Business Idea Generation
jroero
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learning objectives After studying this chapter, you will be able to: LO3- 1
Describe a systematic means for examining skills in order to generate new business ideas.
LO3- 2
Discuss the elements of opportunity analysis.
LO3- 3
Analyze how to choose a business.
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Business Idea Generation and Initial Evaluation
UBER CHANGES THE BUSINESS
UberCab was founded in San Francisco in 2009 as a means of connecting for-hire drivers with potential passengers. Using a mobile platform, the company connects people needing a ride with those offering rides. The system is more efficient than calling a single cab company and more on-demand-oriented than hiring a traditional limo. The application was an instant success and the name was quickly changed to Uber when the company purchased the website Uber.com. Uber takes 20 percent of the charge for the ride and handles the financial transaction via their mobile platform.
The founders of the business are Travis Kalanick and Garret Camp. The company started with no employees and a shoestring budget. The first prototype was developed and the app was launched in San Francisco in 2010.
Since its inception, the business has quickly grown to more than 60 cities around the world. Uber allows drivers who are not employed or even certified by the company to use their own vehicles to pick up passengers. This business model has generated some problems for the company. In 2013, for example, a class-action lawsuit was filed against the companies by taxi drivers who claim that Uber is stealing their tips. Cities have also tried to shut down the service by claiming that Uber is skirting their taxicab laws. In Paris, cabbies who were on strike slashed tires and smashed windows of cars working with Uber. In 2014, an Uber -arranged ride resulted in an accident in which a 6-year-old girl was killed. The company was sued for wrongful death.
The company started as an entrepreneurial venture but has now grown into a venture-backed company with reported revenues in 2013 of over $125 million. Uber was born from an idea to better address the needs of both drivers (who want to maximize the number of rides for hire per day) and passengers (who don’t want to wait for a taxi to pull over or arrange a ride ahead of time) using technology that is now in the hands of virtually everyone.
Questions 1. Uber entered an entrenched industry using mobile technology. What other applications for this technology do you see in
the personal transportation industry? 2. Why haven’t the established cab and limo companies adopted these approaches?
Sources: E. Griffith, “The Uber Effect: The Hot Startup’s Early Investors Are In-Demand,” CNN Money, February 4, 2014, http://tech.fortune.cnn.com/2014/02/04/the-uber-effect-the-hot-startups-early-investors-are-in-demand; J. Brustein, “Uber Explains Why $35 a Mile Is the Right Price,” Bloomberg Businessweek, December 17, 2013, http://www.businessweek.com/articles/2013-12-17/uber-
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explains-why-35-a-mile-is-the-right-price; J. Brustein, “Uber’s Workforce Is Built to Do More Than Chauffeur,” Bloomberg Businessweek, December 11, 2013, http://www.Businessweek.com/articles/2013-12-11/ubers-workforce-is-built-to-do-more-than- chauffeur; D. Streitfeld, “As It Shakes Up the Taxi Business, Uber’s a Target,” The Boston Globe, January 27, 2014; C. Matlack, “Paris Cabbies Slash Tires, Smash Windshields in Protest Against Uber,” Bloomberg Businessweek, January 13, 2014, http://www.businessweek.com/articles/2014-01-13/paris-cabbies-slash-tires-windshields-in-protest-against-uber
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Betty and Joan had previously determined that they wanted to start a business and that they had a similar propensity for risk taking, as discussed in Chapter 2. Even though the two entrepreneurs wanted to start a home health care business, they were not sure of the dimensions of the potential business. They knew there was a very high failure rate among entrepreneurial businesses, so they wanted to be sure to examine their business ideas carefully so this would not be one of the failures. Therefore, they visited with a successful entrepreneur in their area.
This successful entrepreneur gave Betty and Joan some general ideas about the key issues in starting a new business and suggested that the two of them needed to conduct an audit of themselves to better understand what type of focus the business might need. This audit would help them to determine their views on a number of topics. The successful entrepreneur suggested that the audit include questions such as: 1. What skills had they developed in their prior work experiences? 2. What special hobbies had they pursued? 3. What things about the home health care industry did the two really like? 4. What did they want to achieve with a new business? 5. Were there home health care trends in other countries and/or other parts of the country, which seemed interesting but had
not yet reached their area? The two budding entrepreneurs initially answered these questions separately and then summarized their answers as follows:
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Betty and Joan discovered through this audit process that there were important similarities and some differences in their thoughts about a potential business opportunity. Betty and Joan both shared a commitment to family and wanted more time to spend with their families. However, Betty was married and her husband had a good job with a bank. The result was that although she wanted financial rewards, the financial rewards took less priority than time with the family. In contrast, Joan was a single parent. Even though she wanted more time to spend with her family, she was the primary provider to her two children and the financial rewards were critical to her. The financial aspect was even more intense as her two children went to a private, religious-affiliated school. Both women were also very religious. Betty, an African American woman, was particularly committed and involved in her church. Joan, a Hispanic woman, was also involved in her church although the time commitment was less. The religious commitment of both women led them to agree that they wanted to form a business with the highest ethical standards and one that would show compassion and love to their mostly elderly clients.
