Because learning changes everything.

Part 2

Due Diligence on the

Business Idea

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 Because learning changes everything. ®

Chapter 4

External Analysis
 Learning Objectives

• Describe how to examine the industry that the new business plans to
enter.
• Discuss how to create a profile of the target customers for a new
business.
• Explain how to categorize competitors of the new business using
external analysis.
• Explain how to construct competitive maps.
• Ensure that the entrepreneur has considered a full set of concerns in
his or her external analysis.
• Differentiate between those elements of the business that provide a
competitive advantage and those that do not.

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 Chapter Overview

We will look at these critical steps of external analysis.

• Defining the industry in which you will compete.
• Defining your customers.
• Researching the industry yourself.
• Identifying competitors within that industry.
• Researching those competitors.
• Drawing a set of competitive maps.
• Examining and developing insights about the industry.
• Developing an understanding of your competitive advantage.

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 Defining Your Industry 1

Entrepreneurs should be as specific as possible.

If opening an ice cream store, entrepreneurs should ask themselves:

• In what industry does a new ice cream store compete?

• Does it include dessert providers, such as bakeries?

• Does it compete with grocery stores that sell packaged ice cream?

• Is it high-end, high milk-fat ice cream?

Defining the industry is not to be taken lightly.

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 Ways to Gather Information

• Online search.
• Industry magazine or journals.
• Industry associations.

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 Defining Your Industry 2

Entrepreneurs should:

• Define their industry broadly enough to include all potential

competitors, but not so broad as to be overwhelming.
• Be clear about the practical level of actual competition.
• What is a reasonable geographic customer draw for a new business?

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 Industry

Those companies within a specified geographic radius

that will be in direct competition for the same customers
and sales as that of the new business.

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 Defining Your Customers

Entrepreneurs should:

• Define a narrow group of individuals whom they believe will be their

most likely customers.
• Be diligent in the effort to be as accurate as possible.

Helps the new business:

• Focus on its core customer.

• Maintain a strategic distance from its competitors.
• Control expenses.

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 Developing the Information for the External Analysis of
Competitors

Identifying exact competitors who directly compete for the same set of
ideal customers.

By researching the industry themselves, the entrepreneurs will:

• Gain invaluable insight.

• Make themselves an expert.
• Enable themselves to plan a business with a competitive advantage.

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 Know Your 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?

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 Defining Actual Competitors 1

Effective industry analysis starts by identifying every potential competitor

within a reasonable distance of the location.
• First step: Defining a radius from which one will draw his or her
customers.
• Example: 20 minutes driving in traffic.

• Second step: Examining each of your potential competitors within that

radius.

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 Defining Actual Competitors 2

Most entrepreneurial businesses compete in fragmented markets.

• 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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 Competitive Map

Analytical tool used to organize

information about direct competitors on
all points of competition.

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 Developing a Competitive Map

Reasons for developing a competitive map personally.

• It is less expensive.
• Knowledge about competitors allows better positioning of the new
business.
• Insights will be developed regarding positioning, pricing, and facility
layout.

Entrepreneurs are required to:

• Visit all of the potential competitors in whatever form they run their
business.
• Develop a list of criteria that they wish to take away from each visit
and record that information after each visit.
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 Table 4.1: Competitive Map: Golf Course 1

Criteria: 8-Mile Competitor Competitor Competitor Competitor Competitor

Radius 1 2 3 4 5
Population in area NA NA NA NA NA
Number of NA NA NA NA NA
households in area
Average household N A NA NA NA NA
income
Average age in NA NA NA NA NA
area
Number of driving NA NA NA NA NA
ranges
Number of golf NA NA NA NA NA
shops in area

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 Table 4.1: Competitive Map: Golf Course 2

Criteria: 8-Mile Competitor Competitor Competitor Competitor Competitor

Radius 1 2 3 4 5
Number of NA NA NA NA NA
customers per
weekday
Number of NA NA NA NA NA
customers per
weekend
Average number of N A NA NA NA NA
customers per hour
Peak flow of NA NA NA NA NA
customers
Average charge NA NA NA NA NA
per transaction

