INDUSTRY AND MARKET ISSUES (PART 3)

INDUSTRY AND MARKET ISSUES (PART 3)

HARVEST ISSUES

Value-Added Potential

New ventures that are based on strategic value in an industry such as valuable technology, are attractive, while those of low or no strategic value are less attractive. The characteristics of businesses that command a premium price is that they have high value-added strategic importance to their acquirer, such as distribution, customer base, geographic coverage, proprietary technology, contractual rights, and the like. Such companies might be valued four, five, or even six times (or more) last year’s sales, whereas perhaps 60 percent to 80 percent of companies might be purchased at 0.75 to 1.25 times sales. 

Valuation Multiples and Comparable

Consistent with the above point, there is a large spread in the value of the capital markets place on private and public companies. Part of your analysis is to identify some historical boundaries for valuations placed on companies in the market/industry/technology area you intend to pursue.

Exit Mechanism and Strategy

Businesses that are eventually sold – privately or to the public – or acquired, usually are started and grown with a harvest objective in mind. Attractive companies that realize capital gains from the sale of their businesses have, or envision, a harvest or exit mechanism. Unattractive opportunities do not have an exit mechanism in mind.  Planning is critical because, as is often said, it is much harder to get out of a business than to get into it.  Giving some serious thought to the options and likelihood that the company can eventually be harvested is an important initial and ongoing aspect of the entrepreneurial process.

Competitive Advantage Issues: Variable and Fixed costs

An Attractive opportunity has the potential for being the lowest-cost producer and for having the lowest market and distribution costs. For example, Sokoto Cement Company, Sokoto State, Nigeria, was unable to remain competitive in the market for cement after Dangote Cement Company, producers of large scale cement entered the business. Being unable to achieve and sustain a position as a low-cost producer shortens the life expectancy of a new venture.  

Degree of Control

Attractive opportunities have the potential for moderate – to – strong degree of control over prices, costs, and channel of distribution. Fragmented markets where there is no dominate competitor have this potential.  These markets usually have a market leader with a 20 percent market share or less.  For example, sole control of the source of supply of a critical component for a product or of channels of distribution can give a new venture market dominance even if other areas are weak. 

Lack of control over such factors as product development and component prices can make an opportunity unattractive.  A market where a major competitor have a market share of 40 percent or more usually implies a market where power and influence over suppliers, customers,  and pricing create a serious barrier and risk for a new firm.  Such a firm will have few degrees of freedom. However, if a dominant competitor is at full capacity, is slow to innovate or to add capacity in a large and growing market, or routinely ignores or abuses the customer, there may be an entry opportunity.  However, entrepreneurs usually do not find such sleepy competition in dynamic emerging industries dense with opportunity.

Entry Barriers

Having a favorable window of opportunity is important. Having or being able to gain proprietary protection, regulatory advantage, or other legal or contractual advantage, such as exclusive rights to a market or with a distributor, is attractive. Having, or being able to gain an advantage in response/ lead times is important because these can create barriers to entry or expansion by others.  For example, advantages in response/lead times in technology, product innovation, market innovation, people, location, resources, or capacity make an opportunity attractive. 

Possession of well-developed, high quality, accessible contacts that are the product of years of building a top-notch reputation and that cannot be acquired quickly is also advantageous.  Sometimes this competitive avenge may be so strong as to provide dominance in the marketplace, even though many of the other factors are weak or average. 

If a firm cannot keep others out or if it faces already existing entry barriers, it is unattractive. An easily overlooked issue is a firm’s capacity to gain distribution of its product. As simple as it may sound, even venture-capital-backed-companies fall victim to this market issue. A particular airline in Nigeria apparently assembled all the right ingredients, including substantial financing, yet was unable to secure sufficient gate space for its airplanes. Even though it sold the seats, it had no place to pick the passengers up or drop them off.

(Part 4 continues in the next article)

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