EXHIBIT 1 Start-Up Expenses
Ad campaign
Ad agency* $3,000
Brochures† 7,000
Radio spots‡ 8,000
Newspaper ads§ 7,000
Total $25,000
Pre-start-up salaries** 16,000
Nutritionist consulting 6,000
Miscellaneous consulting (legal, etc.) 1,500
Pre-start-up rent and deposits 4,000
Pre-start-up utilities and miscellaneous supplies 2,000
$54,500
*40 hrs. @ $75/hr. †20,000 brochures; printing, development, etc. @ $0.35/ea. ‡4-week intense campaign: 20 spots/week (30 seconds); $100/spot. §50 ads at an average of $100/ad.
**Jan Jones @ 3 months; clerks, two @ 2 weeks.
EXHIBIT 2 Capital Equipment List
Computers:
Apple, Macintosh Office System
3 Mac systems $3,000
Laser printer HP2300 series 1,000
Networking 2,000
Software 3,000
Total $ 9,000
Delivery vans, Chevrolet Astro 66,000
Food lockers and freezers 15,000
Phone system (AT&T) 1,500
Furniture and fixtures 3,500
$95,000
498 PA RT 6 CASES
EXHIBIT 3 Pro Forma Income Statement
Year 1
Mo. 1 Mo. 2 Mo. 3 Mo. 4 Mo. 5 Mo. 6 Mo. 7 Mo. 8 Mo. 9 Mo. 10 Mo. 11 Mo. 12
Sales1 2,600 3,900 6,500 13,000 19,500 23,400 26,000 28,600 31,200 33,800 36,400 39,000
Less: Cost of
goods sold2 1,700 2,550 4,250 8,500 12,750 15,300 17,000 18,700 20,400 22,100 23,800 25,500
Gross profit 900 1,350 2,250 4,500 6,750 8,100 9,000 9,900 10,800 11,700 12,600 13,500
Less: Operating
expenses
Salaries and
wages3 7,400 7,400 7,400 7,400 7,400 7,400 9,800 9,800 9,800 9,800 9,800 9,800
Operating
supplies 300 300 300 300 300 300 300 300 300 300 300 300
Repairs and
maintenance 250 250 250 250 250 250 250 250 250 250 250 250
Advertising and
promotion4 130 195 325 650 975 1,170 1,300 1,430 1,560 1,690 1,820 1,950
Bad debts 100 100 100 100 100 100 100 100 100 100 100 100
Rent5 1,667 1,667 1,667 1,667 1,667 1,667 1,667 1,667 1,667 1,667 1,667 1,667
Utilities 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000
Insurance 600 600 600 600 600 600 600 600 600 600 600 600
General office 150 150 150 150 150 150 150 150 150 150 150 150
Licenses 200 0 0 0 0 0 0 0 0 0 0 0
Interest6 310 310 310 310 310 310 530 530 530 530 530 530
Depreciation7 1,271 1,271 1,271 1,271 1,271 1,271 1,271 1,271 1,271 1,271 1,271 1,271
Total operating
expenses 13,378 13,243 13,373 13,698 14,023 14,218 16,968 17,098 17,228 17,358 17,488 17,618
Profit (loss)
before taxes (12,478) (11,893) (11,123) (9,198) (7,273) (6,118) (7,968) (7,198) (6,428) (5,658) (4,888) (4,118)
Less: Taxes 0 0 0 0 0 0 0 0 0 0 0 0
Net profit (loss) (12,478) (11,893) (11,123) (9,198) (7,273) (6,118) (7,968) (7,198) (6,428) (5,658) (4,888) (4,118)
(1)Average unit sale for groceries is about $43,00, plus $10.00 per week for delivery (Exhibit 1), making the monthly unit sales per household (2 people) about
$212,00. (2)Cost of goods sold—80% of retail grocery price, or $32.00 per household per week ($170.00/month household). (80% an average margin on groceries.) (3)Salaries and wages—Ms. Jones’s salary will be $5,000/month. Order clerks will be paid $1,300/month, and delivery clerks will be paid $1,100/month. One
additional order clerk and delivery clerk each will be added once sales reach 100 households, and again at 200 households. Salaries will escalate at 6%/year. (4)Advertising and promotion—The grocery industry standard is 1% of sales. However, Gourmet to Go, being a new business, will require more than that level;
5% of sales is used in this plan. (Special pre-start-up advertising is covered with other start-up expenses.) (5)Rent—2,000/ft.2 @ $10.00/ft.2; $1,667/month; escalate at 6%/year. (6)Interest—Loans on computer ($10,000) and delivery vehicles ($22,000 ea.) at 12.0%/year. (Delivery vehicles will be added with delivery clerks.) (Debt service—
based on three-year amortization of loans with payments of 1⁄3 at the end of each of three years.) (7)Depreciation—All equipment will be depreciated per ACRS schedules: vehicles and computers—3 years; furniture and fixtures—10 years.
C A S E 7 GOURMET TO GO 499
EXHIBIT 4 Pro Forma Income Statement
Year 2 Year 3
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Sales1 136,500 156,000 194,698 234,000 253,500 273,000 292,500 312,000
Less: Cost of
goods sold2 89,250 102,000 127,302 153,000 165,750 178,500 191,250 204,000
Gross profit 47,250 54,000 67,395 81,000 87,750 94,500 101,250 108,000
Less: Operating expenses
Salaries and wages3 31,164 38,796 38,796 38,796 41,124 41,124 41,124 41,124
Operating supplies 900 900 900 900 900 900 900 900
Repairs and maintenance 750 750 750 750 750 750 750 750
Advertising and promotion4 6,825 7,800 9,735 11,700 12,675 13,650 14,625 15,600
Bad debts 300 300 300 300 300 300 300 300
Rent5 5,301 5,301 5,301 5,301 5,619 5,619 5,619 5,619
Utilities 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000
Insurance 1,800 1,800 1,800 1,800 1,800 1,800 1,800 1,800
General office 450 450 450 450 450 450 450 450
Interest6 1,280 1,940 1,720 1,720 1,410 1,190 970 970
Depreciation7 6,910 6,910 6,910 6,910 7,493 7,493 7,493 7,493
Total operating
expenses 58,680 67,947 69,662 71,627 75,520 76,275 77,030 78,005
Profit (loss)
before taxes (11,430) (13,947) (2,267) 9,373 12,230 18,225 24,220 29,995
Less: Taxes 0
Net profit (loss) (11,430) (13,947) (2,267) 9,373 12,230 18,225 24,220 29,995
(1)Average unit sale for groceries is about $43,00, plus $10.00 per week for delivery (Exhibit 1), making the monthly unit sales per household (2 people) about
$212,00. (2)Cost of goods sold—80% of retail grocery price, or $32.00 per household per week ($138.00/month household). (80% an average margin on groceries—
Progressive Grocer; April 1984; p. 94.) (3)Salaries and wages—Ms. Jones’s salary will be $5,000/month. Order clerks will be paid $1,300/month, and delivery clerks will be paid $1,100/month. One
additional order clerk and delivery clerk each will be added once sales reach 100 households, and again at 200 households. Salaries will escalate at 6%/year. (4)Advertising and promotion—The grocery industry standard is 1% of sales. However, Gourmet to Go, being a new business, will require more than that level;
5% of sales is used in this plan. (Special pre-start-up advertising is covered with other start-up expenses.) (5)Rent—2,000/ft.2 @ $8.00/ft.2; 1,333 $1/month; escalate at 6%/year. (6)Interest—Loans on computer ($10,000) and delivery vehicles ($12,000 ea.) at 12.5% year. (Delivery vehicles will be added with delivery clerks.) (Debt
service—based on three-year amortization of loans with payments of 1⁄3 at the end of each of three years.) (7)Depreciation—All equipment will be depreciated per ACRS schedules: vehicles and computers—3 years; furniture and fixtures—10 years.
E X
H IB
IT 5
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2 0 0
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re st
3 1 0
3 1 0
3 1 0
3 1 0
3 1 0
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t se
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(p ri
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1 0 ,3
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ta l c a sh
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b u
rs e m
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ts 1 3 ,8
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w (1
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(1 0 ,6
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(9 ,8
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(6 ,0
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500
C A S E 7 GOURMET TO GO 501
EXHIBIT 6 Pro Forma Cash Flow Statement
Year 2 Year 3
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Cash receipts
Sales 136,500 156,000 194,698 234,000 253,500 273,000 292,500 312,000
Other
Total cash receipts 136,500 156,000 194,698 234,000 253,500 273,000 292,500 312,000
Cash disbursements
Cost of goods sold 89,250 102,000 127,302 153,000 165,750 178,500 191,250 204,000
Salaries and wages 31,164 38,796 38,796 38,796 41,124 41,124 41,124 41,124
Operating supplies 900 900 900 900 900 900 900 900
Repairs and maintenance 750 750 750 750 750 750 750 750
Advertising and promotion 6,825 7,800 9,735 11,700 12,675 13,650 14,625 15,600
Bad debts 300 300 300 300 300 300 300 300
Rent 5,301 5,301 5,301 5,301 5,619 5,619 5,619 5,619
Utilities 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000
Insurance 1,800 1,800 1,800 1,800 1,800 1,800 1,800 1,800
General office 450 450 450 450 450 450 450 450
Licenses 0 0 0 0 0 0 0 0
Interest 1,280 1,940 1,720 1,720 1,410 1,190 970 970
Debt service (principal) 7,333 10,333 7,333 7,333 10,333
Total cash disbursements 141,020 170,370 190,054 228,050 241,111 254,616 260,788 284,846
Net cash flow (4,520) (14,370) 4,643 5,950 12,389 18,384 31,712 27,154
EXHIBIT 7 Pro Forma Balance Sheets
End of: Year 1 Year 2 Year 3 Year 1 Year 2 Year 3
Assets Liabilities
Current assets Accounts payable 12,750 21,217 31,875
Cash 3,000 5,000 7,000 Notes payable 0 0 0
Accounts receivable 19,500 32,450 48,750 Total current liabilities 12,750 21,217 31,875
Inventory 12,750 21,217 31,875 Long-term liabilities
Supplies 300 300 300 Bank loans payable 42,667 47,000 22,000
Prepaid expenses 1,667 1,767 1,873 Personal loans payable 0 0 0
Total current assets 37,217 60,734 89,798 Total long-term liabilities 42,667 47,000 22,000
Fixed assets Total liabilities 55,417 68,217 53,875
Furniture and fixtures 18,000 16,000 14,000 Owner’s equity
Vehicles 33,000 32,780 8,140 Paid-in capital 133,889 62,897 28,068
Equipment 6,750 3,330 0 Retained earnings (94,339) (18,271) 29,995
Total fixed assets 57,750 52,110 22,140 Total owner’s equity 39,550 44,627 58,063
Total assets 94,967 112,844 111,938 Total liabilities and equity 94,967 112,844 111,938
502 PA RT 6 CASES
MARKETING
Distribution
The product will be delivered directly to the customer.
Sales Strategy
Advertising will include newspaper ads, radio spots, an
Internet Web page, and direct-mail brochures. All four
will be used during normal operations, but an intense
campaign will precede start-up. A series of “teaser”
newspaper ads will be run prior to start-up, announcing
a revolution in grocery shopping. At start-up, the news-
paper ads will have evolved into actually introducing the
product, and radio spots will begin as well. A heavy ad-
vertising schedule will be used during the first four
weeks of business. After start-up, a direct mailing will
detail the description of the service and a menu plan.
Newspaper ads aimed at the target markets will be
placed in entertainment and business sections. Radio
spots will be geared to stations most appealing to the tar-
get market. Since the product is new, it may be possible to
do interviews with newspapers and obtain free publicity.
Sales promotions will offer large discounts to first-
time customers. These promotions will continue for the
first six months of operations.
The service will be priced at $10 per week for deliv-
ery and planning, with the groceries priced at full retail
level. According to the phone survey, most people who
were interested in the service would be willing to pay the
weekly service charge.
MANAGEMENT
The management will consist of the owner/manager.
Other employees will be delivery clerks and order
clerks. It is anticipated that after the business grows, an
operations manager might be added to supervise the
employees.
C A S E 8
INTERVELA D.O.O. KOPER— VICTORY SAILMAKERS
Zvonko and Zeljko stepped through the glass door of the
sail loft they started a decade ago and paused on the
blue iron stairs. Their glances drifted out to the sea,
shimmering in the evening sunshine. The ships in the
Bay of Koper were set on a southerly course. The sail-
boats in the marina were quietly moored as if patiently
waiting for the helmsmen and crews to finally untie them
and unfurl their sails. Grey clouds coming in from the
southwest did not disturb their thoughts; they were
already thinking past dinner to the next day, when time
limits would again be pressuring them. Their most suc-
cessful business year was now behind them and several
new options were emerging.
SAILING
Zvonko Bezic and Zeljko Perovic, both born in 1962,
met each other in the early 1970s when they both started
sailing with the Galeb Sailing Club in Rijeka, Croatia.
As students, they sailed together in the Flying Dutchman
Class. At that time they were already modifying their
EXHIBIT 8 Sources and Uses of Funds
Sources of Funds
Jan Jones (personal funds) $182,913
Bank loans for computer and vehicles 75,000
Total sources $257,913
Uses of Funds
Computer, peripherals, and software $9,000
Food lockers and freezers 15,000
Delivery vehicles* 66,000
Phone system 1,500
Miscellaneous furniture and fixtures 3,500
Start-up expenses 54,600
Working capital† 108,313
Total uses‡ $257,913
*See detail, following. †To cover negative cash flow over first 11⁄2 years of operation. (See pro forma
cash flow statements.) ‡Total for initial 3-year period. Computer and one delivery van will be
acquired prior to start-up, one delivery van will be added 6 months after start-
up, and another will be added 15 months after start-up. Financing will be
handled simultaneously with procurement.
Source: The case was written by Bostjan Antoncic, Faculty of Management at the University of Primorska. Copyright 2001 of the author. Published with the author’s permission.
The case is intended as a basis for class discussion rather than to illustrate either effective or ineffective handling of management situations.
racing sails, primarily of foreign make, adjusting them to
their weight and style of sailing. They finished their uni-
versity studies in the late 1980s (Zvonko Bezic with a
degree in pedagogy and Zeljko Perovic in maritime traf-
fic engineering).
In 1988, they were both employed, Zvonko Bezic as a
journalist and editor for the Rijeka region with the Trade
Union paper “Radnicke novine,” and Zeljko Perovic
(who usually goes by his sailing nickname, Huck) as a
sailing coach in Galeb. Zeljko Perovic occasionally
worked with Mr. Grego, who was making sails. It was
here that Zeljko learned how to make sails for large sail-
boats; this involved knowing how much curve is needed
for each horizontal panel and how to make the sail’s final
cut. In addition, he read English books dealing with this
topic, which he found extremely interesting. In 1988,
Zvonko Bezic and Zeljko Perovic started making sails on
their own, at first only for the smallest optimist-class
sailboats. They made their first design for these sails by
taking apart a sail produced by Green, the most renowned
sail manufacturer among sailors and coaches in the opti-
mist class at that time. The same sail was also usable for
larger sailboats, which was particularly important. The
first set of sails for the sailing school in Rijeka was a direct
copy of such a sail.
THE AFFABLE ESTABLISHMENT
OF A COMPANY
At that time a friend from Rijeka, who himself was al-
ready a well-established and experienced tradesman,
persuaded Zvonko Bezic to start his own business. He
even suggested the type of business (chemicals) and a
partner, but in the end they did not go into that field. In-
stead, together with Zeljko Perovic, they decided to es-
tablish a sail loft business. The above-mentioned friend
offered them a loan of SFR 2,000 under the following
conditions: should their enterprise survive for two years,
they would not have to pay back the loan, but should
they go bankrupt and not be successful, they would have
to repay the loan together with accrued interest. They ac-
cepted the offer. Their friend also provided them with
business cards and promotional material.
In 1989, the two started manufacturing regatta sails for
the youth Optimist Class. They adapted the basic design
and cut of the panels from the disassembled Green sail to
the needs of lighter sails. Zeljko Perovic said that “they
began to play with the form of sails.” They simultaneously
started to manufacture sails for larger sailboats and yachts.
The sails were cut in the school gym they rented on week-
ends; on weekdays the sails were sewed at home together
with Zeljko Perovic’s grandmother. He remembers: “. . .
we occupied a part of her house, first a small room and
then an entire floor and even the garage.” In the manufac-
turing of sails for larger sailboats the know-how and infor-
mation acquired from Mr. Grego helped them extensively.
In 1990, the two decided to go into the sail business full
time. They studied books and magazines and gathered a
great deal of information on: (1) the materials used for
sailmaking, (2) the manufacturing process itself, its his-
tory and developmental trends, and (3) other sail manufac-
turers. They learned about computer-aided sail cutting,
and were also able to obtain information directly from sail
manufacturers, particularly those from Slovenia and
northern Italy. In the then relatively large factory for the
mass production of sails in Forli, Italy, where the pair
offered to sell the Italian firm’s sails in the former
Yugoslavia, they learned how the factory organized sail
production and what equipment they used. “They employed
an expert from New Zealand and used a computer pro-
gram. In Forli we primarily tried to learn what they do and
how they do it,” relates Zeljko Perovic. They also learned
a great deal during their visit to the newly opened sail loft
of the largest global manufacturer, North, in Monfalcone,
Italy, accompanying Dusan Puh who was then ordering
sails for “Elan Team,” of which Zvonko Bezic was a
member, and for the Elan sailboat then called “Packa.”
They got useful information about the equipment they
used and about where it could be ordered. While looking
for a sail loft on Sardegna to have his torn sails repaired,
Zeljko Perovic by chance found himself in a sail loft man-
ufacturing Fois sails. He saw how simply they finish some
details on the sail (e.g., edges and reinforcements) and
how they have adapted their machines for this process.
The two decided to purchase a computer program for
cutting the sails. For half a year they gathered data on
which program to buy and tested five different demo pro-
grams. At the end of 1990, they bought a personal com-
puter and Sailmaker Software (SMSW) from Autometrix,
USA. While they knew that renowned sail manufacturers
were also using plotters and cutters in addition to comput-
ers, they could not afford them. They also had difficulties
financing production and covering fixed costs, since they
had rented manufacturing facilities in Rijeka.
STANDSTILL AND A NEW START
In 1991 they accepted positions as hired sailors in Italy
in order to raise some money. Concurrently, the market
for sails in Croatia and Slovenia shrank that year,
C A S E 8 INTERVELA D.O.O. KOPER—VICTORY SAILMAKERS 503
504 PA RT 6 CASES
resulting in their not manufacturing sails but only
maintaining some resale business. As there was practi-
cally no market in Croatia, they started looking for a
new location for their sail loft—somewhere closer to
Italy. They were about to decide on either Portorose,
Slovenia, or Ravenna, Italy, when Mr. J. Kosmina of-
fered them the opportunity to take over the sail repair
service during the Match Race in Koper, Slovenia.
They decided to stay in Koper and rented premises in the
Koper Marina to start making sails again. At the begin-
ning of 1992 they used their savings to buy a second-hand
Autometrix plotter. “We were among the first in the
local market (i.e., Slovenia, Croatia, and northern Italy)
to start applying computer technology in the manufac-
turing of sails; in the whole of Italy, only the leading
manufacturer—North—availed itself of computer tech-
nology,” explains Zeljko Perovic.
In 1992, while they were making sails in Koper, they
launched an additional activity—making advertising
signs. As they started to plot the letters, they learned
from other sign makers what programs to use, how they
read the sketches and transfer them to the plotter (in
terms of size and form). They used this know-how also
in the computer aided design of reinforcements. The
company was becoming known in this local market and
could more easily establish contacts and exchange infor-
mation with other local sailmakers. At the end of 1992,
the company moved into larger premises in the marina
and modernized their manufacturing process with the
purchase of additional new sewing machines.
MARKETING STRATEGY
In 1993, sales increased and the company was obtaining
customers from Italy, Germany, and Austria. At that time,
the main local competitors of Intervela (their company)
were: Olimpic Trieste, Italy (with sales of about USD
900,000 in 1993), Ulmer Kolius Lignano, Italy (USD
600,000), North Monfalcone, Italy (USD 180,000), Sea-
way Portorose, Slovenia (USD 180,000), and Zadro Tri-
este, Italy (USD 90,000). At the end of that year a sailor
from Koper who had the status of junior researcher at
the Faculty of Economics of the University of Ljubljana,
Slovenia, prepared, in cooperation with both propri-
etors, a marketing plan for Intervela, which had hitherto
only haphazardly planned a marketing strategy. Based
on an analysis of the current demand and the competi-
tion, an increase in sales of 58 percent over the next
three years (1994–1996) was established as the main
goal, along with: a gradual increase in market share, the
promotion of the company and its products to potential
customers, and an improvement in the internal efficiency
of the company and the quality of its products. The
strengths (price and quality, including the finishing of
sails and a two-year warranty), weaknesses (marketing
communication, standardization, design), opportunities
(selling larger series to companies, manufacturing sails
for larger yachts), and threats (market contraction, poor
advertising for sails, essential technological changes)
were also established for sails—the key product of the
company.
Development and market penetration were the primary
focus of the company’s business plan. The marketing
strategy was formulated: product (standardization, design
improvements, the transfer of improvements from racing
sails to other sails, following trends closely, the introduc-
tion and improvement of after-sale services—i.e., the tun-
ing of sails and instructing customers); price (competitive
prices with regard to individual customers); place (the
extension of the distribution network); and promotion
(promotion by means of a first-class sailboat—Gaia
Cube—in races, personal contacts, the distribution of pro-
motional material to sailboat owners, and advertising in
the Slovenian nautical magazine “Val”). They focused on
the promotion of the Victory sail trademark.
In 1993, Intervela was the first to introduce a novelty
in the production of larger sails: double batten pockets.
This concept had previously only been applied to smaller
Olympic sailboats and mentioned in professional jour-
nals. Some local rivals soon copied this idea.
Despite the shrinkage of the Italian market, the
company consistently enjoyed increasing sales through-
out 1994. The quality of their sails and the good publicity
gained when the Gaia Cube sailboat won races con-
tributed much to the sales results. In that year, Mr.
Vencato, a rival from Trieste and the manufacturer of
Ullman sails, proposed cooperation in part to learn
what computer program and plotter they were using
and how they worked. Soon afterwards, Mr. Vencato
bought an improved version of the same software and
plotter that at the same time worked as a cutter.
A DECISION ON THE CUTTER AND
THE SITUATION IN 1995
In 1995, after another successful business year (a further
increase in sales to USD 128,300—see Exhibit 1), the
owner-managers of Intervela decided, among other new
investments, to purchase a new plotter-cutter to cut sail-
cloth material. They also visited Mr. DeMartisu of the
C A S E 8 INTERVELA D.O.O. KOPER—VICTORY SAILMAKERS 505
Olimpic sail loft in Trieste, who had purchased a new
plotter-cutter that year. In 1995 more competitors visited
Intervela than in the year before.
Intervela d.o.o. Koper is a relatively small limited lia-
bility company wholly owned by Zvonko Bezic and
Zeljko Perovic. In 1995, the company primarily manu-
factured sails for racing sailboats and keelboats.1 Sales
under the brand name Victory accounted for 90 percent
of total sales in 1995 (of which 65 percent were regatta
sails), while sail repairs, advertising-sign making, and
the manufacture of canvas covers, bags, and trapezes for
sailboats accounted for the remaining 10 percent. Inter-
vela in 1994 had USD 86,300 in sales revenue and six
full-time staff (including owners) and USD 128,300 in
sales revenue with five full-time employees in 1995.
Zvonko Bezic is primarily responsible for marketing,
while Zeljko Perovic is in charge of production.
THE PURCHASE OF A CUTTER
In 1995, Intervela purchased a sailcloth material cutter
and two software packages for planning and designing
sails, resulting in the use of three different software
packages: SMSW, ProSail, and Crain. The American
ProSail software program is, as one of the sail loft
owners says, rather easy to use particularly for the de-
signs for the cruising sails. The American SMSW and
the French Crain software packages are more complex
and require more time to design sails and are appropri-
ate for the more demanding sails used in racing. The
company started using SMSW in the first half of the
nineties.
THE ACQUISITION OF THE KUTIN SAIL
LOFT WORKSHOP
Due to the rapidly increasing demand for Victory sails,
the two partners looked for additional workspace and
staff in 1996. When the Kutin sail loft in Rijeka declared
bankruptcy, the company acquired the workshop and
moved their old plotter to Rijeka. The new location in
Croatia began operations in May 2000.
ELAN
Prior to the bankruptcy, Kutin made sails for Elan, the
biggest producer of sailboats in Slovenia. The Kutin-
Elan relationship had difficulties due to quality problems
and customer complaints. One of the Intervela owners
explained that about 60 percent of the complaints re-
ceived by Elan at that time concerned sails produced by
Kutin, causing Elan to look for a new supplier.
Elan desired to have an inland supplier. Elan tried to
have Rado Pelajic manufacture sails for small Zeta class
sailboats, but that cooperation did not last. Elan then
EXHIBIT 1 The Growth of Intervela d.o.o.
Source: Data from the company and the annual accounts of Intervela d.o.o.
600,0
500,0
400,0
300,0
200,0
100,0
0,0
T o ta
l s a le
s i n $
1 ,0
0 0
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Year
contacted Intervela and Zvonko and Zeljko prepared a
contract. Because Victory sails were of higher quality
than those produced by Kutin, a higher price was quoted,
above Kutin’s delivery price to Elan. Through negotia-
tions a slightly lower price was agreed to in the final
contract.
Zvonko and Zeljko thought that “this would be some
business to fill in the gaps—in winter time when the
market is flat.” It involved the rather simple mass pro-
duction of sails. A regular customer would also “provide
a certain degree of security.” However, in dealing with
such a big customer as Elan, payment difficulties
occurred. In spite of the agreed 60-day payment term,
payment was received after 120 days or later. In 1998 a
sailboat was received in compensation for unpaid in-
voices. In 2000 that sailboat, an Elan 36, captained by
Franci Stres, sunk in a storm along the Croatian coast. In
a second compensation deal in 1999, an Elan 333 Cruis-
ing boat was received as payment. In that year, Elan
“faced bankruptcy.”
Elan sent to Intervela a proposal for writing off
such receivable claims, but Zvonko and Zeljko did not
agree to it. Negotiations on the allocation of bankruptcy
assets dragged on into mid-2001. “Since we were among
the more important suppliers, they retained us as sup-
pliers and did not write off our receivables,” stated
Zvonko Bezic. In 2001, Intervela continued to do busi-
ness with Elan, but required pre-payment for the sails
supplied. Orders from Elan increased. From 60 sailboats
per year, sales of Elan sailboats (and Victory sails) in-
creased to about 110 sailboats in the year 2000 and a
planned 150 sailboats in 2001. Sales to Elan accounted
for about one-fourth (about USD 137,500) of the total
sales (about USD 550,000) of Intervela in 2000.
THE GAIA CUBE PROJECT
Intervela made their first sails for the racing boat Gaia
Cube (subsequently the Gaia Legend) Consortium in
1995. In the period 1995–1997 they were also members
of the crew and won races at the famous sailing event
Barcolana in the bay of Trieste. Later, in 1998, the
Kosmina family, which played the leading role in the
consortium, decided to use sails made by the Trieste-
based Olimpic. Olimpic, being the strongest local
company at that time, offered some very low prices.
The company made money by selling sails for smaller
sailboats, which made it important to enter into this
project regardless of the low price.
PENETRATING THE GLOBAL MARKET
WITH FINN CLASS SAILS
At the end of 1997 and at the beginning of 1998 Inter-
vela started to manufacture sails for the Olympic one-
man Finn sailboat. Karlo Kuret, a renowned Croatian
sailor in the class, asked them to make him a sail, be-
cause in his Olympic program the cost of sails was very
high. He proposed they make him a copy of the Sobstadt
sail, but Zvonko and Zeljko decided to develop a com-
pletely new sail. This new sail was a great international
success. Using the Victory sail, Kuret won the Olympic
Week race in Athens in February 1998.
Olympic champion Mateusz Kusnierewicz from
Poland wanted to test the new sail at the pre-Olympic re-
gatta in Medemblik, Netherlands. The sail was sewn
by Intervela overnight. The next day Kusnierewicz was
racing with his sail. At the next pre-Olympic regatta, in
Kiel, Germany, Kuznierewicz won seven out of nine
races. From 1999 to 2001, using the Victory sail, he
was the number one sailor in the world—his worst re-
sult was second place in the World and European
championships (World Champion 1999 in Greece and
2000 in England); he took fourth place at the Olympic
Games in Sydney.
When Intervela started to produce the Finn class sails,
they also started to cooperate with the University of
Zagreb, Croatia, where the first analyses of sailcloth were
done. A comparison of various materials was made by
analyzing 26 parameters. This analysis helps the com-
pany determine the quality of materials and the appropri-
ateness of a material for their products.
Zvonko and Zeljko believe that, in addition to the
development of a new product, the securing of top
sailors in the Finn class having good results, and the
application of new materials, the following three fac-
tors were important in their penetration into the Finn
sails market:
• Development of sails. Victory sail representatives visit regattas, watch the races, and collect informa-
tion and comments; Intervela has composed a team
of top-level sailors (four of them were among the
top ten in the world ranking in 2000 as well as of
mid-2001) and offers them special conditions such
as adjusting the sails to their specific needs.
• Novelty in sail design technology. Intervela used sophisticated computer software in designing and
constructing the sails for “one-design” types of
sailboats, such as the Finn.
506 PA RT 6 CASES
C A S E 8 INTERVELA D.O.O. KOPER—VICTORY SAILMAKERS 507
• Analysis of sail quality. The company tests sails by attaching sensors to the sail and a camera to the top
of the mast to record sail performance during sail-
ing; they then improve the sails based on an analysis
of their performance.
Intervela was growing into a globally renowned com-
pany with the Victory brand name. At the Olympics in
Sydney, 18 of the 25 sailors in the Finn class used Vic-
tory sails. The sails are now being sold all over the
world: Canada, USA, Brazil, Australia, New Zealand,
Republic of South Africa, China, Japan, Sweden,
Denmark, Poland, Russia, Belarus, Ukraine, Lithuania,
Germany, Great Britain, Belgium, France, Spain, Italy,
Ireland, Austria, Croatia, Slovenia, Hungary, Greece, and
Turkey.
EUROPE CLASS
The company also succeeded in penetrating the Euro-
pean Dinghy class market. In 1999 the company’s sails
dominated the Slovene, Croatian, and Italian market and
realized some sales even in Poland and Belarus. At the
2000 Olympics, female representatives of the USA, Italy,
Belarus, and Poland raced with Victory sails.
THE OPTIMIST CLASS
In 2001, Intervela started developing a sail for the Opti-
mist youth dinghy. In February and March 2001 the new
sail was completed. They employed Karel Kuret, a top-
sailor and an authority among Croatian sailors, who
helped them with the development of the sail.
The company entered into an agreement with Sime
Fantella, the 2000 World Champion, and with his father
who was also his coach, that he would test their sail dur-
ing the preparation stage (from February to April 2001),
even though he had been racing with sails made by
Olimpic of Trieste. Sime and his father were satisfied
with the sail and soon other members of the Croatian
team started to use Victory sails in races. In April 2001,
Fantella won the South American Championship. The
second Croatian competitor took third place; and in the
women’s competition, first place was won by a Croatian
sailor. The Croatian team also won the team competi-
tion. In spite of the fact that in mid-2001 Olimpic en-
joyed a market share of 50 percent, followed by North,
Denmark and Toni Tio from Spain, the company estab-
lished an objective of having 50 percent of the Croatian
market within two years.
Even before manufacturing sails for the Optimist
class, the company had encountered some competitive
problems. After making a sail for an Italian, who finished
very high in a regatta, an Olimpic representative gave the
Italian one of their sails as a gift. Similarly, when the
company tried to cooperate with Milan Morgan, who
makes Optimist dinghies in Portorose, Slovenia, Inter-
vela gave him some promotional sails. Milan used these
sails as the basis for negotiating with Olimpic. Because
of these and other unpleasant experiences, Intervela de-
cided to proceed in a different way in Croatia. “Our first
goal is the Croatian market—and we will not give up; we
will attain this goal by September (2001). If you do not
control your domestic market, you cannot control for-
eign ones,” stated Zvonko Bezic. In 2001, there were al-
ready too many potential sales agents in Croatia and the
company was receiving calls from agents from Peru,
Brazil, Sweden, England, and the United States.
CLASS 470
Another goal established was to make it to the top in the
470 Olympic class. They started to develop the sails in
cooperation with the coach of Russia’s female sailors. In
Slovenia they started to cooperate with the Olympian
Vesna Dekleva, and in Croatia with Bulaja, who had
participated in the Olympic Games in Sydney.
SAILS FOR CRUISING & RACING YACHTS
In addition to sails for smaller one-design dinghies, such
as the Finn, Europe, Optimist and 470, which in mid-2001
accounted for around 30 percent of Intervela’s sales, and
sails produced for Elan, which accounted for about 30 per-
cent of sales revenue, the company was continually evalu-
ating new market opportunities. The entrepreneurs were
always evaluating their rivals’ products and how they were
producing sails. At the end of the twentieth century, inde-
pendent computer aided development and design of sails
became important. The main markets for their sails were
Slovenia and Croatia, and to a lesser extent Italy.
PROMOTION AND MARKETING
IN 2000 AND 2001
At the beginning Intervela relied primarily on word of
mouth advertising (satisfied owners of sails told other
sailors about their experiences). The company did more
formalized promotion and advertising in 2000 and 2001.
They participated in nautical fairs in Slovenia and Croatia.
They advertised in specialized nautical journals, such as
“Val” and “Navtika” in Slovenia and “More” in Croatia, as
well as in the specialized magazines of international sail-
ing classes such as Finnfare and Optimist Dinghy. They
also promoted their sails in newspaper articles which they
wrote themselves or were written by journalists. Articles
on sailors’ preparations and their cooperation with Inter-
vela, the success of Victory sails and the Intervela com-
pany appeared particularly in the Slovene newspapers
“Primorske novice” and “Slovenske novice,” in the Croa-
tian “Novi list,” and in the Italian journals “Fare Vela” and
“Giornale della vela.”
In 1998 the Web site of the company was designed.
They increased the number of “hits” or visits by publish-
ing news from regattas and by reporting the results on-
line. At the same time, sailing clubs, organizers of races,
and sailing associations started using the Internet for the
real-time online reporting of race results.
The company made the sail covers and packaging
(particularly the sail bags) uniform. They enlarged the
Victory logo and decided on a red-white combination
for the brand and background, because red made the
logo very visible.
The company also created a clearer identity for the
Victory brand name by using special material. They con-
tracted with one of the factories to have a special sail-
cloth made exclusively for Victory sails. The material is
Kevlar and the usual black thread in the cloth was ex-
changed for a red one. In this way, with no additional
costs, easier and clearer recognition of their sails oc-
curred. When they first introduced this novelty in the
Finn class, many sailors believed that it was a completely
new type of sail, not just a new material.
The two started doing more lectures and presentations
in sailing clubs and during sailing races. In sailing clubs,
they discussed, in particular, how sails operate and are
trimmed. After having returned from the United States in
the fall 2000, they presented to the organizer of the
Europe class regatta the material used during that day’s
racing. Digital photos were shown and their presentation
focused on sails and technical advice on trimming the
mast. After establishing the cooperation with Karlo
Kuret Intervela decided to organize training camps for
the best coaches and sailors in the class.
VISIT TO THE USA IN AUTUMN 2000
In the fall 2000, Zvonko Bezic and Zeljko Perovic went
to visit some of the most important factories producing
sailcloth material on the East Coast of the United States.
“When we started, we could not even talk to or visit such
factories or talk to sailcloth material sales representa-
tives. . . . Today sales representatives visit us at least
every three months,” explained Zvonko Bezic.
When they arrived at the biggest sailcloth producer in
the world, Bainbridge International, the general manager
spent the entire day with them. A PowerPoint presenta-
tion, containing a section on cooperation between Bain-
bridge International and Intervela, and a “slide” showing
the logos of both brand names and a link between them
demonstrating future cooperation between the two com-
panies occurred. They were guests of Bainbridge Inter-
national for three days and it was there they got the idea
to start using sales presentations to promote their sails.
MAIN CHANGES IN THE MARKET
In ten years of existence, Intervela has grown and become
an important factor in the sail market. They have grown
faster than their competition and reached and surpassed
most. In 2001 the nautical market was still growing.
“There is no recession, many people are buying yachts,
sails. . . . The market is growing. . . . And Intervela is
growing even faster,” Zvonko Bezic commented.
STAFF, OUTSOURCING, AND
REORGANIZATION
By mid-2001, Intervela had 15 regularly employed indi-
viduals working on contracts in Slovenia and 5 individuals
in Croatia. Since the company did not have sufficient pro-
duction space, they started to outsource the manufacturing
of some parts, such as bags and reinforcements, to suppli-
ers in Koper. A subcontractor was given two sewing ma-
chines and started sewing for Intervela in his garage.
The company introduced the special position of plot-
ter operator, in order to use their facilities more effi-
ciently. This person’s job was to operate the computer or
some other operation of the plotter. “We are looking for
new people all the time. We also employ through the
Employment Agency of Slovenia. But the number em-
ployed through the Agency is actually very low,” com-
mented Zvonko Bezic.
The friend who first helped Zvonko Bezic and Zeljko
Perovic in the start-up of their company, decided—after
the bankruptcy of his relatively large company in
Croatia—to help establish production standards and im-
prove the organization of the workshop. He analyzed how
much a worker can do per hour, how much time is needed
for each element of the production process, and the capa-
bilities of workers. Zvonko Bezic said: “an experienced
508 PA RT 6 CASES
entrepreneur entered our workshop and found a hun-
dred mistakes. . . . We are burdened with complicated
issues. . . . Regarding simpler issues, such as the
proper laying of material, however, improvements can
also be found in the details, which add up to a lot in
the end.”
INTERNATIONAL PRODUCTION
Having taken over the workshop in Rijeka, Croatia, the
company began production there as well. From this
production facility the company covered the Croatian
market and also produced Optimist sails. Two main pos-
sibilities are available for establishing production facili-
ties in Italy.
The company first considered a location in Gorizia—
in the International Business Center (a business incuba-
tor in Trieste with a branch office in Gorizia). The incu-
bator offered assistance such as: sales staff with 50 percent
of the pay subsidized, Internet services at minimum rates,
assistance in getting loans and other forms of financing,
and lower rent for business premises.
In 2001 the company considered purchasing the com-
pany of a local Italian sailor who had machines and work-
ers but was not successful and had no desire to continue in
the business. With the intention to expand their activities
in Italy, they began training an Italian in their sail loft in
Koper so he could then manage the work in Italy.
OTHER PLANS FOR THE FUTURE
AND OPTIONS
In 2001, Intervela was planning to expand their 450
square meter facilities in Croatia. “Particularly for cruis-
ing sails . . . charter business is on the increase: 120 per-
cent more tourists, 300 percent more than in 1999. . . .
We shall have to invest here too,” Zvonko Bezic rea-
soned. They began to search for a new location with
about 1,000 square meters of space.
The company was also considering the possibility
of using the brand name Victory on garments (jackets,
T-shirts, etc.). This would promote the brand name on the
one hand and bring in additional income. They started to
look for partners who manufacture sportswear who would
be willing and able to carry out such a project. In 1999, the
company negotiated with a potential partner, but the
potential partner withdrew from the project. In 2001, In-
tervela was still opposed to pushing the project forward
without finding a good partner who was very interested.
At this same time, the company had contact with
some major sailmakers, mainly in the United States.
They started discussing a possible merger or at least
joining an already established group. The two main
conditions needed were money and less operational
work. Right now Zvonko Bezic and Zeljko Perovic are in
a dilemma regarding the following three alternatives:
• Develop a foreign trade name and work as a member of a group;
• Merge with a foreign company; or
• Sell the company—find a potential partner with money who would acquire a part or the entire
company.
E N D N O T E
1. Keelboats are medium-sized and larger sailing boats
that now prevail in all marinas in the world. They
shall be distinguished from smaller dinghies that, in
most cases, are single-type sport sailboats made
according to strictly defined international rules in
order to avoid, as much as possible, any differences
within the same class (e.g., class: 470, Finn, Laser,
Europe, Optimist, etc.).
C A S E 9
THE GRIL-KLEEN CORPORATION
“Well, where do I begin?” Warren Ryan wondered as he
surveyed the chaos before him. Boxes and bottles were
piled all over the place, invoices and order forms cluttered
the desktop and filled the drawers, and he couldn’t seem
to locate anything resembling an orderly set of books.
It was spring of 2001, and just a few days earlier
Ryan had quit his job with a large management consult-
ing firm to assume the presidency of Gril-Kleen Corpo-
ration and help get the young company off the ground.
The company’s efforts to market its innovative prod-
uct, a liquid restaurant grill cleaner, had been extremely
successful. Ryan felt that with a professional marketing
approach, the product could capture a sizable share of a
national market.
The product, a chemical solution which could be ap-
plied directly to a working grill and would clean off
burnt-on food and accumulated grease in a matter of min-
utes, represented a significant departure from the existing
methods of cleaning restaurant grills. It appeared to have
several major advantages over competing products, and
initially it had generated such enthusiastic response from
users that the product had practically sold itself.
C A S E 9 THE GRIL-KLEEN CORPORATION 509
PRODUCT EVOLUTION
Gril-Kleen had been developed for their own use by
two brothers who owned a small, busy restaurant in
Eastern Massachusetts. The restaurant’s grill needed
cleaning several times a day, especially during busy pe-
riods, and the brothers were disturbed by the amount of
time and effort it took to clean the grill. They were also
bothered by the orders they lost while the grill was be-
ing cleaned.
Most grill-cleaning products then available could not
be used on a hot grill, and the time required to cool, clean,
and then reheat the grill varied from about 20 minutes to
almost an hour, depending on the method being used and
the condition of the grill.
Two of the most popular methods of cleaning grills
used a carborundum “stone” or a wire mesh screen to
scrub the grill clean. Though inexpensive, they required
a great deal of physical labor and both products tended to
wear, with some danger of stone chips or metal particles
ending up in food cooked on the grill.
Spray foam oven-cleaner type products, similar to
those sold for home use, were easier to use but con-
siderably more expensive. Most had critical effective
temperatures of around 160 –200 Fahrenheit, compared
to normal grill operating temperatures of around 350 ,
and often had objectionable odors, which restricted their
use in small or poorly ventilated restaurants.
Dissatisfied with the products then on the market, the
two brothers decided to develop their own grill cleaner.
They sought the advice of one of their customers in the
chemical business, and from him they learned of some
chemicals and began to experiment with different combi-
nations in various proportions.
The cleaner they sought would clean grills quickly,
easily, and at normal operating temperature. It had to be
economical, easy to mix, and have no discernible odor or
taste, and it would have to pass safety requirements (i.e.,
be both nontoxic for use on food preparation surfaces
and noncaustic to the user’s skin). In addition, it had to
leave the grill “seasoned” so that food wouldn’t stick to
the grill after it had been cleaned.
After experimenting and modifying the solution for a
couple of years, the brothers finally arrived at a mixture
having all the desired properties. It would work on both
hot and cold grills, and the grill operator could clean a
grill in less than five minutes by simply pouring the so-
lution on, allowing it to dry, and then rinsing the grill
with water. After a light seasoning with cooking oil, the
grill was ready for use again.
Soon, friends in the restaurant business heard about
the product and began asking for samples, then coming
back for more. As demand increased, the brothers started
to sell the product by the gallon, charging whatever they
felt the market would bear.
THE GRIL-KLEEN CORPORATION
The product appeared to be so successful that the broth-
ers began to think about marketing it on a larger scale.
One of the restaurant’s customers, a line foreman for the
Boston Edison Company, was impressed by the demand
for the product, and urged the brothers to consider man-
ufacturing and selling it on a regular basis. In early 1997,
the three of them formed the Gril-Kleen Corporation.
Working out of the basement of the restaurant, the
three new partners bottled and sold Gril-Kleen in their
spare time and on their days off. The chemicals were
mixed in a large plastic tub with a spigot, then trans-
ferred to gallon-size plastic bottles labeled “Gril-Kleen.”
On Tuesdays, when the restaurant was closed, the two
brothers made sales calls to other restaurants, leaving be-
hind samples of the product. Even with this minimal
sales effort, orders began to increase to the point where
larger facilities were needed to bottle and store the prod-
uct. Less than a year after its incorporation, the Gril-Kleen
Corporation moved to a new and larger headquarters in a
nearby industrial park.
The new plant was a 1,500-square-foot cinderblock
building, and the equipment consisted of a large stainless
steel tub, formerly used for pasteurizing milk and capa-
ble of producing 450 gallons of Gril-Kleen per day. The
company hired one part-time employee to mix the chem-
icals and fill the bottles.
After one unfortunate experience with a traveling
salesman who offered to sell the product and instead,
sold several phony “exclusive distributorships” for Gril-
Kleen throughout New England before he disappeared,
the company established relationships with half a dozen
bona fide distributors of restaurant and cleaning supplies
in New England.
