Finding Profitable Startup Ideas
163 jkuria 18 hrs 56
https://capitalandgrowth.org/articles/770/how-to-find-profitable-business-ideas.html
news.ycombinator.com/item?id=16245216
The reason why I wrote the piece is because most people in the entrepreneurial/startup world seem to focus specifically on chasing "unicorns" and the next big "billion dollar idea". One thing that I have noticed (in my business as an M&A advisor who represents business owners selling their lower/mid-market businesses) is that nearly all of the business owners I deal with have gotten rich by executing well on Red Ocean ideas. They are not hitting grand slams, but they are hitting singles and doubles. And the odds of hitting a base hit or a double look a hell of a lot better than the odds of hitting a grand slam. And to me, selling a $5 to $15 million dollar business is a pretty damn good way to eventually win the game.
In an era of tech startups, angel investors, venture capital funds and unicorn hunting, an often-overlooked avenue for entrepreneurs to create successful businesses with great long-term potential is to discover viable Red Ocean business opportunities within established markets.
Generally, there are two ways that entrepreneurs can create a successful business by meeting a market’s unmet needs – Blue Oceans and Red Oceans.
The first method, discovering Blue Oceans, is sexy and generates tons of press. It involves identifying unmet customer needs within a market, and then solving those unmet needs with a new, customized business solution.
Phrases like “Blue Ocean Strategy” and “business model discovery” are tossed around liberally to describe this approach. If executed correctly, this method can yield entrepreneurs billions of dollars. Examples of successful strategy type have been Google’s search engine, Apple’s iPhone and the Ford Motor Company’s Model T. W. Chan Kim and Renée Mauborgne refer to this type of business idea as a Blue Ocean Strategy.
The second method, finding a good Red Ocean business opportunity, is not particularly sexy, but it is tried and true. Entrepreneurs can identify if a market problem is being underserved by the current providers of solutions for that particular market problem. If so, then entrepreneurs can replicate an existing business solution for that particular market to address that unmet market demand. An example of this would be an entrepreneur opening a casual, family-style restaurant in a small town with sufficient demand for that type of restaurant.
Casual, family style restaurants have been in existence for decades, if not centuries. The entrepreneur is not creating a new, customized business solution to address the market’s demand. Instead, the entrepreneur identified a “gap” in a market that already exists and is simply filling that gap with a readily available business solution. W. Chan Kim and Renée Mauborgne refer to this type of business idea as a Red Ocean strategy.[1]
We have already discussed Blue Ocean Strategy in detail here on Capital & Growth. Now we will focus in on often overlooked ways to discover Red Ocean business ideas. Red Ocean business ideas can be uncovered through using either of both of the two following processes:
1.The Internal Approach 2.The External Approach
Observation
Focus Groups
Reverse Brainstorming
Market Growth
Matrix Charting for Insights
The “Slice of Life” Approach
The Market-Area Saturation Approach
The Competitive Matrix Approach
We will flesh out these two approaches in detail and demonstrate that successful entrepreneurs often don’t need to discover a world changing business model, they often just need great insight into the customer demand within a particular market. Entrepreneurs often approach the task of coming up with a business idea by looking at their own background, skills, passion and abilities. In using this approach, the entrepreneur basically determines that they are the primary factor in whether they will succeed or fail in business. An entrepreneur’s prior industry experience is the most common single source of entrepreneurs’ business ideas. According to Inc. magazine, 43 percent of entrepreneurs reported they got their business idea from the experience they gained while working in the same industry or profession. [2] The experience the entrepreneurs gained from working within their industry helped them identify gaps in the industry’s