Introduction to Entrepreneurship 8 e Donald F Kuratko

• Introduction to Entrepreneurship, 8 e Donald F. Kuratko Chapter 9 Assessment of Entrepreneurial Opportunities © 2009 South-Western, a part of Cengage Learning. All rights reserved.

Chapter Objectives 1. To explain the challenge of new-venture start-ups 2. To review common pitfalls in the selection of newventure ideas 3. To present critical factors involved in new-venture development 4. To examine why new ventures fail 5. To study certain factors that underlie venture success 6. To analyze the evaluation process methods: profile analysis, feasibility criteria approach, and comprehensive feasibility method 7. To outline the specific activities involved in a comprehensive feasibility evaluation © 2009 South-Western, a part of Cengage Learning. All rights reserved. 2

The Challenge of New-Venture Start-Ups • New Venture Formation Ø 600, 000 new firms have emerged in the United States every year since the mid-1990 s. • Ideas for Potential New Businesses Ø The U. S. Patent Office currently reviews more than 375, 000 patent applications per year. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 3

Components of New-Venture Motivation 1. The need for approval 2. The need for independence 3. The need for personal development 4. Welfare (philanthropic) considerations 5. Perception of wealth 6. Tax reduction and indirect benefits 7. Following role models © 2009 South-Western, a part of Cengage Learning. All rights reserved. 4

Reasons for Starting a Venture Personal Characteristics The Environment The Venture Entrepreneurial Motivations © 2009 South-Western, a part of Cengage Learning. All rights reserved. 5

Figure 9. 1 The Elements Affecting New-Venture Performance Source: Arnold C. Cooper, “Challenges in Predicting New Firm Performance, ” Journal of Business Venturing (May 1993): 243. Reprinted with permission. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 6

Pitfalls in Selecting New Ventures • Lack of objective evaluation • No real insight into the market • Inadequate understanding of technical requirements • Poor financial understanding • Lack of venture uniqueness • Ignorance of legal issues © 2009 South-Western, a part of Cengage Learning. All rights reserved. 7

Phases in New-Venture Start-ups • Prestart-up Phase Ø Begins with an idea for the venture and ends when the doors are opened for business. • Start-up Phase Ø Commences with the initiation of sales activity and the delivery of products and services and ends when the business is firmly established and beyond short-term threats to survival. • Poststart-up Phase Ø Lasts until the venture is terminated or the surviving organizational entity is no longer controlled by an entrepreneur. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 8

Critical Factors for New-Venture Development 1. Uniqueness of venture 2. Investment size 3. Expected sales growth Ø Lifestyle ventures Ø Small profitable ventures Ø High-growth ventures 4. Product availability 5. Customer availability © 2009 South-Western, a part of Cengage Learning. All rights reserved. 9

Table 9. 1 A New-Venture Idea Checklist Basic Feasibility of the Venture 1. Can the product or service work? 2. Is it legal? Competitive Advantages of the Venture 1. What specific competitive advantages will the product or service offer? 2. What are the competitive advantages of the companies already in business? 3. How are the competitors likely to respond? 4. How will the initial competitive advantage be maintained? Buyer Decisions in the Venture 1. Who are the customers likely to be? 2. How much will each customer buy, and how many customers are there? 3. Where are these customers located, and how will they be serviced? Marketing of the Goods and Services 1. How much will be spent on advertising and selling? 2. What share of market will the company capture? By when? 3. Who will perform the selling functions? 4. How will prices be set? How will they compare with the competition’s prices? 5. How important is location, and how will it be determined? 6. What distribution channels will be used—wholesale, retail, agents, direct mail? 7. What are the sales targets? By when should they be met? 8. Can any orders be obtained before starting the business? How many? For what total amount? Source: Karl H. Vesper, New Venture Strategies, copyright © 1990, 172. Adapted by permission of Prentice-Hall, Inc. , Englewood Cliffs, New Jersey. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 10