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A fortunate series of events occurred during the early fall of 2012. The large state in which they lived began to encourage more individuals to pursue home health as an alternative to moving the elderly to rehabilitation centers, which would lower the state’s Medicare costs. Medicare is a joint federal and state government program that covers a number of costs for the elderly, including nursing homes, rehabilitation centers, or home health in given situations. While a desirable program, governments are always seeking to control costs. In addition, as a minority-owned business headed by females, the two entrepreneurs learned they would receive special consideration for referral of patients from the state and regional medical facilities. Thus, there appeared to be an opportunity for this type of business.
Individuals come to the decision to begin a new business from many different perspectives and backgrounds. From this widely diverse group of individuals come many successful business ideas. Research shows that successful new business ideas are not determined by who your parents are, your race, your gender, or your religion. Instead, quality ideas are a function of the creativity and thoughtfulness of the person or persons creating the business.
So how does someone come up with an idea for a new business? Among the most popular resources is the individual’s professional background or hobbies. These are domains that the individual knows very well and where it is easier to see shortcomings in the current business offerings and needs that are not being meet. Great insight can also be gained from individuals that the entrepreneur respects or those who have been successful in founding a business. There are a wide variety of sources that can be called upon for ideas about potential businesses. In this chapter we identify a systematic way in which to generate a list of potential businesses. The initial steps in evaluating the viability of these ideas will also be presented as a key element in this process.
EXERCISE 1 1. What similarities in the founders’ answers do you see? 2. The founders chose to focus on home health care. What other options might have been open to them? 3. What is the impact if a national chain is already in your area in this industry?
Generating Business Ideas LO3-1
Describe a systematic means for examining skills in order to generate new business ideas.
Even when individuals may determine that they want to open a new business, the exact type of business to open is much more difficult to determine. We encourage everyone, even individuals who feel that they firmly know which type of business they wish to open, to examine all options through the processes detailed in this chapter. We have found that potential new business owners often feel strongly about the type of business they wish to open, and yet, upon a more systematic examination, move to an alternative idea. Frequently, they do find an opportunity in the market, but it may not be the exact business concept they initially conceived. Alternatively, they may conclude after their analysis that the business they conceptualized would not be successful. Therefore, rather than reacting in a knee-jerk manner to what appears to be an opportunity, or even worse, quickly dismissing a promising idea, an individual needs to make a rational evaluation of a business opportunity and its potential.1
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As discussed in Chapter 2, the desire to own and operate a business is a first step in entrepreneurship—but what business might that be? The generation of business ideas is not something that occurs automatically. Rather, it is a process of identifying the skills of the potential founders, identifying opportunities in the market, matching the initial financial funding available, and then marrying these together into a business idea that interests the potential founders. As noted in Chapter 1, the establishment of a successful new business is challenging. The high demands placed upon everyone involved in the process necessitate that the founders truly enjoy what they are doing. The process presented below is intended to be an open one that considers passion and enjoyment as important elements to success.
While not a sequential formula, we would suggest the following approach to the development of a quality business idea. First, the potential founders should list and evaluate their own personal skill sets. These skills may arise from hobbies,
current work, past work experience, and/or family history. Second, the potential founders should carefully analyze the market and look for a gap, or some need that is not being met
effectively. Finally, the potential founders need to compare their ability to fill those gaps with the opportunity that seems to be
available. We suggest that the best means to do this is the development of a chart (see Table 3.1) that allows for an open, systematic examination. We will look at each of these steps in more detail.
Skills Analysis You might be asking yourself why we suggest starting with the skill set of the potential founders rather than an “opportunity” in the market? The fact is that there are literally millions of “opportunities” in a wide variety of fields, but without the requisite skill set, pursuing (or even considering) these opportunities is simply a frustrating exercise of wasted money and time.
There may be tremendous opportunities in the spa services business. However, if a potential business owner had no skills in this area, then those supposed opportunities are of little use to the potential founders. Without the needed skills, the founders would be faced with not holding any advantage over competitors who have the necessary depth in the area. A founder or founding team must have not only the necessary skills, but also a depth of understanding, so that they can build a long-term advantage in the market; they need a synergy that connects skills, understanding, and a competitive advantage such that the sum of the parts is greater than the individual parts by themselves. Perhaps as important as the business owner’s skills in a particular area is the need for the potential owner(s) to have interest in or passion for starting a business in that domain. We have found that founders without a passion for the business are not willing to devote the time and energy necessary for the business to be successful.
As we mentioned previously, skills come from a variety of areas and are relatively idiosyncratic to the individual. In general, skills are derived from our history, experience, and interests. Several specific areas that potential business owners might examine include hobbies, education, work experience, and family history.
synergy The connection between the entrepreneur’s skills, understanding of an industry, and the ability to create a competitive advantage such that the sum of the parts of the new business is greater than the individual parts alone.
