The document discusses conducting an innovation feasibility study. It defines a feasibility study as examining the viability of an idea that has business potential and is commercially viable. It outlines components of a feasibility study including describing the innovation, market, production methods, infrastructure, costs, and revenue/profit projections. It emphasizes the importance of the marketing study in determining market size, trends, competition, and prices. Conducting a thorough feasibility study is necessary to determine if a project is viable and profitable before committing resources.
2. OutlineOutline
• Definitions/introductionDefinitions/introduction
• Purpose of preparing innovation feasibilitiesPurpose of preparing innovation feasibilities
• Component of the innovation feasibility studyComponent of the innovation feasibility study
• How to prepare a innovation feasibility studyHow to prepare a innovation feasibility study
• How to analyze the investment climateHow to analyze the investment climate
• How to figure out external business opportunitiesHow to figure out external business opportunities
• Marketing studyMarketing study
• Technical studyTechnical study
• Financial studyFinancial study
• Financial analysis/statements/ratiosFinancial analysis/statements/ratios
• Environmental Impact studyEnvironmental Impact study
• Cost and benefits analysisCost and benefits analysis
• How to evaluate an investment projectsHow to evaluate an investment projects
• Payback periodPayback period
• Net present value/Discounted cash flowsNet present value/Discounted cash flows
• Internal rate of returnInternal rate of return
3. Definition of feasibility studyDefinition of feasibility study
is a comprehensive study that examine theis a comprehensive study that examine the
viabilityviability of an ideaof an idea that has athat has a
business potentialbusiness potential and advanced to aand advanced to a
stage where the prospective project isstage where the prospective project is
socially responsiblesocially responsible,, commerciallycommercially
viable and feasible businessviable and feasible business
opportunity exitopportunity exit..
4. A FRAMEWORK FOR NEW VENTURE CREATION
Entrepreneur
Innovative Idea
Market Opportunity
Venture
Concept
Test of
Potential
•Prove viability
•Create initial
“prospectus” to
seek resources
Test of
Feasibility
•Prove feasibility
•Prepare for
implementation
•Gather resources
New
Venture
Resources I
•“Viability” Info
(general market,
process, org., etc.)
•“Sweat” Equity
Resources II
•“Feasibility” Info
(specific market,
process, org., etc.)
•Initial Equity
Resources III
•Prop., Plant & Eqmt
•Personnel
•Management
•Buyers
•Suppliers
•Advisors/Partners
•Full Debt & Equity
Policy Environment
Industry and Market Environment
5. The Purpose of innovationThe Purpose of innovation
feasibility studyfeasibility study
• For Startups micro innovation project;For Startups micro innovation project;
• New established small innovation business;New established small innovation business;
• Expanding existing businesses throughExpanding existing businesses through
innovation;innovation;
• Testing the technical viability, financial viability,Testing the technical viability, financial viability,
market viability of your innovation.market viability of your innovation.
• Developing new product/service (NPD),Developing new product/service (NPD),
• Advocating the innovation project with keyAdvocating the innovation project with key
governmental body, donor agency financing,governmental body, donor agency financing,
• Selling the innovation project for further localSelling the innovation project for further local
ownerships.ownerships.
6. Sources of Investment OpportunitiesSources of Investment Opportunities
• Screening innovative ideasScreening innovative ideas
• Reviewing country importing itemsReviewing country importing items
• Assessing local community needs of publicAssessing local community needs of public
services: education, health, infrastructure, etc.services: education, health, infrastructure, etc.
• Projecting future demands on certain productsProjecting future demands on certain products
and servicesand services
• Examining current diversified industrial trendsExamining current diversified industrial trends
• Reviewing available skilled and workforceReviewing available skilled and workforce
• Participating in international trade fairs/showsParticipating in international trade fairs/shows
• Market intelligence studies/experts researchesMarket intelligence studies/experts researches
7. Pre-feasibility studyPre-feasibility study
1.1. Describing an innovationDescribing an innovation
2.2. Describing market supply and demandsDescribing market supply and demands
3.3. Describing Production methodologiesDescribing Production methodologies
4.4. Describing initial inputs andDescribing initial inputs and
infrastructure supporting services.infrastructure supporting services.
5.5. Selecting the right location/placeSelecting the right location/place
6.6. Estimating Capital and operational costsEstimating Capital and operational costs
7.7. Estimating sales/revenues and profitEstimating sales/revenues and profit
9. 2. Describing market2. Describing market
• Where is the product produced?Where is the product produced?
• What is the number of similar factory or providersWhat is the number of similar factory or providers
of this type of product and in what capacities?of this type of product and in what capacities?
• Estimating the current and future consumptionEstimating the current and future consumption
pattern.pattern.
• Any incentives provided by governmentAny incentives provided by government
• Reviewing to GDP/Export/Import lists/marketReviewing to GDP/Export/Import lists/market
shares.shares.
• Projection of market supply vs. demandProjection of market supply vs. demand
• Similar product prices and substitute pricesSimilar product prices and substitute prices
10. 3. Describing Production methodologies3. Describing Production methodologies
• Describing production processesDescribing production processes
• Describing the type and kind of equipment,Describing the type and kind of equipment,
technical methodologies, etc.technical methodologies, etc.
• Explaining the technology used, skilled laborExplaining the technology used, skilled labor
needed, quality control measures,needed, quality control measures,
• Process engineering, drawings, technical flowProcess engineering, drawings, technical flow
chart,chart,
• The type of maintenance and specializedThe type of maintenance and specialized
knowledge of techniciansknowledge of technicians
• The sources and estimate the cost ofThe sources and estimate the cost of
machines, equipment, automation providersmachines, equipment, automation providers
• Piloting and testing of the prototype, formula,Piloting and testing of the prototype, formula,
product in the market.product in the market.
11. 4. Describing initial inputs and4. Describing initial inputs and
infrastructure supporting servicesinfrastructure supporting services
• Availability of inputs of raw materialsAvailability of inputs of raw materials
• Infrastructure services of roads, sewage,Infrastructure services of roads, sewage,
water, electricity, cleaning disposals, etc.water, electricity, cleaning disposals, etc.
• Availability of good relationships with mainAvailability of good relationships with main
suppliers.suppliers.
• Governmental support and tax benefit bracketsGovernmental support and tax benefit brackets
• Industrial zone, business supportIndustrial zone, business support
centers/incubators.centers/incubators.
• Bank financingsBank financings
• Other supporting industry: packaging,Other supporting industry: packaging,
marketing, logistics, trade facilitation,marketing, logistics, trade facilitation,
technology, etc.technology, etc.
12. 5. Selecting the right location/place5. Selecting the right location/place
• Access to marketAccess to market
• Strategic location fitnessStrategic location fitness
• Exhibition showsExhibition shows
• Access to industrial support facilitiesAccess to industrial support facilities
• Access to public infrastructure servicesAccess to public infrastructure services
• Environment friendly locationEnvironment friendly location
• Socially respected locationSocially respected location
• Community outreach comfortCommunity outreach comfort
13. 6. Estimating Capital & operational6. Estimating Capital & operational
costscosts
• Estimating the costs of fixed assets:Estimating the costs of fixed assets:
• Land, factory building,Land, factory building,
• Capital Machinery, equipment, furnitureCapital Machinery, equipment, furniture
and fixtures.and fixtures.
• Current assets of stocks, inventory,Current assets of stocks, inventory,
• Estimating the costs of running expenses:Estimating the costs of running expenses:
• Salaries for staff, overhead utilities, rent,Salaries for staff, overhead utilities, rent,
electricity, communications, water, fuel,electricity, communications, water, fuel,
maintenance, labor, distribution,maintenance, labor, distribution,
advertisement, transportation, etc.advertisement, transportation, etc.
