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Section 2: The Entrepreneurial Journey Begins

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Essentials of Entrepreneurship and Small Business Management

Ninth Edition

Chapter 4

Conducting a Feasibility Analysis and Designing a Business Model

Learning Objectives (1 of 2)

Describe the process of conducting an idea assessment.

Explain the elements of a feasibility analysis.

Describe the six forces in the macro environment of an industry.

Understand how Porter’s Five Forces Model assesses the competitive environment.

In this chapter, you will:

1. Describe the process of conducting an idea assessment.

2. Explain the elements of a feasibility analysis.

3. Describe the six forces in the macro environment of an industry.

4. Understand how Porter’s Five Forces Model assesses the competitive environment.

Learning Objectives (2 of 2)

Describe the various methods of conducting primary and secondary market research.

Understand the four major elements of a financial feasibility analysis.

Describe the process of assessing entrepreneur feasibility.

Describe the nine elements of a business model in the Business Model Canvas.

In addition, you will:

5. Describe the various methods of conducting primary and secondary market research.

6. Understand the four major elements of a financial feasibility analysis.

7. Describe the process of assessing entrepreneur feasibility.

8. Describe the nine elements of a business model in the Business Model Canvas.

Idea Assessment (1 of 2)

Idea Assessment:

The process of examining a particular need in the market, developing a solution for that need, and determining the entrepreneur’s ability to successfully turn the idea into a business.

Once entrepreneurs develop ideas for new businesses, the next step is to assess these ideas.

New Business Planning Process

Business ideas

Conducting an idea assessment

Conducting a feasibility analysis

Developing a business model

Crafting a business plan

Creating a strategic plan

Launching the business

The idea assessment, feasibility study, business model, business plan, and strategic plan all play important but separate roles in the start-up and growth of an entrepreneurial venture.

Idea Assessment (2 of 2)

Use an idea sketch pad to ask key questions addressing:

Customers

Offering

Value proposition

Core competencies

People

An idea sketch pad helps an entrepreneur assess ideas in a relatively short period of time. When using a sketch pad, the entrepreneur asks a series of key questions addressing five key parameters.

Idea Sketch Pad

Figure 4.2 Idea Sketch Pad

Source: Dr. Alex Bruton, The Innographer, Ltd., theinnographer.com/toolkit/idea-modeling.

Successful entrepreneurs do not become emotionally attached to their ideas. If an idea shows promise based on the idea sketch pad, they move ahead to the next step of conducting a feasibility analysis. If entrepreneurs cannot resolve the gaps or weaknesses that the idea sketch pad reveals in an idea, they turn to the next idea and assess it using the sketch pad process.

Feasibility Analysis

Is a particular idea a viable foundation for creating a successful business?

Feasibility study addresses the question: “Should we proceed with this business idea?”

After conducting the idea assessment, an entrepreneur scrutinizes the idea further through a feasibility analysis.

Elements of a Feasibility Analysis (1 of 4)

Figure 4.3 Elements of a Feasibility Analysis

Figure 4.3 shows the elements of a feasibility analysis.

Environmental Forces and New Ventures

Figure 4.4 Environmental Forces and New Ventures

When examining an industry, an entrepreneur should examine both the macro environment that can have an impact across many industries and the specific competitive environment of the industry of interest.

Industry and Market Feasibility Analysis (1 of 3)

Assess industry attractiveness using six macro forces:

Sociocultural

Technological

Demographic

Economic

Political and legal

Global

Six foundational macro forces create change in industries and the markets they serve.

Industry and Market Feasibility Analysis (2 of 3)

Ask:

How large is the industry?

How fast is it growing?

Is the industry as a whole profitable?

Is the industry characterized by high profit margins or razor-thin margins?

How essential are its products or services to customers?

Entrepreneurs should answer these questions to help evaluate the attractiveness of an industry in light of the macro forces for change.

Industry and Market Feasibility Analysis (3 of 3)

What trends are shaping the industry’s future?

What threats does the industry face?

What opportunities does the industry face?

How crowded is the industry?

How intense is the level of competition in the industry?

Is the industry young, mature, or somewhere in between?

In addition, consider the answers to these questions.

Porter’s Five Forces Model

Five forces interact with one another to determine the setting in which companies compete and, hence, the attractiveness of the industry:

Rivalry among companies in the industry

Bargaining power of suppliers

Bargaining power of buyers

Threat of new entrants

Threat of substitute products or services

A useful tool for analyzing a specific industry’s attractiveness within the competitive environment is the Five Forces Model, developed by Michael Porter of the Harvard Business School.

Five Forces Model (1 of 6)

Figure 4.7 Five Forces Model of Competition

Source: Adapted from Michael E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review 57, no. 2 (March–April 1979): 137–145.