As sales volume grew, the need for a full-time man-
ager became increasingly apparent. Orders and invoices
were piling up, billing was haphazard, records were dis-
organized and incomplete. With no regular system of
record-keeping, orders often went unfilled, or customers
were never billed for orders that had been shipped.
Recognizing that the company had grown too large to
continue operating on a one-day-per-week basis, the own-
ers hired a local politically ambitious individual to run the
510 PA RT 6 CASES
C A S E 9 THE GRIL-KLEEN CORPORATION 511
company, and offered him a 25 percent interest in the busi-
ness. The new partner was well known locally, had a num-
ber of important connections, and the company owners felt
that his name would lend some prestige to the operation.
As it turned out, he devoted little of his time and
attention to running the business and most of it to cam-
paigning for re-election, even charging some of his cam-
paign expenses to the company. After more than a year,
with company sales declining, the other three partners
bought him out, paid his bills, and returned to running
the business on their days off.
WARREN RYAN
At this point, Warren Ryan, a management consultant
working on an assignment nearby, began patronizing the
restaurant and became friendly with the owners. When he
learned of the situation at Gril-Kleen, he suggested that the
company hire his consulting firm to do a market study and
map out an operating and marketing plan for the company.
He also recommended that they utilize his firm’s Executive
Search service to find a new president for Gril-Kleen.
Reluctant to deal with a large consulting firm or to hire
anyone they didn’t know to run the company, the brothers
asked Ryan if he would take over the job himself. Ryan,
an MBA with extensive experience in marketing, advertis-
ing, and industrial management, was intrigued by the idea.
He had grown up in a household with a small, family-
owned business, and had long been interested in applying
his management and marketing skills to running a com-
pany. He agreed to consider the offer, and then began to
research the product and its market. From library sources,
he estimated the national restaurant cleaning market at
about $80 million a year, and learned that no single com-
pany held a dominant share of the market.
From experience with the product and interviews with
current users of Gril-Kleen, he became convinced of Gril-
Kleen’s performance superiority over competing products.
Moreover, he was impressed by the apparent success of
the company despite the lack of good planning, and con-
cluded that the product could be developed successfully.
After serious consideration and considerable research, he
decided to accept the offer, and in April of 2001 became
the new president of the Gril-Kleen Corporation.
THE SITUATION IN EARLY 2001
When Ryan took over, he found the product being man-
ufactured in the small, one-story cinderblock plant in
Hingham. The company’s one part-time employee could
mix and bottle up to 200 gallons a day to meet orders,
and plant capacity could easily be increased by buying a
larger mixing tank and hiring more labor. It was also
possible to rent additional floor space if necessary. The
product was packaged in cases of four (4) one-gallon-size
plastic containers. It was sold for $28 a case retail, $18 a
case wholesale, F.O.B. the wholesaler’s warehouse. In-
cluded with each case was a 16-ounce squeeze-type
plastic applicator bottle.
Sales volume at the time was approximately $35,000
a year. The average usage rate was approximately one
case per month. The company’s primary customers were
six wholesale distributors in Massachusetts: the Gantlin
Company, a supplier of chemicals to restaurants and
institutions; the Downer Company, a paper products dis-
tributor; the Bay State Restaurant Equipment and Sup-
ply Company; Alden Sales Corporation, which supplies
cleaning products to small restaurants; the Janitor Sup-
ply Company, selling to hotels and motels; and The-
atres, Inc., a distributor of food products and supplies to
theatres and drive-ins.
Ryan found few records, little financial data, and no re-
gular flow of paperwork within the company. Prices were
based on those charged for a competitive product, with no
regard for or knowledge of actual costs or profit margins.
To apply for a working capital loan, Ryan had to de-
velop a marketing plan for the next 12 months and pro-
jected cash flow statements for the next three years and
then present his marketing plan and cash requirements to
a bank.
ADDITIONAL PRODUCT USES
Before he could develop a marketing plan, Ryan had to
decide which markets to approach and determine realis-
tic market-share goals for Gril-Kleen. There was con-
siderable evidence that the product could do much more
than just clean restaurant grills. Preliminary tests had in-
dicated that the product was effective in cleaning stain-
less steel, ceramic tile, formica, vinyl, plastic, chrome,
machine tools, clothing, and fiberglass. The last use sug-
gested a possible application in cleaning boat hulls, a
market which strongly appealed to the owners of Gril-
Kleen. (See Exhibit 3.) The product also appeared to be
effective as a rust remover and preventative, suggesting
a wide variety of possible industrial uses.
Ryan had to determine which markets to develop,
which product lines to offer, and what degree of market
penetration could be achieved in each market segment
before he could set profit targets and schedules. The
512 PA RT 6 CASES
restaurant, marine, and industrial markets required dif-
ferent selling methods and different channels of distribu-
tion and posed different pricing, packaging, promotion,
and selling requirements.
Before deciding which markets to pursue, Ryan
needed additional information on the requirements of
each market segment and the dollar and volume potential
for each. Within each market, he had to decide whether
to segment the market by uses, type of customer, or geo-
graphical territory.
Ryan wondered whether market testing would be
useful in analyzing market need, product potential, and
the habit patterns of users in the various markets, and if
so, whether market testing should be accomplished by
field product testing, field interviews, or mail or tele-
phone surveys.
Materials:
1 ounce $.0028
1 batch 32 cases 1,120 lbs. $45.32 (83 percent water)
Bottles (cost per thousand):
Number of Units (dollar amount is cost per 1,000)
Size 1,000 5,000 10,000 25,000
16 oz. $ 90 $ 85 $ 78 $ 60.75
32 oz. 155 135 125 97.30
64 oz. 220 195 154.75 147.25
128 oz.* 245 202.75 184.75 178.95
Caps
28 mm $ 12 $ 10
33 mm 15 12
38 mm 20 15
Printing
16 oz. $ 17.50 $ 15 $ 12.50 $ 12.50
32 oz. 20 17.50 15 15
64 oz. 25 20 20 20
128 oz. 30 30 30 30
Sprayer: (bought separately by customer)
for 28 mm cap $.48 ea. $.43 ea. $.39 ea. $.38 ea. for 15,000 or more
* 1 gallon
Shipping Costs: $6.00 per hundredweight, or about $1.50 per case
Approximate Fixed Costs (per month) Labor
Rent $1,000 32 oz.: $.046 per bottle
Travel 400 128 oz.: .057 per bottle
Telephone 80
Gas heat 450 Sales costs estimated at
Insurance 200 400 percent of labor,
Accounting 300 G & A at 250 percent of labor.
Depreciation 300
Office 500
EXHIBIT 1 Cost Data for Gril-Kleen
It was felt by Warren Ryan that Gril-Kleen could sig-
nificantly increase its share in this market. Current sales
of $35,000 a year represented a little less than half of 1
percent of the potential market for restaurant cleaning
products in the New England area alone. However, the
product appeared to fill a particular need in this market,
while there was considerable competition from similar
products in the other markets under consideration (ma-
rine, industrial, consumer).
PRICING
To help determine standard costs, break-even volumes
over a range of possible product prices, and profit mar-
gins, Ryan collected the cost data in Exhibit 1.
Ryan needed to determine a pricing strategy, set
profit targets, determine the volume necessary to meet
those targets, and establish a policy on trade discounts,
allowances, and credit terms. He also needed further in-
formation on price elasticity (one dealer had tripled his
sales from 4 to 13 cases a month by lowering the retail
price from $28 a case to $24).
Checking the reorder rates, Ryan calculated the rate
of usage of the product to be approximately one case
every month in a small, one-grill restaurant. Approxi-
mately 97 percent of end-users who had tried Gril-Kleen
continued to order it.
DISTRIBUTION
Among the distribution decisions to be made were whether
to (1) hire a sales force (and if so, how large), (2) use
manufacturer’s representatives (and if so, how many and
with what commissions), (3) sell exclusively to whole-
salers, (4) sell directly to restaurants and large chain oper-
ations, and (5) grant exclusive privileges to any dealers,
distributors, or representatives (and if so, what demands to
make upon the holders of such exclusive rights).
Other decisions related to distribution included ques-
tions on consignment sales, volume discounts, and ship-
ping costs. Ryan also had to decide whether to expand
his distribution network geographically or to concentrate
on getting a larger share of the New England market.
PROMOTION
To successfully promote the product, Ryan had to deter-
mine which media to employ, how much to spend on ad-
vertising, and how to push or pull the product through to
the ultimate user. In addition, he had to design some cat-
alog sheets and fact sheets for Gril-Kleen similar to those
in Exhibits 2 and 3. In designing these, he had to decide
which product features to stress: price, convenience, ef-
fectiveness, safety, etc.
PATENT AND TRADEMARK
Ryan also wondered whether he should try to patent the
product. He didn’t know if it was patentable, if it in-
fringed upon any existing patents, or if he could obtain a
trademark on the name Gril-Kleen and/or on the product
logo he planned to design.
He wasn’t sure that a patent would be valuable to the
company, or even necessary, or whether it was worth all
the trouble and expense required for a patent application.
Legal costs alone, whether the patent were granted or not,
could amount to about $4,000 or more and would afford
doubtful protection from imitators. The company would
have the right to sue if it discovered anyone else using its
formula, but patent litigation would be too time-consuming
and expensive for a company of Gril-Kleen’s size.
COMPETITION
The most common grill cleaning products then in use, es-
pecially in smaller restaurants, were the “stone” and the
“screen.” The stone is a block of carborundum (hard
soapstone) about the size of a brick, which was used to
scrub the grill and remove grease and food residue. The
screen was a wire mesh screen placed in a device similar
to a sandpaper holder which was used to scour the grill
much like home scouring pads. Both were inexpensive
but required a great deal of effort to use, took about an
hour to clean a fairly dirty grill, and could not be used on
a hot grill. In addition, the stone especially tended to wear
and chip, with some danger that stone chips might end up
in food cooked on the grill.
There were also several chemical liquid and spray
foam oven-cleaner-type products on the market that
could be used to clean grills. Most of these were fairly
expensive and had critical effective temperatures of
around 160⬚ to 200⬚F. These competitive products were
generally marketed by fairly large companies, with large
advertising budgets and wide distribution networks.
Among these were Swell, DuBois, Easy-Off, and Jifoam.
Colgate-Palmolive and Lever Brothers also had plans to
introduce new chemical oven cleaner products.
DuBois liquid oven cleaner (see Exhibit 2) was sold
in four-gallon cases for $28.00 a case retail and employed
its own sales force to sell directly to retailers. Swell was
marketed via wholesale distributors for $7.00 a gallon or
$26.50 a case retail and used its own sales force to sell to
wholesalers.
C A S E 9 THE GRIL-KLEEN CORPORATION 513
514 PA RT 6 CASES
TECHNICAL DATA FOR OVEN CLEANER AND DEGREASER
General Description—DUBOIS OVEN CLEANER and DEGREASER is a light tan alkaline liquid
which is highly effective for the removal of baked-on fats, greases, and carbon deposits
normally found in baking ovens. Also recommended for grills, deep fryers, and undersides of
range hoods or canopies, where grease and carbon accumulate. OVEN CLEANER is
nonflammable and USDA acceptable in meat and poultry plants.
PROPERTIES—Chemical Composition . . . . Caustic, soil suspending agents and foam
boosting surfactants
Biodegradable . . . . . . . . . Yes, all surfactants
Caustic . . . . . . . . . . . . . . . . Present
pH 1% Solution . . . . . . . . . 11.7
Metal Safety . . . . . . . . . . . Safe on iron, steel, stainless steel, nickel, porcelain,
and glass. May be used on enamel and paint (when
diluted). It may etch aluminum and will tarnish
copper, brass, zinc, and tin, and galvanize on long
contact.
USING PROCEDURE—Oven & Equipment—For first-time cleaning of heavy carbon and grease,
use UNDILUTED. Thereafter, use 1:1 to 1:3 with water.
For best results, use on a warm oven (160⬚–200⬚). Spray on with Trigger Spray Unit, direct
from gallon bottle of solution. Foaming action allows product to cling to walls and top side
of oven: thus, cleaner works harder. Allow cleaner to penetrate for five minutes. For heavy
carbon, use oven brush, or Scotch Bright brand applicator on a handle. Rinse with wet
sponge to remove all grease and carbon residue. Can be applied with good results on cold
oven when cleaner is allowed to set 15 to 20 minutes. Heavily encrusted ovens may require a
second application. One application will be adequate for periodically cleaned ovens.
Grills—use 1:1 to 1:3 with water
Hoods—use 1:4 with water
Fryers—use 1:15 with water
Steak Platter—use 1:1 with water
PACKAGING—Four 1 gal. plastic bottles per case (35# net weight)
6 gal. cans (53# net weight)
30 gal. drums (264# net weight)
CAUTION—ALKALINE. Do not take internally. Do not get in eyes or on skin. In case of
contact, flush skin with plenty of water; for eyes, flush with plenty of water for at least
15 minutes and get medical attention. If swallowed drink a large quantity of water, followed
by whites of eggs or mineral oil, and call physician.
DUBOIS CHEMICALS DIVISION W. R. GRACE & COMPANY
DuBois Technical Representatives are located throughout the U.S., Canada, the United
Kingdom, Latin America, Germany, France, Japan, and Africa.
EXHIBIT 2 Sample Catalog Sheet
DEVELOPING A MARKETING PLAN
To develop a sound marketing plan, it was necessary to
determine the size of the potential market in units and
dollars, estimate the market share that Gril-Kleen could
expect to attain, and then develop sales projections over
a 12-month period.
They needed to find out who and where the distrib-
utors of restaurant cleaning products in New England
were and determine the best means of selling to them.
C A S E 9 THE GRIL-KLEEN CORPORATION 515
They also had to calculate potential sales volumes at
various prices and price the product to maximize
profits (or volume). They would need to construct
volume discount schedules and determine the effects
of any increase or decrease in price on demand and
on profits.
They should consider whether any market or product
testing is necessary, and if so, what type and how much.
These decisions would form the basis for Gril-Kleen’s
marketing plan, from which Warren Ryan could develop
projected cash flow statements and estimate his working
capital needs over the next 12 months.
FANTASTIK BOAT CLEANER—MARINE WHOLESALE FACT SHEET
PRODUCT: Fantastik Boat Cleaner
MANUFACTURER: Texize Chemicals, Inc., P.O. Box 368, Greenville, SC 29602
PACKS: 32 oz. Spray Gun 64 oz. Refill
Code #298 #299
Case pack 12 6
Case weight 31 lbs. 30 lbs.
UNIT RETAIL: $2.59 $3.29
CASE RETAIL: $31.08 $19.74
WHOLESALE DISCOUNT: 50%–10%
WHOLESALE COST: $13.99 $8.88
TERMS: 2%/10 Days Net 30 Days
WHOLESALE INTRODUCTORY OFFER:
Texize Offers One Case Free with Each Five Cases Purchased on All Orders
BILLING: Free Goods to Be Invoiced at No Charge
SALESPERSON INCENTIVE OFFER:
Texize to Pay $1.00 per Case to Salesperson for Each Case Sold to Retail Outlets PAYMENT: Payment to Be Made on a Count and Recount Basis by Texize Representative Monies to Be Paid Directly to Individual Salesperson at the Close of Each Month
WHOLESALE EXCLUSIVE:
Fantastik Boat Cleaner Will Be Offered for Sale Only through Bonified Wholesale
Distributors
Shipments Will Not Be Made Directly to Any Exclusively Retail Accounts
SALES GUARANTEE:
Texize Guarantees the Sale of This Product When Adequately Displayed at Retail Sales Point
ADVERTISING:
Fantastik Boat Cleaner Will Be Advertised with Full- and Half-Page Spreads in the Following Publications: BOATING, MOTOR BOATING, RUDDER, YACHTING, LAKELAND BOATING, BOAT BUYER’S GUIDE, BOATING INDUSTRY, MARINE PRODUCTS, and MARINE MERCHANDISING.
(Plus: The Bonus of a Multi-Million Dollar Campaign That Is Making the Fantastik Name a Household By-Word)
SHIPPING POINTS: Texize Plant or Warehouse
PRODUCT LIABILITY INSURANCE: Yes
EXHIBIT 3 Sample Fact Sheet
C A S E 1 0
THE WINSLOW CLOCK
COMPANY
For the third time, Dr. Winslow sat up in bed, flipped on
the light, and reached for the Winslow Clock Company
business plan. Maybe reading through it again would
calm his growing fears. As he flipped through the pages,
he recalled again all the years of thinking, tinkering, and
discovery that had gone into the development of his
alarm clock. How could something he spent so much
time and energy on be wrong? It was such a good idea,
this “throwable” alarm clock: Millions of Americans
would want to get this kind of revenge on their daily call
to the rat race. And, in its final design, it contained all
kinds of computer-age technology. Surely, the investors
tomorrow will love it!
What had happened to his confidence? He had been
sure enough to invest all his savings in the clock’s de-
velopment. What a time to get second thoughts! Didn’t
he use the best technical help available to design the
clock and plan the production and marketing? Maybe
that was his problem—too much dependence on “ex-
perts.” Being a practicing psychiatrist, he considered
himself a good judge of character and motivation, but
maybe his obsession with his clock had clouded his
perception. Should he take more time to personally
study the different production and marketing scenar-
ios? He didn’t have any more time, if he wanted to get
production started in time to hit the Christmas season.
Should he wait another year, or risk going to market at
a slow time of year, or . . .?
The more he thought, the more the doubts and wor-
ries grew. He had to put a stop to this pointless mental
exercise. The business plan he held in his hands was
what he had to sell tomorrow at the meeting, so he’d
better have confidence in it. If things went badly, then
he could think about changes. For now, he would read
over the business plan for The Winslow Clock Com-
pany (which follows) just once more, concentrating
on the favorable arguments his business “experts” had
made.
SUMMARY
The attached five-year business plan for The Winslow
Clock Company is based primarily on the estimated po-
tential of the company’s first product, an alarm clock
designed and patented by Dr. Michael Winslow, a psy-
chiatrist by profession. He expected the sales and prof-
its generated by this product to reach $8.5 million and
$1.5 million, respectively, within three years, which
would provide sufficient resources to enable the com-
pany to expand its line into related products now under
consideration.
History of the Product
Under development for 10 years, the concept for the
clock stems from Dr. Winslow’s thought that it would
be fun to have the liberty to “get back at” the alarm that
so readily awakens everyone each morning. The “fun”
part—and what makes the alarm unique—is that you
throw it to turn it off.
Development of the microchip and related technol-
ogy in recent years has made the design of such a clock
possible at a reasonable cost. The technical assistance
on the clock was provided by students at the MIT Inno-
vation Center under the guidance of its director. The
business and marketing planning for the clock was done
with the help of Boston College MBA candidates at the
Small Business Development Center under the direction
of its faculty associate.
In addition, Dr. Winslow has contracted with a num-
ber of professional consultants in the areas of product
design, product engineering, marketing and advertising,
production, legal matters, and accounting.
Market Acceptance
Early reaction from such major retailers as Blooming-
dale’s and Hammacher Schlemmer in New York has
been very positive, thus supporting the belief that the
targeted levels of sales are achievable.
Thus, in what might otherwise be considered a ma-
ture market, new design and technology are eagerly
sought by retailers and customers anxious to provide or
find a refreshing selection of alternatives. The com-
pany’s projected level of sales in its first year represents
less than 1 percent of this growing segment of the U.S.
clock market.
Competition
Although several major manufacturers account for most
clock sales (with Japanese manufacturers dominating
the sale of quartz movements), there is nevertheless a
516 PA RT 6 CASES
TABLE 1
Year 1 Year 2 Year 3 Year 4 Year 5
Unit sales (000s) 50 150 200 150 125
Selling price $42.50 $42.50 $42.50 $40.00 $40.00
Net sales (000s) $2,125 $6,375 $8,500 $6,000 $5,000
Net profit (000s) $333 $823* $1,503 $781 $496
Profit ratio 16.0% 13.0% 17.7% 13.0% 10.0%
C A S E 10 THE WINSLOW CLOCK COMPANY 517
significant annual volume attributable to smaller specialty
designers, most of whom purchase the clock movements
on an OEM (original equipment manufacturer) basis
from the larger producers and concentrate on unique
housing designs.
Seiko, the company supplying the movement for
Dr. Winslow’s clock, has made impressive strides in the
United States in the last four years by increasing its annual
OEM business from 400,000 to 2 million units. Besides
selling its own Seiko and Picco brands, it is developing a
reputable supplier business. This strategy allows Seiko to
enjoy some of the profit opportunity created by an ex-
panded market without all the marketing costs and risks.
In addition, a number of large retailers contract with
the major manufacturers for private-label production.
This somewhat fragmented structure has created prof-
itable opportunities for products designed for niches
within the large clock market.
The question arises, If the product is attractive
enough to create a niche in the market, how soon will it
have competition? The concept of a “throwable” alarm
and several components designed specifically for the
product are patented. In addition, it would require some
time and expense for potential competitors to develop the
impact switch and the microchip used in Dr. Winslow’s
clock.
Financial Projections: Opportunities and Risks
Financial projections for the first five years of the com-
pany are summarized in Table 1. (Sales are based on
only the first product, to be introduced in 2004.)
Since components and subassemblies would be
purchased rather than manufactured by the company,
and then assembled and shipped by an outside con-
tractor, the capital investment required is minimal,
estimated at less than $50,000, the majority of which
would be for tooling. Another $50,000 for start-up
expenses, prototypes, and preproduction operating ex-
penses would also be required in the first two months
of 2004.
By March, however, the commitment increases.
Because of the company’s lack of credit history, all in-
dications suggest that suppliers will require letters of
credit to accompany the $814,000 in parts orders
placed between March and September of 2004, when
shipments are expected to begin. In addition, operat-
ing expenses between March and October are fore-
casted at $176,000.
Given the projected level of sales in the first two years,
the company is seeking equity capital of $600,000 as
early as possible in 2004. An additional term loan of
approximately $650,000 would be needed by June to
carry financing and operating costs through year’s end.
It should be emphasized that although this com-
bined cash injection of $1.2 million is at apparent risk
for at least the six to eight months prior to the begin-
ning of shipments (and, of course, beyond), two factors
diminish this risk. First, the initial selling effort in the
spring of 2004 to secure orders for the Christmas season
should provide a clear indication of market accept-
ance by the end of April. The long lead time required
to order components then becomes a positive factor.
Orders for 40,000 of the first season’s production of
50,000 units could be canceled without penalty a
month in advance on standard items such as the clock
movement. This alone would save almost $730,000.
In addition, many operating expenses could be cur-
tailed accordingly and alternative marketing plans put
into place. (Direct mail-order marketing, for example,
is an approach that will be explored from the begin-
ning anyway and, in a downside case, certainly would
be a viable alternative.)
*Assuming $650,000 term loan (plus interest) paid back in December.
518 PA RT 6 CASES
The second factor that diminishes the risk is that low
fixed costs allow the break-even point to be projected at
16,000 units, which should be achieved in October, the
second month of actual shipments.
According to its projected cash flow, the company
should be able to repay its term loan in full within
18 months. From that point on, it can fund its continuing
operations from the generated working capital.
The returns on investment are calculated at 19, 33,
and 37 percent in the first three years, respectively,
with returns on net worth at 34, 46, and 45 percent.
Net present value for the original investors would be
$1.7 million, based on five years of net cash flow and
not including the salable value of the firm or its con-
tinuing earning power after that time. Payback is ex-
pected in one year, based on the forecast of sales and
profits. Specific financial details are found in Exhibits 1
through 7.
INDUSTRY INFORMATION
The clock market in the United States has been grow-
ing at a rate of between 8 and 10 percent per year, with
significantly higher growth (three times the industry
average) recorded in the segments where innovative
design or a technological change has been offered. The
recent introduction of battery-operated quartz mecha-
nisms combined with sleek styling to create lightweight,
portable, wireless clocks has led to at least a 25 per-
cent annual growth rate for decorative or kitchen wall
clocks and to almost a 29 percent increase for alarm
clocks.
Clocks are in most households and constitute an
enduring and important retail gift category. As with
many items that are so inherently useful that they might
be considered a household necessity, the greater the
opportunity to differentiate the product, the greater
the ability to segment the market by appealing to con-
sumers through unique designs that are fashioned to
suit a wide variety of tastes and income levels.
A handful of major competitors serve as the domi-
nant force in the industry and often not only sell their
own brands but also make private-label brands for
large retailers as well. (Seiko, for example, produces
the private-label quartz alarm clocks for both JCPenney
and Sears.) As a result, clock movements are inexpen-
sive and readily available, which in turn spawns a
significant opportunity for a number of smaller com-
panies to specialize in unique designs that range
from the very inexpensive to one-of-a-kind collector’s
items.
Clocks are sold through a variety of retail outlets that
include mass merchandisers, department and specialty
stores, furniture and interior design stores, jewelry stores,
shops that deal exclusively in clocks, and museum gift
stores.
EXHIBIT 1
THE WINSLOW CLOCK COMPANY
Pro Forma Income Statements
Five-Year Projection
Year 1 Year 2 Year 3 Year 4 Year 5
Unit sales 50,000 150,000 200,000 150,000 125,000
Price $42.50 $42.50 $42.50 $40.00 $40.00
Net sales (000s) $2,125 $6,375 $8,500 $6,000 $5,000
Bad debt allowance (2%) 43 128 170 120 100
Adjusted net sales 2,082 6,247 8,330 5,880 4,900
Cost of goods sold 1,093 3,253 4,630 3,655 3,267
Gross margin 989 2,994 3,700 2,225 1,633
Operating costs 323 552 695 663 642
E.B.I.T. 666 2,442 3,005 1,562 991
Taxes (50%) 333 1,221 1,502 781 495
Net income $ 333 $1,221 $1,503 $ 781 $ 496
C A S E 10 THE WINSLOW CLOCK COMPANY 519
EXHIBIT 2
THE WINSLOW CLOCK COMPANY
Pro Forma Balance Sheet
As of December 31 ($000s)
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Assets
Cash 5 203 256 1,019 2,722 3,539
Accounts receivable — 1,345 2,044 2,726 1,924 1,283
Inventory
Finished goods — 73 44 48 53 58
Work-in-process — 106 — 78 — —
Raw materials 55 — 141 155 171 188
Net fixed assets 40 36 32 29 26 24
Total assets 100 1,763 2,517 4,055 4,896 5,092
Liabilities
Accounts payable 40 50 141 155 171 181
Accrued liabilities — — 560 581 626 309
Est’d tax liability — 70 — — — —
Short-term debt — 650 — — — —
Long-term debt — — — — — —
Common stock — 600 600 600 600 600
Paid-in capital
(M. Winslow) 60 60 60 60 60 60
Retained earnings — 333 1,156 2,659 3,439 3,935
Total liabilities 100 1,763 2,517 4,055 4,896 5,092
Catalog sales are also an important means of reach-
ing the clock consumer. Furthermore, within a depart-
ment store, clocks can be found in various departments
that include gifts, luggage, electronics, fine collectibles,
furniture, jewelry, and occasionally even in their own
clock department.
This diversity of product as well as placement makes
the clock market a natural arena in which independent
sales representatives may operate. This fact simplifies,
to some extent, the problems that the smaller producers
face in trying to get their product to the national market-
place without incurring a disproportionate expense for
the hiring, training, and support of a sales force.
It is apparent, then, that the market for clocks has
ample room for product differentiation. Dr. Winslow’s
clock, we believe, presents an exciting opportunity to
capitalize on a segment of this significant market.
THE PRODUCT: PRESENT AND FUTURE
The product will first be described and then discussed in
terms of its future potential.
Product Description
The battery-operated quartz alarm clock consists of two
basic parts, the first of which is a lightweight black
foam ball, approximately 4 inches in diameter, that con-
tains the “brains” of the clock—a microchip, circuit
board, impact switch, small batteries, and the audio de-
vice for the alarm. These are held inside a plastic cap-
sule that is secured by a Velcro enclosure within the
larger foam ball. The second part of the clock is the
quartz movement that is housed in a handsomely styled
cube of molded plastic.
520 PA RT 6 CASES
EXHIBIT 3
THE WINSLOW CLOCK COMPANY
Statement of Sources and Uses of Funds*
Year Ended December 31 ($000s)
Year 1 Year 2 Year 3 Year 4 Year 5
Sources
Funds provided by operations
Net income after taxes 333 823 1,503 780 496
Plus depreciation 4 4 3 3 2
Inc.—accounts payable 10 91 14 16 17
Inc.—accrued liabilities — 560 21 45 —
Inc.—taxes payable 70 — — — —
Inc.—common stock 600 — — — —
Inc.—short-term debt 650
Dec.—accounts receivable — — — 802 641
Dec.—inventories — — — 57 —
Total sources 1,667 1,478 1,541 1,703 1,156
Uses
Inc.—cash 198 53 763 1,703 817
Inc.—accounts receivable 1,345 699 682 — —
Inc.—inventories 124 6 96 — 22
Dec.—accrued liabilities — — — — 317
Dec.—taxes payable — 70 — — —
Dec.—short-term debt — 640 — — —
Total uses 1,667 1,478 1,541 1,703 1,156
*Based on pro forma balance sheets and income statements.
EXHIBIT 4 Break-Even Quantity Calculation
1. Contribution margin per unit is estimated to be $20.81 in 2004 and 2005. (See unit sales, cost, margin analysis in Exhibit 5.)
2. Fixed costs for unit sales in the first year of 50,000 units are estimated to be $332,910, including $10,200 paid for prototype development in 2003. Break-even quantity would be $332,910/20.81 16,000 units.
3. Based on the expected seasonality of sales in the first year of selling, the break-even point should be reached in mid-October 2004, in the second full month of product shipments.
What makes the clock functionally unique is that
throwing the ball turns off the alarm. Great care was
taken to use materials that have virtually no chance of
damaging the wall or any other object. The specifically
designed impact switch is sensitive enough that even a
light impact will stop the alarm. On the other hand, a
throw of considerable force will not disturb the contents
of the inner capsule. Two insurance companies special-
izing in product liability testing have been consulted.
They both feel that the product is safe and free enough
C A S E 10 THE WINSLOW CLOCK COMPANY 521
from liability risk that they have quoted The Winslow
Clock Company the minimum premium for liability
insurance.
Several achievements have made the clock techno-
logically possible. There is no need for an electrical
connection between the clock base and the ball because
an ultrasound device signals the alarm to go off. A re-
ceiver in the inner capsule “reads” the signal and triggers
the humorous crescendo of the alarm; upon “advice”
from the impact switch, a satisfying tone of demise is
produced when the alarm hits the wall. In addition, a
timing device has been built into the circuitry that auto-
matically shuts off the alarm after one minute if the
ball is not thrown.
The overall design and finish of the clock are clean and
sophisticated in order to eliminate any sense of gimmickry
that might lessen the perceived value of the clock. This
elegant styling and the sophisticated electronics, combined
with both the psychological satisfaction and the sense of
fun and playfulness inherent in being able to throw one’s
alarm clock, should appeal to a significant cross section of
consumers, from executives to athletes. The product has
a strong appeal to retailers as well, who, in the words of a
Bloomingdale’s executive, look for “something refreshing
and new to pull people into the stores.”
Technical specifications of the product are as follows:
Dimension: Base—41⁄2 41⁄2 41⁄2 ; Ball—41⁄2
diameter
Color: Model A—white clock housing with black
face, charcoal ball, white, yellow, and red
hands
Model B—black housing with other colors in
Model A
Accuracy of movement: 20 seconds per month
Hands: Luminescent minute and hour hands
Foam ball: 35 ppi Crest Foam
EXHIBIT 5 Financial Data Backup
*Backup detail provided.
Unit sales, cost, margin analysis
Retail suggested list $85.00
Dealer margin 42.50
Mfr. selling price (dealer cost) 42.50
Cost of goods sold* 14.60
Gross margin $27.90
Other variable costs*
Warranty .05
Quality control allowance .29
Shipping & handling contribution .20
Co-op advertising allowance 2.13
Selling commissions 4.25
Designer/developer fee .17
Subtotal variable costs 7.09
Net margin $20.81
Note: Total cost of goods $21.69
Cost of goods sold analysis
Item
Movement* $2.77 $ 3.87
(and circuit board) $1.10
Chip (production model) .79
Capacitors (3) .30
Impact switch 1.03
Battery holder .20
Photo transistor .30
Ball .87
Molded sphere .20
Velcro® .07
Molded cube (housing) 2.00
Batteries .95
Face, crystal, hands, etc. .60
Board .40
Board assembly 1.00
Feet .05
Speaker, lamp, socket 1.08
Assembly .50
Product subtotal $14.21
Package (inc. inside corrugated) .24
Printed inserts .05
Portion (1/6) master carton .10
Package subtotal $14.60
EXHIBIT 6 Financial Data Backup
*Add $0.30 premium per unit for air shipments.
Note: Tooling not amortized in these calculations because first production run
estimated to be 10K units; all other costs listed here based on runs of 100K.
Tooling at this point treated as a capital expenditure and listed under fixed costs.
522 PA RT 6 CASES
Future Potential
The new technologic innovations that have emerged
during the development of this first product have signif-
icance for the future of the company as well. First, ex-
tensions of the basic concept are possible in a variety of
clocks with other features. Obvious examples are clock
radios and snooze alarms. In addition, as production
quantities increase, specialty designs for the premium
market become possible at reasonable cost.
A family of related products such as posters, a wall-
mountable target, and other clocks—all dealing with
the frustration people feel with time, alarm clocks, and
schedules—are natural offshoots of the throwable alarm,
and their development is currently being explored.
MARKETING PLAN AND STRATEGY
Given the clock’s unique function, design, and appeal,
the first year’s marketing plan will focus on placing the
clock in upscale department stores, clock specialty
stores, and catalogs that reach upper-middle-income
and upper-income executives and families. The early
strategy is to keep the clock out of the mass market and
discounters’ trade, instead making it readily available to
consumers more interested in its characteristics and
uniqueness than its suggested list price of $85. The
sales, cost, and margin analysis is based on the assump-
tion that the suggested list price of $85 and dealer price
of $42.50 will be held constant for three years. The
goal is to introduce the product with a large enough
margin for the dealer in the higher-end retail and cata-
log business to make an adequate return and to allow
the company to recapture its fixed costs as quickly as
possible.
While the suggested list and dealer prices at this
time are expected to remain the same in the second and
third years, part of the strategy will be to refine the
production and assembly costs, negotiate volume dis-
counts with suppliers, and devise other cost-saving
measures in order to offer more marketing support to the
expanded dealer base without sacrificing profitability.
EXHIBIT 7 Critical Risks and Problems
Listed below are those areas of particular concern and importance to the management.
1. Timing will play a critical role in the success of this venture. The key variables are:
• Product readiness
• Financing
• Approach to the marketplace
• Production, from delivery of components to assembly, inventory, and shipping procedures
2. Projections used are “best” estimates, and all financial needs and operating costs have been based on what is considered to be the most likely volume of sales achievable. Because selling activities will begin early in 2004, reaction from the marketplace should be clear by late spring. Decisions can still be made to cut back—or to gear up—for the 2004 season.
The first commitment to Seiko for 10,000 units (cost of $4.17 each) will have been made by mid-March, and estimates for the entire year will be in their production plan by then. While cutbacks can be made as late as a month in advance, increased production might be a problem since it would bump into Seiko’s heaviest production season.
3. Financing would be another major consideration if sales were much in excess of expecta- tions, particularly because we must assume that early orders are going to require an accompanying letter of credit. For this and other reasons, the marketing plan is meant to guard against some of these problems and is specifically geared to reach upscale stores and catalogs that will commit early to carry the “limited production” of the first year.
4. Ironing out production and assembly problems will be of major importance in June and July. Although the process is not complex, it will be totally new, and the production rate is currently scheduled at 5,000 units in July and 10,000 in August in order to meet antici- pated shipping requirements in September and to build minimal inventory requirements. For these reasons, selection of an experienced production manager will be critical.
If necessary, cost-saving measures will be adopted that
will make it possible to lower the price dramatically as
a means of defense against competitors in years 3 and 4
of the product’s life.
Sales Tactics
The principals of the firm will contact potential buyers
directly at first, beginning in early 2004 when there
are still budgets available for merchandise for the
2004 Christmas season. Sales in 2004 are planned at
50,000 units, on a first-come, first-served basis, unless
a retailer will commit for a guaranteed order prior to
June 1. A sales rep organization will also be retained
to continue these early sales efforts and to expand dis-
tribution after the first season. A commission averaging
10 percent of the dealer price per unit has been incor-
porated into the cost of sales to cover the activities of
these sales reps.
In addition, an experienced, full-time, in-house sales
manager will coordinate the selling and promotional
activities of the independent rep organization. Other re-
sponsibilities of the sales manager will include (1) mak-
ing direct contact with buyers, (2) making direct contact
with sales reps and evaluating their performance, (3) co-
ordinating the marketing support and promotional activi-
ties of the sales rep force, and (4) developing other possible
avenues for marketing the company’s products. The di-
rect marketing approach referred to earlier is an obvious
example of this.
Advertising and Publicity
A publicity campaign aimed at generating interest in the
clock’s development, its state-of-the-art technology, and
its founder’s concept of “functional fun” will be launched
in early fall 2004. This publicity and accompanying new
product announcements will target the “executive toy”
purchaser.
In addition, a print ad campaign slated for the 2004
Christmas retail market and a cooperative advertising
plan to help participating dealers are expected to aid
sell-through in the clock’s first major season on the
market.
Expanded advertising marketing support for the sec-
ond season will include the following: attendance at
trade shows (notably the Consumer Electronics Show, the
National Hardware Show, and at least one of the major
gift shows); an in-store promotion plan highlighted
by a 90-second video spot designed and produced by
a Clio-award-winning studio based in Cambridge,
Massachusetts; continuation of the co-op advertising
plan; and an overall advertising budget slated at 5 percent
of anticipated sales for the year.
OPERATIONS MANAGEMENT
Since all assembly and subassembly operations will be
handled by independent contractors, with final shipment
emanating from the final point of assembly, the need for
an office, a production staff, and overhead would be
kept to a minimum.
Although Dr. Winslow will oversee all operations,
his regular staff will supervise the critical functions of
marketing and business development, administration
(including office management, billing, accounts receiv-
able and payable), and production management (the
control of all facets of outside assembly and vendor sup-
plies and relations).
Marketing and business development (including
sales in the initial stages) would be managed by
Ms. Kristen Jones, who has 15 years of experience in
marketing and finance in both domestic and interna-
tional operations for Polaroid Corporation. She has an
MBA from Boston College and a BA from Brown
University.
The production management area (including prod-
uct engineering) is currently handled in an advisory
capacity by several consultants, including Mr. Steve
Canon (see profile below). As the company approaches
actual production (now slated for June–July 2004
start-up), a full-time production manager will be hired.
Several candidates are presently being considered for
this position.
Strong relationships with highly responsible subcon-
tractors have already been established. These include
Seiko, for the precision quartz movement and related
technology; Rogers Foam in Somerville, Massachusetts,
for the ball; Aerodyne Control Corporation in Farming-
dale, New York, for the switch; and Santin Engineering
in Beverly, Massachusetts, for the plastic molding.
An outside contractor in the Boston area will handle
the assembly operation, which includes packaging and
shipment to fulfill sales orders. Several companies are
being considered and will be submitting quotes on the
specifications early in 2004. A decision is expected to
be made by the beginning of February. The possibility
of an assembly operation outside the United States will
be investigated as a cost-saving measure once produc-
tion is being handled efficiently here.
C A S E 10 THE WINSLOW CLOCK COMPANY 523
The administrative position will have the responsibil-
ity of handling all office functions, including billing, re-
ceivables, credit, and payables. Two candidates are now
being considered. It will be important to fill this func-
tion as soon as possible, even if it is on a part-time basis
for the first few months. The candidates are available for
such a schedule, if necessary.
Other critical areas that are now, and will continue to
be, handled by consultants are advertising (including
sales promotion and publicity)—Bill Barlow—and
product design—John Edwards.
MANAGEMENT
Dr. Michael Winslow is the inventor of the clock and
founder and president of the company. His profession
is psychiatric medicine, and he is currently practicing
at the Boston Evening Medical Center in Boston,
Massachusetts, as well as at the Matthew Thornton
Health Plan in Nashua, New Hampshire. He also main-
tains his own private practice. Dr. Winslow earned his
undergraduate BS degree at the University of Michigan
and his medical degree at Boston University Medical
School.
It was while he was a resident in psychiatry that he
conceived of the idea for the clock. He first pursued the
concept as a hobby, trying to find a way to throw the
clock without damaging either it or the surface it hit.
Within the last two years, as it became apparent that it
would be possible to create and produce such a clock
at a reasonable cost, further development of the idea
became another full-time occupation for Dr. Winslow.
Though he is a man of great energy, part of
Dr. Winslow’s success in bringing the product from the
initial concept to the prototype stage lies in his effec-
tiveness in finding and utilizing the outside resources
he has needed. He has also had enough confidence in,
and received enough encouragement about, the ulti-
mate marketability of the product that he has invested
his own savings in development costs, a sum of approx-
imately $60,000 to date.
Because his profession is very important to him, Dr.
Winslow intends to continue his private medical prac-
tice. But he will also serve as president of The Winslow
Clock Company, hiring professional managers to run
the day-to-day operations for him and using consultants
in those aspects of the business where a particular ex-
pertise is needed.
Kristen Jones—following a year at the Museum of
Fine Arts, Boston, as an assistant to the head of
research—joined Polaroid Corporation, Cambridge, Mas-
sachusetts, where her experience and responsibilities grew
over a broad range of marketing and finance assignments.
During the years in which Polaroid’s International
Division grew from $30 million to $350 million in an-
nual sales, Jones was responsible for sales planning
and forecasting for all its amateur photographic prod-
ucts. Later, as a financial analyst, her job was to assess
the company’s 130 distributor markets around the
world for potential as profitable wholly owned sub-
sidiaries, as well as to carry out new product profitability
analyses.
She then joined the domestic marketing division,
where her assignments ranged from sales administration
to marketing manager in charge of a test program to as-
sess the potential of selling the company’s instant movie
system on a direct basis. In her last position as national
merchandising manager, she created and managed the
merchandising programs to support the national sales
efforts for all consumer products.
In February 1992, she took advantage of the com-
pany’s voluntary severance program to complete work
on her master’s degree in business administration at
Boston College. Ms. Jones earned her BA degree at
Brown University in Providence, Rhode Island.
Steve Canon is a consultant, teacher, and business-
man whose broad range of experience covers many
aspects of new product design, development, and market-
ing. He presently has over 35 products of his own on the
market and also teaches marketing and business law at
the Rhode Island School of Design. In addition, he pub-
lished a book in the spring of 1996 that deals with in-
vention, product development, and marketing.
Among his numerous accomplishments, he has taught
product design at Harvard, Yale, Princeton, and the
Rhode Island School of Design. He has won awards for
his contributions to the field, including two from Ford
Motor Company for innovative product development.
Canon has appeared on television talk shows, as both
guest and host, discussing product marketing.
Although his primary contributions to The Winslow
Clock Company are in the fields of product develop-
ment and manufacturing/production, his knowledge of
new product introductions has been very helpful in a
number of other areas as well.
Bill Barlow has been president and creative director
of Bill Barlow Advertising since 1998. Prior to establish-
ing his own company, Barlow was director of advertising
for Bose Corporation in Framingham, Massachusetts, a
national sales promotion manager and creative director
524 PA RT 6 CASES
C A S E 11 NEOMED TECHNOLOGIES 525
at Polaroid Corporation, and a creative supervisor for
New York Telephone in New York City.
In his five years as an entrepreneur, Barlow has built
an impressive list of clients and has won numerous
awards and honors for excellence in advertising. His
current list of clients includes Polaroid Corporation,
Hewlett-Packard, Data General, Bose, and Anaconda-
Ericsson Telecommunications.
He will be responsible for advertising, promotional
support materials, and publicity for The Winslow Clock
Company.
John Edwards is the founder of Edwards Design
Associates, Inc., a firm that specializes in industrial
design, product development, and graphic design. For
the past seven years, this company has provided an in-
tegrated approach to the design of both products and
the packaging and collateral materials to support the
products.
Among his clients, primarily in the fields of con-
sumer products and finance, are Polaroid, Bose, Revlon,
Chaps, Helena Rubinstein, Avco, Putnam Funds, and
Hallmark.
Edwards has a BS degree in mechanical engineering
from Worcester Polytechnic Institute and an MS degree in
industrial design from the Illinois Institute of Technology.
In addition to designing Dr. Winslow’s product,
Edwards has also provided invaluable help in finding
sources for the manufacture of several components for
injection molding and for packaging.
C A S E 1 1
NEOMED TECHNOLOGIES
Marc Umeno, president and founder of NeoMed Tech-
nologies, and George Coleman, chief operating officer
and vice president of business development and market-
ing, arrived back at NeoMed headquarters after a frus-
trating and disheartening meeting with venture capital
investors. Now late into August of 2002, after months of
revising the company strategy, continuously improving
the technology and product design, and meeting with in-
vestors still not willing to commit their capital, the com-
pany had finally run out of cash. Such brutal reality made
Marc and George wonder what they could possibly be
doing wrong. There was no doubt in their mind[s] that
NeoMed had the right people and an outstanding technol-
ogy. They were convinced that NeoMed’s device had the
potential for helping people in a way that other alterna-
tives could not. This dedication has sustained the com-
pany to this point. However, despite the great commercial
opportunity of its innovation, the company had walked a
tight rope between technical development and business
and financing issues. Though each team member is con-
vinced that the capital that the company needs to prove
the technology is available, the existing financing envi-
ronment had investors becoming cautious and risk averse.