Hobbies and Activities We all pursue hobbies and activities because we love them. In these hobbies or activities we develop skills specific to the hobbies or skills. The avid skier who opens up a ski shop, the distance runner who opens up a running store, the ham radio operator who becomes a radio equipment dealer are all examples of hobbies leading to a business. If there is a great passion associated with hobbies or activities, that passion can help the success of the new business. A rule of thumb in the founding of businesses has always been that the owner whose business is both a vocation and an avocation is difficult to beat. That person is willing to stick with the business through lean times and develop a following of fellow enthusiasts. A problem that can arise is that the “business” of running the business takes over at some point and time, and the entrepreneur does not enjoy the business like he or she once did. That problem is something we will address in later chapters.
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Your hobbies can impact how you approach business ventures. Do you have any hobbies that might lend themselves to a solid business idea?
At this point the questions the potential business owner should probably ask include: What hobbies or activities do you pursue on an active, perhaps daily basis? What hobbies or activities have you pursued in any manner over your lifetime (whether or not you were serious about
them)? What is it about your hobbies or activities that really excites you? What were the specific skills that these hobbies or activities required? What have your experiences in the hobbies or activities taught you that could help others? What products and services did you use in these hobbies or activities?
Education From the time we are very young, we are in learning mode. From primary school to whatever level of education we pursue, the knowledge gained provides a skill set that can be the basis of a new business. An opportunity that uses your education (formal or informal) is another source of a business. The technological skills developed during the entrepreneur’s education can be particularly valuable.2
What courses did you take that were particularly enjoyable? What courses did you take where the material came to you very easily? Have you attended any unusual education programs? Have you taken specialized training in any specific area? If you had to do it all over again, what areas would you pursue now?
Work Experience Another source of skills for a new business comes from your work experience. Your work experience builds skills that can have direct applicability to the pursuit of a new business. In each job, individuals build up skills that they take with them when they start a new business.
In what businesses have you worked? What skills were critical to the jobs you performed? What positions have you held in business? In what areas would you be considered a type of expert?
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What did you really enjoy about the positions you have held? What frustrated you about the positions that you have held? When were you the most excited about your work?
Your family can be a great help in developing a business. What are some of the risks and rewards that you associate with the idea of working with your family?
Family Family experiences are an often overlooked source of skills for a new business. As we are well aware, every family is unique. There are often things that you do with your family in which you develop expertise. Many times potential entrepreneurs overlook these family experiences as a source of knowledge and skills. Cooking with family members, tracing family history, working on the house or around your family property are all sources of knowledge that can grow into a new business opportunity. One of the authors regularly hires a guide when vacationing in Sedona, Arizona. This particular guide grew up hiking and exploring the Sedona area with his family. After working for the park service for many years, he decided to open his own tour operation. He takes individuals or very small groups on customized adventures in the area that cater to the desires of the customer. He turned his family passion into a business that has grown to include other guides and is a year-round operation. Your pursuits can similarly be the source of a unique skill set for a business.
What is your family history with new business ventures? What types of travel and vacations does your family enjoy? What skill sets exist within your nuclear family? What are the financial resources of your extended family? Are there unique things your family does that others seem very interested in? What skills do you develop in your family activities?
Additional Skills Beyond these categories, we suggest that you also ask yourself the following questions:
1. What are your top three personal skills? 2. What things do you like doing best each day, each week? 3. When you look back over the past year, what one or two things did you enjoy more than any others?
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4. What are the magazines and books you read? 5. What are your three greatest accomplishments in life? What skills were involved in these accomplishments? 6. Do you enjoy working with people? Or would you prefer to be left alone to concentrate your efforts in a particular area? 7. In what industry (retail/wholesale/manufacturing/service) would you prefer to work?
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Chris was very excited about the potential for the new brewery business but still didn’t know if he could really make it work —or whether it was really even a good idea. Looking back over the past 10 years he found out that the location he wanted had been four different restaurant concepts and none of them had succeeded. Even though he thought that his concept was more in line with what might work in the area, he was also unsure about his qualifications.
Looking honestly at himself, Chris recognized that although he was a smart guy, he had no experience running any type of business. He had worked in a microbrewery in college but was a waiter and bartender most of that time. He spent a fair amount of time with the brewmaster learning the trade, which is what had sparked his keen interest in the activity over the past 10 years. He was never the brewmaster in his prior working experience, but he did have experience brewing beer at home. Therefore, Chris decided to examine some aspects of the business before he committed to the idea.
Financially he and his wife were in a sound position. They rented their house, owned both their cars outright, had retirement savings that were beginning to grow, plus they had just over $100,000 in cash to invest in a new business. Doing some quick research, Chris realized that he would probably need $500,000 to purchase everything he needed, run the business for six months until it reached breakeven, and provide him with a salary sufficient to keep up with some of the household expenses. This meant that he would either need to bring in partners to obtain the extra $400,000, take out loans, or obtain a combination of partners and loans.
The time commitment was going to be substantial. Chris knew that it was a business that would need to be open most days until midnight and that the brewing aspect was a seven-day-a-week activity. The business location was less than three miles from his house, he and his wife had no children, and they were both ready to commit the time needed.
