Entrepreneurship

Business Plan Template

U.S. Small Business Administration Small Business Training Network

www.sba.gov/training

Five Important Tips Before You Start!

1. The business plan should tell a compelling

story about your business, explaining who, what, when, where, how and why.

2. Your plan should be focused and clear. It’s not about the number of pages or style of the cover.

3. The plan should define specific business objectives and goals with general parameters to guide the organization.

4. Writing a business plan should force logic and discipline into a business.

5. A good business plan is a living document. It should be updated regularly.

2

Title Page

Your Company Name

Street Address City, State & Zip Code

Phone Number E-Mail Address Web Address

Business Plan Date

3

Table of Contents

1. Table of Contents…………………………………

2. Executive Summary………………………………

3. Business Description & Vision………………….

4. Definition of the Market………………………….

5. Description of Products and Services…………….

6. Organization & Management…………………….

7. Marketing and Sales Strategy…………………….

8. Financial Management……………………………

9. Appendices……………………………………….

4

Executive Summary

This section should:

• Be written last • Provide an enthusiastic snapshot of your company,

explaining who you are, what you do and why • Be less than 2 pages

After reviewing this section the reader should:

• Want to learn more about your business • Have a basic understanding about your company

Start here…

5

Business Description & Vision

This section should include:

• Mission statement (business purpose) • Company vision (statement about company growth) • Business goals and objectives • Brief history of the business • List of key company principals

After reviewing this section the reader should know:

• Who the business is and what it stands for • Your perception of the company’s growth & potential • Specific goals and objectives of the business • Background information about the company

Start here…..

6

Definition of the Market

This section should:

• Describe your business industry and outlook • Define the critical needs of your perceived or existing

market • Identify your target market • Provide a general profile of your targeted clients • Describe what share of the market you currently have

and/or anticipate

After reviewing this section the reader should know:

• Basic information about the industry you operate in and the customer needs you are fulfilling

• The scope and share of your business market, as well as who your target customers are

Start here…..

7

Description of Products and Services

This section should:

• Specifically describe all of your products and services • Explain how your products and services are

competitive • If applicable, reference a picture or brochure of your

products, which would be included in the plan’s appendix

After reviewing this section the reader should know:

• Why you are in business • What your products and services are and how much

they sell for • How and why your products & services are

competitive

Start here…..

8

Organization & Management

This section should:

• Provide a description of how your company is organized as well as an organization chart, if available

• Describe the legal structure of your business (proprietorship, partnership, corporation, etc.)

• Identify necessary or special licenses and/or permits your business operates with

• Provide a brief bio description of key managers within the company

After reviewing this section the reader should know:

• The legal form of ownership for your business • Who the leaders are in your business as well as their

roles • The general flow of operations within the firm

Start here…..

9

Marketing and Sales Strategy

This section should:

• Identify and describe your market – who your customers are and what the demand is for your products & services

• Describe your channels of distribution • Explain your sales strategy, specific to pricing,

promotion, products and place (4Ps) After reviewing this section the reader should:

• Who your market is and how you will reach it • How your company will apply pricing, promotion,

product diversification and channel distribution to sell your products and services competitively

Start here…..

10

Financial Management This section should include: Click here: for automated Balance Sheet template Click here: for automated Income Statement template Click here: for automated Cash Flow Statement template

New Business • Estimate of start-up costs • Projected balance sheet (1 year forward) • Projected income statement (1 year forward) • Projected cash flow statement (12 months forward)

Existing Business

• Balance sheets (last 3 years) • Income statements (last 3 years) • Cash flow statement (12 months)

If Applying for a Loan

• Current personal financial statement on each principal • Federal tax return for prior year

After reviewing this section the reader should:

• Have a good understanding regarding the financial capacity and/or projections for your company

Start here…..

11

Appendices

This section should include as attachments:

• Company brochures • Resumes of key employees • List of business equipment • Copies of press articles and advertisements (if

available) • Pictures of your business location and products

(optional) • Information supporting the growth of your industry

and/or products (optional) • Key business agreements, such as lease, contracts, etc.

(optional) Start here…..

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eText Study Plan

Dynamic Study Modules

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ENTREPRENEURSHIP: STARTING & OPERATING A SMALL BUSINESS

Fifth Edition

Steve Mariotti • Caroline Glackin

Vice President, Business, Economics, and UK Courseware: Donna Battista

Director of Portfolio Management: Stephanie Wall Director, Courseware Portfolio Management: Ashley Dodge Senior Sponsoring Editor: Neeraj Bhalla Editorial Assistant: Linda Albelli Vice President, Product Marketing: Roxanne McCarley Product Marketing Assistant: Marianela Silvestri Manager of Field Marketing, Business Publishing: Adam

Goldstein Field Marketing Manager: Nicole Price Marketing Coordinator: Erin Rush Vice President, Production and Digital Studio, Arts and Business: Etain O’Dea Director, Production and Digital Studio, Business and Economics: Ashley Santora Managing Producer, Business: Melissa Feimer

Content Producer: Yasmita Hota Operations Specialist: Carol Melville Design Lead: Kathryn Foot Manager, Learning Tools: Brian Surette Senior Learning Tools Strategist: Emily Biberger Managing Producer, Digital Studio and GLP: James Bateman Managing Producer, Digital Studio: Diane Lombardo Digital Studio Producer: Regina Dasilva Digital Studio Producer: Alana Coles Full Service Project Management: Kim Fletcher, Integra

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Library of Congress Cataloging-in-Publication Data Names: Mariotti, Steve, author. | Glackin, Caroline, author. Title: Entrepreneurship: starting & operating a small business / Steve Mariotti, Caroline Glackin. Description: Fifth Edition. | New York: Pearson Education, [2020] | Revised edition of the authors’ Entrepreneurship, 2016. | Includes index. Identifiers: LCCN 2018028031 | ISBN 9780135210529 (softcover) Subjects: LCSH: New business enterprises—Management. | Entrepreneurship. Classification: LCC HD62.5 .M3567 2019 | DDC 658.1/1—dc23 LC record available at https://lccn.loc.gov/2018028031 1 18

ISBN 10: 0-13-5210526 ISBN 13: 978-0-13-5210529

Special thanks to Kathryn Davis, Shelby M. C. Davis, Kimberly La Manna, Abby Moffat, and Diana Davis Spencer.

Also to my mother, Nancy Mason Mariotti, who taught me that a great teacher can affect eternity.

—Steve Mariotti

To my children, Elise and Spencer, whose support and love are essential parts of this book.

To my parents, Howard and Maria Wiedenman, who truly understood the importance of education, my love and gratitude.

—Caroline Glackin

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vii

Brief Contents

UNIT 1 Entrepreneurial Pathways 1 Chapter 1 Entrepreneurs and

Entrepreneurship 2 Chapter 2 Pathways to Success: Processes

and Instruments 36 Chapter 3 Creating Business

from  Opportunity 98 Unit 1 Entrepreneurial Pathways:

SPANX—Idea to Entrepreneurial Opportunity 131

UNIT 2 Integrated Marketing 135 Chapter 4 Exploring Your Market 136 Chapter 5 Developing the Marketing

Mix and Plan 164 Chapter 6 Smart Selling and Effective

Customer Service 204 Unit 2 Integrated Marketing:

Kitchen Arts & Letters, Inc.—An Independent Bookstore Defies Industry Odds 229

UNIT 3 Show Me the Money: Finding, Securing, and Managing It 233

Chapter 7 Understanding and Managing Start- Up, Fixed, and Variable Costs 234

Chapter 8 Using Financial Statements to Guide a Business 260

Chapter 9 Cash Flow and Taxes 296

Chapter 10 Financing Strategy and Tactics 328 Unit 3 Show Me the Money: Finding,

Securing, and Managing It—Liu’s Sweet Treats 361

UNIT 4 Operating a Small Business Effectively 365

Chapter 11 Addressing Legal Issues and Managing Risk 366

Chapter 12 Operating for Success 398 Chapter 13 Management, Leadership, and

Ethical Practices 430 Unit 4 Operating a Small Business

Effectively: ONLC Training Centers—Virtual IT Training in a Classroom 467

UNIT 5 Cashing in the Brand 471 Chapter 14 Franchising, Licensing,

and Harvesting: Cashing in Your Brand 472

Unit 5 Cashing in the Brand: Honest Tea— From Start-Up to Harvest 491

Appendix 1 BizBuilder Business Plan 497 Appendix 2 Resources for Entrepreneurs 505 Appendix 3 Useful Formulas and Equations 511 Glossary 513 Index 519

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ix

UNIT 1 Entrepreneurial Pathways 1

Chapter 1 Entrepreneurs and Entrepreneurship 2 Understanding Entrepreneurs and Entrepreneurship 3

What Is an Entrepreneur? 3

The Free-Enterprise System 5 Voluntary Exchange 5

Benefits and Challenges of Free Enterprise 5

What Is a Small Business? 6 Definitions of Success—Monetary and Other 6

Taking the Long View 7

Benefits and Costs of Becoming an Entrepreneur 8

Potential Benefits of Entrepreneurship 8

Potential Costs of Entrepreneurship 10

Cost/Benefit Analysis 11

Opportunity Cost 11

Seeking Advice and Information to Succeed 12

Entrepreneurial Options 14 The Many Faces of Entrepreneurship 16

Unicorns 17

How Do Entrepreneurs Find Opportunities to  Start New Businesses? 17

Entrepreneurs Creatively Exploit Changes in Our World 18

Where Others See Problems, Entrepreneurs Recognize Opportunities 18

Train Your Mind to Recognize Business Opportunities 19

Entrepreneurs Use Their Imaginations 19

An Idea Is Not Necessarily an Opportunity 19

Opportunity Is Situational 20

The Five Roots of Opportunity in the Marketplace 21

Paths to Enterprise Ownership 22 Secure Franchise Rights 22

Buy an Existing Business 22

License Technology 23

Making the Business Work Personally and Professionally 23

A Business Must Make a Profit to Stay in Business 23

Profit Is the Sign That the Entrepreneur Is Adding Value 24

Profit Results from the Entrepreneur’s Choices 24

The Team Approach 24

Developing Skills for Your Career— Entrepreneurship or Employment 25

Chapter 2 Pathways to Success: Processes and Instruments 36 Feasibility Analysis: Does My Idea Work? 38

Analyzing Product and/or Service Feasibility 38

Analyzing Market and Industry Feasibility 39

Analyzing Financial Feasibility 41

Using the Lean Startup Methodology 42 Creating a Business Model Canvas 43 What Is a Business Plan? 46 Do You Need a Business Plan? 47

Your Business Plan Is the Key to Raising Capital 48

The Business Plan Is an Operations/ Execution Guide 48

Business Plan Components 49 Cover Page and Table of Contents 49

Executive Summary: A Snapshot of Your Business 50

Mission, Vision, and Culture: Your Dreams for the Organization 50

Company Description: Background and Track Record 50

Opportunity Analysis and Research: Testing Ideas 51

Marketing Strategy and Plan: Reaching Customers 52

Management and Operations: Making the Plan Happen 53

Financial Analysis and Projections: Translating Action into Money 54

Contents

x CONTENTS

Funding Request and Exit Strategy: The Ask and the Return 58

Appendices: Making the Case in Greater Detail 59

Business Plan Suggestions 59 Presenting Your Business Plan 60

Business Plan, Venture, Business Model, and Pitch Competitions 61

Honest Tea Business Plan 69

Chapter 3 Creating Business from Opportunity 98 What Defines a Business? 99 Use Effectual Reasoning to Your Advantage 100 What Sort of Organization Do You Want? 101

Your Company’s Core Values 101

Your Company’s Mission Is to Satisfy Customers 102

Your Company’s Vision Is the Broader Perspective 102

Your Company’s Culture Defines the Work Environment 102

The Business Opportunity Decision Process 103 Your Competitive Advantage 105

Find Your Competitive Advantage by Determining What Consumers Need and Want 105

You Have Unique Knowledge of Your Market 106

Factors of Competitive Advantage 106

Is Your Competitive Advantage Strong Enough? 107

Checking Out the Competition 108

Example: The Most Chocolate Cake Company 108

Competitive Strategy: Business Definition and Competitive Advantage 111

Feasibility Revisited: The Economics of One Unit as a Litmus Test 112

Defining the Unit of Sale 113

Cost of Goods Sold and Gross Profit 113

Your Business and the Economics of One Unit 114

The Cost of Direct Labor in the EOU—An Example 115

Hiring Others to Make the Unit of Sale 116

Going for Volume 117

Determining the Value of a Business 118 Asset Valuation Method 118

Earnings Valuation Method 119

Cash Flow Valuation Method 119

Unit 1 Entrepreneurial Pathways: SPANX—Idea to Entrepreneurial Opportunity 131

UNIT 2 Integrated Marketing 135

Chapter 4 Exploring Your Market 136 Markets and Marketing Defined 137 Research Prepares You for Success 138

Research Your Market Before You Open Your Business 138

Types and Methods of Research 139

Getting Information Directly from the Source: Primary Research 139

Getting Information Indirectly: Secondary Research 141

Segment and Industry Research Help You Make Decisions 143

Customer Research 144

Industry Research: The 50,000-Foot Perspective 145

Make Research an Integral Part of Your Business 146

Owning a Perception in the Customer’s Mind 148

Features Create Benefits 148

Home Depot: Teaching Customers So They Will Return 148

Which Segment of the Market Will You Target? 149

Successful Segmenting: The Body Shop 149

Applying Market Segmentation Methods 150

The Product Life Cycle 152

Is Your Market Saturated? 154

Market Positioning: Drive Home Your Competitive Advantage 154

Chapter 5 Developing the Marketing Mix and Plan 164 The Marketing Mix 165 Product: What Are You Selling? 167

Focus Your Brand 167

Ford’s Costly Failure: The Edsel 168

Ford’s Focus on Success: The Mustang 168

How to Build Your Brand 169

xi CONTENTS

Price: What It Says about Your Product 170 Strategies and Tactics for Effective Pricing 170

Place: Location, Location, Location! 172 Key Factors in Deciding on a Location 173

Promotion: Advertising and Publicity 173 Use Integrated Marketing Communications for Success 173

Promotional Planning and Budgeting 174

Delving into the Advertising Advantage and Sales Promotion 177

Types of Advertising 178

Media Planning and Buying: Focus on Your Customer 178

Marketing Materials Should Reinforce Your Competitive Advantage 178

Sales Promotion Solutions 179

Additional Marketing Options 181

Electronic and Social Media Marketing 183

Publicity Potential 186 Telling the Story 187

Sample Press Release 188

Follow Up a Press Release 188

Public Relations 188

The Additional P: Philanthropy 190 Cause-Related Marketing 190

Gaining Goodwill 190

Not-for-Profit Organizations 191

What Entrepreneurs Have Built 191

You Have Something to Contribute 192

Developing a Marketing Plan 192 Marketing Analysis 192

Marketing as a Fixed Cost 193

Calculate Your Breakeven Point 193

Chapter 6 Smart Selling and Effective Customer Service 204 Selling Skills Are Essential to Business Success 205

Selling Is a Great Source of Market Research 206

The Essence of Selling Is Teaching 206

The Principles of Selling 206

The Sales Call 208 Email, Blogs, and Social Networks 208

Prequalify Your Sales Calls 209

Focus on the Customer 209

The Eight-Part Sales Call 210

Three Call Behaviors of Successful Salespeople 211

Analyze Your Sales Calls to Become a Star Salesperson 212

Turning Objections into Advantages 212

Use Technology to Sell 213

Creating a Sales Force 213 Company Sales Team—Selling Directly 213

Independent Sales Representative Firms 214

Outsourced Customer Service Representatives 214

Successful Businesses Need Customers Who Return 214

Customer Service Is Keeping Customers Happy 215

The Costs of Losing a Customer 215

Customer Complaints Are Valuable 216

Customer Relationship Management Systems 217

Why Does CRM Matter? 218

Components of CRM for the Small Business 219

How Technology Supports CRM 220

Unit 2 Integrated Marketing: Kitchen Arts & Letters, Inc.— An Independent Bookstore Defies Industry Odds 229

UNIT 3 Show Me the Money: Finding, Securing, and Managing It 233

Chapter 7 Understanding and Managing Start-Up, Fixed, and Variable Costs 234 Start-Up Investment 236

Brainstorm to Avoid Start-Up Surprises 236

Keep a Reserve Equal to One-Half the Start-Up Investment 237

Predict the Payback Period 239

Estimate Value 239

Fixed and Variable Costs: Essential Building Blocks 240

Calculating Critical Costs 240

Fixed Operating Costs Do Change over Time 244

Allocate Fixed Operating Costs Where Possible 244

The Dangers of Fixed Costs 246

xii CONTENTS

Using Accounting Records to Track Fixed and Variable Costs 246

Three Reasons to Keep Good Records Every Day 247

Cash versus Accrual Accounting Methods 249

Recognizing Categories of Costs 249

Chapter 8 Using Financial Statements to Guide a Business 260 Scorecards for the Entrepreneur: What Do Financial Statements Show? 261 Income Statements: Showing Profit and Loss Over Time 262

Parts of an Income Statement 262

A Basic Income Statement 263

The Double Bottom Line 264

An Income Statement for a More Complex Business 264

The Balance Sheet: A Snapshot of Assets, Liabilities, and Equity at a Point in Time 266

Short- and Long-Term Assets and Liabilities 267

The Balance Sheet Equation 268

The Balance Sheet Shows Assets and Liabilities Obtained through Financing 268

The Balance Sheet Shows How a Business Is Financed 269

Analyzing a Balance Sheet 270

Depreciation 272

Financial Ratio Analysis: What Is It, and What Does It Mean to You? 272

Income Statement Ratios 273

Balance Sheet Analysis 275

Chapter 9 Cash Flow and Taxes 296 Cash Flow: The Lifeblood of a Business 297

The Income Statement Does Not Show Available Cash 298

Rules to Keep Cash Flowing 299

Noncash Expenses Can Distort the Financial Picture 299

The Working Capital Cycle 299 The Cyclical and Seasonal Nature of Cash Flow 300

Using a Cash Flow Statement 302 The Cash Flow Equation 302

Forecasting Cash Flow: The Cash Budget 304

Creating a Healthy Cash Flow 305

Managing Inventory to Manage Cash 306

Managing Receivables to Manage Cash 307

The Cash Effects of Accounts Receivable 308

The Life Cycle of Accounts Receivable 308

The Financing of Accounts Receivable 309

Managing Accounts Payable to Manage Cash 309

Negotiating Payment 309

Timing Payables 310

Capital Budgeting and Cash Flow 310 The Burn Rate 311

The Value of Money Changes over Time 312

The Future Value of Money 312

The Present Value of Money 313

Taxes 314 Cash Flow and Taxes 314

Filing Tax Returns 315

Collecting Sales Tax 315

Tax Issues for Different Legal Structures 315

Make Tax Time Easier by Keeping Good Records 316

Chapter 10 Financing Strategy and Tactics 328 Going It Alone Versus Securing Financing 329

How Often Do Small Businesses Really Fail? 330

What Is the Best Type of Financing for You and Your Business? 331 Gifts and Grants 331 Debt Financing 332

Debt Financing: Pros and Cons 334

Debt Advantages 334

Debt Disadvantages 335

Equity Financing 335 Equity Financing: Pros and Cons 335

Where and How to Find Capital That Works for You 336

Having an Excellent Business Plan Goes a Long Way 336

Family and Friends 339

Peer-to-Peer Lending 339

xiii CONTENTS

Financial Institutions and Dimensions of Credit 339

Community Development Financial Institutions 341

Venture Capitalists 342

Angel Investors 343

Insurance Companies 344

Vendor Financing 344

Federally Supported Investment Companies 345

Financing for Rural/Agricultural Businesses 345

Self-Funding: Bootstrap Financing 345

Accessing Sources Through Online Networking 346

Investors Want Their Money to Grow: Can You Make It Happen? 346

How Stocks Work 347

How Bonds Work 348

Unit 3 Show Me the Money: Finding, Securing, and Managing It—Liu’s Sweet Treats 361

UNIT 4 Operating a Small Business Effectively 365

Chapter 11 Addressing Legal Issues and Managing Risk 366 Business Legal Structures 367

Sole Proprietorship 367

Partnership 368

Corporation 369

Tips for Entrepreneurs Who Want to Start a Nonprofit Organization 372

Contracts: The Building Blocks of Business 374

Working with an Attorney 374

Drafting a Contract 375

Letter of Agreement 376

Breach of Contract 376

Small Claims Court 376

Arbitration 376

A Contract Is No Substitute for Trust 376

Commercial Law and the Entrepreneur 377 The Uniform Commercial Code (UCC) 377

The Law of Agency 378

Bankruptcy 378

Protecting Intangible Assets: Intellectual Property 380

Trademarks and Service Marks 380

Copyright 381

Electronic Rights 382

Patents 384

Protecting Tangible Assets: Risk Management 384

Insurance Protects Your Business from Disaster 384

Basic Coverage for Small Business 385

How Insurance Companies Make Money 386

Protect Your Computer and Data 387

Disaster Recovery Plans 387

Licenses, Permits, and Certificates 388

Chapter 12 Operating for Success 398 Operations Permit Businesses to Deliver on Their Promises 400 The Production-Distribution Chain 400 Supply Chain Management 401

Finding Suppliers 402

Managing Inventory 402

Enterprise Resource Planning 404

Facilities, Location, and Design 405 The Location Decision 406

Facilities Design and Layout 410

Special Considerations for Home-Based Businesses 413

Special Considerations for Web-Based Businesses 414

Defining Quality: It Is a Matter of Market Positioning 415

Profits Follow Quality 415

Organization-Wide Quality Initiatives 416

Chapter 13 Management, Leadership, and Ethical Practices 430 The Entrepreneur as Leader 431

Leadership Styles That Work 431

How Entrepreneurs Compensate Themselves 432

Manage Your Time Wisely 433

Business Management: Building a Team 435

What Do Managers Do? 435

Adding Employees to Your Business 436

Growing Your Team 441

Creating and Managing Organizational Culture and Structure 442

Determining Organizational Structure 443

Getting the Best Out of Your Employees 443

xiv CONTENTS

Human Resources Fundamentals 445 Performance Management 447

Firing and Laying Off Employees 447

Ethical Leadership and Ethical Organizations 449

An Ethical Perspective 449

Establishing Ethical Standards 450

Corporate Ethical Scandals 451

Doing the Right Thing in Addition to Doing Things Right 452

Balancing the Needs of Owners, Customers, and Employees 452

Social Responsibility and Ethics 453 Leading with Integrity and by Example 453

Encourage Your Employees to Be Socially Responsible 454

Unit 4 Operating a Small Business Effectively: ONLC Training Centers—Virtual IT Training in a Classroom 467

UNIT 5 Cashing in the Brand 471

Chapter 14 Franchising, Licensing, and Harvesting: Cashing in Your Brand 472 What Do You Want from Your Business? 473

Continuing the Business for the Family 474

Growth Through Diversification 474

Growth Through Licensing and Franchising 475

Focus Your Brand 475

When Licensing Can Be Effective 475

Franchising Revisited from the Franchisor Perspective 476

How a McDonald’s Franchise Works 476

Do Your Research Before You Franchise 477

Harvesting and Exiting Options 477 When to Harvest Your Business 477

How to Value a Business 478

The Science of Valuation 479

Creating Wealth by Selling a Profitable Business 480

Harvesting Options 480

Which Exit Strategy Is Best for You? 482

Investors Will Care About Your Exit Strategy 483

Unit 5 Cashing in the Brand: Honest Tea— From Start-Up to Harvest 491

Appendix 1 BizBuilder Business Plan 497 Appendix 2 Resources for Entrepreneurs 505 Appendix 3 Useful Formulas and Equations 511 Glossary 513 Index 519

Preface

New To This Edition Entrepreneurship: Starting and Operating a Small Business, Fifth Edition, contains substantial new content and changes, including the following:

■■ Chapter Learning Objectives. The objectives have been revised to conform more fully to the categories of knowledge acquisition, comprehension, application, analysis, synthesis, and evaluation commonly assessed in higher education. Each learning objective is associated with a primary chapter topic.

■■ Three new short End-of-Chapter Case Studies: Frankie Patterson, MekaMon Robots, eSight Eyewear. Numerous updated cases with the Bakery Companies most revised.

■■ Four new longer End-of-Chapter Case Studies: Traci Lynn Jewelry, Hammer & Nails, Green and Clean, and Scentsy. Numerous updated cases with Foursquare Swarm the most revised

■■ Step into the Shoes, Entrepreneurial Wisdom, BizFacts, and Global Impact Features have been updated and expanded with 10 new fea- tured items, including eight Step into the Shoes, one Global Impact, and one BizFacts.

■■ Global Impact Features. Among the featured people and organiza- tions are: Pixlee, Lit Motors, Pan Zhang Xin Marita, Gary Vayner- chuk, Burrow, Outcome Health, Chrysler Motors, SafeWander, Tom’s, IQVIA, and Doublemint. These features connect chapter content to business facts and examples to reinforce learning.

■■ Business Model Canvas. The Osterwalder and Pigneur Business Model Canvas is introduced in Chapter 2. Students are encouraged to develop Business Model Canvases and to explore the Lean Start- up process.

■■ Canvas Connections. This feature has been added to facilitate the use of the customer discovery process and for students to create and evolve their Business Model Canvases as their knowledge and under- standing increases.

■■ BizBuilder Business Plan Questions. These have been modified to clarify the work and connect the content to student work using the business plan templates.

New sections/topics Each chapter has been substantially revised to include current content and address emerging topics in entrepreneurship and small business manage- ment. Some specific changes include:

•■ Discussion of necessity-based versus opportunity-based entrepreneurship

•■ Inclusion of an updated Readiness Assessment •■ Addition of unicorns and an improved explanation of corporate

entrepreneurship

xv

xvi PREFACE

•■ New section on skills and careers •■ New section and illustration for the lean start-up methodology •■ Revision of the business plan overview •■ Update of the list of business plan competitions with the addition of

pitch and business model competitions •■ New section on effectual reasoning •■ Addition of materials regarding the extended marketing mix and

social media marketing with illustrations •■ New section on creating a sales force •■ Substantial revisions to the accounting and financial chapters for

increased clarity and simplicity •■ Address Enterprise Resource Planning (ERP) •■ Inclusion of direct selling as a go-to-market strategy

Solving Teaching and Learning Challenges Entrepreneurship: Starting and Operating a Small Business (ESOSB), Fifth Edition is the newest edition in a line of entrepreneurship textbooks writ- ten by Steve Mariotti, founder of the Network for Teaching Entrepreneur- ship (NFTE). Once again, it is written with professor and entrepreneur Caroline Glackin, and it promotes entrepreneurship as a career option for college students.

This textbook is organized to follow the life cycle of an entrepreneurial venture from concept through implementation into harvesting or replica- tion. It is a comprehensive text written in light of the reality that college students often take only one course in entrepreneurship, and the topic is covered in a multitude of ways. For instructors who will teach the course as a “business plan,” ESOSB 5e offers step-by-step content to build a plan over a semester or a quarter, as well as cueing questions for students work- ing through the Lean Start-up process.

Business students, as well as those from other disciplines, can benefit from ESOSB. For business students, it recasts their prior learning from a typi- cal corporate context and focuses it on small and entrepreneurial enterprises. For students in such fields as hospitality, the arts, engineering, and fashion merchandising, the text introduces key business concepts and provides exam- ples from a broad range of careers. Most importantly, ESOSB 5e is a balanced mix of the academic and applied components of entrepreneurship education. Students are introduced to the theories, methods, and knowledge and skills required of entrepreneurs and are immediately given practical examples and discussion opportunities. For those who focus on the management of small and entrepreneurial ventures, there is an abundance of high-quality material on the critical topics of management, human resources, marketing, and op- erations for such ventures. For those charged with teaching a comprehensive introductory course, all of the components are provided.

To improve student results, we recommend pairing the text content with MyLab Entrepreneurship, which is the teaching and learning plat- form that empowers you to reach every student. By combining trusted au- thor content with digital tools and a flexible platform, MyLab personalizes the learning experience and will help your students learn and retain key course concepts while developing skills that future employers are seeking in their candidates. From Mini Sims to Dynamic Study Modules, MyLab Entrepreneurship helps you teach your course, your way. Learn more at http://www.pearson.com/mylab/entrepreneurship.

xvii PREFACE

The Study Plan gives students personalized recommenda- tions, practice opportunities, and learning aids to help them stay on track.

This allows students to focus their study time by pinpointing the precise areas they need to review, and allowing them to use customized practice and learning aids—such as videos, eTexts, tutorials, and more—to help students stay on track.

Mini Sims put students in professional roles and give them the opportu- nity to apply course concepts and develop decision-making skills through real-world business challenges.

The simulations use each student’s decisions to create various sce- nario paths that help them understand the impact their decisions can have on an organization.

xviii PREFACE

Dynamic Study Modules use the latest developments in cognitive science and help students study chapter topics by adapting to their performance in real time.

Video Exercises are available for select chapter topics to help engage stu- dents and hold them accountable for their learning.

Chapter Learning System One of the challenges faced by the instructors is to create an authentic experience for the students. This text provides the below tools that help students to learn to think as an entrepreneur.

Honest Tea Business Plan This is the plan developed by founders Seth Goldman and Barry Nalebuff during Honest Tea’s first year of operations. It appears following Chapter 2 and includes a comprehensive market analysis and detailed historical financials. The business raised over $1 million at a time when sales were less than $250,000 and the company had operating losses. The Honest Tea plan is an excellent example for students and one that many of them will understand, to some extent, as customers of bottled tea.

xix PREFACE

Chapter Openers Set the Stage Each chapter starts with an inspirational quote, an introduction, and learning objectives that provide a “road map” so readers know where they are headed. Readers connect with a story of a real business in the opening vignette that sets the stage for upcoming material.

“Step into the Shoes” of the Experts Step into the Shoes features appear in each chapter and offer insight into the business practices of entrepreneurs and an opportunity to discuss the brief example. This feature brings the content to life with real-world application.

S t e p i n t o t h e S h o e s . . .

Matching Employers and Employees—Indeed With over 200 million unique visitors per month, In- deed, a subsidiary of Recruit Holdings Co., Ltd., claims the top spot among job sites on the Internet.3 Founded in 2004 by Rony Kahan and Paul Forster, Indeed has o�ces in six U.S. cities and nine global cities. The ser- vice covers some 60 nations and 28 languages.

Indeed is a pay-for-performance recruitment advertising network that provides free access to jobs from company websites and job boards. It consolidates available openings into a single meta-search for job

seekers. Employers pay for the service when job seekers click on job openings.

Prior to founding Indeed, Kahan and Forster were successful cofound- ers of jobsinthemoney.com, a site for financial professionals. They sold it to Financial News in 2003 and founded Indeed a year later.

Creatas/Thinkstock/

3Indeed.com, accessed March 30, 2018, http:// www.indeed.com/intl/en/ourcompany.html.

B U

S I

N E

S S

P L

A N

1. Explosive growth in Ready-to-Drink (RTD) tea and bottled water markets market, in the

past ten years Ready-To-Drink teas and bottled water have emerged as alterna-

The tea is brewed at a brewing and bottling facility located within driving range of the target market. The site was selected based on numerous criteria includ- ing capacity, reputation, quality control, production efficiency and willingness to invest in a long-term partnership with Honest Tea. All partners involved in the production process meet United States Department of Agriculture Hazard Analysis Critical Control Plant (HACCP) standards. We are in the process of obtaining Kosher certification from the Orthodox Union (“Circle U”).

In early 1999 we will be making a change in our manufacturing process that will not affect the quality of the product but will have important ramifica – tions for our profitability. Instead of a two-step packaging process, we will consolidate the brewing and labeling under one roof. This consolidation will save Honest Tea more than two dollars a case.

Our tea leaves are provided by internationally known companies that specialize in tea buying, blending and importation. Our primary source is Hälssen & Lyon of Germany, the largest specialty tea company in the world. Another, Assam Tea Traders, has direct ties to tea estates in the Assam District of Northern India. The other ingredients are commodities which are in plentiful supply.

As the Company grows in size, we anticipate dealing more directly with the tea growers. We intend to visit the tea estates so that we can verify that the labor condi- tions of the tea workers meet international standards and International Labor Or- ganization conventions. We also aspire to ensure that the tea is grown organically.

Market Opportunity

Beyond Snapple–The Emerging Market for Quality Bottled Tea We have identified four market trends that are fueling demand for Honest Tea within the $72 billion non-alcoholic liquid refreshment beverage market.

Demand for a healthier, genuine bottled tea

Rise of Cultural Creatives

Emergence of tea cultureExplosive growth in RTD tea & water markets

Boom in Natural Foods

Honest Tea, Inc.

xx PREFACE

BizFacts Many salespeople work on commission, a percentage earned from each sale they make. A salesperson making a 10 percent commission selling cars, for example, would earn $1,000 after selling a $10,000 car.

0.10 * $10,000 = $1,000

Entrepreneurs can use commissions to motivate sales sta�. When you are starting out and cannot a�ord to pay sales representatives full-time salaries, you can o�er commissions instead, because they get paid as you get paid and earn more as they sell more.

Entrepreneurial Wisdom Entrepreneurial Wisdom contains insights or advice that will help students in the preparation of a business plan or management of an enterprise.

10 percent of the work, you can show 10 percent of the income on your statement. In Germany, by contrast, you cannot include any of the in- come on your statement until the contract has been 100 per- cent completed.

Businesses in di�erent countries prepare and present the in- come statement di�erently and even have di�erent names for it. In the United Kingdom, for example, the income statement is called a “group profit and loss account.” Topics where global practices can di�er widely include inventory measure- ment methods and ways in which property and equipment are valued. Countries also have varying laws regarding when a sale can be recognized as income and included on an income statement. The predominant standards are the International Financial Reporting Standards.

In the United States, United Kingdom, Denmark, Norway, Belgium, Brazil, and Japan, for instance, income from a long- term contract can only be included on the income statement as each percentage of the contract is completed. If you have done

E n t r e p r e n e u r ia l W i s d o m . . .

Accounting rules di�er among countries. (Michaela Dusíková/Alamy)

Accounting Di�erences between Countries

Global Impact Global Impact, featured in each chapter, provides examples of entrepre- neurial ventures around the world or information that can be applied in global trade.

G lo b a l I m p a c t . . .

College Degrees for the Military Active-duty members of the U.S. military and their families tend to relocate frequently, often internationally. This job-related relocation makes completing a college degree at a single tradi- tional brick-and-mortar, four-year college di�cult at best.

American Military University is a wholly online, private, for- profit, degree-granting program with students across the United States and in more than 100 other countries. Established by a retired Marine Corps o�cer, James P. Etter, the university has a well-defined target market: military members and their families.

Course delivery, subjects, and content are designed with the military in mind. If they have Internet access, military stu- dents can enroll and take courses. Also, military personnel earn education benefits from the government and can use them at American Military University.

American Military University has served its global target market profitably for over 20 years.

Source: American Military University website, accessed February 24, 2018, http:// www.apus.edu.

End-of-Chapter Learning Portfolio End-of-chapter materials help students demonstrate a working under- standing of key concepts and develop critical-thinking skills.

All chapters include the following:

■■ Key Terms list. ■■ Critical Thinking Exercises that require students to consider

important issues and support thoughtful responses.

BizFacts BizFacts impart useful information regarding entrepreneurship statistics, company practices, or business applications.

xxi PREFACE

■■ Key Concept Questions that review core topics. ■■ Application Exercises that give students a structured opportunity

to reinforce chapter topics through experience. ■■ Exploring Your Community and Exploring Online assignments

that invite students to go into their business communities or search online for information.

■■ Canvas Connections, which provide guidance for students as they evolve their Business Model Canvases during the course of the text.

■■ BizBuilder Business Plan Questions, which guide students through the development of business plan components as they learn new information throughout the book.

■■ Cases for Analysis, including one short case and one longer case with analytical questions. Cases cover a variety of issues and draw on real business scenarios. Examples of businesses that may be familiar to students include Foursquare Swarm, Urban Decay, and Amazon.com. Other organizations that may be less familiar include Happy Belly Curbside Kitchen, Gelato Fiasco, Anago Cleaning Sys- tems, and AYZH. These cases reflect a diverse set of entrepreneurs, industries, and geographic locations.

BizBuilder Business Plan Worksheets and Templates Students can build their business plans using the BizBuilder worksheets available at www.pearsonhighered.com under Instructor resources.

■■ BizBuilder Business Plan Worksheets provide step-by-step instructions on building a business plan.

■■ BizBuilder Business Plan Template provides a professional- looking format for a business plan that ties in with assignments in the text.

■■ BizBuilder Business Plan Presentation Template guides the student through the process of creating a PowerPoint presentation for a business plan.

The BizBuilder business plan worksheets and templates are accompanied by a financial worksheet template to enable students to calculate respec- tive results by plotting relevant data in different worksheets like startup, sales income statement, cash flow, balance sheet, alt. cashflow, and key ratios.

Appendix 2 provides students with instructions on how to use the worksheets that mirror the planning process in the book and contains more questions in some areas than are found in commercially available planning software.

xxii PREFACE

Employability Skills Table

Skills Sections in the text covering these skills

Written and oral communication

End-of-chapter questions— critical thinking exercises

Creating and Presenting a business plan—Chapter 2

EOC Writing Assignment— MyLab Entrepreneurship

Writing Assignment —MyLab Entrepreneurship

Critical thinking and problem solving

Critical thinking exercises Process of developing a business plan— Chapter 2

Video Exercises—MyLab Entrepreneurship

New! Mini Sims—MyLab Entrepreneurship

Teamwork and collaboration

Process of developing a business plan—Chapter 2

Lean start-up process—Chapter 4 and Chapter 7

Chapter 13, “Management, Leadership, and Ethical Practices,” addresses this topic in greater depth.