14. 7. Estimating Revenues and Profit7. Estimating Revenues and Profit
• Projection of Total annual salesProjection of Total annual sales
• Projection of cost of goods soldProjection of cost of goods sold
• Projection of overhead, administrative andProjection of overhead, administrative and
variable expensesvariable expenses
• Projection of the profit marginProjection of the profit margin
• Total Sales – Cost of Goods Sold = GrossTotal Sales – Cost of Goods Sold = Gross
ProfitProfit
• Gross Profit – Overhead, admin, variableGross Profit – Overhead, admin, variable
expenses = Profitexpenses = Profit
15. Writing ExerciseWriting Exercise
• Work in Group of 2 personWork in Group of 2 person
• Review the success innovation stories of yourReview the success innovation stories of your
selectionselection
• Choose a business opportunityChoose a business opportunity
• Start writing the following pre-feasibility studyStart writing the following pre-feasibility study
key section:key section:
16. Case study-Pre-feasibility study formatCase study-Pre-feasibility study format
1.1. Description of an innovationDescription of an innovation
2.2. Description of the marketDescription of the market
3.3. Description of production methodologies andDescription of production methodologies and
technology usedtechnology used
4.4. Description of available infrastructureDescription of available infrastructure
supporting servicessupporting services
5.5. Description of the needed labors and skilledDescription of the needed labors and skilled
workersworkers
6.6. Description of cost estimates: Capital andDescription of cost estimates: Capital and
operating expendituresoperating expenditures
7.7. Projection to revenues and profitsProjection to revenues and profits
18. Why Complete A FeasibilityWhy Complete A Feasibility
Study?Study?
A comprehensive feasibility study allows theA comprehensive feasibility study allows the
user touser to
• Determine if a market for a product existsDetermine if a market for a product exists
• Develop and describe the productionDevelop and describe the production
processes requiredprocesses required
• Determine the costs associated withDetermine the costs associated with
producing the productproducing the product
• Determine if the enterprise is profitable!Determine if the enterprise is profitable!
19. 1. Marketing Study1. Marketing Study
• Market analysis of the a product/serviceMarket analysis of the a product/service
• Description of the production capacityDescription of the production capacity
• Projection of the demand on thisProjection of the demand on this
product/serviceproduct/service
• Estimating the futureEstimating the future
demands/supply/imports/exports on certaindemands/supply/imports/exports on certain
product/serviceproduct/service
• Analyze the competition and majorAnalyze the competition and major
competitorscompetitors
20. Determine Your MarketDetermine Your Market
• This is the most difficult partThis is the most difficult part
• Should be divided into seven key partsShould be divided into seven key parts
1.1. ConsumptionConsumption
2.2. MarketsMarkets
3.3. Distribution systemDistribution system
4.4. Market entryMarket entry
5.5. BuyersBuyers
6.6. Selling ArrangementsSelling Arrangements
7.7. PricesPrices
21. 1.1. ConsumptionConsumption
• What is the current consumption of theWhat is the current consumption of the
product or service?product or service?
• What are the current trends inWhat are the current trends in
consumption? Is consumption increasingconsumption? Is consumption increasing
or decreasing?or decreasing?
• How is the product or service beingHow is the product or service being
consumed? (Packaging, volumes)consumed? (Packaging, volumes)
22. 1.1. Consumption… cont.Consumption… cont.
• What is the quality of the product that isWhat is the quality of the product that is
being consumed?being consumed?
• Who consumes the product? What areWho consumes the product? What are
their demographics? (Age, income,their demographics? (Age, income,
educational levels, marital status, familyeducational levels, marital status, family
size)size)
• Are these demographic segments growingAre these demographic segments growing
or shrinking?or shrinking?
23. 2.2. MarketsMarkets
• What is the current structure of theWhat is the current structure of the
marketplace?marketplace?
• Who is currently supplying these products toWho is currently supplying these products to
customers?customers?
• What will be the reaction of these firms if aWhat will be the reaction of these firms if a
new firm enters the market?new firm enters the market?
• Can a firm compete with existing firms orCan a firm compete with existing firms or
other potential entrants?other potential entrants?
24. 2.2. Markets ……cont.Markets ……cont.
• What are the implications for a firm whoWhat are the implications for a firm who
wants to expand its market?wants to expand its market?
– What are the costs?What are the costs?
– What revenues can be expected?What revenues can be expected?
• Where are the markets (customers)Where are the markets (customers)
located? Are they local, regional, national,located? Are they local, regional, national,
or international? What will it cost to serveor international? What will it cost to serve
them?them?
25. 3.3. Distribution SystemDistribution System
• Will it be necessary to provide deliveryWill it be necessary to provide delivery
services?services?
• What delivery schedules will be required?What delivery schedules will be required?
• What common carrier options are available?What common carrier options are available?
• Should the firm provide delivery itself?Should the firm provide delivery itself?
• Should delivery equipment be purchased orShould delivery equipment be purchased or
leased?leased?
26. 4.4. Market EntryMarket Entry
• How will the product or service beHow will the product or service be
introduced to the market?introduced to the market?
• Will the product be marketed under theWill the product be marketed under the
company’s name or under some othercompany’s name or under some other
name?name?
• What will attract buyers? (Low prices,What will attract buyers? (Low prices,
advertising, promotion, customer service,advertising, promotion, customer service,
or some other method)or some other method)
27. 5.5. BuyersBuyers
• Will you sell directly to consumers or goWill you sell directly to consumers or go
through a “middleman” buyer?through a “middleman” buyer?
• What types of buyers will purchase theWhat types of buyers will purchase the
product?product?
• Where are they located?Where are they located?
• What product specifications will theyWhat product specifications will they
require?require?
28. 5.5. Buyers ……cont.Buyers ……cont.
• Have potential buyers expressed anHave potential buyers expressed an
interest in the product?interest in the product?
• What type of purchasing commitments areWhat type of purchasing commitments are
buyers willing to make?buyers willing to make?
• How reliable are the buyers?How reliable are the buyers?
• What type of payment schedules will beWhat type of payment schedules will be
encountered? How severely will this affectencountered? How severely will this affect
the firm’s cash position?the firm’s cash position?
29. 6.6. Selling ArrangementsSelling Arrangements
• What type of selling services will you needWhat type of selling services will you need
to provide?to provide?
• Will you need to employ a sales force orWill you need to employ a sales force or
go through a buyer?go through a buyer?
• If you employ a sales force, how manyIf you employ a sales force, how many
people will this require? What is theirpeople will this require? What is their
compensation plan?compensation plan?
30. 6.6. Selling Arrangements ….cont.Selling Arrangements ….cont.
• How will they be selling the product?How will they be selling the product?
• What are the costs of these activities?What are the costs of these activities?
• Should you have sales offices locatedShould you have sales offices located
throughout your geographic market area?throughout your geographic market area?
• Why have you chosen one method ofWhy have you chosen one method of
selling activities over another?selling activities over another?
31. 7.7. PricesPrices
• Setting a price is a critical activity in theSetting a price is a critical activity in the
market portion of the study.market portion of the study.
• The price must be high enough to cover allThe price must be high enough to cover all
costs and provide you a profit, but lowcosts and provide you a profit, but low
enough that customers will purchase theenough that customers will purchase the
product or service.product or service.
32. 7.7. Prices ………contPrices ………cont
• ToTo helphelp determine the price, look at:determine the price, look at:
– Past prices of the industryPast prices of the industry
– Current price trendsCurrent price trends
– Expectations of buyers (brokers)Expectations of buyers (brokers)
– Expectations of consumersExpectations of consumers
– Quality levels of substitutes or competitorsQuality levels of substitutes or competitors
• These factors only help you set a price.These factors only help you set a price.
They can’t set the price for youThey can’t set the price for you
34. 2. Technical Study2. Technical Study
• Description of production methodologyDescription of production methodology
• Identifying the required equipment/technology/machineryIdentifying the required equipment/technology/machinery
• Identifying the location, space, engineering design,Identifying the location, space, engineering design,
technical drawings, etc.technical drawings, etc.
• Description of the required energy, fuel, water, transport,Description of the required energy, fuel, water, transport,
logistics and other infrastructure serviceslogistics and other infrastructure services
• Estimating the required raw materials, capacity,Estimating the required raw materials, capacity,
machinery maintenance, labor, IT, the size of factory, etc.machinery maintenance, labor, IT, the size of factory, etc.
• Preparing the manufacturing design, drawings, leveling,Preparing the manufacturing design, drawings, leveling,
basement, construction, infrastructure, finishing,basement, construction, infrastructure, finishing,
electricity, water, health and safety measures, laborelectricity, water, health and safety measures, labor
training, etc.training, etc.
• Projection of fixed cost ad operating costProjection of fixed cost ad operating cost
35. Production ProcessProduction Process
• The production process section of the studyThe production process section of the study
is divided into the following parts:is divided into the following parts:
– Raw materialsRaw materials
• AvailabilityAvailability
• Future SupplyFuture Supply
– Facility DeterminationFacility Determination
– Investment Capital NeedsInvestment Capital Needs
– Labor needsLabor needs
– Production costsProduction costs
36. Facility DeterminationFacility Determination
• The minimum size facility to make theThe minimum size facility to make the
enterprise economically feasible must beenterprise economically feasible must be
determined.determined.
