Business Idea Generation

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learning objectives After studying this chapter, you will be able to: LO4- 1

Describe how to examine the industry that the new business plans to enter.

LO4- 2

Discuss how to create a profile of the target customers for a new business.

LO4- 3

Explain how to categorize competitors of the new business using external analysis.

LO4- Explain how to construct competitive maps.

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4 LO4- 5

Ensure that the entrepreneur has considered a full set of concerns in his or her external analysis.

LO4- 6

Differentiate between those elements of the business that provide a competitive advantage and those that do not.

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External Analysis

GUAYAKÍ SUSTAINABLE RAINFOREST PRODUCTS, INC.

Products and services that are popular in one part of the country or world may be very effective models for new businesses in other parts of the country or world. However, to be successful in starting this type of new business, you must ensure that you understand the interests of potential customers and have the ability to educate the market about the product. Based on a student project to develop a new business, Alex Pryor built a business selling Yerba Mate, a drink that was wildly popular in his native Paraguay. This product is a coffee substitute that seems to have many other benefits, including being an energy enhancer, a body system balancer, and an appetite suppressant.

Alex’s friend Steve Karr joined the business in 1996 to form Guayakí Sustainable Rain-forest Products. Their goal from the beginning has been to capitalize on the desire of many people to live an ecologically sustainable lifestyle. Funding in their early days included several SBA loans, Karr’s entire life savings, and lots of credit cards. The founders traveled and served Yerba Mate from a rain forest mural–painted RV while operating the business out of a one-bedroom apartment. The market developed slowly as each customer was educated in the uses of the drink and the goal of the organization. Even as they provide a sustainable drink product, their organizational goal is to create economic models that drive reforestation while providing a living wage to employees in emerging economies. The entrepreneurs established a carbon-neutral business model and have recently become a significant buyer from women- based businesses that are driving the change to eliminate poverty, malnutrition, and destructive land practices from the area. The firm today has a goal of restoring 200,000 acres of South American Atlantic rain forest and creating 1,000 fair wage jobs by 2020.

Guayakí is now one of the leading providers of organic, fairly traded, rain forest–grown yerba mate in North America, with products sold at thousands of natural foods stores, cafés, and supermarkets. The firm’s success led to it being invited to participate in the Clinton Foundation Global Initiative in 2010.

Questions 1. List Guayaki’s competitive advantages. 2. What is your assessment of Guayaki’s ability to maintain those advantages?

Sources: S. Huszar, “South America’s Secret Weight Loss Tea,” Woman’s World, October 21, 2003; J. Caplin, E. McGirt, and A. Wilson, “Fortune Hunters,” Money, August 2003, www.guayaki.com; S. Anna, “Coffee, Tea or Guayaki: A World Challenge,” Presidio Graduate School, www.triplepundit.com/2011/10/coffee-tea-guayaki-world-challenge-finalist/; J. Cirillo, “Mission Possible,” Beverage World, 2010, pp. 43–44; A. Ardichvili, R. Cardozo, and R. Sourav, “A Theory of Entrepreneurial Opportunity Identification and Development,” Journal of Business Venturing 18, no. 1 (2003), pp. 104–24.

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Starting an entrepreneurial business should be based on the observance of an opportunity.1 The recognition of an opportunity may come from a frustration with the way that existing businesses operate (poor service, lack of selection); a new technology that makes an idea that was previously impractical become available (i.e., an Internet-based service, computer animation); a hobby that provides you unique skills and insight; or a new vacancy at the perfect location for a business. However, even though there are many ways to identify an opportunity, the entrepreneur must ensure that what he or she is observing is truly an opportunity. What may appear to be a great opportunity to one person may in fact not be viable as a business. The key to effective opportunity recognition is a detailed understanding of the external environment.

There are a number of critical steps in examining the nature of the external environment. These include the following: 1. Define the industry in which you are competing. 2. Define your customers. 3. Research the industry yourself. 4. Identify competitors within that industry. 5. Research those competitors. 6. Draw a set of competitive maps. 7. Examine and develop insights about additional economic aspects of the industry, including substitutes, elasticity of

demand, ease of entry and exit, benchmarking, and industry trends. 8. Start developing an understanding of your competitive advantage. We will look at each of these steps in turn in analyzing the external environment.

Defining Your Industry LO4-1 Describe how to examine the industry that the new business plans to enter.

The first part of an external analysis is to determine the industry within which the new business will compete, as well as the general makeup of the industry.2 In doing so the entrepreneur should seek to be as specific as possible. For example, if you want to open a new ice cream store, you might ask, In what industry does a new ice cream store compete? Clearly, the industry will include other ice cream stores. However, if the ice cream store will make a significant part of its revenues from selling ice cream cakes, then the industry might be best viewed as including a broader group of dessert providers, such as bakeries and other businesses that sell competing products. If the ice cream store has both dipping operations where the ice cream is sold in cones and prepackaged gallons of ice cream, perhaps the industry includes competitors that sell ice cream in grocery stores. The industry may also vary if the ice cream is high end with a high milk-fat content (referred to as “frozen custard” in many states such as Wisconsin) versus more typical ice cream that has much lower milk-fat level. Defining the firm’s industry is not something that should be taken lightly.

Nowadays, most information can be obtained on the Web or via a magazine or journal that covers a broad category of firms to which you believe your new business will belong. Industry associations are another prime source of this type of data. Industry associations for virtually any industry you can think of probably exist at the national level, and many have local or state organizations as well. These associations exist primarily to support and promote their industry. They have extensive data on their industry and are usually quite willing to share that with the public.