Table 9. 1 A New-Venture Idea Checklist (cont’d) Production of the Goods and Services 1. Will the company make or buy what it sells? Or will it use a combination of these two strategies? 2. Are sources of supplies available at reasonable prices? 3. How long will delivery take? 4. Have adequate lease arrangements for premises been made? 5. Will the needed equipment be available on time? 6. Do any special problems with plant setup, clearances, or insurance exist? How will they be resolved? 7. How will quality be controlled? 8. How will returns and servicing be handled? 9. How will pilferage, waste, spoilage, and scrap be controlled? Staffing Decisions in the Venture 1. How will competence in each area of the business be ensured? 2. Who will have to be hired? By when? How will they be found and recruited? 3. Will a banker, lawyer, accountant, or other advisers be needed? 4. How will replacements be obtained if key people leave? 5. Will special benefit plans have to be arranged? Control of the Venture 1. What records will be needed? When? 2. Will any special controls be required? What are they? Who will be responsible for them? Source: Karl H. Vesper, New Venture Strategies, copyright © 1990, 172. Adapted by permission of Prentice-Hall, Inc. , Englewood Cliffs, New Jersey. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 11

Table 9. 1 A New-Venture Idea Checklist (cont’d) Financing the Venture 1. How much will be needed for development of the product or service? 2. How much will be needed for setting up operations? 3. How much will be needed for working capital? 4. Where will the money come from? What if more is needed? 5. Which assumptions in the financial forecasts are most uncertain? 6. What will be the return on equity, or sales, and how does it compare with the rest of the industry? 7. When and how will investors get their money back? 8. What will be needed from the bank, and what is the bank’s response? Source: Karl H. Vesper, New Venture Strategies, copyright © 1990, 172. Adapted by permission of Prentice-Hall, Inc. , Englewood Cliffs, New Jersey. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 12

Why New Ventures Fail • Product/Market Problems • Financial Difficulties • Managerial Problems © 2009 South-Western, a part of Cengage Learning. All rights reserved. 13

Causes for Failure • Product/Market Problems Ø Poor timing Ø Product design problems Ø Inappropriate distribution strategy Ø Unclear business definition Ø Overreliance on one customer • Managerial Problems Ø Concept of a team approach Ø Human resource problems • Financial Difficulties Ø Initial undercapitalization Ø Assuming debt too early Ø Venture capital relationship problems © 2009 South-Western, a part of Cengage Learning. All rights reserved. 14

Table 9. 2 Types and Classes of First-Year Problems 1. Obtaining external financing • Obtaining financing for growth • Other or general financing problems 2. Internal financial management • Inadequate working capital • Cash-flow problems • Other or general financial management problems 3. Sales/marketing • Low sales • Dependence on one or few clients/customers • Marketing or distribution channels • Promotion/public relations/advertising • Other or general marketing problems 4. Product development • Developing products/services • Other or general product development problems 5. Production/operations management • Establishing or maintaining quality control • Raw materials/resources/supplies • Other or general production/operations management problems 6. General management • Lack of management experience • Only one person/no time • Managing/controlling growth • Administrative problems • Other or general management problems 7. Human resource management • Recruitment/selection • Turnover/retention • Satisfaction/morale • Employee development • Other or general human resource management problems 8. Economic environment • Poor economy/recession • Other or general economic environment problems 9. Regulatory environment • Insurance Source: David E. Terpstra and Philip D. Olson, “Entrepreneurial Start-up and Growth: A Classification of Problems, ” Entrepreneurship Theory and Practice (spring 1993): 19. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 15

Figure Internal and External Problems Experienced by Entrepreneurs 9. 2 Source: H. Robert Dodge, Sam Fullerton, and John E. Robbins, “Stage of Organization Life Cycle and Competition as Mediators of Problem Perception for Small Businesses, ” Strategic Management Journal 15 (1994): 129. Reprinted by permission of John Wiley & Sons, Ltd. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 16

Table 9. 3 Determinants of New-Venture Failures Entrepreneur Rank Venture Capitalist Rank I—Lack of management skill 1 I—Poor management strategy 2 I—Lack of capitalization 3 I—Lack of vision 4 E—Poor external market conditions 4 I—Poor product design 5 I—Key personnel incompetent 6 I—Poor product timing 6 E = External factor I = Internal factor Source: Andrew L. Zacharakis, G. Dale Meyer, and Julio De. Castro, “Differing Perceptions of New Venture Failure: A Matched Exploratory Study of Venture Capitalists and Entrepreneurs, ” Journal of Small Business Management (July 1999): 8. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 17