• Determining this size plant requires theDetermining this size plant requires the
simultaneous analysis of both demandsimultaneous analysis of both demand
(marketing) and supply (production(marketing) and supply (production
including raw product).including raw product).
• The plant must be of sufficient size toThe plant must be of sufficient size to
maintain a low enough production cost permaintain a low enough production cost per
unit and but not large enough to overloadunit and but not large enough to overload
the market niche.the market niche.
37. 3. Financial Study3. Financial Study
• Estimate of capital expendituresEstimate of capital expenditures
• Estimate of operational expendituresEstimate of operational expenditures
• Estimate of revenues for the coming 5 yearsEstimate of revenues for the coming 5 years
• Estimate the sales over the life of the projectEstimate the sales over the life of the project
• Propose financing plan and equities structurePropose financing plan and equities structure
• Projection of the expected profits under variousProjection of the expected profits under various
assumptionsassumptions
• Financial analysis and ratiosFinancial analysis and ratios
38. Investment Capital NeedsInvestment Capital Needs
• What is the required capital investmentWhat is the required capital investment
necessary to construct the productionnecessary to construct the production
facility?facility?
• What form of financing must be utilized toWhat form of financing must be utilized to
secure these funds?secure these funds?
• What is the cost of these funds and whatWhat is the cost of these funds and what
restrictions are attached to their use?restrictions are attached to their use?
39. Operational CostsOperational Costs
• Includes items such as:Includes items such as:
– Wage ratesWage rates
– Management costsManagement costs
– Raw material costsRaw material costs
– Utility rate structuresUtility rate structures
– Fixed Costs (Depreciation, Taxes, Interest,Fixed Costs (Depreciation, Taxes, Interest,
Insurance)Insurance)
• Costs should be broken down into a per unitCosts should be broken down into a per unit
basisbasis
40. ProfitabilityProfitability
• Given the estimated revenues from theGiven the estimated revenues from the
marketing section and the estimated costsmarketing section and the estimated costs
from the production section, the profitabilityfrom the production section, the profitability
of the enterprise can be ascertained.of the enterprise can be ascertained.
• Profitability is defined as the excess ofProfitability is defined as the excess of
revenues over expenses.revenues over expenses.
• There are two distinct measures ofThere are two distinct measures of
profitability.profitability.
41. Profitability MeasuresProfitability Measures
• Tax ProfitabilityTax Profitability
– Revenues minus expensesRevenues minus expenses
– This is the amount on which you pay taxes.This is the amount on which you pay taxes.
• Economic ProfitabilityEconomic Profitability
– Revenues minus expenses minus a returnRevenues minus expenses minus a return
to the owner.to the owner.
– This captures the value of the manage-This captures the value of the manage-
ment input of the owner.ment input of the owner.
– Excess returns are considered economicExcess returns are considered economic
profit.profit.
42. Profitability ChartsProfitability Charts
• Break-even analysisBreak-even analysis
– Shows the level of production where revenuesShows the level of production where revenues
will just cover costs.will just cover costs.
– Prepare this on a tax profitability and anPrepare this on a tax profitability and an
economic profitability basis.economic profitability basis.
• Show the effect of risk on profitabilityShow the effect of risk on profitability
– Prepare sensitivity analysis to determinePrepare sensitivity analysis to determine
effect of various revenue and cost streams oneffect of various revenue and cost streams on
profitability.profitability.
43. Working CapitalWorking Capital
• Working capital is the cash used for day-to-Working capital is the cash used for day-to-
day expenses such as the payroll, utility bills,day expenses such as the payroll, utility bills,
etc.etc.
• Adequate working capital is crucial toAdequate working capital is crucial to
business survivalbusiness survival
• The cash flow statement demonstrates theThe cash flow statement demonstrates the
need for working capital at specific points inneed for working capital at specific points in
timetime
– Shows the uses of cashShows the uses of cash
– Demonstrates the need for additional borrowingsDemonstrates the need for additional borrowings
44. 4. Management & Organizational Study4. Management & Organizational Study
• Identify the required organizational structure forIdentify the required organizational structure for
the project, department and unitsthe project, department and units
• Description of the main roles and responsibilitiesDescription of the main roles and responsibilities
for each department and unitsfor each department and units
• Identifying main positions, jobs descriptions,Identifying main positions, jobs descriptions,
roles and responsibilities,roles and responsibilities,
• Key competencies and skills among staffKey competencies and skills among staff
• Preparing management structure and HRMPreparing management structure and HRM
manualmanual
• Recommending of the legal entity of the projectRecommending of the legal entity of the project
• Projecting the required HR and HR DevelopmentProjecting the required HR and HR Development
planplan
45. LaborLabor
• How many employees will be required to runHow many employees will be required to run
the production facility?the production facility?
• Compare facility needs to the local laborCompare facility needs to the local labor
force.force.
– What special skills will be required? Are theseWhat special skills will be required? Are these
available from the current labor force?available from the current labor force?
– The local unemployment rate is not necessarilyThe local unemployment rate is not necessarily
an indicator of the labor force.an indicator of the labor force.
• Where will management and techniciansWhere will management and technicians
come from? What costs are involved income from? What costs are involved in
getting them to work for you?getting them to work for you?
46. 5. Socio-economic Study5. Socio-economic Study
• The contribution to social benefitsThe contribution to social benefits
• Adding value to local needsAdding value to local needs
• Offering a product/serviceOffering a product/service
• Social responsibility and community outreachSocial responsibility and community outreach
supportsupport
• Contribution to local demands andContribution to local demands and
• Trade balanceTrade balance
• Cost and benefits analysisCost and benefits analysis
• Contribution to the added valueContribution to the added value
• Contribution to generate more investment andContribution to generate more investment and
business opportunities and employmentbusiness opportunities and employment
opportunities.opportunities.
47. 6. Environmental Impact6. Environmental Impact
assessment studyassessment study
• Assessing environmental impact of the projectAssessing environmental impact of the project
• Assessing the project risk assessment on:Assessing the project risk assessment on:
natural resources,natural resources,
• pollutions,pollutions,
• solid waste,solid waste,
• disposing industry waste anddisposing industry waste and
• biodiversities impact.biodiversities impact.
• Other environmental risk and hazards,Other environmental risk and hazards,
• chemical treatment, emissions, poisons, etc.chemical treatment, emissions, poisons, etc.
49. Third Training DayThird Training Day
Evaluating Feasibility StudyEvaluating Feasibility Study
50. Product features
Performance
Mix & variety of products
Service levels
Small vs. large buyers
Process technology
Wage levels
Product features
Hiring, training,
motivation
Factors That Drive CostsFactors That Drive Costs
Economies of scale
Asset utilization
Capacity utilization
pattern
• Seasonal, cyclical
Interrelationships
Order processing
and distribution
Value chain linkages
• Marketing & sales
• Logistics &
operations
• Service
51. Factors That DriveFactors That Drive
DifferentiationDifferentiation
• Unique product featuresUnique product features
• Unique product performanceUnique product performance
• Exceptional servicesExceptional services
• New technologiesNew technologies
• Quality of inputsQuality of inputs
• Exceptional skill or experienceExceptional skill or experience
• Detailed informationDetailed information
• Extensive personal relationships with buyersExtensive personal relationships with buyers
and suppliersand suppliers
52. Evaluating Feasibility StudyEvaluating Feasibility Study
• Implementation check andImplementation check and
• Fitness of time schedules,Fitness of time schedules,
• Cost estimates,Cost estimates,
• Viability and validity of the assumptions,Viability and validity of the assumptions,
• Financial feasibility:Financial feasibility:
1.1. Capital expenditures,Capital expenditures,
2.2. working capital,working capital,
3.3. cash flows,cash flows,
4.4. equities structures,equities structures,
5.5. debt ratios,debt ratios,
6.6. financial analysis and profitability.financial analysis and profitability.
53. Financial AssessmentFinancial Assessment
• Payback periodPayback period
• Rate of returnRate of return
• Break even analysisBreak even analysis
• Rate of internal returnsRate of internal returns
• Net Present valueNet Present value
• Discounted cash flowsDiscounted cash flows
54. Payback periodPayback period
• Payback period = total $Payback period = total $
investment/annual incomeinvestment/annual income
Example:Example:
• One project spent $50,000 and earnedOne project spent $50,000 and earned
annual income $10,000annual income $10,000
• Payback period =Payback period =
• Calculate: ???Calculate: ???