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To obtain statistical data, the potential entrepreneur will want to obtain the industry categorization. Two relatively simple means are available. The first is to locate your industry’s NAICS (North American Industry Classification System) code for the industry. An NAICS code is a code that can vary from two to seven digits in length (the more digits, the more specific the classification). The codes were generated by the U.S. government in an effort to gather, track, and publish data on specific industries. You can locate this code either on the Internet via a number of sources including the U.S. government websites (www.census.gov/epcd/www/naics.html). The second way to find nationwide information is to locate a public company that might be a direct competitor to the new business and simply use its NAICS code to look up overall industry data (via Dun & Bradstreet, LexisNexis, etc.).

At an aggregated national level, the data gathered on a firm’s industry has some value; however, it is the rare new business that intends to draw customers from across the United States at its founding. Most of the data available will be on a national basis, which provides you some information on national trends but provides little understanding of the local competitive environment. The national industry may be doing very poorly, but your immediate area might contain virtually no competitors and have the potential to do very well. For example, in the recent recession, housing construction businesses in California, Florida, and Nevada were severely hurt, while at the same time the housing construction industry in Texas and Missouri experienced only limited economic slowdown.

Entrepreneurs should define the industry in which they will compete broadly enough to be inclusive of all potential competitors, but not so broadly as to be overwhelming. If you are starting a new jewelry store, it is most likely that not even all the jewelry stores in your area are direct competitors. If your store will be in a shopping mall, clearly, other stores in similar malls will be competitors. However, if there is a Tiffany’s in the same city, it might or might not be a direct competitor, depending on the specific customer market you are seeking to serve. Someone who buys jewelry at Tiffany’s is not likely to purchase items in a small, shopping-mall store, and vice versa.

Even more important, the entrepreneur must be clear about the practical level of actual competition. An entrepreneur should ask, What is a reasonable geographic customer draw for a new business? Opening up a sandwich shop in the downtown area of a city means that the shop most likely competes with other sandwich or fast-food shops within a 10-block radius—and perhaps less, if walking is the primary means of transportation for downtown lunching workers. There are limits to how far someone will travel for a sandwich. Drawing a practical radius around your potential new business location will also help target the customers that are most likely to patronize your business. This raises an interesting question for the brew pub we are examining in each chapter. How far do you believe a potential customer would travel to get to a brew pub like Chris is planning to open? There have been four restaurants that have closed in the location he has chosen. Will customers travel further for the brew pub? If not, does he need to think of a different formula for success than have the prior failed restaurateurs? As we think of other businesses such as Internet businesses the draw may be national—people really don’t care where they order things from. However, as we will discuss later in the book, the key

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to Internet business becomes more how to ensure a business gets through the clutter of the Internet to reach the customers they want, no matter where they live.

Housing construction slowed in recent years due to the recession with the amount of decline varying from state to state.

industry Those direct competitors selling similar products or services within a specified geographic radius that is consistent with a customer’s willingness to travel to purchase those products or services.

For a new entrepreneurial business, the industry is defined as those companies within a specified geographic radius (if the business has a physical presence) that will be in direct competition for the same customers and sales as that of the new business. Thinking about Chris and the brew pub he wishes to open demonstrates some of the difficulties that many new businesses have in their planning. If he defines his industry as “restaurant,” this would push him to design his business in different ways than if he believes his industry is a bar. Recognize that even as Chris starts to consider in what industry he competes, he will also need to drill deeper and consider which competitors might seek the same customers. A customer normally chooses from a wide variety of restaurants within categories such as price, class, ambiance, and location. Just as we highlighted with jewelry stores—a high-end steak house such as Ruth’s Chris is not likely competing against the local chicken- fried steak house. How to determine such choices will be examined next.

Defining Your Customers LO4-2 Discuss how to create a profile of the target customers for a new business.

Once the industry is broadly defined, then the exact nature of the customer should be developed. It is important to define a narrower group of individuals whom you believe will constitute your most likely customers. Where are they located? Where do they currently obtain their product or service? A new burger place opening up near a university is not competing against all burger places in the country, so overall industry figures for the nation, state, or even city are of little assistance. Instead, the customers are going to be the students, faculty, and staff of the university, and the immediate residents of the university area.

In defining the customer, the entrepreneur should be diligent in the effort to be as accurate as possible. We will discuss promotional activities such as advertising in Chapter 11 (“Marketing”), but here we note that defining the customer to which your company caters is important for the effective use of your marketing dollars, as well as the satisfaction of core, repeat customers.

One potential restaurant owner told us that he viewed his target customer market as those individuals from ages 2 to 90, from all income ranges, anywhere within a 50-mile radius. Indeed, he became quite upset when we suggested that this was unreasonable. His view was, why not seek every potential customer he could?

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What would this type of definition mean to the operation of the business? The entrepreneur would have to have food items that appealed to children, teenagers, adults, and senior citizens in all price ranges. The entrepreneur’s original concept for the restaurant was that it was to be an upscale restaurant with some “flash” oriented around the extensive wine selection. However, if he defined his customers as everyone aged 2 to 90, his wine selection would have to run the gamut from alcohol-free wine to jugs of cheap wine to rare vintages, because the range of customers he was targeting would demand to be satisfied, and all of these customers would be equally valued. This egalitarian approach is probably appropriate for a political movement, but is a poor approach to business success.3 The offering of alcohol-free wines and cheap wines turns off the customer who likes high- end wines. Similarly, a large wine list with lots of expensive wines is frustrating and intimidating to the customer looking for a $3 glass of wine.

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As we discussed in previous chapters, Betty and Joan planned to start a home health agency. They hoped to develop a business that provided them an opportunity to benefit from their expertise and also be financially rewarding. A clear understanding of some of the external elements of the business was a crucial start to the design.