As mentioned in Chapter 2, Chris was well known in the local brewing community. He had won a number of local brewing awards and was a sought-out teacher of home brewing. Thus, Chris felt he had the expertise to move from small amounts of brewing to running a microbrewery. However, Chris also recognized that he had to consider the competitors in the area. There was only one true microbrewery in the area, but there were many bars, restaurants, and clubs in which customers could enjoy beer. Local brews were not readily available, however, and although that was positive on the one hand, it really concerned Chris on the other. Would there be sufficient interest in local brews and in a local microbrewery to generate a real revenue stream? The only other microbrewery was part of a national chain with a very well-known name. A microbrew is typically not the cheapest beer to brew or sell. It takes a customer base that is more committed to drinking a high-quality beer that may cost a little more for a microbrewery to prosper.
After weighing all the factors and including his wife’s overwhelming support for his pursuing this effort, Chris decided that he would commit to starting the business.
Clearly, the goal from all these questions is to explore the range of potential skills and abilities that each of us possesses. A few more questions can help you tailor your business to your unique skills and personality:
1. Do you prefer to work extensively with people or not? If not, you need to focus on a business that has minimal interpersonal demands (an Internet-based business or a business that performs tasks for other businesses by handling back-office operations, such as bookkeeping, billing, order fulfillment, etc.). If you thrive on people and have the corresponding skills, then a retail or service-oriented business may be ideal.
2. Do you have an intense detail orientation? If you are very detail oriented, then a business that is procedurally complex and involves managing a wide variety of details may be appropriate. Remember that there are many people and companies out there that will pay handsomely for someone to manage the details of life. For example, a supply company to large manufacturers that
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customizes a product on a wide variety of details might be appropriate. Another area might be project management. Alternatively, an individual who finds this level of detail frustrating should pursue a business with a simpler or more forgiving business model.
3. Are you trained in the area in which you want to work? Your experience and educational skills will have a critical impact on the direction of the business. Someone may believe that there is a need for a computer repair shop in your part of the city. However, if the individual does not have the skills from either educational training or experience to do such repairs, it does little good to consider such a business. As a general rule, focus on what you know best.
What is clear from the questions above is that in this text we believe that the founder(s) of a business need to be intimately involved in the design, funding, and running of the new business. Although we sometimes read about individuals who like to claim they are “idea” people and plan simply to hire everyone needed to run the business, we would suggest that these individuals are not founders—they are bankers with vision. They are simply providing funding and the concept. Such a model might work for people with large amounts of money; however, this model is difficult to pursue successfully for most people. Therefore, in this text in general, and in this chapter in particular, we use the basic assumption that the founder will be intimately involved in the new business.
Opportunity Identification LO3-2 Discuss the elements of opportunity analysis.
Once you have developed a list of your skills, abilities, and interests, the next step is to examine the marketplace for opportunities to use these in a business. The method that we use and recommend is a form of gap analysis. In such an analysis, individuals identify a gap or opportunity that exists between the demand for a product or service and the supply provided by firms in the market. It is then up to you to determine if you have the skills and abilities to fill that gap.
gap analysis A relatively simple process of systematically examining the difference, or gap, between what is expected and what occurs. One type of gap analysis, called opportunity analysis, examines opportunities in the marketplace side-by-side with the individual’s ability to address those gaps.
Potential Businesses There are a variety of ways to identify gaps, or business opportunities, in the marketplace. These include the following:
1. Examining trends around the region, nation, or world that may not have reached your particular geographic location. Trends do not start uniformly. Notice that a number of regional coffee chains have developed significant businesses in specific cities throughout the United States (see the chapter-opening vignette in Chapter 1). Some of these chains (especially those in the Midwest) were developed by their founders examining how firms such as Starbucks were achieving success in major cities on the coast. These businesses achieved a strong local position before the national firms could make significant investments in their local markets.
2. Interview and talk about opportunities with key successful entrepreneurs in the area. Most successful entrepreneurs have great ideas that have the potential to be successful given the right set of circumstances and people. From their own experiences, these individuals have a keen eye for what businesses are needed in an area. However, these individuals often have too much to do with their own businesses to pursue new ventures themselves, so they are willing to share their insights. The result is that they are willing to advise new entrepreneurs, as well as to identify and
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perhaps fund such opportunities. In effect, they become mentors to new entrepreneurs. 3. Discuss potential businesses with family members. Your family members know your abilities and
disposition. Furthermore, they are uniquely positioned to provide a much-needed honest perspective on your efforts. Particularly if any of these individuals have a small business of their own, they might be useful in the process of helping you decide which businesses are best suited to your particular set of skills.
4. Look for environmental changes that create opportunities that did not exist before. Significant regulatory changes create new openings in an industry that did not exist before that regulatory change. Consider all the changes associated with health care reform, for example. Regardless of what you think of the law, it has clearly changed the industrial setting in health care and created new opportunities that entrepreneurs can take advantage of.