Leadership Chapter 13, “Management, Leadership, and Ethical Practices”

Creativity Chapter 1, “Entrepreneurs and Entrepreneurship”

Chapter 2, “Pathways to Success: Processes and Instruments”

Chapter 3, “Creating Business from Opportunity,” introduces creativity and the entrepreneurial mindset.

EOC Writing Assignment— MyLab Entrepreneurship

Ethics Chapter 13, “Management, Leader-ship, and Ethical Practices”

End of Chapter—Case Studies

Information technology skills

End-of-chapter assignments—exploring online

Instructor Teaching Resources This program comes with the following teaching resources.

Supplements available to instructors at www.pearsonhighered.com

Features of the Supplement

Instructor’s Manual authored by Caroline Glackin

• Chapter-by-chapter overview, objectives, and outline • New to the fifth edition • Teaching notes • Lecture enhancers • Key terms • Examples and activities not in the main book • Solutions to all questions and problems in the book

Developing Employability Skills The purpose behind writing this text was to enable students to take an idea and turn it into an entrepreneurial venture. While working on this their em- phasis should be on imagination, design, creation and execution. Creating a business plan requires the student to develop competencies, knowledge, abilities, attitudes, and important skills. The text along with the MyLab helps in developing important skills. In this course, and specifically in this text, students will have the opportunity to develop and practice seven im- portant skills based on various learning features that are summarized in the following table.

Acknowledgments

The guidance and recommendations of the following instructors and consul- tants helped us revise the content and features of this text. We are grateful for their reviews and truly believe that their feedback was indispensable.

H. Lon Addams, Weber State University Elaine Allen, CPA, Mitchell & Titus, LLP (EY Global Limited) Lynn Bible, Fayetteville State University

Stanlee Brimberg, Bank Street School for Children Howard W. Buffett, Jr. John R. Callister, Cornell University Carolyn J. Christensen, CPA, Westchester Community College John D. Christesen, Westchester Community College Stephen Colyer, Miami Dade College Alan J. Dlugash, CPA, Alan J. Dlugash LLC Alex Dontoh, New York University Thomas Emrick, Smithsonian Science Education Center Joyce Ezrow, Anne Arundel Community College Rita Friberg, Friberg, Hogsett & Associates George Gannage, Jr., Ball State University Janet P. Graham, Coastal Carolina University Vada Grantham, Des Moines Area Community College John Harris, Bristol Eastern High School Deborah Hoffman, CPA, Math for America Donald Hoy, Benedictine College

xxiii ACKNOWLEDGMENTS

Supplements available to instructors at www.pearsonhighered.com

Features of the Supplement

Test Bank authored by Ramachandran Subramanian

Over 500 multiple-choice, true/false, and short-answer questions with these annotations: • Difficulty level (1 for straight recall, 2 for some analysis, 3 for complex

analysis) • Type (Multiple-choice, true/false, short-answer, essay) • Learning objective • AACSB learning standard (Written and Oral Communication; Ethical

Understanding and Reasoning; Analytical Thinking; Information Technology; Interpersonal Relations and Teamwork; Diverse and Multicultural Work; Reflective Thinking; Application of Knowledge)

Computerized TestGen TestGen allows instructors to: • Customize, save, and generate classroom tests • Edit, add, or delete questions from the test item files • Analyze test results • Organize a database of tests and student results.

PowerPoints authored by Veronica Horton

Slides include all the graphs, tables, and equations in the textbook.

PowerPoints meet accessibility standards for students with disabilities. Features include, but not limited to: • Keyboard and screen reader access • Alternative text for images • High color contrast between background and foreground colors

Samira Hussein, Johnson County Community College Eileen M. Kearney, Montgomery County Community College Sanford Krieger, Esq., Cranemere.com Jawanza Kunjufu, African-American Images, Inc. Corey Kupfer, Esq., Kupfer & Associates PLLC Walter E. Lara, St. John’s River State College Timothy R. Mittan, Southeast Community College Eric Mulkowsky, Robin Hood Foundation Raffiq Nathoo, New Mountain Capital Ray E. Newton III, Evercore Capital Partners Arnold Ng, Apex Commercial Real Estate Inc. William H. Painter, Emeritus, The George Washington University Peter Patch, President, Patch and Associates Alan Patricof, Apax Partners and Greycroft Partners Laura Portolese, Central Washington University

Richard Relyea, 3i Group PLC Ira Sacks, Esq., Ackerman LLP William A. Sahlman, Emeritus, Harvard University William Searle, Emeritus, Asnuntuck Community College

Marsha Timmerman, LaSalle University Liza Vertinsky, Emory University Peter B. Walker, McKinsey and Company, Inc. Donald A. Wells, University of Arizona Dennis R. Williams, Pennsylvania College of Technology

I would like to thank my coauthor, Caroline Glackin, without whose talent and expertise this text would not have been possible, and Tony Towle, who from NFTE’s inception has helped me organize my thoughts and experiences. I must also single out the help of two outstanding educators: John Harris and Peter Patch. Special thanks as well to Stephanie Wall, Neeraj Bhalla, Yasmita Hota, and the rest of the team at Pearson for their professionalism and editorial assistance.

Thanks also to Heather Van Sickle, President and CEO of the National Association of Community College Entrepreneurship (NACCE), and to Tony Mendes, President of the United States Association for Small Busi- ness and Entrepreneurship (USASBE), as well as the hundreds of members of these associations that have adopted Mariotti and Glackin texts to teach entrepreneurship to college students.

Additionally, I am grateful to Howard Stevenson, William Bygrave, Bob Pritz- ker, Stephen Spinelli, and the late Jeffry Timmons for imparting their wisdom; and to Richard Fink of Koch Industries; Carl Schramm, formerly of the Ewing Marion Kauffman Foundation; and Mike Hennessy and John Hughes of the Coleman Foundation. Special thanks to Eddy Bayardelle and Melanie Mor- timer of Merrill Lynch Global Philanthropy, and Kim Davis of Teneo Holdings.

Further, I would like to acknowledge Steve Alcock, Harsh and Aruna Bhargava, Lena Bondue, Dawn Bowlus, Shelly Chenoweth, Janet McKinstry Cort, Erik Dauwen, Clara Del Villar, Christine Chambers Gilfillan, Andrew Hahn, Kathleen Kirkwood, Michael Simmons, Sheena Lindahl, Cynthia Miree, Henry To, Carol Tully, Dilia Wood, and Elizabeth Wright, as well as Peter Cowie, Joseph Dominic, Paul DeF Hicks, Jr., Ann Mahoney, David Roodberg, Phyllis Ross Schless, and Remi Vermeir, who have all provided countless insights into providing entrepreneurial opportunities to young people.

In addition, I would like to thank my brother, Jack, the best CPA I know, and my father, John, for financing much of NFTE’s early work, and for their continuing

xxiv ACKNOWLEDGMENTS

xxv ACKNOWLEDGMENTS

love and guidance. Thanks are due to all the other teachers, students, experts, and friends who were kind enough to look over my work and help me improve it. Finally, I want to thank my mother, Nancy, a wonderful special education instruc- tor who showed me that one great teacher can affect eternity.

Steve Mariotti

To my coauthor Steve Mariotti, who brought hope, opportunity, and change out of adversity to create the Network for Teaching Entrepreneurship and start- ed this journey—many thanks. As Steve noted, the team at Pearson has been wonderful to work with again. Faculty reviewers and faculty members who have contacted me directly regarding earlier materials are always a valued source of insights.

Most importantly, I appreciate the terrific entrepreneurs who shared their stories with me, including the good, the bad, and the downright ugly! Their interest in sharing their experiences with students and willingness to carve out time to tell their tales demonstrates the kind of energy and enthusiasm we as- sociate with successful entrepreneurs. They have made this endeavor interesting and engaging.

On a more personal note, I would like to thank my “family” at the University of North Carolina System’s Fayetteville State University for their support and encouragement as I worked on Entrepreneurship: Starting and Managing a Small Business, 5e. Special thanks to Jay Azriel, Lynn Bible, Terri Hasson, Burcu Adi- var, Connie Lightner, and Pam Jackson. Finally, to Elise and Spencer Glackin for being the best cheering section a mother could ever have—thanks and love to you both.

Caroline Glackin

About the Authors

xxvi

STEVE MARIOTTI, founder of the Network for Teaching Entrepreneurship (NFTE), is considered one of today’s leading experts in education for at-risk youth. In 1982, he changed career paths when he decided to leave the corpo- rate sector and become a special education teacher in the New York City public school system.

Mariotti’s first assignment was in the East New York section of Brooklyn, and his last was in the Fort Apache section of the South Bronx. During his six and a half years

of teaching, Mariotti discovered he could successfully motivate even his most challenging students by teaching them how to run a business. This experience inspired him to create a new kind of program—the first to bring entrepreneur- ial education to low-income youth.

In 1987, Mariotti founded the NFTE. Today, NFTE’s mission is to provide entrepreneurship education programs to young people from low-income com- munities around the world. NFTE’s programs have a proven track record of success, and the network is widely viewed as the thought leader in the field. NFTE is an active member of the Council on Foreign Relations. In 2013, Mari- otti traveled to Southeast Asia as a guest of the U.S. State Department on a mission to spread entrepreneurial education to youth from emerging econo- mies in the region.

Mariotti was recently nominated for a Pulitzer Prize for his work chroni- cling the lives of entrepreneurs worldwide for The Huffington Post and for a Nobel Peace Prize for his pioneering work in entrepreneurial education. A life- long advocate for low-income students, Mariotti is the recipient of numerous awards, including:

■■ Ernst & Young Entrepreneur of the Year Award

■■ Bernard A. Goldhirsh Social Entrepreneur of the Year Award

■■ National Director’s Entrepreneurship Award from the Minority Business Development Agency of the U.S. Department of Commerce

■■ Association of Education Publishers’ Golden Lamp Award

■■ ACE/Currie Foundation Humanitarian—Venture Award

■■ America’s Top High School Business Teacher

In addition, Mariotti has been the subject of many national media profiles on such programs as ABC Evening News and 20/20.

He has authored and coauthored 34 books and workbooks on entrepreneurship, selling over 10 million copies worldwide and distributing many more for free to at-risk communities, including prisons. His popular book The Young Entrepreneur’s Guide to Starting and Running a Small Business has recently been published in a new edition by Random House and is used to teach entrepreneurship from the United States to China, India, and the Middle East. Mariotti is a regular attendee and speaker at the World Economic Forum.

Raised in Flint, Michigan, Mariotti received his B.B.A. in business economics and his M.B.A. from the University of Michigan, Ann Arbor. He has also studied at Harvard University, Stanford University, Brooklyn College, and Princeton University. He started his professional career as a treasury analyst for Ford Motor Company before founding his own company, Mason Import/ Export Services.

xxvii ABOUT THE AUTHORS

CAROLINE GLACKIN, PH.D., is a “pracademic” who has successfully worked as a microenterprise and small business owner and manager, as an executive director of a community development financial institution, and as an academic in areas of community development fi- nance, entrepreneurship, and management. She is entrepreneurship faculty at Fayetteville State University (University of North Carolina constituent institution). She has been assisting entrepreneurs in achieving their dreams for over 30 years.

Dr. Glackin earned a doctorate from the University of Delaware, where her research emphasis was on access to capital and microfinance. She received an M.B.A. from the Wharton School at the University of Pennsylvania and an A.B.. from Bryn Mawr College. Her professional career began with the DuPont Company, American Bell, Bell Atlantic, and American Management Systems. She has consulted for businesses and not-for-profit agencies in turnaround and high-growth situations. After exiting a family business, she became the executive director of a community development financial institution serving businesses and not-for-profits.

Dr. Glackin has succeeded in leading change in the practical fields of her research and has received numerous honors and awards. These include the first Gloeckner Business Plan Award at the Wharton School, the Minor- ity Business Advocate of the Year for Delaware from the U.S. Small Business Administration, and the She Knows Where She’s Going Award from Girls Inc. Dr. Glackin cochaired the Delaware Governor’s Task Force for Financial Inde- pendence. She has participated in the Cornell University Emerging Markets Think Tank Series and has presented her research and pedagogy at numerous professional conferences.

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U N I T

ENTREPRENEURIAL PATHWAYS

Chapter 1 ENTREPRENEURS AND ENTREPRENEURSHIP

Chapter 2 PATHWAYS TO SUCCESS: PROCESSES AND INSTRUMENTS

Chapter 3 CREATING BUSINESS FROM OPPORTUNITY

1

Kurhan/Fotolia

Tom Szaky, TerraCycle. (Paul Zimmerman/ WireImage/Getty Images)

MyLab Entrepreneurship Improve Your Grade!

If your instructor is using MyLab Entrepreneurship, visit www.pearson.com/ mylab/Entrepreneurship for videos, simulations and writing exercises.

CH A

PT ER

1 Entrepreneurs and Entrepreneurship 1.6 Identify and evaluate

opportunities to start your own business.

1.7 Distinguish between ideas and opportunities.

1.8 Explore the multiple paths to entrepreneurship.

1.9 Explain success signals for entrepreneurs.

1.10 Develop skills for a future career—employment or entrepreneurship.

Learning Objectives 1.1 Summarize what entrepre-

neurship is and what entre- preneurs do.

1.2 Examine how free-enterprise economies work and how entrepreneurs fit into them.

1.3 Describe small business. 1.4 Understand the costs and

benefits of entrepreneurship.

1.5 Recognize the various entre- preneurial options.

3

Tom Szaky was a 20-year-old college student in need of inspiration for a business plan competition when he happened to visit friends who were using red worms to compost waste that they then used as plant fertilizer. The idea captured his imagi- nation, and he created a business plan for an environmentally friendly company that would convert trash into fertilizer. Although he finished in fifth place in the competi- tion, Szaky moved ahead to make the company a viable venture.1

TerraCycle Inc. expanded its product lines to encompass a wide range of re- cycling and upcycling products, including branded products for Target and Kraft Foods. The company was the producer of the world’s first product made from and packed in recycled waste: fertilizer generated from waste. Szaky sold to some of the world’s largest retailers, including Walmart, Target, and Home Depot. From there he led the evolution of the company to involving entire communities in recycling proj- ects, and the company has collected literally billions of discarded items. Its Drink Pouch Brigade (which started with Honest Tea), Bottle Brigade, Yogurt Cup Brigade (Stonyfield Farms), and Energy Bar Brigade (CLIF Bar) collected and repurposed prod- ucts. TerraCycle plant food was twice named the eco-friendliest product in Home Depot. The company now has international offices, Szaky has authored three books, and more major corporations are partners. Tom Szaky and TerraCycle have turned waste into treasure.

Understanding Entrepreneurs and Entrepreneurship Have you ever eaten a Subway sandwich? Used an Apple device? Listened to music with Skullcandy headphones? The entrepreneurs who founded these companies brought these products into your world. Entrepreneurship is all around us.

What Is an Entrepreneur? Most Americans earn money by working in business. They are somehow engaged in the buying and selling of products or services to earn money.

• A product is something that exists in nature or is made by human beings. It is tangible, meaning that it can be physically touched.

• A service is labor or expertise exchanged for money. It is intangible. It cannot be physically touched.

Someone who earns a living by working directly for someone else’s business is an employee of that business. There are many roles for employees. At Ford Motor Company, for instance, some employees build the cars, some sell the cars, and some manage the company. But most employees have one thing in common—they do not own the business; they work for others who do. They know how much money they can earn, and that amount is limited to salary or wages, plus any bonuses and stock options they may receive.

Learning Objective 1.1 Summarize what entrepreneurship is and what entrepreneurs do.

product something tangible that exists in nature or is made by people.

service intangible work that provides time, skills, or expertise in exchange for money.

“Everyone lives by selling something.” —Robert Louis Stevenson, Scottish author

1 TerraCycle Inc., accessed February 4, 2018, http://www.terracycle.com.

4 UNIT 1: Entrepreneurial Pathways

People who have their own businesses work for themselves and are called business owners or entrepreneurs. Entrepreneurs are often both owners and employees. For an entrepreneur who is driven and has the right product-market fit, the sky is the limit as far as earnings are con- cerned. Unlike an employee, an entrepreneur owns profits that his or her business earns and may choose to reinvest profit in the business or take it as payment.

An entrepreneur is someone who recognizes an opportunity to start a business that other people may not have noticed and acts on it. As econ- omist Jeffry A. Timmons wrote in the preface of New Venture Creation: Entrepreneurship for the 21st Century, “A skillful entrepreneur can shape and create an opportunity where others see little or nothing—or see it too early or too late.”2

The French word entrepreneur began to take on its present-day mean- ing in the seventeenth century. It was used to describe someone who undertook any project that entailed risk—military, legal, or political, as well as economic. Eventually, it came to mean someone who started a new business venture—often of a new kind or a new (or improved) way of doing business. French economist Jean-Baptiste Say wrote at the turn of the nineteenth century:

An entrepreneur is an economic agent who unites all means of production— the land of one, the labor of another and the capital of yet another, and thus produces a product. By selling the product in the market he pays rent on land, wages to labor, interest on capital and what remains is his profit. He shifts economic resources out of an area of lower and into an area of higher productivity and greater yield.3

Say argued that entrepreneurs “added value to scarce resources.” Coal is a resource because it is used as fuel. Wood is a resource because it can be used to build a house or a table, to make paper, or to burn as fuel. Economists consider scarce all resources that are worth money, regardless of their relative availability.

Debbi Fields, founder of Mrs. Fields Cookies, took resources—eggs, butter, flour, sugar, chocolate chips—and turned them into cookies. People liked what she did with those resources so much that they were willing to pay her more for the cookies than it cost her to buy the resources to make them. She added value to the resources she purchased by what she did with them and created a multimillion-dollar business in the process.

Entrepreneurs have differing motivations for starting ventures. There are two main categories to differentiate between them according to mo- tivation. Necessity-based entrepreneurs enter entrepreneurship because circumstances make self-employment their best available option for in- come replacement. For example, they may become unemployed and be unable to find suitable work or their family may have health issues which preclude regular employment. Opportunity-based entrepreneurs start businesses to exploit a perceived opportunity or to pursue one that they created. Their motivation is not income replacement, but rather one of an envisioned future.

Regardless of the reasons to start and continue their businesses, entrepreneurs share the common focus of creating and capturing sus- tained value for their customers and themselves. Entrepreneurs seek

entrepreneur a person who recognizes an opportunity and organizes and manages a business, assuming the risk for the sake of potential return.

necessity-based entrepre- neurs enter entrepreneurship because circumstances make self-employment their best available option for income replacement.

opportunity-based entre- preneurs start businesses to exploit a perceived opportunity or to pursue one that they created.

3 Jean-Baptiste Say, A Treatise on Political Economy; Or the Production Distribution and Consumption of Wealth (Traité D’économie Politique ou Simple Exposition de la Manière Dont se Forment, se Distribuent et se Composent les Richesse), ed. Clement C. Biddle, trans. C. R. [slightly modified] (Philadelphia: Lippincott, Grambo & Co., 1855). Library of Economics and Liberty, accessed June 26, 2013, http://www.econlib.org/library/Say/sayT.html.

2 Jeffry A. Timmons & Stephen Spinelli, New Venture Creation: Entrepreneurship for the 21st Century, 8th ed. (New York: Irwin/ McGraw-Hill, 2008).

5 CHAPTER 1: Entrepreneurs and Entrepreneurship

opportunities that they envision as generators of incremental income, or wealth. Whether the business is intended to meet short-term household cash needs, to be passed down through multiple generations, or to grow into a publicly traded company, viability is critical. Each activity of the firm should be driven by this need.

The Free-Enterprise System An economy is the wealth and resources of a country or region, including its financial structure. The economy of the United States is a free-enterprise system because it is characterized by private (rather than governmental) ownership of capital assets and goods, and prices are determined by markets; anyone is free to start a business. Americans do not have to get permission from the government to go into business, although they are expected to obey laws and regulations and report their earnings.

The free-market system, which is also called capitalism, typifies the following attributes:

• Individuals and companies may compete for their own economic gains.

• Private wealth and property ownership are permissible. • Free-market forces primarily determine prices.

Cash or goods invested to generate income and wealth is called capital; in a free-enterprise system, anyone who possesses or can raise the necessary capital may start a business.

Voluntary Exchange The free-enterprise system is also sometimes referred to as a private en- terprise free-trade system because it is based on voluntary exchange. Voluntary exchange occurs when buyers and sellers willingly engage in a market transaction that benefits each party. Each wishes to take advantage of what the trade offers. The parties agree to the exchange because each will benefit.

For example, José has a construction business, and his neighbors hire him to renovate their kitchen. He wants to earn money and is willing to use his skills and time to do so. The neighbors are willing to give him money to get the renovation done. They each have something the other wants, so they are willing to trade. A satisfactory exchange only takes place when both parties believe they will benefit.

Benefits and Challenges of Free Enterprise The public benefits from living in a free-enterprise system because it dis- courages entrepreneurs who waste resources by driving them out of busi- ness. It encourages entrepreneurs to use resources to satisfy consumer needs efficiently by rewarding them with profit and wealth.

Where entrepreneurs are free to trade voluntarily to as large a market as possible, their ability to find customers to buy their goods or services in- creases, as well as their overall ability to meet customer needs. Meanwhile, the Internet has made it much easier for businesses to sell to clients all over the world. Shipping, too, has become much faster and less expensive.

Society in general benefits because free enterprise encourages compe- tition between entrepreneurs. Someone who can make cookies that taste as good as Mrs. Fields Original Cookies and sell them at a lower price would eventually attract the company’s customers. This would force Mrs. Fields

Learning Objective 1.2 Examine how free-enterprise economies work and how en- trepreneurs fit into them.

free-enterprise system economic system in which the market determines the prod- ucts, services sold, and prices charged, and where busi- nesses operate relatively free of government interference.

capitalism the free-market system, characterized by indi- viduals and private companies, as opposed to governments, competing for economic gains, ownership of private property and wealth, and price deter- mination through free-market forces.

capital money or property owned or used in business.

voluntary exchange a market transaction between buyers and sellers who willingly agree to the trade.

6 UNIT 1: Entrepreneurial Pathways

G lo b a l I m p a c t . . .

Free Trade For much of recorded history, international trade was difficult and hazardous. To sell products in another country often re- quired long and dangerous journeys overland or by ship. Many countries were closed to outside trade. Governments also used their power to give their own businesspeople competitive ad- vantages over those from other countries by establishing trade barriers, such as imposing taxes (tariffs) on foreign goods that made them very expensive. Governments could also enforce restrictions on how many imports or exports could cross their borders.

Today, trade barriers have fallen in many parts of the world. The North American Free Trade Agreement (NAFTA)

of 1994 eliminated trade barriers between the United States, Mexico, and Canada. This turned the entire continent into a free-trade zone. The General Agreement on Tariffs and Trade (GATT) cut or eliminated tariffs between 117 countries. This evolved into the World Trade Organization, which has 164 members.

On the flip side, free enterprise has some disadvantages. If a company fails, its employees are out of work. Owners who have invested their financial resources in the business lose money. Other companies or individuals that depended on the products and services of the failed business themselves lose customers or suppliers.

to lower prices to stay competitive, or the company would go out of busi- ness. Consumers would benefit because they would get to buy the same- quality cookie at a lower price.

What Is a Small Business? Many people think of business only in terms of “big” businesses— companies such as Apple, Walmart, Microsoft, General Motors, and Berkshire Hathaway. However, the clear majority of businesses are small businesses. A small business is generally defined by the U.S. Small Business Administration’s Office of Advocacy as having fewer than 500 employees and selling less than $5 million worth of products or services annually. A neighborhood restaurant, a mattress manufacturer, a technol- ogy research company, and a clothing boutique can all be examples of a small business; even a leading local employer may be classified as “small” under this definition.

The core principles involved in running a large company—like Microsoft—and a corner deli are the same. However, the operations of a small business are not the same as those of a large one. Most multi- million-dollar businesses started out as small, entrepreneurial ventures. Therefore, entrepreneurship is often called the engine of an economy. It drives economic creativity, giving rise to wealth and jobs and improving the standard of living.

Definitions of Success—Monetary and Other The millennial generation (born between 1977 and 1995) and Generation Z (born after millennials through the mid-2000s) have redefined success. For them, success is more individualized than the traditional concept and is based on factors beyond those of income and wealth. Business owners may start an enterprise to create a more environmentally friendly approach to a product or process, to provide jobs for a disadvantaged population, or to improve the mental or physical health of themselves or others. For these entrepreneurs, success might be measured by the ability to have an impact on the population they serve. Or success may mean working to provide a lifestyle that permits a shortened work week

Learning Objective 1.3 Describe small business.

7 CHAPTER 1: Entrepreneurs and Entrepreneurship

or telecommuting. Recognition from peers and others could also be a goal. Financial success may be just one of many measures of achievement for an entrepreneur.

Starting a business is an opportunity, and like any opportunity, it should be evaluated by taking a careful look at all aspects of it. One thing is certain, though: The desire to make money, alone, is not a good enough reason to start one’s own business.

The financial rewards of owning your own business may not occur until you have put in years of hard work. The desire to make money may not be enough to keep you going through the difficult early period. Most successful companies have been founded by an entrepreneur with a pow- erful and motivating vision and passion, balanced by a strong work ethic and dedication.

Entrepreneurs have declared that they are “not in business for the money” so often that it has become a cliché, but like most clichés, it is based on a degree of truth.

Taking the Long View Successful entrepreneurs know it is important to begin with the end in mind, so that they can have an idea of where they want the organization to be at their personal exit point, even before they make the first sale. Because the daily tactical decisions they make will be affected by what they hope to create in the short and long term, a clear vision is vital. However, they also recognize the flexibility and resilience needed to succeed, because their assumptions about the business may not play out, and they must pivot to succeed. As you consider an entrepreneurial path, consider these questions:

• Are you planning to be active in the business until retirement? At what age will you retire? Who will take over then? A family member? A new owner?

• Do you plan to grow the business to a certain size or level of maturity and then sell it? If so, what is the target level? Are you looking at an initial public offering or a small private sale? Would you stay with the business after it was sold?

• Would you want to stay active for a given number of years? Then what would you do?

Taking the long view also means considering your personal satisfac- tion and priorities, including conformance with individual values and ethics. Entrepreneurs make hundreds of choices and decisions every day.

BizFacts • There are 29.6 million small businesses in the United States; this means that

99.9  percent of all companies have fewer than 500 employees. • Small businesses in America employed 48 percent of the country’s private (nongov-

ernment) workforce, hired 43 percent of high-tech workers, and created 67 percent of net new jobs annually from 2007 to 2016.

• Home-based businesses make up 52 percent and franchises 2 percent of all small firms.

• Small firms constituted 97.7 percent of all identified exporters and produced 33.6 percent of the country’s known export value in fiscal year 2013.

Source: U.S. Small Business Administration, accessed February 4, 2018, http://www.sba.gov.

8 UNIT 1: Entrepreneurial Pathways

These decisions may conform to their values and ethics or violate them to meet a customer need, provide an expedient or cost-effective solution to an immediate problem, or the like. If you find yourself facing such a decision, for your long-term wellness and the benefit of those around you, it will be critical to keep your core values in the forefront. Consider the legacy you want to leave behind.

Benefits and Costs of Becoming an Entrepreneur Entrepreneurs put a great deal of time and effort into launching their own businesses. While establishing a business, an entrepreneur may also pour all of his or her money into it, along with some from friends and family. An entrepreneur may not be able to buy new clothes or a fancy car, go on vacation, or spend much time with family—at least until the business be- comes profitable and starts generating cash.

If so much work and sacrifice are involved, why become an entrepre- neur? Even if you have a clear vision that you believe will motivate you through the ups and downs of running a business, look closely at the costs and benefits of being an entrepreneur before you decide whether this is the life for you. This examination is fundamental in the decision to be- come an entrepreneur.

Potential Benefits of Entrepreneurship The entrepreneur is working for the following potential rewards:

1. Control over time. Do you work better at midnight than at 8 a.m.? Are you the kind of person who would rather work really hard for two weeks, nonstop, and then take a break? If you start your own busi- ness, you will have control over how you spend your time based on the type of business it is. You can structure your schedule to make this possible. You can also choose to hire others to perform tasks you do not like to do or are not good at, so you can stay focused on what you do best. Bill Gates liked to spend his time designing software. He hired people to manage Microsoft’s operations and to market and sell its products. Many eBay entrepreneurs have carved out flex- ible schedules for responding to orders, packaging, and shipping. Brick-and-mortar retail stores, by contrast, do not often afford such flexibility.

2. Fulfillment. Successful entrepreneurs are passionate about their businesses. They are excited and fulfilled by their work. Entrepreneurs who are working to reach their full potential are rarely bored, because there is always plenty to do. If one facet of running the business is uninteresting, and they have the income to support it, they can hire someone else for that task.

Social entrepreneurs who want to contribute to societal improve- ment find ways to do this while also earning profits. Founders of not-for-profit organizations create enterprises to address public issues that are personally important. Other entrepreneurs start lifestyle businesses that allow them to earn money while following a passion. For example, avid pilots may operate aviation-oriented businesses in which they can fly often, such as specialty delivery companies or flight instruction schools. Art lovers may open galleries, create art rental firms, or operate art tours.

Learning Objective 1.4 Understand the costs and benefits of entrepreneurship.

9 CHAPTER 1: Entrepreneurs and Entrepreneurship

3. Independence/autonomy. Because they are not reporting to managers or supervisors, business owners do not have to follow orders or observe working hours set by someone else. They have control over their decisions.

4. Creation/ownership. Entrepreneurship is a creative endeavor. Doing what they love to do or turning a skill, hobby, or other interest into a business can be highly satisfying. The words of Confucius, “Choose a job that you love, and you will never have to work a day in your life,” are often cited with respect to entrepreneurship.

Entrepreneurs put time and effort into creating a venture they expect will survive and become profitable. Entrepreneurs own the businesses they create and the profits those businesses earn. Ownership is the key to wealth. One goal is to build a business that creates a sustained stream of earnings. Eventually, you may be able to sell that company for a multiple of those earnings. That is how entrepreneurs create wealth. Many entrepreneurs, such as Bill Gore, the inventor of GORE-TEX fabric, start their own business after becoming frustrated or disillusioned in other roles or having ideas rejected by an employer, and leverage the opportunity into personal satisfaction and wealth.

5. Financial reward/control over compensation. Entrepreneurs can build income and wealth through their endeavors. Although income potential is generally capped for employees, entrepreneurs are lim- ited only by their own imagination and tenacity. Entrepreneurs built most of our country’s great fortunes. At the same time, many part- time, seasonal, and lifestyle entrepreneurs find ways to fund gaps in household income, pay for college, or support extraordinary ex- penses through their business endeavors.

Entrepreneurs choose how and when they are paid. As owner of your company, when funds permit, you can decide to: • Pay yourself a salary, a fixed payment made at regular intervals, such

as every week or every month. Salaries are not applicable to sole pro- prietorships, where owners may take a “draw” on revenues, or part- nerships, where they may “draw down” profits.

• Pay yourself a wage, a fixed rate per hour. This is not a common choice, but it is available.

• Take a share of the company’s profit. As the owner, you can pay your- self a portion of the business’s profits. In a corporation, this kind of payment is called a dividend and must be paid to all shareholders.

• Take a commission on every sale you make. A commission is a per- centage of the value of a sale. If you decide to pay yourself a 10 per- cent commission, and sell an item for $120, your commission on the sale would be $12.

6. Control over working conditions. As an entrepreneur, you can create a work environment that reflects your values. If you sup- port recycling, you can make sure your company recycles and encourage recycling, much as TerraCycle has. Depending upon the business, you may bring your dog with you or you may dress informally. You will also evaluate your own performance. If you have control of the company, no one else has the power to fire you. If equality is essential, you may have an office with equal working spaces, no special privileges for managers, and few management layers.

salary fixed amount of money paid to an employee at regular intervals.

wage fixed payment per hour for work performed.

dividend each stockholder’s portion of the profit-per-share paid out by a corporation.

commission a percentage of a sale paid to a salesperson.

10 UNIT 1: Entrepreneurial Pathways

7. Self-esteem. Knowing that they created something valuable can give business owners a strong sense of accomplishment. It can help them feel good about themselves and increase their self-confidence.

8. Contribution to society. Business owners decide how they can add value to their communities and the wider world. The issues they care about can be “designed in” when they form their companies and sup- ported throughout the organization.

Some of the greatest entrepreneurs in the world dealt with prob- lems such as extreme poverty, abuse, or learning disabilities. Sir Richard Branson, for example, had such severe dyslexia that he dropped out of high school. He became a successful entrepreneur, however, creating more than 200 companies—including Virgin Airlines, Virgin Galactic, and Virgin Records. The Virgin Group employs about 69,000 people in 35 countries and has revenues of approximately £16.6 billion.4 Branson has a personal net worth of about $5.3 billion, making him number 324 on the Forbes list of billionaires.5 As an entrepreneur, he was able to create an environment in which he could succeed.

Potential Costs of Entrepreneurship While there are many potential benefits of entrepreneurship, entrepre- neurs also face numerous possible costs.

1. Business failure. About one in five new businesses fails in the first eight years. Another one-third of new businesses close because the entrepreneurs become discouraged and give up. Entrepreneurs risk losing not only their own money but also the financial investments of others.

2. Obstacles. Entrepreneurs run into problems that they will have to solve, primarily by themselves. In addition, their families and friends may not support their vision and may actively discourage them.

3. Loneliness/isolation. It can be lonely and even a little frightening to be completely responsible for the success or failure of a business. While owners have control, they also have responsibility and cannot defer to someone else for decisions.

4 Virgin Group, accessed February 4, 2018, http://www.virgin.com. 5 K. A. Dolan, “Forbes 2017 Billionaires: Meet the Richest People on the Planet,” Forbes, March 20, 2017, accessed February 4, 2018, http://www.forbes.com. 6 Rent the Runway, accessed February 4, 2018, http://www.renttherunway/com.

S t e p i n t o t h e S h o e s . . .

Solving a Problem and Founding a Company When Jennifer (Jenn) Hyman recognized a problem that her sister encountered, she developed the idea into an opportunity with her Harvard Business School section mate, Jennifer (Jenny) Fleiss. Jenn’s sister, Becky, wanted a fashionable outfit to wear to a wedding, but such an outfit was beyond the budget for her salary. What if, Jenn thought, the Beckys of this world could have

access to their dream closet—a new dress for every occasion? And what if designers were able to get their pieces into the hands of young, fashionable women and build an addiction for designer fashion?6 Jenn and Jenny tested the concept and created Rent the Runway, a platform through which users rent designer cloth- ing for special events.

11 CHAPTER 1: Entrepreneurs and Entrepreneurship

4. Financial insecurity. Owners are not guaranteed a salary or ben- efits, or even income at all. They may not always have enough money to pay themselves, particularly in the first 18 months or so of a new enterprise. They also must set up and fund their own retirement and insurance plans.

5. Long hours/hard work. Entrepreneurs must work long hours to get their businesses off the ground. Many entrepreneurs work six or even seven days a week, often for 12 hours or more per day. While they decide when to work, they often end up working or thinking about their businesses many more hours as entrepreneurs than they would as employees.

6. Strain on personal relationships. Even with the strong support of family and friends, the inherent challenges of a small business can strain relationships to the breaking point.

Not everyone is cut out to be an entrepreneur. Entrepreneurs must be able to tolerate more risk and uncertainty than is typical for people who work steady jobs at established employers. With higher risk, however, comes the potential for higher rewards.

Cost/Benefit Analysis Using a comparison of benefits and costs to make a decision is called  a cost/benefit analysis. It is a helpful tool because people often evaluate pros and cons based on emotions, not intellect. Strong emotions may take over to the point where they see only the benefits and not the costs of an action (or vice versa).

For example, Xavier plans to buy a car. He might be overwhelmed by the idea of making such a large purchase, even if the benefits are greater than the costs. In contrast, he might decide to buy a car at a cost that out- weighs the benefits it will bring, simply because he is temporarily blinded by a desire to own an impressive vehicle. Making a list that includes the dollars and cents of the costs and benefits of a purchase is a concrete way to take emotion out of the decision, while also considering nonfinancial factors.

To turn an opportunity into a business, entrepreneurs invest both time and money. Before making this kind of investment, think carefully about:

Costs. The money, energy, and time you will have to invest, as well as the opportunities you will be giving up, to operate the business. Benefits. The wealth you will accrue and the knowledge, skills, self-esteem, and experience you will gain.

Opportunity Cost Cost/benefit analysis is incomplete without considering opportunity cost. This is the cost of your “next-best investment.” Perhaps your goal is to be- come a composer who writes scores for movies. You get a full-time job at a local music store for $400 a week to support yourself, so you can write and record music in the evenings that you hope to sell to producers, agents, or film companies.

You find, however, that whenever a producer or agent wants to meet with you, you cannot get out of work to go. You realize that, even though you are making $400 a week, you are missing some important oppor- tunities. Perhaps it would be smarter to take a part-time job for $300 a week that would leave your mornings free for meetings. The opportunity

cost/benefit analysis a decision-making process in which the costs of taking an action are compared to the benefits.

opportunity cost the value of what must be given up to obtain something else.

12 UNIT 1: Entrepreneurial Pathways

cost of the $100 a week you will lose is offset by the potential income from film-scoring jobs you are missing by not being free to see people in the business. If your first film-scoring job pays $5,000, for example, you would have made the right decision to earn $100 a week less for a few months.

People often make decisions without considering the opportunity cost and then wonder why they are not happy with the outcome. Each time you make a decision about what to do with your time, energy, or money, think about the cost of the opportunities you are giving up. Exhibit 1-1 presents a simple quiz that can help you decide whether you have what it takes to be an entrepreneur.

Seeking Advice and Information to Succeed While experience is an excellent teacher, using knowledge, skills, and abili- ties to avoid errors, problems, and delays is much healthier. A savvy entre- preneur learns from the mistakes of others and appreciates the wisdom and experience of trusted advisors and mentors.