55. Rate of returnRate of return
Average annual accounting income from projectAverage annual accounting income from project
÷÷ Average annual investment in the projectAverage annual investment in the project
== Return on investment (ROI)Return on investment (ROI)
Average annual investment =Average annual investment = (Initial investment +(Initial investment +
Salvage value at end)Salvage value at end) ÷÷ 22
Advantages of ROI method:Advantages of ROI method:
• Simple to explain and compute using financial statementsSimple to explain and compute using financial statements
• Rate of return = average profit after tax/average total investmentRate of return = average profit after tax/average total investment
• Average profit after tax= Total annual profit/number of yearsAverage profit after tax= Total annual profit/number of years
• Average total investment = Total investment (value of startingAverage total investment = Total investment (value of starting
assets) + (value of ending assets)/2assets) + (value of ending assets)/2
56. Breakeven AnalysisBreakeven Analysis
Breakeven pointBreakeven point QQBEBE is the number of units that must be sold at priceis the number of units that must be sold at price
P such that total revenues (TR) equal total costs (TC).P such that total revenues (TR) equal total costs (TC).
TRTR = TC= TC
(P(P ×× QQBEBE)) == [FC + (VC[FC + (VC ×× QQBEBE)])]
[(P - VC)[(P - VC) ×× QQBEBE]] == FCFC
QQBEBE == [FC[FC ÷÷ (P - VC)](P - VC)]
QQBEBE == (FC(FC ÷÷ CM)CM)
At breakeven, the total contribution margin equals fixed costs.At breakeven, the total contribution margin equals fixed costs.
(CM(CM ×× QQBEBE)) == FCFC
58. Rate of internal returnsRate of internal returns
Internal rate of return (IRR) is the interest rate that equatesInternal rate of return (IRR) is the interest rate that equates
the present value of future cash flows to the cashthe present value of future cash flows to the cash
outflows.outflows.
By definition: PV = FVBy definition: PV = FV ÷÷ (1 +(1 + irrirr))
Solution for a single cash flow:Solution for a single cash flow: irrirr = (FV= (FV ÷÷ PV) - 1PV) - 1
Comparison of IRR and DCF/NPV methodsComparison of IRR and DCF/NPV methods
• Both consider time value of cash flowsBoth consider time value of cash flows
• IRR indicatesIRR indicates relativerelative return on investmentreturn on investment
• DCF/NPV indicatesDCF/NPV indicates magnitudemagnitude of investment’s returnof investment’s return
• IRR can yield multiple rates of returnIRR can yield multiple rates of return
• IRR assumes all cash flows reinvested at project’sIRR assumes all cash flows reinvested at project’s
constant IRRconstant IRR
• DCF/NPV discounts all cash flows with specifiedDCF/NPV discounts all cash flows with specified
discount ratediscount rate
59. Net Present valueNet Present value
1.1. Identify after-tax cash flows for each periodIdentify after-tax cash flows for each period
2.2. Determine discount rateDetermine discount rate
3.3. Multiply by appropriate present-value factorMultiply by appropriate present-value factor
(single or annuity) for each cash flow. PV factor(single or annuity) for each cash flow. PV factor
is 1.0 for cash invested nowis 1.0 for cash invested now
4.4. Sum of the present values of all cash flows =Sum of the present values of all cash flows =
net present value (NPV)net present value (NPV)
5. If NPV5. If NPV ≥≥ 0, then accept project0, then accept project
6. If NPV < 0, then reject project6. If NPV < 0, then reject project
NPVNPV is also known as discounted cash flow (is also known as discounted cash flow (DCFDCF).).
60. Value of a firm is equal to the present valueValue of a firm is equal to the present value
of its expected cash flowsof its expected cash flows
Invested
Capital
Market
Value
PV
CF2
PV
CF3
PV
CFt
PV
CF1
PV
CF5
PV
CF6
PV
CF44
Discounted Cash Flow Method
Σ
n Expected Cash Flow
(1 + Cost of Capital)
t
t = 1
Value of Firm =
t
61. Example: Valuation of Coca Cola using DCFExample: Valuation of Coca Cola using DCF
methodmethod
83,002
4,314
Book
Value
11,800
4,419
4,628
4,734
4,504
4,819
4,957
5,078
5,177
5,249
Discounted Free Cash Flow to the Firm
Debt
11,671
Firm Value
130,882
$ millions
Value to Equity = Firm Value - Debt
= $130,882 - $11,671
= $119,211
Market Value per Share = Value to equity / Shares outstanding
= $119,211 million / 2460 million shares
= $48 / share
Current Market Price = $44 / share
Market
Value
Added
107,411
62. Main components of an incomeMain components of an income
statementstatement
SalesSales
Cost of goods soldCost of goods sold
Gross profitGross profit
Operating expensesOperating expenses
Total operatingTotal operating
expensesexpenses
Net income before taxesNet income before taxes
TaxesTaxes
Net incomeNet income
63. Main components of a balanceMain components of a balance
sheetsheet
AssetsAssets
LiabilitiLiabiliti
es andes and
OwnersOwners
’ Equity’ Equity
64. Cash flow is not a stand aloneCash flow is not a stand alone
statementstatement
• Balance sheet and income statementBalance sheet and income statement are notare not
consideringconsidering the timing of receipt and payment ofthe timing of receipt and payment of
cash in recognizing assets, liabilities, owners’cash in recognizing assets, liabilities, owners’
equity, income and expenses.equity, income and expenses.
• Cash flow statement tracks the timing of receiptsCash flow statement tracks the timing of receipts
and payments of cash to help the business analyzeand payments of cash to help the business analyze
its cash flow situation.its cash flow situation.
• Cash flow statements is prepared on the basis ofCash flow statements is prepared on the basis of
financial information in the income statement andfinancial information in the income statement and
65. Cash flow statement is divided to 3 sectionsCash flow statement is divided to 3 sections
• Operating activitiesOperating activities : principal operating activities of the business. Main: principal operating activities of the business. Main
items considered are:items considered are:
– RevenuesRevenues
– Accounts receivableAccounts receivable
– ExpensesExpenses
– Accounts payableAccounts payable
– Prepaid expensesPrepaid expenses
• Investing activitiesInvesting activities : long term items. Main items considered are:: long term items. Main items considered are:
– Fixed assetsFixed assets
– Long-term investmentsLong-term investments
• Financing activitiesFinancing activities : how the business is financed. Main items: how the business is financed. Main items
considered are:considered are:
– CapitalCapital
– DividendsDividends
– LoansLoans
– InterestInterest
66. How the cash flow statement isHow the cash flow statement is
prepared?prepared?
• There are 2 ways to prepare the operating section ofThere are 2 ways to prepare the operating section of
the cash flow statement:the cash flow statement:
• Direct method: translates income statement items –Direct method: translates income statement items –
item by item – using information in the balanceitem by item – using information in the balance
sheet. For example; revenues in the incomesheet. For example; revenues in the income
statement are translated to “cash receipts fromstatement are translated to “cash receipts from
customers” using thecustomers” using the changechange the accountsthe accounts
receivable from the comparative balance sheet.receivable from the comparative balance sheet.
• Indirect method: starts with net income in the incomeIndirect method: starts with net income in the income
statement and reconciles it to net cash provided bystatement and reconciles it to net cash provided by
operating activities through considering items in theoperating activities through considering items in the
balance sheet and income statement.balance sheet and income statement.
67. Comparative Financial Analysis: KeyComparative Financial Analysis: Key
RatiosRatios
Profitability
Leverage
Activity
Liquidity
Type Examples Measures Indicators
Profit after taxes
Shareholder’s equity
Return on
Equity (ROE)
Current Ratio
Asset Turnover
Inventory Turnover
Debt/Equity Ratio
Current Assets
Current Liabilities
Liabilities______
Shareholders’ equity
Sales_________
Total Assets
Sales_________
Inventory
Productivity of
firm’s value-adding
activities
Measure of
financial solvency
Asset use
efficiency
Turnaround of
inventory
Corporate
financing; financial
risk; default risk
68. Basic ways to improve ROA and ROEBasic ways to improve ROA and ROE
Net Income
30,000
Profit Margin
Net Income / Revenues divided by
15.00%
Revenues
200,000
ROA
Net Income / Assets multiplied by
18.75%
Revenues
200,000
Asset Utilization
Revenues / Assets divided by
1.25
Assets
ROE 160,000
Net Income / Equity multiplied by
37.50%
Assets
160,000
Leverage Assets
Assets / Equity divided by
2.00 160,000
Equity
minus
80,000
Liabilities
80,000
69. Net Income
Profit Margin
Net Income / Revenues divided by
Revenues
ROA
Net Income / Assets multiplied by
Revenues
Asset Utilization
Revenues / Assets divided by
Assets
ROE
Net Income / Equity multiplied by
Assets
Leverage Assets
Assets / Equity divided by
Equity
minus
Liabilities
Exercise: ROE and ROAExercise: ROE and ROA
A firm has the
following financial
data:
Assets =$ 200,000
Liabilities = 0
Equity = $ 200,000
Revenues = $200,000
Expenses = $180,000
Complete the ratio
decomposition and
determine
the ROA and ROE.