Five forces interact with one another to determine the setting in which companies compete and hence the attractiveness of the industry: (1) the rivalry among competing firms, (2) the bargaining power of suppliers, (3) the bargaining power of buyers, (4) the threat of new entrants, and (5) the threat of substitute products or services.

Five Forces Model (2 of 6)

The strongest of the five forces in most industries is the rivalry that exists among the businesses competing in a particular market.

Rivalry Among Companies

Strongest of the five forces

Industry is more attractive when:

Number of competitors is large, or, at the other extreme, quite small

Competitors are not similar in size or capacity

Industry is growing fast

Opportunity to sell a differentiated product or service exists

Five Forces Model (3 of 6)

The greater the leverage that suppliers of key raw materials or components have, the less attractive is the industry.

Bargaining Power of Suppliers

The greater the leverage of suppliers, the less attractive the industry.

Industry is more attractive when:

Many suppliers sell a commodity product

Substitutes are available

Switching costs are low

Items account for a small portion of the cost of finished products

Five Forces Model (4 of 6)

Just as suppliers to an industry can be a source of pressure, buyers also have the potential to exert significant power over businesses, making them less attractive.

Bargaining Power of Buyers

Buyers’ influence is high when number of customers is small and cost of switching to a competitor’s product is low.

Industry is more attractive when:

Customers’ switching costs are high

Number of buyers is large

Customers want differentiated products

Customers find it difficult to collect information for comparing suppliers

Items account for a small portion of customers’ finished products

Five Forces Model (5 of 6)

The larger the pool of potential new entrants to an industry, the greater is the threat to existing companies in it.

Threat of New Entrants

The larger the pool of potential new entrants, the less attractive an industry is.

Industry is more attractive to new entrants when:

Advantages of economies of scale are absent

Capital requirements to enter are low

Cost advantages are not related to company size

Buyers are not loyal to existing brands

Government does not restrict the entrance of new companies

Five Forces Model (6 of 6)

Substitute products or services can turn an entire industry on its head.

Threat of Substitutes

Substitute products or services can turn an industry on its head.

Industry is more attractive to new entrants when:

Quality substitutes are not readily available

Prices of substitute products are not significantly lower than those of the industry’s products

Buyers’ switching costs are high

Five Forces Matrix (1 of 2)

Assign a value to rate the importance of each of the five forces to the industry on a 1 (not important) to 5 (very important) scale. Then assign a value to reflect the threat that each force poses to the industry. Multiply the importance rating in column 2 by the threat rating in column 3 to produce a weighted score. Add the weighted scores in column 3 to get a total weighted score. This score measures the industry’s attractiveness. The matrix is a useful tool for comparing the attractiveness of different industries.

Minimum Score = 5 (Very attractive)

Maximum Score = 125 (Very unattractive)

After surveying the power these five forces exert on an industry, entrepreneurs can evaluate the potential for their companies to generate reasonable sales and profits in a particular industry.

Five Forces Matrix (2 of 2)

Table 4.1 Five Forces Matrix

Force	Importance (1 to 5) (1 = Not Important 5 = Very Important)	Threat to Industry (1 to 5) (1 = Low 3 = Medium 5 = High) C	Weighted Score Col 2 × Col 3
Rivalry among companies competing in the industry	5	2	10
Bargaining power of suppliers in the industry	2	2	4
Bargaining power of buyers	2	4	8
Threat of new entrants to the industry	3	4	12
Threat of substitute products or services	4	1	4
Blank	Blank	Total	38

Elements of a Feasibility Analysis (2 of 4)

A product or service feasibility analysis determines the degree to which a product or service idea appeals to potential customers and identifies the resources necessary to produce the product or provide the service. This portion of the feasibility analysis addresses the question “Are customers willing to purchase our goods and services?”

Product or Service Feasibility Analysis (1 of 2)

Determines the degree to which a product or service idea appeals to potential customers and identifies the resources necessary to produce it.

Two questions:

Are customers willing to purchase our product or service?

Can we provide the product or service to customers at a profit?

Product or Service Feasibility Analysis (2 of 2)

Primary Research:

Collect data firsthand and analyze it.

Secondary Research:

Gather data that already have been compiled and analyze it.

Conducting primary research involves collecting data firsthand and analyzing it; secondary research involves gathering data that have already been compiled and is available, often at a reasonable cost or sometimes even for free. In both types of research, gathering both quantitative and qualitative information is important to drawing accurate conclusions about a product’s or service’s market potential.

Primary Research Techniques

Customer surveys and questionnaires

Focus groups

Prototypes

In-home trials

“Windshield” research

Trade associations and business directories

Primary research tools include customer surveys, focus groups, construction of prototypes, in-home trials, and “windshield” research (driving around and observing the competition).