Preparation and planning are keys to avoid making many types of mistakes. Thoughtful consideration of the entrepreneurship option is an excellent starting point. Thorough research and taking advantage of train- ing and/or one-on-one consulting to bridge gaps in your preparation can make a world of difference. You will never be perfectly prepared for entre- preneurship, but you can build competencies, knowledge, and attitudes that will support your entrepreneurial path.

Two of the best resources for getting and staying on track are mentors and business advisors. A mentor is a trusted advisor with whom a person forms a developmental partnership through which information, insight, skills, and knowledge are shared to promote personal and/or professional growth. Finding a committed business mentor with industry-specific knowledge and experience, broad general business experience, or both, is often difficult, but can be a worthwhile endeavor. A successful entrepre- neur in your field, perhaps outside of your geographic area, may prove invaluable if he or she will mentor you. Many successful entrepreneurs will carve out time for promising newcomers. Unfortunately, becoming a mentor may be more of a commitment than your identified entrepreneur is willing or able to make. Perhaps he or she will become an informal advi- sor instead.

In addition to your paid professional advisors, such as attorneys and accountants, individual advisors or an advisory board may mean the dif- ference between success and failure. Even if you are forming a venture with a full slate of experienced technical and managerial professionals, the guidance of a carefully composed advisory board can provide valuable counsel and connections. Such a board might meet only once or twice during a year to listen to your problems, share experiences, and help you advance. During the times between meetings, advisors may also be able to offer substantial assistance.

Of course, taking advantage of available courses in entrepreneur- ship, whether brief workshops, individual college courses, an entrepre- neurial certificate program, or a degree program, can offer considerable benefits. The opportunity to learn from the experiences of others and to systematically explore entrepreneurial options and build skills can be important. There are numerous Internet resources for nascent entrepre- neurs, too.

A well-prepared entrepreneur is more likely to get and stay on the path to success.

mentor a trusted advisor with whom a person forms a devel- opmental partnership through which information, insight, skills, and knowledge are shared to promote personal and/or professional growth.

13 CHAPTER 1: Entrepreneurs and Entrepreneurship

Exhibit 1-1 U.S. Small Business Administration—Small Business Readiness Assessment

Becoming an entrepreneur is not for everyone. In business, there are no guarantees. There is simply no way to eliminate all the risks. It takes a special person with a strong commitment and specific skills to be successful as an entrepreneur. Are you ready to start your own business? Use the Readiness Assessment Guide to better understand how prepared you are. This can be found on the SBA site at http://www.sba.gov where your score can be calculated. Readiness Assessment Guide This guide is designed to help you better understand your readiness for starting a small business. It is not a scientific assess- ment tool. Rather, it is a tool that will prompt you with questions and assist you in evaluating your skills, characteristics, and experience—as they relate to your readiness for starting a business.

Readiness Questions General 1. Do you think you are ready to start a business? 2. Do you have support for your business from family and friends? 3. Have you ever worked in a business like what you are starting? 4. Would people who know you say you are entrepreneurial? 5. Have you ever taken a small business course or seminar?

Personal Characteristics 6. Are you a leader? 7. Do you like to make your own decisions? 8. Do others turn to you for help in making decisions? 9. Do you enjoy competition?

10. Do you have willpower and self-discipline? 11. Do you plan? 12. Do you like people? 13. Do you get along with others? 14. Would people who know you say you are outgoing?

Personal Conditions 15. Are you aware that running your own business may require working more than 12 hours a day, six days a week and maybe

Sundays and holidays? 16. Do you have the physical stamina to handle a “self-employed” workload and schedule? 17. Do you have the emotional strength to deal effectively with pressure? 18. Are you prepared, if needed, to temporarily lower your standard of living until your business is firmly established? 19. Are you prepared to lose a portion of your savings?

Skills and Experience 20. Do you know what basic skills you will need to have a successful business? 21. Do you possess those skills? 22. Do you feel comfortable using a computer? 23. Have you ever worked in a managerial or supervisory capacity? 24. Do you think you can be comfortable hiring, disciplining, and delegating tasks to employees? 25. If you discover you do not have the basic skills needed for your business, will you be willing to delay your plans until you

have acquired the necessary skills?

14 UNIT 1: Entrepreneurial Pathways

Entrepreneurial Options Entrepreneurship extends beyond the fast-growing technology enterprises that are most commonly associated with it. There are many variations on entrepreneurship, and the opportunities are innumerable. For example, entrepreneurship may include for-profit enterprises that support the mis- sions of not-for-profit organizations, businesses designed for social im- pact, and ventures that are environmentally oriented.

Social entrepreneurship has multiple definitions and forms, but it is commonly thought of as a for-profit enterprise with the dual goals of achieving profitability and attaining beneficial returns for society. Another view is that of taking an entrepreneurial perspective toward social problems. Gregory Dees has created the following definition:7

Social entrepreneurs play the role of change agents in the social sector by:

• adopting a mission to create and sustain social value (not just private value);

• recognizing and relentlessly pursuing new opportunities to serve that mission;

• engaging in a process of continuous innovation, adaptation, and learning;

• acting boldly without being limited by resources currently in hand; and • exhibiting heightened accountability to the constituencies served and

for the outcomes created.

In this view, social entrepreneurship is less about profit than it is about social impact. Figure 1-1 provides a visual representation of the many

Learning Objective 1.5 Recognize the various entrepreneurial options.

social entrepreneurship a for-profit enterprise with the dual goals of achieving profit- ability and attaining social returns.

Volunteers

Local HFH affiliate

In-kind donors

Cash donors

Customers

Suppliers

Contractors

Governments

Local communities

Potential HFH

homeowners

Habitat for Humanity ReStore

Figure 1-1 Habitat for Humanity ReStore® Stakeholders

7 Gregory Dees, “The Meaning of ‘Social Entrepreneurship,’” May 30, 2001, accessed July 9, 2013, https://entrepreneurship.duke. edu/news-item/the-meaning-of-social-entrepreneurship/.

15 CHAPTER 1: Entrepreneurs and Entrepreneurship

stakeholders of a social enterprise, a Habitat for Humanity ReStore. Such retail outlets rely on do- nations of inventory from individual community members, businesses, and other mission-driven organizations.

In addition to “social entrepreneurship,” there is the more recent concept of the social business, “a non-loss, non-dividend company designed to address a social objective within the highly regulated marketplace of today. It is distinct from a non-profit because the business should seek to generate a modest profit, but this will be used to expand the company’s reach, im- prove the product or service, or in other ways to subsidize the social mission.”8 In his book Creating a World without Poverty—Social Business and the Future of Capitalism, Mohammad Yunus defines two kinds of social business:

• Type I provides a product and/or service with a particular environ- mental, social, or ethical purpose. Grameen Danone does this by providing food for the poor in Bangladesh.

• Type II is profit-oriented business with ownership consisting of un- derprivileged people who can benefit directly or indirectly.

In addition, venture philanthropy is a subset or segment of so- cial entrepreneurship. Financial and human capital is invested in not- for-profits by individuals and for-profit enterprises with the intention of generating social rather than financial returns. In some cases, venture philanthropy may involve the investment of capital in the for-profit, com- mercial part of a not-for-profit. In others, it may mean investing in not- for-profits directly, to encourage entrepreneurial approaches to achieve social impact.

Green entrepreneurship is another form of social entrepreneur- ship and can be defined as: “Enterprise activities that avoid harm to the environment or help to protect the environment in some way.”9 TerraCycle is an excellent example of green entrepreneurship. According to the Corporation for Enterprise Development (CFED), green entrepre- neurship can:

• create jobs and offer entrepreneurship opportunities; • increase energy efficiency, thus conserving natural resources and sav- ing money;

• decrease harm to workers’ health; • enable businesses to tap into new sources of local, state, and federal funding;

• take advantage of consumer preference for environmentally friendly goods; and

• preserve limited natural assets on which businesses and communi- ties depend for business and quality of life.

Each of these alternative approaches offers opportunities for innova- tion and growth for the right entrepreneur.

social business a company created to achieve a social objective while generating a modest profit to expand its reach, improve the product or service, and subsidize the social mission.

venture philanthropy a subset or segment of social entrepreneurship wherein financial and human capital is invested in not-for-profits by individuals and for-profit enterprises, with the intention of generating social rather than financial returns on their investments.

green entrepreneurship business activities that avoid harm to the environment or help to protect it in some way.

8 Muhammad Yunus, Creating a World without Poverty: Social Business and the Future of Capitalism (New York: PublicAffairs, 2009) 320. 9 “Green Entrepreneurship,” Corporation for Enterprise Development: Effective State Policy and Practice, 5, no. 2, April 2004, http:// www.cfed.org.

Oleksandr Boiko/123RF

16 UNIT 1: Entrepreneurial Pathways

The Many Faces of Entrepreneurship Entrepreneurs are as diverse as the composition of the economy. They are of all ethnicities, races, and religions, and they come from every socioeconomic status. They enter self-employment for a wide range of reasons and choose to continue as entrepreneurs or return to outside employment for just as many. There are women and minority entrepreneurs and young entrepreneurs in record numbers. There are also refugee and immigrant entrepreneurs.

This diverse pool of entrepreneurs does not produce a single path to entrepreneurial success. Rather, the types of businesses formed reflect the diversity of their founders. In addition to full-time ventures founded to maximize growth and wealth, some are started as part-time businesses and microenterprises, artisanal and opportunistic businesses, direct sell- ing distributors, and others.

Microenterprises Most businesses are founded as microenterprises, which are defined as businesses with five or fewer employees, initial capitalization require- ments of less than $50,000, and the habitual operational involvement of the owner. In fact, more than 60 percent of all U.S. firms have four or fewer employees, according to the U.S. Small Business Administration.10 The Association for Enterprise Opportunity (AEO) estimates that the more than 25.5 million microenterprises in the United States account for 91 per- cent of all businesses and 31 percent of all private employment.11

Microenterprises are founded for a variety of reasons and are often more fluid than other types of businesses. These firms may be founded to provide only part-time employment for their owners. They may not be intended as long-term enterprises and may not have the goal of growing larger. They may be planned as only temporary ventures to provide in- come during periods of unemployment or to supplement household fi- nances for a purpose. Lifestyle businesses are microenterprises that per- mit their owners to follow a desired pattern of living, such as supporting college costs or taking vacations. However, a microenterprise could make the difference between a family living in poverty and achieving economic stability.

Other microentrepreneurs get their start as distributors for direct selling companies. Rather than create the product or service model from scratch, these microentrepreneurs join a network of distributors to build businesses by marketing products from direct selling firms such as Amway, Mary Kay, Scentsy, and Princess House. They are independent representatives but are supplied with training, education, marketing materials, and other support to build their own networks and profits. The usual startup cost is approximately $100, and direct selling organizations that are members of the Direct Selling Association are guided by a code of ethics that protects the distributors.

Mainstream Small Firms These constitute the bulk of the small businesses in public perception, in the press, and in community visibility. They provide, or have the potential to provide, substantial profits to their owners. Mainstream small firms can be operated by founder-entrepreneurs, subsequent generations of family members, successor owners, or franchisees. They create many of the jobs included in statistics from the U.S. Small Business Administration and employ most American workers. Unlike many microenterprises, they are

microenterprise a firm with five or fewer employees, initial capitalization requirements of under $50,000, and the regular operational involvement of the owner.

lifestyle business a microenterprise that permits its owners to follow a desired pattern of living, such as sup- porting college costs or taking vacations.

10 U.S. Small Business Administration, Office of Advocacy, 2013. 11 Association for Enterprise Opportunity, accessed February 4, 2018, http://www.microenterpriseworks.org.

17 CHAPTER 1: Entrepreneurs and Entrepreneurship

established with continuity and permanent wealth building in mind and are more often registered with local, state, and federal agencies. Among these mainstream firms are many family enterprises, which are companies owned and operated primarily by related family members. They may span multiple generations and have been passed down from one generation to the next, or they may include siblings in a new venture. The dynamics and issues of family enterprises are interesting and robust. You will have the opportunity to read about many of them in this text and may interact with them as you engage in your community.

Unicorns Some firms are high growth and highly uncommon. These are often labeled as unicorns. In the investment community, startup companies that are valued privately or publicly at over $1 billion are called unicorns, not because they do not exist, but because they are rare and valuable. The term was coined in 2013 by Aileen Lee, founder of Cowboy VC.12 According to Lee, approximately four unicorns are born per year.

Corporate Entrepreneurship Entrepreneurship is not limited to new and small ventures. Corporate entrepreneurship or intrapreneurship occurs when an individual or team within an existing corporation creates or identifies new opportunities for increased profits and/or improved competitive position, secures the neces- sary resources, and creates value through a new organization or innovation within the firm. Intrapreneurs can be found within large organizations glob- ally and are most successful when the organization supports their efforts and rewards entrepreneurial creativity and accepts failure as part of the process.

How Do Entrepreneurs Find Opportunities to Start New Businesses? In the twentieth century, Joseph Schumpeter expanded on Say’s definition of entrepreneurship by adding that entrepreneurs create value “by exploit- ing an invention or, more generally, an untried technological possibility for producing a new commodity or producing an old one in a new way, by opening up a new source of supply of materials or a new outlet for prod- ucts, by reorganizing an industry and so on.”13 This view emphasizes inno- vation as the key to entrepreneurship. Management expert Peter Drucker simplified this view to its essential core of creating a new business, taking on risk, and persevering in light of uncertainty.14

Schumpeter’s definition describes five basic ways that entrepreneurs find opportunities to create new businesses:

1. Using a new technology to produce a new product 2. Using an existing technology to produce a new product 3. Using an existing technology to produce an old product in a new way 4. Finding a new supply of resources (that might enable the entrepre-

neur to produce a product more economically) 5. Developing a new market for an existing product

family enterprise a com- pany owned and operated primarily by related family members.

unicorns startup companies valued at over $1 billion.

corporate entrepreneur- ship or intrapreneurship occurs when an individual or team within an exist- ing corporation creates or identifies new opportunities for increased profits and/or improved competitive posi- tion, secures the necessary resources, and creates value through a new organization or innovation within the firm.

Learning Objective 1.6

Identify and evaluate opportunities to start your own business.

12 Aileen Lee, “Welcome to the Unicorn Club: Learning from Billion-Dollar Startups,” TechCrunch, November 2, 2013. Accessed February 4, 2018, https://techcrunch.com/2013/11/02/welcome-to-the-unicorn-club/. 13 Joseph A. Schumpeter, Capitalism, Socialism and Democracy (New York: Harper & Row, 1942). 14 Peter Drucker, Innovation and Entrepreneurship: Practice and Principles (New York: Harper Collins, 1985).

18 UNIT 1: Entrepreneurial Pathways

Entrepreneurs Creatively Exploit Changes in Our World Contemporary economists and business experts have defined entrepreneur- ship even more specifically. Drucker pointed out that, for a business to be considered entrepreneurial, it should exploit changes in the world. This is in alignment with Schumpeter’s definition of entrepreneurship but explicitly takes it a step further—to take advantage of circumstances. These changes can be technological, like the explosion in computer technology that led Bill Gates and Paul Allen to start Microsoft, or cultural, like the collapse of com- munism, which led to a great many new business opportunities in Eastern Europe. Babson professor Daniel Isenberg narrows the definition of entrepre- neurship to “the contrarian creation and capture of extraordinary value.”15

Nothing changes faster than technology. Not so many years ago, there were no bar codes and no electronic scanners, hardly anyone used email, and smartphones didn’t exist. Today, even the smallest of organizations must use current technologies to be competitive. Sharp entrepreneurs in- crease their efficiency by taking advantage of the latest breakthroughs. To learn about what’s new in technology, read current business and trade magazines and visit such websites as:

• TechCrunch, http://www.TechCrunch.com • The Next Web, http://www.TheNextWeb.com • Mashable, http://www.Mashable.com • The Verge, http://www.TheVerge.com

Peter Drucker defined an entrepreneur as someone who “always searches for change, responds to it, and exploits it as an opportunity.” Entrepreneurs are always on the lookout for ways to create businesses from the opportunity of change.

Where Others See Problems, Entrepreneurs Recognize Opportunities Here is a simple description of an entrepreneur that captures the essen- tials: An entrepreneur recognizes opportunities where other people see only problems or the status quo.

Many famous companies were started because an entrepreneur turned a problem into a successful business. An entrepreneur recognized that the problem was an opportunity. Where there are dissatisfied con- sumers, there are likely opportunities for entrepreneurs.

Anita Roddick was an excellent example of an entrepreneur who started as a dissatisfied consumer. She started The Body Shop International because

15 Daniel Isenberg, Worthless, Impossible and Stupid: How Contrarian Entrepreneurs Create and Capture Extraordinary Value (Cambridge, MA: Harvard Business Press, 2013).

BizFacts Entrepreneurship has proven to be an effective way for minorities and women to enter the business world.

• Approximately 9 million businesses were minority-owned in 2012, and they generated $1.4 billion in revenues.

• In 2012, there were more than 12.4 million non-farm businesses owned by women (or co-owned equally with men), accounting for 36 percent of all U.S. companies.

Source: U.S. Small Business Administration, accessed February 4, 2018, http://www.sba.gov.

19 CHAPTER 1: Entrepreneurs and Entrepreneurship

she was tired of paying for unnecessary perfume and fancy packaging when she bought makeup, and she thought other women might feel the same way.

Train Your Mind to Recognize Business Opportunities An important step in becoming an entrepreneur is to train your mind to recognize business opportunities. A further step is to let your creativity fly. List your interests, passions, hobbies, and challenges. Put them together in new and interesting ways. What business ideas emerge? Consider develop- ing your entrepreneurial instincts by asking yourself:

• What frustrates me the most when I try to buy something? What do I observe frustrating others?

• What product or service would really make my life better? What could improve the lives of my community members?

• What makes me annoyed or angry? What annoys my friends and family? • What product or service would take away the aggravation?

Entrepreneurs Use Their Imaginations Businesses are also formed when entrepreneurs not only fume about prod- ucts or services that annoy them, but fantasize about products or services they would like to have in their lives or for others. Jump-start your imagi- nation by asking yourself such questions as:

• What is the one thing I would like to have more than anything else? • What would it look like? What would its other attributes be like? • What would it do? • What innovative product or service idea have I been mulling over in my mind?

• What problem have I encountered in everyday life and thought: “There has to be a better way to do this”?

Consider posing these questions to friends and family members as well. You might hear about an opportunity you had not yet recognized.

An Idea Is Not Necessarily an Opportunity Not every business idea you have or invention you explore is an opportunity. In fact, most ideas are not viable business possibilities. An opportunity has a unique characteristic that distinguishes it from an ordinary idea. An opportunity is an idea that is based on what customers need or want and are willing to buy sufficiently often at a high enough price to sustain a business.

Learning Objective 1.7

Distinguish between ideas and opportunities.

How Do Entrepreneurs Create Business Ideas? 1. Listen. By listening to others, entrepreneurs get ideas about improving a business

or creating a new one. Create one business idea by listening. Describe how you got the idea.

2. Observe. By constantly keeping their eyes and ears open, entrepreneurs get ideas about how to help society, about what kind of businesses they could start, and about what consumers need. Create a business idea by observing. Describe how you got the idea.

3. Analyze. When entrepreneurs analyze a problem, they think about what product or service could solve it. Create a business idea by thinking up a solution to a problem. Describe how you arrived at the idea.

20 UNIT 1: Entrepreneurial Pathways

A successful business sells what customers need at prices they are willing to pay. Many small businesses fail because entrepreneurs do not understand this or forget how vital it is.

In addition, according to the late Jeffry Timmons, “An opportunity has the qualities of being attractive, durable, and timely and is anchored in a product or service which creates or adds value for its buyer or end user.”16

Timmons’s definition of a business opportunity includes these four characteristics:

1. It is attractive to customers because it creates or adds value for its customers.

2. It will work in the business environment. 3. It can be executed in a defined window of

opportunity. 4. It can be implemented with the right team to make

it durable.

The window of opportunity is the length of time available to get the busi- ness idea to market before the market either diminishes due to lessening demand or is dominated by a competitor. You might have a great idea, but if other entrepreneurs have it too, and have already brought it to the mar- ketplace, that window of opportunity is potentially closed or closing.

Remember, not every idea is an opportunity. For an idea to be a genu- ine opportunity, it must lead to the development of a product or service that is of value to the customer and is profitable for the business.

Opportunity Is Situational Opportunity is situational, meaning it is dependent on variable circum- stances. There are no rules about when or where an opportunity might pres- ent itself. A problem is one example of an opportunity that entrepreneurs need to be able to recognize. A changing situation or a trend is another.

Consider recent changes in computer technology. In the early 1990s, the conventional wisdom was that only the biggest telecommunications companies were able to exploit the Internet and all the opportunities it had to offer. How could entrepreneurs compete with established, resource- laden companies? The opposite has been true. Entrepreneurs penetrated

16 Jeffry Timmons and Stephen Spinelli, New Venture Creation: Entrepreneurship for the 21st Century, 8th ed. (New York: Irwin/ McGraw-Hill, 2008) 7.

Larry Lilac/Alamy Stock Photo

workable accounting system. These are internal to the organization.

• Opportunities. Any positive external events or circum- stances that can help the entrepreneur get ahead of the competition.

• Threats. Any external factors, events, or circumstances that can harm the business, such as competitors, legal issues, or declining economies.

A useful way to evaluate a business idea is to look at its strengths, weaknesses, opportunities, and threats (SWOT). This is called a SWOT analysis.

• Strengths. All the capabilities and positive points the company has, from experience to contacts. These are internal to the organization.

• Weaknesses. All the negatives the company faces, such as lack of capital or training, or failure to set up a

E n t r e p r e n e u r ia l W i s d o m . . .

21 CHAPTER 1: Entrepreneurs and Entrepreneurship

and have dominated the market for Internet-based services. Think of Facebook, Google, and Snapchat. Each was an entrepreneurial venture that left industry giants scrambling to catch up.

It can take a huge corporation multiple years to develop and imple- ment a new business strategy, while entrepreneurs can be nimble and enter and exit the market like roadrunners. Successful entrepreneurs can “turn on a dime rather than a dollar bill.”

The Five Roots of Opportunity in the Marketplace Entrepreneurs can exploit “five roots of opportunity.”17 Notice how similar these are to Schumpeter’s definition of entrepreneurship.

1. Problems your business can solve 2. Changes in laws, situations, or trends 3. Inventions of new products or services 4. Competitive advantages in price, location, quality, reputation, reli-

ability, speed, or other attributes of importance to customers 5. Technological advances that entrepreneurs take from the laboratory

to the marketplace

S t e p i n t o t h e S h o e s . . .

Finding Multiple Opportunities at a Young Age Kyle Wong started his entrepreneurial journey well before most of his peers. He is a graduate of the Network for Teaching Entrepreneurship (NFTE) program and was part of the founding of a few companies at the time. He also was the first member of his immediate family to attend college, enrolling at Stanford University.

At Stanford, Wong was accepted into the university’s prestigious accelerator program, which encourages partici- pants to build from an idea to an opportunity to a functioning company. While part of the accelerator, he co-founded Pixlee, a platform for social media marketing campaigns, with Awad Sayeed in 2012.

Describing Pixlee on his LinkedIn profile, Wong writes, “Powered by the belief that customer stories are the most pow- erful way to articulate the value of a product or service, Pixlee helps brands market and sell with real customer photos and videos.”18 Customer-generated content is curated in real time. Pixlee counts Kenneth Cole, Levi Strauss, 1-800-Flowers, nu- merous professional sports teams, and The North Face among its approximately 150 clients.

Wong identified an opportunity, exploited it, and secured strong funders, including Andreessen Horowitz, Rothenberg Ventures, XSeed Capital, GS Shop, David Jones (You and Mr. Jones), and Bryan Weiner (360i). In addition, he was a contribu- tor for Fortune and Forbes magazines and was named to the 2014 Forbes “30 Under 30” List.

17 Adapted from John Clow, ed., Master Curriculum Guide: Economics and Entrepreneurship (New York: Joint Council on Economic Education, 1991). 18 Kyle Wong LinkedIn profile, accessed May 20, 2018, https://www.linkedin.com/in/kylewong/.

Courtesy of Kyle Wong

22 UNIT 1: Entrepreneurial Pathways

Paths to Enterprise Ownership Not all business owners start their ventures from the ground up. Although the emphasis of this book is on starting and growing your own enterprise, the paths to business ownership are varied. You could buy an existing company, secure franchise rights, license or purchase critical technology or methods, inherit a company, or be hired as a manager.19 There are pros and cons to each approach, and it is worthwhile to give thought to each option. Note the possibilities in Exhibit 1-2.

Secure Franchise Rights “A franchise is a legal and commercial relationship between the owner of a trademark, service mark, trade name, or advertising symbol and an individual or group seeking to use that identification in a business.”20 The two primary forms of franchising are product/trade name franchising and business format franchising. Franchisors can aid in marketing, site selec- tion, securing financing, training, product supply, and business systems. McDonald’s is an example of a business format franchise. Each company’s franchise agreement is different, and while franchises fail less often than fully independent businesses, they are not guaranteed to succeed.

For many people who want to own and operate a business, it is worth- while to consider franchising as a path to business ownership. Some fac- tors to consider before selecting this option are shown in Exhibit 1-2.

Buy an Existing Business The purchase of a business, or acquisition, can be a good way to jump-start entry into small business ownership. If you are purchasing a company, you should perform due diligence, which is the process used to learn about its true financial condition (the current owners may have incentives to pro- vide incomplete, misleading, or inaccurate information), its reputation, and its continuing viability. There is both an art and a science to buying an existing business.

Learning Objective 1.8

Explore the multiple paths to entrepreneurship.

franchise a business that markets a product or service developed by a franchisor, typically in the manner speci- fied by that franchisor.

acquisition a business purchase.

due diligence the exer- cise of reasonable care in the evaluation of a business opportunity.

Business Aspects Start a Business Buy a Business Secure a Franchise or License License Technology

Customers None Established None—but may have name recognition

None

Location Needed In place Assistance possible Needed Management Control

Owner Owner Owner within terms of license Owner within terms of license

Operational Control Owner Owner Owner within terms of license Owner Marketing Needed In place ( + / – ) Assistance possible; rules absolutely Needed Reputation None In place ( + / – ) Should exist; if not, why license? Possible Royalties/Fees Not usual Maybe Ongoing Likely Financing Needed Prior owner may

provide Assistance possible Needed

Disclosures None Buyer beware Franchise Disclosure Document and contracts

Agreement

Exhibit 1-2 Selected Business Entry Options

19 Jerome A. Katz and Richard P. Green, Entrepreneurial Small Business (New York: McGraw-Hill/Irwin, 2008). 20 U.S. Small Business Administration Workshop, “Is Franchising for Me?” accessed December 2007, http://www.sba.gov/idc/ groups/public/documents/sba_homepage/serv_sbp_isfforme.pdf.

23 CHAPTER 1: Entrepreneurs and Entrepreneurship

The challenge is to do a complete, in-depth analysis of the opportu- nity, just as you would for a start-up, with the added dimension of consid- ering an existing history, whether for better or worse. Be wary of owners whose businesses seem to be too good to be true or who are overly eager to sell. Be thorough, whether you are buying an entire firm, a customer list, or some or all assets—and especially if you are taking on some or all debt. Done well, buying a business can be the starting point for success. Done poorly, buying a business can be more challenging and problematic than starting a new venture.

License Technology One way to potentially shorten the product-development cycle and to ac- cess innovative technology is to identify and license that technology—that is, to enter into a contract to use it without purchasing the rights to own it. Whether you acquire such rights through a university, economic develop- ment office, federal agency such as NASA, or an individual scientist/inven- tor, you can create a business based on technology transfer. Or you may find that it makes more sense to purchase the rights outright or over time.

The MBA team of Bruce Black and Matt Ferris, from the University of Georgia, developed a business plan that garnered numerous competitive awards for the KidSmart Vocal Smoke Detector, someone else’s invention that they legitimately brought to market. The product is now available in major retail stores and on the Internet as the Signal One Vocal Smoke Alarm.

Before securing franchise rights, purchasing a business, or licensing technology, be certain to do your research thoroughly to understand what you are and are not buying, and what your ongoing obligations—financial, operational, legal, and reporting—will be. Because these transactions are complex and can have significant financial and personal implications, it is important to invest in qualified legal and financial counsel before signing any agreements of this kind.

Making the Business Work Personally and Professionally What makes a business work is not simply profitability and cash flow. Each entrepreneur has his or her own goals and objectives for the organi- zation. As an entrepreneur, it will be up to you to determine how you want your business to be and to make it happen.

A Business Must Make a Profit to Stay in Business No matter how big or small, a business must ultimately make a profit—that is, show a positive gain from operations after all expenses are subtracted. Most businesses lose money initially because entrepreneurs must spend money to set up operations and advertise to attract customers. If the busi- ness cannot make a profit and generate cash, eventually the entrepreneur will be unable to pay bills and will have to close.

Closing a business is nothing to be ashamed of, if you operate ethically and learn from the experience. In fact, many successful entrepreneurs open and close more than one business during their lives. If your venture is not making a profit after you have gotten it up and running, that is a signal you may be in the wrong business for you. Closing it may be the best decision.

An entrepreneur may change businesses many times over a lifetime in response to changing interests, competition, and consumer needs. Some entrepreneurs enjoy the start-up and early stages and prefer not to remain

Learning Objective 1.9

Explain success signals for entrepreneurs.

profit amount of earnings remaining after all costs are deducted from the income of a business.

24 UNIT 1: Entrepreneurial Pathways

past that time. Others recognize the need for managers with other skills and step aside. Still others have the desire and skills to remain with their organizations for the long haul.

Profit Is the Sign That the Entrepreneur Is Adding Value Profit is the sign that an entrepreneur has added value to the resources he or she is using. Debbi Fields added value to scarce resources by creating something that people were willing to buy for a price that gave her a profit. In contrast, not making a profit is a sign that the entrepreneur is not using resources well and is not adding value to them.

Profit Results from the Entrepreneur’s Choices An entrepreneur’s choices directly affect how much profit the business makes. For example, suppose, like Debbi Fields, you have a business sell- ing homemade cookies. You might decide one week to buy margarine in- stead of butter because it is cheaper, and you haven’t promised real butter in your advertising, even though the cookies may not taste as good made with margarine. This type of choice is called a trade-off. You are giving up one thing (taste) for another (money).

If your customers do not notice the change and continue to buy your cookies, you have made a good choice. You have conserved a resource (money) and increased your profit by lowering your costs. The increase in profit confirms that you have made the right choice.

If your customers notice the change and stop buying your cookies, your profit will decrease. The decrease in profit signals that you have made a bad choice. Next week you should probably go back to butter and hope that you can regain the lost customers. The profit signal taught you that your customers were dissatisfied, and the trade-off was not worth it. Every choice an entrepreneur makes is a trade-off.

The Team Approach While most businesses do not hire employees, successful entrepreneurial ventures grow well beyond their initial founder. Some have multiple co- founders while others grow their teams along with their businesses. The

trade-off the act of giving up one thing for another.

California–Los Angeles Brain Research Institute, suggests the following brain-builders:

• Solving puzzles • Playing a musical instrument • Fixing something, such as learning to repair cars or elec-

trical equipment • Creating art, writing poetry, painting, or sculpting • Dancing • Making friends with people who like to have interesting

conversations

Becoming a successful entrepreneur is all about making con- nections, those “Aha!” moments when you realize what your business opportunity is or when you figure out how to do some- thing better than the competition. Research indicates that mental exercise helps the brain become better at making such connections. Even the most erudite scientists recognize the value of activities that encourage brain cells to make new con- nections. Robotics engineer Hugo de Garis, who has worked on such projects as building an artificial brain for an artificial cat, plays classical piano every day before he sits down at the computer. “This helps to build my own brain,” he told The New York Times.21 Arnold Scheibel, head of the University of

E n t r e p r e n e u r ia l W i s d o m . . .

Build Your Brain

21 Nicholas D. Kristof, “Robokitty,” The New York Times, August 1, 1999.

25 CHAPTER 1: Entrepreneurs and Entrepreneurship

team approach can make or break a business. For example, alone, neither Russell Simmons nor Rick Rubin had enough skills or money to launch a record label, but together they were able to do it. Def Jam was also aided by the fact that each knew different artists and had different contacts in the recording industry.

Potential team members are all around you. Some people in your im- mediate circles of friends and family members might have skills, financial resources, equipment, or contacts that would make them valuable business partners. At the same time, you may reach across the globe to find team members. Perhaps you very much want to start a website design business, because you know of companies in your community that want to put up websites. You are a graphic artist, but you do not know how to use website development programs. If you have a friend who has that knowledge, you might start a business together. Or maybe you would like to start a DJ ven- ture, but you only have some of the necessary equipment. If you form the business with a friend, you can pool equipment. (When forming a business team, organize the enterprise so that everyone involved shares in the owner- ship and profits. People work better when they are working for themselves.) Just be careful of jumping into business relationships with undue haste.

Now carry this idea a step further. Everyone you meet is a potential contact for your business, just as you may be a valuable contact for theirs. Thinking this way will encourage you to network or exchange valuable in- formation and contacts with other businesspeople. Keep your business cards with you always and truly view every individual you encounter as an opportunity for your business. Remember, though, that networking is a two-way street. See how you can help those that you meet first rather than always focusing on how they can help you. The results can be nothing short of amazing.

Developing Skills for Your Career— Entrepreneurship or Employment Whether you intend to become an entrepreneur, already are one, or never expect to become one, the competencies, knowledge, skills, abilities, and attitudes you can experience and develop through using of this book and taking this course can serve you well. The principles of entrepreneur- ship apply to all aspects of life, not only to business, and can assist you in being a more valuable and valued member of your team and community. Large and small companies, new and established ones, for-profit and not- for-profit organizations—all need skilled people to sustain them. Almost without variation, employers and entrepreneurs value skills and compe- tencies such as written and oral communications, critical thinking and problem solving, teamwork and collaboration, creativity, leadership, ethi- cal behavior, and information technology. By being an engaged learner, you will develop and hone your skills in those critical areas:

• Written and oral communication. Successful business leaders com- municate well in writing and orally. Routine written correspondence and verbal interactions should be clear, concise, and correct. As en- trepreneurs search for partners and capital, they must articulate the value they are creating and the assistance they require. For example, business plans, financing proposals, and pitches must be excellent. This text provides an outline and set of guide questions throughout, and these items can serve as writing prompts for you. The skills you develop while answering end-of-chapter questions will assist you in your chosen career.

Learning Objective 1.10

Develop skills for a future career—employment or entrepreneurship.

26 UNIT 1: Entrepreneurial Pathways

• Critical thinking and problem solving. Successful entrepreneurs have solid critical thinking and problem-solving skills, as do success- ful business leaders. In fact, the most successful businesses solve urgent and valued problems for customers. Entrepreneurs constantly practice these skills. Each chapter has a set of “Critical Thinking” ex- ercises and a variety of opportunities to develop and grow these skills. The process of developing a business plan requires these skills, too.

• Teamwork and collaboration. There is power in numbers, and the success rate of businesses with multiple founders is greater than that of businesses with solo founders. Regardless of the number of founders, it takes many stakeholders for business success. Key to this is working in teams in a collegial and constructive manner. Collaboration with internal and external people matters. Whether you are an entrepreneur or an employee, these skills are valuable and valued. You may work with a team through the Lean Start Up process or while developing a business plan during this course. You will read numerous cases about businesses and the teams that cre- ated and grew them. Chapter 13, “Management, Leadership, and Ethical Practices,” addresses this topic in greater depth.

• Leadership. A key entrepreneurial competency is conveying a clear, compelling vision for the organization, so that others want to com- mit to it and perpetuate it. This skill is built from the onset when developing opportunities through exit and harvesting. Chapter 13, “Management, Leadership, and Ethical Practices,” focuses on leader- ship qualities and skills. While you may lead a company later in life, the skills are important in any employment role.

• Creativity. While many people do not see themselves as creative, creativity comes in many forms. Employers want creative talent, and entrepreneurs must be creative to identify and assess opportuni- ties where others only see problems. Chapter 1, “Entrepreneurs and Entrepreneurship,” Chapter 2, “Pathways to Success: Processes and Instruments,” and Chapter 3, “Creating Business from Opportunity,” introduce creativity and the entrepreneurial mindset.

• Ethics. Employees with the skills to act ethically according to common sense and codes of ethics are highly valued. Ethical dilemmas arise in many seemingly straightforward daily decisions, and deciding among options is often difficult. Organizations, whether entrepreneurial ven- tures or large corporations, rise and fall on their ethical decisions, so these skills are essential. Chapter 13, “Management, Leadership, and Ethical Practices,” addresses this topic in greater depth, and cases throughout the text discuss founder and management decisions.

• Information technology skills. Employers expect employees to be up to date in the use of business information technology. These skills also serve entrepreneurs well. You can use projects and activi- ties throughout the semester, as well as end-of-chapter assignments, particularly Exploring Online, to build your technology skills. If you create a business plan, you will use multiple skills that are important regardless of the life path you choose.

All these skills are life skills for entrepreneurs and employees alike. Each of them in isolation is valuable. The combination of all is potent. Being competent in all the above skills and others you may develop will serve you well in your career. This book, used as a resource in your course, will provide much of the information, practice, and knowledge you need to develop, enhance, and hone your skills.

27 CHAPTER 1: Entrepreneurs and Entrepreneurship

Chapter Summary Now that you have studied this chapter, you can do the following:

1. Summarize what entrepreneurship is and what entrepreneurs do. • Entrepreneurs start their own businesses and work for themselves. • Entrepreneurs recognize and create opportunities to start busi-

nesses that other people may not have noticed. • Entrepreneurs shift economic resources from an area of lower

productivity into an area of higher productivity and greater yield. By doing this, they add value to scarce resources.