market or provided the knowledge and insight to create a company that could serve that industry’s market more efficiently. Some entrepreneurs start businesses based upon their hobbies or avocational interests. They turned their passion for a particular activity or subject into a business venture. Some entrepreneurs start comic book or model train stores, small vineyards, or bed and breakfasts. Often these businesses are not started to reap considerable profits, but instead to pursue a lifestyle that brings joy and personal satisfaction to the entrepreneur. Stephen Harper, in his excellent book Extraordinary Entrepreneurship [link], argues that the hobby or personal interest approach to starting a business is “entrepreneurship by Braille.” [3] This could also be starting a business solely based on where you live or where you want to live. Essentially, this is starting a business in search of customers. It is a very different proposition than creating a business to serve readily defined customers who already exist. If what you like is what the market objectively wants, then pursuing the business idea makes sense. But if the market for what you like, what interests you or where you live is too small or diffused to support your business idea, then creating that business is a fool’s errand (unless you have money to burn). In his fantastic essay, “How to Generate Startup Ideas ,” Paul Graham advises that entrepreneurs should conduct “entrepreneurship by braille” – uncovering business ideas that fall within the experience and expertise of the entrepreneur. [4] He claims that entrepreneurs “notice” startup ideas when they perceive solutions to urgent market problems to which adequate solutions do not currently exist. Graham says that noticing a market opportunity is essentially a passive process, and it is usually not achieved by actively trying to create a great business idea. He remarks, “If you look at the way successful founders have had their ideas, it's generally the result of some external stimulus hitting a prepared mind.” Graham advises that entrepreneurs should focus on startup ideas in areas where they have expertise, first-hand experience (which ensures the problem actually exists) or a deep understanding of potential customer pain points. He claims that, “the best approach is more indirect: if you have the right sort of background, good startup ideas will seem obvious to you.” He also states, “ideas… that grow naturally out of the founders' own experiences are organic startup ideas. The most successful startups almost all begin this way.”
The External Approach (or the “Outside-In approach”) to discovering viable business ideas looks first to the external market (verses the skills, knowledge and tastes of the entrepreneur) and tries to methodically discover market gaps that already exist. [5]
The central idea of this approach – opportunity recognition – is that a business can succeed only if it responds to, or creates, a need in the market. In plain English, the External Approach is about finding a gap in a market. A “gap” in the market is where the market, at present, does not contain a solution to a customer problem.
These market gaps are also called “white space.” Market gaps are everywhere. They are in a constant state of flux, morphing and changing as technology, demographics, regulation, culture and global influences shift. It is up to entrepreneurs to determine how big these market opportunities are and why they exist. The “white space” opportunity may be fleeting – a very short-term prospect – or the white space market may not be big enough to sustain a profitable business. But then again, it may just be a defensible, exploitable gap in the market, overlooked and waiting to be exploited. Entrepreneurs must be able to scan their surrounding environment and recognize opportunities (market gaps). This requires the entrepreneur to develop what Harper calls an “opportunity antenna.” Recognizing opportunities always seems easy and obvious in hindsight, but in the present – and that’s what counts – it is a difficult and often infuriating process. A wildly successful example of recognizing a large, sustainable market gap was Chipotle. Chipotle filled a gap in the market between family style restaurants (good Mexican food with fresh ingredients at modest prices) but in a convenient, informal fast food venue.