New Venture Failure Prediction Model 1. Role of profitability and cash flows 2. Role of debt 3. Combination of both 4. Role of initial size 5. Role of velocity of capital 6. Role of control © 2009 South-Western, a part of Cengage Learning. All rights reserved. 18

Table 9. 4 The Failure Process of a Newly Founded Firm 1. Extremely high indebtedness (poor static solidity) and small size 2. Too slow velocity of capital, too fast growth, too poor profitability (as compared to the budget), or some combination of these 3. Unexpected lack of revenue financing (poor dynamic liquidity) 4. Poor static liquidity and debt service ability (dynamic solidity) Source: Erkki K. Laitinen, “Prediction of Failure of a Newly Founded Firm, ” Journal of Business Venturing (July 1992): 326– 328. Reprinted with permission. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 19

The Evaluation Process • Profile Analysis Ø Involves identifying and investigating the financial, marketing, organizational, and human resource variables that influence the business’s potential before the new idea is put into practice. • The Feasibility Criteria Approach Ø Involves the use of a criteria selection list from which entrepreneurs can gain insights into the viability of their venture. • Comprehensive Feasibility Approach Ø Incorporates external factors in addition to those included in the criteria questions. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 20

Feasibility Criteria Approach • Assessing the viability of a venture: Ø Is it proprietary? Ø Are the initial production costs realistic? Ø Are the initial marketing costs realistic? Ø Does the product have potential for very high margins? Ø Is the time required to get to market and to reach the break-even point realistic? Ø Is the potential market large? Ø Is the product the first of a growing family? Ø Does an initial customer exist? Ø Are the development costs and calendar times realistic? Ø Is this a growing industry? Ø Can the product and the need for it be understood by the financial community? © 2009 South-Western, a part of Cengage Learning. All rights reserved. 21

Figure 9. 3 Key Areas for Assessing the Feasibility of a New Venture © 2009 South-Western, a part of Cengage Learning. All rights reserved. 22

Table 9. 5 Specific Activities of Feasibility Analyses Technical Feasibility Analysis Market Feasibility Analysis Financial Feasibility Analysis Organizational Capabilities Analysis Competitive Analysis Crucial technical specifications • Design • Durability • Reliability • Product safety • Standardization Engineering requirements • Machines • Tools • Instruments • Work flow Product development • Blueprints • Models • Prototypes Product testing • Lab testing • Field testing Plant location • Desirable characteristics of plant site (proximity to suppliers, customers), environmental regulations Market potential • Identification of potential customers and their dominant characteristics (e. g. , age, income level, buying habits) • Potential market share (as affected by competitive situation) • Potential sales volume • Sales price projections Market testing • Selection of test • Actual market test • Analysis of market Marketing planning issues • Preferred channels of distribution, impact of promotional efforts, required distribution points (warehouses), packaging considerations, price differentiation Required financial resources • Fixed assets • Current assets • Necessary working capital Available financial resources • Required borrowing • Potential sources for funds • Costs of borrowing • Repayment conditions • Operation cost analysis • Fixed costs • Variable costs • Projected profitability Personnel requirements • Required skill levels and other personal characteristics of potential employees • Managerial requirements • Determination of individual responsibilities • Determination of required organizational relationships • Potential organizational development • Competitive analysis Existing competitors • Size, financial resources, market entrenchment • Potential reaction of competitors to newcomer by means of price cutting, aggressive advertising, introduction of new products, and other actions Source: Hans Schollhammer and Arthur H. Kuriloff, Entrepreneurship and Small Business Management (New York: John Wiley & Sons, 1979): 56. Copyright © 1979 by John Wiley & Sons, Inc. Reprinted by permission of John Wiley & Sons, Inc. © 2009 South-Western, a part of Cengage Learning. All rights reserved. 23

Key Terms and Concepts • comprehensive feasibility • • approach critical factors customer availability external problems failure prediction model feasibility criteria approach growth of sales growth stage © 2009 South-Western, a part of Cengage Learning. All rights reserved. • high-growth venture • internal problems • lifestyle venture • marketability • product availability • small profitable venture • start-up problems • technical feasibility • uniqueness 24