In light of the present situation, NeoMed was at a deci-
sion point as to what actions to take to finally close a deal
with investors and avoid dissolving the company.
COMPANY HISTORY AND FOUNDERS
Marc Umeno, one of the founders of NeoMed Technolo-
gies, developed the initial concept for NeoMed during
graduate work in the Physics Entrepreneurship Pro-
gram, a partnership between the Physics Department
and the Weatherhead School of Management at Case
Western Reserve University (CWRU) in Cleveland,
Ohio. Before starting the program, Marc, in collabora-
tion with a radiologist from West Virginia University,
created patents for a technology that had been intro-
duced to him earlier that year by a scientist looking to
commercialize his ideas. Marc conducted preliminary
research and evaluated the market opportunities for
the technology while participating in the program at
CWRU. As a result, in the spring of 2001, NeoMed was
officially formed with the purpose of commercializing a
novel radionuclide imaging technology for cardiac test-
ing, developed based on research conducted over the
past three decades in experimental particle physics de-
tector technology at the Department of Energy Na-
tional Laboratories and in nuclear cardiology imaging at
UCLA. It was decided to locate the new company in
Cleveland, Ohio, a region that supported world-class re-
search in the area of medical imaging. This allowed
NeoMed to have access to top-notch engineering ser-
vices, software partners, and industry suppliers. Major
players in the diagnostic imaging market, such as GE
Medical and Philips, have also been historically located
in this region. From the very beginning NeoMed was
thought to have a bright future due to the very promising
commercial potential of the market for cardiac testing.
This was based on the fact that in the United States, as
well as other industrialized nations, CAD1 is a leading
cause of fatalities, with the first symptom of this disease
Source: This case study was prepared by Amanda Holland, Nadya Tolshchikova, Jeff Glass, and Robert Hisrich, with the intention of providing a basis for class discussion.
526 PA RT 6 CASES
often being death. Given this sobering reality, it is not
surprising that NeoMed’s vision is as follows:
NeoMed Technologies is committed to establishing its
technology as the standard of care for initial diagnosis
of coronary artery disease and will be instrumental in
saving millions of lives.
Marc Umeno, Stan Majewski, and Harry Bishop were
the three original founders of NeoMed. After search-
ing for recommendations for someone with industry
experience who would work well in the start-up envi-
ronment, Marc was introduced to George Coleman.
George joined the company as COO shortly thereafter,
and Walt Bieganski joined subsequently as the chief fi-
nancial officer (Exhibit 1). As a part of the company for-
mation process, the Board of Directors was initiated
early on in NeoMed’s existence, and from the very be-
ginning, played a significant role in the company’s
strategic positioning. By 2002, the carefully selected
Board consisted of five members (Exhibit 1).
Management Team
Marc Umeno, PhD, President and Founder‡
Dr. Umeno is currently developing NeoMed full-time. He received his BS in Physics at Harvey Mudd College and his PhD in Physics at American University while doing Neuroscience research at the National Institutes of Health. Dr. Umeno has served as a Nuclear Medical Science Officer in the U.S. Army, where he led a multi-agency team of experts to develop critical nuclear weapons standards, was the U.S. representative for three NATO committees, chaired three Department of Defense–wide groups, and was involved in FDA approval of a military pharmaceutical. Prior to his work with NeoMed, Dr. Umeno was a project manager at Veridian, where he managed multiple projects with over $2 million annual budget and led the commercialization of a medical software tool.
George Coleman, Chief Operating Officer and Vice President of Business Development and Marketing
Mr. Coleman is a full-time member of the NeoMed team. He has over 25 years of experience in the medical, biotechnology, and specialty chemical industries. He has start-up experience as General Manager and V.P. of Sales and Marketing for an innovative medical engineering firm that produced image processing and micro-endoscope systems, surgical instruments, and MEMS components. Mr. Coleman also has experience as managing director at Federal Process, new business development manager of biotechnology at British Petroleum, and sales, sales management and marketing management for a division of Merck, where he was awarded Merck’s highest management award for performance.
Walt Bieganski, Chief Financial Officer and General Counsel
Mr. Bieganski is a full-time member of the NeoMed team. He has 16 years of financial and tax advisory experience with Ernst & Young LLP, including 9 years of experience building and managing a multi-million-dollar specialty practice where he serviced clients in various industries, including financial services, distribution, manufacturing, natural resources, and power generation. He also spent two years as a co-leader of the firm’s e-business initiatives in the region. Mr. Bieganski is a CPA and has an MBA in Finance from Cleveland State University and a JD from Ohio State University.
Stan Majewski, PhD, Chief Scientific Officer and Founder
Dr. Majewski is head of the detector group at the Thomas Jefferson National Accelerator Facility. He received his educational degrees in Experimental Particle and High Energy Physics from the University of Warsaw in Poland. Dr. Majewski’s career has included significant work under two Nobel Prize winners at the European Center for Particle Research (CERN) and the Fermi National Accelerator Laboratory. Dr. Majewski has developed many similar devices involving breast cancer detection, surgical probes, and small animal imaging, and has consulted for NIH, NASA, and UCLA. He also has start-up company experience with a device that successfully gained FDA approval and has launched a small technology start-up. At Jefferson Lab, Dr. Majewski led the development of novel biomedical imagers, co-authored over 100 publications, and invented or co-invented eight patents.
Harry Bishop, MD, Medical Advisor and Founder
Dr. Bishop, inventor of the NeoMed cardiac screening test, is an adjunct associate professor of radiology at West Virginia University. He serves as a medical advisor to the company. He has over 40 years of medical experience, specializing in radiology and nuclear medicine. Dr. Bishop received his BA in Physics from UC Berkeley and his MD from UC San Francisco. He was the first physician in the U.S. to perform coronary angiography and was awarded the Picker Fellowship to study cardiac physiology. Dr. Bishop is also an expert in nuclear cardiology and PET for breast cancer imaging. He is a Fellow of the American College of Radiology and has numerous publications.
EXHIBIT 1 Principals/Management Team Board of Directors*
C A S E 11 NEOMED TECHNOLOGIES 527
CORONARY ARTERY DISEASE (CAD)
CAD is the leading cause of death in the U.S. and
throughout the world. It caused more than 1 out of every
5 deaths in the United States in 2000, claiming the lives
of 681,000 people. In 2003 an estimated 650,000 people
in the U.S. alone will have a first coronary attack and
450,000 a recurring attack.2 For example, in the U.S.
approximately every 29 seconds a person will suffer a
coronary event, and nearly every minute someone will
die from it. Nearly 47 percent of coronary events are fa-
tal, of which 250,000 occur without previous symptoms
of the disease. Coronary artery disease takes place when
one or more of the coronary arteries are narrowed down
or blocked resulting in decreased blood supply to the
heart, which can be fatal. It is believed that the addition
of this plaque to the heart blood vessels is a detectable
process that can be estimated indirectly through the
measurement of coronary circulation.
In 1997 there were about 700,000 outpatient surgi-
cal procedures performed on the cardiovascular sys-
tem, 1,200,000 inpatient cardiac catheterizations, and
607,000 coronary bypass surgeries. This level of surgi-
cal intervention not only presents high risk for both pa-
tients and physicians, but uses a very large share of the
nation’s health care resources. For example, the aver-
age cost of coronary artery surgery in 1995 was
$44,820. In 1996, for anyone under the age of 65, the
average cost of a coronary event from admission to
discharge was $22,720, with the average length of stay
Allen Goode, MS
Mr. Goode has committed his availability to coordinate clinical trials and to participate in software development as a
consultant. Mr. Goode is coordinator for five multicenter cardiovascular-related trials in the Division of Nuclear
Cardiology at the University of Virginia. Mr. Goode is also board certified as a nuclear medicine technologist.
Norm Yager
Mr. Yager is currently assisting NeoMed with the FDA approval process. He has written 11 successful FDA 510(k)
applications as a regulatory manager for Picker International (now Marconi Medical, a subsidiary of Philips) and was
previously at Johnson & Johnson.
Board of Directors
Paul Amazeen, PhD‡
Dr. Amazeen has been a senior executive developing medical imaging products for more than 20 years, including
Raytheon, General Electric, Rohe Scientific Corporation, and Sound Imaging. Dr. Amazeen received his BSEE from the
University of New Hampshire and his MS and PhD from Worcester Polytechnic Institute. He has received the Ford
Foundation Faculty Fellowship at MIT and has a patent for a real-time ultrasonic image display.
Robert D. Hisrich, PhD‡
Dr. Hisrich is Professor of Entrepreneurial Studies at Case Western Reserve University’s Weatherhead School of
Management. He has had extensive experience in starting and growing companies and is presently on the Board of
Directors of two publicly traded companies. Dr. Hisrich has been an entrepreneurship professor at the University of
Tulsa and MIT and also has held Fulbright Professorships in Hungary and Ireland. He received his BA from DePauw
University and his MBA and PhD degrees from the University of Cincinnati.
Mark Lowdermilk, MBA‡
Mr. Lowdermilk is currently CEO of a network infrastructure start-up company. He has 28 years of management
experience, including 10 years with medical device components and nuclear medicine. Mr. Lowdermilk was formerly
with Saint-Gobain Crystals and Detectors serving as Business Manager of Nuclear Medicine. He received his BS in
Business Administration from Kent State University and his MBA from the Weatherhead School of Management at
Case Western Reserve University.
Alan Markowitz, MD‡
Dr. Markowitz is currently Chief of Cardiothoracic Surgery at University Hospitals of Cleveland. He received his MD
from the Albany Medical School of Union College. Along with his distinguished clinical record, Dr. Markowitz has been
a consultant for many companies such as Medtronic and Johnson & Johnson, involved in clinical trials for their cardiac
products.
EXHIBIT 1 Principals/Management Team Board of Directors* (continued)
*NeoMed Business Plan, March 2002.
4.3 days.3 Furthermore, in 1998, Medicare paid $10.6 bil-
lion to its beneficiaries for hospital expenses due to
coronary heart disease (CHD)4 [$10,428 per discharge
for acute myocardial infarction (MI);5 $11,399 per dis-
charge for coronary atherosclerosis; and $3,617 per
discharge for other CHDs].6 Moreover, the problem of
an aging population is more likely to escalate these
costs as a result of increased incidence of coronary artery
disease in older people. According to the U.S. Census,
there will be 40 million Americans age 65 and older
in 2010. In addition, an increase in the prevalence of
obesity and type 2 diabetes also amplifies the risk of heart
disease. Given the costs and increase in scope of this
health problem, early identification and nonsurgical
treatment and prevention of CAD are becoming more
important than ever.
CAD DIAGNOSTIC PROCEDURES
Normally, patients are screened for CAD during routine
office visits, even if the patient doesn’t have any symp-
toms of CAD. Frequently detection occurs when the
patient arrives at the emergency room with a myocardial
infarction (heart attack). Typically though, CAD detec-
tion starts with a thorough physical exam and careful
documentation of family, personal history, lifestyle habits,
and other factors. Blood cholesterol tests and blood
pressure measurements are also used to screen for CAD.
Recently, the U.S. government recommended new
guidelines of CAD testing that increase the likelihood
of disease detection with the following test methods
actively used to screen patients.
Chest X-ray produces images of the heart and the
surrounding areas showing the size and shape of the
coronary system. This technology enables detection
of misshaped or enlarged hearts as well as abnormal
calcification in the main blood vessels.
Electrocardiogram (ECG or EKG) is a graphical
record of the electrical activity of the heart.
Typically, a normal ECG rules out the presence of
heart disease while an abnormal ECG has been
relatively good at indicating the existence of the
disease.
Stress Test involves taking ECG before, during, and
after the exercise on the treadmill. Although widely
accepted by health care professionals and
reimbursement organizations due to its low cost,
ease of use, and 50–80 percent accuracy, it has some
major drawbacks such as relatively low accuracy,
ineligibility of some patients due to the high risk of
heart attack during the performance of the test, and
insurance reimbursement problems for
asymptomatic patients.
A preliminary test using Fast/Multi-Slice CT Scan
with ECG is a relatively new noninvasive method of
heart and coronary artery imaging. It is often used
as an alternative for invasive catheterization to
determine calcium deposits in the coronaries and
stenoses (narrowing of arteries) that can eventually
lead to a heart attack.
EBCT,7 when it was first introduced to the market,
attracted attention in the medical community due
to its ability to screen asymptomatic patients for
CAD. Although it was proven that a negative EBCT
scan is highly accurate at excluding CAD, it is not
certain whether the levels of coronary calcification
that EBCT detects can be translated into high CAD
risk.
NUCLEAR DIAGNOSTIC IMAGING
Nuclear medicine uses radioactive material that is injected
into the patient to diagnose disease or assess a patient’s
condition. Nuclear imaging is different from regular
imaging in several important ways: (1) the source of rays
is internal to the patient versus external, (2) the radioac-
tivity is attached to biochemically active agents injected
into the patient’s body so that an organ’s functionality is
observed rather than simply viewing the image of an
organ.
Equipment for nuclear imaging typically contains
several common components. One of these components
is the sodium iodide detector, which consists of a crys-
tal that scintillates with blue light, a photomultiplier to
convert the light into a proportional electrical signal,
and support electronics to intensify and shape the elec-
tric signal into a readable form.
Early nuclear imaging devices used scanning proce-
dures to record information from the patient. More recent
devices are the gamma cameras that are simultane-
ously sensitive to the entire radioactivity within a large
field of view and do not require scanning. These cam-
eras are advantageous because they can measure
changes in the radioactive distribution as a function of
time. In general, nuclear images have a fundamental
resolution that is about 1 percent of the image dimen-
sion, and the images are fairly simple to investigate
quantitatively.8
528 PA RT 6 CASES
C A S E 11 NEOMED TECHNOLOGIES 529
NEOMED NUCLEAR
DIAGNOSTIC IMAGING
During the initial research, NeoMed considered several
applications for its proprietary technology. Founders
recognized that it could be used for the in vivo analysis
of animals in drug studies, allowing researchers to con-
duct long-term drug experiments on animals and ana-
lyze the results without sacrificing the animals’ lives,
thus significantly reducing laboratory costs. In addition,
NeoMed could apply its technology to screening drug
candidates, drug delivery applications, or perhaps even
to detecting cancer. Furthermore, Marc and his team
were convinced that the core set of technologies could
be applied in Homeland Defense for detection of nu-
clear weapons or “dirty bombs.”
However, despite the numerous possible applications
for the technology, it was decided to focus on cardiac
testing for several reasons. Primary among these was
the ability of this technology to fill the largest market
need and address a very real problem in society. It was
estimated that based on a high cholesterol level, 36 mil-
lion people in the U.S. are at risk of CAD, of which 11.3
million visit cardiologists each year. If each CAD diag-
nostic test is estimated to be between $200 and $400 a
test, the overall market potential is projected to be
between $7.2 and $14.4 billion.
Taking into consideration the above reasoning,
NeoMed has developed a device to monitor coronary ar-
tery function that combines 75 years of expertise in the
fields of detector physics and nuclear cardiology and is
unique in its sensors, data acquisition electronics, and
analytical software. Recent developments in scintillation
technology make the NeoMed device possible, allowing
for small, compact, and inexpensive gamma detectors that
can measure high rates of activity while still maintain-
ing excellent resolution. In addition, NeoMed’s propri-
etary state-of-the-art software allows detailed analysis
of the CTI measurements. This powerful functional
package is based on proven technology applied in a new
way, thereby avoiding technological risks and supplier
challenges inherent in a less mature technology.
NeoMed’s diagnostic system provides medical per-
sonnel with the ability to detect coronary artery disease
(CAD) with a quick and painless noninvasive test. In the
process of testing, the patient while at rest is injected with
a radioactive tracer, the passage of which is dynamically
measured as it flows through the heart. As a result, Coro-
nary Transit Index (CTI) is generated, which allows de-
termination of the performance of the heart system. The
radiation dose used in this test is much lower than in stan-
dard diagnostic imaging procedures involving CT, fluo-
roscopy, or traditional nuclear cardiology. Furthermore,
the NeoMed test has a much higher degree of accuracy
than conventional methods of detection, as illustrated in
Exhibit 2. The NeoMed test is expected to be less expen-
sive, will last less than five minutes, and the results will
be obtainable immediately after the completion of the
test. NeoMed’s objectives for its state-of-the-art technol-
ogy are to provide quick and accurate cardiac testing of
patients at risk for CAD and to monitor patients who have
had an acute myocardial infarction or stent surgery.
EXHIBIT 2 Accuracy of CAD Diagnostic Procedures
Source: NeoMed Business Plan, March 2002.
30%
40%
50%
60%
70%
80%
90%
100%
A c c u ra c y
NeoMed Stress ECG EBCT
COMPETITION
The main competition for any new nuclear diagnostic
imaging equipment is most likely to come from the al-
ternative methods rather than in the form of direct com-
petition from other manufacturers. NeoMed decided early
on to focus on functional testing, which acts as a prelim-
inary “gate” test for more detailed and expensive diag-
nostic procedures such as nuclear perfusion, electron
beam tests, and angiography, which are used at later
stages of the diagnostic process. Although not all CAD
diagnostic methods directly compete with NeoMed’s
technology, overcoming ECG Stress Test’s and EBCT’s
popularity in the current health care system presents a
significant barrier to entry for NeoMed.
ECG stress test is a current industry standard that
has been on the market for a few decades and is well
received and accepted by both medical professionals
and Medicare reimbursement agents. Although the
technological shortcomings of this test are well known,
the ease of use, low cost, and although not neces-
sarily high, but consistent, predictive accuracy rate of
50–80 percent have established the ECG stress test as
an industry standard. Some of the drawbacks of this
test, where NeoMed saw an opportunity for its tech-
nology, were absence of ECG test Medicare Reim-
bursement for patients with no symptoms, and a risk
of performing the test on certain patients with severe
symptoms of CAD. One in 10,000 people will die,
and 2–3 in 10,000 will have a major myocardial in-
farction while performing a physical exercise as a part
of this test.9
Another major competitor to the NeoMed technol-
ogy is the EBCT test. However, NeoMed feels that the
controversy around the effectiveness of this technol-
ogy in its ability to detect noncalcium plaques in coro-
nary arteries and its high cost could limit long term
and widespread use of this technology in the future.
According to the recent statistics, the cost of the de-
vice is about $2 million, and the cost of the test ranges
from $420 to $500.10 There are many smaller compa-
nies specializing in EBCT screening tests. One of
them is HeartCheck, a national marketing firm with 7
locations in California, Illinois, and Pennsylvania that
targets smaller regional markets with low penetration
of EBCT systems. Currently there are around 100
hospitals and outpatient imaging centers that provide
EBCT tests to patients, and despite the cost and tech-
nology shortcomings, their number is expected to rapidly
increase.
NEOMED BUSINESS MODEL
According to NeoMed’s current business model, revenue
will be generated through license arrangements with out-
patient imaging centers, cardiology groups, and hospi-
tals. When the test is administered by the diagnostics
provider, a $233 reimbursement fee will be collected
from insurance companies, of which NeoMed will re-
ceive $133. This arrangement allows for a 20 percent
profit margin for the service providers and a 70 percent
gross margin for NeoMed. The price of the NeoMed test
will be set at $400, taking into consideration the pricing
for compatible CAD screening tests ranging from $300
to $700.
Distribution
The first facilities licensed to perform the NeoMed pro-
cedure commercially are expected to be the sites used to
conduct the clinical trials. Using the contacts at these fa-
cilities, NeoMed can further expand its customer base.
Another possible distribution channel is through mobile
nuclear medicine firms who service rural areas. Also,
the international market holds considerable potential
for NeoMed technology and could possibly be tapped
through strategic partnerships. Using these existing sales
and distribution channels would allow NeoMed to estab-
lish a broad market presence more rapidly than building
its own.
Strategic Partnerships
Due to its geographic positioning in an area with the
strong presence of two renowned medical centers (Uni-
versity Hospitals and Cleveland Clinic), NeoMed was
able to take advantage of strategic partnerships with
these institutions that enabled in-kind clinical trials, pilot
projects, and animal studies. It also provided NeoMed
founders with exposure to the world class medical pro-
fessionals in the field of cardiology and an opportunity
to test ideas for the product during multiple stages of
prototype design, market assessment, and effectiveness
trials.
Sales and Marketing Plan
NeoMed expects for its technology to be adopted in the
early stages of the market introduction by cardiologists,
whom NeoMed chose to target as a primary audience.
530 PA RT 6 CASES
C A S E 11 NEOMED TECHNOLOGIES 531
After an extensive analysis of various market segments,
the company decided to focus its entry strategy on two
niche markets that have no current solutions:
• Patients who cannot be stressed (3.5 million patients
per year)
• Monitoring CAD treatment progress (1.5 million
patients per year)
Traditional exercise ECG stress tests cannot be ad-
ministered to 1/3 of patients due to their physical dis-
ability, heart attack risk, or other physical factors.
Also, a large percentage of patients that have under-
gone surgical treatments for CAD experience a reversal
of their treatment. For instance, approximately 20 per-
cent of coronary artery stents will undergo rejection
within two months and 80 percent within 5 years.
These patients have no reliable noninvasive means of
detecting recurring problems. Therefore, NeoMed ex-
pects that its diagnostic method will serve both of
these market segments, which together represent a
market potential of $1.2 billion (Exhibit 3). However,
when it comes to marketing the product, as with most
pharmaceutical products and medical device systems,
NeoMed must primarily market its technology not to
the patients, but instead to the cardiologists who are
the main decision makers in the choice of the diagnostic
testing procedures. NeoMed estimated that there were
close to 19,623 cardiologists in the United States, includ-
ing 4,500 nuclear cardiologists.
NeoMed is planning on penetrating the market
through initially targeting cardiologist opinion leaders
and establishing positive working relationships with
such organizations as the American Heart Associa-
tion, American College of Cardiology, and others,
hoping to receive their endorsements when the prod-
uct is ready to be launched. NeoMed expects to create
product awareness among the rest of the nation’s car-
diologists through active participation in trade shows,
publications in professional journals, and through sales
representatives.
The company anticipates its revenue to increase over
5 years reaching $182 million in 2007. To achieve these
sales, NeoMed’s technology will need to capture 4 per-
cent of the U.S. target market. This revenue is projected
based on the assumption that out of 49 patients a cardi-
ologist sees each week, 15 are nonstress patients.11 If
taking an average of 5 cardiologists per facility working
an average of 50 weeks per year, one facility is esti-
mated to perform 3,750 tests per year, which amounts to
75 percent capacity utilization of a single NeoMed unit.
Table 1 shows the projected sales volume for years 2003
through 2007.
EXHIBIT 3 Market Potential for NeoMed
Source: NeoMed Business Plan, March 2002.
Exercise stress tests 6.8 million $400/test
Stress echo nuclear
perfusion 3.4 million $1–2K/test
Cardiac catheterization
1.8 million $12.5K/test
Annual new patient visits to cardiologists 11.3 million
532 PA RT 6 CASES
COMPANY SITUATION
As of August 2002, NeoMed has built an initial pro-
totype of its nuclear imaging device suitable for use in
research-level patient testing. It has also been approved
for use in preclinical trials at West Virginia University. In
addition, NeoMed was invited to participate in clinical
trials at University Hospitals in Cleveland, Ohio. Further,
an advanced prototype was constructed to be used for
clinical testing, FDA approval, and product develop-
ment. In January 2002, animal studies were performed at
the University of Virginia, resulting in strong evidence
supporting the CTI procedure. Pilot clinical studies are
planned and will be directed by Dr. George Beller, a
leading nuclear cardiologist at the university, as soon as
the additional financing is obtained. For the complete
outline of NeoMed milestones refer to Exhibit 4.
There are numerous challenges that the management
team at NeoMed is facing. First of all, the company se-
riously lacks the financing that is needed to keep the
company solvent and to continue the process of validat-
ing the technology. This requires that clinical studies be
performed, and due to external factors such as the strug-
gling economy and weak venture capital environment,
NeoMed has had a difficult time securing the funds to
conduct these trials. While seemingly close to proving
that their technology will beat the competition, frustra-
tion has been mounting within the ranks of NeoMed,
and Marc and his team have had to constantly keep the
people around them motivated and focused on the long-
term vision of the company. While always maintaining a
belief in their technology, Marc and his colleagues have
been forced to reanalyze their business strategy to deter-
mine the reasons for not getting the financing they need.
NeoMed has also been faced with an ongoing issue of
“how good is good enough,” an issue faced by many
companies in product development situations. While the
NeoMed technology is better than many competing
alternatives, and its accuracy has been proven in animal
studies, the possibility exists that the device can be further
improved to make it easier for technicians to operate,
and thus increase the likelihood of an accurate reading.
The company is faced with two options: (1) keep the
technology as it is and proceed with clinical trials, with
the likelihood of overall trial success, but at a lower de-
gree of accuracy, or (2) take four to five months and the
remaining capital to make improvements in the device,
assuring a better quality product, but assuming the risk
of not having sufficient funds at a later date to validate
the improved technology. While Stan Majewski, the
renowned physicist on the team, suggests that the com-
pany needs to “do it right” and go for the better product,
some members of the team, including the CFO Walt
Bieganski and Marc Umeno himself, see no need to take
higher risks from the capital standpoint if the technology
is already sufficient. Each month of delay is costing
$30,000, and as has been stated before, NeoMed is sim-
ply out of cash. The old saying “perfection is the enemy
of completion” comes to mind.
In addition to the challenges mentioned above, there
are two main contingencies that affect the success of
NeoMed’s diagnostic system: FDA approval and insur-
ance reimbursement.
TABLE 1
Projected Sales Volume
Year 2003 2004 2005 2006 2007
Revenue (millions) $4.7 $22.0 $47.1 $90.6 $182
Gross margin (millions) $1.7 $12.6 $29.2 $58.0 $119
Gross margin % 36% 57% 62% 64% 65%
Net income (millions) ($1.1) $3.6 $8.6 $18.6 $41.0
Net Income % 27% 19% 21% 24% 26%
Centers 4 6 8 10 12
Licenses 21 61 121 242 484
# of Tests—Centers 10,000 21,000 28,000 35,000 50,000
# of Tests—Licensees 29,000 156,000 342,000 700,000 1,415,000
C A S E 11 NEOMED TECHNOLOGIES 533
FDA Approval
NeoMed, as any medical equipment manufacturer and
distributor, faces an FDA approval process. FDA’s Center
for Devices and Radiological Health (CDRH) is respon-
sible for regulating firms who manufacture, repackage,
relabel, and/or import medical devices sold in the United
States. In addition, CDRH regulates radiation-emitting
electronic products (medical and nonmedical) such as
lasers, x-ray systems, ultrasound equipment, and many
household electronic items. Medical devices usually fall
into Class I, II, or III category under FDA classification,
with regulatory control significantly increasing from
Class I to Class III. The device classification regulation
defines the level of regulatory requirements and the stage
of market introduction at which device approval or notifi-
cation becomes necessary. Most Class I devices are ex-
empt from Premarket Notification 510(k); most Class II
devices require Premarket Notification 510(k); and most
Class III devices require Premarket Approval. If the de-
vice requires the submission of a Premarket Notification
510(k), the manufacturer cannot commercially distribute
the device until the “letter of substantial equivalence”
from the FDA is received. This letter states that the device
is substantially equivalent to the device that received au-
thorization to be legally commercialized in the United
States or to the device that has already been determined
by the FDA to be substantially equivalent.
*The costs detailed [here] include allocations of general and administrative expenses.
EXHIBIT 4* Projected Timeline
Q1 2002 Q2 2002 Q3 2002 Q4 2002 Q1 2003 Q2 2003 Q3 2003
Advanced prototype
built
Animal study
completed
Human study
completed
Protocol FDA
binding
Product design
completed
FDA approval
Initial reimbursement
product launch
Full reimbursement
$150K $130K $460K $460K $260K $1.19M $1.95M
Pilot clinical trials Multicenter clinical trials
Description of Milestones for the Timeline Graph:
1. Animal Study. This study will confirm the physiological basis of the NeoMed technology and clinical application.
2. Human Study. 5– to 10–subject human study to further establish the link between coronary vascular blood flow and
the NeoMed exam.
3. Protocol/FDA Binding.
4. Pilot Clinical Trials. A pilot clinical trial involving 80–120 patients is planned to compare the NeoMed technology
with coronary catheterization. Positive results from the clinical trials will be leveraged to assure market adoption of
the NeoMed technology.
5. Product Development. The commercial design and development of the product will be finalized based on feedback
from clinical trials and in-house assessments at NeoMed.
6. FDA Approval.
7. Multicenter Clinical Trials. Multicenter clinical trials are planned involving examination of 400–500 patients to verify
the results from the pilot clinical trial.
8. Product Launch. Establishing operations at targeted hospitals and geographic locations through use of personal
relationships with clinicians involved with the trials.
9. Reimbursement. Widespread reimbursement approval from the Center for Medicare and Medicaid Services and the
private insurance industry as a result of leveraging successful outcomes from the clinical trials.
In addition to the Premarket Notifications, there are
basic regulatory requirements that manufacturers of
medical devices distributed in the U.S. must fulfill, such
as establishment registration, medical device listing, and
labeling requirements, among others. According to FDA
regulations, the NeoMed device falls into the category
of “Class I” devices used for “assessing the risk of car-
diovascular diseases,” but still requires an FDA Premar-
ket Notification [510(k)] before it can be commercially
distributed.
Early in 2002, NeoMed had a meeting with FDA med-
ical officers at the Center for Devices and Radiological
Health (CDRH), at which representatives of the cardi-
ology and nuclear medicine divisions presented rec-
ommendations to NeoMed on several issues that the
company needed to consider for FDA approval. Some of
the topics covered included evidence of CTI efficiency
in diagnosing CAD, explanation of the physiology un-
derlying the CTI procedure using previous clinical data
and animal studies, and estimation of correct patient
population size.
NeoMed was planning to submit an FDA application
by the end of 2002, which would allow the company to
obtain 510(k) approval for its CAD diagnostic probe
system in early 2003, since the approval process typi-
cally takes 3–6 months from the date of submission of
the application. However, given the financial situation
the company is currently facing, it is difficult for Marc
and his team to predict if NeoMed will be able to stick
to its original timeline with an FDA approval process
and submit the application in the next three to four
months.
Insurance Reimbursement
In order to get insurance reimbursement from any com-
pany in the health care field, the given procedure must
receive an approval from the American Medical Associ-
ation (AMA). In the initial stages of this process, most
companies typically hire consultants who help them to
determine whether their procedure falls under one of the
AMA’s reimbursement Current Procedure Terminology
(CPT) codes. If existing codes are identified, the com-
pany files the description of the procedure with the
AMA, along with a Physicians Procedure Report ex-
plaining how the test will be administered. Once the ap-
proval, which typically takes two to three months, is
granted, the procedure can be reimbursed by Medicare
and Medicaid. This is perceived as an important step
in the product commercialization, since it opens up a
likelihood of procedure reimbursement by private insur-
ance companies.
NeoMed is currently in the process of investigating
insurance reimbursement issues and application proce-
dures to prepare the company for the initial CPT code
reviews.
FINANCING
Obtaining adequate financing has been NeoMed’s major
area of concern. Despite the fact that the company has
demonstrated a great commercial opportunity of its nu-
clear diagnostic technology, it is facing the challenges
of balancing technical development with business and
financing objectives of the new venture.
During the initial stages of the fundraising process
that started in early 2001, NeoMed was able to gener-
ate $85,000 in financing through various sources. In
February 2001 the company received a $20,000 grant
from the National Collegiate Inventors and Innovators
Alliance (NCIIA). Since one of the founders, Marc
Umeno, was in the process of completing his graduate
degree at Case Western Reserve University in Cleveland,
the company was able to participate in the Case Western
Reserve University Business Launch Competition in
May of 2001, winning an additional $35,000. Another
$30,000 came from the company’s founders. Using
this capital, NeoMed was able to construct the initial
prototype and begin preclinical tests. However, the
company continued to actively seek additional capital.
The efforts paid off in October of 2001 when NeoMed
was able to secure an additional $200,000 in private
equity, which was used to build an advanced proto-
type, conduct animal studies, and file additional patent
applications.
The next step for the company is to raise further
capital to conduct a human clinical study of 5–10 sub-
jects and develop the clinical protocol for FDA approval.
The founders estimated that they would need around
$130,000. Simultaneously, NeoMed is planning two fu-
ture rounds of equity financing. In the Series A round,
the company will be seeking $2 million to perform clin-
ical testing using the advanced prototype, complete
product development, and obtain FDA approval. In the
Series B round, the company is expecting to obtain
$10 million to begin the development of the commer-
cially applicable device and its market introduction.
This would involve approval of insurance reimburse-
ment from Medicare and Medicaid, as well as private in-
surance companies, and also active product endorsement
534 PA RT 6 CASES
C A S E 11 NEOMED TECHNOLOGIES 535
Sources of Funds
Entrepreneurs $ 85,000
Seed investors 330,000
Series A investors 2,000,000
Total $2,415,000
Application of Funds
Legal/IP/planning $ 135,000
Clinical studies 640,000
FDA approval 570,000
Product development 640,000
Reserve for contingencies 430,000
Total $2,415,000
EXHIBIT 5 Sources and Uses of Funds*
*[This] table . . . summarizes the sources and uses of the Series A plus the pre-
seed and seed investments.
strategies involving the American Heart Association and
American College of Cardiology. Exhibit 5 illustrates
the sources and uses of the Series A plus the preseed and
seed investments. Unfortunately, the venture capital in-
dustry climate and overall financing environment have
affected NeoMed’s ability to obtain financing, in ways
Marc and his partners could not have foreseen when
they started the company less than two years ago.
VENTURE CAPITAL FINANCING
The economic downturn, equity market decline, and in-
creased overall political and national uncertainty in
2002 took its toll on venture capital (VC) investments.
After an unprecedented rise in 2000, VC investment
continued to decline and by the third quarter of 2002,
the VC investment in entrepreneurial firms amounted
to only $4.5 billion invested over 671 companies. In
2002 the total venture capital investment was a modest
$21.2 billion compared to $43.1 billion invested in 2001.
Many believed this downturn was simply a return to
normalcy after the bubble of the late 90s, but either way,
it severely affected the prospects for NeoMed.
Venture Capital Firms
As many expected, venture capital funds experienced a
significant decline in 2002 due to fewer high quality in-
vestment opportunities, lower private company valua-
tions, and increased economic uncertainty. An additional
factor that contributed to the situation was the high level
of capital already committed to venture capital funds,
but not yet invested. Such surplus of investment capital
coupled with the shortage of feasible investment oppor-
tunities created an unprecedented situation in the entire
venture capital industry. As a result, in 2002, 108 venture
funds raised only $6.9 billion, compared to 331 funds in
2001 raising $40.7 billion. The situation did not seem to
be improving. A breakdown of number of funds and
amounts raised in 2002 further illustrates this downward
trend12 (Exhibit 6).
There are several factors that could explain this situ-
ation. First, many large funds were not raising any addi-
tional capital. Instead, they were returning substantial
amounts to the investors who contributed to the funds in
earlier high growth years. Second, as mentioned earlier,
there still existed a large amount of noninvested capital.
It was estimated that, as of the second half of 2002,
there was $80 billion committed capital that had not yet
been invested. This is an indicator of the fact that many
venture capital firms were not raising additional funds,
due to availability of resources to cover the then-current
and near-future investment opportunities, the overall
number of which had also significantly decreased over
the last two years. Third, company valuations dropped
considerably since the downturn in the economy. In ad-
dition, there was a clear shift in investment opportunities
from previous industry sectors, to those more aligned with
the industrial sectors of growing national priority such as
homeland security, military applications, and protection
from various biological and chemical threats. For exam-
ple, in 2002, there were funds in the country that raised
capital exclusively for investments in these areas.
These external factors, coupled with internal oppor-
tunities and threats, forced many venture capital firms
to significantly alter their investment strategies in
2002. Previously, over the last few years, it was a stan-
dard practice to close a fund within a few months,
while by the end of 2002 the process could last as
long as a few quarters. Furthermore, increased budget-
ary constraints, prolonged due diligence, and a will-
ingness to invest only in established firms with a
proven track record, contributed to the changes in the
fundraising process.13
Private Investors
Angel investors are individuals who are willing to invest
in businesses where they can get a higher return than if
investing into traditional ventures. Many of these people
536 PA RT 6 CASES
EXHIBIT 7 Venture Capital Investments by State in 2002 (Number of Deals)
Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association. MoneyTree™ Survey 2002 by State and by Quarter,
http://www.pwcmoneytree.com/moneytree/index.jsp.
AZ
0.83%
Others
4.98% WA
3.79%VA
3.02%UT
0.86% TX
5.65%
PA
2.72%OR
0.93%
OH
1.56%
NY
5.01%
NJ
2.92% NH
1.30% NC
2.92%
MO
1.23% MN
1.83% MI
0.90% MD
3.06% MA
11.19%
IL
2.13%
GA
2.82%
FL
1.76%
CT
1.56%
CO
2.59%
CA
34.44%
EXHIBIT 6 Funds Raised by VC Firms, 2000–2002
5,536 1,761.9
Q1' 00 Q2' 00 Q3' 00 Q4' 00 Q1' 01 Q2' 01 Q3' 01 Q4' 01 Q1' 02 Q2' 02 Q3' 02 Q4' 02
Year
($ i n
m il li o
n s )
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
30,518.3
21,412.7
23,856.9
16,663.3
10,968.1 7,534.3
2,138.9 2,165.4 1,277.7
31,068.8
Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association MoneyTree™ Survey; http://www.pwcmoneytree.com/
moneytree/index.jsp.
C A S E 11 NEOMED TECHNOLOGIES 537
are entrepreneurs themselves, who have started successful
businesses and would like to help other entrepreneurs
succeed. Although, due to the privacy of information, it is
difficult to approximate how much angels invest, it is esti-
mated by the Small Business Administration that there are
about 250,000 angel investors active in the United States,
funding about 30,000 ventures each year with amounts
ranging from $150,000 to $1.5 million. It is estimated
that the total angel investment is anywhere from $20 to
$50 billion a year, compared to the $3 to $5 billion a
year that a formal venture capital community invests. See
Chapter 12 for a description of a typical angel investor.
Most angel investors have clear expectations for the
businesses in which they choose to invest. Although
each investor has his or her own criteria, most of them
expect a board seat or at least a consulting position, and
anywhere from a 5 to 25 percent stake in the business,
an internal rate of return of five times the investment in
a period of five years, and the right of first refusal in the
next round of financing.14
Venture Capital and Private Investors in Ohio
The fact that NeoMed chose to start its business in
Ohio presents the company with certain challenges.
Typically this part of the country has not provided com-
panies with an abundance of financing opportunities.
As Exhibits 7 and 8 indicate, historically, venture capi-
tal investments in Ohio have not represented more than
2 percent of venture capital investments in the country.
The current overall venture capital creates even greater
financing difficulties for companies in Ohio as they are
dealing with a certain level of conservatism of Ohio in-
vestors in addition to the naturally low level of avail-
able funding.
Although, as Exhibit 9 indicates, financing in the
biotechnology arena has been affected less than many
other industries, start-up/seed investments, which were
already low compared to other stages of financing, have
declined greatly, starting in 2000 (Exhibit 10). Ohio was
EXHIBIT 8 Venture Capital Investments by State in 2002 ($ Amount)
CA
44.70%
CO
2.58%CT
1.03%
FL
1.68%
GA
2.77%
IL
1.08%
MA
11.16%
MD
2.95%
MI
0.34%
MO
0.80%
NC
2.58%
NH
1.09%
NJ
2.68%
NY
3.79%
OH
1.04%
OR
0.75%
PA
1.98%
TX
6.06%
UT
0.45% VA
1.93%
WA
2.83%
Others
3.26%
AZ
0.90%
MN
1.54%
Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association. MoneyTree™ Survey 2002 by State and by Quarter, http://www.pwcmoneytree.com/moneytree/index.jsp.
538 PA RT 6 CASES
EXHIBIT 9 Investments by Industry in the 4th Quarter 2002
Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association MoneyTree™ Survey 2002.
Total $ Invested Average $ Per Deal Deals
$4,081,008,000 $5,923,088 689
Industries Defined Amount in $ millions % of Total Deals
Software 869 21 183
Telecommunications 502 12 78
Medical devices and equipment 486 12 57
Biotechnology 474 12 61
Networking and equipment 467 11 47
Semiconductors 243 6 28
IT services 218 5 33
Media and entertainment 142 3 32
Industrial/energy 140 3 37
Computers and peripherals 134 3 26
Health care services 98 2 17
Business products and services 94 2 29
Consumer products and services 68 2 18
Electronics/instrumentation 53 1 11
Financial services 54 1 17
Retailing/distribution 49 1 14
Other 2 0 1
0 200 400 600 800
Other
Retailing/distribution
Financial services
Electronics/instrumentation
Consumer products and services
Business products and services
Health care services
Computers and peripherals
Industrial/energy
Media and entertainment
IT services
Semiconductors
Networking and equipment
Biotechnology
Medical devices and equipment
Telecommunications
Software
100 300 500 700 900
2
49
54
53
68
94
98
134
140
142
218
243
467
474
486
502
869
C A S E 11 NEOMED TECHNOLOGIES 539
not an exception in this respect, with a steady decline in
start-up/seed capital financing over the last two years.
These factors made obtaining financing for NeoMed ex-
tremely difficult. After many months of VC presenta-
tions to various Ohio-based VC firms and follow-up
meetings with discouraging results, NeoMed’s founders
wondered what was keeping them from obtaining capi-
tal. As 2002 progressed, NeoMed was quickly running
out of cash. While the level of frustration and disap-
pointment increased with every venture capital meeting,
Marc and his team wondered if their company would
ever make it to the next important strategic milestone of
clinical trials—a stage that Marc saw as a true chance to
test the technology that he was convinced could save the
lives of many people.
CONCLUSION
Now that the situation is more critical then ever,
NeoMed must re-analyze what steps to take in order to
obtain the desperately needed financing. It is clear to the
team that investors are not yet comfortable with invest-
ing in NeoMed. While every meeting with venture cap-
italists seemed encouraging, the follow-up consisted of
multiple requests to make certain changes to the concept,
product, positioning strategy, or some other aspect of
NeoMed’s business concept. As the team brainstormed
possible strategic solutions, a number of ideas were
brought up, among which were to completely redefine
marketing strategy (pursue other markets and/or seg-
ments); change some aspects of the business model;
obtain additional expertise on the team and the board;
pursue other applications of the core technology; relo-
cate the company to an area with more financing oppor-
tunities; delay operations until the overall environment
becomes more favorable; or finally quit and move on to
something else. Marc and his colleagues obviously op-
posed the last option, but without any injection of new
capital, NeoMed might be left with no other alternative
if drastic measures are not taken soon.
E N D N O T E S
1. Coronary artery disease.
2. Heart Disease and Stroke Statistics—2003 Update,
American Heart Association.
3. www.nicore.com/economicfacts.htm.
4. Includes heart attack, angina pectoris (chest pain),
or both.
EXHIBIT 10 PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association MoneyTree™ Survey
Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association MoneyTree™ Survey 2002.
Start-Up/Seed Stage Early Stage Expansion Stage Later Stage
Year–Qtr ($ in millions) Deals ($ in millions) Deals ($ in millions) Deals ($ in millions) Deals
1995–1 20,418,000 2 10,349,000 5 8,841,000 5 300,000 1
1995–2 1,491,000 2 7,076,000 5 6,525,000 4 1,266,000 1
1995–3 147,000 1 3,886,000 2 2,300,000 1 0 1
1996–1 6,157,000 3 5,206,000 3 3,173,000 5 750,000 1
1996–2 10,262,000 6 3,250,000 2 6,193,000 3 6,000,000 1
1997–1 2,514,000 2 8,953,000 1 11,846,000 5 18,953,000 2
1997–2 6,395,000 3 22,103,000 2 53,250,000 6 10,900,000 2
1997–4 15,000,000 1 12,132,000 5 22,719,000 9 200,000 1
1998–1 4,550,000 3 11,500,000 1 50,223,000 17 3,700,000 3
1998–2 6,500,000 2 26,700,000 5 21,891,000 7 3,282,000 3
1998–3 3,750,000 2 46,724,000 3 63,815,000 6 1,299,000 1
1999–2 3,825,000 2 27,125,000 5 13,374,000 6 6,500,000 1
2000–2 1,000,000 1 20,532,000 6 231,637,000 15 2,700,000 1
2002–3 3,000,000 1 11,500,000 3 7,300,000 4 365,000 1
540 PA RT 6 CASES
5. Myocardial infarction (heart attack).
6. Heart Disease and Stroke Statistics—2003 Update,
American Heart Association.
7. http://imaginis.com/heart-disease/cad_
screen.asp?mode51.
8. John G. Webster, Medical Instrumentation:
Application and Design, 3rd edition,
pp. 555–561.
