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3) Strategy analysis
Once you have been able to gather a sufficient number of business ideas, you will be left with the excruciating task of picking one of them and implementing it (that is, risking your own sweat, time and money in order to concretize your idea and become a successful entrepreneur). Needless to say, you will need to pay extra attention to this stage of the analysis as this is the one which will be the most likely to draw a clear picture of the state of the markets you want to enter: at the end of this section, you will either have realized that a business idea you had is actually too difficult or unreasonable for you to exploit, that it is indeed a good business opportunity which you will be able to pursue, or that your idea falls in-between the two previous categories: it is worth pursuing, but there are actually many more pitfalls that you had imagined at the beginning.
Most likely, your ideas will fall into the third category, and you should particularly beware when such is not the case: do you truly believe that all original and seemingly bizarre ideas are not worth pursuing ? are you aware of many “easy” business opportunities that nobody else wouldn’t have exploited yet ? If your answer to this last question is positive, then please bear in mind that many great entrepreneurs were considered crazy in their time, or at least not taken seriously (witness the fact that Yahoo allowed Google to grow instead of immediately launching a takeover bid, resulting today in the crushing domination of Google and the slow death of Yahoo).
a) Porter’s framework
Porter proposed a now very popular framework in order to conduct a strategic analysis of a company or business sector. The idea is to study this sector as evolving under the pressure of 4 fundamental forces: new entrants (those are the people who would like to enter the business in question), substitution products (those are the products or services which represent a direct threat to the sector by proposing products which could be considered as equivalently satisfying the same needs), suppliers (whose bargaining power is more or less important, which can either play in disfavor or in favor of the business sector or company which is being analyzed), customers (similarly, customers enjoy different bargaining power depending upon their position in the value chain).
Eventually, we will see that Porter’s framework can be extended to a 5-force framework in which complementary products and services would be taken into account: indeed, the current state of complementary business sectors can have a direct impact on the industry which is being analyzed.
i) The industry and its different players
The market
What is the industry (business sector) that you wish to analyze ? In other words, what is the market that your firm belongs to and that you will need to understand before deciding whether you have the means to invest in this sector and define a strategy for this investment ? Try to defined this market as precisely as possible before undertaking any further analysis: for instance, if you plan to sell cars, then you are competing within the automobile industry. If you plan to sell cars, trucks and motorbikes, then your market would be better defined as the vehicles industry. This distinction is important since it will be pivotal in determining what are the substitution products or services related to this market.
Example: importance of defining a market properly.
Imagine that you want to operate a bricks factory in Batesville, Indiana. You will then be operating within the bricks market around Batesville. Indeed, your market will not be international (nor widely national) since bricks have a low value, a high transportation cost and are relatively undifferentiated. Therefore, you won’t really be able to profitably sell them to residents from other states, which will prefer to find closer suppliers.
Now assume that you want to produce cigarettes from a factory in Houston, Texas. Your market will then be that of tobacco and most likely will be international, since cigarettes are relatively cheap to produce and bring in substantial margins. They are thus a profitable product to export.
Once your market has been properly defined, you will want to determine which segment of this market your company is targeting. If you are operating a car factory, then are you positioned towards to low end or towards the high end of the spectrum ? Are you targeting low-income or high-income customers ? Young or old ? Single or married ? By the same token, you can divide your market into small segments and then decide which one best defines the scope of your company.
Example: defining the segment of the market you are competing in
Imagine that you are a Porsche retailer, then your market is the car industry, but you are more specifically targeting this segment composed of single and affluent middle-aged males. Identifying the segment in which you are competing is key to understanding the drivers of your business, i.e. the characteristics of your products or services that bring value to your customers (and thus determine the selling prices). This naturally brings us to the notion of market growth.
Market growth
As we have seen above, determining your market segment enables you to understand the key drivers of your business; once you have been able to do that, you should make it clear whether market growth is driven by value (price) or by volume (quantity of products sold). Achieving a strategy of value or one of volume is very important because this will make it possible for your brand to have a clear positioning in the customers’ mind. It has been shown that statistically a company will be less profitable whenever it pursues neither of the aforementioned strategy but instead remains “stuck in the middle”.
On top of that, you should also determine whether your market growth is determined exclusively by your strategy (of value or volume), or whether the market is also growing “structurally”: are you getting a larger slice of a smaller cake, or a smaller slice of a larger cake ? In order to answer this fundamental question, you need to look both at the raw data (in absolute numbers, e.g., the dollar amount or the volume of your sales over the past 6 months) and at the relative percentage market share that you are achieving (e.g., your value or volume market share over the same period of time).
In a second stage, you should also strive to determine what will be the duration of the expected growth by anticipating the maturity curve of your product (that is, by identifying what will be its introduction, growing and declining periods). Why is this important ? Because this will help you decide when it is time to invest and when it is time to divest. Typically, you will want to incur R&D expenses, marketing costs and buy equipments (capital expenditure) during the starting and growing phase of your product, while you might prefer to curb or just halt investments as your product is forecast to bring less and less money as it slowly declines to its economic death (as an alternative, and whenever it is appropriate, you may also invest more into R&D in order to update your product and bring it back in line with the market expectations; this strategy would then be tantamount with launching a new product and would compel you to redraw a new maturity curve, since the life cycle of your product has been fundamentally modified).