The outside-in approach is generally better than the inside-out approach because it attempts to analyze market opportunities in an objective fashion. But the best approach is when it is possible to combine both approaches – the entrepreneur has a deep knowledge and expertise in an attractive market. We will discuss and analyze the following outside-in techniques for discovering market gaps:
Observing the Market
Focus Groups
Reverse Brainstorming
Market Growth
Matrix Charting for Insights
The “Slice of Life” Approach
The Market-Area Saturation Approach
The Competitive Matrix Approach
None of these approaches is a silver bullet. Its best to use a combination of the methods described below. The more of these approaches that an entrepreneur uses to evaluate a business idea, the more likely accurate the entrepreneur’s analysis is going to be. This technique is deceptively simple and requires an entrepreneur to experience a “blinding flash of the obvious.” [6] The potential entrepreneur should look around and listen to what people are complaining about. The entrepreneur should use their complaints and gripes to identify market gaps that need solutions. An entrepreneur could listen to people in public places, observe complaints on social media (Facebook, Twitter, LinkedIn… etc.) or traditional media and try to formulate possible solutions to the problems those complaints identify. Focus groups are where an entrepreneur gets a sample of people together, lets say 5 to 20, and poses open-ended questions to them to uncover “gaps” in their personal and professional lives. By providing a guided discussion, the entrepreneur can focus in on the participants’ problems. A list of problem areas can be recorded by the entrepreneur during the focus group. After the session, the entrepreneur can attempt to create solutions for the identified problems. The focus group does not have to be conducted face-to-face. An entrepreneur can use social media, such as Facebook, to pose open ended qualitative questions to a particular circle of friends or acquaintances. Reverse brainstorming is where a focus group is asked to consider a particular problem with a product or service (such as smartphones) and identify possible solutions for it. The idea is to basically crowdsource an innovative idea by soliciting a group of people for a creative insight on how to fill in a gap in the market. Once again, social media networks can be leveraged to solicit a group of friends or acquaintances. Questions that can be asked to help solve pain points are: 1) Can it be made smaller, larger, better, or differently? 2) Are there other users, uses or ways to increase the usage rate? 3) Can it be combined with something else? 4) Can it be done more quickly? 5) Can it be made more convenient, available, attractive, quieter or last longer? Matrix charting is a way to systematically search for opportunities by listing important elements for each product or service along the left-hand vertical column of a grid and questions regarding each of these elements along the top horizontal row of the same grid. [7] The entrepreneur then tries to fill in the grid boxes with answers for each attribute question. An entrepreneur can use this technique by herself or with a focus group. Questions may include:
What can it be used for?
Where can it be used?
Who can use it?
When can it be used?
How can it be used?
Below is an example of a Matrix Chart for a Laundry Service:
Industry Growth Rates
At any given time, there are dozens of industries operating within new and underserved markets that are experiencing rapid growth. Some of these industries are growing at up to ten or twenty times faster than the overall economy. These industries are usually in their early growth phase and the companies within them are highly profitable. Furthermore, these industries often have low barriers to entry. This almost always represents a possible entrepreneurial opportunity. To find out which industries are experiencing rapid growth, its often useful to look at secondary research sources. Three great secondary resources to gauge industry growth are IBIS Industry Reports, Dunn & Bradstreet and SageWorks [insert links for all three] For example, IBIS offers comprehensive market reports on over 700 industries. IBIS’s media center on their website is a great resource to find out what industries or industry segments are experiencing rapid growth and high profitability.
In 2018, IBIS identifies the following as five of the fastest growing industries :
Medical and Recreational Marijuana Retail Stores: 40.2% Medical and Recreational Marijuana Growers: 43.6% Wind Turbines: 48.8% Wireless Communications Carrier Industry: 8.6% Armored Vehicles: 17.4% SageWorks is a real-time database of private company financial information. It offers its information services to lending institutions to help those companies gauge lending risk to their borrowers. It too publishes a ranking of the fastest growing industries in the United States every year. The following are its forecast of the top 10 growing industries in 2016.
Richard White, in The Entrepreneur’s Manual, [insert link to resource] creating a decision tree that divides life by time and experiences exactly in half. For example, White recommends a person initially divide life between work and leisure. If you choose work, then you could divide work between productive work time and unproductive work time; if you choose unproductive work time, you can then choose between unproductive work time at work before lunch or after lunch. Once a “slice of life” has been sufficiently broken down into a discrete slice, the object is to analyze that particular slice of life for problems people have during that particular slice of life.
The “Slice of Life” Decision Tree:
There are potentially hundreds of discrete problems people have with this particular slice of life. For example, people could have trouble focusing on work because they are sleepy after lunch; they may not be productive because they do not have access to small amounts of downtime to let their brain rest; they may not be able to concentrate on work because they are hungry and need a snack; they may be unproductive in the afternoon because they are stiff and sore from sitting at a desk for hours by that point. There are hundreds of problems that exist within this slice of life. Life can be sliced up according to geography, time, activity, objects, experiences or people. After you identify the problems, begin searching for solutions. You can do this by coming up with solutions yourself or asking a focus group. For example, a possible solution for “crashing” after lunch may be a simulative energy drink (like coffee, Red Bull, Five Hour Energy) that is natural and won’t harm your body. Each of these problems offer scores of solutions, but they these problems may already be addressed by other firms in the market or the solutions may not be profitable. It is up to the entrepreneur to sift through these potential solutions and look for one that satisfies two conditions: 1)the solution must be potentially profitable and
2) the market currently does not have a solution addressing that problem (or at least one not addressing it well).