5. Brainstorming with key entrepreneurs and family members can also be useful to the potential entrepreneur. Brainstorming is a creative process in which a group of individuals are brought together and asked to generate ideas related to a specific topic or problem, with little effort given to evaluating the true potential for those ideas. In this case, the scenario might be one where a group is provided information on the skill set of the founder and asked to generate a list of businesses that might be appropriate. The interaction within the group leads to a dynamic that can lead to new, innovative ideas. Such brainstorming sessions work well in informal groups. Think of friends or family gathering over a meal and talking in depth about the options that are available; this is brainstorming. The conversation in Chapter 2 in which Chris’s family initially talked about the options for Chris to take over the closed restaurant and open a microbrewery was a form of brainstorming.3
6. Take a look at the things that frustrate you and your family. Daily frustrations are an incredible source of ideas. How would you solve the frustration? What is it about the frustration that needs to be solved? You will find that you might have as many as a dozen aspects that could be solved, but only a few that truly fit with your capabilities and interests. Most (if not all) needs in a developed society are currently being met. However, the degree, level, detail, efficiency, effectiveness, politeness, or access all provide means for improving the satisfaction of a particular need being met.
7. If the potential entrepreneur has an interest and skill set based in technology, one of our personal favorites for the generation of business ideas is the examination of patent files. Millions of patents exist and are maintained by the original inventors and have never been the subject of a commercial attempt. We recommend an examination of patent files (available at www.uspto.gov) to find several that interest the potential entrepreneur. We suggest that you contact the inventor (all of the contact information is included with the patent) to see if that individual would be willing to work exclusively with you in the development of a commercial business. We have worked with entrepreneurs who started with their interest area, found a set of patents that had not been developed into businesses, successfully contacted the inventors, and then based their business on those patents.
brainstorming
A creative process whereby a group of individuals are brought together and asked to generate ideas with little or no effort made to evaluate the potential for each idea rather the focus is to generate numerous ideas.
EXERCISE 2 1. Create a list of ideas in each one of the aforementioned first six idea categories. 2. Do any of these ideas strike you as particularly intriguing for your future business? Why?
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Choosing a Business LO3-3 Analyze how to choose a business.
The process of generating ideas is not something that is done in a single sitting. Instead, it is a process that takes time, interaction, consideration, evaluation, and iteration. These steps do not occur in a linear fashion but should occur in an interactive manner. For example, if a successful entrepreneur suggests a new business that seems to fit well with your skills, then an investigation into the opportunity may be warranted. In discussions with trusted friends and family, the idea will morph and be refined. As the business idea evolves you may realize that you need new skill sets to be successful. This might require including others on the founding team. As a result, the generation of ideas is truly a process that takes time and interaction. However, done well, this effort should lead to a list of three to five business ideas where the founders have the appropriate skills and there appears (at least on the surface level) to be an opportunity.
To illustrate, we worked with an entrepreneur who had strong retail experience. This individual enjoyed working with people and had great orientation to detail. Three opportunities were initially identified by the individual. First, several family members who operated a flower shop in another city were encouraging him to pursue a similar business in his city. These family members thought the potential entrepreneur had the skills for that business, and they could coach him in the business. Second, some experienced businesspeople that he knew identified a gap in the printing services offerings that were available in their area. There was a chain copy shop in the small downtown area of town, but that shop did not provide any really high-quality business printing, despite the relatively large number of small businesses in the area. The focus of the chain store was on individuals, self-service, and low-volume printing jobs. Finally, this individual had noted a trend on the West Coast of the United States (not his area of the country): the growth of restaurants that were in-between fast-food restaurants and full-service restaurants. These restaurants typically focused on regional food offerings. This type of restaurant had an upscale decor, but individuals ordered at the cash register and had their food delivered to them at the table. Thus, it was a different format for a restaurant than he had noticed in his area.
Each of these businesses had a relatively high level of detail involved in the operation of the business, and yet the processes to operate the businesses were relatively well known. Additionally, each of the businesses required high levels of interaction with customers, and customer service seemed to be a critical element of the business model. The background and skills of the potential entrepreneur appeared to fit with all of these businesses. Now he would have to pick one business idea.
Initial Analysis The potential entrepreneur, just as in the example above, will likely have several ideas, but will need to identify one business on which to perform a due diligence analysis. Chapters 4, 5, and 6 identify the process for performing an in-depth analysis on that single business idea. It is possible that after doing the in-depth analysis, the potential entrepreneur will decide not to pursue that particular business and will begin the analysis of business ideas all over again. However, the nature of the effort required to perform an effective due diligence study necessitates a focus on a single business concept. The analysis and thought processes require focus, time, and usually some financial investment. If the potential entrepreneur is to be successful, then the process is to move from the three to five ideas initially generated to a single idea on which to focus. Our would-be entrepreneur in the prior example had to determine whether to focus further analysis on the flower shop, the printing business, or the restaurant. One means to identify which business to pursue is through a gap analysis.
The generation of ideas along the way to selecting a business is a process that takes time and frequent interaction.