9. “Clinical Exercise Stress Testing—Safety and
Performance Guidelines,” MJA The Cardiac
Society of Australia and New Zealand,
164 (1996), pp. 282–84.
10. Robert Roos, “Noninvasive Detection of Coronary
Artery Disease. Can the New Imaging Techniques
Help?” The Physician and Sportsmedicine,
vol. 28, no. 1, January 2000.
11. 1998 Socioeconomic Monitoring System survey
of nonfederal patient care physicians; cited in
“Overview of the Physician Market,” American
Medical Association.
12. National Venture Capital Association, February 10,
2003.
13. Ibid.
14. “Angel Investors,” Small Business Notes,
www.smallbusinessnotes.com/financing/.
C A S E 1 2
RUG BUG CORPORATION
A. L. Young has come a long way with his latest inven-
tion, the Rug Bug, a motorized wheelchair made espe-
cially for children. His lightweight, relatively inexpen-
sive model has no direct competition in a field dominated
by companies that produce scaled-down versions of
adult models that are inappropriate to the needs of chil-
dren. A working prototype has been built, office space
and manufacturing capacity contracted, and an initial
sales force recruited. The only element Young lacks is
enough capital to produce the first 200 units. A business
plan has been drawn up describing the product, its man-
ufacture, and the marketing plan. After several fruitless
months seeking financing, Young was contacted by a
group of investors who had seen a summary of his pro-
posal. Feeling that this might be his only chance, Young
has contacted you for advice on how to present his plan.
He has sent you the following copy of his business plan
and a list of questions. What recommendations would
you make?
Young’s questions:
1. I’m not much of a writer: Do you think my descrip-
tions of the product, competition, marketing, and
so forth, are adequate? Could it be improved easily
without additional outside information (my meeting
is in two days!)?
2. The pro forma income and cash flow statements
were developed from a model I found in a book.
Did I leave anything out?
3. I think $150,000 is a good amount to ask for—big
enough to show we are serious about creating a
growing business but not large enough to scare them
away. Are they going to want to know what I plan to
do with every penny? What should I do if they are
only willing to invest less?
4. I really don’t know what to expect from these in-
vestors. I have my own idea of how much of the
company I want to give up for the $150,000, but I
don’t know what they would consider reasonable.
Can you give me any suggestions?
Mr. and Mrs. A. L. Young established the Rug Bug
Corporation as a Delaware corporation. The sole pur-
pose is to manufacture and distribute a revolutionary
motorized wheelchair, designed for children under the
age of 10. The Rug Bug motorized wheelchair will re-
tail for approximately one-half the cost of any other
motorized wheelchair for this age group. It will weigh
almost 50 percent less than the standard motorized
wheelchair. The unique design of the Rug Bug ac-
counts for the differences in the retail cost and weight
of the chair. In addition, the Rug Bug has numerous
safety features that are not found on other available
motorized wheelchairs. These three features of cost,
weight, and safety allow the Rug Bug to fill a special
niche in the market. It is an appropriate time to intro-
duce this product in light of the current trend in the
medical field to recommend the use of motorized wheel-
chairs for children. This recommendation of medical
professionals arises from their determination that the
spatial relations and sense of movement offered by a
motorized chair provide a handicapped child with sen-
sory experiences normal for young children. The target
market for this product will be greatly increased due to
this philosophical change. In order to establish the com-
pany, the Rug Bug Corporation will need $150,000.
This will finance the production of the molds for various
parts, the manufacture of 200 units (of which 190 will
be sold), and initial marketing efforts. In addition, the
company will use the funds for product liability insur-
ance, legal fees, and continued research and development.
C A S E 12 RUG BUG CORPORATION 541
DESCRIPTION OF THE BUSINESS
The Rug Bug Corporation is primarily a manufactur-
ing and distribution company in the start-up phase of
operation. The inventor’s initial research led to the de-
velopment of a prototype. Marketing research shows
the Rug Bug to be the only vacuum-molded, plastic,
motorized wheelchair with unique safety features cur-
rently available. The owners of the Rug Bug Corpora-
tion believe the company will be successful because of
low production costs, reasonable retail costs, safety
factors, low weight, and visual appeal. The use of mo-
torized chairs by the target age group has been limited
primarily for two reasons. First, the current cost of mo-
torized wheelchairs ranges from $3,000 to $20,000. It
has been difficult to justify such an investment for a
chair since a child’s growth is typically rapid, therefore
limiting the time the chair can be utilized. The Rug
Bug will retail for $1,850. This is a significant price
differential, especially for a chair that offers additional
features such as safety control. The second limitation
was the medical community’s view that muscle use
was of primary concern in a handicapped child’s de-
velopment. They have recently shifted away from that
stance, with many professionals now emphasizing the
development of spatial skills, spatial relations, and
sense of movement—all areas that the motorized chair
can help strengthen.
DESCRIPTION OF THE PRODUCT
The Rug Bug is a vacuum-molded, plastic-body wheel-
chair powered by a rechargeable battery. The 25-pound
chair has the following safety features as standard
equipment:
1. A pressure-sensitive bumper strip surrounding the
vehicle allows the unit to move away from any
obstruction it might encounter.
2. Dual front antennae extend upward to prevent the
chair from moving under low objects, such as a
coffee table.
3. In the case of a confrontation with an uneven surface,
an electric eye located under the front of the chair will
deactivate power in that direction. The power remains
operative in other directions, allowing the occupant to
move away from the potential hazard.
4. A handheld remote control unit enables an adult to
take over control of the chair from the occupant.
5. A variable speed control is built into the unit which
is beyond reach of the occupant. As the ability of
the occupant to maneuver the chair increases, so
may the speed.
6. Though built with a very low center of gravity, the
chair is designed with a roll bar.
The computerized control panel defines the Rug
Bug as a technical machine; however, in appearance,
the Rug Bug is more similar to a currently popular
battery-operated riding toy. The visual appeal immedi-
ately distinguishes the Rug Bug from any other motor-
ized wheelchair on the market today.
MARKETING COMPONENT
1. Market and competition. According to The New York
Times, the U.S. market for home medical equipment
has exceeded $2.5 billion in the late nineties, growing
at a rate of about 10 percent per year. Wheelchairs
account for 38 percent of the market (The Wheeled
Mobility Market Report). According to the Medical
and Healthcare Marketplace Guide, worldwide
wheelchair revenue exceeded $1 billion in 1995.
U.S. market accounts for roughly half of these sales.
The wheelchair market is composed of standard,
lightweight, ultralight, powered, and scooter seg-
ments. There are approximately 1.3 million wheel-
chair users in the United States, and the number is
increasing at a rate of 3 percent per year (Medical
and Healthcare Marketplace Guide). Motorized
and ultralight wheelchairs are the most dynamic
segment of the market of mobility aids.
According to the U.S. Census Bureau, there are
more than 4.5 million children under the age of
15 with disabilities in this country. In the 6–14 age
group alone there are more than 70,000 children
who use wheelchairs. This figure does not reflect
any other potential users in this age bracket, such
as the muscular dystrophy population.
The market has changed significantly for the last
two decades. Specific federal regulations and the in-
troduction of para-Olympics have focused attention
on the improvements in wheelchairs and the needs
of disabled people. Other market trends include the
use of two or more wheelchairs by patients, and a
steady demand for new designs, interest in a range
of colors and styles to choose from, and design
improvements based on new materials (Medical
and Healthcare Marketplace Guide).
There are several major players in the wheeled
mobility market. A dominant participant is Sunrise.
Others include Orthokinetics, Everest & Jennings,
Guardian, Theradyne, and Invacare. Sunrise has pio-
neered a new marketing strategy reaching customers
directly. Competitive dimensions include new tech-
nologies, use of new materials, wheelchair weight,
and maneuverability parameters. The current level
of prices for motorized wheelchairs is in the range
from $3,000 to $20,000 per unit with an average
weight of about 20–30 pounds.
2. Distribution. Since there are distinct and different
methods for purchasing wheelchairs, Rug Bug will
establish two different distribution systems. A direct
system, initially employing individuals connected
with the company, will call on hospitals, the Veter-
ans Administration, Shriners, and other organiza-
tions connected with the care and development of
handicapped children. Of the initial 200 products,
190 will be sold in these outlets in order to generate
sales without paying retail markups. This will also
give the product good exposure. Manufacturers’ rep-
resentatives will make direct sales for subsequent
production runs. A 15 percent commission on the
selling price will be paid on all direct sales. After
the initial 190 units have been sold (with 10 units
being kept for demonstration purposes), the com-
pany will add a retail distribution system. Several
retail outlets will be used in each of the major mar-
kets, including drugstores, bicycle shops, and medical
supply stores. Drugstores account for a significant
share of wheelchair sales and are an important out-
let for the company. Bicycle shops, while not usu-
ally a source for the purchase of wheelchairs, are an
important outlet, as they will provide any service
needed in addition to sales. Company-authorized
service outlets will be established in each market
for ease of repair, an aspect the consumer should
appreciate. Retail margins will be 30 percent off
the established retail selling price of $1,850.
3. Price. The company will sell the product to the re-
tailer for $1,295; the retailer will mark up the prod-
uct 30 percent, resulting in a selling price of $1,850
for the wheelchair. This price will position the prod-
uct favorably against competition and allow for sig-
nificant growth in market share as well as profit.
4. Promotion. Quality brochures describing the prod-
uct and its characteristics will be developed and dis-
tributed as point-of-purchase sale materials in the
retail outlets as well as in all hospitals, clinics, and
other organizations working with handicapped chil-
dren. In addition, sales material, including a price
list indicating markups and return per square foot of
selling space required, will be developed for use in
the company’s direct sales effort.
LOCATION OF THE BUSINESS
The office section of the Rug Bug will be located at Barn
Bicycle on East 61st Street, Tulsa, Oklahoma. The molded
plastic body will be manufactured, and the product assem-
bled, at the Inter-Ocean Oil Company, located at 2630
Mohawk Boulevard, Tulsa, Oklahoma. The Rug Bug Cor-
poration will not be charged for usage of either facility,
although it will pay for utilities and telephones at both.
MANAGEMENT/OPERATIONS
Inventor Al Young will serve as the president of Rug
Bug Corporation. In addition, Young will concentrate
on the research and development section of operations.
Mr. Young’s past experience with electronics and com-
puters fits well with the needs of the company. His abil-
ity to transform a concept into a viable product is shown
through the prototype that Rug Bug currently has in
existence.
Wayne Dunn and Dwaine Farrill will continue to op-
erate in the marketing component of the company. Their
extensive knowledge of and profound belief in the prod-
uct make both Dunn and Farrill ideal people to initially
market it on a commissioned basis.
Linda Bryant will initially serve as the unpaid con-
troller of the company. Ms. Bryant will serve as single
signatory on the banking account and prepare and mon-
itor monthly financial reports. She has served as a cash
management officer at The Fourth National Bank of
Tulsa for over two years and is currently its director of
business development.
FINANCIAL INFORMATION
To ramp up, the Rug Bug Corporation needs $150,000.
The funds will be used to develop the molds for various
parts, manufacture 200 units (of which 190 will be
sold), start the initial marketing effort, and pay em-
ployee salaries, product liability insurance, legal fees,
and other expenses of the organization (see Exhibit 1).
The company will achieve significant sales and profits
starting in the first year, as indicated in the various pro
forma income statements (see Exhibits 1 to 3). The pro
forma income cash flow statements (Exhibits 4 to 6) and
balance sheets (Exhibits 7 to 9) further indicate the
tremendous growth and profit potential.
542 PA RT 6 CASES
543
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544 PA RT 6 CASES544 PA RT 6 CASES
EXHIBIT 2
THE RUG BUG CORPORATION
Pro Forma Income Statement
Second Year, by Quarter
Qtr 1 Qtr 2 Qtr 3 Qtr 4 Total
Sales—Direct $555,000 $1,110,000 $2,220,000 $3,330,000 $7,215,000
Sales—Retail 194,250 388,500 582,750 777,000 1,942,500
Total sales $749,250 $1,498,500 $2,802,750 $4,107,000 $9,157,500
Less: Cost of goods sold—Direct 130,800 261,600 523,200 784,800 1,700,400
Cost of goods sold—Retail 65,400 130,800 196,200 261,600 654,000
Commission—Direct 83,250 166,500 333,000 499,500 1,082,250
Commission—Retail 29,138 58,275 87,413 116,550 291,375
Gross profit $440,663 $ 881,325 $1,662,938 $2,444,550 $5,429,475
Operating expenses
President salary $ 7,200 $ 7,200 $ 7,200 $ 7,200 $ 28,800
Secretary salary 3,500 3,500 3,500 3,500 14,000
VP—Finance salary 12,500 12,500 25,000
Employee insurance 125 125 125 125 500
Product liability insurance 7,493 14,985 28,028 41,070 91,575
Research and development 37,463 74,925 140,138 205,350 457,875
Advertising/printing 2,500 2,500 2,500 2,500 10,000
Travel expenses 1,875 1,875 1,875 1,875 7,500
Accounting services 2,500 2,500 2,500 2,500 10,000
Depreciation—Computer system 250 250 250 250 1,000
Bad debt expense 5,828 11,655 17,483 23,310 58,275
Total operating expenses $ 68,733 $ 119,515 $ 216,098 $ 300,180 $ 704,525
Profit (loss) before tax 371,930 761,810 1,446,840 2,144,370 4,724,950
Taxes 148,772 304,724 578,736 857,748 1,889,980
Net profit (loss) $223,158 $ 457,086 $ 868,104 $1,286,622 $2,834,970
Quantity sold—Direct 300 600 1,200 1,800 3,900
Quantity sold—Retail 150 300 450 600 1,500
Price—Direct 1,850 1,850 1,850 1,850
Price—Retail 1,295 1,295 1,295 1,295
Manufacturing cost 436 436 436 436
Commission percent 15 15 15 15
Tax rate 40 40 40 40
(1) Product liability insurance 1% of sales, R D 5% of sales.
(2) Computer system depreciated at straight line over a 5-year life with no salvage value.
(3) Bad debt expense provision at 3% of retail sales.
(4) Taxes (federal and state) provided at 40%.
C A S E 12 RUG BUG CORPORATION 545
EXHIBIT 3
THE RUG BUG CORPORATION
Pro Forma Income Statement
Third Year, by Quarter
2006/2007
Qtr 1 Qtr 2 Qtr 3 Qtr 4 Total
Sales—Direct $3,700,000 $5,550,000 $ 7,400,000 $ 9,250,000 $25,900,000
Sales—Retail 1,554,000 2,331,000 3,108,000 3,885,000 10,878,000
Total sales $5,254,000 $7,881,000 $10,508,000 $13,135,000 $36,778,000
Less
Cost of goods sold—Direct $ 872,000 $1,308,000 $ 1,744,000 $ 2,180,000 $ 6,104,000
Cost of goods sold—Retail 523,200 784,800 1,046,400 1,308,000 3,662,400
Commission—Direct 555,000 832,500 1,110,000 1,387,500 3,885,000
Commission—Retail 233,100 349,650 466,200 582,750 1,631,700
Gross profit $3,070,700 $4,606,050 $ 6,141,400 $ 7,676,750 $21,494,900
Operating expenses
President salary $ 8,640 $ 8,640 $ 8,640 $ 8,640 $ 34,560
Secretary salary 3,500 3,500 3,500 3,500 14,000
VP—Finance salary 15,000 15,000 15,000 15,000 60,000
Employee insurance 125 125 125 125 500
Product liability insurance 52,540 78,810 105,080 131,350 367,780
Research and development 262,700 394,050 525,400 656,750 1,838,900
Advertising/printing 3,125 3,125 3,125 3,125 12,500
Travel expenses 1,875 1,875 1,875 1,875 7,500
Accounting services 2,500 2,500 2,500 2,500 10,000
Depreciation—Computer system 250 250 250 250 1,000
Bad debt expense 46,620 69,930 93,240 116,550 326,340
Total operating expenses $ 386,875 $ 577,805 $ 758,735 $ 939,665 $ 2,673,080
Profit (loss) before tax 2,673,825 4,023,245 5,382,665 6,737,085 18,821,820
Taxes 1,069,530 1,611,298 2,153,066 2,694,834 7,528,728
Net profit (loss) $1,604,295 $2,416,447 $ 3,229,599 $ 4,042,251 $11,243,042
Quantity sold—Direct 2,000 3,000 4,000 5,000 14,000
Quantity sold—Retail 1,200 1,800 2,400 3,000 8,400
Price—Direct 1,850 1,850 1,850 1,850
Price—Retail 1,295 1,295 1,295 1,295
Manufacturing cost 436 436 436 436
Discount percent 30 30 30 30
Commission percent 15 15 15 15
Tax rate 40 40 40 40
546
E X
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EXHIBIT 5
THE RUG BUG CORPORATION
Pro Forma Cash Flow Statement
Second Year, by Quarter
2005/2006
Qtr 1 Qtr 2 Qtr 3 Qtr 4 Total
Cash receipts
Sales $674,325 $1,423,575 $2,672,325 $3,976,575 $8,746,800
Others
Total cash receipts $674,325 $1,423,575 $2,672,325 $3,976,575 $8,746,800
Cash disbursements
Salaries
President $ 7,200 $ 7,200 $ 7,200 $ 7,200 $ 28,800
Secretary 3,500 3,500 3,500 3,500 14,000
VP—Finance 0 0 12,500 12,500 25,000
Employee insurance 125 125 125 125 500
Product liability insurance 91,575 91,575
Research and development 37,463 74,925 140,138 205,350 457,875
Advertising 2,500 2,500 2,500 2,500 10,000
Travel expenses 1,875 1,875 1,875 1,875 7,500
Accounting services 2,500 2,500 2,500 2,500 10,000
Commissions 101,149 213,536 400,849 596,486 1,312,020
Inventory 327,000 610,400 937,400 1,308,000 3,182,800
Taxes 122,040 122,040
Computer system 5,000 5,000
Total cash disbursements $701,927 $ 916,561 $1,508,586 $2,140,036 $5,267,110
Net cash flow (27,602) 507,014 1,163,739 1,836,539 3,479,690
Cumulative cash flow (27,602) 479,412 1,643,151 3,479,690
Units produced 750 1,400 2,150 3,000 7,300
Unit cost $436 $436 $436 $436
C A S E 12 RUG BUG CORPORATION 547
548
EXHIBIT 6
THE RUG BUG CORPORATION
Pro Forma Cash Flow Statement
Third Year, by Quarter
Qtr 1 Qtr 2 Qtr 3 Qtr 4 Total
Cash receipts
Sales $5,170,442 $7,618,300 $10,245,300 $12,872,300 $35,906,342
Others
Total cash receipts $5,170,442 $7,618,300 $10,245,300 $12,872,300 $35,906,342
Cash disbursements
Salaries
President $ 8,640 $ 8,640 $ 8,640 $ 8,640 $ 34,560
Secretary 3,500 3,500 3,500 3,500 14,000
VP—Finance 15,000 15,000 15,000 15,000 60,000
Employee insurance 125 125 125 125 500
Product liability insurance 52,540 78,810 105,080 131,350 367,780
Research and development 262,700 394,050 525,400 656,750 1,838,900
Advertising 2,500 2,500 2,500 2,500 10,000
Travel expenses 1,875 1,875 1,875 1,875 7,500
Accounting services 2,500 2,500 2,500 2,500 10,000
Commissions 775,566 1,142,745 1,536,795 1,930,845 5,385,951
Inventory 1,831,200 2,528,800 3,313,600 3,749,600 11,423,200
Taxes 1,917,690 1,917,690
Total cash disbursements $4,873,836 $4,178,545 $ 5,515,015 $ 6,502,685 $21,070,081
Net cash flow 296,605 3,439,755 4,730,285 6,369,615 14,836,260
Cumulative cash flow 296,605 3,736,360 8,466,645 14,836,260
Units produced 4,200 5,800 7,600 8,600 26,200
Unit cost $436 $436 $436 $436
EXHIBIT 7
THE RUG BUG CORPORATION
Pro Forma Balance Sheet
As of End of Year 1
Cash $171,261
Inventory 135,225
Accounts receivable 0
Total assets $306,486
Commissions payable 0
Taxes payable 122,040
Retained earnings 34,445
Common stock 150,000
$306,486
C A S E 12 RUG BUG CORPORATION 549
EXHIBIT 9
THE RUG BUG CORPORATION
Pro Forma Balance Sheet
As of End of Year 3
Cash $11,495,496
Computer 3,000
Inventory 1,541,938
Accounts receivable 1,259,000
Total assets $14,299,434
Commissions payable 188,850
Taxes payable 7,663,664
Retained earnings 6,485,770
Contributed capital 150,000
$14,299,434
EXHIBIT 8
THE RUG BUG CORPORATION
Pro Forma Balance Sheet
As of End of Year 2
Cash $2,876,535
Computer system 4,000
Inventory 1,017,145
Accounts receivable 259,000
Total assets $4,156,680
Commissions payable 38,850
Taxes payable 1,917,690
Retained earnings 2,088,990
Common stock 150,000
$4,156,680
C A S E 1 3
NATURE BROS. LTD.
BACKGROUND
Thanksgiving Day 1993 is the day that Dale Morris re-
members as the “public debut” of his creation, a new
seasoned salt mix. Although he was a salesman by tem-
perament and career, his hobby was cooking. Having
experimented with both traditional home cooking and
more exotic gourmet cooking, Morris had developed an
appreciation for many herbs and spices. He had also
done a lot of reading about the health hazards of the typ-
ical American diet. When his mother learned that she
had high blood pressure, Morris decided it was time for
some action. He created a low-salt seasoning mix, based
on a nutritive yeast extract, that could be used to replace
salt in most cases. This Thanksgiving dinner, prepared
for 25 family members and friends, would be his final
testing ground. He used his mix in all the recipes except
the pumpkin pie—everything from the turkey and dress-
ing to the vegetables and even the rolls. As the meal pro-
gressed, the verdict was unanimously in favor of his secret
ingredient, although he had a hard time convincing them
that it was his invention and was only 10 percent salt.
Everyone wanted a sample to try at home.
Over the next two years, Morris perfected his prod-
uct. Experiments in new uses led to “tasting parties” for
friends and neighbors, and the holiday season found the
Morris kitchen transformed into a miniature assembly line
producing gift-wrapped bottles of the mix. Morris became
something of a celebrity in his small town, but it wasn’t
until the Ladies’ Mission Society at his church approached
him with the idea of allowing them to sell his mix as a
fund-raiser that he realized the possibilities of his creation.
His kitchen-scale operation could support the sales effort
of the church women for a short time, but if he wanted to
take advantage of a truly marketable product, he would
have to make other arrangements.
Morris agreed to “test-market” his product through
the church group while he looked for ways to expand
and commercialize his operation. The charity sale was
a huge success (the best the women had ever experi-
enced), and, based on this success, Morris moved to cre-
ate his own company. Naming his product “Nature Bros.
Old Fashioned Seasoning,” he incorporated the com-
pany in 1995 as Nature Bros. Ltd. Morris used most of
his savings to develop and register the trademarks, for
packaging, and for product displays. He researched the
cost of manufacturing and bottling his product in large
quantities and concluded that he just didn’t have the
cash to get started. His first attempts to raise money, in
the form of a personal bank loan, were unsuccessful,
and he was forced to abandon the project.
For several years he concentrated on his career, be-
coming a regional vice president of the insurance com-
pany he worked for. He continued to make “Nature Bros.
Seasoning” in small batches, mainly for his mother and
business associates. These users eventually enabled
Morris to get financial support for his company. To raise
$65,000 to lease manufacturing equipment and building
space, he sold stock to his mother and to two other re-
gional vice presidents of the insurance company. For
their contributions, each became the owner of 15 per-
cent of Nature Bros. Ltd. The process of getting the
product to the retail market began in August 2002, and
the first grocery store sales started in March 2003. The
initial marketing plan was fairly simple—to get the
product in the hands of the consumer. Morris personally
visited the managers of individual supermarkets, both
chains and independents, and convinced many to allow
a tasting demonstration booth to be set up in their stores.
These demonstrations proved as popular as the first
Thanksgiving dinner trial nearly 10 years earlier. Dale
Morris’s product was a hit, and in a short time he was
able to contract with food brokerage firms to place his
product in stores in a 10-state region.
PRESENT SITUATION
As indicated in the balance sheet (see Exhibit 1), more
capital is needed to support the current markets and
expand both markets and products. Two new products
are being developed: a salt-free version of the original
product and an MSG-based flavor enhancer that will
compete with Accent. Morris worked with a business
consultant in drawing up a business plan to describe his
company, its future growth, and its capital needs.
550 PA RT 6 CASES550 PA RT 6 CASES
Source: This case was modified by Sergey Anokhin of the Weather- head School of Management, Case Western Reserve University, as a basis for classroom discussion rather than to illustrate either effective or ineffective handling of an administrative situation. The name of the company and the names of its officers have been disguised. Sup- port for the development of this case was provided by the Centre for International Business Studies, University of Manitoba, Canada.
*Market size estimates are based on two decades of average growth rate for the human nutrition salt market, with some corrections to reflect the growing share of salt substitutes in total consumption of salt-like substances.
551
EXHIBIT 1
NATURE BROS. LTD.
Balance Sheet
As of September 30, 2003
Unaudited Current assets
110 Cash—American Bank $ 527.11 112 Cash—Bank of Okla-Pryor 31.86 115 Cash on hand 24.95 120 Accounts receivable 21,512.75 125 Employee advances 327.37 140 Inventory—Shipping 940.43 141 Inventory—Raw materials 1,082.29 142 Inventory—Work-in-progress 803.70 143 Inventory—Packaging 4,548.41 144 Inventory—Promotional 2,114.95
Total current assets $31,913.82
Fixed assets 160 Leasehold improvements $ 2,402.25 165 Fixtures and furniture 1,222.46 167 Equipment 18,768.21 169 Office equipment .00 170 1986 Lincoln Town Car 15,000.00 180 Less: Accumulated depreciation (7,800.01) 181 Less: Amortization (502.50)
Total fixed assets $29,090.41
Other assets 193 Organizational cost $ 4,083.36 194 Prepaid interest 2,849.69 195 Utility deposits .00
Total fixed and other assets $36,023.46
Total assets $67,937.28
Current liabilities 205 Accounts payable $15,239.41 210 Note payable-premium finances 88.26 220 Federal tax withheld 150.00 225 FICA tax withheld 937.92 230 State tax withheld 266.49 231 State and federal employment taxes 230.92
Total current liabilities $16,913.00
Long-term liabilities 245 Note payable—All fill $ 2,734.86 246 Note payable—American Bank 23,740.00 247 Note payable—Sikeston Leasing 15,126.66
Total long-term liabilities $41,601.52
Total liabilities $58,514.52
Capital account
290 Original capital stock $ 1,000.00 291 Additional paid-in capital 41,580.00 292 Treasury stock (70.00) 295 Retained earnings (3,819.71) 298 Net profit or loss (29,267.53)
Total owner’s equity account $ 9,422.76
Total liabilities and equity $67,937.28
552 PA RT 6 CASES
OVERALL PROJECTIONS
The first section discusses the objectives and sales
projections for 2004 and 2005 (Exhibits 2 and 3). The
resulting pro forma income statements for 2004 to 2005
are in Exhibits 4 and 5.
2004 OBJECTIVES
The company’s objectives for 2004 are to stabilize its
existing markets and to achieve a 5 percent market share
in the category of seasoned salt, a 10 percent market
share in salt substitutes, and a 5 percent market share in
MSG products. Although the original product contains
less than 10 percent salt, the company has developed a
salt-free product to compete with other such products,
such as the one shown in the advertisement in Exhibit 6.
The dollar volume for the seasoned salt category in
the seven markets the company is in will amount to
$7,931,889 in 2004. In 2003, sales of the company in
the Oklahoma market were 5.5 percent of the total
sales for that market for the eight-month period that the
company was operational. Since these sales were accom-
plished with absolutely no advertising, the company can
be even more successful in the future in all seven current
markets with a fully developed and funded advertising
campaign. The marketing approach will include advertise-
ments in the print media, with ads on “food day” offer-
ing cents-off coupons. This program will take place in
all seven markets, while stores will continue to use floor
displays for demonstrations. Nearly 100 percent ware-
house penetration should be achieved in 2004 in these
markets.
The goal for the category of salt substitutes for 2004
is 10 percent of the market share. This larger market
share can be achieved since there are only a few com-
petitors, Mrs. Dash, AMBI Inc. with Cordia Salt Alter-
native, and RCN with No Salt. The company’s product
is superior in all respects and has a retail price advan-
tage of 10 to 20 cents per can. In addition, the com-
pany’s product is much more versatile than competitors’
products. Aggressive marketing and advertising will em-
phasize the tremendous versatility of usage as well as the
great taste and health benefits of the product. The informal
consumer surveys at demonstrations indicated that con-
sumers prefer Nature Bros. to competitors’ products by a
wide margin.
552 PA RT 6 CASES
EXHIBIT 2 2004 Sales Projection
Category Seasoned Salt Salt Substitute MSG
Old Salt-Free
Fashioned Old Fashioned
Our Product Seasoning Seasoning Enhance
Existing markets #1
Oklahoma $1,101,844 $ 715,638 $ 237,778
Nebraska 799,260 605,538 201,916
Springfield, MO 508,620 385,432 128,034
Arkansas 435,960 330,294 109,742
Houston 1,671,180 1,266,128 420,684
Dallas 2,325,120 1,761,570 585,298
Albuquerque 1,089,900 825,736 274,358
$7,931,884 $5,890,246 $1,957,090
Market share (%) ⫻5% ⫻10% ⫻5%
1st year sales $ 396,594 $ 589,024 $ 97,854
396,594
589,024
97,854
Total 1st year sales volume $1,083,472
C A S E 13 NATURE BROS. LTD. 553
A new product, which is already developed, will be
added during this time. Called “Enhance,” it too is a dry-
mixed, noncooked, low-overhead, high-profit food prod-
uct. Its category of MSG products has a dollar volume of
$1,957,090 in these markets. This category includes only
one main competitor, Accent, made by Pet Inc. Accent
has not been heavily advertised, and it is a one-line prod-
uct with little initial name recognition. The company’s
new product will have a 10- to 20-cent per can retail price
advantage to help achieve a 5 percent share of this cate-
gory. In summary, 2004 will be spent solidifying the
company’s present market positions.
EXHIBIT 3 2005 Sales Projection
Category Seasoned Salt Salt Substitute MSG
Old Salt-Free
Fashioned Old Fashioned
Our Product Seasoning Seasoning Enhance
Existing markets #1
Oklahoma $ 1,156,936 $ 751,418 $ 249,778
Nebraska 978,946 635,816 211,350
Springfield, MO 622,966 404,610 134,496
Arkansas 533,970 346,808 115,282
Houston 2,046,886 1,329,432 441,914
Dallas 2,847,842 1,885,644 614,838
Albuquerque 1,334,926 867,020 288,206
Existing markets total $ 9,522,472 $ 6,220,748 $2,055,864
Market share ⫻7.5% ⫻12.5% ⫻7.5%
Existing markets $ volume $ 714,185 $ 775,593 $ 154,189
New markets:
Los Angeles $ 5,784,678 $ 3,757,088 $1,248,888
Phoenix 1,245,930 809,218 268,990
Portland 1,157,294 751,418 249,776
Sacramento 1,690,906 1,098,226 365,060
Salt Lake City 1,157,294 751,416 249,776
San Francisco 2,313,870 1,502,838 499,554
Seattle 1,157,294 751,416 249,776
Spokane 711,960 462,412 153,708
New markets total $15,218,886 $10,064,028 $3,285,528
Market share ⫻5% ⫻10% ⫻5%
New markets $ volume $760,943 $ 1,006,420 $164,276
New markets $ total 760,943 1,006,420 164,276
Existing markets $ total ⫹ 714,185 777,593 154,189
Total volume $ 1,475,128 $ 1,784,013 $ 318,465
Old Fashioned Seasoning sales $1,475,128
Salt-Free Old Fashioned Seasoning sales 1,784,013
Enhance sales (a new product) 318,465
Total 2005 sales $3,557,606
554 PA RT 6 CASES
2005 OBJECTIVES
The company intends to open eight new markets in 2005
that include Los Angeles, Phoenix, Portland, Sacramento,
Salt Lake City, San Francisco, Seattle, and Spokane.
These new markets make up 17.1 percent of grocery store
sales, according to the Progressive Grocer’s Market-
ing Guidebook, the industry standard. In the category
of seasoned salt, these markets have a dollar volume of
$15,218,886 a year. Salt substitutes sell at a volume of
$10,064,028, and the MSG category $3,285,528. With
554 PA RT 6 CASES
EXHIBIT 4 2004 Pro Forma Totals
2004 Percent
Sales $1,083,472 100
Cost of goods
Packaging 129,444 11.9
Ingredients 175,668 16.2
Plant labor 35,580 3.2
Freight in 24,036 2.2
Shipping materials 924 .08
Total cost of goods sold $ 365,004 33.68
Gross profit 718,468 66.31
Operating expenses
President’s salary 43,200
Sales manager 30,000
Secretary 14,400
Employee benefits 2,400
Insurance 1,992
Rent 3,000
Utilities 1,800
Phone 7,200
Office supplies 1,200
Postage 1,200
Car lease 5,640
Professional services 3,000
Travel and entertainment 24,000
Freight out 59,088 5.4
Advertising 216,684 20.0
Promotion 12,036 1.1
Brokerage 54,168 5.0
Incentives 7,500 .6
Cash discounts 21,660 2.0
Total expenses $ 510,168 47.0
Cash flow
Taxes 207,648 19.1
Net profit before debt service 155,736 14.3
C A S E 13 NATURE BROS. LTD. 555
EXHIBIT 5
NATURE BROS. LTD.
Pro Forma Income Statement
2005–2008
2005 2006 2007 2008
Sales $3,557,606 $6,136,224 $10,089,863 $18,506,302
Cost of goods Packaging 423,355 730,210 1,200,693 2,202,249 Ingredients 572,774 987,932 1,624,467 2,979,514 Plant labor 37,359 48,826 60,867 63,910 Freight in 72,930 125,793 206,842 379,379 Shipping materials 2,960 4,908 8,071 14,805
Total cost of goods sold $1,106,575 $1,897,618 $ 3,100,240 $ 5,639,858
Percent of sales 31.36% 31.41% 30.90% 30.65%
Gross profit 2,451,031 4,238,606 6,988,923 12,866,444
Operating expenses President’s salary 43,200 51,840 62,208 74,649 Sales manager 30,000 36,000 39,000 45,000 Sales rep 25,000 30,000 34,000 38,000 Sales rep 25,000 30,000 34,000 Sales rep 26,000 30,000 Sales rep 28,000 Secretary 16,000 18,000 20,000 22,000 Secretary 15,000 Employee benefits 2,400 4,000 10,000 15,000 Insurance 3,000 4,000 5,000 5,000 Rent 3,600 3,600 3,600 3,600 Utilities 2,400 3,000 3,500 4,500 Phone 12,000 14,000 15,000 18,000 Office supplies 2,000 2,500 3,000 5,000 Postage 2,000 2,500 3,000 4,000 Car lease 5,640 5,640 5,640 5,640 Car lease 3,600 3,600 4,000 4,000 Car lease 3,600 3,600 4,000 Car lease 4,000 4,000 Professional services 6,000 8,000 8,000 10,000 Travel and entertainment 48,000 72,000 96,000 120,000 New equipment 4,000 14,000 14,000 24,000 Freight out 197,269 334,424 549,897 1,000,859 Advertising 711,521 1,227,244 2,017,972 3,701,260 Promotion 40,000 68,112 111,997 205,419 Brokerage 177,880 306,811 504,493 925,315 Incentives 24,547 42,399 69,680 205,419 Cash discounts 71,152 122,724 201,792 370,126
Total expenses $1,431,209 $2,402,994 $ 3,845,192 $ 6,921,787
Cash flow before taxes 1,019,822 1,835,612 3,845,192 6,921,787
Taxes 209,063 458,903 785,932 1,486,164
Net profit before debt service $ 810,759 $1,376,709 $ 2,357,799 $ 4,458,493
Percent of sales 22.78% 22.43% 23.36% 24.09%
556 PA RT 6 CASES
proper advertising, the company’s shares forecast in our
current markets will also be realized.
A 5 percent penetration of the seasoned salt category
is a very conservative projection considering the strong
health consciousness of the West Coast. The products
will be introduced in shippers, used in store demonstra-
tions, and supported with media advertising to achieve
at least a 5 percent market share. This would result in
sales of $760,943 in that category.
A 10 percent penetration is targeted in the salt-free
category. Using aggressive marketing, price advantage
at retail, and better packaging, the company will be well
positioned against the lower-quality products of our
competitors. With the dollar volume of this category at
$10,064,028, a conservative estimate of our share would
be $1,006,420. In the category of MSG, a 5 percent
share will be achieved. The main competitor in this cat-
egory does very little advertising. Again, attractive pack-
aging, aggressive marketing, high quality, and a retail
price advantage of 30 to 40 cents per unit will enable the
company to realize a 5 percent market penetration. This
share of the West Coast markets will generate sales of
$164,276. Total sales of all three products in these eight
new markets will be around $1,931,639. The company
plans to continue to solidify the markets previously estab-
lished through the use of coupons, co-op advertising,
quality promotions, and word-of-mouth advertising.
Market share in these original markets should increase
by another 2.5 percent in 2005. The dollar volume of the
seasoned salt category in 2005 should be around
$9,522,472, and our market share at 7.5 percent would
amount to $714,185. The dollar volume for the salt sub-
stitute category would be $6,220,748, giving sales at
12.5 percent of $775,593. In the MSG category, a 7.5 per-
cent market share of the $2,055,864 volume would give
sales of $154,189. The company’s total sales for the exist-
ing markets in 2005 will be in excess of $1,643,967. The
totals for 2005 sales of Nature Bros. Old Fashioned Sea-
soning will be $1,475,128. Nature Bros. Salt-Free volume
should be $1,784,013. The sales of Enhance, our MSG
product, should be $318,465. This will give us a total sales
volume of $3,557,606 for all three products in 2005.
FINANCIAL NEEDS AND PROJECTIONS
In this plan, Morris indicated a need for $100,000 equity
infusion to expand sales, increase markets, and add new
products. The money would be used to secure warehouse
556 PA RT 6 CASES
EXHIBIT 6
Source: Tulsa World, June 17, 2003.
C A S E 14 AMY’S BREAD 557
stocking space, do cooperative print advertising, give
point-of-purchase display allowances, and pay operating
expenses.
NEW PRODUCT DEVELOPMENT
The company plans to continue an ongoing research and
development program to introduce new and winning
products. Four products are already developed that will
be highly marketable and easily produced. Personnel are
dedicated to building a large and profitable company
and attracting quality brokers. The next new product
targets a different market segment but can be brought
online for about $25,000 by using our existing machin-
ery, types of containers, and display pieces. A highly
respected broker felt that the product would be a big
success. The broker previously represented the only
major producer of a similar product, Pet Inc., which
had sales of $4.36 million in 1985. The company can
achieve at least a 5 percent market share with this prod-
uct in the first year. The company’s product will be at
least equal in quality and offer a 17 percent price advan-
tage to the consumer, while still making an excellent
profit.
Another new product would require slightly different
equipment. This product would be initially produced by
a private-label manufacturer. The product would be es-
tablished before any major machinery was purchased.
Many large companies use private-label manufacturers,
or co-packers, as they are called in the trade. Consumer
tests at demonstrations and food shows have indicated
that each of these products will be strong.
PLANT AND EQUIPMENT
The company’s plant is located in a nearly new metal
building in Rose, Oklahoma. The lease on the building
limits payments to no more than $300 per month for the
next seven years. The new computer-controlled filling
equipment will be paid off in two months, and the seam-
ing equipment is leased from the company’s container
manufacturer for only $1 per year. The company has the
capability of producing about 300,000 units a month with
an additional $15,000 investment for an automatic con-
veyer system and a bigger product mixer. This production
level would require two additional plant personnel, work-
ing one shift with no overtime. The company could dou-
ble this production if needed with the addition of another
shift. One of the main advantages of the company’s busi-
ness is the very small overhead required to produce the
products. The company can generate enough product to
reach sales of approximately $4 million a year while
maintaining a production payroll of only $37,000 a year.
To meet the previously outlined production goals, the
company will need to purchase another filling machine
in 2005. This machine will be capable of filling two cans
at once with an overall speed of 75 cans per minute,
which would increase capacity to 720,000 units a month.
A higher-speed seaming machine will also need to be
purchased. The filling machine would cost approxi-
mately $22,000; a rebuilt seamer would cost $25,000,
while a new one would cost $50,000. With the addition
of these two machines, the company would have a ca-
pacity of 1,020,000 units per month on one shift.
By 2006, the company will have to decide whether to
continue the lease or buy the property where located and
expand the facilities. The property has plenty of land for
expansion for the next five years. The company has the
flexibility to produce other types of products with the
same equipment and can react quickly to changes in
customer preferences and modify its production line to
meet such demands as needed.
C A S E 1 4
AMY’S BREAD
Amy glanced at the clock and moaned. It was 3:30 A.M.,
time to get up and head to her Manhattan bakery, but she
hadn’t slept all night. She had a big decision to make.
“No,” she muttered to herself; she had a multitude of big
decisions to make.
Amy muttered to herself, “There are already so
many days when I feel stretched past the breaking
point. There are so many demands.” Amy mentally
ticked them off: Ensuring consistent quality, schedul-
ing and training staff, ordering supplies, developing
new recipes, contacting potential customers, collecting
from slow-paying clients . . . the list was truly endless.
Amy wondered, “If I decide to expand, can I do it suc-
cessfully? Can I find another trustworthy manager, like
Toy Kim Dupree, to help me manage the staff and
maintain bread quality? Can I find expansion space in
Manhattan? Should I close our current location and ex-
pand to a much larger space, thus eliminating the need
to manage two locations? Should I look for a location
Reprinted by permission from the Case Research Journal. Copyright 2001 by Paula S. Weber, Cathleen S. Burns, James E. Weber, and the North American Case Research Association. All rights reserved.
for my wholesale production, or a space that would
provide both retail and wholesale opportunities?” There
was so much to decide. Right now though, Amy’s
dough starters were waiting, as were her employees.
She had to get up and face another busy day at her
bakery.
Amy’s Bread, founded in 1992, served about 50 whole-
sale customers, including some of the finest restaurants,
hotels, and gourmet food shops in Manhattan. Amy’s
Bread also had a waiting list of more than 30 wholesale
customers from other quality restaurants, hotels, and
shops.
Amy thought, “I really want to meet their needs and
accept their business, but any further production expan-
sion in my existing space is impossible. I know I can’t
produce one more loaf without hurting bread quality,
which is absolutely unthinkable! We are already work-
ing three shifts, and there is no more room for addi-
tional equipment.”
Amy and her assistant manager, Toy Kim Dupree, had
commiserated: “The bakery is stretched to the limits.
Dough production ranges from 1,800 to 3,000 pounds of
bread per day, well over capacity for just 1,300 square
feet.” As Toy described, “We are like sardines making
bread. Surviving in these close quarters is so difficult.
Not only do we produce all of the wholesale and retail
bread in this one location, but we also store ingredients
and have a small office.”
Amy worried that some of the customers on her long
waiting list were on the brink of turning away. But, Amy
thought, “Am I really ready to tackle a major expan-
sion? On the one hand, I have worked so hard to make
my dreams a reality, I can’t imagine stopping now. But,
can I handle an expansion and larger ongoing operations?
Financially? Mentally? Physically?” Amy remembered
Toy’s recent comment: “Amy’s Bread is finally turning a
profit.” The thought of an expansion and additional debt
was very scary.
AMY’S PERSONAL HISTORY
Amy was born and raised in Minnesota, where her fa-
ther was a high-level executive for Pillsbury and her
mother was a gourmet cook with a family reputation for
baking fresh breads. As a child, Amy remembered com-
ing home from school to the smell of her mother’s home-
made breads wafting from the kitchen. After high school,
Amy earned a degree in economics and psychology. She
then moved to New York in 1984 to try her luck in the
Big Apple.
Amy soon found that an office job was not for her,
and that she longed to pursue a more creative career.
She talked endlessly to her managers and coworkers
about her dream of opening her own business. It was
then that Amy began to solicit support and promises of
financial backing if she were ever to start her own busi-
ness. After 3 years, Amy left her white-collar marketing
position to pursue her dream. She decided to attend the
New York Restaurant School for culinary training. After
graduating from their program, Amy landed a job as a
chef for one of New York’s most highly acclaimed
French restaurants. After 2 years of very challenging
work and longer hours than her marketing job, Amy es-
caped to Europe. Amy said, “It was there I discovered
my true passion: bread baking.” She backpacked around
England and Italy and eventually settled in France,
where there are strong traditions of bread baking. Amy
worked at French bakeries in three different towns,
spending a month at each. “When I returned to New
York in 1989, I was brimming with ideas and excite-
ment about opening my own bakery,” Amy recalled.
Amy spent the next 2 years as a pastry chef and
bread baker for another top New York eatery. As Amy
worked, she simultaneously developed recipes and busi-
ness plans. Amy dreamed that someday soon she would
be working for herself.