Industry The two friends would clearly be in the home health care industry; however, the two knew that many businesses call themselves home health when the services they actually provide run a spectrum of needs, including physical therapy, car service to and from doctors’ offices, running errands, providing meals, cleaning, and simple accompaniment to the elderly. The two entrepreneurs were very clear that they wanted to provide the medically necessary elements of home health care and not the routine domestic elements that could be provided by anyone with or without a college education.

Customers Betty and Joan realized they also needed to have a clear definition of their perfect customers. They also wanted to be sure to focus their work where they would qualify as a minority-owned business for referral of Medicaid patients. Thus, they would not focus on other insurance providers or customers who are primarily private-pay customers. However, they also recognized that many times customers wanted more from a home health service than the government will pay for. For example, the family may need more hours of medical care than the government is willing to pay for. In those cases the entrepreneurs also wanted to be able to offer extra services for private payment. Therefore, they targeted an upper-middle- income section of the city as their starting point. They reasoned that the very wealthy would want only private care and the entrepreneurs’ status as minority business owners would provide no benefit. The south side of their city seemed to meet their target group the best.

Competition There were five major home health competitors in the south side of the city. One was part of a large national chain. The service from this vendor was more expensive, but there was a halo effect created by its television advertising campaign. The firm had very good systems in place to ensure efficiency and timeliness of the care, but those same systems could become very bureaucratic for the family being served.

The other four competitors on the south side were all local firms that varied widely in size. The first firm was the largest and was associated with and received most of its patients from a large, local nonprofit hospital (not the one for which Betty and Joan worked). It had a natural connection to the patients but also a history of weak customer service. Interestingly, the home health unit of the hospital was a profit center for the hospital that generated significant cash; however, it was not the major focus of the hospital, so the care of the customers was often less than satisfactory.

The second firm was a small business that had a good reputation. The firm was started by a successful entrepreneur when he could not find good care for his mother. The fact that the business was not the entrepreneur’s main source of income resulted in the firm limiting its growth. The entrepreneur was mostly concerned about providing very high-quality care for his family, their friends, and their friends’ families. Thus, the pricing for the service was competitive, but the profit was very low as the entrepreneur paid higher-than-average wages to his employees.

The third firm was a minority-owned business such as the one Betty and Joan planned. The firm appeared to be well run in terms of health care. Unfortunately, this business was the hardest to find information about. This lack of information made Betty and Joan wonder how well the business aspects of the business were conducted.

The fourth potential competitor was a mid-sized business that appeared to be on the verge of bankruptcy. The newspaper had run a feature story about one of their employee caregivers who had sat and texted while she thought the elderly person in her care was asleep. The elderly patient instead had gotten up out of bed, fallen, and later died. Although the business might be around for a while longer, it did not seem likely to be a significant competitor.

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Once the entrepreneur realized the expansive—and expensive—scope of the plan he wanted to pursue, he decided to narrow his true target to adults aged 30 to 50 with a median income of $60,000 who lived within about 20 minutes’ drive from the restaurant. This is not to suggest that he will, or would want to, turn away anyone who wishes to dine at his establishment. It does, however, suggest that the only patrons that he specifically caters to are those in his demographic target. An outcome of this approach is that if a college-aged couple comes in and complains about the wine selection being too expensive, the owner no longer has to feel the need to appeal to them and provide inexpensive wines. In fact, he specifically does not want to do that as it would affect the image and cost structure of the restaurant. The college couple is not his perfect customer.

This approach helps the entrepreneurial business clearly focus on its core customer. It also helps the business maintain a strategic distance between itself and its competitors, as the firm is not trying to do what everyone else may do. Finally, a clear understanding of the business’s customers assists the owners in controlling expenses, as the business does not try to be everything to everybody. The inventory can therefore be much more focused than if the entrepreneur tries to be everything to everyone.

EXERCISE 1 1. What other questions do you think Betty and Joan should ask as they do their customer analysis of Friends’ Home Health? 2. On what basis do you believe the competitors are trying to differentiate themselves? 3. Do you believe that Friends’ is sufficiently differentiated from these competitors?

Developing the Information for the External Analysis of Competitors LO4-3 Explain how to categorize competitors of the new business using external analysis.

The Friends’ Home Health founders were able to develop some very good information for their external analysis. They accomplished this with a lot of legwork and by using publically available information. Next we discuss a number of ways to conduct such research.

Research Your Industry Yourself At this point in your efforts to start a new business, you should have defined the industry that interests you, determined who your potential customers might be and why they might want to buy from your business, and gathered some information on these domains. The next issue is to identify the exact competitors within that industry. These competitors are those firms that directly compete for the same set of ideal customers as your proposed business. If the new business owners are very clear regarding their customers’ needs, then the ability to identify direct competitors becomes significantly easier. For many new entrepreneurial ventures, these businesses will be geographically local. Thus, the most obvious and mundane places to look for these competitors are the local telephone book and the front seat of your car.

Although it is certainly possible to hire a consulting company to perform the type of customer research service discussed above, the entrepreneur will gain invaluable insight by handling this process personally. We assisted a small group of highly committed golfers who had the idea of developing an affordable, nonmember 18-hole golf course in the Dallas–Fort Worth (DFW) metroplex. Their idea was to offer a country club–level course without the membership commitment and expense involved with playing on some of the area’s quality courses. The group had a tract of land that had been in the family of one of the potential founders and

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had been given to him upon the death of his father. Although this is substantially larger than the usual entrepreneurial business idea we present in the text, we believe the concepts point out the critical issues that any potential entrepreneur must address.

