Entrepreneurs are often visionary, creative, passionate and energetic individuals. While a growing number of entrepreneurs are in their 20s or even younger – for example, Mark Zuckerberg was 19 when he founded Facebook – many start-up firms are founded by people in their 40s, 50s or even older who have either been downsized in the current economy or simply want a career change. Others may hear about the success of a friend or former colleague in a certain industry and want a “piece of the pie” for themselves. There is more required for success with a new venture than passion and energy, however. A critical first step is a shrewd evaluation of your market to determine its potential for competitive success and profitability. A good idea is not necessarily a good business opportunity.

Customers

First and foremost, entrepreneurs need to assess if their product or service is needed. Specifically, does the product or service satisfy a vital customer need and ultimately provide value? Does it fix a pain point for the customer or is it something that’s simply “nice to have”?

One way to gauge general interest is to conduct a concept test, which involves providing a preliminary description of a product or service idea to industry experts and potential customers to solicit their feedback. It should be shown to people familiar with the industry. Avoid showing it to family members and friends who may be biased in their response.

Once initial feedback is received, demand for the product or service can be evaluated through buying intentions surveys, including the use of Internet sites like SurveyMonkey.com. Such surveys do not typically use a scientifically random sample and responses are often overly optimistic, but they do provide a general sense of customer interest.

In addition to assessing customer need, you must identify how to best build awareness for your product or service and then convince your target audience to purchase. Marketers’ ability to reach customers through promotional efforts varies by industry. An assessment of sales and marketing initiatives should include tactics, costs and to what extent customers will respond. Customers with strong brand loyalties to existing competitors will not be easily swayed to purchase a new product or service that does not have a unique point of difference. New products that fulfill a need better than competitors will be received faster and with more enthusiasm.

The Market

Prior to purchasing or starting a new business, entrepreneurs need to assess and understand the market that they will compete in – specifically, the market structure, size and growth rate, stage of development, industry forces and attainable market share.

Market structure refers to the level of fragmentation or concentration that currently exists in a market. A market that is highly fragmented will have many small competitors, each holding a small market share percentage, without a large market share owner in existence. Fragmented markets offer potential for a new entrant to consolidate, and eventually, dominate a market. Concentrated markets, on the other hand, have one or a few players who hold a large percentage of the market share. These large players control the market because they have brand loyalty, established distribution networks, and the capital needed for extensive promotional efforts. New entrant success in a concentrated industry typically requires establishing a new market niche that essentially operates under the radar of the big firms. In general, the more fragmented a market, the more potential for a new venture.

Market size and growth are not as difficult to estimate as one may think, thanks to the Internet. Resources such as Hoover’s Mergent Online and LexisNexis can provide valuable historical and financial information about an industry. Even so, these databases don’t produce the exact information you want in the format you need. You may have to patch together revenue information of key firms to estimate total sales for a market you have identified. Larger markets (total revenue of $100 million or more) or those with the potential to become large due to a fast growth rate (thirty percent or more) offer the most potential.

The stage of development for a market is critical for determining its window of opportunity. Markets evolve through the stages of introduction, early growth, late growth, maturity and decline. Too many entrepreneurs enter at the late growth or early maturity phase, the point when everyone recognizes a market is strong. It is normally too late by then! On the other hand, markets in the introductory stage lack structure and are fraught with uncertainty. Thus, early growth offers the most potential for a new venture. General business articles about an industry can help you estimate the stage of a market’s development.

Industry forces can significantly influence the attractiveness of a market. These forces go beyond the amount of competition among firms in direct rivalry with one another to include the threat of new entrants, the threat of substitute products, the power of suppliers, and the power of buyers. Take the power of your suppliers, for example. If there are only a few of them, which means your options are limited, and their product or service is critical for the success of your business, then the supplier power is strong and suppliers will have significant control over your component costs. A full assessment of the strength of each force will help you gauge your level of control over prices, costs, distribution and, to some extent, competitive rivalry.

Attainable market share refers to your venture’s projected sales revenue taken as a percentage of total market revenue. Two approaches to estimating sales are the top-down versus the bottom-up approach. With the top-down approach, a business owner estimates what percentage of total market sales his or her firm can achieve. With the bottom-up approach, the business owner estimates individual unit sales and then combines the total. This method makes more sense when you are dealing with unit sales, such as home renovations for a builder. Fragmented markets offer more potential for a firm to gain significant market share because there is no large player currently controlling the market.

Cost Structure

There is wide variance among industries in cost of goods sold, operational expenses, working capital requirements, and start-up capital needs. This means big differences in gross and profit margins, cash flow characteristics and risk.

Cost of goods sold and operational expenses have a direct effect on gross profit and net income. Ventures in markets with high raw material, equipment and labor costs cannot afford to make many operational mistakes because they have already used up a large percentage of their sales revenue to cover these expenses. For example, in general, the grocery industry has low profit margins due to high asset needs, high operational expenses and competitive pricing. Firms competing in this industry achieve success through sales volume and efficient operations. Understanding these criteria is critical for new entrant survival.

Working capital is the amount of cash needed to keep a business running on a daily basis, and it directly affects a venture’s cash flow. The name of the game, especially in the early years, is cash flow management. It is quite possible to have positive sales, and even positive profits, and still run out of cash due to the timing of accounts receivables and accounts payables. Both can vary depending on the industry, so it is important to understand timing associated with receivables and payables in addition to the cost of capital needed to fund ongoing operations. Ventures with higher working capital requirements and extended receivables are at greater risk for failure.

Start-up capital requirements directly affect the risk of a new venture, and they are often underestimated by entrepreneurs. The risk-return tradeoff in entrepreneurship is not the same as the tradeoff in established financial markets. Higher risk does not always bring the potential for higher return, and lower risk does not always mean lower return. It is possible to begin a venture with almost nothing and still do extremely well with profits and harvest. High capital start-up requirements and the associated risks, can lead to lower returns, so entrepreneurs need to be careful in choosing their business model.

Competitive Advantage Ultimately, entrepreneurs must find a way to achieve a competitive advantage in the market, which simply means the ability of a firm to create superior value over the competition for its customers and superior profits for itself. Competitive advantage can arise from product differentiation; control over costs, prices and distribution; as well as from barriers to market entry, such as proprietary protection and contractual advantages. A thorough understanding of the market – its structural elements, costs, potential size and customers – is the first step in determining your venture’s source of competitive advantage.

Beverly K. Brockman, Ph.D., is Associate Professor of Marketing and Entrepreneurship at the University of Tennessee at Chattanooga. She received her Ph.D. in marketing from the University of Alabama. Her areas of specialization include marketing strategy, entrepreneurship, product development and organizational learning.