HISTORY OF AMY’S BREAD
Amy knew that opening a bakery in New York would be
extremely challenging. First, it was a highly competitive
industry with low wholesale profit margins. Second, space
in New York was always at a premium, and renting a
desirable location was going to be extremely expensive.
Third, she discovered that banks would not loan her
money. Banks viewed bakeries as restaurants—far too
risky an investment without a prior proven track record.
Amy remained undaunted. She was determined to achieve
her goal of running her own business, one that sold a mil-
lion dollars worth of beautiful breads each year made by
employees who took pride in their work and were re-
warded for their efforts. Amy had clear goals: “I wanted to
be famous for making a great product and for creating a
good place to work. I did not care a lot about being rich. I
just want to sell beautiful breads from a cute, cozy place.”
In 1992, armed with some savings, a loan from her
parents, private loans from her former colleagues in the
marketing profession, a good business mind, and a very
determined spirit, Amy took the big step. She quit her
restaurant job and opened Amy’s Bread on Ninth Avenue
558 PA RT 6 CASES
in a tough area of Manhattan known as Hell’s Kitchen.
The space she found was an old storefront that had been
a fish market and had been empty for 5 years. Although
only 650 square feet, it was still expensive, but it was
the most affordable space she could find. With the help
of family and friends, it still took 6 months to renovate
the space, including plastering and painting. Amy installed
equipment, hired and trained staff, developed a customer
list, and began production.
CURRENT OPERATIONS OF AMY’S BREAD
Personnel
Amy’s Bread started with a staff of six dedicated em-
ployees who scrubbed up used equipment, built shelves,
and lent a hand as needed. Amy recalled, “I taught them
bread making techniques, and then, with little idea of
what was to come, we opened for business.” Amy’s Bread
sometimes used newspaper advertisements for attracting
employees, but most responded to a “Now Hiring” sign
in the bakery’s window. Assistant manager, Toy Kim
Dupree, described reasons employees came to work for
Amy’s Bread. “Some were interested in bread baking,
but many came because we offered a 5-day workweek
while many bakeries and restaurants have a 6-day work-
week. We also worked hard to create a happy, open, and
friendly environment. It’s what we wanted for ourselves
and what we hoped to create for our employees. Our
aim was to have a perfect product, but we recognized
that we were dealing with human beings. Anyone who
is too intense does not fit in well here. We don’t have
any room for prima donnas. We also tend to pay more
than our competitors.”
A typical employee would begin in the shaping area,
working to form the bread loaves. From there, they can
move to baking the bread and, finally, to the mixing of
the dough. Toy described a key management challenge
as “helping employees to beat the boredom of their rep-
etitious work.” Toy said, “Our most successful employ-
ees have a positive outlook, are dependable and consci-
entious, think on their feet, and interact well with their
coworkers. We have no cubicles here!” Employees sug-
gested solutions to management issues, with Amy having
the final say. As Toy described, “We all put our heads to-
gether, bringing in our separate areas of expertise. Our
goals were to produce very high-quality breads by hand,
pay our employees a decent living wage, and ensure that
our customers get good value for their money.”
Over the years, Amy’s Bread had experienced very
low turnover. Retail staff started at $8.00 an hour and
baking staff at $10.00. In fact, Amy’s Bread’s lowest
paid employees were the cleaning staff, and they started
at $7.50 an hour, well above minimum wage. Benefits
were available to employees who worked more than
20 hours a week, and employees who were with the com-
pany longer than a year were eligible for a 401k plan. The
majority of her employees (88 percent) were minorities
for whom English was a second language. Training was
often done by demonstration. Payroll expenses were ex-
tremely high, representing over 50 percent of sales.
With a handmade product, it was difficult to attain any
economy of scale concerning labor. New sales led to addi-
tional payroll expense.
Amy reminisced, “The first year was by far the
toughest. We learned to handle dough in stifling hot
weather. We had to keep going on only a few hours of
sleep a day and get by without money when our cus-
tomers were slow to pay. Our space was so narrow and
cramped that we struggled to get racks of dough through
it. However, sales were good, and sometimes all the
bread was sold by noon!”
Bread Production
Amy surmised that “practice and patience were the keys
to perfect bread, and all successful bread started with
quality ingredients.” Amy explained, “Dough batters are
very challenging. They can be too dry, too wet, not ris-
ing quickly enough, or rising too quickly. Many external
elements can affect the dough, including the air temper-
ature, the temperature of the water, the timing of each
step.” One of the most critical aspects of the success of
Amy’s Bread was her devotion to sourdough starters.
The starters are essentially flour, yeast, and water. Amy
quipped, “The starters are the miracle ingredient that
gives life to the bread.”
Amy mused, “A baker’s work is really never done.
The demands are constant. The dough keeps rising and
must be carefully watched throughout the process. The
bakery operates 24 hours a day, 7 days a week. Whole-
sale customers want bread every day. On weekends and
holidays, their orders double!” Amy’s Bread had a staff
of 32 bread mixers, shapers, and bakers by 1998.
At about 5:00 A.M., the mixing began. Amy described
the process: “We fill a large mixer with flour, water, the
all-important sourdough starter, salt, and yeast. Before
long, the mixer’s fork kneader pulls and stretches a mass
of supple dough. The dough is put aside to rest and rise
slowly at a cool temperature and then divided into por-
tions to be shaped and baked.”
C A S E 14 AMY’S BREAD 559
Every step was physically demanding, and workers
got sore arms and shoulders and very, very tired legs
and feet. At noon, the shaping of the loaves for the next
day’s orders began. Racks of rising dough were cut and
formed. This was a totally manual process, as each loaf
must be hand-shaped. The bread was then left to rise
again at a cool temperature so it can ferment. Finally,
the loaves were baked in the early hours of the morning.
After the bread was baked, it was cooled and packed for
delivery by an Amy’s Bread truck. Amy commented,
“Smelling the bread as it comes out of the oven, seeing
its golden color, feeling its texture, and enjoying its de-
licious flavor certainly contribute to job satisfaction!”
Customers
Amy’s original business plans called for providing breads
wholesale to restaurants and hotels. She had a loyal
customer in a former employer and a list of interested
customers. Her location was really not the best for retail
traffic. Retail business would simply be a sideline—she
would sell excess loaves to people who wandered in to
check out the bakery.
Slowly, but surely, Amy began earning a city-wide
reputation for high-quality, innovative yet consistent
products. Her signature bread, semolina with golden
raisins and fennel, brought Amy’s Bread lots of attention.
By 1996, her wholesale customer list had grown to almost
40 customers, and she was preparing about 600 lbs. of
dough a day just for her semolina, golden raisin, fennel
bread. Her product line included approximately 50 items
made from 15 different doughs. Amy’s best-selling prod-
ucts included her semolina bread, walnut scallion bread,
black olive twists, apple walnut raisin rings, and organic
whole wheat bread with toasted seeds.
As Amy’s business grew, she discovered a growing
retail interest. The area around Amy’s Bread was improv-
ing, and new restaurants and coffee shops were opening.
She began to bake rolls and single-serving loaves specif-
ically for retail customers. She eventually hired counter
help to service the retail customers and began selling
not only breakfast breads, like muffins and scones, but
sandwiches to customers as well. She set up attractive
window displays and added a few small tables in the
front of her shop. Amy’s retail business gradually grew
until it represented about 25 percent of sales. Best-selling
items for retail traffic included focaccia with rosemary,
bread twists, sourdough baguettes, and country sour-
dough loaves. Amy noted that her staff “took great pride
in serving retail customers.” They told Amy, “We en-
joyed hearing directly from the customers how much
they enjoy the bread.”
Amy commented that “wholesale is my mainstay and
where the greatest volume of sales exist. However, the
profit margin on retail is better than on wholesale.” Amy
remarked, “A critical part of my expansion decision is
deciding whether the expansion should be solely for
wholesale space, a combination of retail and wholesale,
or purely retail.” Amy felt this was a crucial issue because
the use of the space really drove the location decision.
Amy knew, “If I were to expand to meet my waiting list
of wholesale customers only, then the facility needed to
have good access to major streets with an ample truck
dock for loading baked loaves and unloading supplies
and ingredients. It also could be located in a less “desir-
able” neighborhood. However, if retail were to be the
emphasis, then I needed to find an attractive space with
lots of foot traffic in a neighborhood where many people
lived and worked.”
Competitors
When Amy’s Bread opened, bread baking appeared to
be a growth industry, boosted by healthful eating trends.
The U.S. Department of Commerce reported that per
capita consumption of specialty breads increased 12 per-
cent from 1988 to 1993. A 1992 article in Bakery Pro-
duction and Marketing stated that key trends predicted
for supermarkets in the 1990s would be the expansion
of in-store bakeries as a key aspect of enhancing their
outreach to customers.
In 1993, per capita consumption of specialty breads
was 23.28 pounds, which represented 30 percent of all
bread consumption. A Gallup Poll in January 1995
showed that 71 percent of adults prefer bread to all other
grain-based foods. Ninety percent indicated that grain-
based foods were convenient, and 63 percent thought
bread was low fat. New bread chains and franchise loca-
tions were springing up every day, including Stone Mill
Bread Company, Panere, La Madeleine, and the original,
Au Bon Pain. Perhaps the biggest of the franchise chains
was the Great Harvest Bread Company, founded in 1976.
In 1995, Great Harvest had 87 stores with 15 more under
development, sporting a 30 percent annual growth rate.
Closer to home, Amy’s Bread had several primary
competitors for specialty breads, including the Tom Cat
Bakery in Queens (one of New York’s other boroughs),
Ecce Panis, and Eli’s Bread. They were well-established
and larger than Amy’s Bread. They supported a client
list that included famous restaurants such as the Union
560 PA RT 6 CASES
Square Café, Balducci’s, and Dean & Deluca. These
bakeries tended to be more mechanized than Amy’s
Bread, utilizing equipment for dough shaping and
baking.
Some of the larger commercial bakeries had folded
due to competitive pressures but, at the same time,
more and more small bakeries featuring specialty va-
rieties were opened in Manhattan and the surrounding
area. These microbakeries, like Amy’s Bread, catered
to upscale restaurants and gourmet shops that wanted
to pamper their customers with the best of fresh, cre-
ative breads. Amy felt that “the secret to financial
success in the bakery business was to differentiate
your breads, rather than copying what everyone else
made.” Amy maintained, “The keys to getting and
maintaining wholesale customers are innovative and
consistently high-quality breads. One of the ways I
ensure high quality is by the hand-shaping and indi-
vidual baking of the bread. The retail customers also
want consistent quality, but they are looking for con-
venient locations and prompt service, too. I don’t focus
on what my competitors charge. Occasionally, I see their
price lists, but I basically charge what I feel I must to cover
my expenses and overhead. In fact, many of our prices
have not changed since we first opened for business.”
Financial Results
Shortly after her 1992 opening, Amy discovered what
many entrepreneurs find to be a major roadblock: cash
flow. As new entrepreneurial businesses began to flour-
ish, more and more up-front money was needed for
equipment, supplies, and staff. Typically, the customer
base had not grown large enough to cover all the ex-
penses, nor were customer accounts as current as desired,
and sometimes products were not priced correctly. Amy
remarked, “Soon after opening, I discovered that even
if I sold every loaf I could make, my revenue would not
be high enough to cover my high monthly lease and
equipment rental expenses.” Amy was very lucky though,
when adjoining space opened up in December, and al-
though she could not easily afford to lease the space,
she also knew that she could not continue to exist with-
out expanding. Quickly, Amy was able to borrow enough
additional funds from family and friends to lease the
adjoining open space. By January 1993, she was in full
production in her newly expanded space.
Though the beginning months proved to be quite a
struggle, Amy’s Bread gradually grew. The 1998 income
statement and accompanying schedules for Amy’s Bread
highlight her sales and profitability. Amy remarked,
“Since payroll expenses rise with sales, the real profits
only come from economies of scale reached with fixed ex-
penses like rent and utilities.” Amy further noted, “Given
the low unemployment rate, there often is a shortage of
good staff available at the salaries my business could
afford to pay.” Amy’s contribution margin on retail op-
erations was 47 percent; it was only 35 percent for
wholesale operations. Other bakeries that were more
mechanized experienced higher profit margins. In order
to ensure the highest quality of product, Amy’s Bread
hand-shaped all their breads; therefore, labor costs were
much higher than other bakeries. For example, a “mecha-
nized” bakery with sales revenue similar to Amy’s Bread
had only five employees; Amy’s Bread needed 20 em-
ployees to produce the same amount of sales.
In analyzing other expenses, Amy commented,
“Food cost changes usually come from flour, nuts, dairy
products, and olive oil. Prices for those products are
quite volatile while prices for other ingredients remain
quite stable.” In the mid-1990s the baking industry ex-
perienced a steep rise in the price of flour. However, in-
dustry reports showed that bakeries were only able to
raise their prices 5 percent over the same time period. In
addition, restaurants, overwhelmed with sources of bread
providers, were resistant to bakery industry pressures
for price hikes. For quality reasons, though, Amy rejected
using “quick-bread” mixes where you only add eggs and
oil, preferring more expensive fresh, organic ingredients
and sourdough starters.
Marketing Techniques
Amy said her most successful marketing technique was
to “keep current customers happy.” She noted, “Word
of mouth is very powerful in the New York restaurant
business.” Another way that Amy had obtained new
customers was by being very available to the press.
Amy emphasized, “Whenever someone calls for an in-
terview, I make the time to meet with them and make
every effort to make them feel welcome. I invariably
discuss what is unique about my breads and, of course,
everyone receives free bread samples. The fact that I
am a woman in a male-dominated industry helps ensure
that my business is an interesting story.” Amy also de-
termined that “whenever there was a mention of my
business in a local paper, business increased a great deal
for the next 2 to 3 weeks, and some of the new customers
continued to return. A positive review by an outsider
is better than any ad I could write.” However, limited
C A S E 14 AMY’S BREAD 561
advertising was used for special events or seasonal
product promotion.
Amy’s Bread has been recognized by The New York
Times, New York Magazine, Modern Baking, Gourmet, and
Food & Wine, just to mention a few. Excerpts from these
articles include the following.
“At her tiny, charming storefront in what used to be
known as Hell’s Kitchen, Amy Scherber turns out a dozen
and a half sublime varieties that are anything but conven-
tional white bread. Amy’s is the candy store of bread bak-
eries.” New York Magazine, June 1994. “Armed with a
gentle manner, modest business plan and a genuine love
for baking bread, Amy Scherber, 34, has managed, in less
than 2 years, to position her bakery in the highly competi-
tive, sometimes cutthroat, specialty wholesale bread mar-
ket of New York City.” Modern Baking, November 1994.
Amy had other successes as well. The 1996 Zagat
Marketplace Survey ranked Amy’s bread third out of
27 New York bread bakeries. “The best thing to happen
to Ninth Avenue” say admirers of this “charming” bread
shop filled with the aroma of “home baking”; it offers
“imaginative breads to build meals around” and “con-
soling sticky buns”; the breads are also sold in food spe-
cialty shops around Manhattan; owner, Amy Scherber
(the “Streisand of bakers”) and her “friendly” staff “revere
bread and it shows in every loaf.” Zagat, 1996.
Other marketing techniques pursued by Amy’s Bread
included decorating the shop windows for every holiday.
One could find large decorated heart cookies on Valen-
tine’s Day and big baskets of specialty breads on Easter.
Amy regularly sent free samples of her breads to influen-
tial chefs. She donated bread to charities, taught baking
classes, and appeared on television Food Network shows.
In addition, the Amy’s Bread delivery truck helped spread
the word as it circled Manhattan delivering bread.
Amy was not one to rest on her laurels. With her as-
sistant manager, Toy Kim Dupree, Amy developed a cook-
book that was published in 1996. This effort consumed
countless hours to carefully modify recipes meant for
huge batches of dough down to the one loaf size. It also
involved having the recipes tested by untrained bakers
and editing and improving the instructions. Amy had to
explain her techniques so that the novice baker could
understand them. Amy noted, “The cookbook project took
way more of my time than I could have ever anticipated.”
The cookbook was a hit with bakers everywhere. Re-
views of the book, as well as glowing customer com-
ments, were posted at the Amazon.com Web site.
To add to her challenges, Amy’s long-time exposure
to bread and yeast had made her allergic to many basic
bread ingredients. Amy said, “I have learned that if I
spend too much time around the mixing of the dough, I
get an itchy nose, watery eyes, and a cough. I also have
to be careful to eat bread in moderation.”
Because of the popularity of her Manhattan bakery
and her cookbook, Amy was contacted to consult with
bakeries across the country. She also made a videotape
appearance on the Oprah Winfrey show featuring suc-
cessful young entrepreneurs.
Amy was also in the process of developing an Amy’s
Bread Web site designed primarily for marketing and
public relations purposes. Although they would accept
on-line orders, Amy noted that,”bread is about fresh-
ness, impulse buying, and temptation. We do not expect
much mail-order business, and truthfully, shipping ex-
penses can often be higher than the cost of the bread.”
Future Opportunities
Armed with 6 years of continuing success, Amy was fac-
ing a critical decision. Should she expand or stand pat?
She had a waiting list of wholesale customers, but could
she stretch herself and her resources enough to expand
successfully? Despite the popularity of Amy’s Bread,
Amy was still working long hours and earning only a
modest income. Amy had managed to put away a good-
sized nest egg, but it wasn’t nearly enough for expansion.
Armed with sales and financial projections, she began by
looking for additional wholesale production space in
Manhattan. Amy was looking for about 3,000 to 4,000
square feet that would essentially triple her current space.
She based this requirement on her growing waiting list of
potential customers, analyses of optimal production lay-
outs, and associated projections for sales and expenses.
Amy eventually found a 6000-square-foot building
on 31st Street that she felt she could afford. She also
succeeded in getting a bank to agree to a $150,000 loan
for her business plan. Unlike her 1992 application for a
loan, Amy now had a proven track record and was inter-
ested in borrowing funds to purchase a hard asset, a
building. However, her estimated budget for purchasing
the building and making needed improvements was ap-
proximately $300,000. Amy’s personal savings as well
as the bakery business savings were not enough to make
up the difference. Creative finances would be required
to expand . . . but Amy declared, “I have managed be-
fore and will again.”
While pursuing this plan, a developer contacted
Amy with a new option. A lease was available on a
7,500-square-foot space that was part of a block-long
562 PA RT 6 CASES
warehouse renovation on 15th Street. The developer’s
idea was to fill the space with a variety of food producers
with small retail shops who sold their products at
slightly reduced prices directly from the production
source. The proposed market would include a fresh pro-
duce shop, flower shop, and pastry shop. This space was
essentially an empty shell with no wiring, ventilation,
plumbing, or interior walls. Amy would need to make
all the leasehold improvements, but she could also
choose how things were to be designed and constructed.
Amy estimated that it would take 4 months to construct
her store at a cost of approximately $500,000. This
rental space had retail potential; the 31st Street building
she could purchase was essentially a production facility
only and was located in a desolate area. Amy was faced
with a decision to lease space that would service both
retail and wholesale customers, or to buy a space that
would serve wholesale customers only.
Amy commented, “Although retail is profitable, you
need many locations to reach more customers and in-
crease retail volume. Wholesale business volume can be
increased from just one location.” Amy’s gross sales were
approximately 75 percent wholesale and 25 percent retail.
The wholesale business was much more stable with ad-
vance bread orders for large, fixed amounts. Retail busi-
ness depended on individual consumer buying decisions
for much smaller quantities. However, an item that sold
for $1.10 wholesale would retail at $1.75. This repre-
sented a price increase of 59 percent contrasted with an
additional retail cost of only about 14 percent (for counter
staff, table space, and so forth) resulting in a projected per
item net retail gross profit margin increase of 45 percent.
And, retail sales were for cash only.
Amy said, “I am sure the answer lies in careful finan-
cial projections for sales and associated costs, a bit of
luck, and a lot of passion and hard work.” It was time to
complete some detailed financial analysis, including
cash flows to help decide the best course of action. Amy
stated, “Deciding not to expand would be the only
“sure” bet. But, I’m not sure I am ready to sit back and
be satisfied with what I have already accomplished. I
have worked so hard to get this far, I am not sure I can
turn hard-earned customers away. And, what if my busi-
ness slumps because I can’t meet increasing demand?
Can I keep interest in my bread high if I am turning
away potential customers? Should I rely on my personal
insights and awareness of New York City trends?”
“What should Amy do? Expand or stand pat? If ex-
pand, should it be a wholesale operation only? Whole-
sale and retail? Retail only? Two locations or one?”
CC AA SS EE 11 55
OKLAHOMA NATIONAL BANK
“The bank that makes dreams come true.”
INTRO
It’s January 1, 2002, and the momentum is high among
the top executive leaders of Oklahoma National Bank.
The bank has just been named the fastest growing new
bank in its economic region of the country and the future
is looking very bright. After opening its doors in January
of 2000 with $11 million in capital, the bank has grown to
over $127 million in assets. The major growth over the
past two years has been fueled by the strong organiza-
tional culture and the bank’s ability to maintain high asset
quality. To look ahead, the major concern is finding other
sources of income and building and managing a sustain-
able growth strategy for the future.
THE U.S. BANKING INDUSTRY
There were 9,613 FDIC-insured banking institutions at
the end of 2001. Of these, 8,080 were commercial
banks; 1,533 were savings institutions. Total assets at
FDIC-insured commercial banks are $6.569 trillion;
savings institutions hold $1.299 trillion. Out of 9,613
banks, 5,062 hold less than $100 million in assets. Thus,
the majority of banks are small, community banks that
hold just 3 percent of the industry’s total assets.
In the last decade, the world of commercial banking
has undergone significant changes, but the pace of con-
solidation and mergers has finally slowed. In 2001, merg-
ers absorbed 422 banks and savings institutions. This
contrasts with 2000, when 499 institutions merged. In
1999, there were 513 mergers and in 1998, there were
680 mergers. Also in 2001, 146 new banks and/or savings
institutions had been chartered, while 208 new banks and
savings institutions were chartered during 2000.
Compared to 2000, 56.7 percent of all U.S. commer-
cial banks reported higher annual earnings in 2001. Full
year 2001 earnings of $74.3 billion outperformed the
previous record of $71.7 billion set in 1999. Key factors
in the improvement in industry earnings included sharply
lowering funding costs (Federal Reserve’s cut in inter-
est rates) and higher gains on sales of securities and
other assets. Through much of 2001, lower interest rates
C A S E 15 OKLAHOMA NATIONAL BANK 563
Source: This case study was prepared by Dana Glover with the intention of providing a basis for class discussion.
continued to boost the values of banks’ fixed-rate securi-
ties. Rising provisions for loan losses and a lack of growth
in noninterest revenues limited this increase in profits.
Noninterest income was only $368 million (0.9 percent)
higher than the fourth quarter of 2000.
For the year, asset growth slowed to 5.2 percent, the
lowest annual rate since 1992. Loans increased by only
2.0 percent in 2001, after growing by 9.4 percent in
2000. Most major banks have been experiencing trouble
maintaining the quality of their assets. Declining asset
quality has been a trend over the past two years and the
level of problems and the pace of deterioration continue
to be significantly greater at large banks. Increases in
charge-offs were reported on commercial and industrial
loans, credit card loans, commercial real estate loans,
home equity loans, and residential mortgage loans.
ISSUES AFFECTING THE BANKING INDUSTRY
The first trend, an area of concern, is household and
business debt levels. Spending by households and busi-
nesses is growing faster than cash income, resulting in
debt rapidly increasing. Further, recent growth in busi-
ness indebtedness raises concerns about commercial
credit quality. After expanding at the fastest growth rate
in more than a decade during 1998, the commercial and
industrial (C&I) loan portfolios at insured depository in-
stitutions continued to grow rapidly in 1999. Evidence
of weakening corporate credit quality began to appear
during 1999, and the federal banking regulators have
publicly expressed their concerns about the quantity and
quality of commercial credit risk in the system. Despite
starting from very low levels, net C&I loan charge-offs
for all insured institutions totaled $3.6 billion during
1999—a 51 percent increase over 1998. Moreover, results
from the annual interagency review of large commercial
credits—the Shared National Credit (SNC) Program—
noted a sharp rise in criticized loans. At the same time,
corporate bond defaults and negative credit rating revi-
sions during 1999 reached levels not seen since the early
1990s. This deterioration in commercial credit quality
occurred during a particularly strong economic environ-
ment, leading to questions about how much further credit
quality might deteriorate in the event of a moderate to
severe recession.
Second, intense competition in banking is driving
business strategies. Evidence also suggests that, to main-
tain loan growth and meet funding needs, institutions
are pursuing asset-liability structures with higher levels
of interest rate risk. Innovations and cost-cutting initia-
tives used by insured institutions to counter competitive
pressures may introduce new risks associated with com-
plex accounting valuations, weakening internal controls,
and the need for more intensive loan servicing.
Third, the economy and the banking system are vul-
nerable to sudden shocks from financial market instabil-
ity. The 1990s were marked by recurring, and perhaps
more frequent, episodes of financial market turbulence,
and the banking industry asset growth has outstripped
growth in deposits, creating greater reliance on more ex-
pensive and less stable market-based sources of funding.
These funding trends present challenges for community
institutions.
TRENDS SHAPING THE FUTURE OF THE INDUSTRY
Consolidation
While most financial services companies spent most of
the past five years scrambling to become bigger so that
they could be all things to all people, community banks
emerged to fill the gap left by the ongoing consolidation
in the banking industry. Many consumers and busi-
nesses were left with fewer choices among financial in-
stitutions. This created an opportunity for community
banks such as Oklahoma National Bank to develop a
profitable niche by providing personalized service to
local residents and businesses in their communities.
Slow Economic Growth
Rising problem loans and compressed profit margins,
combined with slow economic growth over the past two
years, have created a much more challenging environ-
ment for banks and securities firms. This has caused
management teams to focus on nurturing high perform-
ing units, cutting costs, and eliminating nonperforming
units.
Falling Low Cost Consumer Deposits
Profits derived from the net interest margin achieved by
making business and consumer loans funded by rela-
tively low cost consumer deposits make up the bulk of
traditional bank earnings. As competition from invest-
ment banks and mutual fund companies gets more in-
tense, consumers are leaving less and less low cost
money in their checking and savings accounts. Banks
564 PA RT 6 CASES
have had to bid up their pricing on certificates of deposit
in order to attract adequate funding for their loans. As a
result, net interest margins have declined.
Noninterest Income
Noninterest refers to income that is derived from activ-
ity other than the interest spread received from loans:
service charges, overdraft fees, trust fees, servicing fees on
sold loans, and selling insurance and brokerage services.
In recent years, banks have increased their focus on
noninterest income as a way to increase their profitabil-
ity. Noninterest income can be more stable than tradi-
tional lending, and this revenue does not adhere to the
typical loan growth cycle. This income also provides an
offset to declining net interest margins.
THE OKLAHOMA BANKING INDUSTRY
Despite a nationwide earnings decline in 2001, the
Oklahoma banking industry is growing faster than
the national industry. In its Quarterly Banking Profile,
the Federal Deposit Insurance Corporation reported that
Oklahoma banks posted a net income of $487 million as
of December 31, 2001.
Following are details from the FDIC report for
Oklahoma:
• Total loans and leases outstanding from Oklahoma banks stood at $27.5 billion as of December 31,
2001, compared to $26.0 billion a year earlier;
a 5.8 percent increase.
• Oklahoma bank assets totaled $45.9 billion at the end of the year, up 6.2 percent from the same point
in 2000.
• The average return on assets for the state industry was 1.09 percent, up from 1.07 percent a year
earlier. Return on equity averaged 11.77 percent
across the state.
• Total Oklahoma bank deposits grew by 5.1 percent, from $33.4 billion in 2000 to $35.1 billion in 2001.
• The net interest margin for Oklahoma banks averaged 4.11 percent, compared to 4.18 percent in
the same period of 2000.
• The ratio of noninterest income to average earning assets grew from 1.40 percent in 2000 to 1.46
percent in 2001.
• The ratio of net loans and leases to total bank assets was 59.13 percent, down slightly from 59.43 in 2000.
• The percent of unprofitable banks decreased from 5.94 percent in 2000 to 3.55 percent in 2001.
However, the number of banks with earning gains
decreased from 62.24 percent to 58.16 percent.
• The ratio of noncurrent loans and leases to total loans and leases remained steady at 1.1 percent
while the ratio of nonperforming assets to total
assets increased slightly.
• The ratio of net loan charge-offs (losses) to total loans increased in 2001 to 0.44 percent from
0.32 percent in 2000 and 2001.
• The FDIC reported that Oklahoma had 282 commercial banks as of December 31, 2001, down
from 286 in 2000. The number of bank employees
in the state grew by more than 400, to 17,701.
HISTORY OF OKLAHOMA
NATIONAL BANK
After retiring from 26 years in the banking business and
serving as president of Stillwater National Bank in Tulsa,
Tom Bennett, Jr., Oklahoma National Bank (ONB) Chair-
man and Chief Executive Officer, got the idea for a start-
up bank from his son, Tom III, during a family ski trip.
His first call was to an old friend from college, Garry
Groom, who had been CFO at two other Oklahoma
banks. In response to Bennett’s invitation to create a new
bank in a way they had always dreamed that a bank
should be run, he became ONB’s CFO. A short time
later, Bennett was introduced to Michael Bezanson
through one of his potential investors. Bezanson had
been president and CEO of Security National Bank of
Sapulpa and had also been thinking about starting a bank.
Bezanson quickly became Oklahoma National Bank’s
president, and the process of creating a dream to turn
into reality began around the Bennetts’ kitchen table with
three banking veterans (Bennett, Bezanson, & Groom)
and one rookie (Tom Bennett III).
Bennett pulled together a group of investors and board
members that reflected the bank’s interests in small busi-
nesses, entrepreneurs, and local professionals. Among the
board members are B. J. Dumond, chairman and chief ex-
ecutive officer of Simple Simon’s Pizza; Dr. Ben Johnson,
president of Tulsa Dental Products; and home builder
Stephen Murphy of Murphy Resources Inc. It has been
said that the bank’s investors and board members read
like the Who’s Who of Business in Tulsa.
The bank’s employees include a mix of veteran
bankers and industry newcomers. Among them are
C A S E 15 OKLAHOMA NATIONAL BANK 565
Bennett’s wife, Sue, who serves as director of marketing
and investor relations, and their son, Tom, who is currently
a vice president with the bank. The average banking expe-
rience of the 12 senior officers is 22 years, and the average
banking experience of the 33-person staff is 15 years.
OKLAHOMA NATIONAL
BANK OPERATIONS
Products
Oklahoma National Bank offers a variety of deposit prod-
ucts including regular checking, business checking, sav-
ings accounts, and tiered rate money market accounts and
CDs with the most competitive rates in Tulsa. One depos-
itory product that is unique is their personal checking
account that pays a CD rate of interest as long as the cus-
tomer maintains a minimum balance of $5,000. They’ve
developed the NetTeller online banking system to offer
customers the opportunity to visit their Oklahoma Na-
tional Bank account from any Internet connection, and
they offer to reimburse their customers for ATM access
fees charged by other banks when ONB customers use
other banks’ ATMs to access ONB accounts.
Oklahoma National Bank also makes mortgage loans
and consumer loans and specializes in small- to medium-
sized business loans, SBA loans, and loans to profes-
sionals. They believe that their success at growing a high
volume of high quality, well-priced loans has been their
ability to understand their customers’ financial needs
and their willingness to propose creative loan solutions
that tailor repayment programs to each customer’s unique
ability to repay, and to make prompt commitments fol-
lowed by fast loan closings.
Financial Performance
Like most other start-ups, Oklahoma National Bank
was expected to lose money during early operations
and not to turn a profit until [its] third year of opera-
tions. However, in 2001 Oklahoma National Bank made
a net profit of $65,237 for the year; $359,237 ahead of
the original plan given to investors. The net profit of
$65,237 was after allocating $708,000 to the reserve
for loan losses. This represented $809,676 in pre-reserve
earnings for 2001, a figure that also outperformed the
2001 budget.
Loan performance also fueled the growth of Oklahoma
National Bank during the 2001 operating year as the
loan portfolio grew from $42.1 million to $110.8 mil-
lion. More importantly, even during slow economic
growth, Oklahoma National Bank was able to maintain
stellar asset quality. As of September of 2001, the bank
had no loans that were over 30 days past due and no net
charge-offs for the year. The performance of ONB is in-
dicated in Exhibits 1 through 4.
566 PA RT 6 CASES
I Introduction
I am pleased to report that the state of your banking company, both Twenty First Century Financial Services Company
and Oklahoma National Bank & Trust Company, is excellent! No, now that I think about it, it’s better than excellent,
it’s amazing! I have been an optimist all of my life, and even I am surprised at our extraordinary growth, more rapid
than expected profitability, and excellent asset quality. I am also very pleased with the high quality staff that we have
continued to assemble and the continued growth in our many wonderful relationships with customers and friends. For
ONB, these are the best of times.
II Perspective
Last year our big announcements were:
1. Our first month of profitability in March 2001, our 14th full month of doing business.
2. That in our first 15 months we had exceeded all of our 24 month goals.
3. That we had successfully recruited Oklahoma’s #1 radio personality, John Erling, to be our spokesman.
4. That we were the fastest growing new bank in the region.
5. That we were about to finish our drive-in at 91st & Yale.
6. That we had just finished our first Habitat for Humanity House.
7. That we had moved from the 17th largest bank in Tulsa to #12, and we rightfully celebrated these achievements!
EXHIBIT 1 State of the Bank Report, April 19, 2002
C A S E 15 OKLAHOMA NATIONAL BANK 567
III The Last 12 Months & Where We Stand Today
Let me tell you now about the road we have traveled in the last 12 months and where we stand today.
1. Last year we went from being profitable in March, to being profitable for the entire year. In 2001, the Bank earned a net profit of $65,000, which was $241,000 ahead of the original pro forma loss of $176,000 for the year 2001 in your initial private placement memorandum. This resulted in the Holding Company having a net profit of $37,000 for the year, with the major difference being the interest paid by the Holding Company on a bank stock loan that was used to inject capital into the Bank. Overall, our company is $602,000 ahead of our original pro forma losses in our first two years, which I think is pretty amazing!
2. This week, our bank exceeded $155 million in total assets, which is a $5 million increase over our 3/31/02 quarter end. In reaching $155 million in assets, we are two and one-half times the size that we thought we would be at year end 2002 and nearly twice the size that we thought we would be at year end 2003. Now, some of you might think we were bragging in our initial pro formas. The fact is that out of the 22 new banks that were started in 2000 in our region of the country, including banks in Dallas, Houston, Kansas City, and St. Louis, the average size at year end 2001 was $44 million. Our original pro forma showed us at $44 million at year end 2001. So, achieving our pro forma growth would have made us average. While we thought we might be a little better than the average, we never imagined we would be nearly 300 percent of the average, which is what we have in fact achieved. To me, this too is amazing!
3. We will never top the [coup] of recruiting John Erling as our spokesman; but we have pulled an equally great, dif- ferent kind of [coup] in the new Advisory Board members we have recruited from Sapulpa. I will let Mike introduce them all later. But, I have to say that I never believed we could open our first branch in a new town and get the Mayor, the President of the Rotary Club, and a Who’s Who of Local Business People to join our cause. Those of you who are members of our Sapulpa Advisory Board—you are amazing!
4. We are still the fastest growing new bank in this region of the country. In addition, we are in the top 10 percent in the country of new banks in growth, earnings, and asset quality! We are in the top 10 in all three categories all at the same time.
Comparing ONB to the average start-up bank in our region from the year 2000, at year end 2001:
• They reached $44 million in assets; we reached $124.7 [million].
• They had experienced an average loss of 5.7 percent on equity; we had a 0.7 percent profit.
• They had loan losses of 0.11 percent of their loans; we had 0.00 percent loan losses.
• They had 0.21 percent of their loans over 30 days past due; we had 0.01 percent.
To me, all of this is amazing!
5. Last year, we finished our drive-in at 91st & Yale; this year we opened our first full-service branch in Sapulpa on April 10, 2002 (and it has a drive-in), we opened a Loan Production Office in Owasso in February; and we have just been approved by our bank regulators to open our new branch at 21st & Lewis this fall. At our last Board meeting, we approved a budget of $1.5 million to renovate the first floor, build a four-lane drive-in, and provide bank only parking on the north side of the building at 21st Street. I’ve heard that all the other Banks in town think that is amazing!
6. Last year we finished our first Habitat for Humanity House. This year we have asked our Sapulpa Advisory Board to help us identify a similar type of project to do in Sapulpa . . . it too may be a Habitat for Humanity House, but I’m not sure. I know many members of our staff, and many of you as investors, have been involved in a wide range of philanthropic projects in this last year. It’s hard to put it all in perspective following the events of September 11th. However, it is clear that we have much to do in our community, our state, our nation, and throughout the world. My prayer for all of us is that we will find God’s activity and listen to His calling, and go to join Him wherever that might be. For some, it will be our local Red Cross or the local bowl-a-thon for Big Brothers & Sisters in which ONB Club is sponsoring eight teams this weekend, for others it will be serving the orphans of Russia or Vietnam. One thing I am sure about is that the challenge for all of us is almost overwhelming. However, I believe that as we follow God’s leadership, somehow it will all work out for good, and the fact that we may be a part of that goodness . . . that is amazing!
7. Last year we had moved from the 17th largest bank headquartered in Tulsa when we started #12 on 3/31/01. This year we became the 7th largest bank headquartered in Tulsa on 3-31-02 . . . and I believe in the last three weeks, we are now actually #6. At year end 2001, we became the 64th largest bank in Oklahoma. Probably we are now about 50th out of 290 . . . in two years, two months, and twelve days. Now that’s amazing!
EXHIBIT 1 State of the Bank Report, April 19, 2002 (continued)
(Continued)
568 PA RT 6 CASES
IV Looking Forward
I think in the future, our focus will not be on bigness . . . rather it will be on quality.
1. Our #1 Priority must be quality relationships:
• With you as our investors, we want to behave like partners.
• With the members of our staff, we want to be, in the best sense, like family.
• With our customers, we want to be known as bankers who really have a heart for service.
• With our regulators, we want to be known as the epitome of compliance and integrity.
• With those thousands of people who are not yet our customers who live in our community, we want to be the
bank they are comparing their bank to—and considering moving their business to.
Overall, we really do want to build and maintain quality relationships. So, help us meet your family, friends,
neighbors, and associates. And, if you hear about, or see, or experience our messing up, please let me know. We
want to apologize for our errors and begin again immediately.
I believe that a focus on quality relationships will move us forward more happily and successfully than anything
else that we might do.
In this regard, we are looking to recruit a few more quality bankers to our staff. If you know good bankers at
other banks that we ought to call and recruit, please let me know.
2. We also want to excel at quality service and quality facilities.
• Tell your friends that ONB is not just another bank . . . we are a better bank.
• Tell them ONB offers the highest rates in Oklahoma on personal checking accounts and CDs, totally free ATM
access at any ATM owned by any bank in Oklahoma, and prompt personalized responses to loan proposals. In all
these areas, we really are a better bank than our competitor.
• And, I hope you are as proud of our facilities as we are. Special thanks to Ward Seibert, and all those involved in
this area of our work.
3. We must continue to grow a high volume of quality loans. The #1 thing that can go wrong in a bank is bad loans. I
want to compliment Mike, Tom, and all our lenders for the great job they are doing in maintaining the quality of
our loan portfolio.
If you know good people who have borrowing needs, ask them to give your bank a shot at the business. It’s the
#1 way we make money, so we really need your help in this area.
Also, if you hear of bad things going on in our local economy, let us know so that we can take efforts to avoid
loan problems associated with economic difficulties.
4. We are also going to try to expand the range of our products and services by associating our company with our
quality service providers and allowing them to cross sell our customers their products and split the fees with the
bank. Mike will tell you about our new venture with Family Business Partners later. We also offer trust services
through The Trust Company of Oklahoma, and we are exploring other opportunities that may increase our
earnings in the future.
5. We are also looking at branch sites in Owasso and Broken Arrow for 2002, and keeping our eye on Oklahoma
City in 2003. We are committed to doing all of those things in a quality manner, to build a company that is both
profitable—and a company you can be proud to own.
V Summary and Conclusion
1. Our last year was an amazing year! While we would like to stop and celebrate our successes, they have yielded us
many new opportunities . . . so we are pressing on into 2002 in what we hope will be a year known for its quality in
all that we do.
2. So far we’re off to a very fast start . . . and we are just getting started in Sapulpa, and we are excited about the
prospects of Midtown.
EXHIBIT 1 State of the Bank Report, April 19, 2002 (continued)
Dollar Figures in Thousands
Assets and Liabilities 31-Dec-2000 31-Dec-2001
Total employees (full-time equivalent) 25 34
Total Assets 64,487 127,437
Cash due from depository institutions 963 3,279
Interest-bearing balances 22 21
Securities 5,479 0
Federal funds sold & reverse repurchase agreements 12,613 3,052
Net loans & leases 42,078 110,799
Loan loss allowance 390 1,097
Trading account assets 0 0
Bank premises and fixed assets 2,300 6,705
All other assets 1,054 3,602
Total liabilities and capital 64,487 127,437
Total Liabilities 56,929 115,763
Total deposits 50,483 95,545
Interest-bearing deposits 45,032 83,833
Deposits held in domestic offices 50,483 95,545
% insured (estimated) 89.85% 82.60%
Other borrowed funds 6,260 20,000
All other liabilities 186 218
Equity capital 7,558 11,674
Common stock 1,063 1,063
Surplus 7,437 11,511
Undivided profits ⫺942 ⫺900
Memoranda
Noncurrent loans and leases 0 15
Income earned, not collected on loans 348 618
Earning assets 60,192 113,872
Long-term assets (5⫹ years) 740 3,415
Average assets, year-to-date 43,900 96,290
Average assets, quarterly 58,086 120,643
Volatile liabilities 15,503 40,982
Insider loans 2,376 1,400
FHLB advances N/A 20,000
Loans and leases held for sale 102 1,767
Unused loan commitments 19,788 24,170
Total unused commitments 19,788 24,170
EXHIBIT 2 Oklahoma National Bank Financial Performance, 2000–2001
C A S E 15 OKLAHOMA NATIONAL BANK 569
570 PA RT 6 CASES
Dollar Figures in Thousands
Income and Expense 31-Dec-2000 31-Dec-2001
Number of institutions reporting 1 1
Total interest income 2,883 7,350
Total interest expense 1,576 4,034
Net interest income 1,307 3,316
Provision for loan and lease losses 390 708
Total noninterest income 49 332
Fiduciary activities N/A 1
Service charges on deposit accounts 37 139
Trading account gains & fees N/A 0
Additional noninterest income 12 192
Total noninterest expense 2,072 2,912
Salaries and employee benefits 1,195 1,934
Premises and equipment expense 201 19
All other noninterest expense 676 959
Pre-tax net operating income ⫺1,106 28
Securities gains (losses) 0 74
Applicable income taxes ⫺385 37
Income before extraordinary items ⫺721 65
Extraordinary gains—net 0 0
Net Income ⫺721 65
Net charge-offs 0 1
Cash dividends 0 0
Sale, conversion, retirement of capital stock, net 8,255 N/A
Net operating income ⫺721 18
EXHIBIT 3 Income and Expense Statement
CULTURE
We like to think that the story of the bank is a story
about relationships. The first relationship would be be-
tween the founders and God. One unusual aspect of our
company is that we open all meetings with a prayer. We
see this adventure as a blessing from God, and we
earnestly seek to be good stewards.
Certainly there is an element of relationships between
our 112 investors, our 37 staff members, and our rapidly
increasing number of customers. We say that we are “the
bank that makes dreams come true.” That begins with lis-
tening to each other’s dreams, then trying to help each
other pursue them. So far, it has been a lot of fun.
Thomas E. Bennett, Jr.
Chairman & CEO
How many banks announce to their customer that
they will be glad to make arrangements to meet with
you at any time or a place that is more convenient to
you? How many banks promise you will always speak
to a “live” person when you give them a call? How many
banks start each meeting with a prayer? The unique cor-
porate culture at Oklahoma National Bank has provided
an opportunity for the bank to develop a competitive ad-
vantage centered on customer service. One of Oklahoma
National Bank’s major corporate values includes the
building of a fun organization with excellent relation-
ships. Tom Bennett feels it is important to know the cus-
tomer, big or small, and build long-lasting relationships
that meet their needs. Employee and customer surveys
have revealed that the bank has one of the best reputa-
tions in the community.
The bank’s founders describe Oklahoma National
Bank’s business model as a marriage of sound banking
principles and dedication to building strong relation-
ships. This model has allowed the bank to effectively
manage lending risks while serving the needs of the cus-
tomers and community. Relationship building is one of
the key ingredients in Oklahoma National Bank’s risk
mitigation strategy.
MARKET DYNAMICS
Oklahoma National Bank has chosen one of the most
successful economic regions in Oklahoma as its home.
Tulsa, Oklahoma, accounts for 32 percent of all the gross
domestic product in the state, but only 23.4 percent of
the population. The value of the goods and services
produced in the Tulsa area is growing faster than in most
cities nationwide. Business expansions and increases in
productivity have pushed the gross domestic product in
the area to a record $30.7 billion in 2001, up 3.9 percent
from 2000. The gross domestic product is expected to
increase at a faster rate in Tulsa than in the state and the
nation. In 2002, the GDP in Tulsa is expected to increase
to $31.7 billion (up 3.3 percent), compared to a 1.1 percent
statewide and a 3 percent nationwide increase. In 2005, it
is expected to increase 21.6 percent, compared to a 14.5
percent statewide and 22.9 percent nationwide increase.