At the first meeting, the golf professionals were clear that they knew the market and what the market needed. However, basic market questions kept coming up that they were unable to answer. Some of the questions raised for which they had no answers included these:

1. How many 18-hole courses are there in the DFW metroplex? 2. How many of these courses are not tied to a country club? 3. How many rounds of golf are played on a typical weekend at these courses? 4. How far does the average golfer drive to play a round? 5. Are there capacity problems at some of the more popular courses? 6. How much does the average golfer spend in food and drink while playing 18 holes? 7. What is charged to play at various times of the day or week at each of the open courses? 8. Where is the population growth area for golfers? 9. What is the profile of a typical golfer? It was clear that these individuals who wanted to start the business loved golf and thought they had a great understanding of

the local industry; however, the golfers had not done any in-depth study of the market. These individuals were frustrated when they realized that they did not have a detailed understanding of the potential customer. In response, they were ready to hire a company to collect this information, despite the high cost of pursuing that option. Instead, we encouraged them to collect this information themselves. Doing so would make them the experts in the area and enable them to develop a plan for a business that would give them a competitive advantage. The benefits of planning and analysis are the nuanced insights it provides the individuals performing the activities. Hiring a company to gather information is not only expensive, but also limits the insights to more factual data.

Therefore, the founders prepared a list of questions about a golf course that would help differentiate their business. After doing some quick research to find every 18-hole course in the metroplex, they divided up the courses and individually visited each one. They played each course and tried to experience all the offerings at the course. The questionnaires that they developed were completed after each visit and an overall analysis was completed describing the entire market.

When planning new development like a golf course, knowing your market is crucial. What activities would you want to control personally when developing your business?

EXERCISE 2 Using the golf course initiative as an example, pair up with one other person and explain your business idea to him or her. Have the person role-play a friend who would be investing in your business. Have the person ask you questions about what the customer desires to get out of the product or service. Use the list as a starting point for your own competitor analysis.

Defining Actual Competitors An effective industry analysis starts by identifying every potential competitor within that previously defined reasonable distance of your planned establishment location. What a reasonable distance consists of is a matter

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of interpretation, and the interpreter is the new businessperson. Although someone could argue with any individual’s assessment of that distance, it must be established, and this is much more a matter of art than a matter of science. In any case, the first step is to define a radius from which you believe you will draw a majority of your customers. Make this distance reasonable, not just a wish.4 If the business does not have a physical restriction to its operation, then it is important to create a list of competitors that can easily be found electronically by your customers.5

A woman in Knoxville, Tennessee, was planning a quick-serve, breakfast-oriented restaurant. She needed to define a reasonable radius from which she would draw her ideal customers. She originally said that she would draw customers from the entire metropolitan Knoxville area, and (much like our previous restaurant owner) was adamant that she did not want to forego any business. Once again, we certainly do not suggest that you forego business unnecessarily, but an assessment that a business draws from an entire region is unreasonable for many reasons. Just one is that if you try to cater to everyone in a metro area, you will distort your advertising efforts, and you will dramatically increase your costs. Instead, this entrepreneur needed to focus on customers within a reasonable commuting distance from the restaurant. She eventually narrowed that distance to 20 minutes of driving in traffic. Although you may indeed draw customers from outside this area, they are not your primary group at the outset. (Think of yourself and how much time you are willing to travel to get breakfast?) If you need to rethink this distance as your operations mature, then you can. The core information is already in hand and will still be relevant if you expand or contract the market radius later. The opening story in Chapter 1 is a great example of this. Oren’s Daily Roast Coffee & Teas has opened 10 locations on the island of Manhattan primarily because customers will walk only so far for a great cup of coffee.

Once our breakfast restaurant entrepreneur had identified the area she wanted to serve, she began driving around the area, to see what competitors might be in operation. She also identified businesses through the phone book. The end result was that with relatively little expense, she was able to identify those restaurants that would be her direct and indirect competitors.

Once you have established a reasonable radius from which you will draw your primary customer, the next step is to examine each of your potential competitors. It is easy to discuss practices in the industry in general terms. For example, you might hear that all the area photocopying places have poor service, wait times are long, and the local shops have poor-quality equipment. These general feelings about the industry may help an entrepreneur believe he or she sees an opportunity, but actually running a business requires specific knowledge about the competitors. Even in a poor industry, there are probably some competitors who will be tough to beat. The entrepreneur must identify those competitors, what they do well, and where they are located.

Most entrepreneurial businesses compete in what is referred to as fragmented markets.6 These are markets that have no clear dominant competitor and are instead made up of a large number of similar-sized firms. If the entrepreneurial business is competing directly with well-established firms, this virtually guarantees that at a minimum, the entrepreneurial business will be operating at a cost disadvantage and will have to compete on some other basis. The number and size of all competitors need to be detailed so that the entrepreneur has a rich and full understanding of their competition. Additionally, the differences in how the various businesses compete and their competitive advantages also need to be well understood.

fragmented markets Markets in which no one competitor has a substantial share of the market and the means of competition vary widely within the same market space.

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In the Knoxville restaurant example discussed, the ability to drive by and visit the various existing restaurants allowed the entrepreneur to understand each of those establishments in greater depth as well as which might be the strongest competitors. Straightforward observations made by an entrepreneur who understands the competitive issues of the industry can provide valuable insight. However, there is another tool available to the entrepreneur that can provide additional information. Specifically, an analytical tool that has the ability to digest information and display this information to others is a competitive map.

competitive map

An analytical tool used to organize information about direct competitors on all points of competition.

Developing a Competitive Map LO4-4

Explain how to construct competitive maps.