2. Examine how free-enterprise economies work and how entrepre- neurs fit into them. • The free-enterprise system is based on voluntary exchange. Volun-

tary exchange is a trade between two parties who agree to trade money for a product or service. Both parties agree to the trade because each benefits from the exchange.

• The free-enterprise system encourages entrepreneurs who use resourc- es efficiently to satisfy consumer needs by rewarding them with profit.

3. Describe small business. • A small business is generally defined by the U.S. Small Business Ad-

ministration’s Office of Advocacy as having fewer than 500 employees and selling less than $5 million worth of products or services annually.

4. Understand the costs and benefits of entrepreneurship. • Benefits

• Control over time • Fulfillment • Independence/autonomy • Creation/ownership • Financial reward/control over compensation • Control over working conditions • Self-esteem • Contribution to society

• Costs • Business failure • Obstacles • Loneliness/isolation • Financial insecurity • Long hours/hard work • Strain on personal relationships

5. Recognize the various entrepreneurial options. • Social entrepreneurship • Green entrepreneurship • Microenterprise • Mainstream small firms • Unicorns • Corporate entrepreneurship

6. Identify and evaluate opportunities to start your own business. • The five roots of opportunity are

• problems that your business can solve; • changes in laws, situations, or trends;

28 UNIT 1: Entrepreneurial Pathways

• inventions of totally new products or services; • competition (if you can find a way to beat the competition on price,

location, quality, reputation, reliability, or speed, you can create a successful business with an existing product or service); and

• technological advances (scientists may invent new technology, but entrepreneurs figure out how to sell it).

7. Distinguish between ideas and opportunities. • Ideas are not necessarily opportunities • Opportunity is situational • There are five roots of opportunity

• Problems your business can solve • Changes in laws, situations, or trends • Inventions of new products or services • Competitive advantages of importance to customers • Technological advances that entrepreneurs take from the labora-

tory to the marketplace 8. Explore the multiple paths to entrepreneurship.

• Start your own business • Buy an existing business • Secure a franchise or license • License technology

9. Explain success signals for entrepreneurs. • Profit is the sign that an entrepreneur has added value to the

scarce resources he or she is using. • Not making a profit is a sign that the entrepreneur is not using

resources well and is not adding value to them. 10. Develop skills for a future career—employment or entrepreneurship.

• Written and oral communications • Critical thinking and problem solving • Teamwork and collaboration • Leadership • Creativity and discovery • Ethics • Information technology skills • Information literacy

Key Terms acquisition capital capitalism commission corporate entrepreneurship cost/benefit analysis dividend due diligence entrepreneur family enterprise franchise free-enterprise system green entrepreneurship lifestyle business mentor

microenterprise necessity-based entrepreneurs opportunity-based entrepreneurs opportunity cost product profit salary service social business social entrepreneurship trade-off unicorns venture philanthropy voluntary exchange wage

E n t r e p r e n e u rs h i p Po r t fo lio

Critical Thinking Exercises 1-1. What would be the best thing about owning your own business?

What would be the worst for you? Why? 1-2. Choose three nonfinancial benefits of entrepreneurship that might

be important to you. Write a paragraph about each and why it would be important.

1-3. If you were to start a business five years from now, what would you expect opportunity cost to be? In other words, what would be the next-best use of your time? How much money could you make working as an employee, instead? The answer to this last question will give you a rough idea of how to value your time when you start a business and figure out how much to pay yourself.

1-4. Select and describe an idea that you have for a business. Summarize how it could satisfy a customer need. What problem is it solving? For whom?

1-5. Provide an example of a change that has occurred or is about to occur in your area/neighborhood. Discuss at least three business opportunities this change might create.

1-6. Identify and list five business opportunities in your environment and the need(s) each would satisfy. Indicate whether each oppor- tunity you describe is likely to be a lifestyle business, microenter- prise, small business, unicorn, or some other type of business.

1-7. How have you worked to develop the critical skills discussed in this chapter? Which skills are your strongest? How might you build those that need improvement?

Key Concept Questions 1-8. Define small business according to the U.S. Small Business

Administration terms. How, if at all, does this differ from what you expected the definition to be?

1-9. Explain how profit works as a signal to the entrepreneur. 1-10. It will probably take about three to 18 months for your business to

start earning a profit. Do you agree or disagree? Why? If you dis- agree, how long do you expect it to take? What are the three most important factors in determining the time frame?

1-11. Summarize three facts about capitalism. 1-12. Compare and contrast the meaning of a business opportunity and

a business idea. 1-13. Visit the U.S. Small Business Administration website (http://www.

sba.gov). Read an article on starting a business and write a sum- mary of the key information (200 words or fewer). Remember to create a proper citation for the article.

Application Exercises 1-14. Have a conversation with a friend or relative. Discuss things he or

she finds frustrating in his or her area/neighborhood. a. Write down these comments.

29 CHAPTER 1: Entrepreneurs and Entrepreneurship

30 UNIT 1: Entrepreneurial Pathways

b. Generate at least three business opportunities from this con- versation.

c. Use the checklist below to evaluate each of your three business ideas as opportunities.

Business Idea ____           Critical Evaluation Would it be attractive to potential customers? Yes No

Would it work in your business environment? Yes No

Is there a sufficient window of opportunity? Yes No

Do you have the skills and resources to create this business? Yes No

If you do not have the skills and resources to create this business, do you know someone who does and might want to create the business with you? (Consider how you might determine this.)

Yes No

d. Choose the best of the business opportunities and develop a SWOT analysis for it.

e. Create a cost/benefit analysis for starting this business. Use the analysis to explain why you would or would not actually start it.

Exploring Your Community 1-15. Interview an entrepreneur, preferably in person. Entrepreneurs

are busy people, but many are willing to spend time speaking with someone who is interested in what they are doing. Meeting over a light meal might be the most efficient use of the entrepreneur’s time. Before the interview, brainstorm 10 questions in the follow- ing four categories. After the interview, be sure to send a thank- you note. a. Information gathering. Open the interview with questions

about the entrepreneur’s family (any other entrepreneurs in it?) and educational and work background.

b. Starting the business. Next, ask questions about how the business was started. How did the entrepreneur recognize an opportunity and develop it?

c. Running the business. Ask about which challenges arose as the business got underway and how they were solved.

d. Reflection. Ask the entrepreneur to reflect. What advice would he or she give to an aspiring entrepreneur? Has running a busi- ness been rewarding?

Reflect on the interview and what you learned about entrepreneurship and small business. Summarize your thoughts and describe how this new learning may impact you as an entrepreneur.

Exploring Online 1-16. Visit an Internet search engine such as Google, Yahoo! or Bing.

Search for one of the following terms: entrepreneurship ideas, busi- nesses for sale, or franchise opportunities. For the search you se- lected, answer: a. Which search engine and term were used? b. What were the number of matches (“hits”)?

1-17. Find a website based on question 1-15 that looks promising and answer these questions: a. What is the website (URL and name)? b. Who is sponsoring the website? c. Is the website selling a product or information (as a primary

function, not through banner ads)? If so, what product(s) or information?

d. Identify three businesses/ideas/opportunities from the site, and state why they might or might not be viable opportunities for you.

MyLab Entrepreneurship Writing Assignments Go to www.pearson.com/mylab/entrepreneurship for Auto-graded writing questions as well as the following Assisted-graded writing questions:

1-1. Entrepreneurs put a lot of time, effort, and often a great deal of their own money, into launching their own businesses. Do the po- tential benefits of entrepreneurship outweigh the potential costs? Explain why or why not, citing specific reasons in your response.

1-2. There are many variations on entrepreneurship and the opportu- nities are seemingly endless. Explain the concept of social entre- preneurship. What impact can these kinds of ventures have on society?

CHAPTER 1: Entrepreneurs and Entrepreneurship 31

Sandy Lerner cofounded Cisco Systems in 1984 with her former husband, Leonard Bosack. It became a world leader in sales of computer routers. When she was ousted from the com- pany in 1990, Lerner had the time and financial resources to focus on charitable activities and other business opportunities. By 1995, she was ready to start another company that would fill a market void.

Lerner believed that there was an opportu- nity in the beauty market for quality nontradi- tional products. According to the Urban Decay website, “Our story opens nearly 20 years ago, when pink, red and beige enslaved the prestige beauty market. Heaven forbid you wanted purple or green nails, because you’d either have to whip out a marker, or risk life and limb with that back- alley drugstore junk.” Lerner had seen a Chanel polish that was a deep red color, nearly black, but found little else in high-end products that met the need she identified.

Lerner’s business manager introduced her to a creative businesswoman and self-described makeup addict, Wende Zomnir, and the busi- ness began to take shape. “Over high tea, the two forged a pact that led to renegade nail pol- ish mixing sessions in Wende’s Laguna Beach bungalow.” Urban Decay launched in 1996 with 12 nail enamels and 10 lipsticks. “Inspired by seedier facets of the urban landscape, they bore groundbreaking names like Roach, Smog, Rust, Oil Slick, and Acid Rain. The first magazine ad queried ‘Does Pink Make You Puke?,’ fueling the revolution as cosmetics industry executives scrambled to keep up.” Today, the company de- scribes itself this way: “Urban Decay is beauty with an edge. It is feminine, dangerous and fun . . . appealing to anyone who relishes their individu- ality and dares to express it.”

Even after the ’90s grunge style faded, Urban Decay thrived. The company became a global organization; it is a popular full cosmetic line at major retailers such as Sephora, Macy’s, and Ulta, and is found on the Internet through Beauty.com. Urban Decay is sold by retailers in the Middle East, the United Kingdom, Italy, Canada, France, Singapore, and Spain. After sev- eral transitions, it is currently owned by L’Oreal Cosmetics, and Zomnir continues to work at the company.

Urban Decay notes factors contributing to its success: “And although UD fans around the world might approach our products in wildly

Urban Decay: Finding an Entrepreneurial Opportunity

Case Study

different ways, we’ve noticed they share an inde- pendent spirit that unites them. Maybe this hun- ger for something unique explains the passionate support we’ve received over the years.”

Clearly, Lerner and her cofounders saw op- portunity in beauty.

Case Study Analysis 1-18. What unmet needs of the consumer

contributed to the success of Urban Decay?

1-19. Was founding Urban Decay an expected next step after leaving Cisco Systems for Sandy Lerner? Why or why not?

1-20. What characteristics made Urban Decay an opportunity rather than simply an idea? Which of the five roots of opportu- nity apply here?

1-21. Is there a future for Urban Decay? Assess what that future might look like.

Case Sources “Sandy Lerner,” Encyclopedia of World Biography, accessed March 10, 2014, http://www.notablebiographies.com/ newsmakers2/2005-La-Pr/Lerner-Sandy.html. Urban Decay, accessed March 10, 2014, http:// www.urbandecay.com.

Martin Lee/Alamy Stock Photo

32

Foursquare is the ubiquitous location-based so- cial network that creatively incorporates gaming elements and marketing. It is the brainchild of Dennis Crowley and Naveen Selvadurai.

Foursquare SwarmCase Study

option for mobile devices that was available in many U.S. cities. Google acquired and oper- ated Dodgeball until 2009, when Dodgeball was shut down and replaced with Google Latitude. AreaCode was a software start-up around game play when Crowley worked there.

RunTunes was a company, started by some friends of Selvadurai, that aimed to bring music to phones. It was bought by Sony Music. Finally, Socialight is a company that creates and pro- motes local content with social interaction and user-content contributions.

NetPhotos/Alamy Stock Photo

Dennis Crowley and Naveen Selvadurai. Scott McDermott/USA Network/NBCUniversal/Getty Images

The Founders Crowley and Selvadurai met in New York City in 2007. They worked for different technology com- panies (AreaCode and Socialight, respectively), but in the same office space. Crowley is a gradu- ate of Syracuse University. He has a degree in advertising and holds a master’s from New York University’s Interactive Telecommunications Program. Selvadurai, a software engineer, holds computer science degrees from King’s College (London) and Worcester Polytechnic Institute (Worcester, Massachusetts).

Both founders had prior experience in the technology field. Crowley worked at Jupiter Communications directly out of college, and at Vindego after that. He cofounded Dodgeball in 2003 and sold it to Google in 2005; he worked for Google after the acquisition. Then, he joined AreaCode as its director of product development. Selvadurai worked at Sun Microsystems, Lucent, RunTunes, and Sony Music. He later joined Socialight as its vice president of engineering.

The companies where the founders worked were related to the business that Foursquare is today. Vindego created mobile applications, in- cluding city guides. Dodgeball was based on Crowley’s graduate thesis, and he partnered with Alex Rainert (currently head of product at Foursquare) to commercialize the concept. Dodgeball was a location-based social networking

Creating at the Kitchen Table About a year after they met, Crowley and Selvadurai began building the first version of Foursquare at Crowley’s kitchen table in the East Village. In March 2009, Foursquare launched at South by Southwest Interactive.

The Products Foursquare was widely popular and became an even more useful mobile app with its increas- ing numbers of users. As users checked in on their mobile devices at various locations, such as restaurants, retail stores, and museums, they added recommendations/reviews. This served three purposes: (1) They told friends where they were. (2) They constructed a set of places visited to serve as reminders. (3) The recommendations provided additional data for other Foursquare users and thus added value to the app.

To increase usage and improve the user ex- perience, Crowley and Selvadurai built incen- tives into the app. For example, users became the “mayor” of a location based on the number of

33

34 UNIT 1: Entrepreneurial Pathways

visits. Users earned virtual badges for the num- ber or variety of check-ins. They also could re- ceive discounts and incentives from advertisers when they checked in. A restaurant might have provided a 10 percent discount or a free dessert.

Foursquare’s original app was designed to generate frequent use. Selvadurai said, “Your app has to have a primary-use case. That brings people back. I think simplicity has a lot to do with it. Simplicity is probably high on that list.” In the case of Foursquare, the “check-in” was the primary use case. The app was designed to make the process quick and easy.

Since its inception, the company has cre- ated two separate apps and developer tools. All of them are based upon “location-aware” expe- riences. Foursquare for Developers is for com- panies and app developers that use it for venue search, geo-tagging and other needs. The prod- ucts are called Places API, Pilgrim SDK, and Places Database. There is a free version of Places API as well as enterprise versions of all products.

The apps are Swarm and City Guide. Foursquare Swarm is “a lifelog that keeps track of every place you go.” The Foursquare City Guide app includes recommendations from other users in a variety of places. As of early 2018, Foursquare reported over 50 million monthly users of its apps with over 12 billion check-ins. The number of employees had reached approxi- mately 250 globally.

Zeljkodan/Shutterstock

Financing A start-up like Foursquare required resources beyond what Crowley and Selvadurai could contribute. They sought venture capital in mul- tiple offerings. The Series A round totaled $1.35

million, which they raised in 2009. The primary investors were Union Square Ventures with O’Reilly AlphaTech Ventures, and the funding was an equity investment. At the time of the in- vestment, Foursquare was valued at $6 million.

The Series B, or second round, totaled $20 million, with Foursquare valued at $95 million in 2010. The group of venture capitalists was led by Andreessen Horowitz with participation by Union Square Ventures and O’Reilly AlphaTech Ventures. The funds were needed to continue the expansion of the company, including the addition of critical team members and a new office space.

The next round of financing was raised on June 24, 2011, at $50 million in equity from Andreessen Horowitz, with Union Square Ventures, O’Reilly AlphaTech Ventures, and Spark Capital. Interestingly, Sarah Lacy notes, “Some firms said they shied away from the deal, because they felt monetization was only more unclear now. With the local space on fire, Foursquare’s target advertisers are already beset with salespeople from Yelp, Living Social, Groupon, Google, and others calling on them. There’s going to be a level of retailer fatigue, and business-wise Foursquare is late to the party.” For this round, the company was valued at $600 mil- lion; again, the funds were needed for expansion.

In the spring of 2013, Foursquare raised an additional $41 million in a loan and convertible debt, rather than equity. The lead on this round was Silver Lake, a private equity firm, which provided a multi-year loan. Both Andreessen Horowitz and Union Square Ventures partici- pated in this round, but with convertible debt. They added $45 million more in 2016.

In total, through these rounds of financ- ing, Foursquare raised $207.4 million in to fuel its start-up and growth, including funding from Union Square Ventures, Morgan Stanley, O’Reilly AlphaTech Ventures, Andreessen Horowitz, Spark Capital, DFJ Growth, SMALLCAP World Fund, Silver Lake Waterman, Microsoft, and a handful of angel investors.

Cofounder Perspective During a presentation in October 2011, Selvadurai shared his seven formulas for creat- ing and building a successful venture:

1. Keep good company. 2. Make something people want. 3. Build around an “atomic action” (e.g., a

check-in).

35 CHAPTER 1: Entrepreneurs and Entrepreneurship

4. Seek mentors early. 5. At first, hunch; then, data. 6. Balance unknowns with knowns. 7. Always be recruiting.

Foursquare reflects the opportunity its founders identified, the team they created, and the resources they garnered.

Case Study Analysis 1-22. Evaluate how Foursquare fits

Schumpeter’s definition and the five basic ways entrepreneurs find opportuni- ties to create new businesses.

1-23. Identify elements of Selvadurai’s seven formulas that were surprising/different for you. How have you already imple- mented some of this formulas in your life? How might you use them in the future?

1-24. Apply Porter’s generic strategies to the industry in which Foursquare Swarm competes, using case information and your own knowledge. Synthesize your analysis. Based on this work, what did you find?

1-25. What prepared the founders to create Foursquare and its specific products?

1-26. What gaps in the founders’ team and resources needed to be filled by outside sources? Name four specific resources they acquired.

1-27. Identify the features and benefits the founders included in the original Foursquare app to ensure its popularity. Why were these selected?

1-28. Is Foursquare Swarm the only app of its kind? If not, what other apps are simi- lar? How do you know this?

1-29. What future do you predict for Foursquare Swarm and City Guide?

Case Sources Spencer E. Ante, “Foursquare Locates New Funds to Expand,” The Wall Street Journal, June 28, 2010, accessed June 30, 2013, http://online. wsj.com/article/SB1000142405274870484600457 5333222375027784.html. “Foursquare,” Crunchbase, accessed February 8, 2018, http://www.crunchbase.com/company/ foursquare. Dan Frommer, “Foursquare Raises $1.35 Million, Led by Union Square Ventures,” BusinessInsider, September 4, 2009, accessed June 30, 2013, http://www.businessinsider.com/ foursquare-raises-13-million-from-union-square- ventures-2009-9. Tomio Geron, “Foursquare Gets $41 Million, Postpones Valuation Question,” April 11, 2013, accessed June 20, 2013, http://www.forbes.com/ sites/tomiogeron/2013/04/11/foursquare-gets- 41-million-postpones-valuation-question/. Antiq Hawk, “Dennis Crowley—Co-Founder and CEO of Foursquare,” Who & Whom, accessed June 29, 2013, http://www.whoandwhom.com/ dennis-crowley/. “Foursquare Closes $50M at a $600M Valuation,” Sarah Lacy, TechCrunch, June 24, 2011. Used with permission. Christopher Nomes, “Naveen Selvadurai—Co- Founder of Foursquare,” Who & Whom, ac- cessed June 29, 2013, http://www.whoandwhom. com/naveen-selvadurai/. Foursquare, accessed February 8, 2018, https:// foursquare.com/about. Naveen Selvadurai, September 30, 2011, Presentation, Reuters Video, accessed June 29, 2013, http://www.youtube.com/watch?v=AbgcM 4QFaH0&feature=player_embedded. Naveen Selvadurai, October 2, 2011, Presentation, Start-Up Bootcamp, accessed June 29, 2013, http://www.youtube.com/watch?v=hH KdkfUM4Js.

CH A

PT ER

2 Pathways to Success: Processes and Instruments

2.5 Summarize the various pur- poses for a business plan and the audiences for one.

2.6 Differentiate the components of a business plan.

2.7 Recognize and demonstrate proper development and for- matting of a business plan.

Learning Objectives 2.1 Describe what a feasibility

analysis is and choose when to create one.

2.2 Articulate the Lean Startup methodology.

2.3 Prepare a Business Model Canvas. 2.4 Identify the primary business

plan contents.

MyLab Entrepreneurship  Improve Your Grade!

If your instructor is using MyLab Entrepreneurship, visit www.pearson.com/ mylab/Entrepreneurship for videos, simulations and writing exercises.

JGI/Jamie Grill/Blend Images/Alamy Stock Photo

37

Great business ideas can grow into great businesses, or they can wither away from neglect or unfavorable circumstances. Successful businesses share the common factors of a sound idea and an entrepreneur who has a plan for turning the that into reality.

Frank Jao worked as a translator for the American military during the Vietnam War, and when Saigon fell in 1975, he and his wife, Kathy, were flown out of the coun- try to Camp Pendleton, California.1 They had the clothes on their backs and about $20.

Frank got a job selling vacuum cleaners door to door within 48 hours of arrival. He also met with a community college counselor who discovered that Frank had sold heavy equipment in Vietnam. The counselor suggested that, because such equipment was a big-ticket item with a long sales cycle, perhaps Frank should try real estate— which was also a big-ticket item with a long sales cycle.

Frank joined a firm that had commercial and residential divisions and was as- signed to residential sales. He observed that the agents working on the commercial side were making more money than his group, so he decided to earn the right to move to the commercial division. In 1979, he made a sale that brought a commission of $350,000, which he and Kathy used to purchase a parcel of raw land in Westminster, California.

Frank dreamed of creating a shopping area that would provide a place for the Vietnamese community to buy and sell products and services they enjoyed in their native land. This dream was realized as the Asian Garden Mall, a modern indoor mall that stands at the center of what is known in Orange County as Little Saigon. Frank has done so much for this community that city leaders named an exit on the busy Interstate 405 freeway after him.

Was it easy to parlay the $350,000 into the Asian Garden Mall? No. Frank had invested his cash into raw land. He had to convince a banker to loan him $3 million needed to build on the land. The banker told Frank that to get a loan he must bring back

a feasibility study and a loan package. In 1979, there was no Internet on which to find free business plans and feasibility analysis templates—and Frank did not have enough money to pay for a professionally prepared loan package with a business plan.

That night, after Frank met with the loan officer, when the bank was closed and the parking lot dark, he climbed into the bank dumpster, where he found several loan packages (privacy rules were different then). He figured that, because they were in the trash, no one would miss them. Using these as guides, he and Kathy created a plan. Three weeks after his first meeting with a commercial lender, Frank was back with the complete loan package, and that banker made the $3 million loan.

“If you don’t know where you are going, any road will get you there.” —Caroll, Lewis. Alice’s Adventures in Wonderland. MacMillan, 1865.

1Original case prepared by Hattie Bryant, creator of Small Business School, a television series made for PBS and Voice of America, http://SmallBusinessSchool.org. Updated with material from M. Roosevelt (2015 April 30), Frank Jao’s story: From refugee to business mogul, Orange County Register.

Dee Jolie/Alamy Stock Photo

38 UNIT 1: Entrepreneurial Pathways

Because of Frank and Kathy’s creativity, courage, and persistence over the years, they have developed over $400 million in retail and residential buildings and have been landlords to 1,200 Vietnamese businesses. Today, their daughter, Felicia Jao, works with Frank to develop the Chinese market.

Feasibility Analysis: Does My Idea Work? The time and energy involved in generating and exploring business ideas can be extensive, with the U.S. Small Business Administration (SBA) re- porting that, for many entrepreneurs, the process can take years. With that sort of massive investment, it is an advantage to filter out the ideas that are viable from those that are not. A feasibility analysis will assist in making the go/no go decision—based on a close examination of product/service, market, industry, and financial data, in a sufficient degree of detail to en- sure confidence in the results. This is an excellent precursor to committing the time and resources to planning the implementation of the business and then presenting it for financing—after the creation of a comprehen- sive business plan. The feasibility analysis essentially tests a business con- cept for viability in three areas:

1. product and/or service feasibility, 2. market and industry feasibility, and 3. financial feasibility.

A feasibility study presupposes the business’s desirability and your interest in this segment of the industry.

Analyzing Product and/or Service Feasibility Entrepreneurs are often described as being committed to their business idea. They take on an almost religious zeal and essentially fall in love with the con- cept of the product or service, creating a fantasy of what the business will be. Conducting a product or service feasibility analysis serves the dual purpose of determining whether realization of the product or delivery of the service is possible at a profit and whether customer demand will be sufficient. Without affirmative answers to both these questions, success will be elusive at best.

A product or service is only worth pursuing if it can be produced and delivered at a profit in an ongoing manner. For example, scientists develop innovative technologies in their laboratories that can significantly outper- form any technology that is commercially available. Some entrepreneurs may want to introduce products that embody the next big technology and move down the path toward securing financing and establishing market- ing strategies, only to find out that the production cost would lead to an unreasonable price and the volume of production would be too low to serve the target market. To avoid such unwelcome surprises, you can cre- ate the production design for your product and create a working model, called a prototype, fabricated for testing by laboratories and prospective customers. Services can also be tested for timeliness and cost of delivery.

Determining whether a product appeals to prospective customers and whether the appeal would translate into sales is vital to assessing feasibil- ity. Subsequent chapters of this text will address specific sources of in- formation that you can use to determine feasibility. These sources can be learned directly from the targeted customer base (primary) or through al- ready existing research (secondary).

It is important to perform this feasibility study to avoid wasting valu- able resources. An amazing product or innovative service will not neces- sarily translate into enough sales to sustain your business.

Learning Objective 2.1

Describe what a feasibility analysis is and choose when to create one.

feasibility analysis a study to assist in making the go/ no go decision based on a close examination of product/ service, market, industry, and financial data.

39 CHAPTER 2: Pathways to Success: Processes and Instruments

If the results of the feasibility analysis are negative, it is time to seri- ously rethink the product or service and its potential fit in the marketplace. Inconclusive or positive results on the product or service itself can be con- sidered, with the balance of the feasibility analysis, to decide whether to proceed to the business plan stage.

Analyzing Market and Industry Feasibility Evaluating the targeted market and industry is essential to determin- ing the viability of a business idea. Just as a seed will grow in fertile soil and wither away in barren earth, business ideas will take hold or fail based largely on the market and industry environment in which they are launched. This segment of a feasibility analysis examines the attractive- ness of the proposed industry and the opportunity to find strategic, de- fensible niches. Later chapters will provide resources for conducting such analysis in greater detail.

One tool that is frequently used for industry analysis is the “five forces” model created by Michael Porter of Harvard University, which focuses on the competitive intensity of a market. The model is designed to assess the overall industry competitiveness level in which closely related or similar products and/or services are sold. You would create a separate model for each proposed line of business. Figure 2-1 provides a visual summary of the model.

The interaction of the forces creates the industry environment, and the attractiveness of participating in it, for a given business.2 The five in- dustry forces identified by Porter are existing competitive rivalry, barriers to entry, threat of substitutes, supplier power, and buyer power.

Existing Competitive Rivalry The degree of rivalry among existing competitors is generally the stron- gest force in an industry and is influenced by all the other forces. Some industries are more aggressive and competitive than others, and you will want to know how your business could fit in the existing environment. For example, look at the number of Chinese restaurants in a large city or

2Adapted from Michael E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review, March/April 1979, pp. 137–145.

Figure 2-1 Porter’s Five Forces of Competition in an Industry

Bargaining Power of Suppliers (Supplier Power)

Threat of New Entrants (Barriers to Entry)

Threat of Substitute Products

Bargaining Power of Customers (Buyer Power)

Competitive Rivalry among

Existing Firms

40 UNIT 1: Entrepreneurial Pathways

the competitive environment for power companies. Key aspects of intense rivalry, according to Porter, include:

• Many firms of approximately the same size • An industry experiencing slow growth • Lack of differentiation • Low switching costs for customers • High fixed costs • Perishable products • The need to create new production capacity in large increments • High barriers to exiting • Diverse rivals

Barriers to Entry In an industry, the threat of new entrants is largely defined by the strength of the barriers erected to prevent them. As an entrant, you want the barriers to be low. As an established firm, you want them to be high. For example, it is relatively easy to start a landscaping company, so competitors range from the neighborhood teenager with the family mower to larger compa- nies with more expensive equipment and many employees. According to Porter, sources of barriers to entry include:

• Capital requirements • Cost advantages • Economies of scale • Access to distribution channels • Product differentiation • Government policy

Threat of Substitutes The level of threat posed by alternative products and services to industry customers matters. Substitutes cap the price a company can charge and affect the industry as a whole. For example, newspapers are closing as peo- ple increasingly receive their news and other information via electronic media. The retail movie-rental business had been seen as a threat to movie theaters, and now those same retail rental stores are vanishing with the advent of Netflix and pay-per-view movies. Some defining factors include:

• Convenience • Price competitiveness • Supply availability • Switching costs • Public policies

Supplier Power The less bargaining power and control the suppliers of raw materials, com- ponents, and labor have over competitors, the more attractive the industry. Where there are a few powerful suppliers, new entrants will have little flex- ibility or control, both of which they need. Porter suggests that suppliers are more powerful when the following industry factors apply:

• There is domination by a few companies. • The products are differentiated. • Switching costs are high.

41 CHAPTER 2: Pathways to Success: Processes and Instruments

• Substitutes are not readily available. • They can threaten to move into the business themselves. • The industry is not important to the supplier.

Buyer Power This force is like that of suppliers, but on the demand side. The larger and more diverse the customer base, the less dependent competitors in an in- dustry will be on particular customers. Where customers are many, they can exert control to force prices downward, quality upward, and margins to the floor. Generally, the more a company is recognized for being the low-price leader in its industry, the more it applies pressure to its suppliers and will have the power to get what it wants. According to Porter, buyers are more powerful in an industry if:

• They are concentrated. • They purchase a lot. • Products are undifferentiated or standard. • Products are not a big part of the overall cost. • Profits are low. • Product quality is not important. • Products do not save money for the buyer.

As you examine the industry in relation to each business idea, it will be- come easier to determine its current attractiveness. To further analyze the information, you can create a table listing each factor and assign a weight to each to develop a quantitative analysis of the competitiveness in each industry.

Once you have selected the industry, it is time to find a defensible target or set of targets that you can claim and protect. You can design a focus strategy to foster business success if you have identified a niche of sufficient size to permit profitability. Identifying this niche and the poten- tial growth of the segment will be an excellent precursor to completing the financial feasibility analysis.

Analyzing Financial Feasibility Having completed the product or service feasibility analysis and con- ducted one for the market and industry, you can complete this process by assessing the financial viability of your business idea. This analysis does not need to be detailed. At this point, addressing capital requirements, rev- enues, costs, and earnings should suffice.

The amount of start-up capital required will be a function of the size and type of organization you are starting. For example, a business that is bringing a patented technology to market by assembling components manufactured by other companies will have lower capital costs than one that manufactures and assembles the parts. Some businesses require very little start-up capital, whereas others might require millions of dollars before making a single sale. A complete financial feasibility analysis will forecast and incorporate such factors.

An entrepreneur can better assess feasibility with a reasonable projec- tion of revenues based on anticipated pricing and volume. Using industry- comparable data can support estimates. There is often temptation to be overly optimistic or pessimistic at this stage, so tempering these extremes with valid data can be significant.

Finally, cost factors should be calculated, and returns on investment should be projected. The earlier analysis of the product or service viability

42 UNIT 1: Entrepreneurial Pathways

enters into this calculation. By understanding projected costs and offset- ting them against revenues, profit projections are possible. With these pro- jections in hand, you can evaluate the return on the capital invested to make a go/no go decision.

The outcome of the feasibility analysis will be to show whether the business idea can be a profitable venture with a sufficiently large return on investment. This is a step in the filtering and selection process that nar- rows and focuses the business idea so that it can be further developed or set aside for a more desirable concept.

Using the Lean Startup Methodology Much work and discussion have revolved around determining the best way to assess feasibility and how entrepreneurs should proceed. After the dot-com bubble collapsed around the turn of the twenty-first century, the heady days of creating business models without business plans for inves- tors gave way to a reconsideration of the importance of business plans and viable models. In addition, various methods of getting to a more rapid rev- enue stream have evolved. It is important to understand that the audiences for your business concept and the industry in which it will compete have a lot to do with what will work best.

The notion of the Lean Startup, a hypothesis-driven approach using iterative development, was introduced by Eric Ries in 2008 and has gained substantial traction since then. Because of the many constraints on startup resources such as time and money and the high level of uncertainty, the ability to rapidly create and test hypotheses (guesses) can reduce costs, stretch scarce resources and avoid the ultimate failure . . . offering a prod- uct or service that does not sell.

The Lean Startup’s hypothesis-driven approach shortens product de- velopment cycles through experimentation, iterative product releases, and validated learning. It reduces waste and increases value. It relies upon the iterative process illustrated in Figure 2-2. This process of focusing on speed in product development works toward ensuring product-market fit. If a start-up’s products are not a good fit with its markets, the likeli- hood of success is slim at best. This process also leads to the generation of actionable metrics, which are measurements of the key drivers of the start-up business that guide informed decisions and actions. Once all re- maining hypotheses are validated to the organization’s satisfaction, it is time to move into execution.

Learning Objective 2.2

Articulate the Lean Startup methodology.

Lean Startup a hypothesis driven approach to business startup using iterative development.

actionable metrics mea- surements of the key drivers of the start-up business that guide informed decisions and actions.

Figure 2-2 Build–Measure–Learn Loop

Create ideas

Build product

Measure Analyze

data

Learn

43 CHAPTER 2: Pathways to Success: Processes and Instruments

These iterative stages include several parts. A key tool used in the Lean Startup is the business model canvas, a visual representation of the primary business hypotheses, as described in detail in the next section. Start-ups cre- ate minimum viable products (MVP), models or version of a new product that are designed to secure maximum customer feedback with minimal effort. By testing MVPs, start-ups avoid wasting precious resources develop- ing product features and benefits that customers don’t want or need. Once hypotheses are tested, start-ups can pivot, persevere, or perish. If they pivot, they change the model to some extent, but keep parts of it. If they elect to persevere, they continue the same path. Or they may opt to perish and discontinue the start-up. Groupon is an excellent example of an organiza- tion that pivoted successfully. It started out as The Point, an online activ- ism platform that struggled to gain traction. However, one day it offered a coupon promotion for the pizzeria in its building through its Word Press blog, and the response came as a surprise. This pivot from digital activism to digital discounts meant the difference between success and failure.

The Lean Startup methodology was initially introduced in the web/ mobile arena with IMVU and expanded across many industries and busi- ness types. It can be adopted in a multitude of situations. However, it is not an excellent choice under several circumstances. For example, if the in- dustry is highly regulated and the opportunities to test and iterate are lim- ited or very costly, such hypothesis testing becomes unwiedly, as it does in cases where society will not tolerate mistakes, particularly in human trials for pharmaceuticals. Another challenge arises in instances when the devel- opment cycle for the product is particularly long, because the development cycle simply prevents the ability to follow the Lean Startup principles of launching early and failing fast.

Creating a Business Model Canvas Beyond the feasibility analysis described earlier, there is value and elegance in using the Lean Startup process and creating a series of busi- ness model canvases to focus your thinking as you launch the business planning process.

Alexander Osterwalder and Yves Pigneur, along with hundreds of online collaborators, have created a tool for generating business models called the Business Model Canvas.3 A business model is a company’s plan to generate revenue and make a profit from operations. The Business Model Canvas is a visual representation of the critical components, and creating it well will compel you to think through many facets of the business. The “canvas” is intended to be created on a large scale, so that ideas and information can be posted on it to create a clear representation. Many variations on the Business Model Canvas have been created and are available online. An illustration of the Osterwalder-Pigneur canvas is included here as Figure 2-3. As you progress through this text, you will find end-of-chapter Canvas Connections that will relate chapter content to the Business Model Canvas.

The canvas includes nine core building blocks that are intended to supply answers to critical questions. These building blocks are meant to be implemented in the company. They are:

1. Customer segments (CS): the customers for whom the company creates value a. Mass market—a large, broadly similar group of customers b. Niche market—a narrow, specialized, specific group of customers

minimum viable product a model or version of a new product that is designed to secure maximum customer feedback with minimal effort.

Learning Objective 2.3

Prepare a business model canvas.

business model a com- pany’s plan to generate rev- enue and make a profit from operations.

Business Model Canvas a visual representation of a Lean Startup’s core business hypotheses.

3Alexander Osterwalder and Yves Pigneur, Business Model Generation: A Handbook for Visionaries, Game Changers, and Challengers, Hoboken, NJ: John Wiley & Sons, 2010.

44 UNIT 1: Entrepreneurial Pathways

Figure 2-3 Business Model Canvas

Key Partners

Who are our Key Partners?

Who are our Key Suppliers?

Which Key Resources are we acquiring from partners?

Which Key Activities do partners perform?

Motivations for partnerships:

Optimization and economy

Reduction of risk and

uncertainty

Acquisition of particular

resources and activities

What Key Activities do our Value Propositions require?

Our Distribution Channels?

Customer Relationships?

Revenue Stream?

Categories:

Production

Problem Solving

Platform/Network

What value do we deliver to the customer?

Which one of our customer’s problems are we helping to solve? What bundles of products and services are we offering to each Customer Segment?

Which customer needs are we satisfying?

Characteristics:

Newness

Performance

Customization

“Getting the Job Done”

Design

Brand/Status

Price

Cost Reduction

Risk Reduction

Accessibility

Convenience/Usability

What type of relationship does each of our Customer Segments expect us to establish and maintain with them?

Which ones have we established? How are they integrated with the rest of our business model?

How costly are they?

Examples: Personal Assistance

Dedicated Personal

Assistance

Self-Service

Automated Services

Communities

Co-creation

For whom are we creating value?

Who are our most important customers?

Mass Market

Niche Market

Segmented

Diversified

Multi-sided Platform

Through which Channels do our Customer Segments want to be reached?

How are we reaching them now?

How are our Channels integrated?