70. Exercise: ROE and ROAExercise: ROE and ROA
Net Income
Profit Margin
Net Income / Revenues divided by
Revenues
ROA
Net Income / Assets multiplied by
Revenues
Asset Utilization
Revenues / Assets divided by
Assets
ROE
Net Income / Equity multiplied by
Assets
Leverage Assets
Assets / Equity divided by
Equity
minus
Liabilities
A firm has the following
financial data:
Assets = $200,000
Liabilities = 0
Equity = $200,000
Revenues = $200,000
Expenses = $170,000
Complete the ratio
decomposition and
determine
the ROA and ROE.
71. Economic AssessmentEconomic Assessment
• Cost and benefit analysisCost and benefit analysis
• Can an estimate of required capital
investment be made?
• Contribution to economic developmentContribution to economic development
• Contribution to job creation andContribution to job creation and
employmentemployment
• Contribution to trade balance andContribution to trade balance and
• export marketexport market
• Contribution to added value andContribution to added value and
• GDPGDP
72. Environmental Assessment
• What is the expected environmental effect
of the option?
• How significant is the estimated reduction
in wastes or emissions?
• Will the option affect public or operator
health (positive or negative)? If so, what is
the magnitude of these effects in terms of
toxicity and exposure?
73. Information required whenInformation required when
undertaking feasibility studyundertaking feasibility study
• Population statistics:Population statistics:
• Demographics statisticsDemographics statistics
• Socio-economic factorsSocio-economic factors
• EducationEducation
• Housing StatisticsHousing Statistics
74. Income LevelsIncome Levels
• Income per capitaIncome per capita
• Income distributionIncome distribution
• Income and consumption distributionIncome and consumption distribution
• Consumer preferencesConsumer preferences
• Consumption trendsConsumption trends
75. Law and legal data and policies ofLaw and legal data and policies of
public servicespublic services
• Restriction on importsRestriction on imports
• Customs tariffCustoms tariff
• Pricing policyPricing policy
• Regulation and de-regulationRegulation and de-regulation
• Trade agreementTrade agreement
• Industry free tax zonesIndustry free tax zones
• IncubatorsIncubators
76. Data about the product/serviceData about the product/service
• Local productionLocal production
• Local demand and supplyLocal demand and supply
• Import/export productsImport/export products
• International trends in internationalInternational trends in international
marketsmarkets
77. Data on Product PricesData on Product Prices
• Prices of competitors productsPrices of competitors products
• Prices of similar productsPrices of similar products
• Prices of related productsPrices of related products
• Price wars and strategies adoptedPrice wars and strategies adopted
• Prices of wholesales and in retail pricesPrices of wholesales and in retail prices
• Trends on international market pricesTrends on international market prices
79. Research and DevelopmentResearch and Development
• Researchers and Scientific CentersResearchers and Scientific Centers
• Others market researches andOthers market researches and
developmentdevelopment
• Hi-tech industry development centerHi-tech industry development center
• Technology laboratoryTechnology laboratory
• Innovation and product developmentInnovation and product development
institutioninstitution
80. External Environmental AnalysisExternal Environmental Analysis
Strategic IntentStrategic Intent
Strategic MissionStrategic Mission
The ExternalThe External
EnvironmentEnvironment
Analysis of general environmentAnalysis of general environment
Analysis of industry environmentAnalysis of industry environment
Analysis of competitor environmentAnalysis of competitor environment
The ExternalThe External
EnvironmentEnvironment
81. General EnvironmentGeneral Environment
• Socio-cultural segmentSocio-cultural segment
Women in the workplaceWomen in the workplace
Workforce diversityWorkforce diversity
Attitudes about quality of worklifeAttitudes about quality of worklife
Concerns about environmentConcerns about environment
Shifts in work and career preferencesShifts in work and career preferences
Shifts in product and service preferencesShifts in product and service preferences
82. • Economic segmentEconomic segment
General EnvironmentGeneral Environment
Inflation ratesInflation rates
Interest ratesInterest rates
Trade deficits or surplusesTrade deficits or surpluses
Budget deficits or surplusesBudget deficits or surpluses
Personal savings ratePersonal savings rate
Business savings ratesBusiness savings rates
Gross domestic productGross domestic product
83. General EnvironmentGeneral Environment
• Political/Legal SegmentPolitical/Legal Segment
Antitrust lawsAntitrust laws
Taxation lawsTaxation laws
Deregulation philosophiesDeregulation philosophies
Labor training lawsLabor training laws
Educational philosophies and policiesEducational philosophies and policies
84. General EnvironmentGeneral Environment
• Technological SegmentTechnological Segment
Product innovationsProduct innovations
Applications of knowledgeApplications of knowledge
Focus of private and government-supportedFocus of private and government-supported
R&D expendituresR&D expenditures
New communication technologiesNew communication technologies
85. General EnvironmentGeneral Environment
• Global SegmentGlobal Segment
Important political eventsImportant political events
Critical global marketsCritical global markets
Newly industrialize countriesNewly industrialize countries
Different cultural and institutional attributesDifferent cultural and institutional attributes
86. General EnvironmentGeneral Environment
• Demographic SegmentDemographic Segment
Population sizePopulation size
Age structureAge structure
Geographic distributionGeographic distribution
Ethnic mixEthnic mix
Income distributionIncome distribution
87. Industry EnvironmentIndustry Environment
• A set of factors that directly influences a companyA set of factors that directly influences a company
and its competitive actions and responsesand its competitive actions and responses
• Interaction among these factors determine anInteraction among these factors determine an
industry’s profit potentialindustry’s profit potential
Threat of new entrantsThreat of new entrants
Power of suppliersPower of suppliers
Power of buyersPower of buyers
Product substitutesProduct substitutes
Intensity of rivalryIntensity of rivalry
88. Five Forces Model ofFive Forces Model of
CompetitionCompetition
• Identify current and potential competitors andIdentify current and potential competitors and
determine which firms serve themdetermine which firms serve them
• Conduct competitive analysisConduct competitive analysis
• Recognize that suppliers and buyers canRecognize that suppliers and buyers can
become competitorsbecome competitors
• Recognize that producers of potentialRecognize that producers of potential
substitutes may become competitorssubstitutes may become competitors
89. Threat of New
Entrants
Threat of New
Entrants
BargainingPowerof
BargainingPowerof
Suppliers
Suppliers
Bargaining Power ofBargaining Power of
BuyersBuyers
ThreatofSubstitute
ThreatofSubstitute
Products
Products
Rivalry Among
Rivalry Among
Competing Firms
Competing Firms
Five Forces Model ofFive Forces Model of
CompetitionCompetition
Five Forces ofFive Forces of
CompetitionCompetition
90. Threat of New EntrantsThreat of New Entrants
• Barriers to entryBarriers to entry
• Economies of scaleEconomies of scale
• Product differentiationProduct differentiation
• Capital requirementsCapital requirements
• Switching costsSwitching costs
• Access to distribution channelsAccess to distribution channels
• Cost disadvantages independent of scaleCost disadvantages independent of scale
• Government policyGovernment policy
• Expected retaliationExpected retaliation
91. Bargaining Power of SuppliersBargaining Power of Suppliers
• A supplier group is powerful when:A supplier group is powerful when:
• it is dominated by a few large companiesit is dominated by a few large companies
• satisfactory substitute products are not available tosatisfactory substitute products are not available to
industry firmsindustry firms
• industry firms are not a significant customer for theindustry firms are not a significant customer for the
supplier groupsupplier group
• suppliers’ goods are critical to buyers’ marketplacesuppliers’ goods are critical to buyers’ marketplace
successsuccess
• effectiveness of suppliers’ products has created higheffectiveness of suppliers’ products has created high
switching costsswitching costs
• suppliers are a credible threat to integrate forward intosuppliers are a credible threat to integrate forward into
the buyers’ industrythe buyers’ industry
92. Bargaining Power of BuyersBargaining Power of Buyers
• Buyers (customers) are powerful when:Buyers (customers) are powerful when:
• they purchase a large portion of an industry’s totalthey purchase a large portion of an industry’s total
outputoutput
• the sales of the product being purchased account for athe sales of the product being purchased account for a
significant portion of the seller’s annual revenuessignificant portion of the seller’s annual revenues
• they could easily switch to another productthey could easily switch to another product
• the industry’s products are undifferentiated orthe industry’s products are undifferentiated or
standardized, and buyers pose a credible threat if theystandardized, and buyers pose a credible threat if they
were to integrate backward into the seller’s industrywere to integrate backward into the seller’s industry
93. Threat of Substitute ProductsThreat of Substitute Products
• Product substitutes are strong threat when:Product substitutes are strong threat when:
• customers face few switching costscustomers face few switching costs
• substitute product’s price is lowersubstitute product’s price is lower
• substitute product’s quality and performancesubstitute product’s quality and performance
capabilities are equal to or greater than those of thecapabilities are equal to or greater than those of the
competing productcompeting product
94. Intensity of RivalryIntensity of Rivalry
• Intensity of rivalry is stronger when competitors:Intensity of rivalry is stronger when competitors:
• are numerous or equally balancedare numerous or equally balanced
• experience slow industry growthexperience slow industry growth
• have high fixed costs or high storage costshave high fixed costs or high storage costs
• lack differentiation or low switching costslack differentiation or low switching costs
• experience high strategic stakesexperience high strategic stakes
• have high exit barriershave high exit barriers
95. High Exit BarriersHigh Exit Barriers
• Common exit barriers include:Common exit barriers include:
• specialized assets (assets with values linked to aspecialized assets (assets with values linked to a
particular business or location)particular business or location)
• fixed costs of exit such as labor agreementsfixed costs of exit such as labor agreements
• strategic interrelationships (relationships of mutualstrategic interrelationships (relationships of mutual
dependence between one business and other parts ofdependence between one business and other parts of
a company’s operation, such as shared facilities anda company’s operation, such as shared facilities and
access to financial markets)access to financial markets)
• emotional barriers (career concerns, loyalty toemotional barriers (career concerns, loyalty to
employees, etc.)employees, etc.)