MAJOR COMPETITORS
Bank of America
Bank of America reported operating earnings of $8.04 bil-
lion, or $4.95 per share (diluted), which excludes the
charges incurred to exit the auto leasing and subprime
Performance and Condition Ratios 31-Dec-2000 31-Dec-2001
Yield on earning assets 7.23% 8.51%
Cost of funding earning assets 3.95% 4.67%
Net interest margin 3.28% 3.84%
Noninterest income to earning assets 0.12% 0.38%
Noninterest expense to earning assets 5.20% 3.37%
Net operating income to assets ⫺1.64% 0.02%
Return on assets (ROA) ⫺1.64% 0.07%
Return on equity (ROE) ⫺9.25% 0.70%
Retained earnings to average equity (YTD only) ⫺9.25% 0.70%
Net charge-offs to loans 0 0.00%
Credit loss provision to net charge-offs N/A 70800.00%
Earnings coverage of net loan charge-offs (x) N/A 736
Efficiency ratio 152.80% 79.82%
Assets per employee ($ millions) 2.58 3.75
Condition Ratios (%)
Loss allowance to loans 0.92% 0.98%
Noncurrent loans to loans 0 0.01%
Net loans and leases to deposits 83.35% 115.97%
Net loans and leases to core deposits 120.29% 159.28%
Equity capital to assets 11.72% 9.16%
Core capital (leverage) ratio 12.79% 9.62%
Tier 1 risk-based capital ratio 14.18% 10.39%
Total risk-based capital ratio 14.97% 11.36%
EXHIBIT 4 Performance Ratios
C A S E 15 OKLAHOMA NATIONAL BANK 571
real estate lending businesses. A year earlier, the com-
pany reported operating earnings of $7.86 billion, or
$4.72 per share. Net income for 2001 was $6.79 billion,
or $4.18 per share, compared to net income of $7.52 bil-
lion, or $4.52 per share a year ago. Bank of America
currently operates 49 full service banking centers in the
state of Oklahoma.
Bank of Oklahoma
Bank of Oklahoma (BOK) is a multi-bank holding com-
pany based in Tulsa, Oklahoma. The assets of the organ-
ization exceed $11 billion, and Bank of Oklahoma enjoys
market leadership throughout the state of Oklahoma.
During the past five years, the organization has sought
acquisitions in high-growth markets in contiguous states
to Oklahoma. BOK Financial operates four principal
lines of business under its Bank of Oklahoma franchise:
corporate banking, consumer banking, mortgage bank-
ing, and trust services. Bank of Oklahoma’s operating
philosophy embraces a “community atmosphere” with
local boards of directors with local decision making and
marketing efforts.
Stillwater National Bank and Trust Company
Stillwater National offers commercial and consumer
lending and deposit services from offices in Stillwater,
Tulsa, Oklahoma City, and Chickasha, Oklahoma. A
substantial portion of current business and focus for the
future are services for local businesses, their primary em-
ployees, and other managers and professionals living and
working in its Oklahoma market areas. At December 31,
2001, Stillwater had total assets of $1.2 billion, deposits
of $905 million, and shareholders’ equity of $85.1 mil-
lion. Stillwater’s philosophy is to provide a high level of
quality customer service, a wide range of financial ser-
vices, and products responsive to customer needs.
THE FUTURE
The bank plans to add three new branches in the Tulsa
area within the next year, but Tom Bennett and his man-
agement team know that if they remain fixed on Tulsa
it will be very hard to grow. They hope to grow to
$170 million in total assets by the year end 2002, and
to $250 million by [the] bank’s 5th year anniversary in
2005, but where should growth come from? New
products? Acquisitions? Market expansion? How can
Oklahoma National Bank expand profitability while
maintaining its unique culture and unwavering dedica-
tion to customer satisfaction? Is it possible to grow
without sacrificing service and relationships?
C A S E 1 6
DATAVANTAGE CORPORATION
. . . CONTINUING THE ENTREPRENEURIAL SPIRIT
Christopher Columbus set the foundation for the entre-
preneurial spirit in America, by pursuing at great risk
his vision of a different world. This spirit has evolved
from that early point in American history to become the
cornerstone of today’s business innovation and growth.
Those embodying the spirit look beyond current busi-
ness practices and processes to question their most fun-
damental beliefs and corporate structures. They seek
not merely to satisfy market demands, but to anticipate
and create markets that have not yet been conceived.
They invent a vibrant corporate culture and elicit the
dynamic leadership needed to bring it into action. They
rewrite the rules and take on seemingly impossible
tasks. And, they invest in a future so bold it redefines
not only an organization, but an entire industry.1
It was a brisk fall day outside in Cleveland, Ohio,
where Chaz Napoli, president of Datavantage, and Marvin
Lader, CEO of Datavantage, were having lunch at a new
restaurant that had just opened near their office. As the
anxious restaurant owner came by to check on their
meal, the restaurateur’s concern for his business imme-
diately reminded them of their concern regarding the
looming decisions they were faced with regarding their
own organization. During Chaz and Marvin’s discussion
of the situation at hand, they remarked how much their
business had evolved.
After having initially started out in 1988 as a reseller
of third-party software to small distribution businesses
and corporate systems for retail home offices, Datavan-
tage made a conscious strategic decision in 1994 to bet-
ter control its own destiny and internally develop its
own point-of-sale software products. Even though
Datavantage’s financial performance was healthy at that
572 PA RT 6 CASES
Source: This case study was prepared by Michael Harriston, Nadya Tolshchikova, Michael Walsh, and Sean Wenger of the Weatherhead School of Management, Case Western Reserve University, with the intention of providing a basis for class discussion.
C A S E 16 DATAVANTAGE CORPORATION 573
time as a distributor of third-party software, the two
owners knew that the transition to become a developer
would be best for the long-term success of the company.
Now, they were faced with another decision that could
potentially change the company—they were in the final
stages of negotiation to acquire XBR Track, which was a
small loss prevention software company based in Boston,
Massachusetts. Chaz and Marvin discussed many re-
lated issues regarding the XBR acquisition—was loss
prevention going to become a viable new market for the
retail industry to justify the price of XBR? What would
be the internal implications of this new product line on
the company’s culture, financial and organizational
structure, as well as sales and marketing capabilities?
Would it be complementary to Datavantage’s current
business model? As the two finished their meal, they be-
gan to discuss the options that lay ahead.
DATAVANTAGE—BACKGROUND
Datavantage was founded in 1988 by Marvin Lader, an
IBM veteran and a serial entrepreneur from Cleveland,
Ohio. Marvin’s background in sales and application
software/system engineering, gained after many years at
IBM, allowed him to collect extensive knowledge of
business applications that ranged from sales to feeder
distributors to large retail chain applications. Exposure
to the retail industry, coupled with the experience of
starting two other companies prior to Datavantage, one
of which went public, allowed him by 1993 to grow
Datavantage to 16 employees and $1.5 million in sales
with only $50,000 of external financing. The company
was a reseller of business application software to small
distribution businesses and corporate systems for the
retailers’ home offices as well as a provider of legacy
COBOL Systems for Distributors (SFD). Only a few pro-
grams were written internally and, by 1993, Datavantage
was slowly transforming itself into a consulting com-
pany. Despite relative success, it wasn’t exactly what
Marvin envisioned to be an exciting entrepreneurial op-
portunity and [he] was ready to get out of the business.
A radical change was needed in order for Marvin to
consider staying and growing the company.
The opportunity arrived in 1994 when Datavantage
acquired the retail services division of LDI that was up
for sale at an affordable price. LDI was a reseller of
products for store systems and provided a complemen-
tary foundation for Datavantage’s further development.
LDI’s business was centered on [the] niche, specialty re-
tail market segment, providing Datavantage with a base
for future company growth. This acquisition dramati-
cally changed Marvin’s perception of Datavantage’s over-
all future potential.
Soon after the acquisition was complete, Chaz, who
originally started at LDI and stayed with the company af-
ter Datavantage took over, decided to completely redefine
the company’s product strategy under Marvin’s guidance.
Chaz’s knowledge of the industry came from his back-
ground in retail marketing and extensive consulting expe-
rience with retail stores. The blend of Marvin’s technical
background and entrepreneurial skills with Chaz’s retail
experience resulted in a shift of Datavantage’s strategic
direction. Not surprisingly, both Marvin and Chaz see this
period as the real beginning of Datavantage. (The balance
sheet and statement of operations for the company are in-
dicated in Exhibits 2 and 3.)
DATAVANTAGE SOLUTIONS
As a part of the new strategy, Datavantage moved from
a pure reseller to a software developer and point-of-sale
solution provider. Both Marvin and Chaz felt that this
would build the value of the company and allow it to
control its own destiny. Furthermore, it was decided
not to outsource the product development for two
main reasons: (1) it was very rare that companies out-
sourced product development at that time, making Data-
vantage somewhat uncertain about the benefits of the
yet unproven strategy, and (2) Datavantage had lim-
ited time and resources to get the initial product to
market. Under these circumstances Chaz and Marvin
felt that the development should be kept in-house,
which would allow Datavantage to better deal with the
pressures of new product introduction. Therefore, the next
step was to execute the strategy by defining the market,
developing the product, and creating a feasible busi-
ness model supported by a strong organizational infra-
structure.
Target Market
Looking back on that period of time, Chaz and Marvin
realize that they did not consciously identify the market
segment that Datavantage decided to target; instead, it
happened by default. Since LDI had already built sub-
stantial expertise and credibility in the niche specialty
retail segment, Datavantage decided to initially target
this particular area of the retail industry. Specialty retail-
ers concentrate on a single product category niche such
as apparel, sporting goods, jewelry, and others. Although
grocery stores, mass-merchandising (Wal-Mart), food
service and hospitality (hotels, cruise ships), and [conven-
ience] stores (BP, Shell) were also potentially large and
profitable segments, specialty retail seemed to be the most
attractive retail category. Despite the slow growth in the
overall retail industry, the specialty retail segment was ex-
periencing significant expansion with many new start-up
retailers opening their stores all over the country.
INDUSTRY/COMPETITION
Point-of-sale [POS] software is a relatively young, frag-
mented part of the software industry that in the last few
years has started undergoing rapid consolidation. A wave
of mergers and acquisitions has transformed the industry,
such that it is now dominated by a few large players. This
shift has been supported by the fast advances in technol-
ogy, changing point-of-sale systems from being glorified
calculators to sophisticated POS software solutions. Such
technology/product shift occurs about every 10 years,
bringing new innovations to existing systems. In light of
these industry transformations, the Datavantage founders
knew that there would emerge only a few highly success-
ful companies in this industry and (they) were determined
to have Datavantage be one of this elite group.
Store 21
Having evaluated various point-of-sale packages that
were on the market at that time, Datavantage founders
were not able to identify a single product that they felt
had a true competitive advantage. Therefore, they saw a
real market opportunity and decided to launch the devel-
opment of their own product that could run on Windows
technology, a relatively new operating system at the
time. This was a very critical decision since at the time
POS systems still ran on the DOS platforms. The goal
was to develop one product and one user interface that
could run all store operations such as register, inventory
management, production, internal fraud, employee sched-
uling, and others. Based on clients’ requests, consult-
ants’ input, and Chaz’s and Marvin’s personal industry
experiences, the two major requirements for the new
product were functionality and simplicity.
When Store 21 was developed and introduced to the
market in 1996, it was a complete store management
system based on full transaction point-of-sale (POS) ap-
plications software that ran on Windows. The system
combined point-of-service features, such as deal pricing
and item location, with several back office functions
including labor management and scheduling, inventory
shipping/receiving, productivity goals, and clientelling.2
The software also performed as a state-of-the-art con-
nectivity package that linked individual stores with the
home office via secure Internet/Intranet communications.
This feature was called the “chatterbox” module, which
gave the retailer real-time access to centralized intelli-
gence or enterprise sales reporting. The centralized com-
munication capability allowed for faster credit, debit, and
check authorizations which significantly increased pro-
ductivity of store transaction data streams.
RETAIL INDUSTRY’S CURRENT NEEDS
Despite the presence of the state-of-the-art POS software
in many retail stores, most retailers were still struggling
to reduce store shrinkage problems. Retailers in the U.S.
were losing an average of 2 percent of sales due to retail
theft or shrinkage each year. The losses due to shrinkage
directly affected the bottom line of the retailer in the form
of a pure profit loss. It was estimated that retail employees
account for 55 percent to 75 percent of lost revenue be-
cause of various fraudulent transactions. Transaction fraud
ranged from improper cash refunds and price overrides, to
employee discount abuse and fraudulent credit card activ-
ity, amounting to $13.2 billion in retail losses annually.
On the basis of a preliminary market study to iden-
tify where inventory shrinkage occurs, Datavantage de-
termined that employee theft and shoplifting combined
accounted for the largest source of property crime com-
mitted annually in the United States3 with the following
classifications:
• Employee Theft 44.5 percent
• Average financial loss caused by the typical dishonest employee theft is $1,023.
• A dishonest employee typically works for his or her employer an average of nine months.
• Shoplifting 32.7 percent
• The average value of merchandise taken by the typical shoplifter is $128.
• Administrative Error 17.5 percent
• Vendor Fraud 5.1 percent
Additionally, the following retail segments were de-
termined to have higher than average shrink rates as a
percent of sales:
• Gifts 2.91%
• Toys & Hobbies 2.81%
• Optical 2.59%
574 PA RT 6 CASES
• Discount Stores 2.01%
• Sporting Goods 1.91%
• Department Stores 1.89%
Retailers were looking for new technology and tech-
niques to help them become more proactive in identify-
ing problem cashiers or employees at their stores, as
well as providing real-time validation that certain em-
ployees were in fact committing crimes. Historically, re-
tailers’ loss prevention technology had been ineffective
due to its highly manual characteristics. Retailers were
also hampered by a lack of technical resources available
for loss prevention initiatives.
The techniques that existed to specifically link an
employee to a theft were not user friendly to a com-
pany’s loss prevention manager. Transaction logs (t-logs)
had to be manually sorted to provide concrete evidence
of a specific employee theft. Employees’ schedules also
needed to be verified with the dates and times of the
transactions to make a stronger case to the court system.
The volume of data generated by point-of-sale (POS)
key t-logs made it difficult, if not impossible, to sort
through transaction activity looking for trends that
would identify employee theft. A secondary drawback
to existing loss prevention software was the length of
time, typically several days, required to alert a retailer of
a suspicious transaction. The lack of timeliness in iden-
tifying shrinkage limited the effectiveness of an investi-
gation, confrontation, and the ultimate resolution of a
theft.
XBR LOSS PREVENTION SOFTWARE
The XBR Loss Prevention software application that
Datavantage is considering acquiring is based on “by
exception” reporting methods that are determined by the
specialty retail store. The main reason for Datavantage’s
interest in this software is the groundbreaking solution it
can bring to the retail stores. Just as Store 21 is consid-
ered to be “best in class” point-of-sale application soft-
ware, Marvin and Chaz know that XBR has the same
potential in the loss prevention segment of the technical
solution market for the retail industry. The system is de-
signed to quickly identify, track, and manage potentially
fraudulent transactions. An exception history for an as-
sociate or store is developed by establishing control
points that sift through transactions to identify and ana-
lyze trends. The control point feature of XBR also al-
lows for comparisons to other employees and stores in
the same risk transaction areas.
In addition, the software has the capability to per-
form digital register surveillance, which is used to “mark”
high risk transactions. A loss prevention officer is then
able to retrieve the digital video clip of a specific trans-
action to verify and resolve employee theft.
The XBR Track software has the potential to substan-
tially reduce employee fraud if it could be optimized to
search t-logs for defined exceptions. While Store 21 can
give the home office real-time POS transaction data and
employee scheduling, it was not designed to scan for
fraud. Chaz considers that the combination of the two
applications would increase a store’s productivity and
reduce shrinkage, while creating value for both cus-
tomers and Datavantage. A number of Datavantage’s
customers have already successfully integrated XBR
Track with Store 21, which allows them to be proactive
in dealing with employee fraud through predetermined
“by exception” features.
In addition to the technical benefits, Datavantage ex-
pects to use XBR as the main instrument to initiate rela-
tionships with new customers. Chaz calls it “get into the
castle” strategy, which ultimately means establishing a
relationship with a customer through a relatively low-
cost project that would create the necessary level of trust
to commit to larger projects in the future. To Datavan-
tage, XBR is just that instrument due to its relatively
low cost and almost guaranteed return on investment.
Moreover, the concept of XBR is fairly straightforward
compared to the other complex solutions Datavantage is
developing, which would make it easier for the sales
people to sell XBR to the new Datavantage customers.
Finally, both Chaz and Marvin are convinced that if they
do not purchase XBR, someone else will, creating a po-
tential to significantly change competitive dynamics, not
in Datavantage’s favor.
DATAVANTAGE—CUSTOMERS
Early in its existence Datavantage set a goal to differen-
tiate itself by keeping its products and services simple,
continuously improving through innovation, excelling at
the delivery of the highest quality products and services,
and developing stable technology and an unmatched
level of customer care.
The company experienced multiple challenges when
going through a rapid growth stage. By 1997 it was able
to obtain 5 percent market share in the U.S. specialty re-
tail market, which was a significant accomplishment in
the fragmented market that retail systems data manage-
ment represented at that time. Despite extensive product
C A S E 16 DATAVANTAGE CORPORATION 575
development beginning in 1994, Datavantage did not
launch Store 21 until 1996. At that time, the software
was introduced to its then two largest customers, Lids
and The Finish Line, which [composed] a significant
portion of the company’s total revenue.
Although, during the early stages of the company’s
development, having a few customers account for a sub-
stantial portion of annual revenue was an acceptable
arrangement, Datavantage recognized that it had to
quickly grow its customer base in order to minimize the
risk of dependence on a few larger customers. A stated
goal was not to allow a single customer to comprise
more than a few percent of the revenue base. By 1997,
Datavantage had each customer representing between
10 and 20 percent of the total company revenue, with
the largest customer varying from year to year.
Further, Chaz and Marvin realized that they had to
target only certain types of customers in order to maxi-
mize profitability. Accordingly, Datavantage used the
following customer selection criteria:
• The client had to be a relatively large retailer operating a minimum of 30 stores; or
• The client’s minimum revenue had to be at least $200 million.
Datavantage mainly concentrated on niche retailers
that had stores at shopping malls and outlet shopping
centers, operated on average from 400 to 1,000 stores,
or earned gross revenue anywhere between $200 million
and $1 billion.
As of 1997, Datavantage had about 20 customers,
many of which were large nationwide retail chains. See
Exhibit 1 for the list of Datavantage’s largest retail cus-
tomers in 1997.
Along with growing its client base, Datavantage sought
to provide additional solutions to customers. Even though
the majority of Datavantage’s revenue was driven by
Store 21, both Marvin and Chaz understood that the
acquisition of XBR Track could provide further growth
of the already successful Store 21 product, which had
been on the market for a year. Although XBR Track was
projected to account for only about 15 percent of Data-
vantage’s revenue, it would further strengthen its busi-
ness by providing Datavantage’s customers with the
ability to control shrinkage through an integrated suite
of applications. Additionally, it would provide cus-
tomers with remarkable savings of about 2 percent of
revenue, which was currently being lost on internal and
external shrinkage. The combined benefits of Store 21
and XBR would result in a potentially significant finan-
cial savings to the customer, and consequently, a quick
return on their investment in the XBR Track product.
DATAVANTAGE—SALES AND MARKETING
The primary methods utilized by Datavantage to sell
its products and services are direct marketing, trade
shows, and existing client testimonials. After develop-
ing Store 21, Chaz and Marvin realized that the exist-
ing reseller sales and marketing staff were not capable
of selling the new product. The necessary level of knowl-
edge and motivation was simply not there. This resulted in
nearly an entire turnover of the sales and marketing staff.
Following this complete turnover, Datavantage was
able to create a strong sales and marketing team that fol-
lowed a very precise and thorough marketing strategy.
Instead of using a traditional marketing campaign target-
ing retailers in general, the company concentrates heav-
ily on what Chaz refers to as “personal marketing and
referential selling.” This involves using existing client
testimonials and case studies (with Datavantage products
at the center of the solution) which are featured in the
company’s publications and regularly mailed to targeted
new and prospective customers. However, this approach
has its own drawbacks, which include an increase in the
sales cycle period that consequently requires a higher
level of persistence and customer relationship building
on the part of the sales people.
The company also actively participates in the major
retail trade shows and leverages its strong sales force
to gain contacts that are often converted into valuable
customer relationships. As one Datavantage customer
mentioned:
One of the company’s strengths is its very well thought
through marketing strategy. They always try to be in the
right place at the right time.
Another important strategy that the company incorpo-
rated into its standard selling and marketing practice is
the “Annual User Conference” organized each year in
576 PA RT 6 CASES
EXHIBIT 1 Datavantage’s Largest Customers in 1997
Sunglass Hut Things Remembered
S&K Menswear Piercing Pagoda Jewelers
Casual Male Genesco
Footaction Lids
The Athlete’s Foot Tradehome Shoes
The Finish Line
Cleveland, Ohio, where all Datavantage clients are
invited to attend. It is a three-day event full of presenta-
tions on new products or updates, Q&A sessions, and
entertainment activities. Customers are able to interact in
an informal setting with other Datavantage customers, as
well as employees, and share their experiences.
In order to support its active sales and marketing ef-
forts, Datavantage implemented an extensive hiring and
training program for its sales representatives. This pro-
gram focuses on good work ethics, honesty, integrity,
and the development of close relationships with existing
and potential clients. As a result, Datavantage sales peo-
ple are able to close over 90 percent of sales during the
final product presentation round during which customers
travel to Cleveland to Datavantage headquarters. When
asked for the reason for such success, Chaz responded:
We hire people with the same grass roots who are con-
cerned with good work.
Convinced that proper sales and marketing tech-
niques significantly contribute to the company’s suc-
cess, Chaz continually encourages the sales people to
sell the benefits rather than features of Datavantage’s
products. This strategy is based on the company’s “Guid-
ing Principles,” which are as follows:
1. Invest in Products “Best in Class.”
2. Invest in Infrastructure and Operations.
3. Superior Sales & Marketing: Position Itself as a Re-
tail Company Selling Technology vs. a Technology
Company Selling Retail Systems.
4. Product, Service, and Sales Are Three Key Areas of
Main Focus.
HELP DESK/CALL CENTER
Business application software for the retail industry,
such as Datavantage’s, requires real-time customer sup-
port through a call center or help desk, which was es-
tablished early in the development of Store 21. Although
one of the company’s goals was to provide the best
level of service to its customers, things did not always go
as anticipated. The company’s strategy to quickly acquire
new customers led to an unintentional decrease in the level
of service provided to existing long-term customers.
While not losing a single customer due to these short-
comings, Datavantage nevertheless recognized it as a
major issue to be addressed. Over time the improvement
in the Help Desk area allowed Datavantage to handle most
of the problems over the phone, with major problems
being solved by sending a specialist on site. Due to its
responsiveness and strong drive for customer satisfaction,
Datavantage soon was able to build a reputation of being
one of the top vendors among clients’ large pool of suppli-
ers. Surveyed clients attributed their high level of satisfac-
tion to the dedication of Datavantage personnel, their
honesty and openness about issues, customer driven inter-
nal culture, and continuous drive for improvement.
As stated by one of the clients, “With Datavantage I
never feel that my problems are being put on the corpo-
rate agenda when it takes a while to solve a problem.
Datavantage always accepts responsibility and if some-
thing can’t be done right away because of lack of re-
sources or for any other reason, admits it.” According to
another customer: “They have passion for what they do
and get done what needs to get done.” Yet one more cus-
tomer confessed: “They make me feel that they really
care about my business.”
Chaz and Marvin think the reason for such a high
level of customer satisfaction is the very candid way in
which the company operates. In fact, Chaz constantly
reminds his employees that they are a direct extension
of the client’s staff, to the extent that their paychecks
should not have the Datavantage name on them because
the checks entirely come from the client’s business.
With Datavantage personnel being carefully selected
and capable of providing a high level of service, reflect-
ing on the turnover in sales and marketing personnel re-
lated to Store 21, Chaz and Marvin wondered whether
the acquisition of XBR would put the company through
another hiring and firing turmoil that could threaten the
company’s strong position with its customers.
DATAVANTAGE—BUSINESS MODEL
Chaz and Marvin continued to develop Datavantage
away from a reseller of third-party software, into a busi-
ness applications technology company that develops its
own proprietary business-to-business software for spe-
cialty retailers. The company developed a revenue
model that incorporated both product and service rev-
enue streams that were generated from the following
five distinct and standalone profit centers.
The first profit center, Software Licenses & Royal-
ties, generated product-related revenue that accounted
for 17 percent of the total sales revenue in 1997, and
was forecasted to further increase as a percentage of
sales. This profit center was comprised of the Store 21
product line. When XBR is in fact acquired, the associ-
ated revenue would be part of this classification.
The second profit center, Hardware & Equipment,
generated product-related revenue that accounted for
C A S E 16 DATAVANTAGE CORPORATION 577
50 percent of the total sales revenue in 1997, and was
forecasted to decrease as a percentage of sales.
The third profit center, Professional Services, gener-
ated service-related revenue that accounted for 19 per-
cent of the total sales revenue in 1997, and was forecasted
to increase as a percentage of sales. This service com-
ponent of the company’s business model included
Datacomm Services, Handling/Restocking, Staging Fees,
Professional Services Training, and Consulting.
The fourth profit center, Software Maintenance &
Development, generated service-related revenue that
accounted for 11 percent of the total sales revenue in
1997, and was forecasted to increase as a percentage
of sales. This service component of the company’s
business model included SMA4 Fees, Chatterbox, and
Custom Software Modifications.
The final profit center of Datavantage was its Help
Desk/Call Center Operations.
The strategy behind using these five specific profit
centers was to match revenue to key similar functional
areas, and allow associated categories of revenue to be
pooled together. For example, anything related to hard-
ware procurement had its own revenue category; all the
software licensing revenue was grouped in a category;
anything to do with a nonprogramming professional
service, such as consulting, training, staging systems,
technical support, etc., had a revenue category; anything
having to do with computer programming, both ongoing
software maintenance fees and any custom programming,
was in a separate category; and finally the call center ser-
vices were also in a standalone revenue category.
This categorization allowed for accountability of the
company’s main services by keeping clean lines of own-
ership in the profit centers, so that appropriate business
plans and goals could be established and monitored on a
moving forward basis.
DATAVANTAGE—FINANCING
The company financed its entire operations and growth
primarily through retained earnings, as a result of solid
cash management. A critical success factor in its cash
management has been Datavantage’s ability to aggres-
sively control its accounts receivable, an especially diffi-
cult task in the retail industry. This strong cash position
allowed the company to consider all possibilities in
negotiating the purchase price for XBR. The issue still
remained, though, how best to finance the transaction.
Should the company purchase the software outright and
pay all cash, structure the purchase as an all royalty
deal, or come up with some combination of cash and
royalties? An all cash purchase would significantly in-
crease the consequences of a situation where the loss
prevention market did not develop as hoped. If Data-
vantage incorporates a royalty scenario, and the loss
prevention market is successful, Datavantage may not
realize as much return on its investment as would other-
wise be possible from an all cash deal. As a result, Data-
vantage wondered what would be the best way to structure
the XBR Track deal, so as to provide protection against
downside risk as well as maximize the upside potential.
Both Chaz and Marvin agreed that the combination
of cash and royalties seemed to be the best acquisition
financing option. Datavantage planned to structure the
deal with an initial $300,000 payment for the right to
use the product and royalties of 5 percent of gross rev-
enue resulting from the product sales. A buyout clause
was expected to be incorporated into the agreement,
which would allow Datavantage to buy out the remain-
ing royalty payments. This option was perceived as a
relatively low risk and low upfront cash deal that would
provide high expected return on investment.
The company’s strong cash position allowed for sus-
tained growth that did not require any equity financing.
As a result, Datavantage management and employees
maintained 100 percent equity ownership of the com-
pany. However, taking into account the trade-offs of ex-
ternal equity financing, Chaz and Marvin wondered if
outside financing should be considered to purchase
XBR Track, or to possibly pursue future opportunities.
DATAVANTAGE—MANAGEMENT CULTURE
Datavantage has experienced constant evolution over
the life of the organization. In early 1994, when the
company consisted of 25–30 employees with Marvin
and Chaz as the only senior level managers, the two
founders made the majority of critical decisions, includ-
ing sales presentations to new customers. Chaz still
feels that in a small company start-up environment this
type of top-down organizational structure was necessary
to keep control over the company’s limited resources
and carefully protect the company’s emerging image be-
cause every strategic decision had a potential of signifi-
cantly affecting the future success of the organization.
By the time Datavantage reached about $10 million in
revenue, Chaz realized that the company needed a well-
defined infrastructure and a capable management team.
Consequently, Datavantage significantly decentralized its
decision making by creating a more distributive culture
578 PA RT 6 CASES
where each manager had authority to make critical deci-
sions in their area of responsibility. As a direct result of the
decision to create an empowered environment, members
of the senior management team received authority to con-
tribute input toward the strategic direction of the company.
This shift allowed Chaz and Marvin to move away from
initiating and following through with each strategic move.
Now they mostly review the proposals brought to them by
the team of executive managers in the organization.
However, as Datavantage became less centralized,
the founders wondered what effect it would have on the
entrepreneurial small-company environment that domi-
nated the company internally from the very beginning
and significantly contributed to its success. As a result,
Chaz and Marvin identified main aspects of the entre-
preneurial culture and put strong emphasis on instilling
these into Datavantage’s rapidly evolving internal orga-
nizational structure.
Major elements of entrepreneurial culture:
• Stability of the management team
• Commitment to empowerment
• Limited bureaucracy
• Clearly defined reward and compensation system that involves bonuses and equity
• Clear lines of responsibility
• Working management culture—“hands on” management style
In addition to its entrepreneurial culture, the key char-
acteristic of Datavantage’s success is its ability to take
calculated risks. While not a risk averse organization, Data-
vantage put mechanisms in place to help mitigate it. Every
important decision, such as an acquisition or new product
launch, is first explored in a formal business plan. Team
leaders have control over the development of business
plans and are expected to execute the plans they create.
Therefore, Chaz and Marvin were able to form an
empowered organization measured with a set of con-
trols to oversee the performance of each decision-
maker within the organization. Chaz calls this approach
“management by exception” and Datavantage’s overall
organizational culture “decentralized and empowered
culture with right controls.”
Effective communication, as another key to the suc-
cess of any small organization going through an active
growth and transformation period, was embodied in
Datavantage’s daily operations. In fact, from the early
years of organizational growth, Datavantage made it a
rule not to penalize employees for making mistakes as
long as a mistake or a shortcoming is immediately re-
ported before it turns into a major problem. To emphasize
the importance of communication, twice a year Chaz
presents the “State of the Company” address to all the
employees and senior management. The major objective
of this communication tool is to highlight the progress of
each department, identify key goals and objectives for the
upcoming year, and also restate Datavantage’s guiding
principles that ensure the company’s success.
Similarly to many successful start-ups, Datavantage
shared equity with its key managers in order to maintain
employees’ existing level of commitment to the organi-
zation and its future. It did not only allow the company
to maintain its successful approach to business, but kept
employees from making decisions that sacrificed future
growth for immediate results. However, Marvin and
Chaz realized that there is significant risk associated
with this strategy because giving someone equity does
not mean that they would align their performance and
the vision for the company with their status. Therefore,
since equity stake in business is the most expensive and
therefore valuable compensation that the company can
offer to an employee, both Marvin and Chaz created a
culture where people see the value of this compensation
and are willing to perform accordingly by aligning their
actions with the organizational goals and objectives.
MERGING OF TWO CULTURES
After deciding to acquire XBR, Marvin and Chaz had to
create a strategy to merge the two different organiza-
tions. Both founders recall the acquisition of LDI where
most of the LDI employees had to be let go. Although
this was less likely to be the case with XBR, both Chaz
and Marvin knew that the growth and long-term success
of the company was directly correlated to the level of its
employees’ competency. Reflecting on the LDI acquisi-
tion, Chaz thought:
As we grew into a tier one company, we put increas-
ingly high efforts on continuously upgrading our staff.
The acquisition had several factors for the entre-
preneurs to consider. The most important issue was in-
tegration of the two cultures into one. Marvin and Chaz
wondered whether the XBR acquisition would affect Data-
vantage’s well-organized internal structure, which fos-
ters the company’s present entrepreneurial environment.
Would XBR management buy into Datavantage’s rules
and principles of internal organization and relation-
ships with external partners? Although XBR had only
C A S E 16 DATAVANTAGE CORPORATION 579
580
EXHIBIT 2 Datavantage Corporation Balance Sheets
December 31
1995 (Unaudited) 1996 (Unaudited) 1997 (Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 501,875 $ 362,286 $ 319,885
Accounts receivable 970,836 842,234 1,675,554
Prepaid expenses 97,716 44,961 94,541
Refundable income taxes — — —
Deferred tax asset — — —
Inventory 860,769 84,163 —
Total current assets 2,431,196 1,333,644 2,089,980
Fixed assets:
Computers and office equipment 458,357 606,613 688,045
Furniture and fixtures 161,776 245,373 241,590
Leasehold improvements 29,787 97,867 106,284
Other 39,480 6,732 34,122
689,400 956,585 1,070,041
Less allowance for depreciation (370,280) (521,293) (423,215)
319,120 435,292 646,826
Purchased and licensed software, net — — 359,512
Deferred loan costs, net
Software development costs, net — — —
— — 359,512
Deferred tax asset — — —
Other assets 11,233 17,519 12,456
Total assets $2,761,549 $1,786,455 $ 3,108,774
Liabilities and Shareholders’ Equity
Current liabilities:
Bank term loan $ — $ — $ 166,667
Supplier note payable — — —
Notes payable to employees — — —
Current portion of obligation under capital leases — — 16,883
Deferred revenue 1,218,086 332,512 1,087,103
Accrued expenses 336,475 426,924 759,291
Income/Franchise tax payable — — —
Salaries, wages, taxes and commissions payable 87,000 6,950 231,032
Accounts payable 355,768 278,487 426,796
Total current liabilities 1,997,329 1,044,873 2,687,772
Long-term obligations:
Bank term loan & line of credit — — 291,667
Subordinated notes payable — — —
Supplier note payable — — —
Obligations under capital leases — — 9,802
Total long-term obligations — — 301,469
Shareholders’ equity:
Common stock 7,620 7,800 5,578
Treasury stock — — (1,145,043)
Additional capital 115,151 132,971 207,847
Retained earnings 641,449 600,811 1,051,151
Total shareholders’ equity 764,220 741,582 119,533
Total liabilities and shareholders’ equity $2,761,549 $1,786,455 $ 3,108,774
EXHIBIT 3 Datavantage Corporation Statements of Operations
Actual for the Years Ended December 31
1995 % 1996 % 1997 %
(Unaudited) (Unaudited) (Unaudited)
Revenue
Point-of-sale equipment $5,058,561 64% $4,887,461 54% $6,333,718 50%
Software licenses 432,778 5% 489,352 5% 2,180,104 17%
Professional services 1,522,417 19% 2,301,031 25% 2,444,015 19%
Software maintenance & development 840,033 11% 1,181,135 13% 1,379,602 11%
Operating system software — 0% 69,566 1% 48,084 0%
Other 103,437 1% 155,756 2% 326,867 3%
Total revenue 7,957,226 100% 9,084,301 100% 12,712,390 100%
Operating Costs and Expenses
Cost of equipment sold 3,851,672 48% 3,689,238 41% 4,967,024 39%
Salaries, wages, and benefits 1,870,324 24% 2,613,105 29% 3,923,645 31%
Professional fees 428,885 5% 712,991 8% 628,093 5%
Selling, general, and administrative 359,346 5% 367,759 4% 437,808 3%
Research and development 339,384 4% 389,777 4% 820,920 6%
Cost of system software sold — 0% 55,653 1% 35,033 0%
Travel 99,191 1% 137,203 2% 241,173 2%
Depreciation and amortization 137,511 2% 146,788 2% 104,630 1%
Telephone 127,059 2% 287,168 3% 289,346 2%
Purchase of stock option rights — 0% — 0% — 0%
Total operating expenses 7,213,372 91% 8,399,682 92% 11,447,672 90%
Income from operations 743,854 9% 684,619 8% 1,264,718 10%
Other Income (Expense)
Interest income 33,935 0% 18,603 0% 6,441 0%
Interest expense — 0% — 0% (20,008) 0%
Total other income (expense) 33,935 0% 18,603 0% (13,567) 0%
Income taxes — 0% — 0% — 0%
Net income $ 777,789 10% $ 703,222 8% $1,251,151 10%
EBITDA $ 881,365 11% $ 850,010 9% $1,375,789 11%
C A S E 16 DATAVANTAGE CORPORATION 581
12 employees, Datavantage believed that the company
had a strong management team in place. Therefore,
when considering making a decision regarding the fate
of these employees, Chaz believed the two companies
had a good chance of success:
One of the keys to our enthusiasm for their manage-
ment team is the similarity in cultures. Both cultures are
hard working and very customer service oriented.
Location was another issue. Since XBR was head-
quartered in Boston, several hundred miles away from
Cleveland, Datavantage had to decide whether reloca-
tion and physical integration of the two companies in
Datavantage’s headquarters in Cleveland, Ohio, was a
feasible option. An alternative would be to have XBR
remain in Boston and operate as a standalone division of
Datavantage.
The success of this acquisition could bring signifi-
cant competitive advantage to Datavantage. However, if
some of the important factors discussed above are not
taken into consideration, the acquisition and postacqui-
sition integration could negatively affect the very factors
that allowed Datavantage’s success in the first place,
inhibiting long-term company performance.
E N D N O T E S
1. Modified from the Web site of Legacy Consulting.
2. Clientelling is the process of gathering data about
an individual customer’s buying habits and prefer-
ences during interactions in the store, typically
applied in high-end or luxury retail stores.
3. 2000 National Retail Security Survey.
4. SMA stands for software maintenance, which is a re-
curring annual fee that virtually all clients pay for that
provides the right to any bug corrections at no addi-
tional charge, as well as the right to receive upgrades
to the software as new and improved versions are re-
leased. The typical fee is 15 percent of all license fees
and customization fees paid to Datavantage; therefore,
this amount can increase as the client purchases more
licenses or pays for more customization.
C A S E 1 7
DUAL PANE COMPANY
John Grayson had been in the housing restoration business
for 15 years when, in 2001, he designed a machine that
could remove old windows from their frames without de-
stroying the wooden panes known as muntins and mul-
lions that surround the glass (see Exhibit 1). One of the big
advantages of the tool is that it was built around a routing
drill piece that moved on a three-dimensional plane. This
allowed Grayson to replace windows that up until then
could not be serviced. Once the small panes were re-
moved, they would be replaced by one large pane of dou-
ble glass. The muntins and mullions would be inserted
over the window to give it the same look as before.
Grayson applied for a patent as soon as he realized
his machine was unique, and the patent was granted in
August 2002. He has been operating the business since
that time under the name of Dual Pane Company. He
and his wife, Elizabeth, are the sole owners and employ-
ees of the company. She oversees the advertising and
promotional aspects, and John does the actual installing.
They both engage in the selling process, particularly in
the colder months when the actual installation business
is slower. Their current geographic market is the Boston
area, although they have done business outside it. They
generally have concentrated on the residential market,
but have periodically completed commercial jobs.
The restoration market is affected by several factors
that include the state of the overall economy, local em-
ployment levels, and the amount of a consumer’s dis-
posable income. Since the company began operations,
the economy has been favorable. The GNP has been in-
creasing, real disposable income has risen moderately,
and there has been a decrease in unemployment in the
Boston area. The restoration of windows is a relatively
large expense, costing between $3,000 and $7,000, de-
pending on the number of windows installed in a house.
Home owners are more likely to invest in this type of
restoration when their level of net disposable income is
greater and when the economy is good. Today, there is a
trend toward less saving on the part of many Americans,
and consumers are tending to borrow for expenditures
like housing restorations. Therefore, the level of interest
rates affects Dual Pane’s business. Fortunately, interest
rates have been low recently, so consumers have been
able to afford such restorations.
Another factor that affects the restoration market is
the cost of energy. In the late 1970s, the energy crisis
forced many people to see energy as a limited resource.
Since that time, people have generally tried to conserve
energy. Consumers are faced with finding alternative
sources of energy to heat and cool their homes and offices.
This concern with conservation gives Dual Pane an advan-
tage in that it is replacing single-pane noninsulated win-
dows with energy-efficient dual-pane insulated windows.
Due to the favorable economy and Dual Pane’s unique
method of installing double-pane glass, the Graysons
have had more business than they can handle. They have
advertised in the yellow pages and have sent direct mail
to the subscribers of a regional home improvement mag-
azine. Their customers have referred their friends to the
Graysons, so business has expanded considerably. John
has two ideas on how to handle his growing business. He
could hire and train a staff of salespeople and installers,
or he could franchise his business. He enjoyed the selling
and the actual installing of the windows, but neither he
nor his wife was interested in managing a staff of workers.
Therefore, franchising was more appealing to him. He
582 PA RT 6 CASES
Source: This case study was prepared by Dana Glover with the intention of providing a basis for class discussion.
felt that one of Dual Pane’s big advantages was the
patented cutting tool, and he could bring the name Dual
Pane to more customers if he franchised the business.
Several contractors he contacted had expressed an inter-
est in the Dual Pane machine and wondered if he was in-
terested in franchising.
John decided that his goal was to franchise the busi-
ness. There were three groups of people he could con-
tact regarding franchising. First, he could sell the rights
of the product to contractors who were in the business
of restoring residential homes or commercial offices. He
felt that their reach with consumers could help to
broaden the exposure of the Dual Pane name. He also
thought that glass companies in the Boston area might
be interested in a Dual Pane franchise. Since his tool
could cut odd-shaped glass, it had an advantage over ex-
isting methods, which glass companies would benefit
from. Elizabeth mentioned that individuals who wanted
to get into the restoration business might also be poten-
tial targets for franchising.
John needed to know how to go about franchising the
business. What kind of legalities were involved? He
knew that he had patent protection on the machine, but
what kind of procedures should he follow in terms of set-
ting up guidelines for owning a Dual Pane franchise?
Which group should he target for franchising? How
much should the franchise cost? He wanted to sell his
franchise to the group or groups that would give the Dual
Pane name the most exposure and continue to emphasize
the quality of the work. How should he proceed?
C A S E 17 DUAL PANE COMPANY 583
EXHIBIT 1
Glazing
Mullions
Sash
Muntins
Double pane glass
Lock
584
A. Monroe Lock and Security Systems (AMLSS) (Case Study), 468–470
Aaker, D. A., 90
Aarons, Martha, 108
ABBA, 484–486, 488, 490, 491
Abell, D. F., 90
Acacia Research (ACTG), 168
Accounting fraud, 177–178, 360–361, 389
Accounts receivable loans, 313
Acid-test ratio, 354
ACM Enterprises, 426–427
Acquisition financing, 336, 337
Acquisitions
advantages of, 424
candidates for, 427–428
disadvantages of, 425
explanation of, 424
structure of, 425–427
synergy and, 425
Action plans. See Marketing strategy
Active Capital, 130
Activity ratios, 354
Acumen Fund, 370
Adams, C., 408
Adams, James, 138
Adams, Karen Booth, 384
Adams, Robert V., 50
Adaptation, 76
Adelman, Philip J., 300
Adler, Carlye, 461
Advanced Scientific Corporation, 50
Advisors, outside, 274–275
African Americans, 44
Aftermarket support, 369, 370
Agiliance Inc., 274
Agreements, 426–427
AIG, 360
Ajzen, J., 61
Aldrich, Howard, 62
Allen, Derene, 384
Almquist, E., 62
Aloe Gato, 307
Alphacorp Holdings, 439
Amabile, T. M., 31
Amazon.com, 118, 166
American Express, 321
American Research Development Corporation (ARD), 342
American Tourister, 151
AMG, 427
Amstein, Michael, 321
Amy’s Bread (Case Study)
background of, 557–559
current operations of, 559–562
financial results of, 561
future opportunities, 562–563
marketing techniques and, 561–562
Analiza, Inc., 107
Analysis principle, 400
Anderson, Alistair, 60
Andruss, Paula, 301
Angels. See Business angels; Private investors
Angrist, S., 62
Animation SKG, 174
Anokhin, Sergey, 550n
Ansoff, H. I., 381n, 408
Answer.com, 412
Ante, Spencer E., 311n
Antoncic, B., 62, 63, 502n
Antonelli, Heather, 450
Apogee Enterprises, 417
Apple Computer Inc., 50, 56, 127, 168
ARC International, 174
Ardichvili, Alexander, 87, 111n
Arkansas Aviation Sales, 94
Armstrong, Larry, 63
Arndt, Rachel Z., 451n
Arnolite Pallet Company, Inc., 98
Arthur Andersen, 177
Asaki Chemicals, 423
Asian Americans, 44
Assets
base for loan, 313
explanation of, 292–293
management of fixed, 393
of newness, 84
Association of Health Insurance Agents, 177
AT&T, 52
AT&T Ventures, 50
Attorneys, 161, 163
Attribute listing, 105
Auto Critic of America Inc., 418
Autometrix, USA, 503, 504
Aventis Pharma, 5
Average collection period ratio, 354
Avery, R. B., 375
Avila, Ramon A., 459
Avila, Stephen M., 459
Babaei, Ari, 214
Backward integration, 383
BAE Systems, 138
Bahls, Jane Easter, 162n
Bahls, Steven, 162n
Bainbridge International, 508
Baird, Douglas G., 459
Baker, Stephen, 248
Bandura, A., 61
Bank of America, 338
Bankrate, 449, 456
Bankruptcy
Chapter 7, 18, 448, 449, 450, 452
Chapter 11, 18, 448, 449–451, 453
Chapter 13, 448, 449, 452, 453
examples of, 448–449, 450
facing reality regarding, 456
involuntary, 452
keeping venture going during, 453–454
methods for surviving, 450–451
overview of, 447–448
provisions regarding, 449
reorganization strategies and, 453
INDEX
Page numbers followed by n indicate notes.
