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Starting a Business For Dummies
By Colin Barrow
John Wiley & SonsCopyright © 2014 John Wiley & Sons, Ltd
All rights reserved.
Preparing for Business
In This Chapter
* Getting to grips with the basics of business strategy
* Working up to opening up
* Measuring your business's viability
* Growing for success
When you're starting a business, particularly your first business, you need to carry out the same level of preparation as you would for crossing the Gobi Desert or exploring the jungles of South America. You're entering hostile territory. A stroll down any high street in the land shows you just how tough it is out there. Since the last edition of this book, Comet, JJB Sports, Clinton Cards, Game, Borders, Barratts, Jane Norman, Habitat, Oddbins, Adams Childrenswear, Principles, Sofa Workshop, Allied Carpets, Viyella, Dewhursts, Woolworths, MFI and Zavvi/Virgin Megastore have hit the rocks. Some 53 retailers have closed 4,000 stores.
Your business idea may be good, it may even be great, but such ideas are two a penny. The patent office is stuffed full of great inventions that have never returned tuppence to the inventors who spent so much time and money filing them. And failure is pretty much a norm for business start-ups. Over the past three years, nearly half a million small firms have shut up shop in the UK alone. As if that wasn't bad enough, the small-business population has actually grown by over a quarter of a million, at a time when the economy has shrunk by around 6 per cent. That means thousands more businesses are chasing a shrinking pot of customer spending power.
How you plan, how you prepare and how you implement your plan makes the difference between success and failure. This chapter sets the scene to make sure that you're well prepared for the journey ahead.
Understanding the Enduring Rules of Business Strategy
When you're engulfed by enthusiasm for an idea for a new business or engaged in the challenge of getting it off the ground, you can easily miss out on the knowledge you can gain by lifting your eyes up and taking the big picture on board too. You won't gain much from taking aim at the wrong target from the outset!
Credit for devising the most succinct and usable way to get a handle on the big picture has to be given to Michael E. Porter, who trained as an economist at Princeton, taking his MBA at Harvard Business School where he's now a professor. Porter's research led him to conclude that two factors above all influence a business's chances of making superior profits surely an absolute must if you're going to all the pain of working for yourself:
[check] The attractiveness or otherwise of the industry in which it primarily operates. That's down to your research, a subject I cover in Chapters 2 and 4.
[check] How the business positions itself within the industry in terms of an organisation's sphere of influence. In that respect, a business can only have a cost advantage if it can make products or deliver services for less than others. Alternatively, the business may be different in a way that matters to consumers, so that its offers are unique, or at least relatively so.
Porter added a further twist to his prescription. Businesses can follow a cost advantage path or a differentiation path industry wide, or they can take a third path – they can concentrate on a narrow specific segment with cost advantage or differentiation. This path he termed focus strategy, which I discuss in the following sections.
Focusing on focus – and a bit more besides
Whoa up a minute. Before you can get a handle on focus, you need to understand exactly what the good professor means by cost leadership and differentiation, because the combination of those provides the most fruitful arena for a new business to compete.
Don't confuse low cost with low price. A business with low costs may or may not pass those savings on to customers. Alternatively, the business can use low costs alongside tight cost controls and low margins to create an effective barrier to others considering entering or extending their penetration of that market.
Businesses are most likely to achieve low-cost strategies in large markets, requiring large-scale capital investment, where production or service volumes are high and businesses can achieve economies of scale from long runs. If you've deep pockets, or can put together a proposition that convinces the money men to stump up the cash, this avenue may be one to pursue. (I cover everything you need to put together a great business plan in Chapter 6.)
Ryanair and easyJet are examples of fairly recent business start-ups where analysing every component of the business made it possible to strip out major elements of cost (meals, free baggage and allocated seating, for example) while leaving the essential proposition – we fly you from A to B – intact. This plan proved enough of a strategy to give bigger, more established rivals such as British Airways a few sleepless nights.
The key to differentiation (ensuring that your product or service has a unique element that makes it stand out from the rest) is a deep understanding of what customers really want and need and, more importantly, what they're prepared to pay more for. Apple's opening strategy was based around a 'fun' operating system based on icons, rather than the dull MS-DOS. This belief was based on Apple's understanding that computer users were mostly young and wanted an intuitive command system and the 'graphical user interface' delivered just that. Sony and BMW are also examples of differentiators. Both have distinctive and desirable differences in their products. Neither they nor Apple offer the lowest price in their respective industries; customers are willing to pay extra for the idiosyncratic and prized differences embedded in their products.