Which ones work best?

Which ones are most cost-efficient?

How are we integrating them with customer routines?

Channel Phases: 1. Awareness

2. Evaluation

3. Purchase

4. Delivery

5. After sales

What Key Resources do our Value

Propositions require?

Our Distribution Channels?

Customer Relationships?

Revenue Streams?

Types of Resources:

Physical

Intellectual (brand patents,

copyrights, data)

Human

Financial

Key Activities

Key Resources Channels

Revenue StreamsCost Structure

Value Propositions Customer Relationships

Customer Segments

What are the most important costs inherent in our business model?

Which Key Resources are most expensive?

Which Key Activities are most expensive?

Is your business more:

Cost Driven?

Value Driven?

Sample Characteristics:

Fixed Costs

Variable Costs

Economies of Scale

Economies of Scope

For what value are our customers really willing to pay?

For what do they currently pay?

How are they currently paying?

How would they prefer to pay?

How much does each Revenue Stream contribute to overall revenues?

Types: Asset sale

Usage fees

Subscription fees

Lending/Renting/Leasing

Licensing

Brokerage fees

Advertising

Fixed Pricing: List Price

Product-feature dependent

Customer-segment dependent

Volume dependent

Dynamic Pricing: Negotiation (bargaining)

Yield Management

Real-time-Market

Designed by: Business Model Foundry AG. The makers of Business Model Generation and Strategyzer. This work is licensed under the Creative Commons Attribution-Share Alike 3.0 Unported License. To view a copy of this license, visit: http://creativecommons.org/licenses/by-sa/3.0/or send a letter to Creative Commons, 171 Second Street, Suite 300, San Francisco, CA, 94105, USA.

c. Segmented market—groups with slightly different needs and problems

d. Diversified markets—segments that aren’t related and have very different needs

e. Multi-sided markets—generally are composed of supplier and customer segments that are all served

45 CHAPTER 2: Pathways to Success: Processes and Instruments

2. Value proposition (VP): the reason customers select the products/services a. Newness b. Performance c. “Getting the job done” d. Design e. Brand/status f. Price g. Cost reduction h. Risk reduction i. Accessibility j. Convenience/usability

3. Channels (CN): how the company reaches and communicates with customer segments a. Own channels versus partners b. Direct (sales force, web sales, own stores) versus indirect (partner

stores, wholesalers)

4. Customer relationships (CR): types established through consumer segments reached a. Personal assistance b. Dedicated personal assistance c. Self-service d. Automated services e. User communities f. Co-creation

5. Revenue streams (R$): how funds are generated a. Asset sales b. Usage fee c. Subscription fees d. Lending/renting/leasing e. Licensing f. Brokerage fees g. Advertising fees

6. Key resources (KR): that which is critical to making the model function a. Physical b. Financial c. Intellectual d. Human

7. Key activities (KA): critical actions for success a. Production b. Problem solving c. Platform/network

8. Key partnerships (KP): the suppliers and partners needed in the network a. Strategic alliances between noncompetitors b. Cooperation (strategic alliances between competitors) c. Joint ventures d. Buyer–supplier relationships

9. Cost structure (C$): all costs of operations

46 UNIT 1: Entrepreneurial Pathways

An example of a business model canvas for Foursquare (see Chapter 1) is shown in Figure 2-4. It creates a clear visual representation of the critical factors for the success of the company as described in the case studies. A video about the canvas and a printable poster are available on the Business Model Generation site at http://www.businessmodelgeneration.com.

What Is a Business Plan? Each approach to business start-ups requires a business plan for funding and operations. Therefore, it is always good to know how to create a full business plan. This text will walk you through the business plan develop- ment process and make the value clear.

By the time you complete this book, you may write a business plan that you can use to design, start, and operate your own venture. A business plan is a document that thoroughly explains a business idea and how it is intended to be carried out. It is more an execution

Learning Objective 2.4

Identify the primary busi- ness plan contents.

business plan a document that thoroughly explains a business idea and how it is intended to be carried out.

Figure 2-4 Simple Business Model Canvas for Foursquare

Key Partners Key Activities

Key Resources Channels

Revenue StreamsCost Structure

Value Propositions Customer Relationships

Customer Segments

Technology suppliers

Charitable beneficiaries

Co-creators (users)

Information providers

Contract support

Marketing

Software production/development

Technology upgrades

Platform/Network

Data acquisition

Customization

City Guide-City Searchers

Increased quality experiences

Convenience/Usability

Customization

Geotagging

Customization

Performance

“Getting the job done”

Venue Search

Convenience/Usability

“Getting the job done” = reach Convenience

“Location aware” apps & development tools

Advertisers

Performance

Customization

Swarm-Life Loggers

Tracking experiences

Fun

Price

Fun

Price

Foursquare API & Analytics,

Database-Developers/ Pilgrim SDK, Places

Companies

Personal assistance

Automated services

Automated services

Communities Personal Assistance

Automated services Co-creation

Advertisers

Large Corporations-app

development

Location Aware App Developers

Multi-sided market

Life Loggers

City Searchers

Intellectual property (data, patents,

copyrights)

Human capital

Financial capital ($207.4 million

by 2018)

Word-of-mouth Social media Publicity

App Developers & Large Corporations

Advertisers

Advertisers

Life Loggers & City Searchers

App Developers & Large Corporations

App Developers

Large Corporations

Advertisers, Life Loggers, City Searchers Web/mobile

Advertising Salesforce

Web/mobile SaaS

Marketing

Technology

Human Resources

Legal

Facilities

Enterprise licenses, consulting, upgrades

Advertising sales

Developer fees

47 CHAPTER 2: Pathways to Success: Processes and Instruments

document than an exploratory one. The plan should include the following:

• the story of what the business is and hopes to become, • costs projections and a marketing plan, • a description of how the business expects to be financed, and • an estimate of projected earnings.

The foremost reason to write a business plan is to organize your thoughts before starting a business, preferably as you complete the Lean Startup process. Some of the entrepreneurs in this book wrote a business plan before they made a single sale. However, many, if not most, busi- nesses are started based on a concept in the founder’s head. Writing a busi- ness  plan can be a daunting and time-consuming process. Even though creating a plan is a best practice for execution and financing, many entre- preneurs elect not to create one, often to their detriment. In fact, a well- written plan will help guide you as you develop your business from a start- up in search of a scalable model to an established organization.

A complete business plan is included in this chapter to assist you in developing your plan. The Honest Tea business plan was created by Seth Goldman and Barry Nalebuff in 1998. It has its strengths and weak- nesses, as Goldman will readily admit, but it will show how you might create a plan of your own. There are numerous sample plans available via the Internet as well. In addition, the BizBuilder Business Plan tem- plate will lead you through a series of questions to assist in your plan’s development.

Do You Need a Business Plan? Whether you are planning a microenterprise with virtually no start-up costs or a multimillion-dollar venture, you will find a business plan an valued resource. No serious professional investor will agree to meet unless you have put together a comprehensive, convincing business plan. A plan can also help you determine on paper whether your busi- ness can be viable before you make predictable mistakes in the real world—allowing you to adjust accordingly. It will force you to analyze markets and opportunities before you attempt to secure financing. The business plan is used by current and proposed businesses as a guide to operations and direction, which can be modified as the organization evolves.

While you work on your plan, you will also be assessing how to make your business successful. Before you serve your first customer, you will have answered every question you can think of. How much should you charge for your product or service? What exactly is your product or ser- vice? Who will buy it? What will your costs be? How are you going to mar- ket your product or service? How and where will you sell it? Figuring all this out in advance should save you time and money.

The business plan can be a first line of defense against a poor idea. If your proposed business is weak or marginal, you should see this as you develop the plan and avoid the high cost of failure. It is less costly not to begin a business than it is to fail in one that had fatal flaws from the outset.

If you start your business without a plan, these kinds of questions can overwhelm you. By the time you have completed the exercises in this book, though, you will have answers, and you will be able to chart a road map for your own business. You can use the BizBuilder tools to create a

Learning Objective 2.5

Summarize the various pur- poses for a business plan and the audiences for one.

48 UNIT 1: Entrepreneurial Pathways

professional plan and a presentation deck (often in PowerPoint) that will emphasize the highlights of your strategy.

Several software packages are designed to help you write a business plan. These products and their sample business plans will provide guidance in developing your own unique design. Be wary of creating a cookie-cutter plan and fall- ing into the trap of using the data and financial projections of sample plans. In the end, a busi- ness plan must be the creation of the individual who will operate the business.

In addition, by using the web, you can save some time and money by presenting your busi- ness plan to several investors at a time, no matter where they are located. You can broadcast your presentation in real time over the web or send it electronically to interested parties. Although it is always preferable to make a presentation in per- son, this can be an effective way to submit your business plan to investors at their convenience. Remember, though, that proper nondisclosure

agreements are an absolute necessity, because business plans are the valued property of their developers.

Your Business Plan Is the Key to Raising Capital As mentioned, bankers and other potential investors will refuse to see an entrepreneur who does not have a business plan (unless the loan or invest- ment you are seeking is very small). You may have a brilliant idea, but if it is not written, people will be extremely unlikely to invest in your business or loan you money.

A well-written plan will show investors that you have carefully thought through how you intend to make your business profitable. Combining it with the results of your Lean Startup process can be particularly potent. The more detail you offer investors about how their money will be used, the more willing they will be to invest. The financial projections should be realistic and attainable. Your plan should be so thoughtful and well writ- ten that the only question it raises in an investor’s mind is: “How soon can I invest?”

The Business Plan Is an Operations/Execution Guide Whether or not you need to raise capital, a business plan will be a use- ful tool for guiding internal operations. Business owners and managers increase the probability of success by taking the plan in their heads and committing it to paper. The transition may be bumpy, because the process of writing a coherent plan will require you to answer difficult questions. However, in addition to guiding you as the entrepreneur, developing the plan will generate an increased clarity of vision, mission, and goals for your entire team. With your business plan as your benchmarking tool, you can compare your company’s progress to your stated plan. You can also use the business plan as a point of reference when it seems you are going off track or becoming distracted from your goals. The presence of finan- cial and operational goals and measures, as well as mission and vision statements, can feed a drive for success and motivate a team to excellence.

Writing a business plan will allow you to address all known angles of your business idea. (George Doyle/Stockbyte/Getty Images)

49 CHAPTER 2: Pathways to Success: Processes and Instruments

Business Plan Components As you launch a new enterprise, there is a seemingly endless variety of problems and questions. Such a situation could quickly overwhelm you with- out a plan. However, by the time you have worked through all the steps of a business plan, you will have many answers. You will develop a love for the business, rather than being in love with the idea of the business. The order of the components of a plan can vary somewhat, but there are elements common to all. An outline of one kind of business plan is illustrated in Exhibit 2-1.

Cover Page and Table of Contents The cover page should be professional, neat, and attractive. It should pro- vide the name of the business and the principals, the date, contact infor- mation, and any confidentiality statement. The table of contents should be detailed enough that the reader can easily find a section, but not so detailed that it takes up pages of the plan.

Learning Objective 2.6

Differentiate the components of a business plan.

Cover Page Table of Contents 1.0 Executive Summary 2.0 Mission, Vision, and Culture 3.0 Company Description 4.0 Opportunity Analysis and Research

4.1 Industry Analysis 4.2 Environmental Analysis 4.3 Competitive Analysis

5.0 Marketing Strategy and Plan 5.1 Products/Services 5.2 Pricing 5.3 Promotion 5.4 Place

6.0 Management and Operations 6.1 Management Team 6.2 Research and Development 6.3 Physical Location 6.4 Facilities 6.5 Inventory, Production, and Quality Assurance

7.0 Financial Analysis and Projections 7.1 Sources and Uses of Capital 7.2 Cash Flow Projections 7.3 Balance Sheet Projections 7.4 Income Statement Projections 7.5 Breakeven Analysis 7.6 Ratio Analysis 7.7 Risks and Assumptions

8.0 Funding Request and Exit Strategy 8.1 Amount and Type of Funds Requested 8.2 Exit Plan 8.3 Milestones

Appendices Resumes Sample Promotional Materials Product Illustrations/Diagrams Detailed Financial Projections

Exhibit 2-1 Business Plan Outline

50 UNIT 1: Entrepreneurial Pathways

Executive Summary: A Snapshot of Your Business The executive summary must be compelling and comprehensive. It may be the only part that many people will read. It will be the hook that at- tracts potential investors or loses their attention. If a reader doesn’t fully understand the business concept and the purpose of the plan from the executive summary, the rest of the plan is likely to remain unread. The executive summary must encapsulate the story of the business clearly and concisely, propose the funding request, and inspire enthusiasm for its po- tential success.

This section should be written last and limited to one or two pages. It should answer the who, what, when, why, and how questions for the busi- ness. Who will manage the business? What will it do, and what is the owner asking for in the plan? When will the proposed plan be implemented? How will the business succeed? If the executive summary is done well, the reader will have a “light-bulb” moment and be eager to read the rest of the plan.

Mission, Vision, and Culture: Your Dreams for the Organization Each company can create its own unique mission, vision, and culture. The founding team can determine how to strategically use the company’s competitive advantage to satisfy customers. Culture that the owners model and support can be shaped according to the environment and the manner of treating employees, customers, and other stakeholders. The mission of your business, expressed in a mission statement, is a concise communi- cation of strategy, including your business definition and competitive ad- vantage. The function of a mission statement is to clarify what you are trying to do, and it can provide direction and motivation to those who are involved in the business.

A clearly stated mission statement not only tells your customers and employees what your business is about but can also be a guide for every decision you make. It should capture your passion for the business and your commitment to satisfying your customers. The mission statement should be clear and concise, no more than 21 to 40 words.

The vision for your business will be broader and more comprehen- sive, painting the big picture of what you want your organization to be- come. It is built on the core values and belief system of the organization. It is typically shorter than the mission statement, with a loftier perspective.

The culture of an organization, whether intentionally or unintention- ally created, is largely defined by its leadership. You can build a culture for your company by making beliefs, values, and behavioral norms explicit and intentional. A business’s culture has many components, including atti- tudes toward risk tolerance and innovation and its orientation with respect to people, team formation and outcomes, attention to detail, and commu- nication. Whether you want a free-thinking, aggressive company with in- formal communications or a structured, formal organization with more “official” interactions, you will set the standards and be the role model for your business’s culture.

Company Description: Background and Track Record If the company is already established, is a franchise, or is the reincarnation of a previous business, there will be a history to share with the reader. The business description does not need to be long; it should simply provide the background for understanding. It should include summary information about the company’s founding, its progress, and its financial success.

mission a concise commu- nication of strategy, includ- ing a business definition and explanation of competitive advantage.

mission statement a brief, written statement that informs customers and employees what an organization’s goal is and describes the strategy and tactics to meet it.

vision a broader and more comprehensive perspective on an organization than its mission; built on the core val- ues and belief systems of the organization.

culture the beliefs, values, and behavioral norms of an organization.

51 CHAPTER 2: Pathways to Success: Processes and Instruments

If this is a start-up venture, this section should describe briefly the background story of the company, explaining what you have done thus far and why you have done it. The legal form of the business (sole proprietor- ship, corporation, LLC, partnership) should also be noted.

Opportunity Analysis and Research: Testing Ideas The opportunity analysis and research section will provide the credible in- formation to demonstrate the market viability of your proposed business before you launch. It should be a clear description of why the business pres- ents an excellent opportunity, based on sound research and logic, including hypothesis testing. Entrepreneurs often either put little time and attention into this section or ignore data that contradict their optimistic view of the opportunity. This can prove to be a fatal flaw. A sound opportunity analysis can help to move your business to the head of the line for financing.

The industry analysis will provide the broad context. It will address such factors as industry definition, industry size and growth (or decline), product and industry life cycle, and any current or anticipated legal or reg- ulatory concerns. Determining industry structure, including geographic distribution, business size of member firms, concentration of power, and rates of failure, is also important. For example, the failure rate of restau- rants is notoriously high and should be addressed in a business plan for a dining establishment.

The environmental analysis addresses the roles of the community, region, nation, and world relative to your business. Whether or not demographic and family changes are working in your favor could mean adjustments for the business. Changes in technologies and economic con- ditions might radically alter your plans. Examples could include the aging of the baby boomer generation or the prevalence of computer technology.

The opportunity analysis should include a proof of market investi- gation that will provide evidence of a market opportunity for your orga- nization. This should identify market size, both in terms of dollars and units. There must be enough customers who will purchase your product or service in sufficient quantity at a high enough price and often enough for your business to be sustainable. This can also be provided through the analysis of product-market fit conducted in the Lean Startup process.

industry analysis a critical view of industry definition, industry size and growth, product and industry life cycle, and any current or anticipated legal or regulatory concerns.

environmental analysis a review that addresses the roles of the community, region, nation, and world relative to a business.

proof of market an investi- gation that provides evidence of a market opportunity.

G lo b a l I m p a c t .   .   .

Upcycling Waste Internationally—TerraCycle, Inc. In 2003, John Szaky’s TerraCycle won a business plan contest from Carrot Capital for $1 million in seed funding. But the ven- ture capital firm wanted TerraCycle to drop its environmental focus, and Szaky turned down the offer. It was a critical de- cision that later helped the business achieve its competitive advantage.

TerraCycle converts unrecyclable packaging waste to upcycled products. An early inspiration was implemented when TerraCycle ran out of money to buy bottles in which to sell fertil- izer derived from worm waste. It was decided to pack it in recy- cled soda bottles. This concept expanded into the production of other green products. Pencil holders made from Kool-Aid pack- ets, tote bags made from Capri Sun drink pouches, and back- packs made from Clif Bar wrappers are just a few examples of

the more than 100 TerraCycle products sold in large retail chains, including Home Depot, Whole Foods, Walmart, and Target. The concept has spread to the United Kingdom, Brazil, Mexico, Israel, and Canada, among others. By working with concerned groups in each country, TerraCycle has become an iconic representative of upcycled waste. TerraCycle calls this process turning “branded” waste into “spon- sored” waste. Source: TerraCycle, Inc., accessed April 6, 2014 and February 11, 2018, http://www.terracycle.com. Renee Bonnafon/Sacramento

Bee/MCT/Newscom

52 UNIT 1: Entrepreneurial Pathways

Next, this analysis should describe your target market segments, which are groups of people defined by common factors, such as demographics, psychographics, behavioral factors, or geography. For example, your target market segment for a gospel club may be African-American Christians between 18 and 25 years of age living in the metropolitan area of Mobile, Alabama. Discuss the size of your target market and the market share that would be attainable. This is also where you can describe identified customers.

A competitive analysis is the next important component of the oppor- tunity analysis. This should compare your organization with several direct and indirect competitors by name and include comparisons that would be meaningful to customers. The format of a competitive analysis can vary significantly, but it must make clear where your competitive strengths and weaknesses are and where there are gaps in the competitors’ businesses. Factors to compare may include, but would not be limited to, location, product selection, market share, product or service quality, experience, ad- vertising, pricing, finances, capacity, hours, size and skill of workforce, and reputation. It is often most effective to create a chart or table to show this.

Marketing Strategy and Plan: Reaching Customers A description of how you will reach your customers and your anticipated sales volume brings the opportunity and research discussion to the bot- tom line of sales. Your marketing mix will be the combination of the four factors (the “Four Ps”) that form your competitive advantage—also known as your core competency—product, price, promotion, and place. As you choose the elements of your marketing plan, always keep your vision in mind. What benefit is your product or service providing to customers? What is your value proposition?

• Products/Services. The product or service must meet or create a customer need. The distinctive features and benefits of the entire product or service must be clearly stated. If you are introducing an innovative technology, the value of the innovation to customers war- rants explanation.

• Pricing. The product or service must be priced so that your tar- get customers will buy it and the business will make a profit. Price should reflect your vision, strategy, and policy. It must be right. For example, if you are marketing a luxury item, a relatively low price might send the wrong message. Highlight competitive advantages— such as quality, credit terms, warranty type and length, service, and innovativeness—that support the pricing.

• Promotion. Promotion consists of advertising, publicity, and other promotional methods, such as discount coupons or giveaways. Publicity is free, whereas advertising is purchased. The description of your promotional plans should be specific with respect to the meth- ods used, the timeline for implementation, and the budget. Often this section is further divided into advertising, public relations and publicity, and direct marketing. Advertising consists of paid promo- tion through media outlets, such as broadcast or cable television, the Internet, radio, magazines, and newspapers. Public relations consists of community activities that are designed to enhance your organization’s image. Publicity is free notice in the media presented as news. Direct marketing includes telemarketing, direct mail, in- person selling, and other personalized efforts. Remember to include samples of your promotional materials in the appendices of your plan, if possible.

target market groups de- fined by common factors such as demographics, psycho- graphics, behavioral factors, or geography that are of pri- mary interest to a business.

competitive analysis research that compares an organization with several direct and indirect competi- tors by name in a manner that is meaningful to targeted customers.

marketing mix the combi- nation of the four factors— product, price, place, and pro- motion—that communicates a marketing vision.

marketing plan a statement of the marketing goals and ob- jectives for a business and the intended strategies and tactics to attain them.

advertising paid promotion through media outlets.

public relations community activities that are designed to enhance an organization’s image.

publicity free promotion.

direct marketing includes telemarketing, direct mail, in-person selling, and other personalized promotional efforts.

53 CHAPTER 2: Pathways to Success: Processes and Instruments

• Place. This is where you will sell or distribute your product. If you are a physical retailer, your selling location should be where consum- ers in your target market do their shopping. Where should you be to bring your company to the attention of your market? If you are selling a luxury item, you will need to place it in stores or on websites that are visited by customers who can afford it. Included in place is your selection of a type of sales force (e.g., independent, company, single line, or multiline), any geographic definition of your market, and all channels of distribution. Are you going to sell directly to consumers, work through wholesale distributors, be web-based, or sell at retail?

Management and Operations: Making the Plan Happen The people you hire and the processes you plan to implement will be an es- sential part of your business plan. This is where the rubber meets the road in the planning process.

The management team is often the deciding factor for a potential inves- tor’s decision to fund a business. Moreover, with all other factors being equal, a strong management team will be successful in a business, and a weak one will fail. The team must be composed of an effective balance of members with technical expertise (e.g., engineering, marketing, accounting, and operations), experience in the field, and life experience. Briefly discuss the current and proposed management team and reference their resumes in the appendices.

It can also be worthwhile to add an organizational chart representing the company as it is proposed in the near term and with growth. In addi- tion, descriptions of key roles and responsibilities, and the compensation rates and structures for each, need to be included.

If your business will be involved in research and development, this sec- tion should describe it. Include the state of development, such as MVP, proto- type, testing, or commercialization. Any patents, patents pending, or other intellectual property should be discussed, within the limits of law (not losing protection), plus the stage of commercial readiness.

The description of the operating location is like the discussion of place in the marketing mix but with the emphasis on logistics and workforce readiness. Describe the desired physical location(s) of the organization and the rationale. For example, if you require a concentration of highly skilled scientists, you might want to lo- cate near a university with a strong science orientation or near other firms with similar labor-pool requirements. Local wage rates and community support are other factors to mention. In addition, geographic proximity to customers and/or suppliers or distribu- tors may be a critical site factor. Other aspects to consider are business-friendly laws and courts, tax rates and structures, school systems, overall quality of life, and environment.

The facilities required for the success of your enterprise should be discussed in detail. You should describe the building according to its type and size, and equipment should be specified and “costed out” (details can be included in the appendices). If you know that you require production, warehousing, showroom, or office space, you can describe each. Discuss your plans to lease or purchase prop- erty and equipment and the tipping point for switching from lease to purchase. Remember that it isn’t financially prudent to buy a building when you only need a small “incubator” space to get started. Nascent entrepre- neurs often immediately want to buy facilities and brand-new equipment. In reality, leasing space and equipment reduces required start-up capital and can provide greater flexibility.

The facilities and equipment for your business should be planned with the management team. (Todd Wright/Blend Images/ Alamy Stock Photo)

54 UNIT 1: Entrepreneurial Pathways

The production methods and inventory-control systems that you plan to use will be critical to your success. Even if you are in a service enter- prise, you will have supply issues to address in terms of staffing, logistics, and materials. The business plan is an opportunity to set inventory control systems, production processes, and quality-assurance methods. You can highlight any technological innovations that will enhance the company’s competitive position. What to include will vary considerably, but the iden- tification of your choices and methods of measurement is essential.

Financial Analysis and Projections: Translating Action into Money The financial section is the numeric representation of the business plan. It should demonstrate organizational viability in financial terms. Commercial lenders will often go directly from the executive summary to the financials before reading anything else. If the numbers make sense, they may look at the rest of the plan. If not, your plan may well land in the trash basket. Your financial estimates should be as realistic as you can make them. Don’t pad the numbers. It is not in your best interest to create unrealistic expectations, to delude yourself and your business associates, or to have potential investors or lenders reject your projections as pie-in- the-sky. You are likely to show initial losses, and you should be up front about this. The financials should match both the general market and the other information you provided throughout the business plan. Investors can sense overblown numbers and will react accordingly.

• Sources and uses of capital. This section is the numeric representa- tion of the start-up costs plus a verbal description of capital require- ments. It states where you expect to obtain your financial support and how you will use the funds. When securing bank or community development financing, your lender may require you to “draw down” funds in accordance with your list of costs. Make the list as complete and accurate as possible. It is a sad day for everyone when an entre- preneur’s credit and cash are completely exhausted just short of the start-up point. A sample start-up cost list is shown in Exhibit 2-2.

S t e p i n t o t h e S h o e s .   .   .

Lit Motors, Attacking Congestion and Pollution Danny Kim, an ASE certified Land Rover mechanic, always liked to build things. In 2003, he traveled the world and no- ticed that two-wheeled vehicles were the predominant mode of transportation. The following year, he realized that he could create a balanced “half-car” for city use, and the seed for Lit Motors was planted. After studying at the Rhode Island School of Design, Danny relocated to San Francisco and in 2010, he founded Lit Motors.

Danny did not wait until he had a full-size prototype to so- licit customer feedback. In fact, he secured a three-year lease from an excited property owner who had seen a ¼ scale proto- type. In 2011, at the advice of Steve Jurvetson, venture capital- ist, Lit Motors formally applied the Lean Startup methodologies using a minimum viable product. After developing a series of prototypes, the company built a full-scale driving prototype.

With funding ($1.7 million) came a more advanced prototype. Though he faced a setback after a horrendous motorcycle ac- cident in 2015, Danny returned to Lit Motors six months later to prepare for production.

Kimihiro Hoshino/AFP/Getty Images

Energy Mavens LLC Estimated Start-Up Costs

Start-Up Expenses Estimate Notes/Assumptions

Certifications $ 20,000 Federal certifications for manufacturing Consulting Fees $ 5,000 Manufacturing consultants Expensed Equipment $ 3,000 Computers, printers, and the like Financial Institution Fees $ 5,000 Loan fees at 2% Identity Set/Stationery $ 2,000 Letterhead, business cards, envelopes Insurance $ 6,000 6 months Licenses $ 300 City, state, county Marketing $ 19,000 Pre-venture advertising and promotion Marketing Materials $ 20,000 Website, brochures, presentations Owner’s Wages $ 7,500 Pre-opening 3 months Payroll (with taxes) $ 40,000 Engineer and manager 3 months Permits $ 200 Building permits for leasehold improvements Professional Fees—Accounting $ 1,000 Setup of accounting system Professional Fees—Legal $ 3,000 LLC formations, lease review, contracts Professional Fees—Other $ 2,000 Professionals involved in leasehold improvements Rent $ 15,000 $4.00/sq. foot; 15,000 sq. feet; 3 months Research and Development $ 5,000 Technical analysis Supplies—Office $ 1,000 General supplies Telephone/Internet $ 300 $100 per month for 3 months Travel/Fuel (.55xmiles) $ 10,000 Pitching product to companies and investors Utilities $ 9,000 Eventually switch over to panels Web Fees $ 500 Web—URL and fees Other $ 300 Accounting software Total Start-Up Expenses $ 175,100

Start-Up Assets Cash on Hand $ 1,000 Funds for miscellaneous purchases Building (if purchased) $ Not applicable Cars, Trucks, and Other Vehicles $ 60,000 Prius and local delivery truck Equipment (including installation) $ 20,000 Factory equipment Furniture and Fixtures $ 20,000 Primarily warehouse fixtures Inventory—Raw Materials $ 100,000 Component items Inventory—Semi-Finished Goods $ 25,000 Partially produced components Inventory—Finished Goods $ Not applicable Land (if purchased) $ Not applicable Leasehold Improvements $ 20,000 Custom system and other fit-out Machinery $ 3,200,000 Specialized equipment detailed in plan Rent Deposit (Prepaid Expense) $ 10,000 First and last month Signage $ 10,000 Exterior and interior Software for Manufacturing $ 50,000 Specialized software Utility Deposits (Prepaid Expense) $ 3,000 All deposits

Total Start-Up Assets $ 3,519,000

Total Start-Up Requirements $ 3,694,100

Contingency Funds (10%) $ 369,410

Start-Up with Contingency $ 4,063,510 Budgeted Start-Up Investment

Exhibit 2-2 Start-Up Costs

55 CHAPTER 2: Pathways to Success: Processes and Instruments

56 UNIT 1: Entrepreneurial Pathways

• Cash flow projections. The cash flow statement shows cash re- ceipts less cash disbursements over a period. Creating your cash flow projections for three years will bring financial potential and risks into clear focus both for you and your stakeholders. Don’t be alarmed to see negative numbers on your first couple of efforts at this. However, if the numbers truly do not work, it might be time to reconsider your business approach rather than simply manipulating the figures to achieve satisfactory results.

In a start-up business, cash flow is likely to project as negative at various points, such as in the early months or in certain seasons. A business cannot survive long with negative cash flow, so it must increase cash coming in (revenues, loans, equity investments, and the like) and/or reduce the amount of cash going out (expenses, equip- ment purchases, and debt repayment, for example). Remember, be realistic about these projections. Be careful of significantly increas- ing your revenue projections solely to improve the numbers. If you add debt, account for its interest and principal repayment in future periods. When you have finished your business plan, it should never show a negative cash balance at the end of a period, because it is un- acceptable. You may very well have suffered losses that are reflected on your income statement, but the ending cash balance cannot be negative. Exhibit 2-3 shows how cash balances are calculated.

• Balance sheet projections. Your three years of projected balance sheets will provide snapshots of your business at specific points in time, such as the last day of a month, quarter, or year. Balance sheets show the business’s assets (what you own), liabilities (what you owe), and net worth, or owner’s equity. These statements provide insights into your financing strategy and overall business health. Exhibit 2-4 shows a rudimentary balance sheet format.

• Income statements for three years. An income statement or profit and loss statement summarizes income and expense activity over a specified period, such as a month, quarter, or year, and shows net profit or net loss. Generally, startup enterprises suffer losses for several months, or even a few years, depending on the type of business. You can show initial losses in your statements, but they must be compara- ble to industry norms, and you must have cash to cover any shortfalls. The projections you provide should be based on the detailed break- down of sales, pricing, cost, and other data in your plan. It is helpful to show best-case, worst-case, and expected scenarios for income. Be careful to avoid ski-slope projections, which add projections lin- early, with profitability occurring suddenly in either year three or five. A simple example of an income statement is shown in Exhibit 2-5.

cash flow statement a financial statement show- ing cash receipts less cash disbursements for a business over a period of time.

balance sheet a financial statement summarizing the assets, liabilities, and net worth of a business.

asset any item of value.

liability a business debt.

net worth the difference between assets and liabilities.

owner’s equity net worth.

income statement a finan- cial document that summarizes income and expense activity over a specified period and shows net profit or loss.

profit and loss statement (P&L) an income statement.

Starting Cash ( + ) Cash In from Operations [Sales] ( + ) Cash Out from Operations [Cost of Goods Sold, Expenses, Taxes] ( – ) Cash In from Investing [Equity Infusions, Earnings on Investments] ( + ) Cash Out from Investing [Equipment Purchases, Repaying Investors] ( – ) Cash In from Financing [Loans] ( + ) Cash Out for Financing [Repayment of Debt] ( – )

Ending Cash Balance [Starting Balance for Next Period] (=)

Exhibit 2-3 Cash Flow Calculations

57 CHAPTER 2: Pathways to Success: Processes and Instruments

• Breakeven analysis. This calculation will determine your organiza- tion’s breakeven point—that is, when the volume of sales exactly covers the fixed costs. Calculating the breakeven point will help dem- onstrate whether there is a viable market for your business. For ex- ample, if there are 1,500 students in a school and you must sell 2,500 yearbooks to reach breakeven, you know that it is time to reconsider your plan. Breakeven is calculated as

Fixed Cost ($) Gross Profit per Unit ($)

= Breakeven Units

• Ratio analysis. To understand your business performance relative to your industry peers, use ratio analysis. A business plan should in- clude standard ratios: gross profit, quick, current, debt, collection pe- riod, receivable turnover, inventory turnover, net profit on sales, net profit to assets, and net profit to equity. One of the best ways to in- terpret your calculated ratios is to compare them with others in your industry via databases you may access at a library or purchase online

breakeven point when the volume of sales exactly covers the fixed costs.

Energy Mavens LLC Balance Sheet as of December 31

2014 2015 2016

Assets

Short-Term Assets $200,000 $300,000 $450,000 Long-Term Assets 3,500,000 3,200,000 2,800,000

Total Assets $3,700,000 $3,500,000 $3,250,000

Liabilities Short-Term Liabilities $100,000 $200,000 $200,000 Long-Term Liabilities 1,500,000 1,050,000 800,000

Total Liabilities $1,600,000 $1,250,000 $1,000,000 Owner’s Equity $2,100,000 $2,250,000 $2,250,000

Total Liabilities and Equity $3,700,000 $3,500,000 $3,250,000

Exhibit 2-4 Balance Sheet Summary Format

Energy Mavens LLC Income Statement for the Year Ending December 31

2014 2015 2016

Net Sales Revenue $2,500,000 $3,500,000 $5,500,000 Cost of Goods Sold 1,400,000 1,700,000 3,000,000 Gross Profit $1,100,000 $1,800,000 $2,500,000 Operating Expenses 300,000 400,000 600,000 Earnings before Interest and Taxes $800,000 $1,400,000 $1,900,000 Interest Expense 100,000 90,000 80,000 Taxes 0 0 0 Net Income $700,000 $1,310,000 $1,820,000

Exhibit 2-5 Income Statement Summary Format

58 UNIT 1: Entrepreneurial Pathways

for specific industries. By comparing your business from one period to another and looking at the industry norms, you can adjust the way you will operate, or you can explain why you are outperforming or underperforming your industry.

• Risks and assumptions. All businesses take risks and make their projections based on assumptions: you need to state your financial assumptions and known risks explicitly. For example, you can in- clude the per-unit costs and volume projections, anticipated tax and benefits rates, and other calculated and projected values. You can also articulate the risks of implementation delays, cost overruns, lower-than-expected sales, industry price wars, and so forth. As with the other sections, this should be balanced and realistic, not over- stated or underplayed.

Funding Request and Exit Strategy: The Ask and the Return Your business plan should explicitly state the funds you will need. Whether the need is $5,000 or $50 million, the logic must be clear and compelling. You should identify the type of financing you are requesting and include your own financial contribution and that of any partners or co-owners, the amount of debt (loans) you will need to take on, and the percentage of eq- uity (ownership) you want to retain. State the financing terms you would like, including rates and repayment periods. This is part of negotiation, and the request should be carefully structured. If you intend to sell shares of stock in a corporation or are forming a business partnership, legal coun- sel will be essential so that you do not violate federal regulations and laws or create an improper agreement. The importance of your “ask” cannot be overemphasized. Business plan readers need to know what you want.

S t e p i n t o t h e S h o e s .   .   .

Turning Play into Profits P’Kolino, LLC, 2004 MOOT Corp Competitor What happens when you pair up two Babson MBA students with an idea and a group of students from the Rhode Island School of Design (RISD)? In 2004, the answer was P’Kolino, a creative company focused on “better” play.

Antonio Turco-Rivas and J. B. Schneider worked together to create a winning business plan that succeeded in being se- lected for the prestigious international business plan compe- tition called MOOT Corp in 2004. Their initial product was an innovative play table designed by the RISD team.

Since then, Turco-Rivas and Schneider have combined their interests as fathers with a desire to have well-designed products for children to create a successful company. P’Kolino products are sold in such upscale locations in New York as the Metropolitan Museum of Art, the Guggenheim Museum, the Museum of Modern Art, the Strand Book Store, and Saks Fifth Avenue. National mass-market retailers Toys R Us and Buy Buy Baby feature P’Kolino products in selected stores.

For P’Kolino’s founders, the business plan was an exer- cise that let them play in the children’s market.

hkeita/Shutterstock

59 CHAPTER 2: Pathways to Success: Processes and Instruments

The exit strategy is the way in which you and/or your investors expect to leave the company in a planned and orderly way. For investors, this might mean a buyout plan for their equity, or an initial public offering (IPO) when the company goes public—that is, puts itself on a stock ex- change. It could mean the sale of the business when certain benchmarks are met or at a predetermined point in time. It could mean having you give up day-to-day operations according to a succession plan. Lenders and in- vestors will want to know how they will recoup their investment and earn enough profit to warrant the risk.

Any business plan is only as strong as its implementation schedule. Therefore, the schedule—timetable—of milestones will be important to your business and your stakeholders. By establishing realistic deadlines for the completion of activities, you demonstrate knowledge and un- derstanding of the necessary tasks. You can use PERT or GANTT charts or any structured method that details the starting and ending dates of tasks and enumerates the resources needed and the responsibility of personnel.

Appendices: Making the Case in Greater Detail The appendices will provide you with an opportunity to strengthen your business plan with examples and details that are not critical for inclusion in the main portions. This is the place to add management resumes, sam- ple promotional materials, and illustrations or diagrams of products and packaging. In some cases, the detailed financial projections will appear in the appendices. Each appendix should be numbered and placed in the plan according to the order of reference in the text. The appendices should be listed in your table of contents.