• government and social restrictionsgovernment and social restrictions
96. Case studyCase study
• Complete feasibility study format andComplete feasibility study format and
writing exercises:writing exercises:
• Topics to be determined:Topics to be determined:
1.1. AgribusinessAgribusiness
2.2. Retail IndustryRetail Industry
3.3. Service industryService industry
4.4. Manufacturing industryManufacturing industry
5.5. ICTICT
6.6. othersothers
97. Feasibility outline formatFeasibility outline format
1.1. Executive SummaryExecutive Summary
2.2. Regional Socio-Economic Situation (General DescriptionRegional Socio-Economic Situation (General Description
of the current situation). Most likely including brief on yourof the current situation). Most likely including brief on your
local economy.local economy.
3.3. Legal StudyLegal Study
4.4. Financial PlanFinancial Plan
5.5. Project Implementation ScheduleProject Implementation Schedule
6.6. Market Study and MarketingMarket Study and Marketing
7.7. Detail Description of ActivitiesDetail Description of Activities
8.8. Environmental protectionEnvironmental protection
9.9. ControlControl
10.10. Financial Analysis and ProjectionsFinancial Analysis and Projections
11.11. 11) Social Economic Effects / Multiplier effects, related11) Social Economic Effects / Multiplier effects, related
studiesstudies
12.12. 12) Options Analysis on different hypothesis and12) Options Analysis on different hypothesis and
scenariosscenarios
98. Writing pitfall for feasibility studyWriting pitfall for feasibility study
Summary guide when writing keySummary guide when writing key
componentscomponents
99. Feasibility Study ContentsFeasibility Study Contents
• Venture ConceptVenture Concept
• Market AssessmentMarket Assessment
• Technical Feasibility of your ideaTechnical Feasibility of your idea
• Your Marketing PlanYour Marketing Plan
• Managing the Supply SituationManaging the Supply Situation
• Conduct cost and profitability assessmentConduct cost and profitability assessment
• Plan for future actionPlan for future action
100. Feasibility Study ContentsFeasibility Study Contents
• Venture ConceptVenture Concept
– Explain clearly and concisely the principalExplain clearly and concisely the principal
concept underlying your venture and what sets itconcept underlying your venture and what sets it
apart from other businessesapart from other businesses
• Market AssessmentMarket Assessment
– Describe the profile of your principal targetDescribe the profile of your principal target
customerscustomers
– Indicate current market size, trends and seasonalIndicate current market size, trends and seasonal
patternspatterns
– How do you plan to test your idea?How do you plan to test your idea?
– Describe any market research or customerDescribe any market research or customer
surveys you plan to conductsurveys you plan to conduct
– Assess the nature of your competitionAssess the nature of your competition
– Estimate your expected sales and market shareEstimate your expected sales and market share
101. Feasibility Study Contents …Feasibility Study Contents …
• Technical FeasibilityTechnical Feasibility
– Indicate the degree of innovativeness of yourIndicate the degree of innovativeness of your
venture idea and the risks associated with itventure idea and the risks associated with it
– Does it need to be subjected to some form ofDoes it need to be subjected to some form of
technical evaluation or assessment?technical evaluation or assessment?
Does the business need accreditation?Does the business need accreditation?
Do you have a prototype? Has it been testedDo you have a prototype? Has it been tested
from a technological point of view? Will it havefrom a technological point of view? Will it have
the specifications to meet the needs andthe specifications to meet the needs and
expectations of the market?expectations of the market?
Can it be mass produced? Job shopCan it be mass produced? Job shop
production? Sub contracted?production? Sub contracted?
102. Feasibility Study Contents …Feasibility Study Contents …
• Your Marketing PlanYour Marketing Plan
– Detail the marketing strategy you plan to useDetail the marketing strategy you plan to use
– Describe your marketing plan including your salesDescribe your marketing plan including your sales
strategy, advertising and promotion plans, pricingstrategy, advertising and promotion plans, pricing
policy and channels of distribution.policy and channels of distribution.
103. Feasibility Study Contents …Feasibility Study Contents …
• Managing the Supply SituationManaging the Supply Situation
– How do you plan to assure continuing access toHow do you plan to assure continuing access to
critical supplies of raw materials and componentcritical supplies of raw materials and component
parts at reasonable prices?parts at reasonable prices?
– Will you produce or subcontract your production?Will you produce or subcontract your production?
104. Feasibility Study Contents …Feasibility Study Contents …
• Cost and Profitability AssessmentCost and Profitability Assessment
– Estimate funds required to set up your businessEstimate funds required to set up your business
– Develop short-term financial projections including:Develop short-term financial projections including:
Cash flow forecastsCash flow forecasts
Pro forma profit and loss statementsPro forma profit and loss statements
Pro forma balance sheetPro forma balance sheet
Break even analysisBreak even analysis
105. Feasibility Study Contents …Feasibility Study Contents …
• Plan for future actionPlan for future action
– What were the strong and weak points of yourWhat were the strong and weak points of your
venture idea?venture idea?
– Did your assessment indicate the business wasDid your assessment indicate the business was
likely to be profitable?likely to be profitable?
– Is it sufficiently attractive to proceed with theIs it sufficiently attractive to proceed with the
development of a complete business plan?development of a complete business plan?
106. Any comments?Any comments?
Thanks for participationThanks for participation
If you need any help, feel free to send yourIf you need any help, feel free to send your
queries/questions through:queries/questions through:
Consulting Group for Development, CGDConsulting Group for Development, CGD
By: Khaled AyeshBy: Khaled Ayesh
Chief Technical Advisor and Team LeaderChief Technical Advisor and Team Leader
Email:Email: k.ayesh@hotmail.comk.ayesh@hotmail.com
Jawwal: +972-599-689118Jawwal: +972-599-689118
Editor's Notes
The feasibility study examines market conditions and defines the conditions by which a demand for the product must exist. The study then summarizes these conditions by projecting a level of expected revenues that could (not should nor would) be owned by the business.
The study must also provide a fairly concrete estimate of the costs associated with operating the business. These costs are divided into two separate areas. First of all, a description of the production process must be developed including investment (fixed) and
operating costs. Investment costs include the plant and equipment necessary to produce the product. Operating costs include (but are not limited to) the raw material purchases required to produce the product, the labor required to operate and maintain the equipment, and the overhead required to keep the plant operating on an efficient basis.