Note: This technique is derived from a fantastic book by Stephen C. Harper called Extraordinary Entrepreneurship . I highly recommend this book if you want to explore this opportunity identification method further. Harper derived the Slice of Life approach from Richard White’s classic book, The Entrepreneur’s Manual .
The Market-Area Saturation Approach is used to find potential market gaps within a specific geographic area. The Market-Area Saturation Approach “is based upon the premise that for a town with X number of people, there should be Y number of businesses of Z type.” [1] Basically, entrepreneurs can analyze particular population centers and then try to identify if the current brick-and-mortar retail or service enterprises are underserving those markets. This could be determined by taking the number of specific establishments (say pizza parlors) in your state and divide it by your state’s population. Then, multiply that fraction by the population of the geographic area you are analyzing (say 100,000 people). That product would be the average number of establishments, in your state, that a particular geographic area could support.
For example, a certain town (or a collection of towns within a given geographic radius) you are analyzing may have roughly 100,000 people.
After conducting some research, you discover that in your state, you may roughly expect that a population of 100,000 people would contain, on average, 11.3 pizza restaurants, 2.0 florist shops, 1.6 tanning salons, 4.0 gyms and 1.0 bowling alley. A great resource for conducting this research is SimplyAnalytics. Another resource is the Business & Industry section of the U.S. Census Bureau at http://www.census.gov/econ/index.html.
After completing this task, you would then survey a specific geographic area with a similar population profile (100,000 for instance) and count the number of establishments serving customers within this area.
A resource you could use for this is Google Maps . Your search may turn up that your target geographic area contains nine pizza parlors, three florist shops, two tanning salons, one gym and one bowling alley.
According to this analysis, it would appear that the particular geographic area and population you analyzed has significant unmet demand for gyms and modestly unmet demand for both pizza parlors and tanning salons. Your analysis also determined that bowling alley demand is currently being met while there is probably an oversupply of florist shops. Based upon these findings, it would probably be a good bet that there is enough demand within this particular geography and population to justify opening a gym. The market-area saturation approach should be seen as a rule of thumb, not a precise scientific instrument. The size, location, competitive strength and qualitative factors of each establishment are not considered with this analysis. But this broad brushstroke approach may find potential business opportunities that deserve closer scrutiny. If a prospective entrepreneur has already decided what general product or service she wants to sell within a niche market space (geographic and otherwise), then the Competitive Matrix may help identify potential gaps in the market. The Competitive Matrix is an attempt to quantify the existence of a potential market gap, but the value of that quantification relies on the quality of the entrepreneur’s analysis of the market. An entrepreneur should divide the market that they want to enter into corresponding market segments. These market segments can be characterized by geography, demographic and psychographic characteristics, and behavioral patterns. For each of these market segments, the entrepreneur will create a matrix. The top horizontal row will identify the current businesses that currently provide value proposition(s) (goods and services the entrepreneur seeks to provide) to the market segment. The left vertical column of the matrix will list key factors important to the business’ value proposition(s). A blank customer segment competitive matrix example is shown below.
The entrepreneur will need to conduct first hand research (by using polling research and/or focus groups of the market segment’s customers) to determine:
1. Competitive Factor Importance – The level of importance that members of a market segment place on each competitive factor (value proposition). This number is measured as a whole number from 1 to 5, with 1 being the worst and 5 being the best. This number is placed within the upper left-hand box in each Competitive Factor/Business # cell.
- Competitive Factor Satisfaction – How well each current business meets its customers’ needs for each competitive factor (value proposition) to the customers within a particular market segment. This number is measured as a whole number from 1 to 5, with 1 being the worst and 5 being the best. This number is placed within the upper right-hand box in each Competitive Factor/Business # cell.