Business Plan Suggestions As you create your business plan, several guidelines can help you get the most value for your time and effort. These will make the plan more professional, easier to read, and more likely to be thoughtfully consid- ered. You will find it easier to refer to your business plan if it is clear, concise, visually appealing, and well organized. With this in mind, you should

• Write for your audience. Whether the plan is for an internal (you and your team) or an external (lenders and investors) audience, it will need to address issues and concerns in language your read- ers will understand. They need to see that this business is some- thing they want to be on board with or that it satisfies a market demand.

• Show that you are invested in the company. No matter who the au- dience is, they will want to know that you are emotionally, intellectu- ally, and financially invested in the business.

• Be clear and concise. Simple, direct language written without too many adjectives or unnecessarily complex terminology is best. Even for highly technical sections, the business plan should avoid jargon and repeated references made through acronyms and ini- tialisms. This includes writing in a self-important way. Keep it simple. Readers know that explaining a complex subject in a clear, concise manner requires a thorough understanding of the subject. Depending on your audience and the type of business, your plan should be from 15 to 40 pages long, including appendices.

initial public offering (IPO) first offering of corpo- rate stock to investors on the open (public) market.

Learning Objective 2.7

Recognize and demonstrate proper development and for- matting of a business plan.

60 UNIT 1: Entrepreneurial Pathways

It is often more challenging to boil the business plan down to its essen- tials than to make a full exposition. For a formal presentation, an at- tractive multimedia presentation, free from errors, excessive animation, and other distractions, works best. Some presentation tips are given in Exhibit 2-6.

Business plan, business model, and pitch competitions provide ad- vantages and disadvantages. Certainly, the preparation for competition is an excellent opportunity to put a deadline on the creation of a plan, and the presentations are opportunities to hone a variety of skills, as well as to strengthen the concept. Also, competitions may provide significant cash prizes and access to venture capital. However, competitions are time con- suming and can prove to be a distraction from making progress on the ac- tual business. Some competitions will likely have team guidelines that do not conform to your actual business team, so the competitors on the team will have varying levels of interest and commitment, which may create tension and conflict. Even if you win a competition, you may not want to accept the prize if the terms and conditions are not acceptable. Your time might be better spent elsewhere. Weigh the pros and cons before investing the time and effort.

Business Plan, Venture, Business Model, and Pitch Competitions Numerous competitions are held each year across the globe. Many busi- ness schools and classes hold internal competitions and then advance win- ners to regional, national, and even international events. Prizes may range from $500, to financing and professional-services packages worth millions. A list of selected state, regional, national, and international competitions for undergraduate students can be found in Exhibit 2-7.

elevator pitch a 30-second to 2-minute presentation that conveys “in an engaging way” what a business is proposing and why the listener should be interested.

• Use current data and reports for your industry. This is important to validate that you are being realistic and have truly done your re- search. If you are out of step with current or anticipated conditions, the assumptions you make for your financial and market perfor- mance are likely to be inaccurate and unrealistic.

• Choose a voice and stick with it. It is best to write your business plan in the third person (not the first person—“I” or “we”) to give it an objective tone. Be careful not to switch back and forth between voices.

• Use a consistent, easy-to-read format. Choose a format and use it consistently throughout the plan. For example, using 1-inch margins, double spacing, and a serif font (such as Times New Roman) will make the document easy to read.

• Number and label. Number pages, figures (drawings, illustrations, photos), and tables, and refer to each in the text by title and num- ber to make it easy for the reader to understand and find sections of the plan. Each figure or table should be numbered sequentially and should be given a heading.

• Present it professionally. A professional business plan on high-qual- ity paper with a neat, attractive cover, cover page, and professional binding will go a long way toward impressing the reader. A dirty, dog-eared, or unbound business plan will probably not be read. An overly fancy, elaborate plan, bound like a book, with four-color glossy illustrations, may cause the reader to wonder why you have gone to such unnecessary expense, suspecting that you are either being wasteful or are perhaps camouflaging an unsound plan with bells and whistles.

Have others look at your business plan before you circulate it to poten- tial investors. If you can get relatively objective friends, colleagues, or fam- ily members to read the plan as early as the first draft, you can probably get valuable feedback and ideas for improvement. If you need assistance with spelling and grammar, or any other aspect of the format, this is the time to get it. It is also a good time to use any community resources that may be available to you, such as a Small Business Technical Development Center (SBTDC) or Rural Entrepreneurship Center.

Presenting Your Business Plan A written business plan is only one component of the process. It may open the door for a presentation to potential investors, or it may be the leave- behind document to remind the investors of your conversation. In either case, the presentation of the road map for your venture is your opportu- nity to convey your business concept to an audience and then to have an interactive discussion regarding your proposal.

Business plan presentations may be formal or informal, and you may have anywhere from a few minutes to a couple of hours for the complete presentation and discussion. Presentations to venture capital- ists may be limited to as little as 5 to 20 minutes. Regardless of the set- ting or audience, your presentation should be articulate, well thought out, organized, rehearsed, polished, and professional. As you work on plans for your enterprise, it is a good idea to work on an elevator pitch that quickly conveys to the listener in an engaging way what you are proposing and why he or she should be interested. This should take 30 seconds to a maximum of 2 minutes (the duration of an elevator ride).

61 CHAPTER 2: Pathways to Success: Processes and Instruments

It is often more challenging to boil the business plan down to its essen- tials than to make a full exposition. For a formal presentation, an at- tractive multimedia presentation, free from errors, excessive animation, and other distractions, works best. Some presentation tips are given in Exhibit 2-6.

Business plan, business model, and pitch competitions provide ad- vantages and disadvantages. Certainly, the preparation for competition is an excellent opportunity to put a deadline on the creation of a plan, and the presentations are opportunities to hone a variety of skills, as well as to strengthen the concept. Also, competitions may provide significant cash prizes and access to venture capital. However, competitions are time con- suming and can prove to be a distraction from making progress on the ac- tual business. Some competitions will likely have team guidelines that do not conform to your actual business team, so the competitors on the team will have varying levels of interest and commitment, which may create tension and conflict. Even if you win a competition, you may not want to accept the prize if the terms and conditions are not acceptable. Your time might be better spent elsewhere. Weigh the pros and cons before investing the time and effort.

Business Plan, Venture, Business Model, and Pitch Competitions Numerous competitions are held each year across the globe. Many busi- ness schools and classes hold internal competitions and then advance win- ners to regional, national, and even international events. Prizes may range from $500, to financing and professional-services packages worth millions. A list of selected state, regional, national, and international competitions for undergraduate students can be found in Exhibit 2-7.

elevator pitch a 30-second to 2-minute presentation that conveys “in an engaging way” what a business is proposing and why the listener should be interested.

Source: Adapted from Thomas W. Zimmerer and Norman M. Scarborough, Essentials of Entrepreneurship and Small Business Management, 5th ed. (Upper Saddle River, NJ: Prentice Hall, 2007).

Timing • Be prompt and ready to start on time. • Use the entire time allocated, and use it productively.

Audience • Know your audience and tailor the presentation accordingly. • Establish rapport with the audience.

Presentation Style • Dress appropriately and maintain a professional demeanor. • Be enthusiastic, but not artificial or arrogant. • Use proper pronunciation and language.

Presentation Contents • Create a “hook” to capture the audience quickly. • Hit the highlights without going into excessive detail. • Keep it simple by emphasizing key points and avoiding

technical jargon and acronyms that will lose your audience’s interest.

• Use visual aids, such as slides and sample or prototype prod- ucts, to reinforce your message without distracting from it.

• Emphasize the benefits of the opportunity so that they are clear to the audience.

• Conclude with a “Thank You.” Follow-Up • Expect and prepare for questions. Be thoughtful and positive

in your responses. • Contact each audience member to move toward your goals.

Exhibit 2-6 Venture Presentation Tips

62 UNIT 1: Entrepreneurial Pathways

Competition Host/Sponsor Website

Arkansas Governor’s Cup Collegiate Business Plan Competition

Arkansas Capital Corporation http://arcapital.com

Baylor Business New Venture Competition

Baylor University http://www.baylor.edu

Big Ideas @ Berkeley Rudd Family Foundation http://bigideas.berkeley.edu Connecticut New Venture Competition Entrepreneurship Foundation http://entrepreneurshipfoundation.org CU Boulder New Venture Challenge University of Colorado at Boulder https://www.colorado.edu/nvc/ Cupid’s Cup Plank Foundation for

Entrepreneurship http://www.cupidscup.com

Cornell Venture Challenge BR Venture Fund http://www.brventurefund.com DEW Startup Pitch & Competition IDG World Expo http://dewexpo.com Donald W. Reynolds Governor’s Cup (Nevada)

Nevada Statewide Committee http://nvgovernorscup.org

FastPitch Competition Northern Illinois University http://www.eigerlab.org FLOW DOE Cleantech UP California Institute of Technology http://flow.caltech.edu Garner Holt Student Fast Pitch Competition

California State San Bernardino http://iece.csusb.edu

Giants Entrepreneurship Challenge University of North Dakota http://business.und.edu Global Pitch Competition Collegiate Entrepreneurs

Organization http://www.c-e-o.org

Global Social Venture Competition University of California at Berkeley http://www.gsvc.org Global Student Entrepreneurs Awards (GSEA)

Entrepreneurs’ Organization http://www.gsea.org

Hult Prize Hult Prize Foundation http://hultprizeat.com Idea State U (Kentucky) University of Kentucky http://ideastateu.com Idea to Product Competition (I2P) University of Texas at Austin http://www.ideatoproduct.org International Business Model Competition

Brigham Young University http://www.businessmodelcompetition. com

Lee Kuan Yew Global Business Plan Competition

Singapore Management University http://www.smu.edu.sg

MIT Clean Energy MIT, U.S. Department of Energy, NSTAR

http://cep.mit.edu

National Collegiate Venture Competition The Conductor & University of Central Arkansas

https://uca.edu

NCPA Pruitt-Schutte Student Business Plan Competition

National Community Pharmacists Association

http://www.ncpanet.org

New York Business Plan Competition University at Albany (SUNY) http://apply.nybplan.com SEC Student Pitch Competition SECU http://www.thesecu.com Spin Master—Ivey HBA Business Plan Competition

University of Western Ontario http://www.ivey.uwo.ca

Student Startup Madness Syracuse University http://studentstartupmadness.com Student Venture Open University of San Diego http://www.wbtshowcase.com SVP Fast Pitch Social Venture Partners http://www.socialventurepartners.org tecBridge Business Plan Competition tecBridge http://www.nepbpc.com Technovation Challenge Iridescent http://technovationchallenge.org Texas Business Plan Competition University of Texas at Austin http://texasbusinessplancompetition.

splashthat.com Tigerlaunch Princeton University http://www.tigerlaunch.com

Exhibit 2-7 Business Plan, Venture, Business Model, and Pitch Competitions for Undergraduate Students

63 CHAPTER 2: Pathways to Success: Processes and Instruments

Chapter Summary Now that you have studied this chapter, you can do the following:

1. Describe what a feasibility analysis is and choose when to create one. The feasibility analysis essentially tests a business concept for viabil- ity through: • product and/or service feasibility • market and industry feasibility • financial feasibility

2. Articulate the Lean Startup methodology. The Lean Startup methodology is a hypothesis-driven approach for start-ups to validate business models using: • Hypotheses often illustrated in a Business Model Canvas • Minimum viable products • Pivots, perseverance, and perishing • Actionable metrics • Build–measure–learn loops

3. Prepare a Business Model Canvas. Make a visual representation of the nine facets: • Key partners • Key activities • Key resources • Value propositions • Customer relationships • Channels • Customer segments • Cost structure • Revenue streams

4. Identify primary business plan contents. • The story of what the business is and will be • All costs and a marketing plan • A description of how the business will be financed • An estimate of projected earnings

Competition Host/Sponsor Website

TCU Richards Barrentine Values and Ventures® Competition

Texas Christian University http://neeley.tcu.edu/vandv/

UMaine Business Challenge Business Lending Solutions http://www.umainebusinesschallenge. com

University Startup World Cup Venture Cup http://universityworldcup.com U.Pitch Future Founders Foundation http://futurefounders.com Utah Entrepreneur Challenge University of Utah http://lassonde.utah.edu/uec/ Verb (formerly Dell Social Innovation Challenge)

Verb https://verb.net

West Virginia Statewide Collegiate Business Plan Competition

West Virginia University http://www.be.wvu.edu

Exhibit 2-7 Business Plan, Venture, Business Model, and Pitch Competitions for Undergraduate Students

64 UNIT 1: Entrepreneurial Pathways

5. Summarize the various purposes of a business plan and the audi- ences for one. • A business plan is used by entrepreneurs to organize their thoughts

before starting a business and to determine business viability. • It can be used to raise money from investors and lenders. Almost

always, bankers and other potential investors will refuse to consider funding an entrepreneur who does not have a business plan.

• It can help guide the operation of the business. 6. Differentiate the components of a business plan.

The parts of a business plan include a cover page; table of contents; executive summary; mission, vision, and culture; company descrip- tion; opportunity analysis; marketing strategy and plan; manage- ment and operations; financial analysis and projections; funding request; and exit strategy.

7. Recognize and demonstrate proper development and formatting of a business plan.

A solid, viable business plan that is sloppy and filled with errors may be rejected on that basis alone. The business plan should be well organized, neatly presented, and written in correct English.

Key Terms actionable metrics advertising asset balance sheet breakeven point business model business model canvas business plan cash flow statement competitive analysis culture direct marketing elevator pitch environmental analysis feasibility analysis income statement industry analysis

initial public offering (IPO) Lean Startup liability marketing mix marketing plan minimum viable product (MVP) mission mission statement net worth owner’s equity profit and loss statement (P&L) proof of market public relations publicity target market vision

65 CHAPTER 2: Pathways to Success: Processes and Instruments

E n t r e p r e n e u rs h i p Po r t fo lio

Critical Thinking Exercises 2-1. Shawn is creating a business that provides advertising on public

restroom stall doors. He is funding the project from his personal savings of $5,000 and does not expect to use any outside financ- ing. Should he utilize the Lean Startup process? Create Business Model Canvases? Develop a business plan? Why or why not?

2-2. Charity and Devon are planning to license technology from NASA that would make it impossible to accidentally lock a child in a car. The technology is complex, and the market analysis and financial assumptions take up a lot of pages. The two women have written a 63-page business plan. Explain your concerns about the plan con- sidering the chapter text.

2-3. What factors make the difference between a good business plan and an excellent one?

2-4. Visit an Internet shopping site, such as the Home Shopping Network (http://www.HSN.com) or QVC (http://www.QVC.com). Select five products for sale that you find interesting or unusual. Make a list of the products and your explanation of the market op- portunities they reflect.

2-5. Explain how this statement applies to business plans: Errors of omission can sometimes be greater than errors of commission.

Key Concept Questions 2-6. Explain why a prospective business founder might want to create

a feasibility study or Business Model Canvas before developing a complete business plan.

2-7. How can investing time in the Lean Startup process save an entre- preneur time and money in the short and long term?

2-8. What are the parts of a Business Model Canvas? How can the en- tire canvas assist an entrepreneur?

2-9. Explain why the executive summary is the most important section of any business plan.

2-10. One mistake entrepreneurs make in their business plans is that of only including an income statement. What other financial state- ments should be incorporated and why?

2-11. Print an assignment, or any body of text, with 1-inch margins, double spaced, using 12-point Times New Roman font. Then, print the same document with 0.8-inch margins, single spaced, using a 10-point Arial typeface. Which is easier to read? Why? How would this relate to a business plan?

2-12. Name three categories of investors/lenders that might have an in- terest in your business plan.

2-13. Why is it important to identify a business’s culture from the beginning?

Application Exercises 2-14. Prepare a Business Model Canvas for Honest Tea based on the

business plan included at the end of this chapter.

66 UNIT 1: Entrepreneurial Pathways

2-15. Call or visit an entrepreneur in your community to discuss busi- ness plans. a. Ask whether he or she wrote a business plan before starting

the business. Since then? b. If the owner did write a plan, for what has it been used? c. If the owner did not write a plan, why not? d. Did the owner have any assistance in writing or reviewing the

plan? e. If so, what was the source of assistance?

Exploring Online 2-16. Find and provide the URL for a business plan on the Internet.

Examine it to see whether it follows the guidelines provided in this text. Use a highlighter to mark the sections of the plan that are present. Then, make a list of missing or incomplete sections. Indicate how it does/does not follow the rules for formatting and content. Is the plan viable? Why or why not? Would you invest in it? Why or why not?

2-17. Find a Business Model Canvas example online (can be a video). Compare its hypotheses to the types identified in the business model canvas section of the chapter. What has been added? What is missing?

In Your Opinion 2-18. If an entrepreneur presents a business plan that an investor be-

lieves is deliberately vague and has provided inflated financial statements, what should that investor do?

2-19. What, if any, value do you see in the hypothesis-driven approach of the Lean Startup, with its iterative processes? How does this compare to the value in the traditional linear process of creating a business plan? How do they conflict, if at all? How do they com- plement one another?

MyLab Entrepreneurship Writing Assignments Go to www.pearson.com/mylab/entrepreneurship for Auto-graded writing ques- tions as well as the following Assisted-graded writing questions:

2-1. A business plan is a document that thoroughly explains a business idea and how it will be carried out. Describe the various purposes of this document. Which is most important and why? Justify your response with specific reasons.

2-2. There are many components to a business plan, one of which is the opportunity analysis and research section. Describe the ele- ments included in this section. Explain the pitfalls that entrepre- neurs should avoid when working on this section.

67

Frankie’s Challenge: Customer Discovery

Case Study

Frankie Cheri Patterson grew up in the funeral business and saw the opportunity to disrupt the in- dustry. By age 20, she operated two funeral homes in North Carolina with her mother, Sharon. Her father, Frankie Patterson, opened the Eastover Community Funeral Home in 2002 and passed away in 2009, leaving the business to Sharon and young Frankie. From her earliest days, Frankie assisted her parents and was trained to operate funeral homes as she grew, and the organization added a second location called Celebrations of Life by Leggett-Patterson and renamed the origi- nal location Patterson Memorial Funeral Home.

As she considered ideas for increasing earn- ings, Frankie considered the challenges faced by funeral homes and their owners. She observed that many people are extremely uncomfortable visiting funeral homes either when deciding for their own services through pre-planning or arranging ser- vices for loved ones who have died. Funeral homes prefer pre-planning and pre-arranged payment for numerous reasons. The central challenge that Frankie identified was finding more convenient, comfortable options for customers and creating cost savings and efficiency for funeral homes.

While working with a team of college class- mates at Fayetteville State University, Frankie explored the idea of a comprehensive online fu- neral planning site that would permit selection of services and products, pre-payment, and interac- tion without ever setting foot in a funeral home. The notion was to design a menu of options for customers and link them to participating funeral homes. Because funeral services are normally de- livered locally, a network of participating funeral homes would be required. Frankie’s company would be paid for the listing and upon contract delivery by the participating funeral home and the insurer for the pre-planning.

The student team followed steps of customer discovery from the Lean Startup methodology. They brainstormed issues, options, and problem- solution fit, and they created a set of hypotheses that they mapped onto an ever-evolving business model canvas. As a minimum viable product, the team created a web landing page that included a video, price list, and pictures. Customer in- terviews resulted in several pivots, primarily in products, services, and pricing. The team quickly learned that customers wanted funeral packages and were often willing to pay more than antici- pated, particularly for added services such as New Orleans–style jazz funeral processions and other special music and dance performances.

As a sophomore, Frankie was not ready to fully pursue the new venture, but as a graduat- ing senior, she revisited it with the intention of implementation.

Case Questions 2-20. What specific steps of customer discov-

ery are described above? What, if any- thing, is missing?

2-21. How might Frankie improve her chances of success? Identify a minimum of five ways.

2-22. What customer segments and value proposition would you suggest apply for this business? How would you test them?

Case Source: Frankie Patterson, Patterson Memorial Funeral Home, http://www.pattersonmemorialfh.com.Frankie & Sharon Patterson

(Courtesy of Frankie Patterson)

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Honest Tea Business Plan

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Honest Tea, Inc.

Business Plan for 1999 December 1998 4905 Del Ray Avenue, Suite 304 Bethesda, Maryland 20814 Phone: 301-652-3556 Fax: 301-652-3557

E-mail: [email protected]

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Table of Contents

Mission Statement ……………………………………………………………………………….. 74 Executive Summary ……………………………………………………………………………… 75 Company Story …………………………………………………………………………………….. 75 The Product …………………………………………………………………………………………. 76

The Taste ………………………………………………………………………………………. 76 Low in Calories ……………………………………………………………………………… 76 Health Benefits of Brewed Tea ……………………………………………………….. 78 Cultural Experience of Tea ……………………………………………………………… 78 Flagship Line of Flavors …………………………………………………………………. 78

Production and Manufacturing ……………………………………………………………… 79 Market Opportunity ……………………………………………………………………………… 79

Beyond Snapple—The Emerging Market for Quality Bottled Tea ……… 79 Profile of Target Customer ……………………………………………………………… 81 Market Research ……………………………………………………………………………. 81 Market Response …………………………………………………………………………… 81

Marketing and Distribution …………………………………………………………………… 84 National Natural/Specialty Foods Channels …………………………………….. 84 Higher End Food Service ……………………………………………………………….. 84 Promotion …………………………………………………………………………………….. 84 Packaging and Pricing ……………………………………………………………………. 85 International Markets ……………………………………………………………………. 85 Product Development and Future Products …………………………………….. 86

Management ………………………………………………………………………………………… 86 President & TeaEO ………………………………………………………………………… 86 Chairman of the Board ………………………………………………………………….. 87 Brewmaster …………………………………………………………………………………… 87 National Sales Director ………………………………………………………………….. 87 Retail Sales Manager ……………………………………………………………………… 87 Consultants and Advisors ……………………………………………………………….. 87

Financial Statements ……………………………………………………………………………. 88 Financial Statements—Year-to-Date and Projections ………………………………. 88 The Investment Opportunity …………………………………………………………………. 96

The Offering ………………………………………………………………………………….. 96 Financing History ………………………………………………………………………….. 96 Exit Strategies ……………………………………………………………………………….. 96 Investment Risks …………………………………………………………………………… 96 Competitive Advantage ………………………………………………………………….. 97

A Parting Thought ………………………………………………………………………………… 97

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Mission Statement

Honest Tea seeks to provide bottled tea that tastes like tea—a world of flavor freshly brewed and barely sweetened. We seek to provide

better-tasting, healthier teas the way nature and their cultures of origin intended them to be. We strive for relationships with our customers,

employees, suppliers and stakeholders which are as healthy and honest as the tea we brew.

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Executive Summary

Honest Tea, a bottled iced tea company, has completed a strong summer of sales in the mid-Atlantic region and is now raising capital to fund the brand’s expansion across the United States as well as overseas. Since the all-natural tea first hit the mid-Atlantic market in June of 1998, Honest Tea has developed a loyal following of customers who have made the product the best-selling tea in its largest account, Fresh Fields/Whole Food Markets, significantly outselling Snapple and the Whole Foods 365 brand. In addition to success in retail chan- nels, Honest Tea has also been warmly received in food service channels.

Unlike the sweetened tea drinks made from concentrate or powder which cur- rently dominate the $2 billion bottled tea market, Honest Tea is brewed with loose leaf tea and then barely sweetened with pure cane sugar or honey. The product is poised to take advantage of the rapid growth in the bottled tea, bottled water, and natural food markets, as well as the developing “tea culture” in the United States. It also has potential to tap into the large market of health-conscious diet soda drinkers. The target audience is an emerging subset of the population, which seeks out authentic products and is attuned to global and environmental issues.

Toward the end of the summer and through the fall the company continued to penetrate large supermarket chains and is in the process of finalizing a national network of brokers and distributors for 1999. In September 1998 the company hired two sales managers, each of whom brings more than 15 years of experi- ence and contacts to the business.

Although there was an often painful and occasionally costly product develop- ment phase, the company has now perfected the brewing and production pro- cess to the point where it can produce several thousand cases in one shift with the desired consistency. In early 1999 the company will add a West Coast site to its current East Coast production site. In addition, the company will be imple- menting steps to consolidate its packaging operation which will widen the per case profit margin.

The company has demonstrated an ability to gain free media coverage, including stories in the Washington Post, the Wall Street Journal, and Fitness Magazine. It has also cultivated a loyal customer base among some of the country’s most influ- ential celebrities which it intends to publicize at the appropriate time. It has just entered into a contract with a well-recognized public relations firm, which has demonstrated its success with several early-stage companies. Finally, the com- pany has finalized a partnership with a Native American tribe that will position Honest Tea to emerge as a leader in the socially responsible business movement.

Honest Tea is looking to raise up to $1.2 million in equity capital to finance the national distribution of the product as well as the introduction of two new fla- vors and international sales.

Company Story

Honest Tea is a company brewed in the classic entrepreneurial tradition. After a parching run through Central Park in 1997, Seth Goldman teamed up with his Yale School of Management professor, Barry Nalebuff, to reignite their three- year old conversation on the beverage industry. While at Yale Goldman and Nalebuff had converged on the opportunity in the beverage market between the supersweet drinks and the flavorless waters. The energy they share around the idea of a less-sweet beverage leads to several marathon tea-brewing sessions. Their conversation is fueled in part by their extensive travels through tea-drink- ing cultures such as India, China and Russia. As ideas and investors for the com- pany gather critical mass, Seth takes the dive. He leaves his marketing and sales

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post at Calvert Group, the nation’s largest family of socially and environmentally responsible mutual funds and launches Honest Tea out of the guest room in his house. Using five large thermoses and label mock-ups, he sells the product to the eighteen Fresh Fields stores of the Whole Foods Market chain. Once the tea has been manufactured, the company moves into a small office and distributes tea out of U-Hauls until other distributors start carrying the product. By the end of the summer, Honest Tea has become the best-selling tea throughout the Fresh Fields chain and has been accepted by several national supermarket chains and distributors.

The Product

The Taste: Bottled tea that tastes like tea, freshly brewed and barely sweetened.

Somewhere between the pumped-up, sugar-saturated drinks and the tasteless waters, there is a need for a healthier beverage which provides genuine natural taste without the artificially concocted sweeteners and preservatives designed to compensate for lack of taste.

Honest Tea allows people to enjoy the world’s second most popular drink the way hundreds of civilizations and nature intended it to be. Tea that tastes like tea—A world of flavor freshly brewed and barely sweetened. The concept of Honest Tea is as direct and clear as the tea we brew—we start with select tea leaves from around the world, then we brew the tea in spring water and add a hint of honey or pure cane sugar. Finally, we filter the tea to produce a pure genuine taste that doesn’t need a disguise.

Unlike most of the bottled teas in the marketplace, Honest Tea is not made with bricks of tea dust, tea concentrate, or other artificial sweeteners or acids. The tea has no bitter aftertaste or sugar kick and does not leave a syrupy film on the drinker’s teeth. To make a comparison with wine, today’s leading iced teas are like jug wine and Honest Tea is like Robert Mondavi Opus One. But unlike fine wine, premium bottled tea is quite affordable, usually priced under $1.50 for 16 ounces.

Although taste is the primary benefit of drinking Honest Tea, the product has three other benefits which enhance its acceptance and marketability:

Low in calories: A 12-ounce serving of Honest Tea has 17 calories, dramatically less than other bottled teas or comparable beverages. We have found that the low-calorie profile of Honest Tea makes the drink attractive to three key audiences – 1) Disenchant- ed bottled tea drinkers who think the drinks are too sweet, 2) Bottled water drinkers who long for taste and variety and 3) diet soda drinkers who are inter- ested in a low-calorie beverage that doesn’t contain artificial sweeteners such as NutraSweet. The following table illustrates the difference between Honest Tea and the rest of the beverage market:

There are three other players in the less-sweetened bottled tea market that can be considered among the competition for Honest Tea: Tejava, Malibu Teaz and The Republic of Tea. All three brands are currently based and primarily focused on the West Coast. We are heartened by their existence because it confirms our belief that there are untapped opportunities in the beverage market, particularly on the East Coast, where none of the new entrants has any significant pres- ence. Tejava, which is enjoying a warm reception in California, is a mild-tasting, zero-calorie unsweetened tea produced by Crystal Geyser that comes in only one

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flavor. We believe this product, which has been described by a beverage consul- tant as “water with a tea aftertaste,” would be more flavorful if it were barely sweetened. While Tejava clearly competes with our product, we believe there is room for more than one product in the low-calorie tea marketplace. We also believe that Honest Tea has an edge over Tejava because our drinks are more flavorful and come in a wider variety of flavors.

Malibu Teaz is a company focused on lightly sweetened herbal tea, 35 calories for an 8-ounce serving. The products seem to have limited distribution and the label, which features a topless mermaid, seems designed to cater to a different clientele than Honest Tea.

The Republic of Tea is a well-established producer of loose leaf teas which has recently begun selling unsweetened bottled tea exclusively through its catalogue and premium restaurants. The cost of a four-pack in the catalogue is $15.00, or $3.75 for a 17-ounce bottle. We believe that this price is not viable in retail chan- nels and have spoken with several disillusioned distributors whose experience confirms that assumption. Even if the Republic of Tea changed its sales strategy, we still see room for more than one player in the low-calorie tea market. We also think the modest amount of natural sweetener in Honest Tea helps create a superior flavor.

One other brand that can be considered competition is Tazo, which presents itself as “The reincarnation of Tea.” While Tazo is enjoying some success in natural foods channels, we feel that Honest Tea is different from Tazo in three important ways: first Honest Tea is genuine tea whereas Tazo is usually tea mixed with juice or other sweeteners, (usually 80 calories for an 8-ounce serv- ing). Secondly, Tazo’s packaging, with its mysterious symbols and discussion of “the mumbled chantings of a certified tea shaman” is designed to reach a New Age audience. In contrast, the colorful art on the Honest Tea labels are accessible to a wider audience, offering a more genuine tea experience. Fi- nally, Tazo’s price point is significantly higher than Honest Tea in supermarket channels, selling for $1.69 versus Honest Tea’s price of $1.19. Where the two brands have competed head-to-head, Honest Tea has significantly outsold, and in many cases, eliminated Tazo from the shelf. Our response to Tazo’s “reincarnation of tea” is that tea doesn’t need to be reincarnated if it is made right the first time.

Calories per 8-ounce serving

0 20 40 60 80 100 120 140 160 180

Honest Tea

Nestea

Tazo Tazoberry

Tradewinds Honey w / Ginseng

Lipton Lemon

Mistic

SoBe Oolong

AriZona

Coca-Cola

Snapple Lemon

Tropicana Pure Premium

Fruitopia Fruit Passion

Nantuckt Nectrs Pnpple Orng Guva

Starbucks Frappucino

Ocean Spray CranGrape

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Health benefits of brewed tea: The curative properties of tea have been known for thousands of years. Because Honest Tea is brewed from genuine tea leaves it imparts many health benefits not found in tea-flavored drinks. In addition to serving as a digestive aid, tea has powerful antioxidants, which impair the development of free radicals which con- tribute to cancer and heart disease. The antioxidants in green tea are believed to be at least 100 times more effective than Vitamin C and twenty-five times better than Vitamin E at protecting cells and DNA from damage believed to be linked to cancer, heart disease and other potentially life-threatening illnesses.

Cultural experience of tea: Each Honest Tea flavor is brewed based on a recipe perfected over generations in a specific region of the world. As a result, drinking Honest Tea becomes a cultural experience, from the genuine tastes to the distinctive international art and information on the label. While some bottled teas seek to cloak themselves in a cosmopolitan mantle by including exotic-looking drawings on the label, the front of each Honest Tea label features authentic art from the culture of origin.

Flagship line of flavors Our flagship line of teas come from four different continents:

Kashmiri Chai – The people of Kashmir have mixed spices into their chai for generations. Our recipe is made with spring water, premium tea leaves, crushed cardamom, cinnamon, orange peel, cloves, pepper, ginger, malic acid and a touch of sucanat evaporated sugar cane juice. Approximately one third the caffeine of coffee.

Black Forest Berry – Our Black Forest Berry tea is a fruit infusion made with spring water, hibiscus, currants, strawberries, raspberries, brambleberries, elderberries, and a touch of unrefined organic cane sugar. Caffeine-free.

Moroccan Mint – Our Moroccan Mint is a tightly rolled green tea from China blended with a generous amount of peppermint, brewed in spring water with cit- ric acid and a touch of white clover honey. Approximately one fourth the caffeine of coffee.

Gold Rush – Our Gold Rush tea is an herbal infusion made with spring water, rooibush, rosehips, chamomile, cinnamon, peppermint, ginger, orange peel, malic acid, and a touch of raw cane sugar, and natural flavors. Caffeine-free.

Assam – These golden-tipped flowery leaves from the Sonarie Estate gain their distinctive taste from being picked as tender leaf buds at the height of the sea- son. Brewed in spring water with Vitamin C, malic acid, unrefined organic cane sugar, and a hint of maple syrup. Approximately one half the caffeine of coffee.

In early 1999 we will be introducing two new teas:

Decaf Ceylon – In response to feedback from more than 500 sampling events where we continually heard requests for a decaffeinated black tea, we will be introducing a Decaf Ceylon with lemon grass. The label for this tea features original art which captures the cultural and relaxing attributes of the tea.

First Nation’s Peppermint – After months of negotiation and a consultation with the tribal elders, we have developed an organic herbal tea in conjunction with a woman-owned company based on the Crow Reservation in Montana. This tea is exciting not only for its flavor but also for the partnership we have developed with the tribe. In addition to licensing the flavor and artwork from the tribe, we are also buying the tea from our partner on the reservation with the under- standing that over time the community will develop the capacity to grow all the

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1. Explosive growth in Ready-to-Drink (RTD) tea and bottled water markets –  Although carbonated soft drinks still dominate the beverage market, in the past ten years Ready-To-Drink teas and bottled water have emerged as alterna- tives. Since 1992 the US tea market has enjoyed 60% annual growth, reaching sales of $2 billion in 1996. The bottled water market has grown to $2.4 billion, with most of the growth fueled by sales of single-serving bottles.

ingredients on the reservation. This unprecedented relationship should prove to be a valuable public relations tool.

Production and Manufacturing

Though we had our share of “learning experiences” along the way, we have developed several proprietary brewing tools and techniques which enable us to manufacture several thousand cases of tea a day on both coasts with the desired consistency. In addition, since we have a full-time brewmaster on staff, the company retains the knowledge of manufacturing the product, instead of relying on a co-packer for that information.

The tea is brewed at a brewing and bottling facility located within driving range of the target market. The site was selected based on numerous criteria includ- ing capacity, reputation, quality control, production efficiency and willingness to invest in a long-term partnership with Honest Tea. All partners involved in the production process meet United States Department of Agriculture Hazard Analysis Critical Control Plant (HACCP) standards. We are in the process of obtaining Kosher certification from the Orthodox Union (“Circle U”).

In early 1999 we will be making a change in our manufacturing process that will not affect the quality of the product but will have important ramifica- tions for our profitability. Instead of a two-step packaging process, we will consolidate the brewing and labeling under one roof. This consolidation will save Honest Tea more than two dollars a case.

Our tea leaves are provided by internationally known companies that specialize in tea buying, blending and importation. Our primary source is Hälssen & Lyon of Germany, the largest specialty tea company in the world. Another, Assam Tea Traders, has direct ties to tea estates in the Assam District of Northern India. The other ingredients are commodities which are in plentiful supply.

As the Company grows in size, we anticipate dealing more directly with the tea growers. We intend to visit the tea estates so that we can verify that the labor condi- tions of the tea workers meet international standards and International Labor Or- ganization conventions. We also aspire to ensure that the tea is grown organically.

Market Opportunity

Beyond Snapple–The Emerging Market for Quality Bottled Tea We have identified four market trends that are fueling demand for Honest Tea within the $72 billion non-alcoholic liquid refreshment beverage market.

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2. Beyond the tea bag – The emergence of tea culture – Snapple and similar brands helped make tea accessible to a broader population. But now in the same way that gourmet coffees have become popular, consumers are beginning to develop an appreciation for finer teas. Over the last six years U.S. loose leaf tea sales have more than doubled, from $1.8 billion in 1990 to $4.2 billion in 19964 According to the Tea Council, there are over a thousand tea houses or tea parlors in the country, mostly opened within the last two or three years. These parlors focus almost exclusively on tea, products that go with tea as well as tea hard- ware. They carry names such as Teaism, TeaLuxe, Elixir Tonics and Teas, and Tea & Company. Even Lipton is opening a flagship tea bar in Pasadena, Cali- fornia. In addition to the burgeoning of tea cafes, tea culture is spreading in the form of tea magazines, tea-flavored ice cream, frozen tea ice bars, tea-scented perfume and bubble bath, tea jelly, tea calendars and even books about tea. The paperback Loving Tea was recently spotted as a “cash register book” at the book- store, commanding prime space next to Dilbert and Chicken Soup for the Soul.

3. The natural foods boom – The natural product category has also exploded in the past 6 years. Fueled by an increase in health consciousness and rising envi- ronmental awareness, demand has grown for foods and products which are best when eaten or used as close to their original state in nature. According to Natu- ral Foods Merchandiser, the natural products industry has nearly tripled in size since 1990 from $4.2 billion to $11.5 billion in 1996. And the boom is expected to continue well into the next decade. Analysts, such as Mark Hanratty of Paine Webber, are forecasting 15–20 percent annual growth over the next three to five years, reaching $50 billion by 2003.