Once these two areas are developed, the profitability of the enterprise can be determined.
The determination of the market is the most difficult and time consuming phase of the feasibility study. There are seven distinct areas that should be examined in this phase. Each of these will be analyzed in turn.
The first step in developing the marketing study portion of the feasibility study is to determine the consumption patterns of your producers. In attempting to determine the current consumption of the product and the recent trends of that consumption, many sources may be available. First of all look at any industry sources or associations that may have tracked consumption over the past few years. In some cases, the government can assist. For example, the Economic Research Service tracks the consumption of many food items. Finally, you may be able to get some data from retail outlets, particularly if you are planning on supplying product to them. Grocery store owners and manager, for example, may be able to tell you how the sales of salsa has been trading through this outlet over the past few months.
You also need to determine what type of product the customer is buying and how that product is being packaged. If you are interested in food processing, visit local grocery stores and talk to the owners and managers. You may also just stand in an aisle and watch what sizes people are buying of a particular product.
Determining the quality level of a customer’s purchase is more difficult. While some quality can be measured by the brands that certain people choose. However, you also need to determine who is purchasing product with either a perceived higher quality or lower quality. The demographics of these buyers is extremely important to capture and may either not be available from industry or government sources or may be misleading. For example, the American Bowling Association states that the average bowler has an annual income of $60,000, is married, and may or may not have children at home. However, a specific location may have a tremendous demand for a bowling facility even though very few people in the community earn $60,000 per year. In a case such as this, you may need to employ survey or interview tactics to determine exactly what a localized or regionalized demand is.
The other factor that you need to account for with consumption demographics is whether the population that is most likely to demand your product is either growing or shrinking. If this population is growing, then there may be additional opportunities to develop new markets. If this population is shrinking, then it may be much more difficult to acquire market share from other firms.
You also need to examine the market in which the product is currently sold. First of all, what is the current structure of the market. How many firms are selling substitutes or alternatives to your product(s)? How large are these firms? Who are they? Are they primarily chair stores, mom and pop operations, speciality shops, etc.?
One major concern to the new entrance to a market place is the reaction of the existing firms? Will the existing firms institute price was other intensive marketing strategies such as enhanced promotional activities?
Another point to consider in the strength of the firm in the face of competition with other existing firms or in competition with newer entrance into the market. The major concern with this scenario is whether the firm has the working capital necessary to withstand a price war.
Another concern faces the firm that expects to increase its market share over time. There may be substantial costs incurred from market expansion activities and the firm must decide whether the revenues that are realized from market expansion may cover these costs.
Finally, the firm must examine the markets it hopes to serve (particularly the location of these markets). If the firm’s target market consists of customers that are either local or live within a fairly small region, the firm maybe able to employ a relatively simple marketing strategy. However, if the firm plans to target customers on either a national or international basis, then a much different and probably much more complicated and expensive strategy must be employed. The firm which seeks to serve these larger markets must carefully analyze the costs that will be required to satisfy the needs of these customers. The firm should also be aware of any regulations that may be in effect when shipping across state or national borders. There may also be substantial costs in complying with these regulations.
Another major factor which the firm should address in the feasibility study is the distribution system that it will utilize in getting its product to its customers. If the business is to deal solely with a retail storefront where customers will come in and pickup their purchases, then the distribution system is probably not a concern. However, with any other type of operation, a distribution system may become a necessity.
The first question that must be answered is whether the firm will need to provide delivery services. If the firm does need to provide those services, will it need to purchase delivery trucks and what delivery schedules will need to be implemented? Also, would it be more economical to purchase or lease the equipment? Both of these options have advantages and disadvantages. While purchasing a fleet of trucks does create an asset for the company, the company may end up with a lot of old trucks. Whose repair costs may be quite high. While an asset is not created in a leasing arrangement, older trucks can be turned in for newer ones on a fairly regular basis and should keep repair costs to a
minimum. If the firm needs to deliver its product to customers and does not want to maintain a fleet of trucks and drivers, There are many types of common carriers and each of these have distinct advantages and disadvantages. The firm will need to identify the one(s) that has the most efficient and cost effective feature that best fit the company’s distribution plan.
Once the final product or service has been decided upon, the question arises as to how that product or service will be introduced to the marketplace. There are many marketing and promotional strategies that can be used to accomplish this and the business owner must decide which will be the most effective given budgetary constraints.
One strategy that may be applicable to some businesses is to market the product under another business’s identity. For example, some apple butter manufacturers will put a specialty store’s label on their product and let the specialty store market the product to the final consumer.
However, each firm must decide what strategy will attract and retain buyers. If you are marketing your product to WalMart, a low price is the primary concern. Other buyers, particularly final consumers, may be willing to sacrifice low prices in favor of an effective marketing campaign or superb customer service.
In some industries (e.g., the pet supply industry), the product manufacturer must work through a buyer or broken who then markets the product to retail outlets. If this is the marketing avenue that a firm has decided to take, then there are several concerns which must be addressed. Will the buyers be working for large brokerage houses or will they be operating as more or less independent businesspeople? Also, you must determine where the buyers are located and the geographic area that they serve. This is extremely important if the buyer must handle the product before it is shipped to the retail outlet. In this case, you will be required to make some type of shipping arrangements to get the product to the buyer.
Product specifications are also very important to buyers. Their reputation depends on the products that they market to their customers. Therefore, any product that they handle must meet production and quality specifications or they cannot afford to sell your product.
Next, have the buyers expressed an interest in your product? Remember that these buyers are in the industry market every day and should have a good perception of what will and will not sell. If the buyer does not have an interest in marketing your product, there may be a good reason and you need to find out what that reason is.
To protect yourself, you need to determine the types of purchasing commitments that buyers are willing to make. Will the buyer be able to make a large enough commitment so that you can manufacture a large enough volume of product that would be profitable? If not, you will either need to find another buyer or adjust your pricing strategies.
The next question that you need to answer concerns the reliability of the buyers that your are dealing with. Most buyers are extremely scrupulous in their dealings with manufacturers. However, as with any type of position, there are some that are not interested in anything except making money for themselves and will resort to any means to accomplish that goal. You want to work with a buyer that will work for himself and for you.
Finally, the firm must carefully analyze the payment schedules that will be encountered with the broker. Will the broker pay for the merchandise upon his or her receipt of the merchandise or will the merchandise be paid for when the broken receives payment from the retailer. The latter situation could have a dramatic effect on the firm’s cash flow.
Whether the firm is planning on marketing its products or services to buyers, retail outlets, or the final consumer, it must decide on its selling strategy and arrangements. While the rest of this section will focus primarily on an outside sales force, the same types of questions need to be answered for most other types of selling arrangements. In fact, the first question that needs to be answered deals with the type of selling services that you are going to offer. Will you need an outside sales force or will people in the manufacturing or sales facility suffice? In this same line, will you need to go through a buyer or broker as in the pet supply industry? If you do decide to go through a buyer, who is going to be responsible for staying in touch with the buyer and making sure that the buyer’s needs are continually and consistently met.
If you do employ a sales force, you must determine how many sales people it will require to effectively and efficiently service your market. There is no rule of thumb to determine this number since it depends on the type of customers you are targeting, the industry you are servicing, etc. It has been said that effective salespeople are the most coveted people in business. In many cases, product or services cannot be sold without salespersons. As such, you must provide a compensation plan that not only rewards them, but also provides an incentive for them to increase performance.
As you develop a sales force, you must continually pay attention to the method that these people will use to market your product or services. Will they make appointments for sales calls to individual companies, make door-to-do calls to sell to individual customers, or use telemarketing methods. All of these methods have advantages and disadvantages, but it is important to remember that they all have costs that must be built into the marketing budget and incorporated into the price. Advantages, disadvantages, and costs are factors to consider when you choose a sales method(s) over others.
One of the most important marketing activities that you will undertake is setting a price for your products or services. Remember that the price must be high enough to cover the costs of production and provide a return to the entrepreneur, but must also be low enough to entice your customers to purchase the product or service.
One of the most important factors to consider in the setting of prices is the level of production. As we will see in the following slides, production costs per unit can vary greatly with the level of production. Raw input prices may be lower when purchasing large quantities or the capital equipment costs per unit will be higher when producing small quantities of product.
While your production costs, marketing costs, required return for the entrepreneur, and market demand conditions will be the ultimate factors in setting the price, there are indicators that can help you to keep the price within industry bounds. These include the past prices of the industry, current price trends, buyer advice and expectations, consumer expectations and preferences, and the quality level of substitutes or complements.