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Gap Analysis How do you decide that a sufficient business opportunity exists and that you have the resources necessary to take advantage of that opportunity? While there is more art to this process than science, starting with the list of three to five ideas that you have generated, you can now develop a chart that examines the issues that might impact the success of the new business. The business ideas are listed down in the first column, with a brief explanation of what each idea entails. (Later, each of these descriptions will be put into a short paragraph explaining the business and its opportunity for economic success.) You should be able to tell anyone succinctly—in less than two minutes—what your idea is and how it will bring substantial success. (You will see student business plan competitions called “elevator pitches” that are essentially the same concept—pitch your business in two minutes, or the time to ride the elevator to the top of a building.) Taking more time simply indicates that you have not clearly identified the opportunity or how it will work. We refer to this as gap analysis, and it should look roughly like the one in Table 3.1. We have filled in the three business ideas generated by the small business founder discussed in the previous section (flower shop, printing shop, and restaurant). However, you would use this form for your own business ideas.
In the second column, next to a given idea (and this may take several spreadsheet pages), list each category you will use to analyze the idea. We urge you to consider, one at a time, at least these five categories, which are crucial to the founding and successful running of a business: finances, time, nonfinancial resources, risk, and competitors. Each of these categories will be discussed in greater detail once we illustrate why this is a gap analysis.
In the third column, you should provide a realistic estimation of personal resources. In the fourth column, you should list your estimates of what resources are required for success. For the last column, you should qualitatively compare your skills and resources with the perceived requirements of that particular business, and record the perceived deficit or gap. Then you can answer an important question: Is that deficit surmountable, or is it one that kills the idea?
This qualitative chart can be completed with minimal or no research. What we are suggesting at this stage of investigation is a gut-level, reasonably quick analysis to see if the business passes an initial test. The gap analysis is intended to be completed by the entrepreneur or entrepreneurial team in a very short time period.
As we mentioned before, the second column lists “categories.” These are categories that should be used for analysis. There are a number of categories that the entrepreneur needs to consider for a gap analysis. Following are the five important categories we have listed briefly. We will examine all of these in greater detail in later chapters. The list below is not meant to be exhaustive, as every type of new business will have its own unique categories.
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Table 3.1 Form to Compare Three Different Business Ideas
1. Finances. You must examine the amount of money required to start and operate a business. A principal cause of new business failure is insufficient financial resources at founding. An entrepreneur may have a good idea but then run out of funds long before a sufficient client base can be built. This will be discussed further when we examine cash flow in Chapter 6. However, we feel that at this stage of analysis, the entrepreneur needs to have a basic understanding of the financial demands of the business. a. Your resources—What financial resources do you have that you can realistically commit to the new venture? This
should include estimates of savings, retirement accounts that may be used, your spouse’s salary, and other. Do you have family resources that could be committed to the effort? How much money could you realistically raise on short notice?
b. Business need—Estimating how much money do you expect to need to start and to stay in business for one year? Without a lot
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of investigation, consider the following: rent, furniture, utilities, advertising, renovation, equipment, supplies, cost of an employee or two, taxes, and fees. Take whatever number you develop and add 50 percent to it. A standing rule-of-thumb is that start-ups take twice the money that was initially forecasted to achieve a sustainable level of operation. Is this number within the range that you would be willing to commit?
2. Time. It takes time to start a business. You will hear many successful entrepreneurs say that they estimate the time it will take to do something from scratch and then triple it. Again, you need to assure that you have the time necessary to start the business. Each type of business started will require different time frames. This is an area that many entrepreneurs grossly underestimate. a. Your resources—If you are currently employed, how much time can you dedicate to starting this new venture? Will
you quit your current job to work in the new business? How much time on a weekly basis are you willing to commit to the business once it is up and running? What other time commitments have you made? Does your family support your efforts?
b. Business need—What will the hours of operation require? How many additional hours will be required to manage the operation? Do you need staff early in the life of the business? When do you eat, sleep, and so on? What can be done concurrently versus sequentially?
3. Nonfinancial Resources. There are many other resources the new business will need beyond financing and the time commitment. This list can be long and should include such things as special contacts with suppliers or customer groups as well as the physical location of the business. This is a category where the entrepreneur should exercise some creativity in the analysis of the situation and the needs of the business. a. Your resources—What do you bring to the business beyond the financial? What unique
capabilities/experiences/knowledge provide you with a competitive advantage? Are these visible to the rest of the world? Are there others, such as family members, who can provide critical needs of the new firm?
b. Business needs—What unique skills will be required to run the business? Can you contract with individuals for the areas that you are missing? Can you obtain the resource in short order? (For example, to open a printing business, it would be very helpful to have wide experience on various types of printing presses. This could be gained by going to work for someone else for a period of time or by taking classes offered by contractors or the printing press company.) What unique resources are necessary to develop a competitive advantage in this business?