4. Rise of Cultural Creatives – Market research in the past three years has identified a consumer mindset which would seem to be particularly recep- tive to Honest Tea. A 1996 study by the market research firm American LIVES identified a subset of the population, roughly 44 million Americans, which they labeled “Cultural Creatives.”5 Among the key characteristics and values identified for this group, the following seem to make them ideal cus- tomers for Honest Tea:

• Experiential consumers – they want to know where a product came from, how it was made, and who made it

• Holistic – they view nature as sacred; they form the core market for alternative health care and natural foods

4Investor’s Business Daily, “Tea: Are you Prepared to Join the Party?”, January 30, 1998, p. 1. 5American Demographics, February 1997, Dr. Paul H. Ray.

*Water and Soft drink figures come from Beverage Marketing, Inc. The RTD Tea figure is based on 1997 sales estimate of $2.5 billion, which equates to roughly one billion gallons.

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• Aggressive consumers of cultural products, love of things foreign and exotic

• Desire for authenticity – favoring high integrity over high fashion

• Disdainful of mainstream media and consumerist culture which, in their view, is too superficial, not enough attention to the full story

• Attuned to global issues and whole systems, have a sense of belonging to a global village

Profile of Target Customer When we combine these four trends and compare them with the demographics of the Cultural Creatives study as well as other market demographic informa- tion6, we are able to develop a profile of our target customers:

• 60% women, 40% men

• Median age 42, with a range from 30–65

• Likely to live near a concentrated urban area

• Likely to have graduated college or have an advanced degree

• Likely to currently be bottled water or RTD tea drinkers, occasionally drink iced cappuccino

• Interested in running, hiking and outdoor healthy activities

• Average family income $52,000

Market Research To test the receptivity of this audience to Honest Tea, we held two focus groups in New York. The sessions, facilitated by an independent market research firm, pro- vided encouraging results and helpful guidance in terms of product line and label presentation. The first focus group consisted of health-conscious women between the ages of 30 and 60, all of whom occasionally drink bottled tea or bottled water. The second group was a mix of men and women who were selected based on their responses to questions which identified them as fitting the Cultural Creatives profile. The sessions began with a discussion of what was missing in the bever- age market. Within 5 minutes, unprompted by the moderator, both groups agreed that they wanted something that was not as boring as water but didn’t have all the “junk” in commercial bottled tea.

One important lesson from the focus groups was that most consumers have a limit- ed understanding about the differences between tea varieties. The situation may be comparable to the way many consumers thought about wine several decades ago. At first people distinguished wines in terms of red and white wine, then in terms of rose and chablis, then in terms of California wines versus French wines, later by the kind of grape, and today some people select wines based on the estate. The focus groups suggested that the American tea market is still in the red versus white stage. One implication of this finding was that our labels and other communications needed to include some educational information about each tea, including health benefits, history and country of origin.

Market Response More important than our pre-market focus group is the market response to Honest Tea, i.e., sales. In the eighteen Fresh Fields/Whole Foods Markets of the mid-Atlantic region Honest Tea has become the best-selling bottled tea, outsell- ing Snapple and the house brand. During the month of August, when Honest Tea was promotionally priced at 99 cents, 22,417 bottles of teas were sold, with several stores averaging more than 100 bottles per day.

61997 MRI Spring data, population weighted.

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Perhaps more important than the numbers from one region are the thousands of responses we have gotten from our customers via unsolicited emails, letters, phone calls, and conversations at hundreds of sampling events. The feedback we have received make it clear that we have created something that was missing in the marketplace. Every week we receive several unsolicited emails and letters from customers. Typical comments include the following (see Exhibit A for more tea-mail – Excluded in the interest of space):

Subject: BEST TEA EVER!

Dear Honest Tea,

I have never bought a product that I thought was so fantastic that I felt the need to write about it. I love tea, but I always would brew it myself and cart it around because I can’t stand the syrupy-sweet “tea” that is sold most places.

I saw your tea at Fresh Fields in Annapolis, MD. At first I was hesitant because I have it in my mind that all bottled iced teas = yucky sweet. But I was intrigued by the flavor choices and yes, the pretty bottles and bought one of each. Well, I went to my car and proceeded to drink all of them right then and there. The first one was so good and so different that I couldn’t help myself and had to try the rest. It actually tasted like tea! THEN… when I turned the bottle over and saw how few calories were in it I flipped! There is no reason not to drink this tea! You guys have truly done it, this is quality stuff! So keep it up and get this tea out there! I wish you success and happy brewing!

-Cindy W., Annapolis, MD

RE: Help! I need Honest Tea!

I just returned from a trip to Wash, DC (I live in Pittsburgh) and found that your tea is not available here. I love it and must have more. Can you ship it to me? Price is no object (to some degree).

If you cannot ship it to me please advise me of any support groups or counseling that I may seek in order to recover from this lack of Honest Tea. I must warn you that I may get desperate, causing me to highjack an Honest Tea truck in the Washington area and bring it back to Pittsburgh. I am becoming a heartless, Honest Tea junkie. I hope that you can help.

Thanks, EEOber

Subject: Chai tea was great!

I just came from my local Fresh Fields Market in Reston, VA after trying a bottle of your Kashmiri Chai tea. Fantastic! Imagine my surprise to learn the entire bottle was only 34 calories and 1/3 the caffeine of coffee!

This is great stuff folks – my only complaint is that I can’t seem to find anywhere that sells it by the case. I don’t mind buying a couple bottles at a time for occasional consumption, but I would appreciate being able to purchase a case to bring to work and a case to keep at home. It would be a great way to replace soda and other sugary, high calorie drinks in my diet. Unfortunately, I cannot spare the time to stop at the store every day to pick up a couple bottles. Any plans to sell by the case (hopefully at a slight discount)??

Colin C. Reston, VA

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Re: Honest Tea!

Your tea is fabulous! I have never written a letter in support of a food product before, but ever since I stumbled across your Honest Tea last week at Fairway, I’ve been raving about it! At last, someone intelligent enough to realize that not all people like that syrupy junk that is on the market, and that nutri-sweet and artificial sweeteners taste like crap. I’ve grown so tired of “well, it’s what the consumers are demanding.” Not. The rest of us have spent the last decade or so brewing tea at home and keeping it in our refrigerators since traditional marketing researchers have been incapable of using their research to produce anything innovative. Bravo, bravo, bravo. Nice labels, too.

Lisa P., New York City

The response from grocery buyers at the corporate level has been equally as exciting.

The new products buyer for Wild Oats/Alfalfa Community Market ap- proved Honest Tea for sale in all of the chain’s 60+ stores. Here is her comment to the grocery buyers which she sent out on the Product Ap- proval Form (see Exhibit B – Excluded in the interest of space):

Mark My Words: Honest Tea will be a success. The only bottled tea that is not loaded with sugars and tastes great. This is what people (like me) have been seeking for years. Too good to be true? No! I mean it now – BRING THESE IN!

The natural foods buyer for Harris Teeter chose to carry the product in all 140 stores. Her buying committee told her this was the first innova- tion in the iced tea market they’d seen in about five years. Some even said that Honest Tea represents a new beverage category.

In addition to this feedback, Honest Tea has been presented with several promising opportunities to be plugged into several large supermarket chains. The status of these opportunities is as follows:

Store # of Outlets Region Status Penetration

Albertson’s 96 Florida December decision

Food Emporium

40 NY/NJ December decision

Genuardi’s 32 NJ/PA/DE Approved for all stores

Will go on sale in December ’98

Giant 179 C/MD/VA/ DENJ/PA

Approved On sale in flagship store

Harris Teeter 140 NC/SC/GA/VA/ KY/TN

Approved for all stores

On sale in all stores

Shaw’s 127 New England Approved On sale in test market store

Superfresh 78 NJ/PA Approved for all stores

On sale in some stores

Ukrop’s 40 VA Approved for all stores

On sale in some stores

Whole Foods 117 Nationwide Approved for mid-Atlantic and SE

On sale in 20 stores

Wild Oats/ Alfalfa’s

60 Nationwide Approved for all stores

On sale in 12 stores

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In addition to success in the supermarket channel, Honest Tea is also being warmly received in food service and retail accounts. We have experienced strong repeat sales in cafeterias such as Bear Stearns, Lazard Freres and have just been approved for sale in the NFL corporate cafeteria. Honest Tea is the best-selling beverage at the Mangia gourmet eatery in Manhattan where it is priced at $2.50 a bottle. Honest Tea is also sold in well-known restaurants such as Legal Sea Foods. Finally, we have also had strong repeat sales from food outlets on the campuses of Boston University, Harvard University, Yale University and Wellesley College.

As with Snapple and other bottled iced teas, there does seem to be a seasonality affect to the sales of Honest Tea, particularly in the supermarket channel. How- ever, as we expand our distribution to the Southern states and to more upscale cafeterias, we expect to see less of a dip in sales during the winter months.

Marketing & Distribution

Given the above market trends, target customer profile and record of success in the mid-Atlantic natural and specialty foods market, Honest Tea’s marketing and distribution strategy for 1999 is as follows:

1. National natural/specialty foods channels, working with brokers and dis- tributors to achieve full distribution throughout the Whole Foods and Wild Oats chains as well as natural foods buyers in mainstream supermarkets.

2. Higher end food service – working with large national food distributors such as Sysco, Aramark and Marriott to penetrate restaurants and institu- tional eateries.

3. Opportunistic public relations and extensive sampling in health and natural food settings to build the brand name as well as facilitate trial.

National natural/specialty foods channels

We are in the process of finalizing national distribution and brokerage arrange- ments. We are currently working with Haddon House, the largest retail distribu- tor of gourmet foods on the East Coast. In addition, we have recently contracted with numerous natural food brokers to represent our product for the East Coast, Midwest, West Coast and the South.

Higher end food service

We are working food management companies to expand our presence in busi- ness and institutional cafeterias. and has been approved for sale in Restaurant Associates and Marriott International. We are currently in discussions with Aramark and Sysco. We are also in conversation with several large restaurant chains and sports arenas.

Promotion

We recognize that because we are not as well-financed or as well-established as much of our competition, whenever we play by their marketing rules, we are at a disadvantage. Therefore, instead of spending a lot of money on advertising, Honest Tea relies instead on opportunistic ways to gain public attention and promote trial of the product.

We have proven our ability to gain positive free media coverage in The Washington Post, The Wall Street Journal, Christian Science Monitor and Fortune magazine. (See Exhibit C). In addition to what has already been printed, sev- eral articles are in the pipeline, including upcoming articles in magazines such as Shape, Self, Fitness, Start-Ups, and Seventeen. We are currently finalizing a

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contract with a highly-regarded public relations firm, which has a proven track record of gaining extensive exposure for early-stage companies. Just as we have paid a portion of our label designer’s expenses in the form of equity, we intend to pay a portion of the PR firm’s retainer in stock to encourage their investment in our business. We also have developed a web page at www.honesttea.com which has regularly attracted 50 visitors a day and has helped attract several new accounts.

In addition, we have been very aggressive with sampling. Because Honest Tea started the summer as an unknown product and is unlike any product currently on the market, we took great pains to introduce as many people to the product as we could. During the month of August, we organized demos as often as eight times a month per Fresh Fields/Whole Foods Market (See Exhibit D – Excluded in the interest of space).

Finally, we have developed a loyal following among several nationally-known celebrities which we hope to use to our advantage this coming Spring. For ex- ample, we recently rushed the delivery of ten cases to Oprah Winfrey’s studios at her personal request.

Packaging and Pricing Honest Tea’s flagship line of products is sold in 16-ounce glass bottles. All of our labels feature culturally authentic artwork from the tea’s country of origin. All of our caps have a distinctive black matte finish which complements the black border on the front of the label. In 1999 our caps will have the “pop-button” seal. Our packaging communicates the attributes of the tea inside in four ways:

1. High quality – By using colorful and artistically sophisticated artwork pre- sented with spot labels, (i.e., front and back instead of wraparound) our bot- tles evoke comparisons with a bottle of fine wine or another gourmet food.

2. Culturally authentic – By using artwork directly from the culture where the tea comes from, we are presenting the tea as is, without any “spin” or West- ernized interpretation of what an Indian painting might look like.

3. Honest – By using the spot labels, there is more space for the consumer to see the tea. Since we use real tea leaves, we have nothing to hide inside.

4. Simplicity – The essence of this millenia-old drink of water and leaves is its simplicity. Our packaging has no flashy slogans, advertising call-outs or marketing hype. The package helps condition the consumer for what they are about to experience, an honest taste of tea.

In 1999 we plan to introduce a “Varietea” pack which will contain a selection of flavors, and will help introduce consumers to our product. The Varietea pack will be sold at a modest discount to encourage first-time trial.

The retail price for a 16-ounce Honest Tea varies between $1.19 and $2.00, slightly more expensive than Snapple, which usually sells for $.99. In food ser- vice accounts we have seen the price range from $1.29 to $2.50.

International Markets Since tea is the world’s second most popular beverage, there is an intrinsic international appeal for Honest Tea’s world of flavor freshly brewed and barely sweetened. Although our primary energies are directed toward the US market, we have recently entered into a contract with a firm that has extensive interna- tional marketing expertise. They will be showing our product in the UK early next year with the intent to sell the bottled tea in the Spring of 1999.

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Product Development and Future Products In 1999 we will be introducing at least two new flavors in direct response to feedback from our customers. Our Decaf Ceylon will be the only decaffeinated black tea served in a Ready-to-Drink bottle. The decaf tea has a great taste and a captivating label.

In addition to being our first organic tea, our First Nation Peppermint has a smooth taste and a compelling label featuring an intense photo of a Crow war- rior. This product should also attract free media coverage for the innovative partnership we have forged with the Crow – Nation.

Despite the thousands of tea flavors that exist, we have taken a relatively conser- vative approach by identifying accessible flavors from different continents. In ad- dition to Decaf – Ceylon and First Nation’s Peppermint, several more flavors have been identified which will be introduced within the next twelve months. Some are as accessible as the flagship products, others may be more appealing to certain segments of the population. For example, Japanese green tea has a strong taste which can repel untrained Western tastebuds, but we believe this product has commercial viability provided it is strategically marketed and distributed.

In addition to other bottled tea flavors, we are exploring related products such as “Tea”-shirts featuring art from our labels, tea bags sold under the Honest Tea name and other tea-related products such as tea marinade and even “tea bags” for the bathtub.

Management

The management team of Honest Tea has a proven record of entrepreneurial success and innovative business strategy and has recently added two senior sales managers with extensive experience in the specialty foods and beverage indus- tries. They are, in order of seniority:

President & TeaEO

Seth Goldman launched Honest Tea after leaving the Calvert Group where he was Vice President of Calvert Social Investment Fund, the nation’s largest family of mutual funds that invest in socially and environmentally responsible companies. In this role, Seth managed the marketing and sales efforts, includ- ing a ground-breaking public awareness campaign that increased website traffic eightfold and doubled sales in the company’s flagship equity fund. His other work at Calvert Group includes active involvement in the company’s private equity portfolio and managing a corporate child labor initiative for the Calvert Foundation.

His previous work includes directing a nationally-recognized demonstration project for Americorps, the president’s national service program, and serving as Senator Lloyd Bentsen’s Deputy Press Secretary for two and a half years. Be- fore that he worked for a year in China (1987–1988) and a year and a half in the former Soviet Union (1989–1990), where he developed, among other things, an appreciation for the role tea plays in bringing people together.

Seth graduated from the Yale School of Management in 1995. While at Yale, he and a classmate were winners of the inaugural Connecticut Future Fund New Enterprise Competition for a business plan they developed based on a diagnos- tic invented at the Yale School of Medicine. Seth is a graduate of Harvard Col- lege, where he was elected Class Marshal and was a member of the Varsity Track team. He serves as Chair of the Yale School of Management Annual Fund and the Montgomery Public Schools Educational Foundation. He is a former board member of Students for Responsible Business.

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Seth’s experience at Calvert Group has enhanced his contribution to Honest Tea in two important ways. As Calvert’s most visible presence within the community of socially responsible businesses, Seth’s contacts and connections help give Honest Tea a mark of credibility which is essential for the brand identity the Company is trying to create. In addition, the target customer for Calvert’s equity funds is very much in line with the Cultural Creative profile discussed earlier. Seth’s record of success in communicating with this audience while at Calvert Group has conveyed well to Honest Tea.

Chairman of the Board

Barry Nalebuff is the Milton Steinbach Professor of Economics and Manage- ment at Yale School of Management. He taught at Harvard and Princeton before coming to Yale. He teaches competitive strategy, mergers and acquisition, politi- cal marketing, and decision-making and game theory at the management school negotiation at Yale law school, and social choice, political theory, and welfare economics to undergraduates. An expert on Game Theory, he has written exten- sively on its applications for managers. Barry is co-author of Thinking Strategi- cally: The Competitive Edge in Business, Politics, and Everyday Life. His new book on business strategy, Co-opetition, co-authored with Adam Brandenburger, was a Business Week bestseller. He has applied the use of game theory in consulting to companies in banking, consumer products, healthcare, high-tech manufac- turing, insurance, oil, pharmaceuticals software, and telecommunications. A graduate of M.I.T. and a Rhodes Scholar, he earned his doctorate in economics at Oxford University.

Brewmaster

George Scalf joined Honest Tea in March of 1998 to manage the production of the tea. As the founder of numerous natural beverage enterprises including Blue Range Natural Foods and New Dawn Natural Foods, George brings more than 20 years of expertise and contacts in beverage manufacturing. He also has numerous contacts in the natural foods marketplace.

National Sales Director

Jim Lambert joined Honest Tea in September from Stanley Foods where he was the Vice President of Sales for the DC/Baltimore area’s premier specialty food distributor. Jim is a 15-year veteran of the food industry. His previous positions include Chain Accounts Manager at US Foodservice Baltimore and with Atlan- tic Foodservices. In his role as National Sales Director, Jim is responsible for overseeing all sales and distribution relationships, with particular focus on food service and mainstream supermarket accounts.

Retail Sales Manager

Melanie Knitzer came to Honest Tea in October from her post as Director of Corporate Sales with Gourm-E-Co Imports, a mid-Atlantic specialty food dis- tributor. Melanie also brings 15 years of experience to Honest Tea, including roles as General Manager with Dolce Europa and Gourmand. In her role as Retail Sales Manager, Melanie is responsible for managing all natural foods and gourmet foods retail accounts.

Consultants and Advisors

Throughout the development of the Honest Tea business planning process, we have been fortunate to tap into a wealth of tea, beverage, natural foods, and en- trepreneurial expertise. The people listed below have served as resources for us. Several of them may continue to play a role in the company in the future.

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Joe Dobrow – Director of Marketing Programs, Fresh Fields/Whole Foods Markets

John May – Managing director, New Century Partners, social venture capital investment advisor

Lawrence Omene – Quality Assurance Manager, Mid-Atlantic Coca-Cola Bottling Company

Karin Schryver – Natural foods buyer for Harris Teeter, chain of l40 upscale supermarkets in the Southeastern United States

Financial Statements

Although a statement of social and environmental responsibility is not usually found in most business plans, these issues are central to Honest Tea’s identity and purpose. Not only is the value of our brand based on authenticity, integrity and purity, but our management team is committed to these values as well. We will never claim to be a perfect company, but we will address difficult issues and strive to be honest about our ability or inability to resolve them. For example, we recognize that the labor and environmental conditions on many tea estates are below internationally accepted standards. We will strive to work with our suppliers to promote higher standards while recognizing the limited influence we have as a small company. We value diversity in the workplace and we intend to become a visible presence in the communities where our products are sold. When presented with a purchasing decision between two financially comparable alternatives, we will attempt to choose the option which better addresses the needs of economically disadvantaged communities.

We have taken our first substantive step in that direction with the development of our newest tea flavor, First Nation’s Peppermint. After much negotiation with Itchik, a woman-owned company based on the Crow reservation, we have cre- ated a partnership that allows the Crow community to be economically involved in the production and sale of the tea. -Itchik is serving as Honest Tea’s buyer for the ingredients, charging a modest administrative fee per kilo of tea with the un- derstanding that over time Itchik will develop the capacity to harvest the tea on the reservation. In addition, Itchik is licensing the recipe and artwork to Honest Tea in a royalty arrangement. A portion of the royalties will be directed to the Pretty Shield Foundation, a non-profit created to address the needs of foster Na- tive American children.

Financial Statements–Year-to-Date and Projections

Exhibit E presents the monthly income statement and balance sheet for Honest Tea from January 1998 through November 30, 1998. Exhibit F presents the 1999 projected income and cash flow statement, with assumptions included at the bottom.

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8

B U

S I

N E

S S

P L

A N

96

The Investment Opportunity7

Honest Tea is seeking equity investments totaling $1.2 million in equity capital to finance the national distribution of the product as well as the introduction of two new flavors and international sales.

The Offering (Excluded from the Plan)

Financing History Initial financing for Honest Tea came from the founders, Seth Goldman and Barry Nalebuff, and their friends and family. This equity funding of approximately $500,000 was used to start the business and to generate the first production run.

Exit Strategies Investors in Honest Tea would be able to realize a return on the appre- ciation of their investments under any of the following scenarios:

Investment by a strategic partner—As Ocean Spray’s recent pur- chase of a significant share of Nantucket Nectars demonstrates, there may be opportunities for investors to realize their gains through the sale of their Honest Tea shares to a strategic investor who can help the company expand its production and distribution. Acquisition—There are numerous precedents of companies that might be interested in leveraging the integrity and purity of Honest Tea’s brand. Some recent examples are the acquisition of Mistic and Snapple by Triarc. Honest Tea has already been approached by some well-known beverage companies to discuss possible acquisition opportunities. Initial Public Offering—If Honest Tea meets our expectations for growth, the Company might consider some form of public offering to raise capital for expansion in the future.

Investment Risks In addition to the economic and business factors which pose risks for most early-stage companies, an investment in Honest Tea carries several other risks:

Product Risk—Although we are insured for product liability, a health-related incident such as the one Odwalla experienced sev- eral years ago could do significant damage to the Honest Tea brand name. Of course, since our product is pasteurized twice, there is less of a risk that the same types of bacteria could emerge.

Competitive Risk—Republic of Tea, a company that has a well- established brand name among tea lovers, might decide to enter the retail market with a more competitively priced product. Such a move could dampen the uniqueness of our message. Crystal Geyser, a company which has deep pockets and pre-existing distribution relationships, might decide to introduce additional products beyond Tejava and spread its distribution more aggressively beyond the West Coast.

7The Investment Opportunity section, including the offering and financing history is not included in the business plan as avail- able on the Honest Tea Web site. The comments included here are based upon multiple sources and are meant to be a fair repre- sentation of the original information.

B U

S I

N E

S S

P L

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97

Management Risk—At this point, the development of the company has been concentrated largely in the hands of Seth Goldman and Barry Nalebuff. If either of them were unable to continue to play a role in the Company’s progress, the growth of Honest Tea might be impaired.

Competitive Advantage The results of this past summer clearly indicate that Honest Tea has tapped into a market opportunity. When we were planning the compa- ny’s strategy last year we entertained the idea of spending several years building up a strong presence in a local market before expanding nation- ally. We have chosen to grow in a more aggressive manner for several reasons:

Market Niche—We have created a new beverage category and are currently the only -company filling that category. If we hesitate, other companies are likely to move in. Compelling brand image and story—The packaging, presentation and profile of the -Honest Tea brand fit together extremely well with the product. Although we may improve on the bottle design in the future, this is a package that comes close to selling itself. It is also a brand and a story, which has successfully gained free media cover- age, and should continue to do so. Management Team—We have developed a team with the right com- bination of sales -experience and market creativity that is capable of growing the company on a national, and even international, scale.

A Parting Thought

Prospective investors in Honest Tea are advised to keep in mind the words of Sung Dynasty poet Li Chi Lai who cited the three great evils that might beset the land:

the spoiling of gallant youths through bad education; the degrada- tion of good art through incompetent criticism; and the waste of fine tea through careless making.

While we may not be able to have much direct influence over education and the arts, -Honest Tea stands poised to restore integrity to a bever- age that has brought people together for hundreds of generations and throughout dozens of civilizations. There has never been a time when consumers have been so overwhelmed with choices. And yet there has never been a time when integrity and authenticity are as cherished as they are scarce. There has never been a better time for Honest Tea.

Tony Hsieh, Zappos.com (Noah Berger/ Bloomberg/Getty Images)

3 CH

A PT

ER Creating Business from Opportunity

Learning Objectives 3.1 Define your business. 3.2 Distinguish between entre-

preneurial and managerial thinking.

3.3 Articulate your core beliefs, mission, and vision.

3.4 Decide how to approach busi- ness opportunities

3.5 Analyze your competitive advantage.

3.6 Prepare viability tests using the economics of one unit.

3.7 Calculate the value of a business.

MyLab Entrepreneurship Improve Your Grade!

If your instructor is using MyLab Entrepreneurship, visit www.pearson.com/ mylab/Entrepreneurship for videos, simulations and writing exercises.

99

Entrepreneurs find and take advantage of opportunities that others do not recognize or cannot access the resources to exploit. When Zappos.com founder Nick Swinmurn be- came frustrated by looking for shoes in a San Francisco mall and online, he saw an oppor- tunity to create an online pure-play e-commerce megastore that would carry a multitude of sizes, styles, and colors. Swinmurn was three years out of college when he launched ShoeSite.com, with $150,000, in 1999. Within a month, he relaunched as Zappos.com. In 2000, Tony Hsieh of Venture Frog Incubators saw the opportunity in Zappos, investing $1.1 million and joining Swinmurn. The company has thrived on providing the best selection and service, with a focus on the “wow” factor and delivering happiness. Zappos.com car- ries more than 1,000 brands, employs 3,800 people, and has annual revenues of more than $1 billion.1 In November 2009, Amazon.com acquired Zappos.com Inc. in a deal valued at $1.2 billion. Zappos.com has since expanded its product offerings to include handbags, clothing, and other items, and it was restructured into 10 separate companies.

What Defines a Business? Before you can start a business, you should define it along several dimen- sions. This business definition includes the offer, target market, and prod- uct and delivery capability—answering the questions of who, what, and how. A solid business definition has three elements:

1. The offer. What will you sell to your customers? That is called your offer, and it includes the complete bundle of products and services you will be bringing to the marketplace. This should address not only the tangible product or intangible service but their benefits. For example, you will provide online and telephone fitness consulting services for an initial four-week period at $25 per week, or eight weeks at $20 per week.

2. Target market. Which segment of the market are you aiming to serve? As discussed in Chapter 2, this will be your target market. Defining your target market in a way that will help you identify qualified potential customers is critical to achieving success. This definition must be precise enough for you to identify a viable mar- ket for the business and focus your marketing. A target market of every adult in the United States is too broad and unfocused. A mar- ket of every member of Congress from the state of Rhode Island (three individuals) would be too narrow.

3. Production and delivery capability. How will you provide your offer to your targeted customers? This includes how to perform the key activities required to produce the product or service, deliver it to your customers, and ensure they are satisfied. This part of the busi- ness definition includes the primary activities of:

• buying, developing, or manufacturing the product; • identifying its potential qualified customers and selling the prod-

uct to them; • producing and delivering the product or service; and • receiving payment.

Learning Objective 3.1 Define your business.

“Problems are only opportunities in work clothes.” —Henry J. Kaiser, American industrialist

1 Zappos.com Inc., accessed February 15, 2018, http://www.zappos.com.

100 UNIT 1: Entrepreneurial Pathways

S t e p i n t o t h e S h o e s . . .

Pan Zhang Xin Marita—Building a Real Estate Empire from Opportunity Real estate developer Pan Zhang Xin Marita has built a fortune by identifying economic opportunities in China. She is the cofounder and CEO of SOHO China. As of February 2018, she and her family had an estimated net worth of $3.7 billion.

This is a very different life from Zhang’s early days of living in poverty in Henan province and in Hong Kong. She left China to get an education in England at the University of Sussex and then Cambridge. Her work history includes investment banking in New York and Hong Kong. Yet she always maintained ties to the land of her birth.

Zhang and her husband, Pan Shiyi, created Beijing Redstone Industries Co. Ltd., a property development firm they later renamed SOHO China, in 1995. SOHO China is the nation’s largest commercial real estate developer, with 54  million square feet of developments, and is a public

company trading on the Stock Exchange of Hong Kong ($1.9 billion IPO in 2007). Zhang and Shiyi saw opportunities for modern, high-style properties in Beijing and Shanghai when others did not.

Zhang is a prominent woman in China, with over 10 million followers on Sina Weibo (a social media plat- form). She is recognized for her busi- ness acumen, her role in urbanizing China, and her staunch belief that democracy will come to China.

Source: “China Rich List, Zhang Xin & Family (#69),” Forbes, November 15, 2017, accessed February 15, 2018, http://www.forbes.com. “Company Profile,” SOHO China, accessed February 15, 2018, http://www.sohochina.com.

Pan Zhang Xin Marita, SOHO China (Nelson Ching/Bloomberg/ Getty Images)

Use Effectual Reasoning to Your Advantage For many years, researchers have attempted to define entrepreneurs by traits such as birth order, personality, competencies, and entrepreneur- ial orientation—with mixed results. One analysis originated by Dr. Saras Sarasvathy examines entrepreneurial thinking and actions. This analysis of effectual logic versus causal logic is important to understanding how suc- cessful entrepreneurs can create businesses from opportunities. Effectual logic is also known as entrepreneurial thinking and is defined as a way of thinking employed by entrepreneurs that includes decision-making princi- ples applied in situations of uncertainty. Causal logic is managerial think- ing and is based on cause and effect, with managers planning and creating steps toward a specific goal in a linear fashion. Exhibit 3-1 compares the two. What entrepreneurial thinking means to a start-up entrepreneur is the creativity and flexibility to work with the resources available to be agile in the development of a viable business.

Learning Objective 3.2 Distinguish between entrepreneurial and manage- rial thinking.

Effectual logic a way of thinking employed by entrepre- neurs that includes decision- making principles applied in situations of uncertainty.

Causal logic a way of think- ing based on cause and effect, with managers planning and creating steps toward a spe- cific goal in a linear fashion.

Effectual Logic Causal Logic

Bird-in-hand principle—start with your means Start with a set goal—cause and effect Affordable loss principle Calculate expected return Lemonade principle Avoid failure (failure equated to death) Crazy quilt principle—collaborate and co-create Compete Pilot-in-the-plane principle—future is made Future is found or predicted Iterative and bumpy Plan, plan, plan, and plan some more Small actions, taken incrementally Bold moves, in a linear process

Exhibit 3-1 Comparing Effectual and Causal Logic

Source: Based on Saras D. Sarasvathy, “Causation and Effectuation: Toward a Theoretical Shift from Economic Inevitability to Entrepreneurial Contingency,” Academy of Management Review, 2001, 26(2), pp. 243–263.

101 CHAPTER 3: Creating Business from Opportunity

What Sort of Organization Do You Want? Each organization can create a unique mission, vision, and culture that will be supported by its core values. The management team can determine how to use the company’s competitive advantage to satisfy customers. The organization’s culture can be shaped according to the business environ- ment and by the way employees, customers, and other stakeholders are treated—an example that is set by the founding entrepreneur (owner).

Your Company’s Core Values When you start your own company, what beliefs will you use to guide it? These are the core values of your business. Core values include the funda- mental ethical and moral philosophy and beliefs that form the foundation of the organization and provide broad guidance for all decision making. Examples of the core values of a business might be:

• “At Superior Printing, we engage in business practices that affect the environment as little as possible.”

• “At Sheila’s Restaurant, we believe in supporting local organic farmers.”

Core values will affect business decisions. The owner of Superior Printing, for example, will choose ink that is less harmful to the environ- ment over a cheaper ink that is more harmful. Superior Printing may also have a paper-recycling program to offset its paper consumption. The owner of Sheila’s Restaurant will buy fruits and vegetables from local or- ganic farmers. Your core beliefs will affect everything, from the cost of materials to the prices you charge and how you treat customers. For ad- ditional examples of core values, see Exhibit 3-2.

Learning Objective 3.3 Articulate your core beliefs, mission, and vision.

core values the fundamental ethical and moral philosophy and beliefs that form the foun- dation of the organization and provide broad guidance for all decision making.

Exhibit 3-2 Core Values

Zappos.com 1. Deliver WOW through service 2. Embrace and drive change 3. Create fun and a little weirdness 4. Be adventurous, creative, and open-minded 5. Pursue growth and learning 6. Build open and honest relationships with communications 7. Build a positive team and family spirit 8. Do more with less 9. Be passionate and determined

10. Be humble

Dow AgroSciences To ensure the prosperity and well-being of Dow AgroSciences’ employees, customers and shareholders, growth is essential. How we achieve this objective is as important as the objective itself. Fundamental to our success are the core values we be- lieve in and practice. • Collaborative: We communicate openly, treat each other with respect, promote teamwork, and encourage personal

initiative and growth. Excellence in performance is sought and rewarded. • Resourceful: We go above and beyond to continuously improve our technology and add value to our customers and end users. • Genuine: We believe in fairness and respect for each other and our customers. Our employees strive to be transparent and

honest in their endeavors. • Responsible: Our conduct demonstrates a deep concern for human safety and environmental stewardship, while embracing

the highest standards of ethics and citizenship.

DuPont Company Safety and health, environmental stewardship, respect for people, and highest ethical behavior.

102 UNIT 1: Entrepreneurial Pathways

Exhibit 3-3 Mission Statements

Sources: DuPont Company – Vision Statement used with permission. Google – Mission Statement used with permission. Kiva, accessed March 9, 2018, http://www.kiva.org used with permission. Caroline Glackin, Revolutionary Coworking Mission Statement used with permission. Teach for America – Mission Statement used with permission. Healing Hands Body Therapy, Inc. used with permission.

Your Company’s Mission Is to Satisfy Customers Your mission statement is a concise communication of your purpose, busi- ness definition, and values. Its function is to clarify what the business is trying to do in the present, and it can provide direction and motivation for future action through a clear and compelling message.

As noted in Chapter 2, a well-crafted mission statement will not only tell your customers and employees what your business is about but should be a guide for every decision you make. It should capture your passion for the business and your commitment to satisfying your customers. A mis- sion statement should be limited to 21 to 40 words to induce clarity in concept and expression. The mission statement should address the follow- ing topics: target customers; products and services; markets served; use of technology; importance of public issues and employees; and focus on survival, profitability, and growth.

Here is an example of a 27-word mission statement for the Most Chocolate Cake Company:

To create the richest, tastiest, most chocolaty cakes made from the fin- est, freshest ingredients according to our secret recipes and decorated with our extraordinary frostings and fillings.

The Most Chocolate Cake Company’s mission statement defines the business and its competitive advantage—the core of its strategy. Examples of mission statements from a range of organizations appear in Exhibit 3-3.

Your Company’s Vision Is the Broader Perspective The vision for your business is broader and more comprehensive than its mission, painting a picture of the overall view of what you want your organiza- tion to become in the future. It is built on the core values of the organization. It should energize your people, and they should embrace it with enthusiasm and passion. This means the vision must be compelling across the organiza- tion. It must matter. Employees need to be empowered to fulfill the vision. Examples of vision statements for various organizations appear in Exhibit 3-4.

Your Company’s Culture Defines the Work Environment The culture of an organization is largely shaped by its leadership. Culture is composed of the core values in action. Leaders of a company build a culture by making the beliefs, values, and behavioral norms explicit and

DuPont Company—DuPont puts science to work by creating sustainable solutions essential to a better, safer, healthier life for people everywhere. Google—To organize the world’s information and make it universally accessible and useful. Kiva Microfunds—To connect people through lending to alleviate poverty. Revolutionary Coworking—Revolutionary Coworking provides services that empower the underserved community of vetre- preneurs, milpreneurs, independent professionals, and non-traditional students, by fostering an environment that promotes education, innovation, collaboration, workspace liberty, and sustainability. Teach for America—Teach For America finds, develops, and supports a diverse network of leaders who expand opportunity for children from classrooms, schools, and every sector and field that shapes the broader systems in which schools operate. Healing Hands Body Therapy—Healing Hands Body Therapy provides comprehensive care in the form of manual therapy to those who have pain. We are committed to creating an environment where passion and purpose come together to provide the best care for every patient. Healing Hands Body Therapy is dedicated to the pursuit of continued knowledge and engaging our patients on their journey to health and wellness.

103 CHAPTER 3: Creating Business from Opportunity

intentional. Culture includes factors such as risk tolerance and innova- tion; orientation with respect to people, teams, and outcomes; attention to detail; and communications norms. Organizational culture is learned by members of the team in many ways, including through anecdotes, ceremo- nies and events, material symbols, and use of language. For example, at General Electric, stories of Jack Welch are legendary. At Hewlett-Packard, there was the “Hewlett-Packard Way,” based on anecdotes passed down from one generation of employees to the next. Those who work in small enterprises often see the top management daily and take their cues di- rectly, because there are very few or no layers between them. As enter- prises become larger, the firm’s leaders may not often be on view to most employees and frequently take on larger-than-life roles through stories.

Ceremonies can make a significant difference in a company’s culture. Are there periodic recognition events for innovation? Does the company invite family members to appropriate occasions throughout the year? Is there a birthday celebration for each employee? Are years of service recognized? Material symbols come in many shapes and forms. At the Wilmington, Delaware, headquarters of former MBNA America, the values of the company appeared on every archway, and handprints of the employ- ees made colorful wall art in some buildings. At any business, reserved parking spots and special privileges for certain employees send a message to everyone. Are these spaces for top executives? Expectant mothers? Are office sizes determined by pay grade? Finally, language tells a lot about the culture. Is everyone on a first-name basis with everyone else? Are some people addressed formally while others are not? Is the language around the company in general formal or informal? Is communication respectful?

These and many other factors are all part of the culture of an orga- nization. Culture should be crafted to follow core beliefs and support the mission and vision of the business.