At this point in the process, the amount of detail about competitors that needs to be organized raises the need for a systematic means to categorize that information. Thus, the next step in your external analysis is to develop a competitive map to better understand competitors and their capabilities.7 Although there are many companies available that are in business to examine competitors, as we have stated previously, we recommend that the entrepreneur develop this map personally, for the following reasons:

Chris was progressing and starting to think more about his bar. He had the opportunity to sit and visit with a banker about possible financing and the banker asked a number of great questions that Chris could not answer. Specifically, he asked about the target customer and competition. Chris had thought the target customers would be people who were beer connoisseurs such as himself. However, the following week he went to his beer club, which was made up of beer connoisseurs, and began to realize that he needed to be clearer about his customers. His beer club was made up of great people, but their incomes ran the full range of virtually none to very high. In addition, it was not clear if they would come often enough to the downtown area where his bar was to be located for him to have a viable business.

Chris then made a visit to Seattle for a cousin’s wedding. While there, he had the opportunity to visit a brew pub similar to the type he wanted to establish. During the time at the brew pub he got to visit with one of the pub’s owners. The owner’s background was similar to Chris’s in that he had a love of beer. What Chris found interesting in the conversation was that the core profits of the business came not from beer but from the food that was served with the beer. The beer was what attracted the customers, but what made money for the establishment was the food and also renting the facilities out for private parties. Chris was also surprised to find that most of the customers at this brew pub were not even beer connoisseurs. They were instead young professionals who liked beer, but their actual discrimination in taste was limited. The young professionals liked the idea of craft beers, but this brew pub actually had to educate their customers on what made a great beer.

This insight on customers led Chris to realize he would have to plan his bar similar to the brew pub in Seattle. Chris may brew a great beer, but the beer alone could not be what would drive the success of the bar. Instead, he would need to be able to reach out to other customers. In thinking of the customers, Chris decided that he would pursue a customer profile like the brew pub in Seattle—young professionals.

The nature of the competition changed dramatically as Chris began to think through his customers. He now realized that he would need to have a more elegant environment than he had envisioned and that food would play a much greater role in the success of the business.

As Chris began to think through his planned business, he examined the downtown area and found approximately 40 restaurants within two miles of the center of the city. Of those he determined that 10 would be the closest in competition to him. These 10 also served a professional crowd and relied on a mixture of alcohol and food to prosper. Three competitors

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specifically pitched themselves as a place for beer lovers, but only one of those actually brewed any beer on-site. The other 30 restaurants included fast-food franchises and diners, which Chris did not consider to be significant competitors.

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EXERCISE 3 1. Think of your campus or downtown area. Would a brewery such as Chris is planning be a viable business in this area? 2. How would customers and competitors differ around a campus versus the downtown area in a major city? 3. How would you develop a competitive map for this business?

1. It is less expensive. 2. Knowledge of what is right and wrong with each of the competitors allows the entrepreneur to better position the new

business. 3. Insights will be developed regarding positioning, pricing, and even facility layout. Developing a competitive map requires that the entrepreneur visit all of the potential competitors in whatever form they run

their business. Further, we recommend that you be a customer of your competitors. Even if your desired entrepreneurial business sells business to business, you can still seek to interact with the competitors to try to understand their activities. There is nothing like obtaining the customer perspective from a series of such visits; the comparisons to your potential competitors become easier with this type of insight. With this in mind, the entrepreneur must develop a list of criteria that they wish to take away from each visit and record that information after each visit. Although this list might change depending on the type of establishment, we suggest a list of potential items to consider if the business is a retail business selling to customers in a brick- and-mortar location:

1. Parking availability (how many spots and what quality?) 2. Access from road 3. Nearby attractions for customers 4. Size of facility 5. Décor 6. Pricing 7. Product breadth 8. Product depth 9. Staffing (number and quality) 10. Capacity 11. Brochures/advertising material 12. Customer traffic at several different times of day 13. Average sale 14. Friendliness/helpfulness 15. Unique features 16. Suppliers (what company is delivering to their business?) Although this list is most applicable to retail businesses that have a set location, you should recognize that many of the same

concepts apply to any Internet business or other business types. The key in each case is to determine the key competitive factors that you wish to understand about your competitors.

An example of a competitive map is shown in Table 4.1. This competitive map (for the Dallas–Fort Worth golf course discussed earlier) encompasses a number of criteria that could be used in the evaluations of the business. The eight-mile radius employed in this map is based on the distance the partners determined from their research that someone would drive to play golf.

Some of these items (and there will be other ones for your venture) can be easily categorized and analyzed. Others are more descriptive and

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give you a rich sense of what is available to customers right now. We have included a description of some of the findings from the group seeking to establish the golf course.

Table 4.1 Competitive Map: Golf Course (Eight-Mile Radius)

At the time of this investigation the DFW area had 74 golf courses. However, it was determined from surveys with potential customers that on average, individuals would drive no more than 30 minutes one way to the golf course. Therefore, rather than examine all 74 courses, the entrepreneurs chose to examine only those courses in Fort Worth because that is where their land was and those no farther than 30 minutes from downtown. This resulted in our entrepreneurial team visiting 24 golf courses, 25 percent of which were private. The private courses in this particular area are very difficult to join. The membership or initiation fees at these clubs are quite expensive, several are at capacity, the current members appear to be very particular about who is a member, and the benefits of belonging to the club are more about social/business connections than the golf. Therefore, the focus of the entrepreneurial team shifted to the remaining 18 nonclub courses.

Five of the 18 public courses appeared to be poorly maintained. However, the other 13 were in good shape, with at least 6 of those in excellent shape. In visiting with golfers at the courses and playing the courses themselves, the potential entrepreneurs discovered that there

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was no difficulty in getting on the courses. Both the access and the nature of the courses were generally excellent. The fact that they were public courses was a result of city government subsidies, which provided the operators with subsidized lease payments and some assistance with the maintenance expenses.