INDEX 585
starting over following, 455–456
types of, 448
voluntary, 452
warning signs of, 454–455, 457
Bankruptcy Amendments Act of 1984, 449, 450
Bankruptcy Amendments Act of 2005, 449, 452
Banks. See Commercial banks
Barbato, Robert, 15
Bargaining zone, 431
Barnes & Noble, 118
Barnett, James J., 277
Barnett, Steven T., 279
Barney, Jay B., 27, 87, 90
BarNir, Anat, 89
Baron, Robert A., 27, 59, 155
Baroncelli, Eugenia, 181
Barr, Kate, 329
Barrett, Mike, 121
Barriers to entry, 79
Barriers to international trade, 152–153
Barter, 135
Bassett’s Original Turkey, 418
Baucus, David A., 121
Baucus, Melissa S., 121
Baum, J. Robert, 406
Bazerman, Max, 431, 432, 435, 437
The Beach Carrier (Case Study), 492–495
Bean, Curtis, 417
Beauchamp, T. C., 33
Beech, Wendy, 250
Beer Chips, 297
Beijing Sammies (Case Study)
background of, 473–475, 477
charity sponsorship and, 475
competition and, 477
corporate clients and Sammies rewards and, 473–475
environment and, 477–479
income statements and, 478–484
introduction and, 470–473
Bekman, Jen, 272
Bell, Joseph, 376
BeneTrends, 321
Berger, Ron, 455
Berlew, F. K., 437
Bernier, Nathaniel, 454
Betros, Chris, 373
Biddulph, Jennifer. See Maxwell, Jennifer
Big-dream approach, 106
Bigelow, Fran, 271
Biggadike, R., 63
BillMatrix Corporation, 307
Biotechnology ventures, 344, 416
Birley, S., 62
BJ’s Wholesale Club, 255
Black, Joanne, 229
Blake, Stuart, 267
Blakely, Sara, 108
Blood, D. O., 183
Blue-sky laws, 369
Blum, Jonathan, 461
Board of advisors, 178, 274
Board of directors, 178, 273–274
Boden, Richard J., 59
Boeing/Mitsubishi/Fuji/Kawasaki, 422
Bogoslaw, David, 300
Bonding, 176
Bongiorno, L., 437
Book value, 352–353, 356
Booster Juice, 418
Boothe, Jim, 467–468
Bootstrap financing, 326–327
Borden, Gail, 455
Borders, 118
Boston Market, 210
Boulding, William, 87
Bower, G. H., 32
Bowie, N. E., 33
Boxer, Barbara, 342
Brainstorming, 100, 102, 105
Brainwriting, 100
Brand-name franchises, 417
Brazael, D. V., 62
Break-even analysis, 294–296
Break-even formula, 294, 295
Breakeven
explanation of, 294
graphic illustration of, 296
Breakthrough innovations, 25, 106–107
Bredin, Alice, 321
Breeding, Marshall, 216
Bremer, John, 214
Brin, Sergey, 272
Broad-scope strategy, 82
Brodsky, Norman, 302
Brodzinski, Carrie, 459
Brokers, 427, 445
Brown, A., 32
Brown, Paul, 302
Brown, T., 45n, 50n, 59, 63
Bruno, A. V., 32
Brush, Candida G., 31, 250
Bruton, Gary D., 87
Bryan, Lowell, 80
Bucar, Branko, 39n
Buckhan, Tom, 492
Budgets
for marketing action and strategy decisions, 246
operating and capital, 282–285, 288
Burger King, 418
Burmeister, Paul, 214
Burns, Cathleen S., 563n
Burnsed, Brian, 321n
Burton, John, 122
Busenitz, Lowell W., 27, 29, 89, 123
Bush, Robert P., 250
Business. See also Organizations
capital requirements for, 261–262
continuity of, 260
costs of starting, 260
exit strategy for, 442
legal advice about starting, 260
legal forms of, 258–263
options for selling, 444–447
ownership and, 258
succession of, 442–444
tax attributes of forms of, 263–265
turnaround measures for, 456–457
Business angels. See also Private investors
brands of, 341
characteristics of, 339–340, 342
explanation of, 337
statistics regarding, 337, 339–341
women as, 342
Business ethics, 21–23, 78. See also Ethics
586 INDEX
Business failure
causes of, 19
dual process of learning from, 21
economic implications of, 387
how to beat, 441
negative emotional reactions and, 19–20
recovery and learning process from, 20–21
statistics regarding, 18
Business Finance Turnaround Association, 457
Business method patents, 166–167
Business plan components
appendix as, 210
environmental and industry analysis as, 203–205
executive summary as, 202–203
financial plan as, 209–210
introductory page as, 202
marketing plan as, 208
operations plan as, 207–208
organizational plan as, 208–209
outline as, 200, 201
production plan as, 207
risk assessment as, 209
venture description as, 205–207
Business plans
development of, 7, 9
example of international, 156–157
explanation of, 189
financial information for, 199
implementation of, 7, 10
information needs for, 195–199
Internet as information source for, 199–200
lender and investor evaluation of, 192–194
market information for, 195–198
operations information for, 198–199
vs. opportunity assessment plan, 129
preparation of, 190
presentation of, 194
reasons for failure, 212
sample, 216–221
scope and value of, 191–192
use and implementation of, 210–212
Business Source Complete, 131
Business-to-business company marketing plan, 252
Business-to-business markets, 244–246
C. A. Litzler, 145
C corporation, 258, 265, 266
Caballero-Sanz, F., 181
Campbell, Andrew, 278
Capital. See also Financing
for franchise operations, 414
raised from family and friends, 312
required for new ventures, 261–262
Capital budgets
explanation of, 282, 285
for Internet start-ups, 288
Cardamone, Joseph R., 248
Cardozo, Richard N., 87, 111n
Carley, K., 409
Carnegie, Andrew, 38
Carrison, Dan, 389n
Carsrud, Alan L., 62
Carter, Adrienne, 342n
Carter, Richard B., 300
Cascioli, Teresa, 439–440, 453
Case Western Reserve University, 107, 321, 465, 525
Cash flow
direct method to project, 289, 291
indirect method to project, 289
management of, 290, 390–392
present value of future, 356
pro forma, 291–292
Cash flow financing, 314
Casualty insurance, 176
Causal process, 10–11
Celanese Corporation, 422
Celuch, Kevin, 250
Cenar, Kara E. F., 162
Census reports, 131
Center for Responsible Lending, 338
Center for Venture Research, 342
Center for Women’s Business Research, 43, 342
Chadha, Sumir, 370
Chakravarthy, Bala, 89
Chandler, Gaylen N., 155
Chang, Sea Jin, 435
Chanin, Natalie, 71
Channel strategy. See Distribution channels
Chapter 7 bankruptcy, 18, 448, 449, 450, 452
Chapter 11 bankruptcy, 18, 448, 449–451, 453
Chapter 13 bankruptcy, 448, 449, 452, 453
Character loans, 314
Charles River Ventures, 311
Chase, Robin, 274
Chaudhry, Rahul, 182
Checkers of America Inc., 417
Checklist method, 103
Checkmark Software Inc., 298
Chell, Robert, 192
Chen, J., 184
Chen, Roger R., 436
“Chess,” 484, 485, 486–487, 488, 491
Chiagouris, Larry, 214
Chow, K., 183
Chrisman, James, 406
Christianson, S., 32
Chu, Jeff, 279
Churchill, N. C., 331
Circulation Expertí, Ltd., 223–225
Cirtin, Arnold, 216
Cisco Systems Foundation, 370
Citigroup, 338
CitySearch, 412
Clark, Charles H., 123
Clark, Lawrence S., 461
Clarke, Geri, 214
Clayton Act, 428
Clean-energy trend, 96
Clearstone Venture Partners, 370
Cloutier, George, 290n, 441n
Clyman, John, 216
COBRA, 177
Code of ethics, 23. See also Ethics
Cognitive adaptability
explanation of, 13
function of, 18
method to determine, 13, 15–17
method to increase, 13, 15, 17–18
Coleman, H. D., 166n
Coleman, Susan, 59
Collective notebook method, 103, 105
Collegiate Entrepreneurs’ Organization, 131
Collins, J. M., 90
Columbia University, 344
Comment letter, 369
Commercial banks
cash flow financing from, 314
lending decisions by, 314–315
INDEX 587
loans from, 312–313
new credit lines from, 338
Commercial Marine Products, 79
Communication, with employees, 398
Compensation, 274
Competition
analysis of, 225–226
competitive company and product information, 131
identification of, 204
pricing and, 242
Competitive advantage
of first movers, 73
resources as source of, 67–68
Comprehension questions, 13, 15
Computertots, 418
Concept stage, 114, 116–117
Conley, William, 306
Connection tasks, 15, 17
Consignment financing, 327
Consortium for Entrepreneurship Education, 131
Consumer markets, 244–246
Consumer Product Safety Act of 1972, 175
Consumer Product Safety Commission, 175
Consumer products company marketing plan, 251
Consumers, 97, 109
Contracts
conditions of, 178–179
explanation of, 178
international entrepreneurship and, 136–137
management, 149
Conventional bank loans, 314
Cooney, Thomas M., 277
Cooper, A. C., 62
Cooper, Marjorie J., 248
Copyrights. See also Intellectual property
explanation of, 170
licensing of, 173
Corbett, Andrew, 60
Core values
establishment of, 272
ethics as, 23
Corporate entrepreneurship
causes for interest in, 48, 50–51
culture establishment for, 51–53
establishment of, 54–57
explanation of, 51
leadership and, 53–54
problems related to, 56–57
Corporate venturing, 51, 343
Corporations
C, 258, 265, 266
capital requirements for, 262
continuity in, 260
creation of, 260
explanation of, 258
legal factors in, 259
management control in, 262
profit and loss distribution in, 263
raising capital for, 263
S, 258, 265–266, 444
tax issues for, 264, 265
transfer of interest in, 261
Cosmos Ignite Innovations, 370
Costco Wholesale Corporation, 118, 255–256
Costs
advantages in franchising, 415, 417
of going public, 363–364
management of, 394–395
pricing and, 241
start-up, 260
switching, 79
Cova, B., 32
Covin, J. G., 32, 60, 61
Cox, Keith K., 122
Coy, Peter, 63
Craig, Justin, 123
Cravalho, Ernest G., 33, 123
Craymer, Judy, 484–485, 488, 489–490, 491
Creative problem-solving techniques
attribute listing as, 105
big-dream approach as, 106
brainstorming as, 102
checklist method as, 103
collective notebook method as, 103, 105
forced relationships as, 103, 104
free association as, 103
function of, 101–102
Gordon method as, 102
parameter analysis as, 106
reverse brainstorming as, 102
Creative synthesis, 106
Creativity, 99, 101–102. See also Ideas
Credit default swaps (CDSs), 338
Cromley, Timothy, 182
Cronin, Michael P., 331
Cruickshank, Nancy, 329
CSO Insights, 229
Culture. See also Entrepreneurial culture
corporate, establishment of, 51–53
economics and economic philosophy and, 141
education and, 141
in entrepreneurial firms, 48
ethics and, 22
evaluating changes in, 203
international entrepreneurship and, 138–140, 143
manners and customs and, 141
political philosophy and, 141
religion and, 141
social structure and, 140
Cummings, L., 62
Curhan, Jared R., 435
Current account, 135
Current ratio, 353–354
Curry in a Hurry restaurant, 10–12
Curves for Women, 418
Customer base, expanding, 229
Customer loyalty, 79
Customs, 141
Cyert, R. M., 437
Cyr, Linda A., 330
Dagoba Organic Chocolate, 445
Dahl, Darren, 329
Daniels, Chris, 461
Danneels, Erwin, 406
Dannhauser, C., 461
Datavantage Corporation (Case Study)
background of, 572–574
business model and, 577–578
customers and, 575–576
financing and, 578, 580–581
help desk/call center and, 577
industry/competition and, 574
management culture and, 578–579, 581–582
retail industry current needs and, 574–575
sales and marketing and, 576–577
target market and, 573–574
XBR loss prevention software and, 575
588 INDEX
Dataworkforce, 80
Davidsson, P., 45n, 50n, 59, 62, 63, 406, 408
Davis, B., 376
Davis, James, 459
Day, G. S., 90
Day, Kathleen, 338
Dayton Hudson, 151
De Castro, J. O., 62
Deal structure, 359
Dealership franchises, 417
Debelak, Don, 427n
Debt financing, 308–309
Debt ratio, 354
Debt-to-equity ratio, 355
Defensive Publication Program (U.S. Patent and Trademark Office), 164
Delaney, Laurel, 373
Delegation, 399
Dell Computer, 75, 168, 236, 240–241, 243, 244
Delmar, Frédérick, 406, 408
Deloitte Technology, 168
DeLuca, Fred, 415
Demand uncertainty, 75
DeMarie, Samuel M., 28, 31
DeMarse, Elizabeth, 449
Demographic markets, 382
Dennison, R., 31
Depoorter, Ben, 182
Design Edge, 401
Design patents, 163–164
Desire principle, 400
Dess, Gregory G., 60, 63, 90
Detamore-Rodman, Crystal, 331
DeTienne, D. R., 62, 155
Development Corporation, 107
Development financing, 336, 337
DeviceAtlas, 174
Diamond Chain, 151
Diaz, Katherine A., 215
Dibb, Sally, 248
Diener, Marc, 419n
Dietmeyer, Brian J., 435
DiGiantommaso, Robert M., 279
DigiBee Microsystems, 370
Dino, Richard N., 407
Direct exporting, 148
Disbursements, 211
Disclosure document, franchise, 420, 421
Disclosure document, patents. See Provisional patent application
Disclosure Document Program (U.S. Patent and Trademark Office), 164
Disney Corporation, 174, 382
Distribution, 242–244
Distribution channels
importance of, 98
international entrepreneurship and, 142
strategy for, 242–244
Distribution tasks, 430
Diversification strategies, 383–385
Diversified activity merger, 151
Dividends, capacity to pay, 353
Dodwell, William J., 182
Doriot, Georges, 342
Douglas, Evan J., 62, 402, 460
Dow Chemical, 423
DreamWorks, 174
Drucker, Peter, 285
Dual Pane Company (Case Study), 582–583
Dual process for learning from failure, 21
Due diligence, 349, 358
Duffner, Stefan, 374
Duffy, Bobby, 214
Dunkelberg, W., 62
Durant, William, 38
Dyer, Linda M., 60
E-commerce
creative use of, 118, 272
entrepreneurial companies involved in, 119–120
explanation of, 117
online service marketplaces, 132, 133
statistics regarding, 117, 200
tracking customer information and, 119
Web sites and, 118–119
Earley, C., 31
Early-stage financing, 336–337
Earnings approach, 356
eBay, 166–167, 370
Echambadi, R. A. J., 437
Eckert, Robert, 285
Economic development
role of entrepreneurship in, 23–25
stages of, 134–135
Economic trend, 97
Economies of scale, 151
Economy
business failure and, 387
evaluating trends in, 203
international entrepreneurship and, 134, 141
valuation process and, 352
Eddleston, Kimberly, 60
Edison, Thomas, 106, 455
Education
of entrepreneurs, 38–39
international entrepreneurship and, 141
Edwards, M. O., 123
Effectiveness principle, 400
Effectuation
examination of, 10–11
explanation of, 10
function of, 11–12
Effectuation process, 10
Efficient consumer response (ECR), 392
Eisenhardt, Kathleen, 436
El-Hagrassey, Galal M., 89
Elance, 132, 133
Electronic data interchanges (EDIs), 392
Ellentuck, Albert B., 277, 279
Elliehausen, G. E., 375
Elonso, B., 376
Emerging industries, 75
Eminence Style, 450
Employee stock option plan (ESOP), 442, 446
Employees
communication and, 398
esprit de corps and, 399
feedback to and from, 399
interviewing and hiring, 269
management of, 388, 397–401
team spirit, 398
training for, 399
Engardio, Pete, 133n
Ennew, C., 62
Enron, 112, 177, 361, 389
Ensley, Michael D., 155
EntertainNet, 412
Entrepreneurial action, 7
Entrepreneurial culture
corporate, establishment of, 51–53
nature of, 48
INDEX 589
Entrepreneurial entry strategies. See also New entries
direct foreign investment as, 149–151
exporting as, 147–148
international entrepreneurship and, 147–151
nonequity arrangements as, 148–149
Entrepreneurial intentions
within existing organizations, 45
explanation of, 38
Entrepreneurial management
commitment and control of resources and, 46–47
culture and, 48
growth orientation and, 48
management structure and, 47
measurement of, 48, 49–50
reward philosophy and, 47–48
strategic orientation and, 46
traditional vs., 45
Entrepreneurial mind-set, 13
Entrepreneurial orientation
toward commitment of resources, 46–47
toward control of resources, 47
toward culture, 48
toward growth, 48
toward management structure, 47
toward opportunity, 46
toward resources, 47
Entrepreneurial philosophy toward rewards, 47–48
Entrepreneurial process
business plan development phase of, 7, 9
enterprise management phase of, 7, 10
ethics and, 22
explanation of, 7
opportunity identification phase of, 7–9
resource determination phase of, 7, 9
Entrepreneurial resources, 68–69
Entrepreneurial self-efficacy, 38
Entrepreneurial strategy, 67
Entrepreneurial teams. See Teamwork
Entrepreneurs
age of successful, 40
challenges and opportunities for, 7–8
cognitive adaptability of, 13, 15–18
definition of, 6–7
educational level of, 38–39
effectuation by, 10
ethics and social responsibility of, 21–23
expanding customer base, 229
failure, ability to learn from, 18–21
as innovators, 80
interest in, 6
from minority groups, 43–45
opportunity assessment plan and, 129
partnering of, 151–152
role models and support systems for, 40–43
skills assessment of, 190
women as, 43–44
work history of, 40
Entrepreneurship. See also Corporate entrepreneurship; International
entrepreneurship
definition of, 6–7
economic development and, 23–25
of minorities, 43–45
Environmental analysis
critical issues for, 205
explanation of, 203–204
Environmental issues, 243
Environmental trends
evaluation of, 196–197
marketing plan and, 234–236
Equipment loans, 313
Equity financing, 309
Equity participation, 341
Equity partnership, 319
Equity pool, 341
Erikson, Truls, 87
Error of commission, 72
Error of omission, 72
ESPN, 159, 160
Esprit de corps, 399
Estridge, Philip, 57
Ethics
accounting fraud and, 177–178, 360–361, 389
American attitudes on, 22
business ethics, 22–23, 78
code of ethics, 23
of entrepreneurs vs. managers, 39
illegal downloading on Internet, 171
international entrepreneurship and, 138, 139
leadership and, 112–113, 284–285, 316–317
negotiating and, 419
partnerships and, 267
regarding financially troubled ventures, 447
sales and, 236
social responsibility of entrepreneurs and, 21–23
Euromonitor, 131
European Community (EC), 153
Evalueserve, 132
Ewing Marion Kauffman Foundation, 5, 130, 131, 341, 342
Exit strategy, 442
Expedia, 167
Exporting, 147–148
External environment
explanation of, 235
first movers and, 74–75
Facebook, 97, 333–336
Facemash, 333
Factor approach, 356–357
Factors in valuation, 352–353
Failure. See Business failure
Family
as source of capital, 312
transfer of business to, 443
Farrell, Christopher, 329
Fast, N. D., 63
FastTrac, 130
Feasibility, 38
Fed-Mart, 255
Federal Express, 93–95
Federal Trade Commission, 420
Feedback, employee, 399
Feltham, Glenn, 277
Feltham, Tammi S., 277
Ferrarone, Christopher, 470n, 484n
Ferriss, Timothy, 133
Fertuck, L., 331
Ferziger, Rubin, 267
Fetterman, W. H., 461
Fiat, 135
Fiegener, Mark K., 278
Fifth Third, 338
Final approval stage, venture capital, 350
Financial control
cash flow management and, 290, 390–392
cost and profit management, 394–395
fixed asset management and, 393
inventory management and, 392–393
overview of, 388–389
590 INDEX
Financial control—Cont.
record keeping and, 396
tax management and, 395–396
Financial Industry Regulatory Authority (FINRA), 363, 366–367
Financial plans
break-even analysis and, 294–296
elements of, 199, 235
explanation of, 209–210, 282
operating and capital budgets and, 282–285
pro forma balance sheet and, 292–294
pro forma cash flow and, 288–292
pro forma income statements and, 285–288
pro forma sources and applications of funds and, 296–297
software packages for, 298
Financial ratios, 353
Financing
bootstrap, 326–327
from capital from family and friends, 312
from commercial banks, 312–315
consignment, 327
deal structure and, 359
debt, 308–309
equity, 309
from external funds, 310
from 401(k)s, 321
from government grants, 320–323
informal risk-capital market and, 337, 339–341
from internal funds, 309–310
methods for, 261–263
overview of, 336
from personal funds, 310–312
from private investors, 324–326
from research and development limited partnerships, 318–320
from Small Business Administration, 315–318
stages of, 336–337
valuation issues and, 352–359
venture capital and, 341–352
Finder’s fee, 192
Fink, Carsten, 181
Fiol, C. Marlene, 88
Firestone, Paul, 239
First movers
competitive advantage of, 73
customer uncertainty and, 76–78
disadvantages of, 74–75
environmental instability and, 74–76
lead time and, 78–79
First, Tom, 244
Fischer, Eileen, 407
Fiserv Inc., 307
Fixed assets, 393
Fletcher, Joseph, 138
Florida, Richard, 99
Floyd, Steven, 60
Focus groups, 99–100, 232
Folta, T. B., 62
Foo, Maw Der, 28, 88, 123
Foote, P. S., 184
Forced relationships, 103, 104
Ford, C. M., 62
Ford, Henry, 38, 238
Ford Motor Company, 229
Foreign Corrupt Practices Act (FCPA), 138
Form S-1, 367, 368
Fortune Small Business, 193
Forward integration, 383
Foster, M. John, 156
401(k)s, financing from, 321
Fox, 174
Fox Sports Network, 160
France, M., 182
Franchise Rule (Federal Trade Commission), 420
Franchisee
advantages of franchising to, 413–415
capital requirements and, 414
disadvantages for, 417
knowledge of market and, 414
management expertise and, 413–414
operating and structural controls and, 414–415
product acceptance and, 413
training for, 413–414
Franchising
advantages of, 413–415, 417
disadvantages of, 417
explanation of, 413
function of, 412
as imitation strategy, 83
investment in, 418–421
trademark licensing and, 173
types of, 417–418
Franchisor, 413
advantages of franchising to, 415, 417
cost advantages for, 415, 417
disadvantages for, 417
expansion risk and, 415
Francis, Theo, 338n
Franklin, Neil, 80
Fraser, J., 408
Fraud, accounting, 177–178, 360–361, 389
Free association, 103
Free Trade Area (FTA), 152–153
Freeman, R. E., 33
Fried, Vance H., 376
Friends, as source of capital, 312
Fritz, K., 183
Frost and Sullivan, 131
Fry, Arthur, 56
Full and fair disclosure, 366
TheFunded.com, 311
Gaglio, Connie Marie, 28, 62, 123
Gahagan, Jim, 300
Gale Directory Library, 131
Gallagher, Scott, 436
Gallo, Ray, 267
Gambhir, Sahil, 216
Game Trust, 311
Gannon, M., 375
Gartner, 131
Gartner, W. B., 31, 406
GC Micro Corporation, 187–188
GC Micro Corporation v. the Defense Logistics Agency, 188
Geiger, Scott W., 330
Genentech, 320
General Agreement on Tariffs and Trade (GATT), 152, 164
General Electric (GE), 113–114, 139, 422
General Foods, 101
General Motors, 422
General partners, 318–319
General valuation approaches, 355–357
General valuation method, 357–358
Geographical markets, new, 382
George, Bill, 139n
George, Gerard, 28, 435
Gesiko, Agnes, 278, 279
Gifford, Sharon, 28
Gilbert, A., 32
Gimeno, J., 62
INDEX 591
Gimmon, Eli, 329
Gioia, D. A., 62
Global business. See International business
GlobeTask, 133
Glover, Dana, 563n, 582n
GNP Inc., 412
Going public
advantages of, 360–361
aftermarket support following, 369, 370
costs of, 363–364
disadvantages of, 360, 362–364
explanation of, 359
legal issues related to, 369
registration statement and timetable and, 366–369
relationship with financial community after, 370–371
reporting requirements after, 371
timing of, 364–365
underwriter selection and, 365–366
Goldsborough, Reid, 249
Goldsmith, Marshall, 113n
Gonen, Ron, 416
Goodwin, Stephen, 250
Google, 271
Goold, Michael, 278
Gopalakrishnan, Kris, 361n
Gopher It business plan, 216–221
GoPicnic, 273
Gordon method, 102
Gourmet To Go (Case Study)
background, 495–496
financial information and, 497–502
future growth and, 496
industry and, 496–497
management and, 502
manufacturing and packaging and, 496
marketing and, 502
sales prediction and, 497
Government
information sources from, 131–132
as source of ideas, 98
Government grants
explanation of, 320, 322
facts on, 323
procedure for, 322–323
training grants, 323
Government-Owned Inventories Available for License
(U.S. Patent and Trademark Office), 98
Granger, C., 62
Grants. See Government grants
Green, Beverly, 44
Green trend, 96
Greenhouse, S., 279
Grey, S., 183
The Gril-Kleen Corporation (Case Study), 509–515
Grokster, 170
Gross, Bill, 411–412
Ground Round Grill & Bar, 448–449
Grousbeck, H. Irving, 31
Grove, Andrew S., 14
Growth
economic implications of, 385–387
financial control and, 388–396
of firms, 387–388
implications for entrepreneur, 401–403
pressures on employee management and, 397–401
pressures on existing financial resources and, 388
pressures on existing human resources and, 396–397
time pressures and, 399–401
Growth orientation, 48
Growth strategies
diversification, 383–385
example of, 385
market development, 382
overview of, 380–381
penetration, 381
product development, 382
Gruber, Karen, 210
Guadarrama, Belinda, 187–188
Guidant Financial Group, 321
Gulati, Ranjay, 435
Gull, Nicole, 279
Gumpert, David E., 63, 216
Gupta, A. K., 90
Gupta, Sumeet, 249
Gurock, Eli, 453
Gurock, Sheri, 453
Guru.com, 132, 133
Gustavsson, Helena, 406
Gustofson, Anna, 96
Guterman, E., 32
Haas, Jill, 210
Hackman, J. R., 279
Haefele, J. W., 123
Hahn Loeser & Parks LLP, 257
Hair, Joseph F., Jr., 250
Hall, Jeremy, 406
Halpern, S. W., 183
Hamel, Gary, 122
Hampton Inn/Suites, 118
Hamstra, Mark, 279
Haner, F. T., 428n
Hanes Corporation, 108
Hansen, Corey, 279
Hanson, Randall, 461
Hanson, Robin, 99n
Harding, Harold F., 123
Harrigan, Kathryn Rudie, 437
Harris, S. G., 32
Harrison, Jeffrey S., 437
Harrison, Sam, 122
Harriston, Michael, 572n
Hartley, S., 250, 301, 302
Hatemi, Abdulnasser, 406
Hatfield, Louise, 436
Hayeck, F. A., 408
Haynie, J. Michael, 13, 16, 17n, 31, 32, 88
Hayton, James C., 28
Head Ski Company, 385
Headd, Brian, 59
Health, and time management, 400
Health care insurance, 176–177
Health Insurance Association of America, 177
Health trend, 97
HealthSource Chiropractic, 418
Heavin, Gary, 418
Heesen, Mark, 416
Heffes, Ellen M., 182
Heilbrunn, Sibylle, 330
Heineman, Ben, 139
Heintz, Nadine, 461
Helfert, E. A., 302
Hempel, Jessie, 375
Heng, Xu, 249
Henricks, Mark, 15n, 80n, 214, 216, 384n
Herron, Lenny, 123
Hershey Company, 445
Hewlett-Packard (HP), 56–57
592 INDEX
Higginbotham, James B., 122
Higgins, Monica C., 435
Hill, Katie, 370
Hillenbrand Industries, 151
Hillman, Alan L., 89, 90
Hilzenrath, David S., 278
Hiring plan, 272
Hispanic Americans, 44, 187
Hisrich, Robert D., 31, 39n, 63, 111n, 115n, 116n, 122, 123, 250, 331, 375,
376, 437, 525n
Hitt, Michael A., 28, 31, 90, 409
Hmieleski, Keith, 60
Hoang, H., 62
Hoechst Marion Roussel, 5
Hoffman, Ivan T., 409
Hoffman, John, 459
Hoffman, William, 216
Hogan, Mike, 42n
Holden, Stephen, 492
Holland, Amanda, 525n
Holmberg, Stevan R., 436
Holt, Knut, 123
Home-based businesses, 177
Honig, Benson, 59, 62
Hoovers, 131
Hopkins, David S., 238n, 251n, 252n, 253n
Horizontal integration, 384–385
Horizontal merger, 150
Hornsby, Jeffrey, 61
Hoskisson, R. E., 90, 409
Hot & Cold Inc., 290
HourPower, 143
House, Charles, 56
Hsieh, Tony, 278, 281–282
Hsupply.com, 19
Huffman, F., 437
Huggins, Kenneth, 376
Hughes, Chris, 333
Human resources, 388, 396–397
Human, Sherrie E., 121
Hwang, Jeffrey, 416
IBM, 57, 174
Idea stage, 114
Idealab, 411–412
Ideas. See also Creativity
creative problem solving for, 101–106
innovation and, 106–110
methods of generating, 99–101
need for new, 99, 114, 115
opportunity assessment plan and, 129–130
protection of, 194
sources of new, 97–98
trends influencing, 96–97
value of, 114, 116
IKEA, 397
Imitation strategies, 82–84
Inc. magazine study, 385–387
Indirect exporting, 148
Industry analysis
competitor analysis as element of, 225–226
critical issues for, 205
explanation of, 204–205
function of, 225
Industry demand, 204
Industry-university agreements, 422
Informal risk-capital market
angels involved in, 339–341, 342
explanation of, 337
profile of, 337, 339
Information, market, 131
Information sources
competitive company and product information, 131
for foreign market selection, 146
general information, 130–131
government sources, 131–132
industry and market information, 131
search engines, 132, 200
trade associations, 132
trade publications, 133
Infosys (INFY), 361
Initial public offering (IPO)
exit strategy and, 442
explanation of, 362
Robert Mondavi Winery and, 36–37
transferring or selling business through, 447
underwriting and, 363, 370
Inner-city revitalization, 25
Innovation. See also Technological innovations
advice about, 80
corporate venturing and, 51
defining new, 108–109
explanation of, 106
federal grants for, 320, 322–323
new product classification and, 109–110
product evolution and, 24–25
techniques for, 104–105
types of, 25, 106–108
Innovators, 80
Installment loans, 314
Insurance, 175–177
Integration
backward, 383
forward, 383
horizontal, 384–385
Integration tasks, 430
Intel, 343
Intellectual property
advice regarding, 162
attorneys and, 161, 163
copyrights as, 170
explanation of, 136, 161
licensing of, 173–175
patents as, 163–167
trade secrets as, 171–173
trademarks as, 167, 169–170
Internal environment, 235–236
International business
entrepreneurial entry strategies for, 147–151
entrepreneurial partnering as, 151–152
example of business plan for, 156–157
importance of, 134
market selection for, 144, 146
motivations for, 142–143
overview of, 127–128
strategic effects of, 143–144
International entrepreneurship
culture and, 138–141
distribution systems and, 142
domestic entrepreneurship vs., 134–137
ethics and, 138, 139
explanation of, 133–134
family businesses and, 145
implications for, 153
international trade barriers and, 152–153
micro-multinational businesses, 132, 133
technological environment, 137
International entry strategies. See Entrepreneurial entry strategies
International patents, 164
International trade barriers, 152–153
INDEX 593
Internet. See also E-commerce; Web sites
business plan information on, 190
as business plan resource tool, 199–200
educational information on, 245
growing into new markets using, 384
illegal downloading on, 170, 171
online service marketplaces, 132, 133
search engines, 132, 200
shopping companies, 281–282
surveys on, 230
trading links on, 245
Internet companies
capital budget for start-up, 288
valuation of, 358–359
Intervela d.o.o. Koper—Victory Sailmakers (Case Study)
background and, 502–504
cutter decision and, 504–505
Elan and, 505–506
future plans and, 509
Gaia Cube project and, 506
international production and, 507–509
Kutin sail loft and, 505
marketing strategy and, 504, 508
promotion and marketing and, 507–508
sails and, 506–507
staff, outsourcing, and reorganization, 508–509
Interviews, 230
Invacare Corporation, 125–127
Invention process, 106
Inventors, 164
Inventory control, 211
Inventory loans, 313
Inventory management, 392–393
Inventory turnover ratio, 354
Investors. See Business angels; Private investors
Involuntary bankruptcy, 452
Ireland, R. Duane, 28, 31, 60, 61, 90, 409
IRX Therapeutics, 416
Iterative synthesis, 25
J. Walter Thompson, 210
Jack, Sarah, 60
Jackson, Garrison, 224, 250
Jackson, Jay, 195
Jackson, Kirk, 460
Jackson, Warren G., 223–225
Jankowicz, A. D., 331, 376
Janney, Jay, 60
Jansson, David G., 33, 123
Jarillo, J. Carlos, 61
Javorcik, Beata, 181
JBS Associates, 192
JC Penney, 143
Jelaca, Pam, 273
Jen Bekman Gallery, 272
Jennings, Marianne, 461
Job satisfaction, 399
Jobs, Steven, 50, 127, 272
Johannisson, B., 62
Johnson & Johnson (J&J), 112, 113, 125, 126
Johnson, Catherine, 488
Johnson, E. Scott, 182
Joint ventures
explanation of, 421–422
factors in success of, 423–424
international, 149–150, 422–423
research and development limited partnerships and, 319
types of, 422–423
Jones, Craig, 300
Jones, Pearce, 401
Jordan, Charles E., 300
Jordan, Scott, 398
JPMorgan Chase, 338
Jungle Jim’s Playland, 418
Jupiter Media Matrix, 384
Justis, R. T., 331
Kalakota, Ravi, 19
Kamath, J. P., 183
Kamei, Kajigailiu G., 182
Kamprad, Ingvar, 397
Kanimuri, K., 370
Kanter, R. M., 63
Kaplan, Steven N., 374
Kapor, Mitch, 412
Katila, Riitta, 436
Katz, Jerome, 28, 88, 90
Kauffman, Ewing Marion, 3–5
Kauffman Foundation. See Ewing Marion Kauffman Foundation
Kaufmann, D. J., 437
Keats, Barbara W., 28, 31
Keh, Hean Tat, 28, 88, 123
Kelleher, Herb, 401–402
Kelly, Michael P., 279
Kenefake, Maggie, 342
Kenis, Patrick, 436
Kerin, R., 250, 301, 302
Kerr, John, 376
Keshan, Amit, 133
Key success factors, 74–75
Khosla, Vinod, 370
Kimberly, John R., 89, 90
KinderCare, 418
Kindley, M., 461
King, Martin Luther, Jr., 54
Kirchhoff, Bruce, 406
Klaerner, Gerrit, 416
Klein, Karen E., 192n, 229n, 267n
Kleinberger, Daniel S., 279
Kluwe, R. H., 32
Knight, F. H., 90
Knoke, David, 436
Knowledge, 69–71
Knowledge Adventure, 412
Kocak, Akin, 249
Kooser, Amanda C., 42n
Kopin, Sheldon, 192
Kopit, Alan S., 257
Kotler, Philip, 11
Koven, Peter, 461
Kraft, 210
Kramarski, B., 32
Kreuger, Norris F. J., 61, 62
Kuemmerle, Walter, 61
Kuratko, Donald F., 32, 60, 61, 216
Kushnirovich, Nonna, 330
LaBarre, Polly, 122
Labatt Brewing Company Ltd., 440
LaCugna, J. R., 90
LaGesse, David, 279
Lakeport Brewing, 439–440, 453, 456
Lakes Entertainment, 160
Lakhani, Dave, 14–15
Lakshman, Nandini, 370n
Lament, L. M., 461
Landau, Zev, 279
Landström, H., 62
Lane, Peter, 60
Language use, 137
594 INDEX
Lant, Theresa, 29
Larson, A., 62
Latham, Scott, 460
Lawler, E. E., III, 279
Lawyers. See Attorneys
Lawyers.com, 257
Lazarus, Bruce, 492
Lead time, 78–79
Leadership characteristics, 53–54
Lear, Norman, 159
Lear, William, 38
Legal issues
anticipation of, 203–204
finder’s fee, 192
forms of business, 258–263
for international entrepreneurship, 135–137
related to going public, 369
in setting up organizations, 163, 257
Lehmann, Donald R., 249, 250
Leiber, Nick, 272n
LeMieux, Aaron, 451
Lerch, Renata L., 249
Leverage ratios, 354–355
Leveraged buyout (LBO), 429–430
Lévesque, Moren, 62, 88
Levisohn, Ben, 338n
Lewis, V. L., 331
Li, Yao Tzu, 33, 123
Liabilities
of business owners, 258–260
explanation of, 293–294
of newness, 84
Licensing
as entrepreneurial entry strategy, 148
explanation of, 173
revenue through, 173–175
Lichtenstein, Benyamin B., 88, 90
Lieberman, Marvin B., 88, 90
Life insurance, 176
Lim, Boon Chong, 28, 88, 123
Limited liability company (LLC)
advantages of, 268
characteristics of, 267–268
explanation of, 258
liability in, 259–260
S corporation vs., 265
succession in, 444
tax issues for, 264, 268
Limited liability partnership (LLP)
continuity in, 260
explanation of, 258
liability in, 259–260
management control in, 262
profit and loss distribution in, 263
tax issues for, 264
transfer of interest in, 261
Limited partners, 318
Lindmark, L., 408
Lindsay, Noel J., 123
LinkExchange, 281
Lipscomb, Steve, 159–160
Liquidation. See Chapter 7 bankruptcy
Liquidation value, 357
Liquidity ratios, 353–354
Litzler, Matt, 145
Liu, Chung-Chiun, 107
Living and Learning, 418
Lloyd, Phyllida, 488
Loans
character loans, 314
from commercial banks, 312–313, 338
conventional bank, 314
installment loans, 314
long-term loans, 314
Small Business Administration, 315–318
straight commercial loans, 314
Locke, Edwin A., 406
Long, R. A., 3–4
Long-term loans, 314
Longevity Alliance, 97
Lorsch, J. W., 279
Loss-orientation, 20, 21
Lubatkin, Michael H., 407
Lumpkin, G. T., 63, 88, 90
MacMillan, Ian, 29, 31, 376
Macrae, John, 214
Macy, Rowland Hussey, 455
Madan, Sanjay, 281
Madden, Terry, 321
Madden, Tim, 321
Maddock, G. Michael, 105n
Maddy, Monique, 460
Madoff, Bernard L., 316
Mail surveys, 230
Majority interest, 150
“Mamma Mia!” The Little Show That Could! (Case Study), 484–492
ABBA and, 485–486, 488
background and, 484–485
Broadway and, 490–491
as business, 491
“Chess” and, 486–487
London theater and, 487–488
road show and, 489–490
Management. See also Entrepreneurial management
commitment to corporate entrepreneurship, 55
as element of marketing plan, 235
participative style of, 397
Management buyout, 446–447
Management contracts, 149
Management structure, 47
Management team
development of, 257
function of, 271–272
Managing newness strategy, 84–85
Managing underwriter, 365–366
Mangelsdorf, Martha E., 386n, 408
Manners, 141
Manufacturers’ Agents National Association, 229
Manufacturing budget, 283
Manufacturing operations, 198–199
Marcial, Gene, 168n
Margins, 241–242
Marino, Louis, 436
Marion Laboratories, 4–5
Marion Merrill Dow, Inc., 5
Market
explanation of, 11
franchisor knowledge of, 414
opportunity assessment plan and, 129
selection of foreign, 144, 146
Market development strategies, 382, 385
Market extension merger, 151
Market information, 131, 195–198
Market knowledge, 69–70
Market potential, 195–196
INDEX 595
Market scope strategies
broad-scope, 82
narrow-scope, 81–82
Market segmentation, 238–239
Marketing, 120, 240
Marketing mix
critical decisions for, 237
explanation of, 236–237
Marketing plans
characteristics of, 233–236
examples of, 251–253
explanation of, 234
flowchart of, 238
function of, 232–233
implementation of, 246
importance of, 208
industry analysis and, 225–226
marketing mix and, 236–237
marketing research and, 226–232
monitoring of, 246
steps to prepare, 237–246
Marketing research
analyzing and interpreting results of, 232
defining purpose or objectives for, 227
explanation of, 226
gathering primary source data for, 229–232
gathering secondary source data for, 227–228
Marketing strategy
budgeting and, 246
consumer products vs. business-to-business products and, 244–246
distribution and, 242–244
explanation of, 240
pricing and, 241–242
product or service and, 240–241
promotion and, 244
Marketing system, 234, 235
Markman, Gideon D., 59
Markowitz, Stephen, 15
Marks, Alan M., 300
Markups, 241–242
Markus, Christen, 87
Marone-Cinzano, Enrico, 71
Marr, M., 183
Marshall, Jeffrey, 182
Marshall, Samantha, 290n, 441n
Maslin, Janet, 492
Mason, Colin, 215
Matherne, Brett P., 215
Matson, E., 437
Mattel, 151, 285
Matthews, G., 32
Maxwell, Brian, 379–380
Maxwell, Jennifer, 379–380
McCall, Kimberly L., 236n
McClatchey, Christine, 376
McConnell, J., 437
McDonald’s, 83, 150, 174, 413, 418
McDougall, Patricia, 29
McEvily, Susan K., 89
McGrath, Rita, 19, 29, 31, 32, 408
McLaughlin, Molly K., 216
McMullan, Ed, 406
McMullen, Jeffery S., 29, 31, 32, 88, 90
McQuarrie, E. F., 32
“Me-too” strategy, 83–84
Medical insurance, 176–177
Medtronic (MDT), 76, 139
Meetup, 272
Mehta, Stephanie N., 279
Mentors, 41–43
MercExchange, 167
Mergent, 131
Mergers
determining value of, 429
explanation of, 428
in international business, 150
motivations for, 428
objectives, 428–429
transferring or selling business through, 447
types of, 150–151
Messmer, Max, 23n
Mevarech, Z. R., 32
Michael, Steven C., 436
Micro-multinational businesses, 132, 133
Microelectronics and Computer Technology Corporation (MCC), 422
Microsoft Corporation, 173–174, 281, 412
Facebook and, 335
Microsoft Corporation/NBC Universal, 422
Microsoft Excel, 298
Microsoft Office Accounting, 298
MightyLight, 370
Miller Brewing, 151
Min, Sungwook, 89
Minority interest, 149
Minority-owned businesses, 44–45, 188
Minority small-business investment companies (MESBICs), 343
Mises, L. V., 31
Mission statement
explanation of, 205
in marketing plan, 236
MIT, 344
Mitchell, Ron, 29
Mixon, A. Malachi, III, 125–127
MJ Media, 427
Mochari, I., 409
Mohanty, Soumendra, 215
Mondavi, Robert G., 35–37
Moner-Colonques, R., 181
MoneyTree, 416
Monsanto, 343
Montgomery, David B., 88, 90
Moore, John, 492
Moral-support networks, 41
Moran, Gwen, 250
Morgan, Howard, 113
Morgan, J. P., 419
Morgan, Kathryn Boe, 436
Morris, Michael, 249
Morrison, Edward R., 459
Morrison, Jennifer, 461
Morrissey, Brian, 301
Morse, Eric, 29
Mosakowski, E., 31
Moskovitz, Dustin, 333
Mount, I., 184
Murphy, Anne, 331
MySpace, 97
Naffziger, Douglas W., 459
Nanotechnology, 42, 107
Nantell, T. J., 437
Nantucket Nectars, 244
Napster, 170
Narasimba, Subba, 376
Nard, C. A., 183
Narrow-scope strategy, 81–82
596 INDEX
National Aeronautics and Space Administration (NASA), 322
National Association of Small Business Investment Companies, 130
National Business Incubation Association, 130
National Science Foundation (NSF), 322
National Securities Markets Improvements Act of 1996, 369
National Testing Centers (NTC), 465, 466
National Trade Data Bank (NTDB), 146
National Venture Capital Association, 130, 350, 416
Native Americans, 44
Nature Bros. Ltd. (Case Study)
background of, 550
new product development and, 557
objectives and, 552–554, 556
plant and equipment, 557
present situation and, 550–551
projections and, 552–557
Nature’s Formula, 307
NBC Universal, 174
Neale, Margaret A., 431, 432, 437
Negotiation
assessments for, 431–432
honesty and deception in, 419
strategies for, 426, 432–433
tasks for, 430–431
NeoMed Technologies (Case Study)
background of, 525–528
business model and, 530–531
CAD diagnostic procedures and, 528
company situation and, 532–534
competition and, 530
conclusions and, 539
coronary artery disease and, 527–528