A market gap exists within a market segment when existing businesses that cater to it are not supplying the type or quantity of value that the market segment demands. In other words, market gaps exist where a business is underserving a competitive factor to their customers relative to the level of importance customers in that market segment place on that competitive factor.
For example, if quality is important to a particular market segment (5), but the current businesses catering to that market segment are providing goods with mediocre quality (3), there is then a gap in the market related to this competitive factor. For each competitive factor, gaps of only one point of separation between what the segment considers important but existing businesses do not provide the level of value demanded by the market segment indicates a small gap in the market. But existing businesses can usually adapt to cover this gap without much effort. For each competitive factor, gaps of at least 2 points of separation between what the segment considers important but existing businesses do not provide that level of value to the segment will require those businesses to make significant changes in the existing business’ strategy. This is a market gap ripe for exploitation.
Items of Note:
If the difference between the Competitive Factor Importance and the Competitive Factor Satisfaction is a gap of one point, it will be signified within each bottom right box of its competitive matrix cell by a .
If the difference between the Competitive Factor Importance and the Competitive Factor Satisfaction is a gap of two or three points, it will be signified within each bottom right box of its competitive matrix cell with either or .
The combined score for each competitive factor is the product of the business’s Competitive Factor Importance and the business’s Competitive Factor Satisfaction. For example: 3 x 4 = 12. The number signifies how well each current business satisfies the customer segment for a particular competitive factor.
The Business’ Relative Strength for the Customer Segment row (at the bottom of the matrix) is an aggregate approximation of how well each current business serves the market segment.
Gaps of two points or greater represent significant market opportunities for market entrants.
If a whole row has asterisks, then none of the current businesses is meeting the segment’s expectations.
Example: Casual Dining Market
Market Segment – University Faculty and Staff, Establishments within ½ mile of an urban university
Survey and/or Focus Group Results
A Note of Caution in using the Competitive Matrix Approach
This method may take considerable time, money and market research to complete. If an entrepreneur uses this approach, he or she should confine the analysis to a few select market segments within a market.
The Competitive Market Approach can be a powerful tool, but its effectiveness is solely dependent on the quality of data collected from the customer segment’s being analyzed. If the quality of the collected data is low, the resulting analysis could be wildly off the mark.
Why Red Oceans Matter In today’s tech-centered vision of entrepreneurship, where everyone is intent on inventing and proving new business models and discovering new markets, its important to remember and carefully consider the proven value of Red Ocean ideas. For every tech unicorn tech story like Uber or Airbnb, there are a hundred Red Ocean success stories (like Papa Johns, Peets Coffee or Motel 6). While these Red Ocean ideas may not (and probably won’t) result in creating multibillion dollar companies within a ten-year period of time, they do offer entrepreneurs the opportunity to create excellent, successful businesses that can lead to riches and personal autonomy.
[1] W. Chan Kim and Renée Mauborgne, Blue ocean Strategy: How to Create Uncontested Market Space and Make the Competition Irrelevant, Harvard Business School Press, pg. 4, 2005.
[2] John Case, “The Origins of Entrepreneurship,” Inc. June, 1989, 51-62. [3] Stephen C. Harper, Extraordinary Entrepreneurship, John Wiley & Sons, Inc., Hoboken, New Jersey, 2005, pg. 68. This is only pursuing opportunities that are within reach – namely what you know and like.
[4] http://www.paulgraham.com/startupideas.html#f3n Graham counsels that the best way entrepreneurs can develop startup ideas is organically by “noticing” market opportunities.
[5] Peggy Lambing and Charles R. Kuehl, Entrepreneurship, Prentice-Hall, Inc., Upper Saddle River, New Jersey, 2000, pg. 92. [6] Stephen C. Harper, Extraordinary Entrepreneurship, John Wiley & Sons, Inc., Hoboken, New Jersey, 2005, pg. 77. [7] Stephen C. Harper, Extraordinary Entrepreneurship, John Wiley & Sons, Inc., Hoboken, New Jersey, 2005, pg. 80.