Market Share
As stipulated above in the definition of the market, market shares must be treated cautiously because their signification is dependent upon the scope of the industry: for instance, a 30% market share in the US tobacco market bears little meaning because the tobacco market is international (as we explained in the above example, tobacco products bring in high margins and thus are fit to be exported). On the contrary, a 30% market share in the Californian bricks market is meaningful because bricks constitute a low value added product and thus cannot really be profitably exported.
Moreover, when analyzing the market share of a company or product, you may want to break it down into its most basic constituents, that is to say by geographical location and income class of buyers, etc … in order to have a better idea on how your market shares are or will be gained (which will have direct consequences on how you will implement your strategy).
Market Risk
Just how risky is the market that you are considering ?
Are demand and prices cyclical within this market ? If such is the case then you might prefer to start up during a growth phase rather than during a downward phase. Also, it might be important that you begin with some decent amount of cash available so as to absorb losses that might arise from the next downward phase of the cycle (see it as the required flexibility, amortization)
Are the kinds of services and products you will be selling considered as luxury product or as first necessity goods ? During an economic crisis, people will be prompt to cut on luxury products and will spend more exclusively on staples (which sounds logical, considering that we need to cater first to our own physical survival before indulging ourselves in luxury products).
Are these products and services original or not ? Always keep in mind that innovation triggers an impulsion to buy, while repeat purchases don’t appeal to our curiosity in the same fashion. Therefore, customers will sometimes prefer to buy a new original product even if this means sacrificing their budget on other goods that they were already used to purchase on a regular basis.
Production Models
Determining the nature of the production model is paramount in order to develop an idea of the logistics that will be involved in the process (number of employees needed, industrial equipment, etc …). Of course, the production model preferred must be in line with the strategic positioning of the company.
The first step in specifying the production model of your future business is to determine whether the production function will be outsourced or not, and whether your staff will be temporary or permanent.
Oftentimes, outsourcing may prove to be beneficial when it involves delegating a part of the work which doesn’t require your expertise, which can be done more efficiently and at a lower price by other firms which are specialized in doing this work and benefit from cost efficiencies thanks to the high volume they process. Under these circumstances, outsourcing will allow you to concentrate your efforts on the chore of your business, which is where most of the value added will originate from (and keep in mind that value added is what justifies the premium you will be asking from your customers).
The question to decide whether your staff should be made of temporary or permanent workers is also an essential question, and several issues need to be considered. Temporary workers will allow your activities to be more flexible and your business will adapt more quickly to demand, especially during periods of crises. However, a high turnover will also induce higher costs; for instance, every time you will hire a new worker, you will need to pay for his training. But there are also numerous other costs which are harder to quantify, such as the lack of motivation generated by the absence of professional perspectives, a degraded or inexistent corporate culture, etc ... On the other hand, resorting to permanent workers limits training costs, allows you to build a corporate culture and preserve the loyalty and dedication of your employees, but will also make your business less adaptable to the economic conjuncture.
In a second phase, you need to decide which type of organization will be used in order to product the goods that you will be selling (that is, if you are also a producer). Are you going to turn to mass production, workshops, project-type manufacturing ?
Distribution Networks
How will the distribution of your products be organized ? Are you going to outsource the distribution function, or centralize orders and process them yourself directly from your own factories, shops or offices ?
If you decide to outsource the distribution function, who will be your dealers and how will they be remunerated ? What will be their exact role? Will they just be in charge of selling your products or will they also have to provide after-sale services to the customers ? Will they be able to efficiently provide you with the feedback they will be receiving from their clients so that you can improve your products before your sales start degrading ?
Example: selling dematerialized services
In some instances, the distribution network could be reduced to a single web server.
For instance, imagine that you want to sell a software that will generate math riddles for 8th graders. What you will do is set up one server on which you will introduce your product and on which people will be able to purchase it. This method will allow you to be the exclusive seller of the product and thus to appropriate most of the informational feedback from your customers, while keeping all the cash generated by the sales (since you don’t have to pay commissions to any dealer).
This strategy might not be optimal, though, because expanding your distribution network by selling your products through affiliates could, in some instances, bring in a much larger revenue thanks to the multiple selling points which will generate higher volumes. Obviously, you will need to pay a percentage of the sales to your affiliates, but this will be offset by the higher market share that you will attain in terms of higher number of units sold.
Corporate Culture
What are the values that will be prevailing in your company and how (and in which direction) will you direct the work environment of your employees ? Creating a well-defined original corporate culture may be a way to differentiate your company from others and thus be perceived by your customers as “standing out of the crowd”. Beyond the image you will be projecting to the world, a strong corporate culture reinforces the bonds between the employees and their company, which also can help your business to achieve a lower employee turnover and better work practices.
Example: The corporate culture at Google
Since its inception, Google has been striving to maintain an image of dynamism in order to attract and retain the best talents in the world in a nondiscriminatory fashion. Additionally, its goal is to provide its employees with a “small company work environment feel” and with a lot of perquisites. The result is a company where employees feel like home and which almost substitutes for their own home; consequently, Google workers become dependent upon their company facilities and the employee turnover is minimized.
The competition
The next step in your analysis of the industry will be to identify the competitors, their respective size (market share) and main characteristics: are you dealing with a monopoly (a single company is controlling the whole market), an oligopoly (a few companies are sharing the whole market), or are you playing within a perfectly competitive market (many companies are sharing the market, each of them having a relatively innocuous influence over the market as a whole) ?