We now move from the marketing portion of the feasibility study to the production portion. The production process is divided into five separate functions. The first function is the supply of raw materials that are available to the business for the manufacture of finished products. There are several basic questions that must be asked with regard to raw material supply. First is the raw material available in a sufficient supply and of the required quality to produce the product. Also, you must investigate the availability of future supplies of the raw product. How are current and future regulations going to affect quantity, quality, and price?
When analyzing the proper facility in which to produce the product, you should first determine the minimum size production facility that is required to make the enterprise economically feasible. This provides an indication of the level of marketing activity that must occur in order for the enterprise to be profitable. While planning for future expansion is certainly a concern, you don’t want to build a facility that is certain to overload your market niche.
There are two types of funds that must be secured in order to produce your products or services. The first to be considered is the need for investment capital that will be used to construct or purchase the manufacturing facility, retail outlets, or office building and to purchase the equipment required to produce the product. First, you must determine the level of funds that you will need to accomplish these tasks. Then, you must determine what sources are available to provide you with the funds. These sources may include personal savings, government secured or direct loans, normal financial institution loans, sales of equities, or bringing in additional investors. When examining these sources and determining the best option for your enterprise, you must be sure to consider the costs involved with each option and determine what restriction will be placed on any source of capital monies.
Operational costs are those costs which are required to produce the product or service. These costs can take many forms. Wage rates, management and overhead costs, raw material costs, utility expenses, and fixed operational costs such as depreciation and insurance all have a great impact on the level of operational costs that the firm must face. Once these costs are assembled, they should be broken down into a per unit basis. This is necessary to help establish a price for the product.
Once the revenues and costs of the enterprise are estimated, then the potential profitability of the enterprise can be analyzed. Profitability is simply the measure of revenues minus expenses. There are two ways in which profitability can be measured.
Tax profit is revenues minus expenses. This is the amount that you pay taxes on and is the only amount that your accountant is interested in. However, there is another type of profit that is more accurate in measuring the success of the enterprise. This measure is called economic profit and classifies the required return of the business to the entrepreneur as a necessary business cost rather than as a profit (the way that the tax profit measures the return to the entrepreneur). This means that as the breakeven point of the business is measured, the required return to the entrepreneur is included in the breakeven level of the business. If the required return is not met, then the firm may pay taxes on accounting profits, but will experience an economic loss.
There are several ways to show either type of profit to the entrepreneur or any type of analyst that may be looking at the statements. The first is a breakeven analysis that may show the level of production (and by implication, marketing) that must occur for the firm to break even (revenues just cover costs) or it may show the price that must occur for the firm to break even given a level of production and marketing.
Another method that can demonstrate a measure of profitability is a sensitivity analysis. The sensitivity analysis can introduce a measure for risk into the feasibility study by showing the effect of different price and quantity combinations on profit.
Finally, one of the most important factors to the ongoing operation of the firm is the level of working capital that the firm is able to maintain over a specified time period. Working capital is simply defined as the cash that the firm is able to use to meet its day-to-day expenses. If the firm can’t meet its daily cash obligations, then vendors will cut off credit, employees will not show up for work, etc. The best method of showing the level of working capital for the time period in question is the cash flow statement.
Labor is a major concern for any business. While determining the number of employees that it will take to operate the production facility may seem obvious, what may not be as obvious are the factors which must be present in order to have an effective and efficient labor force. You must be aware of any of the special skills that should be possessed by your workers. You must determine whether local workers possess these skills or if they must be trained. Also, you should also remember that the local published unemployment rate may not be a good indicator of the needed labor force.
Another source of concern for a business owner is from what source will management and technical personnel be obtained. While quality personnel to fill these tasks are costly in any circumstances, these costs could be substantially higher if these personnel must be relocated to the production facility.
2How to Obtain a Differentiation Advantage (cont.)
Retailing and Airlines: Other examples in two domains (cont.)
Airlines
•Southwest Airline says, “low prices lead to freedom,” “airline with personality,”
“Click’n Save,” the “fun factor”—Differentiate on cost and fun ambiance
•Midwest Express Airline says, “the best care in the air,” “high-quality travel experience,”
“The best airline in the U.S.” (7 consecutive years), “Most comfortable coach
seat” (10 consecutive years); typical meal: Filet mignon with lobster, a roll with butter,
spinach, mandarin salad, and chocolate banana-split cake—Differentiate on prestige,
comfort
•United, US Airways, Delta, American Airlines, etc. says more flights to . . ., more
schedule flexibility, and if you want low cost you will need to be flexible on your
schedule—Mixed
For example, Delta’s Fan Fares offers travel bargains to cities hosting special sports
events, concerts, exhibitions, etc., but travel is restricted to this coming weekend. United
offers various “specials” from E-Fares, last minute fares “priced to go,” etc. Finally,
American Airlines offers “AAdvantage Net SAAver Awards.” Like their rivals, these are
next weekend travel for either fewer miles than normally required or for lower fare and
“must be purchased by Friday.”
Ask
Assume that you were placed in one of the above airlines’ jets, but all company logos and
emblems were removed. Would be able to tell whether you were seated in a United,
American, or Delta Airlines aircraft?
The External Environment (cont.)
Where do firms find growth in poor economic times?
Example: Financial Services Industry (Bank of America and
NationsBank) (cont.)
Target Growing Minority Market
Expansion into areas where minority population is growing the fastest:
•Product development: SafePay, which allows immigrants, specifically Latin Americans,
to send cash back home. Competes with Monygram and Western Union.
•Targeted Marketing I: Leverage outlets like Univision and Telemundo to reach Latin
American population
•Targeted Marketing II: Install Spanish-language option ATMs in all key markets
•Diversity hiring strategy: Aggressively hire a diverse management-level workforce in
order to better reflect the customer base
•Customer Service I: Multilingual customer service call centers and branch personnel
•Consumer Service II: Multilingual websites
Punch Line
Bank of America is betting on the demographic changes to generate much needed revenue
growth.
Industry Environment
Can firms anticipate new entrants to the market? (Grocery Retailing)
Example 1: Wal-Mart
Question
How do we (Wal-Mart) leverage our strengths (fast turnover of goods, low-cost volume
buying, etc.) to increase traffic and volume at our stores? In 2000 U.S. grocery sales grew
by 3.4%, reaching $570 billion.
Answer
•Create and expand shelf space for groceries and dry good products.
•Expand Supercenter Format to leverage additional shelf space: in 2001, grocery sales
accounted for $17.1 billion in sales or 30% of total sales:
o First Supercenter store opened in 1988; by 2000 Wal-Mart had 721 Supercenters
o Supercenter openings consist of 60%-70% of new store openings within Wal-Mart
o Wal-Mart projects 1,400 Supercenters by 2005
Fast Forward
What share of the grocery market will Wal-Mart control in 2010?
Five Forces Model of Competition
Can firms anticipate new entrants to the market? (Grocery Retailing)
Example 2: Traditional Supermarkets
Question
Given the low margins and relatively low growth of this industry, should we (traditional
supermarkets) expect new entrants into our domain? In 2000 U.S. grocery sales grew by
3.4%, reaching $570 billion.
Answer
No new entrants are likely. Thus prepare for continued industry consolidation.
Specific Case
Winn Dixie (now known as WD) is a good example. It has over 1,000 stores in 14 states,
primarily in the Southeast, a stronghold for Wal-Mart. WD has responded to Wal-Mart’s
challenge by remodeling its stores (over 60% in the franchise), closing unprofitable stores
(112 stores in 2001) and other manufacturing / distribution centers, taking a $522 million
restructuring charge.
Strategic Reaction I
Crank up M&A activity to gain economies of scale and lower its cost structure:
•In 2000 WD acquired the Gooding’s Markets chain in Orlando.
•In 2001 WD acquired 68 stores of Mississippi-based Jitney Jungle.
(Continued on next slide.)
Five Forces Model of Competition (cont.)
Can firms anticipate new entrants to the market? (Grocery Retailing)
Example 2: Traditional Supermarkets (cont.)
Strategic Reaction II
Expand private label items: WD brand items carry higher profit margins than comparable
national brands. Fifty-one percent of buying public purchase private label brands “every
time” or “fairly often” when they shop. WD can leverage this trend. For example, its WD
Chek soda is a market leader in many of WD’s core markets.
Fast Forward
Will WD still be in existence as an independent company in 2010?