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 Table 4.1: Competitive Map: Golf Course 3

Criteria: 8-Mile Competitor Competitor Competitor Competitor Competitor

Radius 1 2 3 4 5
Tee charge: peak NA NA NA NA NA
and off-peak

Clubhouse feel NA NA NA NA NA

Course feel NA NA NA NA NA

Variety of menu NA NA NA NA NA
offerings:
clubhouse
Variety of menu NA NA NA NA NA
offerings: course

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 Additional Issues for External Analysis

• Substitutes.
• Elasticity of demand.
• Ease of entry or exit.
• Benchmarking.
• Industry trends.

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 Substitutes

Products that perform a similar function or achieve the same result, but
are not precise imitations.

Entrepreneurs:

• Need to be aware of potential substitutes and their impacts.

• Recognize that at some price trade-off point, customers will switch to
substitutes.

Help form a ceiling on the price that can be charged for the product or
service.

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 Elasticity of Demand

• Consumers’ response to price changes.

• For example, as the prices of luxury items increase, demand usually
declines as these goods are not essential and their purchase can be
delayed.
• Conversely, items such as gas for a car typically have relatively
inelastic demand as one will not stop using it as the price increases.

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 Exit Barrier

• Barrier, such as investment in capital assets, that keeps a firm from

leaving an industry.
• Ease of entering and exiting a business investment is an important
detail to consider.

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 Ease of Entry or Exit

Closing a clothing store has a high exit barrier.

• Sharp discounts are in order.

Closing a golf course has a low exit barrier.

• The land can be converted to a housing tract.

Ability to exit a business easily tends to:

• Limit the intensity of competition in the industry.

• Reduce the threat posed by a new entry.

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 Benchmarking

• Working with and learning from a company outside of one's industry

that has a particular skill that is potentially critical to one's operation.
• Benchmarking a business that is successful in a particular area but
that does not compete in one's own industry can be considered to
strengthen areas of competitive advantage.
• Most companies will share knowledge as long as one is not a
competitor.

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 Industry Trends

Shape the long-term prospects of the industry.

• The United States is moving to a self-service economy.
• Companies that can move that process forward or take advantage of this
movement appear to have an opportunity for success.

• Healthy, mid-price-range restaurant sales have been increasing

dramatically.
• Restaurant that enters an emerging market may be able to create a niche
and gain a competitive advantage.

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 Competitive Advantage

• The edge that a business has over competing businesses made up of

those things that the business does better than any business in the
industry.
• Understanding the competitive advantage is the last step in external
analysis.
• Reason why customers go to one particular business and not to one
of its competitors.

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 Sources of Competitive Advantage

Activity of the firm.

• Type of service or product it provides.

Structure.
• High-quality location.

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 Competitive Factors

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.

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 Table 4.2: Company Evaluation of Resources and
Capabilities
Normal business resources and Potentially unique business
capabilities resources and capabilities

A storefront A small, intimate facility

Tables Fixed tile tables
Chairs Roller, cushioned chairs
Floor covering Tile floors
Lights Mood lighting throughout
Cash register Card swipe machine at each table
Signs Custom neon signs
Menu Touch screen at each table
Kitchen equipment NA
Cook staff or waitstaff Trained chefs or unique outfits
Trash cans NA
Utilities NA

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 Resource-Based Analysis

• Theoretical approach and practical methodology.

• Examines the functioning of a business in terms of whether a product
or service simultaneously meets certain criteria.

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 Resource-Based View

To develop into a competitive advantage, unusual products or services

must meet the following criteria:

• Rare.
• Durable.
• Relatively nonsubstitutable.
• Valuable.

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 Chapter Review

This chapter examined the reasons and methods to develop a knowledge

of the competitive conditions.
• Entrepreneur decides what constitutes the "industry."
• Entrepreneur must limit the defined "industry."

Tools provided in this chapter for the entrepreneurs can be used to

personally develop their own analysis of the environment and their ability
to compete within that environment.

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