After completing their map, the potential golf entrepreneurs concluded that the competitive landscape was not at all what they had envisioned. They concluded that the DFW area was overbuilt and that the presence of public subsidies for many courses distorted competition. They decided that the market was not as attractive as they originally had thought.

EXERCISE 4 Develop the basis of a competitive map for your proposed venture. Outline in columns each of the items that you would like to observe while visiting your competitors. Present this to the class and ask for help in developing a complete map.

Additional Issues for External Analysis LO4-5 Ensure that the entrepreneur has considered a full set of concerns in his or her external analysis.

There are a number of other economic issues that founders of a new business will want to consider as they develop their external analysis. These include substitutes, elasticity of demand, ease of entry and exit, benchmarking, and industry trends. Each will be discussed briefly.

Substitutes The potential new businessperson should keep in mind potential substitutes for the activities of the business. A substitute exists if the service or product performs a similar function or achieves the same result as the planned business, but is not a precise imitation. 8 In the case of golf, a substitute might be tennis or boating. Any other sport that the customer can pursue in place of golf could be a substitute.

substitute A product that performs a similar function or achieves the same result, but is not a precise imitation.

In developing a competitive map, the entrepreneur needs to be aware of such substitutes and the potential impact they can have. However, it is also important that the new businessperson not get overwhelmed with so many potential substitutes that it appears there is no way to compete in the industry. Each new businessperson must judge the potential impact of a substitute, but the important issue is the recognition that at some price trade-off point, customers will switch to substitutes. For example, if you charge $500 for a single round of golf, individuals will eventually seek out other means of entertainment (unless you are Pebble Beach). Thus, substitutes can help form a ceiling on the price that can be charged for the product or service.

Elasticity of Demand Elasticity of demand refers to customers switching to substitutes or not using a product as the price of the product rises. 9 A product or service for which customers are willing to pay virtually any price is said to have a very inelastic demand. In other words, for your cancer medicine, the price is irrelevant; you will still seek out the medicine and buy it. In this case, substitutes have very little impact because they do not perform the exact same function. However, for a product that has elastic demand, such as rounds of golf, a price increase of $25 for a round may create a significant substitute impact. Chapter 11 will deal more in detail with the marketing and pricing of goods; it is sufficient here to say that the presence and power of substitutes need to be considered by the new business-person. When developing your competitive map, you will need to include those companies that are close substitutes for your product or service and determine how to evaluate a trade-off value.

elasticity of demand Consumers’ respond to price changes. For example, as the prices of luxury items increase, the demand usually declines as these goods are not essential and their purchase can be delayed. This would be called elastic demand. Conversely, items such as gas for your car typically have relatively inelastic demand as you will not stop using it as the price increases.

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Ease of Entry or Exit Another issue that needs to be considered is the ease of entry to and exit from the industry. Once a business is in operation, expenses are being incurred. If those expenses are such that an entrepreneur cannot easily recoup the investment, then the level of competition will be more intense. This is considered an exit barrier10—that is, a barrier that keeps an entrepreneur from leaving a business she has invested in.

To illustrate an exit barrier, consider the principal investments for a clothing store, the clothes in the store. Clothes tend to be very seasonal. If a piece of clothing is not sold in season, then it likely has limited value in the near future. Think about the value of white polyester suits if you need to be convinced. (Your parents probably wore them.) To close a clothing store is easy, but to recover the initial investment is not. The owner will need to sharply discount the price of the goods just to get as much of their invested money back before they have to close the store.

In our golf example, the initial investment for the golf course is very high, but the ease of exiting the business is also very high, as the real estate could be converted to another use such as a housing tract; thus, in the case of the golf course, there is no real exit barrier. If a business owner cannot easily exit an industry, then that owner is more likely to use predatory pricing in an effort to generate cash flow and survive. The ability to exit the industry must be taken into consideration when evaluating the competitive threat posed by existing businesses. A clothing store would have a high-intensity competition, whereas a golf course would have somewhat less. In contrast to the clothing store, a liquor store’s principal investment is alcohol. If a liquor store is not doing well and needs to close, there is always a secondary market for liquor. There is little need to have deep price discounts to seek to recover the investment. Thus, exit is relatively easy, and competition would be expected to be a bit lower. The ability to exit a business relatively easily tends to limit the intensity of competition in the industry and reduces the threat posed by a new entry.

Benchmarking There may be specific areas in your business that you have identified as potentially providing you a competitive advantage. To strengthen those areas, you may consider benchmarking a business that is very successful in that particular arena, but that does not compete in your industry.11

The ease of entering and exiting a business investment is an important detail to consider.

exit barrier

A barrier, such as investment in capital assets, that keeps a firm from leaving an industry.

ETHICAL CHALLENGE How far can or should you go to collect information about your competitors? Most competitors will be private companies, and their financial information will not be part of the public record. Is it appropriate to be a customer of your competitor for the purpose of collecting competitive information? At what stage does acting as a customer cross an ethical line? Can you lie about why you are there? Can you hire a private investigator to find out information that is not in the public domain? What if the existing firm is owned by a friend? At what stage can you copy ideas from your friend and still maintain your ethical standards?

QUESTIONS

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1. In terms of your own business what information would be useful about your competition as you start your business. List all potential data.

2. Rank this information in order of how easy it will be to obtain. 3. Which of the data do you think would cross the line of ethics?

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benchmarking Working with and learning from a company outside of your industry that has a particular skill that is potentially critical to your operation.

The ability to provide a top-flight call center for your business could be dramatically improved by your looking to companies in other industries that have excellent call-center operations. Most companies are more than willing to share their knowledge as long as you are not a potential competitor.