financing and, 534–535
nuclear diagnostic imaging and, 528–530
venture capital financing and, 535–539
Nestlé Toll House Café, 321
Nestlé USA, 380
Net profit margin, 355
Neubaum, Donald O., 89
New entries
assessing attractiveness of, 70–73
customer uncertainty and, 76–78
decision to exploit or not exploit, 72–73
decisions under uncertainty and, 72
entrepreneurial resources and, 67–70
environmental instability and, 74–76
explanation of, 66–67
information on, 70–71
international, 147–151
lead time and, 78–79
resources as source of competitive advantage and, 67–68
New entry exploitation
entry strategy for, 73–79
risk reduction strategies for, 81–85
Newman, Rick, 122
Ngiam, Kee-Min, 183
Niagra, Vincent, 417
Nicholas, A., 184
Nierenberg, Brad, 271, 272
Nike, 164
Nilssen, David, 321
Nolen-Hoeksema, S., 32
NoMoreCold-Calling, 229
Noncompete agreement, 194
Nondisclosure agreement, 172, 194
Nonequity arrangements, 148–149
Nonverbal communication, 139–140
Norelli, Ron, 444
North American Free Trade Agreement (NAFTA), 153
North American Industrial Classification System (NAICS), 131, 132
Norton, Clint, 306
Norton, William I., Jr., 121
Novatium, 370
nPower Personal Energy Generator, 451
Obama, Barack, 164, 316
O’Brien, Jeffrey M., 278, 301
Observation, 229–230
Occupational Safety and Health Act (OSHA), 98
O’Connor, Edward J., 88
Official Gazette (U.S. Patent and Trademark Office), 98, 170
Ohlson, Kristin, 216
Oklahoma National Bank (Case Study)
background of, 563, 565–566
competition and, 571–572
culture and, 570–571
financial performance and, 566–570
future and, 572
market dynamics and, 571
Oklahoma banking industry and, 565
products and, 566
U.S. banking industry and, 563–565
Olm, Kenneth W., 62
Olmstead, L., 183
Olofsson, C., 408
Olson, E. M., 90
Omidyar, Pierre M., 370
one2one Learning Foundation, 306
O’Neill, Sean, 168
Operating budget, 282–285
Operations plans, 207–208
Opportunity analysis, 8–9
Opportunity assessment plan, 8–9, 128–130
Opportunity, entrepreneurial orientation toward, 46
Opportunity identification, 7–9
Opportunity recognition
explanation of, 110–111
information sources and, 130–133
opportunity assessment plan and, 128–130
Opportunity, window of, 8, 46, 71–72
Ordinary innovations, 25, 107–108
O’Reilly, Brian, 216
Organic-orientation trend, 96
Organization culture, 271–272
Organizational plans, 208–209
Organizations
board of advisors for, 274
board of directors for, 273–274
capital requirements for, 261–262
continuity of, 260
costs of starting, 260
design of, 268–270
entrepreneurial intentions within existing, 45–54
establishing corporate entrepreneurship in, 54–57
legal issues in setting up, 163, 257
limited liability company and, 265–268
management control of, 262
management team and culture in, 271–272
new product classification by, 109–110
outside advisors and, 274–275
owner liability in, 258–260
ownership and, 258
profit and loss distribution in, 262–263
raising capital for, 263
S corporations and, 265–266
tax issues for, 263–265
transferability of interest in, 261
Ortinau, David J., 250
INDEX 597
Osborn, Alex F., 123
Oscar and Belle, 96
Outsourcing, 132, 133
Owater, 244
Owner equity, 294
Packard, David, 56
Pagac, Steve, 426–427
Page, Larry, 272
Paine, Katharine, 14, 15
Pap, Peter, 193
Parameter analysis, 106
Paranoia, 14–15
Parer, Justin, 65–66
Parisi, Francisco, 182
Park, Choelsson, 406
Park, Seung H., 436
Parnes, Sidney J., 123
Participative style of management, 397–398
Partnering, entrepreneurial, 151–152
Partnerships
budgeting decisions in, 282–283
capital requirements for, 261
continuity of, 260
explanation of, 258
legal factors in, 259
liability in, 258–260
management control in, 262
profit and loss distribution in, 262–263
tax issues for, 263–265
transfer of interest in, 261, 444
Patent Cooperation Treaty (PCT), 164
Patents. See also Intellectual property; U.S. Patent and Trademark Office (PTO)
application for, 165
business method, 166–167
checklist to minimize risks regarding, 167
explanation of, 163
infringement of, 166, 168
international, 164
license agreement for, 173
patent-licensing businesses, 168
provisional application for, 164–165
reform bill for, 164
start-up without, 167
types of, 163–164
Patrick, Darren, 374
Patzelt, Holger, 408
Peachtree (Sage Software), 298
Pearce, John A., II, 436
Penetration strategies, 381, 385
Pennington, April Y., 71n, 398n
Penrose, Edith, 407
Penttila, Chris, 279
Pepsi-Cola, 135
Perceived desirability, 38
Perdue, Frank, 95
Perfect Dinner, 210
Perry, Stephen C., 215
Personal surveys, 230
Peters, Michael P., 111n, 115n, 116n, 122, 123, 250
Petersen, Chris, 122
Pettus, Michael L., 407
Philip Morris, 143, 151
Philips, Edward A., 460
Philips Petroleum, 150
Pickens, T. Boone, 305
Pickus, David, 418
Pike, G., 183
Pilmar, John, 249
Pinchot, G., III, 63
Pinedat, Yovanna, 330
Pixar Animation Studios, 174
Plant patents, 164
Plunkett, 131
Pofeldt, E., 408
Poker, television, 159–160
Polaroid Corporation, 523, 524
Political-legal environment, 135–137
Political philosophy, 141
Political risk analysis, 136
Polonchek, Amy, 376
Portfolio of initiatives approach, 80
Portfolio Research, 333
PoshTots, 384
Port, K. L., 183
Porter, L. W., 279
Powell, Gary N., 60
Powell, W., 62
PowerBar Inc., 379–380
Poza, Ernesto, 145n
Pratt, S. E., 63
Precept Business Services, 306
Preliminary screening, venture capital, 349
Present value of future cash flow, 356
Price Club, 255
Price, Sol, 255
Priceline.com, 167
PriceSmart, 255
Pricing
competition and, 242
costs and, 241
markups or margins and, 241–242
Pricing amendment, 369
Primary sources
explanation of, 229
on international markets, 144
methods to gather data from, 229–232
Principle of analysis, 400
Principle of desire, 400
Principle of effectiveness, 400
Principle of prioritized planning, 401
Principle of reanalysis, 401
Principle of teamwork, 400–401
Prior knowledge, 70
Prioritized planning principle, 401
Private investors. See also Business angels
business plans and pitches and, 191–194
characteristics of, 339–340
private offerings for, 324
Regulation D and, 324–326
statistics regarding, 339–341
types of, 324
Private offerings
explanation of, 324
Regulation D and, 324–326
Private venture-capital firms, 343
Pro forma balance sheet, 292–294
Pro forma cash flow, 288–292
Pro forma income statements
explanation of, 285–286
preparation of, 286–288
projections for, 292
Pro forma sources and applications of funds, 296–297
Problem inventory analysis, 100–101
ProCore Laboratories, 308
Procter & Gamble, 114
Proctor, Roy, 492
Product development stage, 117
598 INDEX
Product development strategies, 382, 385
Product-evolution process, 24–25
Product extension merger, 150–151
Product life cycle, 111
Product planning and development process
concept stage of, 114, 116–117
establishing evaluation criteria during, 111–114
explanation of, 111
idea stage of, 114
product development stage of, 117
test marketing stage of, 117
Product safety and liability, 137, 175
Production budget, 283
Production control, 211
Production plans, 207
Productivity, 399
Products
classification of new, 109–110
competitive company and product information, 131
defining new, 109
of franchises, 413
horizontal integration and, 384–385
new uses of, 382
as source of ideas, 98
Professional employer organizations (PEOs), 397
Professional-support networks, 41–43
Profitability ratios, 355
Profits management, 394–395
Progressive Rehab, 418
Promotion, 244
Property insurance, 176
Proprietorships
capital requirements for, 261
continuity of, 260
explanation of, 258
legal factors in, 259
management control in, 262
profit and loss distribution in, 262–263
tax issues for, 263, 264
transfer of interest in, 261
Prospectus, 367–368
Protectionism, 152
Provisional patent application, 164–165
Prowse, S., 375
P2P companies, 171
Public domain, 163
Public-equity market, 337
Public offering. See Initial public offering (IPO)
Publix grocery store, 297
Purcell, C., 183
Qian, Gongming, 407
Quad Mark, 50
Quality control
explanation of, 211
of franchises, 414–415
Questionnaires
example of, 231
function of, 230, 232
QuickBooks (Intuit Inc.), 298
Quiet period, 369
Quinta Corporation, 397
R. H. Macy and Co., 430
R&H Safety Sales Company, 98
Rapoza, J., 183
Rappaport, Alfred, 300
Ratio analysis, 353
Ratios
activity, 354
calculation of financial, 353
financial, 353
leverage, 354–355
liquidity, 353–354
profitability, 355
Rawlinson, J. Geoffrey, 123
Ray, Sourav, 87
Rayasam, Renuka, 330
Real estate loans, 313
Reanalysis principle, 401
Record keeping, 396
Recording Industry Association of America (RIAA), 170, 171
RecycleBank, 416
Red herring, 368
RedPeg Marketing, 271
Reebok, 164, 239
Referral sources, 341
Reflection tasks, 18
Registration statement
explanation of, 366–367
procedure for, 368–369
prospectus and, 367–368
Regulation D
explanation of, 324–326
filings under, 337, 339
Reis, Bob, 95
Religion, 141
Relypsa, 416
Reorganization. See Chapter 11 bankruptcy
RepHunter.net, 229
Replacement value, 356
Research and development limited partnerships
benefits and costs of, 319–320
components of, 318–319
examples of, 320
explanation of, 318
procedure for, 319
Research and development (R&D), 98
Reservation price, 431
Resources
commitment and control of, 46–47
creating bundle of, 68–70
determination of required, 9
entrepreneurial, 68–69
explanation of, 68
as source of competitive advantage, 67–68
Ressi, Adeo, 311
Ressi, Alex, 311
Restoration-orientation, 20, 21
Return on investment, 355
Reuber, Rebecca A., 407
Reverse brainstorming, 102
Reward system, 47–48, 53, 56
Rezaee, Zabihollah, 301
Rhodes, David, 301
Riddle, Liesl, 155
Rinn, Andrew, 279
Risk
expansion, 415
explanation of, 81
window of opportunity and, 8
Risk assessment, 209
Risk-capital markets, 337
Risk reduction strategies
broad-scope, 82
imitation, 82–84
INDEX 599
managing newness, 84–85
narrow-scope, 81–82
Rizzo, Frank, 492
Robbie, K., 62
Robbins, D. E., 437
Robbins, McLean, 461
Robert Mondavi Winery, 35–37
Roberts, Michael J., 31
Robertson, Thomas, 109
Robinson, William T., 89
Roche-Tarry, Dona E., 279
Rockefeller Foundation, 370
Rodriguez, Alex, 316
Rodriguez, Julie, 44
Rohrbach, Bernard, 100
Role models, 40–41
Ronstadt, Robert C., 31, 62
Roos, Robert, 540
Rosati, Fabio, 132, 133
Rosen, Ben, 62
Rosenberg, Nathan, 90
Rosenberger, Jeff, 436
Rosenburg, K., 437
Ross, Christopher A., 60
Round, John, 156
Royalty partnership, 319
Rubanik, Yuri, 87
Rudelius, W., 250, 301, 302
Ruefli, T. W., 90
Ruekert, R. W., 90
Rug Bug Corporation (Case Study)
background of, 540
business description and, 541
business location and, 542
financial information and, 542–549
management/operations and, 542
marketing component and, 541–542
product description and, 541
Rugman, Alan M., 407
Rule 145 (SEC), 337
Rule 146 (SEC), 337
Rule 504 (SEC), 325
Rule 505 (SEC), 325
Rule 506 (SEC), 325
Rutherford, J., 183
Ryan, Kenneth E., 182
Ryan, Paul, 168
S corporation
advantages of, 266
disadvantages of, 266
ethics and, 267
explanation of, 258, 265–266
limited liability company vs., 265
succession in, 444
Safeway, 174
Sahlman, William A., 215
Sahu, Vimal, 249
Sale of business
direct, 445–446
employee stock option plan and, 446
management buyout, 446–447
Sales budget, 283
Sales control, 211
Sales ethics, 236
Salzman, Jessica Reagan, 301
Sam’s Club, 255
Sandberg, Sheryl, 335
Sandoloski, Lee, 418
Santiago Solutions Group, 384
Sapienza, H. J., 90, 123
Sarasvathy, Saras, 10–12, 29, 30, 31
Sarbanes-Oxley Act of 2002
explanation of, 177–178
financial transparency and, 361
function of, 273, 362
reporting requirements and, 371
Sarkar, M. B., 437
Satyam (SAY), 360
Saverin, Eduardo, 333
SBIC firms. See Small business investment companies (SBIC)
SBIR grants program, 320, 322–323
Scarbrough, Shelby, 461
Schaper, Michael, 155
Scheinfeld, R. C., 183
Schilling, Frederick, 445
Schindehutte, Minet, 249
Schmid, Markus M., 374
Schmitt, Emily, 297n
Schnaars, S. P., 90
Schraw, G., 31
Schreiber, Jeff, 310
Schulze, William S., 407
Schumpeter, J. A., 31
Schuppe, W. P., 461
Schut, H., 32
Schwartz, J. Stanford, 89, 90
Scope, 81
SCORE. See Service Corps of Retired Executives (SCORE)
Scott eVest LLC, 398
Scott, Matthew, 370
Seaman, Samuel, 248
SeaRail International Inc., 78
Search engines, 132, 200
Sebastian, Robert, 171n
Secondary sources
explanation of, 227
function of, 225
on international markets, 144, 146
for market research data, 227–228
Securities Act of 1933, 339, 359, 367
Securities and Exchange Commission (SEC)
financial transparency and, 360–361
financing issues and, 324, 326, 337, 339
going public and, 359, 362–363
registration statement and, 366–367, 368–369
reporting requirements and, 371
Securities Exchange Act of 1934, 371
Seda, Catherine, 245n
Seiko, 517
Self-efficacy, 38
Seltz, D. D., 437
Semiconductor Research Corporation, 422
Sempere-Monerris, J., 181
Service Corps of Retired Executives (SCORE), 130, 190, 232, 456
Senior Helpers, 418
Sensoy, Berk A., 374
Sequoia Capital India, 370
Service company marketing plan, 253
Services, 98, 108, 208
franchises offering, 417
7-Eleven Convenience Stores, 150
Sexton, D., 62
Shane, S., 123
Shanley, M., 90, 460
Shapero, Albert, 31
600 INDEX
Sharper Image, 448
Shepherd, Dean A., 17n, 29, 30, 31, 32, 61, 62, 88, 90, 402n, 407, 408,
437, 460
Sherman Act, 428
Sherman, Aliza Pilar, 44n
Shrader, Rodney, 88, 90
Siegel, W., 437
Siemens (SI), 138, 168
Significant capital appreciation, venture capital, 349
Silicon Storage Technology (SST), 364
Silver-Greenberg, Jessica, 338n
Silver, Spencer, 56
Simmonds, Mark, 121
Simon, H. A., 31
Sinegal, Jim, 255–256, 269, 279
Singh, Alok, 370
Singular Research, 168
Sirmon, D. G., 31
Sitkin, S. B., 32
Situation analysis, 237
Siwilop, S., 182
Skills assessment, 190
Skolnik Industries, 392
SkyMall, 427
Slater, S. F., 90
Slower, Farrell K., 376
Small Business Administration (SBA), 43, 130, 188, 190, 193, 315–318, 447,
454, 456
Small Business Development Centers (SBDC), 130, 190, 456
Small Business Innovation Research (SBIR) program, 320, 322–323
Small business investment companies (SBIC), 343
Small Business Investment Act of 1958, 342
Small Business Protection Act of 1996, 265
Small Business Technology Transfer Act of 1992, 322
Small Business Technology Transfer (STTR) program, 322–323
Smith, Brock, 29
Smith, Frederick W., 93–95
Smith, James K., 461
Smith, Kate, 214
Smith, Ken G., 406
Snap Fitness Inc., 418
Snyder, Rick, 42
Social network Web sites, 200
Facebook, 97, 333–336
Social structure, 140
Social trend, 97
Softbank Capital, 311
Software
financial, 298
venture-capital investment in, 344, 345
Soh, Pek-hooi, 375
Sohl, Jeffrey, 342
Song, Jaeki, 249
Sonnenfeld, Jeffrey A., 278
Sony, 174
Souccar, Miriam, 492
Souder, William E., 104n, 123
Souitaris, Vangelis, 375
Southland Stores, 150
Southwest Airlines, 401–402
Spanx, 108
Spindler, James C., 374
Stagen, Rand, 105
Stakeholders, 22
Stamberger, Julia, 273
Standard Industrial Classification (SIC) codes, 132
Stanford University, 344
Stark, Matthew, 215
Start-ups
capital budget for Internet, 288
costs of, 260
failure of, 447–448
venture capital financing and, 416
without patents, 167
State-sponsored venture-capital fund, 343
State, W. B., 183
Staw, B., 62
Steensma, Kevin H., 436
Stein, Alexander, 215
Steinhart, Michael J., 216
Stelter, Daniel, 301
Stemmle, Dennis, 50
Stern, Brett, 297
Stevenson, Howard H., 31, 45, 50n, 61, 63
Stewart, Wayne, Jr., 89
Stickney, Clyde P., 302
Stock sales, 353, 442
Stodder, Gayle Sato, 78n
Stoller, Gregory L., 470n, 484n
STP (segmentation, targeting, and positioning) process, 11
Straight commercial loans, 314
Strake, J., 62
Strandholm, Karen, 436
Strategic orientation, 46
Strategic tasks, 18
StreamCast, 170
Stroebe, M. S., 32
Strömberg, Per, 374
Subway, 413, 415
Succession
explanation of, 442
to family members, 443
to nonfamily members, 443–444
Sullivan, J. D., 183
SuperValu (SVU), 297
Suppliers, 235
Support systems
moral-support networks, 41
professional-support networks, 41–43
Surveys
explanation of, 230
focus groups, 99–100, 232
methods for, 230
Sutton, R. I., 32
Svanfeldt, C., 32
Switching costs, 79
Synergy
explanation of, 425
joint ventures and, 150
mergers and, 151
Syntex Corporation, 320
Tarantino, David, 301
Target market
explanation of, 237–238
market segmentation and, 238–239
strengths and weaknesses of, 240
understanding needs of, 239–240
Taub, R. P., 123
Tauber, Edward M., 101n
Taulli, Tom, 374
Taunton, Peter, 418
Tax issues
for corporations, 264, 265
for entrepreneurs, 395–396
mergers and, 151
INDEX 601
for partnerships, 263–265
for proprietorships, 263, 264
Taylor Gifts, 427
Taylor, Mandie, 301
Taylor, Steven A., 250
Taylor, William, 122
Teal, Robert, 397
Team spirit, 398
Teamwork, 52, 54
management teams, 257, 271–272
Teamwork principle, 400–401
Technological innovations
combining, in mergers, 151
corporate entrepreneurship and, 55
evaluating potential, 203
explanation of, 25, 106, 107
international market and, 137
knowledge and, 70
Technological uncertainty, 75–76
Tehan, Jim, 307, 308
TelePay, 306
Telephone surveys, 230
Television poker, 159–160
Teplensky, Jill D., 89, 90
Teresa Cascioli Charitable Foundation, 440
Terhanian, George, 214
Test marketing stage, 117
Things Remembered, 143
Third-party arrangements, 135
Thomson Reuters, 416
3i, 370
3M, 52, 56–57, 343
Time management, 388
benefits of, 399–400
principles of, 400–401
Tiscione, Anthony, 426
Tiscione, James, 426–427
Tolshchikova, Nadya, 525n, 572n
Top management commitment, 55
Torgrimson, C. G., 32
Torres, Nichole L., 257n, 461
Tosh, Ronald, 418
Toyota, 75, 422
Tozzi, John, 416n
Trade
barriers to, 152–153
entrepreneurial entry and, 147–148
Trade associations, 132
Trade blocs, 152–153
Trade publications, 133
Trade secrets. See also Intellectual property
explanation of, 171
nondisclosure agreement for, 171, 172
protection of, 171–173
Trademark Electronic Application System (TEAS), 170
Trademark Official Gazette (U.S. Patent and Trademark Office), 170
Trademarks. See also Intellectual property
explanation of, 167, 169
licensing of, 173
registering of, 169–170
Trailer, Barry, 229
Training
employee, 399
franchisee, 413–414
Transition Networks Inc., 119
Transport mode selection, 392
Tremont Electric, 451
Trends, 96–97
Trilogy Limited, 320
TriNet Employer Group Inc., 397
Tubs To Go, 418
Tudor, Keith, 384
Turn-key projects, 148–149
Turner Test Prep Co. (Case Study), 465–467
Tustin, Marcus, 492
Twomey, David, 461
Tyco, 361
Ucbasaran, Deniz, 89, 155
Umeno, Marc, 529
Uncertainty
for customers, 76–78
demand, 75
making decisions under, 72
technological, 75–76
Underwriting, 364, 365–366
aftermarket support, 369, 370
IPO and, 363, 370
Underwriting syndicate, 365
Unilever, 343
U.S. Bancorp, 338
U.S. Bankruptcy Court, 450
U.S. Chamber Small Business Center, 130
U.S. Department of Commerce, 146, 200, 384, 444
U.S. Department of Defense (DOD), 322
U.S. Department of Energy (DOE), 322
U.S. Department of Health and Human Services (DHHS), 322
U.S. Department of Justice, 428
U.S. Department of Labor, 177
U.S. Patent and Trademark Office (PTO), 98, 163, 164, 165, 169–170, 426
U.S. Treasury Department Office of Thrift Supervision (OTS), 338
University-sponsored venture-capital funds, 343–344
Upton, Nancy, 248
USAA, 118
Useem, J., 437
Utility patents, 163
Uzzi, B., 62, 63
Valuation
activity ratios and, 354
factors in, 352–353
general approaches to, 355–357
general method of, 357–358
of Internet companies, 358–359
leverage ratios and, 354–355
liquidity ratios and, 353–354
profitability ratios and, 355
ratio analysis and, 353
Value-added chain, 383–384
Values, core, 23, 272
Van Auken, Howard, 300
Vandenberg, J. D., 166n
Vanneste, Sven, 182
Venkataraman, S., 33
Venture-capital firms, evaluation of, 311
Venture-capital investments
criteria for commitment of, 348–349
in developing world, 370
explanation of, 341
favorite startups, 416
historical background of, 342–344
by industry sector, 344, 345
methods for locating, 350
by region, 346–347
risks and returns for, 348
strategies for obtaining, 350–352
602 INDEX
Venture-capital limited partnerships, 341
Venture-capital market
explanation of, 337
profile of, 344–346
types of firms in, 343–344
Venture-capital process
explanation of, 347
stages in, 344, 345, 346, 347–350
Venture Frogs, 281
Ventures, 205–207
Verbeke, Alan, 407
Verizon, 168
Vertical merger, 150
Vesper, Karl, 31
Vibrant Brains, 97
Victoria’s Secret, 307
Vitón, Raphael Louis, 105n
Voluntary bankruptcy, 452
Wal-Mart, 255, 256
Waldron, Marilyn A., 300
Walker, Frank, 78
Walker, O. C., Jr., 90
Walker, Scott, 305–308
Walsh, Michael, 572n
Walsh, Rod, 389n
Wansley, Brant, 214
Ward, John L., 279
Warehouse stores, 255–256
Warner Brothers, 174
Warren, Elizabeth, 460
Waterford, 143
Watkins-Mathys, Lorraine, 156
Watson, Warren, 89
Weaver, Mark K., 436
Web sites. See also Internet
advice about, 245
development of, 118–119
E-commerce and, 118
evaluation of, 211
Web trend, 97
Weber, James E., 563n
Weber, Paula S., 563n
Webgrity, 133
Webster, John G., 540
Weinert, F. E., 32
Weinstein, Bruce, 285n, 317n
Weiss, Carter, 183
Weiss, G., 184
Weiss, L. E., 63
Wells, A., 32
Wells Fargo, 338
Welsh & Katz, 162
Wenger, Sean, 572n
Westbrook, Jay Lawrence, 460
Westerman, James W., 330
Western Publishing, 151
Westhead, Paul, 89, 155
Westinghouse, 422
Wetzel, W. E., Jr., 375
Whalen, James, 302
Whole Foods (WFMI), 210, 297
Wiklund, J., 45n, 50n, 59, 63, 402n, 407, 408, 437
Wilburn, Nicola, 132, 133
Wilburn, Randy, 132, 133
Wild Rufus Records, 454, 456
Wildie, Paul, 461
Williams, Colin C., 156
Williams, David, 250
Williams, Ted, 373
Wilson, Charlie, 78
Wilson, Sara, 301
Window of opportunity, 8, 46, 71–72
Window Works, 417
Winer, Russell S., 249, 250
Winn, Steven, 492
The Winslow Clock Company (Case Study)
background of, 516–518
industry information and, 518–519
management and, 524–525
marketing plan and strategy and, 522–523
operations management and, 523–524
product information and, 519–522
Witt, Clyde E., 461
Wolinsky, Howard, 210n
Women Angels, 342
Women, as business angels, 342
Women-owned businesses, 43–44
Women’s Business Enterprise National Council (WBENC), 44
Women’s Business Enterprise (WBE), 44
Wong, Poh-kam, 375
Woo, C., 62
Wood, D. Robley, Jr., 435
Woodward, David, 156
Woodward, William, 62
Woolston, Tom, 167
Work history, 40
Workers’ compensation, 176
World Intellectual Property Organization (WIPO), 164
World Poker Tour, 159, 160
World Trade Organization (WTO), 164
Worldcom, 361
Worrell, David, 279
Worthington Company, 125
Wozniak, Steven, 56
WPT China National Traktor Poker Tour, 160
WPT Enterprises, 160
Wright, M., 62, 89, 155
Xerox, 50, 52, 343
Xerox Technology Ventures (XTV), 50
Yale University, 422
Yarbrough, Jeffrey, 448, 461
Yeh, Bing, 364
Zachary, George, 311
Zackarakis, Andrew, 460
Zahedi, Fatemeh Mariam, 249
Zahra, Shaker A., 28, 60, 89, 435
Zappos.com, 281–282
Zayre’s, 255
Zeitz, Gerald J., 408
Zemann, L., 376
Zhang, Jing, 375
Ziegler, Robert W., 104n, 123
Zimmer, Catherine, 62
Zimmerman, Heinz, 374
Zimmerman, Monica A., 408
Zipcar, 274
Ziqitza, 370
Zuckerberg, Mark, 333–336
- Tittle
- Contents
- PART 1 THE ENTREPRENEURIAL PERSPECTIVE
- 1 ENTREPRENEURSHIP AND THE ENTREPRENEURIAL MIND-SET
- Opening Profile: Ewing Marion Kauffman
- Nature and Development of Entrepreneurship
- The Entrepreneurial Process
- Identify and Evaluate the Opportunity
- Develop a Business Plan
- Determine the Resources Required
- Manage the Enterprise
- How Entrepreneurs Think
- Effectuation
- Cognitive Adaptability
- As Seen in Entrepreneur Magazine: What Me Worry? How Smart Entrepreneurs Harness the Power of Paranoia
- Learning from Business Failure
- Recovery and Learning Process
- A Dual Process for Learning from Failure
- Ethics and Social Responsibility of Entrepreneurs
- Ethics: Company’s Code of Ethics
- Role of Entrepreneurship in Economic Development
- 2 ENTREPRENEURIAL INTENTIONS AND CORPORATE ENTREPRENEURSHIP
- As Seen in Entrepreneur Magazine: Hot or Not?
- Minority Entrepreneurs
- As Seen in Entrepreneur Magazine: Provide Advice to an Entrepreneur about Improving a Business through Certification as a Woman-Owned Business
- Entrepreneurial Intentions within Existing Organizations
- Managerial versus Entrepreneurial Decision Making
- Strategic Orientation and Commitment to Opportunity
- Commitment of Resources and Control of Resources
- Management Structure and Reward Philosophy
- Growth Orientation and Entrepreneurial Culture
- Causes for Interest in Corporate Entrepreneurship
- Establishing a Culture for Corporate Entrepreneurship
- Leadership Characteristics of Corporate Entrepreneurs
- Establishing Corporate Entrepreneurship in the Organization
- Problems and Successful Efforts
- Opening Profile: Robert Mondavi
- The Intention to Act Entrepreneurially
- Entrepreneur Background and Characteristics
- Education
- Ethics: Ethical Conduct of Entrepreneurs versus Managers
- Age
- Work History
- Role Models and Support Systems
- Moral-Support Network
- Professional-Support Network
- 3 ENTREPRENEURIAL STRATEGY: GENERATING AND EXPLOITING NEW ENTRIES
- Opening Profile: Justin Parer
- New Entry
- Generation of a New Entry Opportunity
- Resources as a Source of Competitive Advantage
- Creating a Resource Bundle That Is Valuable, Rare, and Inimitable
- Assessing the Attractiveness of a New Entry Opportunity
- Information on a New Entry
- As Seen in Entrepreneur Magazine: Elevator Pitch for Project Alabama
- Comfort with Making a Decision under Uncertainty
- Decision to Exploit or Not to Exploit the New Entry
- Entry Strategy for New Entry Exploitation
- Environmental Instability and First-Mover (Dis)Advantages
- Customers’ Uncertainty and First-Mover (Dis)Advantages
- Ethics: Do the Right Thing
- Lead Time and First-Mover (Dis)Advantages
- As Seen in Entrepreneur Magazine: Provide Advice to an Entrepreneur about Being More Innovative
- Risk Reduction Strategies for New Entry Exploitation
- Market Scope Strategies
- Imitation Strategies
- Managing Newness
- PART 2 FROM IDEA TO THE OPPORTUNITY
- 4 CREATIVITY AND THE BUSINESS IDEA
- Opening Profile: Frederick W. Smith
- Trends
- Green Trend
- Clean-Energy Trend
- Organic-Orientation Trend
- Economic Trend
- Social Trend
- Health Trend
- Web Trend
- Sources of New Ideas
- Consumers
- Existing Products and Services
- Distribution Channels
- Federal Government
- Research and Development
- As Seen in BusinessWeek: The Myth of Creativity
- Methods of Generating Ideas
- Focus Groups
- Brainstorming
- Brainwriting
- Problem Inventory Analysis
- Creative Problem Solving
- Brainstorming
- Reverse Brainstorming
- Gordon Method
- Checklist Method
- Free Association
- Forced Relationships
- Collective Notebook Method
- As Seen in BusinessWeek: How to Produce Big Ideas on Demand
- Attribute Listing
- Big-Dream Approach
- Parameter Analysis
- Innovation
- Types of Innovation
- Defining a New Innovation (Product or Service)
- Classification of New Products
- Opportunity Recognition
- Product Planning and Development Process
- Establishing Evaluation Criteria
- Ethics: Leadership Is about Doing, Not Saying
- Idea Stage
- Concept Stage
- Product Development Stage
- Test Marketing Stage
- E-Commerce and Business Start-Up
- Using E-Commerce Creatively
- Web Sites
- Tracking Customer Information
- Doing E-Commerce as an Entrepreneurial Company
- 5 IDENTIFYING AND ANALYZING DOMESTIC AND INTERNATIONAL OPPORTUNITIES
- Opening Profile: A. Malachi Mixon III
- Introduction
- Opportunity Recognition and the Opportunity Assessment Plan
- Information Sources
- General Information
- Industry and Market Information
- Competitive Company and Product Information
- Government Sources
- As Seen in BusinessWeek: Mom-and-Pop Multinationals
- Search Engines
- Trade Associations
- Trade Publications
- The Nature of International Entrepreneurship
- The Importance of International Business to the Firm
- International versus Domestic Entrepreneurship
- Economics
- Stage of Economic Development
- Current Account
- Type of Economic System
- Political–Legal Environment
- Language
- Technological Environment
- Ethics: Ethics Must Be Global Not Local
- Culture
- Social Structure
- Religion
- Political Philosophy
- Economics and Economic Philosophy
- Education
- Manners and Customs
- Available Distribution Systems
- Motivations to Go Global
- Strategic Effects of Going Global
- Foreign Market Selection
- As Seen in BusinessWeek: Stranger in a Strange Land
- Entrepreneurial Entry Strategies
- Exporting
- Nonequity Arrangements
- Direct Foreign Investment
- Entrepreneurial Partnering
- Barriers to International Trade
- General Agreement on Tariffs and Trade (GATT)
- Increasing Protectionist Attitudes
- Trade Blocs and Free Trade Areas
- Entrepreneur’s Strategy and Trade Barriers
- Implications for the Global Entrepreneur
- Appendix 5A: Example Outline of an International Business Plan
- 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR
- Opening Profile: Steve Lipscomb
- What Is Intellectual Property?
- Need for a Lawyer
- How to Select a Lawyer
- As Seen in Entrepreneur Magazine: Provide Advice to an Entrepreneur about Intellectual Property Protection
- Legal Issues in Setting Up the Organization
- Patents
- International Patents
- The Provisional Application
- The Patent Application
- Patent Infringement
- Business Method Patents
- Start-Up without a Patent
- As Seen in BusinessWeek: Provide Advice to an Entrepreneur Inventor about How to Make Patents Pay
- Trademarks
- Registering the Trademark
- Copyrights
- Ethics: How Much Responsibility Should Our Youth Have for Illegal Downloading?
- Trade Secrets
- Licensing
- Product Safety and Liability
- Insurance
- Sarbanes-Oxley Act
- Contracts
- PART 3 FROM THE OPPORTUNITY TO THE BUSINESS PLAN
- 7 THE BUSINESS PLAN: CREATING AND STARTING THE VENTURE
- Opening Profile: Belinda Guadarrama
- Planning as Part of the Business Operation
- What Is the Business Plan?
- Who Should Write the Plan?
- Scope and Value of the Business Plan—Who Reads the Plan?
- As Seen in BusinessWeek: Don't Expect a Fee for Making an Introduction
- How Do Potential Lenders and Investors Evaluate the Plan?
- Ethics: Protecting Your Business Idea
- Presenting the Plan
- Information Needs
- Market Information
- Operations Information Needs
- Financial Information Needs
- Using the Internet as a Resource Tool
- Writing the Business Plan
- Introductory Page
- Executive Summary
- Environmental and Industry Analysis
- Description of Venture
- Production Plan
- Operations Plan
- Marketing Plan
- Organizational Plan
- Assessment of Risk
- Financial Plan
- As Seen in BusinessWeek: Elevator Pitch for Perfect Dinner
- Appendix
- Using and Implementing the Business Plan
- Measuring Plan Progress
- Updating the Plan
- Why Some Business Plans Fail
- Appendix 7A: Sample Business Plan—Gopher It
- 8 THE MARKETING PLAN
- Opening Profile: Warren G. Jackson
- Industry Analysis
- Competitor Analysis
- Marketing Research for the New Venture
- Step One: Defining the Purpose or Objectives
- Step Two: Gathering Data from Secondary Sources
- As Seen in BusinessWeek: How to Expand Your Customer Base
- Step Three: Gathering Information from Primary Sources
- Step Four: Analyzing and Interpreting the Results
- Understanding the Marketing Plan
- Characteristics of a Marketing Plan
- Ethics: Devil's Advocate
- The Marketing Mix
- Steps in Preparing the Marketing Plan
- Defining the Business Situation
- Defining the Target Market: Opportunities and Threats
- Considering Strengths and Weaknesses
- Establishing Goals and Objectives
- Defining Marketing Strategy and Action Programs
- Marketing Strategy: Consumer versus Business-to- Business Markets
- As Seen in Entrepreneur Magazine: Provide Advice to an Entrepreneur about Web Sites
- Budgeting the Marketing Strategy
- Implementation of the Market Plan
- Monitoring the Progress of Marketing Actions
- Appendix 8A: Marketing Plan Outlines
- 9 THE ORGANIZATIONAL PLAN
- The Limited Liability Company versus the S Corporation
- S Corporation
- Advantages of an S Corporation
- Disadvantages of an S Corporation
- Opening Profile: Jim Sinegal
- Developing the Management Team
- As Seen in Entrepreneur Magazine: Provide Advice to an Entrepreneur about Some Legal Aspects of Starting a Business
- Legal Forms of Business
- Ownership
- Liability of Owners
- Costs of Starting a Business
- Continuity of Business
- Transferability of Interest
- Capital Requirements
- Management Control
- Distribution of Profits and Losses
- Attractiveness for Raising Capital
- Tax Attributes of Forms of Business
- Tax Issues for Proprietorship
- Tax Issues for Partnership
- Tax Issues for Corporation
- Ethics: Lawyers Explain the Steps to Take If Your Business Partner Violates His or Her Obligations to the Business
- The Limited Liability Company
- Advantages of an LLC
- Designing the Organization
- Building the Management Team and a Successful Organization Culture
- As Seen in BusinessWeek: Elevator Pitch for 20x200 Web Site
- The Role of a Board of Directors
- The Board of Advisors
- The Organization and Use of Advisors
- 10 THE FINANCIAL PLAN
- Opening Profile: Tony Hsieh
- Operating and Capital Budgets
- Ethics: Are You a Good Leader?
- Pro Forma Income Statements
- Pro Forma Cash Flow
- As Seen in BusinessWeek: Provide Advice to an Entrepreneur about Solving Their Cash-Flow Problem to Stay in Business
- Pro Forma Balance Sheet
- Break-Even Analysis
- Pro Forma Sources and Applications of Funds
- As Seen in BusinessWeek: Elevator Pitch for Beer Chips
- Software Packages
- PART 4 FROM THE BUSINESS PLAN TO FUNDING THE VENTURE
- 11 SOURCES OF CAPITAL
- Opening Profile: Scott Walker
- An Overview
- Debt or Equity Financing
- Internal or External Funds
- Personal Funds
- As Seen in BusinessWeek: Show Me the Moneymen
- Family and Friends
- Commercial Banks
- Types of Bank Loans
- Cash Flow Financing
- Bank Lending Decisions
- Role of the SBA in Small-Business Financing
- Ethics: We Need an Ethics Czar
- Research and Development Limited Partnerships
- Major Elements
- Procedure
- Benefits and Costs
- Examples
- Government Grants
- As Seen in BusinessWeek: From 401(k) Nest Egg to Seed Money
- Procedure
- Other Government Grants
- Private Placement
- Types of Investors
- Private Offerings
- Regulation D
- Bootstrap Financing
- 12 INFORMAL RISK CAPITAL, VENTURE CAPITAL, AND GOING PUBLIC
- Opening Profile: Mark Zuckerberg
- Financing the Business
- Informal Risk-Capital Market
- As Seen in BusinessWeek: Old Banks, New Lending Tricks
- Venture Capital
- Nature of Venture Capital
- As Seen in BusinessWeek: She’s an Angel
- Overview of the Venture-Capital Industry
- Venture-Capital Process
- Locating Venture Capitalists
- Approaching a Venture Capitalist
- Valuing Your Company
- Factors in Valuation
- Ratio Analysis
- Liquidity Ratios
- Activity Ratios
- Leverage Ratios
- Profitability Ratios
- General Valuation Approaches
- General Valuation Method
- Evaluation of an Internet Company
- Deal Structure
- Going Public
- Ethics: Financial Transparency a Must
- Advantages
- Disadvantages
- Timing of Going Public and Underwriter Selection
- Timing
- Underwriter Selection
- Registration Statement and Timetable
- The Prospectus
- The Registration Statement
- Procedure
- Legal Issues and Blue-Sky Qualifications
- Legal Issues
- Blue-Sky Qualifications
- After Going Public
- As Seen in BusinessWeek: Where Venture Capital Never Ventured Before
- Aftermarket Support
- Relationship with the Financial Community
- Reporting Requirements
- PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE
- 13 STRATEGIES FOR GROWTH AND MANAGING THE IMPLICATIONS OF GROWTH
- Opening Profile: Brian and Jennifer Maxwell
- Growth Strategies: Where to Look for Growth Opportunities
- Penetration Strategies
- Market Development Strategies
- Product Development Strategies
- Diversification Strategies
- As Seen in Entrepreneur Magazine: Provide Advice to an Entrepreneur about Growing into New Markets Using the Internet
- Example of Growth Strategies
- Economic Implications of Growth
- Implications of Growth for the Firm
- Pressures on Existing Financial Resources
- Pressures on Human Resources
- Pressures on the Management of Employees
- Pressures on the Entrepreneur’s Time
- Overcoming Pressures on Existing Financial Resources
- Financial Control
- Ethics: Lessons from Enron
- Managing Cash Flow
- Managing Inventory
- Managing Fixed Assets
- Managing Costs and Profits
- Taxes
- Record Keeping
- Overcoming Pressures on Existing Human Resources
- Overcoming Pressures on the Management of Employees
- As Seen in Entrepreneur Magazine: Elevator Pitch for eVest
- Overcoming Pressures on Entrepreneurs’ Time
- Basic Principles of Time Management
- Implications of Firm Growth for the Entrepreneur
- A Categorization of Entrepreneurs and Their Firms’ Growth
- 14 ACCESSING RESOURCES FOR GROWTH FROM EXTERNAL SOURCES
- Opening Profile: Bill Gross
- Using External Parties to Help Grow a Business
- Franchising
- Advantages of Franchising—to the Franchisee
- Advantages of Franchising—to the Franchisor
- As Seen in BusinessWeek: Venture Capital’s Favorite Startups
- Disadvantages of Franchising
- Types of Franchises
- Investing in a Franchise
- Ethics: Fair Enough
- Joint Ventures
- Types of Joint Ventures
- Factors in Joint Venture Success
- Acquisitions
- Advantages of an Acquisition
- Disadvantages of an Acquisition
- Synergy
- Structuring the Deal
- As Seen in Entrepreneur Magazine: Provide Advice to an Entrepreneur about Entering into Agreements
- Locating Acquisition Candidates
- Mergers
- Leveraged Buyouts
- Overcoming Constraints by Negotiating for More Resources
- 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE
- Opening Profile: Teresa Cascioli
- As Seen in BusinessWeek: Provide Advice to an Entrepreneur on How to Beat Failure and Be the Boss Again
- Exit Strategy
- Succession of Business
- Transfer to Family Members
- Transfer to Nonfamily Members
- Options for Selling the Business
- Direct Sale
- Employee Stock Option Plan
- Management Buyout
- Ethics: Involving Employees, Bankers, and Business Associates in the Problem
- Bankruptcy—An Overview
- Chapter 11—Reorganization
- Surviving Bankruptcy
- As Seen in BusinessWeek: Elevator Pitch for nPower Personal Energy Generator
- Chapter 13—Extended Time Payment Plans
- Chapter 7—Liquidation
- Strategy during Reorganization
- Keeping the Venture Going
- Warning Signs of Bankruptcy
- Starting Over
- The Reality of Failure
- Business Turnarounds
- As Seen in BusinessWeek: Provide Advice to an Entrepreneur On How to Beat Failure and Be the Boss Again
- As Seen in BusinessWeek: Elevator Pitch for nPower Personal Energy Generator
- PART 6 CASES
- Case 1 Turner Test Prep Co.
- Case 2 Jim Boothe, Inventor
- Case 3 A. Monroe Lock and Security Systems
- Case 4 Beijing Sammies
- Case 5 “Mamma Mia!” The Little Show That Could!
- Case 6 The Beach Carrier
- Case 7 Gourmet to Go
- Case 8 Intervela d.o.o. Koper—Victory Sailmakers
- Case 9 The Gril-Kleen Corporation
- Case 10 The Winslow Clock Company
- Case 11 NeoMed Technologies
- Case 12 Rug Bug Corporation
- Case 13 Nature Bros. Ltd.
- Case 14 Amy’s Bread
- Case 15 Oklahoma National Bank
- Case 16 Datavantage Corporation
- Case 17 Dual Pane Company
- INDEX