4. Risk. All new businesses have an inherent amount of risk associated with the starting and operation of the business. Whereas what constitutes that risk is determined by the entrepreneur, the level of risk needs to be commensurate with the rewards and within the tolerance level of the individual involved in the business founding. To determine your own risk tolerance, you should look at your own life over the past few years. When the economy
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is not in a recession, do you invest primarily in high-risk stocks or in safer places such as savings accounts? If you invest in savings accounts, then you are probably somewhat risk adverse. There are two types of specific risk you should consider: personal and business. a. Personal risk—Risk at a personal level has many definitions and potential means of examination. It is certainly well
beyond just the financial. What level of risk to personal reputation are you willing to live with? If the business fails, what will you do? There is a strategic risk to starting a business when you are not ready, not committed, not sufficiently funded, and the like. A failed business idea may lead to others imitating your idea and even doing it better, or may affect your ability to pursue that or a similar type of business in the future.
b. Business risk—How aggressively does the business need to grow to be successful? Is there a competitive advantage that is fleeting? What level of product or geographic breadth is necessary to not only be a player, but be a success in the industry? What are the limiting factors in the growth of this business? What are the factors that could disrupt your supply chain?4
As mentioned in Chapter 1, you can also characterize and examine business risk by considering three threats to business success: (1) threats to the profit margin, (2) threats to sales generation schemes, and (3) threats to operational financing.5 Each of these areas represents a systematic examination of business risk.
1. Threats to Profit Margin. A significant threat to the success of a new venture is its ability to establish and maintain a high-margin product or service. That is, the firm is unable to make a high level of profit on each unit of product or service sold. What might inhibit your pricing or cost structure? Who are your significant competitors? Why do people shop with your competitor? How does pricing impact your ability to attract customers from your competitors?
threats to profit margin The threat of not being able to achieve a profit margin sufficient to allow the business to attain substantial returns.
2. Threats to Sales Generation Schemes. A new venture must have the opportunity to sell to many customers and to obtain repeat business. The ability to develop a sales scheme that is broad enough to appeal to a wide variety of customers is critical to the development of a successful business.6 Can your competitors meet or exceed your quality? Undercut your price? Position themselves better physically? Lock you out of suppliers?
threats to sales generation schemes The threat of not being able to generate sufficient sales required to make the firm profitable.
3. Threats to Operational Financing. There are a number of specific threats to the new venture in obtaining the necessary financing for its growth. Some such threats are high development costs, rapid expansion plans, high inventory needs, and/or an entrepreneurial team with a low asset base. As will be discussed in Chapter 6, one of the greatest risks to a new business is fast growth. Typically, you will be selling products or services effectively on credit (delayed billing) but having to pay cash for your inputs as a new firm. Thus, rapid expansion can quickly overextend your financial resources. Research has shown that firms with higher initial capitalization have the opportunity to grow faster.7 Why don’t new ventures simply increase the amount of financial capital they need before starting the business? Why would you need additional operating capital once the business was growing? What
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might impact your assessment of “enough” money to start and grow your business?
threats to operational financing The threat of not obtaining sufficient financing to operate a firm.
4. Competitors. The new business also must be realistic about its competitors. There are competitors for every business contemplated. If the potential entrepreneur cannot think of any company doing exactly the same thing as the new potential business, then what are customers doing now to satisfy that need/want? That current solution to the customer’s problem is a competitor and will have to be dealt with by the new business. Most of the time, there are obvious competitors trying to lure the same set of customers as the potential new business. List who exists in this competitive set and why you believe they are competitors for your new business.
To illustrate how critical the accurate evaluation of these issues is to the success of the new firm, consider a business we worked with at the onset of the first Internet boom (late 1990s). This firm proposed to use the Internet to automate (and make remarkably more efficient) a process that previously had been done only through extensive use of the telephone— one call at a time. The former process involved making 30 or more phone calls to various individuals and then trying to coordinate their activities in a stepwise fashion while waiting for each to return the call (which usually came in while the initial caller was on the phone with another individual). The product developed by the founding entrepreneurial team was a Web page–based product that would perform this function on one screen at the same time (something we take for granted today). The initial response by the customers was immediate and positive. The software behind the product was modestly complex; nonetheless, once the Web page was available and visible, it would not be overly difficult for a well-heeled competitor to imitate it in just a couple of months. Some of the founders believed that the Web page itself and the software code that supported it was the key to success, and that the rollout could be incremental. They wanted to limit their risk and use cash flow to fund their expansion with a systematic plan to expand the business slowly. Another group of the founders believed that the critical limiting factor was obtaining exclusive commitments from as many of the 300 core customers as soon as possible, before the competition realized what was happening to the industry. Once the key customers were secured they were less likely to change to another provider of the service.
ETHICAL CHALLENGE The risk of a business increases dramatically as the investment in the business provided by family members goes up. It is one thing to tell an outside investor that you lost his money; it is an altogether more difficult conversation when the investment came from your sister. Before you accept money from your family or close friends, consider how you will handle that money in your business and how you will reward their confidence in you. All new ventures are inherently risky. As part of your risk analysis, you have to consider how much financial risk you are willing to commit to personally and with funds provided from those close to you. There are a rich set of questions that an entrepreneur should ask themselves as they move forward.
QUESTIONS 1. How would having your grandmother’s retirement funds invested in the firm affect your judgment of the risk of a
venture? 2. What if the business investment included your college funds? 3. What if those funds had been left to you by a relative? 4. How does the risk equation change if you had children that were young as opposed to approaching college?