Consumers can be a pretty fickle bunch. Dangle something faster, brighter or just plain newer and you can usually grab their attention. Your difference doesn't have to be profound or even high-tech to capture a slice of the market. Book buyers rushed in droves to Waterstones for no more profound a reason than that its doors remained open in the evenings and on Sundays, when most other established bookshops were firmly closed.
Your patience is about to be rewarded. Now I can get to the strategy that Porter reckoned was the most fruitful for new business starters to plunge into.
Focused strategy involves concentrating on serving a particular market or a defined geographic region. IKEA, for example, targets young, white-collar workers as its prime customer segment, selling through 235 stores in more than 30 countries. Ingvar Kamprad, an entrepreneur from the Småland province in southern Sweden, who founded the business in the late 1940s, offers home furnishing products of good function and design at prices young people can afford. He achieves this quality and price by using simple cost-cutting solutions that don't affect the quality of products. (You can read more about Kamprad in the sidebar 'Less is more'.)
Warren Buffett, one of the world's richest men, knows a thing or two about focus. His investment company combined with Mars to buy US chewing gum manufacturer Wrigley for $23 billion (£11.6 billion) in May 2008. Chigago-based Wrigley, which launched its Spearmint and Juicy Fruit gums in the 1890s, has specialised in chewing gum ever since and consistently outperformed its more diversified competitors. Wrigley is the only major consumer products company to grow comfortably faster than the population in its markets and above the rate of inflation. Over the past decade or so, for example, other consumer products companies have diversified. Gillette moved into batteries used to drive many of its products by acquiring Duracell. Nestlé bought Ralston Purina, Dreyer's, Ice Cream Partners and Chef America. Both have trailed Wrigley's performance.
Businesses often lose their focus over time and periodically have to rediscover their core strategic purpose. Procter & Gamble is an example of a business that had to refocus to cure weak growth. In 2000 the company was losing share in seven of its top nine categories, and had lowered earnings expectations four times in two quarters. This situation prompted the company to restructure and refocus on its core business: big brands, big customers and big countries. Procter & Gamble sold off non-core businesses, establishing five global business units with a closely focused product portfolio.
Appreciating the forces at work in your sector
Aside from articulating the generic approach to business strategy, Porter's other major contribution to the field was what has become known as the Five Forces Theory of Industry Structure. Porter postulated that you have to understand the five forces that drive competition in an industry as part of the process of choosing which of the three generic strategies (cost leadership, differentiation or focus) to pursue. The forces he identified are:
[check] Threat of substitution: Can customers buy something else instead of your product? For example, Apple – and to a lesser extent Sony – have laptop computers that are distinctive enough to make substitution difficult. Dell, on the other hand, faces intense competition from dozens of other suppliers with near-identical products competing mostly on price alone.
[check] Threat of new entrants: If it's easy to enter your market, start-up costs are low and no barriers to entry exist, such as intellectual property protection, then the threat is high.
[check] Supplier power: Usually, the fewer the suppliers, the more powerful they are. Oil is a classic example where less than a dozen countries supply the whole market and consequently can set prices.
[check] Buyer power: In the food market, for example, just a few, powerful supermarket buyers are supplied by thousands of much smaller businesses, so the buyers are often able to dictate terms.
[check] Industry competition: The number and capability of competitors is one determinant of a business's power. Few competitors with relatively less attractive products or services lower the intensity of rivalry in a sector. Often these sectors slip into oligopolistic behaviour, preferring to collude rather than compete. You can see a video clip of Professor Porter discussing the Five Force model on the Harvard Business School website (http://hbr.org/2008/01/ the-five-competitive-forces-that-shape-strategy/ar/1).
Recognising the first-to-market fallacy
People use the words 'first mover advantage' like a mantra to justify a headlong rush into starting a business without doing enough basic research. That won't happen to you – after all, you're reading this book and by the end of this section you'll be glad you paused for thought.
The idea that you've the best chance of being successful if you get in first is one of the most enduring in business theory and practice. Entrepreneurs and established giants are always in a race to be first. Research from the 1980s claimed to show that market pioneers have enduring advantages in distribution, product-line breadth, product quality and, especially, market share.