The Business Opportunity Decision Process Translating opportunity into success can and has happened in literally mil- lions of different ways. Each business has a different story. As discussed in Chapters 1 and 2, entrepreneurs create and find opportunities in numer- ous ways and analyze them strategically, through the lean start-up process, and in terms of their business plan. There are some tried and true ways of generating the ideas to explore and develop. There are three primary routes in the deliberative search process to create and identify opportunities:

• The entrepreneur looks for business opportunities through a process of identification and selection, beginning with self-developed (or group-developed) ideas.

Learning Objective 3.4 Decide how to approach business opportunities.

Exhibit 3-4 Vision Statements

General Motors—General Motors is leading the transportation revolution by delivering safer, better and more sustainable ways for people to get around. Driven by 177,000 talented employees across the globe, General Motors’ vision is to help create a world with zero crashes, zero emissions and zero congestion. Google—To provide access to the world’s information in one click. Kiva—We envision a world where all people—even in the most remote areas of the globe—hold the power to create opportunities for themselves and others. Healing Hands Body Therapy—Healing Hands Body Therapy incorporates a vision which creates a safe, positive and enriching environment where you can rely upon professional help in overcoming your pain and injuries without the traditional prescriptions or surgeries.

Sources: General Motors – Vision Statement used with permission. Google – Vision Statement use with permission. Kiva, accessed March 9, 2018, http://www.kiva.org used with permission. Healing Hands Body Therapy, Inc. used with permission.

104 UNIT 1: Entrepreneurial Pathways

• The entrepreneur uses essentially the same process but starts with research on hot businesses, trends, or growth areas.

• The entrepreneur has an idea for a product or service or has a prob- lem to solve and searches for a market.

These processes are illustrated in Figure 3-1. In each case, a decision is made based on personal values and thinking.

Whereas each ultimately funnels the procedure down to a business concept, the processes are repeated—often with many ideas being considered— before a viable picture emerges. The first two options are market driven; the third is product or problem driven. Entrepreneurs do better looking to the market(s) of interest, rather than creating a product and then trying to find a customer base. You can do all this alone, but it is best to work with others who will provide honest, constructive feedback.

Conduct In-Depth Research

Select a Business to Pursue

Business 1 Business 2

Reduce Options

More Research & Analysis

Conduct In-Depth Research

Select a Business to Pursue

Idea

Idea

Idea 1 Idea 2 Idea 3

Idea Idea

Idea

IdeaIdea

Idea

Idea

Idea

Idea Idea

IdeaIdea Idea

Idea

Select Concepts of Interest

Idea 1 Idea 2 Idea 3

Prioritize Concepts

Research & Analyze Concepts

Brainstorm Concepts

Idea

Identify “HOT” Markets

Reduce List by Interest, Skills, or Other

Research & Create Business Concepts

Prioritize Concepts

Market Market Market Market

MarketMarketMarket

Market Market

Market

Market Market

Market

Evaluate Preliminary Viability

Accept Reject

Accept Reject

Conduct In-Depth Research

Pursue the Opportunity

Drop Idea

Think of a Business Concept

Conduct Research on the Concept

Drop Idea

Business 1 Business 2

Reduce Options

Idea Idea

Idea Idea

Idea Idea

Idea

Idea

Idea Idea

Figure 3-1 Business Opportunity Decision Processes

105 CHAPTER 3: Creating Business from Opportunity

Critical to this process is continuous feedback and development with an emphasis on getting prototypes into the hands of prospective custom- ers early and often. By getting market feedback early in the process, you create products that are meaningful to your target market. This process of creating minimum viable products (MVP) is part of the lean start-up process described in the work of Eric Ries and discussed in greater detail in Chapter 2.2

Your Competitive Advantage For your business to be successful and to fulfill your mission and vision, you will need a strategy for outperforming the competition. This will be your competitive advantage, or core competency. It is whatever you can do better than the competition that will attract a sufficient number of custom- ers to your business, so it can succeed. The competitive advantage must be sustainable to create long-term viability. Your competition is defined by your target market and can be direct (selling the same or similar products to the same market) or indirect (selling different products that compete for the same share of customer spending). For example, a children’s museum will indirectly compete with rental movies/movie theaters, indoor/outdoor play areas, sports and recreation venues, and other leisure-time activities for family entertainment time and money. Your competitive advantage is whatever meaningful benefit you can provide that puts you ahead of the competition and keeps you there.

• Can you attract more customers than your competitors by offering better quality or some special service?

• Can you supply your product at a lower price than other businesses serving your market?

If you are running a party rental business, perhaps you could deliver the popcorn and flavorings along with popcorn machines, so customers would not have to purchase from two vendors. That would be your competitive advantage. If you can beat your competitors on price and service, you will be very strong in your market.

Find Your Competitive Advantage by Determining What Consumers Need and Want Bill Gates did not invent computer software, but he did recognize that peo- ple were frustrated and intimidated by it. From there, he supplied operat- ing systems that he purchased from another software company to IBM, created user-friendly software applications that consumers wanted, and packaged them attractively with easy-to-read manuals. That was his com- petitive advantage over other software companies. When you know your customers’ wants and needs and your competitors’ capabilities, you should be able to find a competitive advantage.

Remember, as you identify environmental trends and search for product or service opportunity gaps, there will be outside forces at work regarding the effectiveness of the idea. These will include economic and social forces, technological advances, and political and regula- tory changes. Any of these forces can be a source of opportunity and advantage.

Learning Objective 3.5 Analyze your competitive advantage.

2 Eric Ries, The Lean Startup: How Today’s Entrepreneurs Use Continuous Innovation to Create Radically Successful Businesses (New York: Crown Business, 2011).

106 UNIT 1: Entrepreneurial Pathways

You Have Unique Knowledge of Your Market You may be wondering: “How do I figure out what customers need? I don’t know anything about them.” Actually, you do. Your market may well be composed of your friends, neighbors, classmates, relatives, and colleagues. You already have the most important knowledge you need to succeed. And if you are starting a business to address a problem you have encountered, chances are that you know your market very well. However, be careful to make the distinction between what you are assuming and what is true, so that you will make good decisions. Using the customer discovery process in the lean start-up method is quite beneficial in working from your as- sumptions to the reality of the marketplace to find product-market fit.

Sir Richard Branson, the CEO of Virgin Corporation, chose “Virgin” because it reflected his total inexperience in business. His empire, which includes Virgin Megastores, Virgin Atlantic Airways, and Virgin Mobile, began as a tiny discount mail-order record company, which he started at age 19 after he dropped out of high school. Branson knew his market— other young people who were into music—very well. Then, he learned about the other markets before he entered them.

How will you know if a business idea is going to be successful? You can- not have a guarantee, but your market will tell you a lot about your chances. The answer will come in the form of the signal called profit. You can learn a lot about the potential for success well ahead of starting your enterprise, through customer and market research, in addition to competitive analysis.

Factors of Competitive Advantage Competitive advantage comes from one (or a combination) of several factors:

1. Quality. Can you provide higher quality than competing businesses? 2. Price. Can you offer a lower price on a sustained basis than your com-

petition, or does your higher price reflect quality and/or uniqueness? 3. Location. Can you find a more convenient location for customers? 4. Selection. Can you provide a wider range of choices than your com-

petitors can? 5. Service. Can you provide better, more personalized customer service? 6. Speed/turnaround. Can you deliver your product/service more

quickly than the competition? 7. Convenience. Is it easy to use your product? Is your product accessible? 8. “Getting the job done.” Does the product or service accomplish a

task that has been problematic?

G lo b a l I m p a c t . . .

SOFTtribe Founders See Tropical Tolerance Needed for Software in Ghana Herman Kojo Chinery-Hesse and Joe Jackson saw an oppor- tunity in the need for adapting software for tropical climates when they founded SOFTtribe Ltd. in 1991. Their company de- velops software, taking into consideration the unique require- ments of the West African social and business environment. According to their partner, Microsoft, “The SOFTtribe soft- ware is practical and resilient, functional under conditions of

intermittent connectivity, power fluctuations, low bandwidth, and operators who, as a rule, are less familiar with computing than in some other parts of the world.”3

Chinery-Hesse has been called the Bill Gates of Ghana for his success in building SOFTtribe. It is the largest software company in Ghana and is a Microsoft partner to permit its expansion.

3 “Taking African Business Global,” Microsoft Unlimited Potential, May 27, 2009, accessed January 13, 2010, http://www.micro- soft.com/unlimitedpotential/.

107 CHAPTER 3: Creating Business from Opportunity

9. Brand/status. Will customers associate your product with a quality brand or with luxury and status?

10. Newness. Is your product new and novel? Is it on the leading edge of technology?

11. Customization. Can your product or service be tailored to the re- quirements of your customers?

The importance of each factor will depend on the wants and needs of tar- get customers. More isn’t always better, if customers aren’t interested.

Is Your Competitive Advantage Strong Enough? When deciding whether your business concept is viable, it will be essential to determine your competitive advantage and whether it is strong enough. According to Jeffry Timmons’s New Venture Creation, a successful com- pany needs to do one of the following.

• Sell to a market that is large and growing. The market for smart- phones is a good example. New products are being marketed to meet the demand, such as printers that turn digital photos into prints with digital photo frames.

• Sell to a market where the competition can make a profit. It will be interesting to observe what happens in the market for hybrid cars. The jury is out as to whether the companies manufacturing them can make a profit, so most automakers are not yet entering the field. There still may not be a sufficiently large market to make entry worthwhile.

• Sell to a market where the competition is succeeding but is not so powerful as to make it impossible for a new entrepreneur to enter. Microsoft has been taken to court several times by competitors who argue that it is so big that new software companies cannot enter the market. Barriers to entry are the factors that contribute to the ease or difficulty of a new competitor joining an established market, and they cannot be so high that market entry and success are not possible.

• Sell a product or service that solves problems consumers may have with the competition. Problems can include poor quality or slow delivery. FedEx beat its competition—the Flying Tigers, the U.S. Postal Service, and United Parcel Service (UPS)—when it entered the package delivery market with guaranteed overnight service.

• Sell a product or service at a competitive price that will attract customers. UPS fought back by offering a less-expensive overnight delivery service than FedEx’s.

barriers to entry the factors that contribute to the ease or difficulty of a new competitor joining an established market.

you intend to learn from failures and disappointments. Do not let them get you down. Learn, so that you do not make the same mistakes again.

In addition to the above, it is also necessary to:

• understand the needs of your customers; • have a sustainable competitive advantage or multiple

evolving advantages; and • deliver a product or service that meets your custom-

ers’ needs at the right price.

A new business usually will require time before it can turn a profit. FedEx, in fact, suffered initial losses of $1 million a month! But if you are not making enough money to stay in busi- ness, that is the market speaking. It is telling you that your busi- ness is not satisfying consumer needs well enough. Do not take it personally. Many famous entrepreneurs opened and closed several businesses during their lifetime.

Henry Ford failed in business twice before he succeeded with Ford Motor Company. If you want to be a successful en- trepreneur, start growing a thick skin and decide right now that

E n t r e p r e n e u r ia l W i s d o m . . .

108 UNIT 1: Entrepreneurial Pathways

Checking Out the Competition One useful exercise is to learn everything you can about key competitors, especially those that have earned the respect of the marketplace. Try to identify the sources of their competitive advantage. Examine their websites. Conduct Internet searches. Track their advertising and promotion, includ- ing print, broadcast, Internet, and sponsorships. If they are retailers, shop their stores or have your friends and family do so. Get to know them (but do not do anything unethical or illegal to obtain information). You will also need to keep an eye on your competition after you have started your busi- ness, because new factors might undermine your competitive advantage.

Today’s entrepreneurs, even those starting microenterprises and life- style businesses, may face competition from far beyond their neighbor- hoods, because customers can shop on the web. Optimism is a trait that frequently goes with entrepreneurship, so beginning entrepreneurs tend to get excited about the web’s huge customer base. What they often do not consider is that the competition is already selling to their potential customers through the web. Therefore, get online and conduct a thorough search of your industry. You may find that there is literally a world of op- portunity or, conversely, that the world is full of competitors.

To determine whether you have a competitive advantage that will en- able you to outperform your closest and strongest competitors, ask these questions:

• Competitive offers. How does your offer compare with those of your leading competitors? What are the key features of each?

• Unique selling proposition. Based on that comparison, what is your unique selling proposition (USP), the distinctive features and bene- fits that set you apart from your competition? Determining your USP will require a comparison of offers and identifying what is unique about yours. What is it about your offer that your competitors can- not or will not match?

• Cost structure. What is different about your business activities and the cost of doing business, compared to the competition? Overall, are you at a cost advantage or disadvantage?

To be successful, you must have a USP that will attract customers to buy from you. You must also have a cost structure that is sufficiently ad- vantageous so that, when all your costs are deducted from your revenue, you will have sufficient profit left over. If you can achieve a cost advantage or at least minimize any cost disadvantage, this will help you achieve a profit. This profit is your reward for operating a successful business.

Example: The Most Chocolate Cake Company There are many ways to highlight your competitive advantage and to iden- tify opportunities. In this simple example, Amy makes and sells specialty chocolate cakes. She chose this product because she loves chocolate and she enjoys baking cakes and has been paid by friends to bake for special occasions. She decided to make the most chocolate cakes possible. From this decision, she developed the concept for her product and the name of her business, The Most Chocolate Cake Company, LLC.

Amy’s target market was the segment of the public in her community, Springfield, that loved chocolate cakes but did not have the time, interest, or skills to bake them. Because cakes are usually purchased for special occasions, Amy believed she could charge a premium price, at least as much as a bakery store cake.

unique selling proposi- tion (USP) the distinctive features and benefits that set a company apart from its competition.

109 CHAPTER 3: Creating Business from Opportunity

Sergio 33/Shutterstock

She decided she would make the cakes special by:

• using the finest ingredients and a secret recipe (quality);

• personalizing each cake through expert custom decorating (selection/customiza- tion); and

• baking the cakes to order, so they would be fresh for the event (quality).

Amy bakes her cakes at home in her specially designed commercial kitchen, which makes them literally homemade, and thus reduces the cost of producing them—she is not renting commercial space or paying a staff. Of course, the flip side of baking at home is that her production is relatively limited. Also, she may have to take time to deliver each cake, depending on local zoning regulations regarding retail trade. Exhibit 3-5 shows her business definition in tabu- lar form.

Amy expects, after careful analysis, that her more chocolaty cake with its special frosting and decoration, as well as its freshly homemade qual- ity, will be successful in the marketplace. This is her USP. She intends for it to be a source of competitive advantage, along with the cost advantage of baking the cakes at home. Based on this analysis, she has determined how she wants to make her offering better and different from those of her competitors.

Competitive Analysis Another approach to the analysis is to compare your business concept with the competitors that you have identified through your research. A simple comparative table is a good way to display this. The table should include the factors of competitive advantage that are most important to your prospective customers (remember your hypotheses in the lean start- up methodology). Plus, if there are features you want to highlight, or spe- cific aspects of the factors, adding them to the table will make them more prominent. These ratings can be done solely by you—your team—through market research techniques, or however you can get the most unbiased responses.

There are many ways to construct this type of competitive analysis table. Exhibit 3-6 includes a simple qualitative competitive analysis that

Exhibit 3-5 Business Definition

Business Definition Question The Most Chocolate Cake Company

1. The Offer. What products and services will be sold?

Chocolate cakes with various fillings and decorations for special events at premium prices.

2. Target Market. Which consumer segment will the business focus on?

People who love chocolate and want a special cake for a special event. Dual-income households with greater than median income.

3. Production Capability. How will that offer be produced and delivered to those customers?

Homemade and baked to order to ensure freshness, using high-quality ingredients and a secret recipe.

4. Problem Solving. What problem does the busi- ness solve for its customers?

Great appearance and flavor without the work or mess for special occasions.

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Exhibit 3-6 Comparative Analysis—Qualitative—The Most Chocolate Cake Company

The Most Chocolate Cake Company

Mega Super Market, Inc.

Average Bakery Company

Fancy Bakery, LLC

Quality Excellent Fair Fair Excellent Price Fair Good Moderate Poor Location Moderate Excellent Moderate Good Selection Fair Moderate Good Moderate Service Excellent Fair Moderate Fair Speed/Turnaround Good Excellent Moderate Fair Specialization Excellent Poor Fair Moderate Personalization Excellent Moderate Good Excellent

Exhibit 3-7 Comparative Analysis—Quantitative—The Most Chocolate Cake Company

The Most Chocolate Cake Company

Mega Super Market

Average Bakery Co.

Fancy Bakery, LLC

Attributes Important to Customers

Weight (a)

Rating (b)

Weighted Rating

1c = a * b2 Rating

(d)

Weighted Rating

1e = a * d2 Rating

(f)

Weighted Rating 1g = a * f2

Rating (h)

Weighted Rating

1i = a * h2 Quality 0.20 5 1.00 2 0.40 2 0.40 5 1.00 Price 0.10 2 0.20 4 0.40 3 0.30 1 0.10 Location 0.10 3 0.30 5 0.50 3 0.30 4 0.40 Selection 0.15 2 0.30 3 0.45 4 0.60 3 0.45 Service 0.10 5 0.50 2 0.20 3 0.30 2 0.20 Speed/ Turnaround

0.05 4 0.20 5 0.25 3 0.15 2 0.10

Specialization 0.20 5 1.00 1 0.20 2 0.40 3 0.60 Personalization 0.10 5 0.50 3 0.30 4 0.40 5 0.50 Total 1.00 4.00 2.70 2.85 3.35

shows ratings of excellent, good, moderate, fair, and poor for each factor with each competitor. The entrepreneur (or prospective customers) can establish this information by using their knowledge of each competitor. The analysis should consider those factors that are of greatest importance to the target market. Such a table will make competitive advantages and weaknesses clear.

The chart in Exhibit 3-7 is an example of a simple quantitative ap- proach to competitive analysis. First, based on industry data or quality customer research, each factor is assigned a weight according to its im- portance to the company’s target customers, with the total of all factors equaling 1.00 (or 100 percent). For example, quality could be weighted 0.20, location weighted 0.10, with other factors adding up to 0.70, if cus- tomers are very concerned about the quality of the product and whether they can buy it on the Internet. Second, each competitor should be rated on an odd-numbered scale, such as 1 to 5, with 1 being lowest and 5 being highest, on each factor. For example, The Most Chocolate Cake Company could rate a 5 on quality and 2 on selection, whereas the su- permarket could rate 2 on quality and 5 on location. Third, to calculate

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a weighted score, each rating should be multiplied by the associated weight to obtain a total. For example, if quality is rated 0.20 and The Most Chocolate Cake Company’s quality is rated 5, the weighted value is 1.00. Looking across the competitors’ scores on individual factors can yield insights into areas of strength or vulnerability. Finally, all the weighted values for each company should be totaled and an overall rat- ing calculated. By looking at the ratings, it becomes apparent who the strongest and weakest competitors are, and a company can address the results of the analysis.

Competitive Strategy: Business Definition and Competitive Advantage Your business will only succeed if you can offer the customers in your market something more, better, and/or different from what the competi- tion is doing. Your competitive advantage (core competency) is essential, and once you establish it, your business decisions will start to fall into place. Every advertisement, every promotion, even the price of your prod- uct and the location of your business should be designed to get customers excited about your competitive advantage (or your value proposition, if you want to use the business model canvas terminology).

Your competitive strategy combines your business definition with your competitive advantage. A competitive advantage must be sustainable, meaning that you can keep it going. If you decide to beat the competition by selling your product at a lower price, your advantage will not last long if you cannot afford to continue at that price. Small business owners should realize that price alone is not likely to work as an advantage in the long run. A larger business can almost always beat you on price, because it can buy larger quantities than you can and therefore receive a greater discount from suppliers.

Being able to temporarily undercut the competition’s prices is not a competitive advantage. Being able to permanently sell at a lower price be- cause you have discovered a secret, less costly way to produce or deliver the product is a competitive advantage. Being able to develop and main- tain proprietary product or service features and benefits is another ap- proach to finding a sustainable advantage.

Strategy versus Tactics Your strategy is the plan for outperforming the competition. Your tactics are the ways in which you will carry out your strategy.

If you plan to open a bookstore, how will you compete with the nearby big box bookstore or online bookseller? This competitor buys many more books than you do and will receive higher discounts from wholesalers, so you will not be able to compete on price. How else could you attract customers? Perhaps you could make your bookstore a kind of community center, so people will want to gather there. What tactics could you use to carry out this strategy?

• Hold poetry readings and one-performer concerts to promote local poets and musicians.

• Create special-interest book discussion groups. • Offer free tea and coffee. • Provide comfortable seating areas for conversation and reading to

encourage customers to spend time in your store. • Set up a binder of personal ads as a dating service.

competitive strategy the combination of the business definition with its competitive advantage.

strategy a plan for how an organization or individual intends to outperform its competitors.

tactics the specific ways in which a business carries out its strategy.

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If your tactics attract enough customers to make a profit, you will have found a strategy for achieving a competitive advantage. Remember, you will have to create a strategy that considers the online bookstores and e-books, too.

To find a competitive advantage, think about everything your business will offer. Examine your location, product/service, design, and price. What can you do to be different—and better in some way that matters signifi- cantly to your customer base—from the competition?

Feasibility Revisited: The Economics of One Unit as a Litmus Test Once you have chosen a business idea and determined your competitive advantage, you should make a preliminary analysis to determine whether the idea would be financially viable. In other words, can you provide your product or service at a price that will cover your costs and provide you with a profit? Stephen Wozniak and Steve Jobs were able to set up busi- ness in an office once they secured Mike Markkula’s investment in Apple. This gave them a better environment in which to develop and introduce the Apple II, and that gave them operating profits. Before investing a great deal of time, effort, and money on your business concept, you can use what you learned from your competitive analysis to make a preliminary assess- ment of the financial opportunity. Considerably more financial analysis will be done before opening your doors, but this is a good point at which to do a preliminary evaluation.

Entrepreneurs use profits to pay themselves, to expand their businesses, and to start or invest in other businesses. Therefore, every entrepreneur

Learning Objective 3.6 Prepare viability tests using the economics of one unit of sale.

S t e p i n t o t h e S h o e s . . .

Burrow—“The Luxury Couch for Real Life” Wharton School students Kabeer Chopra and Stephen Kuhl were inspired to found Burrow based on Kabeer’s experience furnishing a Philadelphia apartment. They cre- ated a couch that is reasonably priced, has rapid delivery time, is easy to ship and move, and is comfortable. They describe the Burrow sofas as “the luxury couch for real life” and as “the most clever, comfortable sofa designed for your life and living room.” It is delivered to customers in compact boxes and requires less than 10 minutes for assembly.

The start-up process involved over 15 iterations to create the modular solution they introduced in 2017. During the process, Kabeer and Stephen won the 2017 iDesign Prize from the School of Design. They identified several value propositions, including durability, environ- mental sustainability, hand crafting, stain resistance, convenience (USB charger, portability, free shipping), modularity and adaptability, and style. Prospective cus- tomers can visit the Burrow Lounge in New York City or one of many partner showrooms, or they can order fabric swatches and products online.

Burrow

Kabeer Chopra and Stephen Kuhl pursued an opportunity to create a business.

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needs to know how much gross profit (price minus cost of goods sold) the business will earn on each item it sells. To do this, entrepreneurs can calcu- late the economics of one unit of sale (EOU), which will reveal how much gross profit is being earned on each unit of the product or service that is sold.

Defining the Unit of Sale Begin with the unit of sale, which is the basic unit of the product or ser- vice sold by the business. Entrepreneurs usually define their unit of sale according to the type of business. For example:

Manufacturing. One order (any quantity; e.g., 100 watches). Wholesale. A dozen of an item (e.g., 12 watches). Retail. One item (e.g., one watch). Service. One hour of service time (e.g., one hour of lawn-mowing service) or a standard block of time devoted to a task (e.g., one mowed lawn).

If the business sells a combination of differently priced items (such as in a restaurant), the unit of sale is more complicated. The entrepreneur can use the average sale per customer minus the average cost of goods sold per customer to find the economics of one unit of sale. The formula would be as follows:

Average Sale per Customer – Average Cost of Sale per Customer = Average Gross Profit per Customer

A business that sells a variety of items may choose to express one unit of sale as an average sale per customer (see Exhibit 3-8).

Cost of Goods Sold and Gross Profit To get a closer look at one unit of sale, entrepreneurs analyze the cost of goods sold (COGS) of one unit. These are:

• the cost of materials used to make the product (or deliver the service) and

• the cost of labor directly used to make the product (or to deliver the service).

For a product, the cost of direct labor used to make the product plus the cost of materials used make up the COGS. The equivalent for a service business, the cost of services sold (COSS), is the cost of the direct labor used to produce the service plus the cost of the delivery of the service.

gross profit total sales rev- enue minus total cost of goods sold.

economics of one unit of sale (EOU) the amount of gross profit that is earned on each unit of the product or service a business sells.

unit of sale the basic unit of the product or service sold by the business.

cost of goods sold (COGS) the cost of producing a tangible item.

cost of services sold (COSS) the cost of delivering a service.

Exhibit 3-8 Unit of Sale as a Combination of Different Items

UNIT OF SALE AND ECONOMICS OF ONE UNIT OF SALE

Type of Business Unit of Sale Economics of One

Unit of Sale Gross Profit

per Unit

Retail & Manufacturing One item (e.g., one tie) $7 – $3 = $4 $4

Service One hour (e.g., one hour of mowing a lawn) $20 – $10 = $10 $10

Wholesale Multiple of same item (e.g., one dozen roses) $240 – $120 = $120 $120

Combination Average sale per customer minus average cost of goods sold per customer (e.g., restaurant meals)

$20 – $10 = $10 $10 average gross profit

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The COGS per unit can be thought of as the cost of selling an addi- tional unit. If you buy watches and then resell them, your COGS per unit is the price you paid for one watch. Once you know your COGS, you can cal- culate gross profit by subtracting COGS from revenue (see Exhibit 3-9).

Your Business and the Economics of One Unit The economics of one unit of sale is a method for seeing whether your business idea could be profitable. If one unit of sale is profitable, the whole business may be. By contrast, if one unit of sale is not profitable, then no matter how many units you sell, the business will never be successful. The EOU is best for determining what will not be profitable, because the total opportunity analysis will consider all the other costs of doing business. The EOU is a quick and easy method to determine whether profitability is unlikely. Let’s use Exhibit 3-9 as an example.

Say you have a business selling decorative hand-blown wineglasses that you buy from a local artist wholesale for $12 each and resell to friends for $20 each. The cost of goods sold for each wineglass is the wholesale price of $12; gross profit = $8.

You buy a dozen glasses for $12 each wholesale. Your unit of sale is one glass. Your cost of goods sold is $12 per unit, assuming you have no direct labor cost.

You sell all the glasses at $20 each. Here is how you would calculate your gross profit.

Total revenue = 12 glasses * +20 selling price = +240 Total cost of goods sold = 12 glasses * +12 purchase price = +144 Total gross profit 1contribution margin2 = +96 +240 revenue – +144 COGS = +96

Total Revenue – Total Cost of Goods Sold = Total Gross Profit

You made a gross profit of $96. For a manufacturing business, one unit might be one pair of sneakers.

The costs would include direct labor, the money paid to the people who made the product (sneakers, in this example), and the supplies, such as fabric, rubber, and leather (see Exhibit 3-10).

direct labor employees that actively produce or deliver a product or service.

Exhibit 3-9 Economics of One Unit of Sale versus Total Gross Profit

Economics of One Unit (EOU)

Total Gross Profit for 12 Units (@ $10 per Unit Sold)

Price Sold/Revenue -Cost of Goods Sold

Gross Profit

$20 -$12

$8

$240 (12 : $20) -$144 (12 : $12)

$96 (12 : $8)

ECONOMICS OF ONE UNIT (EOU)

Manufacturing Business: Unit = One Pair of Sneakers

Selling Price per Unit: Labor Cost per Hour: No. of Hours per Unit: Materials per Unit:

$4.00 2 hours $ 8.00

4.00

$15.00

Cost of Goods Sold per Unit: $12.00 12.00 Gross Profit per Unit: $ 3.00

Exhibit 3-10 Economics of One Unit, Manufacturing

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The manufacturer makes a gross profit of $3 for every pair of sneakers sold. That may not seem like much, but manufacturers sell in bulk. In other words, a manufacturer might sell several million pairs of sneakers per year.

The economics of one unit also applies to wholesale, retail, and ser- vice businesses. Assume the wholesaler buys a set of one dozen pairs of sneakers from the manufacturer for $180 and sells them to a retailer for $240 (see Exhibit 3-11).

The retailer pays the wholesaler $240 for one dozen pairs of sneak- ers. The retailer’s COGS, therefore, is $20 ($240/12 for the shoes only; the retailer does not add direct labor). The store sells one pair at a time to cus- tomers for $35 (see Exhibit 3-12).

The economics of one unit for service businesses is shown in the ex- ample of a hair stylist who charges $50 per cut (see Exhibit 3-13).

The Cost of Direct Labor in the EOU—An Example Janet has a business designing handmade bookmarkers. Her unit of sale is one bookmarker. Below is additional information about Janet’s business:

• She sells 40 bookmarkers per week to a bookstore in her neighborhood.

• Her selling price is $4.50 each, including an envelope. • Her costs are 80¢ per card for materials (construction paper, glue,

and paint) and 20¢ each for the envelopes, for a total of $1.00 each. • On average, it takes her one hour to make six bookmarkers. • Janet pays herself $9 an hour.

Exhibit 3-11 Economics of One Unit, Wholesale

ECONOMICS OF ONE UNIT (EOU)

Wholesale Business: Unit = One Dozen Pairs of Sneakers

Selling Price per Unit: Cost of Goods Sold per Unit: Gross Profit per Unit:

$240.00 180.00 $60.00

ECONOMICS OF ONE UNIT (EOU)

Retail Business: Unit = One Pair of Sneakers

Selling Price per Unit: Cost of Goods Sold per Unit: Gross Profit per Unit:

$60.00 20.00 $40.00

Exhibit 3-12 Economics of One Unit, Retail

ECONOMICS OF ONE UNIT (EOU)

Service Business: Unit = One Hour

Selling Price per Unit: $50.00 Supplies per Unit (hair gel, etc.): $ 2.00 Labor Costs per Hour: 25.00

Cost of Goods Sold per Unit: $27.00 27.00 Gross Profit per Unit: $23.00

Exhibit 3-13 Economics of One Unit, Service

116 UNIT 1: Entrepreneurial Pathways

The direct labor for each bookmarker is $1.50 ($9/6). Janet wisely re- alizes that she must include the cost of her labor in the EOU. See how she did this in Exhibit 3-14.

Janet’s gross profit is $2 per bookmarker sold. Assuming no other ex- penses, such as taxes, she will keep this as owner of the business. She also earns $1.50 per bookmarker by supplying the labor, thus ending up with a profit of $3.50 per bookmarker.

Now, think back to Amy of The Most Chocolate Cake Company and perform a similar analysis:

• Amy takes an average of two hours to bake a cake. • It costs $5 for the ingredients for an average cake. • Amy pays herself $15 an hour. • The price of an average cake is $40.

This cost structure ($5 materials and $30 direct labor) yields a gross profit of $5 per cake on a $40 cake. With the gross profit of $5 and the $30 she paid herself, Amy ends up with $35 per cake. Assuming she does not have to deliver the cakes, this may be sufficient for her. If she needs to earn more, she will have to charge more, work faster, work more hours, or de- crease the costs. These may or may not be realistic options.

Hiring Others to Make the Unit of Sale Janet realizes that if the bookstore wants to order more bookmarkers, or if she can sell them to additional bookstores, she will not have enough time to make them all herself. To solve this issue, she hires a friend to make the bookmarkers for $9 per hour. Although the EOU will stay the same, Janet will have more time to look for new opportunities for her business. Her in- come from the business will now come solely from the gross profit, which is currently $2 per unit.

Amy from The Most Chocolate Cake Company can produce about 20 cakes during a 40-hour workweek and 30 cakes in 60 hours. That means she can earn $600 to $750 per week, or between $31,200 and $39,000 per year before taxes, without allowing for vacation or sick days. There would be an additional $100 to $150 in gross profit per week before other expenses are figured. Assuming Amy can sell 20 to 30  cakes per week at $40 each, she will have a maximum income of about $46,800.

Amy knows she will have other expenses, so $40,000 is more realistic. Like Janet, Amy would like to earn more than that per year, so she too could add employees if the market would support greater volume. If she paid her employees $15 per hour (assumed for this example as the mini- mum living wage), she would need to sell 8,000 cakes per year to make her $40,000. That is 154 cakes per week, requiring perhaps seven full-time

ECONOMICS OF ONE UNIT (EOU)

Manufacturing Business: Unit = One Bookmarker

Selling Price per Unit: $4.50 Materials: $1.00 Labor: 1.50

Cost of Goods Sold per Unit: $2.50 2.50 Gross Profit per Unit: $2.00

Exhibit 3-14 EOU Example, Janet’s Company

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bakers. This would not be possible in her home kitchen. The EOU analysis helps to identify this challenge.

However, we must be sure that Amy is not comparing apples to or- anges when making the analysis. With more people, the tasks could be delegated, so that it takes only one hour per cake, bringing the gross profit to $20 each. If Amy could also get better pricing on ingredients because of increased volume, the gross profit would be even higher. At $20 per unit gross profit, Amy would need to sell only 2,000 cakes per year, or 39 per week. That could be accomplished with two full-time bakers. As a home- based business, that would be more realistic.

Amy, like any entrepreneur, must decide what is achievable and what her goals are.

Going for Volume Janet meets a bookstore-supply wholesaler. He offers to buy 2,000 book- markers if Janet can deliver them in one month and sell them for $3.50 each, $1 less than she had been getting. This would reduce her gross profit but offer higher revenue. Three questions immediately came to her mind:

1. Can I produce the 2,000-unit order in the required time frame? After doing some calculations, Janet realizes that if she hires 10 people each to work 35 hours a month, she could deliver the order in time. Janet convinces 10 people to take on the one-month commit- ment by offering $12 per hour.

2. If I lower the price to $3.50 for each bookmarker (instead of $4.50), will I still make an acceptable gross profit per unit? To an- swer this question, Janet creates a chart (see Exhibit 3-15) and real- izes that her new gross profit per unit would be $1. Let us look at the EOU if she factors in her labor at $12 per hour, or $2 per bookmarker.

3. How much in total gross profit will I make from the order? To an- swer this question, Janet creates another chart (see Exhibit 3-16) and realizes that her total gross profit would be $1,000.

ECONOMICS OF ONE UNIT (EOU)

Manufacturing Business: Unit = 1 Bookmarker

Selling Price per Unit: $3.50 Materials: $1.00 Labor: 1.50

Cost of Goods Sold per Unit: $2.50 2.50 Gross Profit per Unit: $1.00

Exhibit 3-15 EOU Example, Janet’s Company with Employees

Exhibit 3-16 Gross Profit Projection, Janet’s Company with Employees

GROSS PROFIT PROJECTION (BASED ON EOU)

Janet’s Total Gross Profit

Revenue ($3.50 : 2,000 bookmarkers): $7,000.00 Materials ($1 * 2,000): $2,000.00 Labor ($2.00 * 2,000): 4,000.00

Cost of Goods Sold: $6,000.00 6,000.00 Gross Profit: $1,000.00

118 UNIT 1: Entrepreneurial Pathways

Janet concludes that $1,000 in gross profit is much better than earn- ing $80 a week in gross profit, plus $60 a week for her labor (what she earned making the bookmarkers herself each week at a selling price of $4.50). Even though the wholesaler is asking for a lower selling price, her total revenue, and therefore her total gross profit, would be much higher. When Janet realizes that she could deliver the order in the required time and make $1,000, she accepts the offer.

Five breakthrough steps entrepreneurs can take to understand pre- liminary feasibility are:

1. calculating the unit of sale, 2. determining the economics of one unit of sale, 3. substituting someone else’s labor, 4. selling in volume, and 5. creating jobs and operating at a profit.

At first, an entrepreneur can be part of his own economics of one unit. If you start making (manufacturing) computers in your garage, like Steve Jobs and Stephen Wozniak did when they started Apple, you should include your labor on the EOU worksheet.

Over time, though, Jobs and Wozniak made enough profit to hire oth- ers to manufacture the computers. Jobs and Wozniak took themselves out of the economics of one unit, so they could be the creative leaders of the company. And, by lowering prices, they were able to sell millions of units.

Determining the Value of a Business The valuation of a business is a combination of art and science, and ulti- mately a matter of arriving at a price and set of terms that both the buyer and seller find acceptable. For a public company, valuation is the worth of the stockholders’ equity. For a going concern with audited financials, the determination can be based on projected earnings and cash flows. For other going concerns, the process is more complex because the quality and reli- ability of the financial information is less certain. The primary methods of valuation are asset valuation, earnings valuation, and cash flow valuation.

Asset Valuation Method Asset valuation is a method that analyzes the underlying value of the firm’s assets as a basis for negotiating the price. The four most common standards are:

Learning Objective 3.7 Calculate the value of a business.

asset valuation a method that analyzes the underlying value of a business’s assets as a basis for negotiating a price.

G lo b a l I m p a c t . . .

Selling Your Product around the World Through the Internet, even a very small business run by one person can reach customers internationally. What if a cus- tomer from Germany contacts you through your website and wants to pay for your product in euros, the currency of much of Europe? Currency is a term for money when it is exchanged internationally. In the United States, the currency is the dollar. In Japan, it is the yen. In Mexico, it is the peso.

The foreign exchange (FX) rate is the relative value of one currency to another. It describes the buying power of

a currency. The FX rate is expressed as a ratio. If one dollar is worth 1.25 euros, to calculate how many euros a certain num- ber of dollars is worth, multiply that number by 1.25.

$5 = $5 * €1.25 = €6.25

How would you figure out how many dollars €6.25 is worth? Simply divide €6.25 by 1.25 to get $5.

currency a term for money when it is exchanged internationally. foreign exchange (FX) rate the relative value of one currency to another.