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This focus on the importance of the customers as the source of competitive advantage changed the whole approach for the new business. The owners decided that rather than rolling the business out incrementally, they would seek to sign up the core customers as quickly as possible. The solution chosen by the team was to hire a sales company that put 35 contract salespeople on the project for 90 days. The cost and risk of this approach was significantly higher for the founders. However, the result was that before competitors even realized that there was a new company in the field, the founders had locked up over 210 of the 300 customers. The first competitor showed up 70 days after they started their operation and was able to sign up only 14 customers after a year in operation.
For this new business, there was a significant strategic risk of misreading the critical factor(s) in the business, and a great idea could have simply limped along because of a poor implementation decision. If the business founders had not recognized the risk of their business idea being copied, they might have implemented the wrong approach and would likely have been replaced in the market by a larger, richer firm.
Now let’s go back and take a look at our entrepreneur who is debating between a printing shop, a flower shop, and a restaurant. The entrepreneur contemplated the situation and developed the following insights about location and the associated cost. The printing shop would not have to be in prime retail space, because it was not going to focus on retail customers as did the large chain near campus, but instead was to focus on business customers. The flower shop needed to be in prime retail space to obtain the impulse purchases that are a high percentage of the flower business. The size of the space needed and the need for excellent access to customers would make the restaurant’s location the most expensive of all three.
The entrepreneur in thinking through the competition and profits realized that the flower shop’s competition would be the strongest, and the profit margins in that industry were lower than in the other two industries. The printing shop had good profit margins, but the investment in the equipment necessary was relatively high. The restaurant seemed to have the highest competition risk. The nature of eating out is both eclectic and faddish. Individuals might desire one type of food for a while, then switch to another type of food. Additionally, returns in the restaurant industry are historically low, although individual restaurants can be quite profitable.
Considering time, the entrepreneur realized that the time needed to start up the flower shop and the printing shop would be shortest. The time it takes to set up and start a restaurant can be quite high, due to the nature of the finish to the interior that is required in the restaurant itself. The restaurant will have to develop a character and must be decorated, whereas the print shop might just have white walls. Finally, in terms of staffing, a far bigger staff is required in the restaurant, so the need for extensive hiring and training is an inherent and integral part of the business.
The entrepreneur had financial support from his family as well as some personal savings; had been laid off from his job, so he had lots of time
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to dedicate to the business; was single; and was dedicated to starting a business. His personal take on the deficit analysis for these three factors is provided in Table 3.2.
As a result of this analysis, the entrepreneur decided to focus his due diligence on the printing business. The due diligence proved that there was a need for the business (this concept will be discussed more in Chapter 4); that a successful and sustainable strategy had the potential to be developed (this concept will be discussed more in Chapter 5); and that the potential business had the opportunity for positive cash flows (this concept will be discussed more in Chapter 6). As a result of that due diligence process, the small-business person established the business and has made it a success.
Table 3.2 Example of Entrepreneur’s Personal Deficit Analysis
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SUMMARY In this chapter we presented a method for the potential new entrepreneur to develop and perform an initial evaluation of various business ideas. This process starts with an evaluation of the skills that the individual brings to the new business. What education, experience, hobbies, and other interests do you already have in your pocket before the new business gets founded? The next step is to look at the world around you and systematically evaluate the potential opportunities. There are literally millions of ideas out there. The real question is: Do you have the ability to successfully take advantage of those ideas to create a successful business? Finally, we presented a gap analysis methodology that has been used successfully for some time to determine potential fit with a business idea.
KEY TERMS brainstorming gap analysis synergy threats to operational financing threats to profit margin threats to sales generation schemes
REVIEW QUESTIONS 1. Based on your education, what are the skills you have that could be the basis for a business? 2. Based on your work experience, what are the skills you have that could be the basis for a business? 3. Based on your hobbies, what are the skills you have that could be the basis for a business? 4. What are your top three personal skills? 5. What things do you like doing best? 6. What magazines and books do you read? 7. What are your three greatest accomplishments in life? What skills were involved in these accomplishments? 8. Do you enjoy working with people? 9. In what general industry (retail/wholesale/manufacturing/service) would you prefer to work?
BUSINESS PLAN DEVELOPMENT QUESTIONS Conduct the following for yourself to determine which businesses would be an appropriate match for the skills and traits as you work on your business plan. 1. Think about what trends around the region/nation/world you know about that have not reached your area. 2. Interview and talk about opportunities with key successful entrepreneurs in the area. Where do they find a match
between opportunity and your skills? 3. Discuss with family members what potential businesses they believe might be best for you. 4. Take the business ideas that have met your criteria thus far and perform a deficit analysis of those ideas. Which idea
has the most potential for success, given your resources, time, risk position, and so on?
INDIVIDUAL EXERCISES 1. Pick a successful business in your area that is not a franchise. What was the opportunity this business identified? Does
that opportunity still exist for another business in either another location or if addressed in a different manner? 2. For this business, what key skills would the entrepreneur need to be successful? 3. If you can visit with this entrepreneur, then see if you can determine if your analysis was correct.
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