Beguiling though the theory of first mover advantage is, it's probably wrong. Gerard Tellis, of the University of Southern California, and Peter Golder, of New York University's Stern Business School, argue in their research that previous studies on the subject were deeply flawed. In the first instance earlier studies were based on surveys of surviving companies and brands, excluding all the pioneers that failed. This fact helps some companies to look as though they were first to market even when they weren't. Procter & Gamble boasts that it created the USA's disposable-nappy (diaper) business. In fact, a company called Chux launched its product a quarter of a century before Procter & Gamble entered the market in 1961.
Also, the questions used to gather much of the data in earlier research were at best ambiguous and perhaps dangerously so. For example, researchers had used the term 'one of the pioneers in first developing such products or services' as a proxy for 'first to market'. The authors emphasise their point by listing popular misconceptions of who the real pioneers were across the 66 markets they analysed:
[check] Online book sales: Amazon (wrong); Bookshop.co.uk (right). Amazon opened on 16 July 1995. Bookshop.co.uk opened in 1992 and was bought out by WH Smith in 1998 for £9.4 million.
[check] PCs: IBM/Apple (both wrong); Micro Instrumentation Telemetry Systems (right) – it introduced its PC, the Altair, a $400 kit, in 1974 followed by Tandy Corporation (Radio Shack) in 1977.
[check] Search engines: Google (wrong); Archie (right). The credit for developing the first search engine goes to Alan Emtage, a student at McGill University in Montreal, who in 1990 created Archie, an index for archiving computer files. The following year, Mark McCahill, a student at the University of Minnesota, used hypertext to create Gopher, which was able to search for plain text references in files. Then the search engine race was on, starting with Excite (1993), followed by Yahoo!, WebCrawler, Infoseek and Lycos (1994), AltaVista (1995), Inktomi (1996) and Ask Jeeves, now Ask (1997). Google didn't come on the scene until 1997, making it 11th in the race, but nevertheless the winner.
In fact the most compelling evidence from all the research is that nearly half of all firms pursuing a first-to-market strategy are fated to fail, but those following fairly close behind are three times as likely to succeed. Tellis and Golder claim the best strategy is to enter the market a few years after pioneers, learn from their mistakes, benefit from their product and market development and be more certain about customer preferences.
Getting in Shape to Start Up
You need to be in great shape to start a business. You don't have to diet or exercise, at least not in the conventional sense of those words, but you do have to be sure that you've the skills and knowledge you need for the business you have in mind, or know how to tap into sources of such expertise.
The following sections help you through a pre-opening check-up so that you can be absolutely certain that your abilities and interests closely align to those that the business you have in mind requires. The sections also help you to check that a profitable market exists for your products or services. You can use these sections as a vehicle for sifting through your business ideas to see whether they're worth the devotion of time and energy that you need to start up a business.
You may well not have all the expertise you need to do everything yourself. Chapter 7 introduces you to the zillions of agencies and advisers who can fill in the gaps in your expertise.
Assessing your abilities
Business lore claims that for every ten people who want to start their own business, only one finally does. It follows that an awful lot of dreamers exist who, while liking the idea of starting their own business, never get around to taking action. Chapter 3 looks in detail at how you can assess whether you're a dreamer or a doer when it comes to entrepreneurship. For now, see whether you fit into one of the following entrepreneurial categories:
[check] Nature: If one of your parents or siblings runs a business, successfully or otherwise, you're highly likely to start up your own business. No big surprise here, because the rules and experiences of business are being discussed every day in such families and some of this knowledge is bound to rub off. It also helps if you're a risk-taker who's comfortable with uncertainty.
[check] Nurture: For every entrepreneur whose parents or siblings have a business, two don't. If you can find a business idea that excites you and has the prospect of providing personal satisfaction and wealth, then you can assemble all the skills and resources you need to succeed in your own business. You need to acquire good planning and organisational skills (Chapter 6 covers all aspects of writing a business plan) and develop a well-rounded knowledge of basic finance, people management, operational systems, business law, marketing and selling, or get help and advice from people who have that knowledge.
Excerpted from Starting a Business For Dummies by Colin Barrow. Copyright © 2014 John Wiley & Sons, Ltd. Excerpted by permission of John Wiley & Sons.
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