Secondary Research Techniques

Trade associations and business directories

Industry databases

Demographic data

Census data

Forecasts

Market research

Articles

Local data

Internet

Secondary research should be used to support, not replace, primary research. Secondary research, which is usually less expensive to collect than primary data, includes these sources.

Elements of a Feasibility Analysis (3 of 4)

The third component of a feasibility analysis involves assessing the financial feasibility of a proposed business venture.

Financial Feasibility Analysis

Capital requirements: an estimate of how much start-up capital is required to launch the business.

Estimated earnings: forecasted income statements.

Time out of cash: the total cash it will take to sustain the business until the business achieves break-even cash flow.

Return on investment: combining the previous two estimates to determine how much investors can expect their investments to return.

This component of the feasibility analysis answers the question “Can this business generate adequate profits?”

. The four major elements to be included in a financial feasibility analysis are the initial capital requirement, estimated earnings, time out of cash, and resulting return on investment.

Elements of a Feasibility Analysis (4 of 4)

There is one last component of feasibility to examine: the readiness of the entrepreneur to launch the venture successfully.

Entrepreneur Feasibility

Is this idea right for me?

Assess entrepreneurial readiness: knowledge, experience, and skills necessary for entrepreneurs to be successful.

Assess whether the business will be able to generate enough profit to support everyone’s income needs.

Many new businesses require that an entrepreneur have a certain set of knowledge, experiences, and skills to have any chance of being successful. This is called entrepreneurial readiness.

Developing and Testing a Business Model

Key questions to address:

What value does the business offer customers?

Who is my target market?

What do they expect of me as my customers?

How do I get information to them, and how do they want to get the product?

What are the key activities to make all this come together, and what will they cost?

What resources do I need to make this happen, including money?

Who are the key partners I will need to attract to be successful?

When building a business model, an entrepreneur addresses a series of key questions that explain how the business will become successful.

The Business Modeling Process (1 of 5)

Figure 4.9 The Business Modeling Process

Developing a business model is a four-phase process as shown in Figure 4.9.

The Business Modeling Process (2 of 5)

The first phase of the Business Modeling Process is to create an initial Business Model Canvas.

The Business Model Canvas

Figure 4.8 The Business Model Canvas

Source: Business Model Generation: A Handbook for Visionaries, Game Changers, and Challengers by Osterwalder, Alexander; Pigneur, Yves Reproduced with permission of Wiley in the format Book via Copyright ClearanceCenter.

Figure 4.8 shows the Business Model Canvas which provides entrepreneurs with a dynamic framework to guide them through the process of developing, testing, and refining their business models.

The Business Modeling Process (3 of 5)

The second phase in designing the business model is to test the problem that the team thinks the business solves through its core value proposition.

Test the Value Proposition

Ask customers:

Do we really understand the customer problem the business model is trying to address?

Do these customers care enough about this problem to spend their hard-earned money on our product?

Do these customers care enough about our product to help us by telling others through word-of-mouth?

By engaging potential customers early in the development of a new business and listening to what they have to say, the team has a much better chance of developing a business model that will attract customers.

The Business Modeling Process (4 of 5)

The third phase is to test the solution to the problem in the market.

Business Prototyping (1 of 2)

Entrepreneurs test their business models on a small scale before committing serious resources to launch a business that might not work.

Recognizes that a business idea is a hypothesis that needs to be tested before taking it full scale.

One technique to test the solution offered by the business model involves business prototyping.

Business Prototyping (2 of 2)

Test early versions of a product or service using a lean start-up: a process of rapidly developing simple prototypes to test key assumptions by engaging real customers

Begin the lean start-up process using a minimal viable product: the simplest version of a product or service with which an entrepreneur can create a sustainable business

Entrepreneurs can test their ideas by selling their products on established sites such as eBay or by setting up their own Web sites to gauge customers’ response.

The Business Modeling Process (5 of 5)

The fourth phase of designing a business model is to make changes and adjustments in the business, called pivots, based on what the entrepreneur learns from engaging the market about the problem and the solution that the new business intends to pursue.

Pivots

Pivots: the process of making changes and adjustments in the business model on the basis of the feedback a company receives from customers.

Product pivot

Customer pivot

Revenue model pivot

There are three major types of pivots.

Conclusion (1 of 2)

The best business ideas start with a common problem or need.

The ideas assessment process helps an entrepreneur more efficiently and effectively examine multiple ideas to identify the solution with the most potential.

A feasibility analysis helps the entrepreneur determine whether an idea can be transformed into a viable business.

Conclusion (2 of 2)

Developing a business model helps the entrepreneur better understand all that will be required to launch and build a business.

Once the entrepreneur completes the idea assessment, feasibility study, and business model, he or she is ready to develop the business plan.