Industry Trends An overarching part of any analysis of competitors is an understanding of the trends in the industry. These trends shape the long-term prospects of the industry. For example, the United States is moving toward a more self-service economy, and companies that can move that process forward or take advantage of this movement appear to have an opportunity for success. Another example might be restaurant patronage. Whereas the number of people eating at restaurants has not changed dramatically over the past few years, what they eat has been changing in a consistently predictable manner. Healthy, mid-price- range restaurant sales have been increasing dramatically. Thus, the percentage of individuals who are willing to pay a little more than fast-food prices for differentiated product is steadily increasing, while there has been little change in those willing to pay for very high-end restaurants. As a result, a restaurant that enters an emerging market (utilizing the Atkins Diet or another diet craze as a menu theme, for example) may be able to be among the first to enter that niche, and thereby gain an advantage over other firms.

Competitive Advantage LO4-6 Differentiate between those elements of the business that provide a competitive advantage and those that do not.

Once the industry, customer, and competitor issues have been clearly identified, an entrepreneur must develop a deep understanding of the competitive advantage they expect to hold. A competitive advantage is made up of those things that your business does uniquely well, or better than anyone else in your industry (remember, the industry is defined by you, and consists of those businesses in direct competition with you in your area).

Understanding the competitive advantage is the last step in your external analysis. We will discuss competitive advantage in greater detail in Chapter 5; it is important at this point to understand that these advantages (we hope there will be several) will ultimately be the reason that individuals come to your business and not to one of your competitors. Those areas that provide you with competitive advantages are the ones that are valuable, allowing the business to charge a price that exceeds that of its direct competitors, provide a product or service that might be priced the same as competitors, but at a lower cost structure or allows the new business to draw in new customers even if the price and costs are at an equivalent level with your competitors.

A competitive advantage must provide the new business with the opportunity to make money in excess of the competition. Few new businesses perform better than their competitors in all areas, nor should they be concerned about doing so. Instead, there are many functions that a business must perform (and perform well) simply to be a player in the industry. In most industries the new business is similar to its competitors, but there is one (or hopefully, several) fundamental characteristic(s) with which the firm is able to exceed the performance of the industry. These characteristics constitute the business’s competitive advantage. In order to be able

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to define the potential areas for this advantage, it is imperative that you have completed the competitive map and are able to discuss how each of your competitors do business today.

competitive advantage The edge a business has over competing businesses, made up of those things that the business does better than anyone else in the industry.

The source of the competitive advantage can be an activity of the firm, such as the type of service or product they provide. It can also be something structural, such as a high-quality location. The new business must be clear about what its own competitive advantages will be, as well as about the current advantages of its competitors. One of the causes of failure for new businesses is a lack of focus on their competitive advantages. Individuals might believe they have a great idea and work hard to implement it, but they may not clearly understand why a customer might choose their business over that of their competitors. Your customers must have reasons to consciously choose your business, and you must know what those reasons are to maintain your advantage.

In thinking about competitive advantage, it is helpful to examine the business as consisting of performance within two areas. The normal or ordinary parts of the business must be done and done well, but there is little reason to do any of these things any better than the average in the industry. The unusual or unique parts of the business that are central to the firm’s competitive advantage over others should be the focus of the energy, money, and time of the business, because they are the means by which a business can differentiate itself from its competitors. 12 What provides a competitive advantage varies by industry, and it varies with time in an industry. The standard practices in an industry move, and they inexorably move to greater and greater heights. For example, when the frequent-flyer program was initiated, it was unusual and allowed the pioneering airline to stand out, gaining customers and profit at the expense of its competitors. However, today virtually every airline has a frequent-flyer program, and indeed, many have shared programs. What starts out as unusual will (if it is effective) lead to imitation, and thus become normal in the industry. That said, we suggest that the new businessperson examine the competitive map carefully. What is normal in the industry—that is, what does virtually everyone do just to be a player in the industry? These are the standard things you will have to provide just to be a business in this arena. What is unusual in your industry? What are competitors doing that varies from one to another? What can you do that is unusual and might form a competitive advantage?

The need to be complete in this area is critical. Table 4.2 explores the competitive advantage of a new restaurant. Although not complete, it provides a bit of insight into this process.

Even though this chart may appear to be a bit excessive, it is not nearly complete. It would be difficult for us to overemphasize the importance of developing this chart prior to beginning operations, so that entrepreneurs are clear as to what might form a competitive advantage for them. We have found few tools more helpful in defining the uniqueness of the potential start-up, as well as defining the potential start-up expenses.

Resource-Based View To understand the unique resources and capabilities of a business and develop a competitive advantage the new business owner should use a technique generally known as resource-based analysis (although it can be found with a variety of acronyms such as VRIN or VRIST). This tool helps the entrepreneur delve deeper into what actually creates an advantage. In the prior list of potentially unique actions for a restaurant that could create a advantage for a restaurant it was noted that tiles on the table could be a normal business item. However, upon further consideration, the tiles are really just part of a larger resource that relates to the ambiance of the restaurant. The tiles themselves are good, but they need to be part of something more significant to have an impact. Resource-based analysis has been developed over the past 50 years;13 it has become one of the most effective tools in defining a business’s competitive advantages and in differentiating these from their competitors. While we will cover this topic in depth in the next chapter, we feel that some introduction to this topic is warranted in the discussion of positioning relative to your competitors. The focus of resource-based analysis is solely upon the potentially unusual products or services that you will offer in your business, which can be a source of competitive advantage.

normal or ordinary competitive factor

Describing those areas of a business that are simply standard practice in the industry and are necessary for the business to be a player.

unusual or unique competitive factor

Describing those areas of a business that are unique or unusual when compared to the standard practices of the industry, and that provide the opportunity for the business to gain value over and above the ordinary returns in the industry.

