Tuesday, April 3, 2012

Small Business and Entrepreneurship - To Startup or Not to Startup Part VIII - Industry Analysis

"There exist limitless opportunities in every industry. Where there is an open mind, there will always be a frontier" - Charles F. Kettering

"The early bird gets the worm but the second mouse gets the cheese" - Willie Nelson

We continue our series on the decision of whether or not to start a business by analyzing industries and markets.

Industries are typically defined according to their product (automobiles, soda, solar panels, etc), and industry participants can include all those companies along the value chain leading to product creation. Since an industry may be defined by its product there are therefore nearly an infinite number of industries. It can therefore be difficult to decide in which industry you are competing.

Let us say we want to start a company making solar power inverters (a device that converts the direct current (DC) received from solar panels into the alternating current (AC) used in our homes). Are we in the inverter industry? The photovoltaic (PV) industry? The solar power industry (Photovoltaics, Solar Thermal (ST), Concentrating Solar Power (CSP))? It can be tough to figure out where to draw the line, but for this section we want to take a pretty broad approach, and narrow things down more when we get into markets and customers (markets are typically defined along customer groupings).

Running with this example, what we can do then is start with a brief look at power generation (gas, coal, nuclear, solar, wind, etc), then look at solar power generation (PV, ST, CSP) when it looks like we will begin excluding potential customers by narrowing further that may be a good time to stop.

For example, inverters would not be used with ST and probably not with CSP, so we concentrate on PV, but if we try to narrow the PV industry down further we may start excluding inverter users.

Now that we’ve got an idea of what our industry is we can move on to what we want to know. We will eventually want to become experts in our industry, to start we can begin with:

  • What has happened in our industry in the past?
  • What is happening now?
  • What changes are coming, what will happen in the future?
  • Is the industry growing?

Answering these 4 questions can give us a good grasp and insight into our industry and help us understand changes that are occurring. Change means opportunity and the ability to find a niche for a new company or product in a changing landscape is many an entrepreneur’s key to success.

When trying to understand the dynamic of the industry as it is now, one analysis tool that is helpful (and taught in every business school) is Porter’s 5 Forces. Our list will include more than 5 items but is heavily based on the original Porter’s forces. Analyzing our industry along these lines can greatly contribute to our understanding of the way the industry works.

Substitutes – A substitute product is a competitor that does not directly compete in your industry but which customers may still choose as an alternative. This is best explained with a simple example: in the soda industry where Coke and Pepsi may compete with one another, tap water is a substitute.

Barriers to Entry / Exit – Are there heavy capital requirements to get in our out of this industry? If so it may be a big deterrent. When thinking of high barriers to entry or exit one common example may be the airline industry, where if you decided you wanted to start an airline you may need quite a bit of money to get in, conversely if you felt you were done running your airline company and wanted out, having to sell off your assets in order to exit may be a little difficult.

Suppliers – How common or rare are the supplies you need to create your product, and therefore, how much power over you will your suppliers have, how vulnerable are you to shifts in supply? In 2009 the PV industry saw a major drop in prices (revenues for some companies) due to an overproduction of silicon, an important component of photovoltaic cells. This overproduction was a response to prior years of short supply in which the high cost of silicon made solar installations much more expensive. How vulnerable is our industry to shifts in supply?

Buyers – On the other side, what is the power of the buyers in this industry? If your industry has few buyers then they would seemingly have more power, however if the buyers have limited options available to them, limited competing products or substitutes that would lower the buyer’s relative power.

Complements – Complementary products are those that increase value when combined or used together with other products. If our product has a complementary product, where does the power in that relationship lie? Think of the solar panel example. To the end user, let’s say a homeowner, the solar panel and inverter may be complementary products, in fact, if the homeowner wishes to use a solar panel he needs an inverter to convert the power to useable alternating current. From the perspective of the inverter company, the solar panel is a strong complement, but an extremely powerful complementary product as few customers are likely to buy inverters without also buying the solar panel.  

Rivalry - In this area we are considering what are the established competing companies, how concentrated is the industry, are these companies locked in fierce price-wars (which would make things a little unattractive to a new entry)? Perhaps there is room, if there are large companies locked in fierce competition perhaps a small new entry focusing on one product niche may be tolerated as the larger companies focus on each other?

Considering all these angles, where the industry has been, whether it is growing, the nature of competition in the industry, and where the industry may be headed will hopefully lead to a good idea of the way the industry operates and possibly point out potential problems or potential opportunities for our new venture. In our next section we will narrow things down a little bit and look at analyzing markets. 

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