EXERCISE 5

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Develop a two-column list for your new business. Label the first column “Normal” and the second “Unusual.” In the “normal” column, list everything that you will need to have (physically) and do (actively) just to be accepted by customers in the industry. In the second column, explain what your business will have or do that is rare or unusual compared to your competitors.

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Table 4.2 Company Evaluation of Resources and Capabilities

resource-based analysis A theoretical approach and practical methodology that examines the functioning of a business in terms of whether a product or service simultaneously meets the criteria of being rare, durable, nonsubstitutable, and valuable.

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To develop into a competitive advantage, the potentially unusual products or services offered by the new business need to meet all of the following criteria: They must be rare, durable, relatively nonsubstitutable, and valuable to develop into a competitive advantage. “Rare” describes a quality that competitors will find difficult to obtain. For example, a particular chef might be unique, or a location may be particularly valued. “Durability” has three elements to it where any one element provides the company with the ability to hold onto the competitive advantage. The first has to do with the length of time that you might be able to gain and hold a competitive advantage. The second is an evaluation of how long would it take for a competitor to imitate you or to wash away your advantage. The third is an evaluation of the desire of your competitors to compete with you with the same potential resource or capability. “Relatively nonsubstitutable” is a determination about whether the product or service may be easily substituted by something else that a competitor could provide. “Valuable” refers to your ability to gain extraordinary returns from your product or service. A product or service might be rare, durable, and nonsubstitutable, but if you cannot obtain returns in excess of your competition from its sale, then it will not provide you with a resource-based advantage.

As you examine your list of unusual products or services for the new business, consider each one along these four dimensions. Those items that meet all four criteria are your primary points of competitive advantage. These are the points on which you should concentrate your resources, time, and effort. These are the areas that will provide you with a competitive advantage relative to your competitors, and will be the reasons that customers choose you over the competition. We will discuss this in much more depth in the next chapter.

SUMMARY This chapter examined the reasons and methods for the potential entrepreneur to develop a complete, well-reasoned, and personal knowledge of the competitive conditions for their business. This analysis is fundamentally founded upon the idea that the entrepreneur decides what constitutes the “industry.” The industry does not include (except in unusual circumstances) the whole country or the world. It is important that the entrepreneur limit the defined “industry” as it relates to the specific business, to effectively analyze the competition and the potential competitive threat. We have provided these highly practical tools for the founders to personally develop their own analysis of the environment and their ability to compete within that environment.

KEY TERMS benchmarking competitive advantage competitive map elasticity of demand exit barrier fragmented markets industry normal or ordinary competitive factor resource-based analysis substitute unusual or unique competitive factor

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REVIEW QUESTIONS 1. How would you advise a potential entrepreneur define the industry for a new business? 2. How should a new business develop a profile for its potential customers? 3. Why should a potential entrepreneur research the industry personally? 4. What techniques would you recommend for identifying competitors within an industry? 5. How would you recommend developing a complete analysis of the competitors for a new business? 6. What elements are in a competitive map?

BUSINESS PLAN DEVELOPMENT QUESTIONS 1. What is the industry for your potential business? 2. Who is the customer? 3. Who are the competitors? 4. Develop a competitive map for your business. 5. What do you believe your tentative competitive advantages will be?

INDIVIDUAL EXERCISES 1. Using your map developed for the business plan exercise above, visit (virtually or in-person) the first two competitors

on your list and adjust the map according to reality. a. What additional items might you add to the map? b. What qualitative areas of competition did you add to your map?

2. Using the material that you have developed in the previous exercises, write a two- to three-page description of the competitive environment in which your proposed new business will compete.

3. Develop a competitive map for the restaurants around campus. Discuss in class how everyone else designed their competitive map of this group.

GROUP EXERCISES 1. Look at the list of items for the restaurant in Table 4.2 of this chapter. What would be the resources that would drive

the potential sources of competitive advantage? 2. Take the material that you developed outside of class. Break into small groups. Create a final list of resources you will

need to develop your competitive advantage for the firm.

ENDNOTES 1. A. Ardichvili, R. Cardozo, and R. Sourav, “A Theory of Entrepreneurial Opportunity Identification and

Development,” Journal of Business Venturing 18, no. 1 (2003), pp. 104–24. 2. F. Delmar, P. Davidson, and W. Gartner, “Arriving at the High-Growth Firm,” Journal of Business Venturing 18, no. 2

(2003), pp. 189–217. 3. N. Kumar, “The CEO’s Marketing Manifesto,” Marketing Management 17, no. 6 (2008), pp. 24–29. 4. C. Comaford-Lynch, “The Power of Positioning,” BusinessWeek Online, June 3, 2008, p. 13. 5. H. Corrigan, G. Craciun, and A. Powerll, “How Does Target Know So Much About Its Customers? Utilizing

Customer Analytics to Make Marketing Decisions,” Marketing Education Review 24, no. 2 (2014), pp. 159–66. 6. G. Dess, “Consensus on Strategy Formulation and Organizational Performance: Competitors in a Fragmented

Market,” Strategic Management Journal 8, no. 3 (1987), pp. 259–79. 7. W. Bogner, H. Thomas, and J. McGee, “A Longitudinal Study of the Competitive Positions and Entry Paths of

European Firms in the U.S. Pharmaceutical Market,” Strategic Management Journal 17, no. 2 (1996), pp. 85–108. 8. M. Peteraf and M. Bergen, “Scanning Dynamic Competitive Landscapes: A Market-Based and Resource-Based

Framework,” Strategic Management Journal 24, no. 10 (2003), pp. 1027–42. 9. D. Teece, G. Pisano, and A. Shuen, “Dynamic Capabilities and Strategic Management,” Strategic Management

Journal 18, no. 7 (1997), pp. 509–30.

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