Venture opportunity screening

noreply@blogspirit.com (Russell Davison) — Tue, 31 Oct 2006 13:53:44 +0100

I originally wrote this article, “Venture opportunity screening” in November 2003.

An opportunity has been screened for the export of handcrafted goods from Singapore and the venture appears attractive. New technology and new business processes are used by the venture to provide small retailers of antiques clocks, gifts, handicrafts and home décor with handcrafted goods from Asia by 15 Kg air parcels, delivered in 7 days. The average value of each consignment is S$800 and credit card payment, with order, gives UK retailers 4 weeks to 7 weeks credit with the card company, whilst the venture is assured payment by VISA and Mastercard monthly. Direct mail and telemarketing are used to create and penetrate the market and bilingual staff are close to Asian suppliers and possess superior customer service skills.

A quick screening of the new venture identifies the potential market of small UK retailers and the gross margin is estimated to be 50%. The competitive advantages identified are identified as low fixed costs, control over costs, location and people advantages. The value created is 10% profit after tax and an IPO exit mechanism is foreseen after 3 years.

The opportunity concept takes advantage of the recent halving of prices for Transpacific freight and international call costs in the last couple of years and new techniques for receiving assured payment from international customers. The new venture strategy is to penetrate 10% of the market of UK retailers who sell antiques, clocks, gifts, handicrafts and home décor.

The market profile is of reachable customers who seek product variety. The competition is fragmented and market sizes are estimated as S$20M, S$80M and S$100M in the UK, US and Europe, respectively. The venture economics profile is of low capital requirements and favourable free cash flow characteristics. The time to break even is 15 months. The IPO exit mechanism is estimated to harvest S$2M for the founder in three years. The venture provides a good fit with the goals of the founder and a bilingual team will be created within the first 2 years of operation. Strategic differentiation from the competition is by superior customer service, use of technology, pricing and product quality. The market entry strategy is to create customer awareness that it is now possible to quickly receive quality Asian goods in small quantities at a competitive price from the newly formed company.

The reasons for making the company believe that the idea is an opportunity are concerned with the main components of customer need, premium pricing, underlying value creation proposition, market niche and product mix. Small UK retailers need a variety of high value products to differentiate themselves from the larger UK retailers and to compensate for their lower lever of sales activity. They are required to purchase goods in modest volumes from wholesalers and UK manufacturers to realize wholesale discounts and are prepared to pay a premium to reduce their investment in inventory. The new venture has an underlying value creation proposition of supplying UK retailers direct in more frequent, smaller volumes to reduce inventory and to take advantage of lower freight costs and international telemarketing call costs. The marker niche of UK retailers selling antiques, clocks, gifts, handicrafts and home décor is chosen to avoid dealing with the end-user consumer, whose average order value would be unlikely to exceed S$100, unacceptably increasing the administration costs. The product mix is carefully chosen to include only those items whose sales price to weight ratio is high, to ensure low air parcel distribution costs (as a percentage of the selling price). There are currently no substitutes for the marketing mix of premium priced products promoted by direct sales and telemarketing from Singapore.

The new venture seeks to improve upon the existing value chain by eliminating the warehouses of UK wholesalers. This is achieved by employing the ‘just in time' distribution technique that has been successfully used within manufacturing industries for the last 20 years to reduce inventory costs. The product strengths are the uniqueness of Asian designs, handcrafted features, unfamiliar materials, unusual colours, peculiar symbology and aesthetics. The product weaknesses are unproven demand, freight costs, fumigation certification for wooden items, humidity control requirements and the non-uniformity of designs. Existing competitors in the industry have been assessed. Direct mail costs are estimated to be S$1,000 per thousand contacts, telemarketing IDD call costs are S$10 per hour and the web-host charges 1½% per transaction and S$70 per month. The distribution costs have been estimated and are 22% of sales. Value chain physical, margin and information flows have been mapped and they reveal that the suppliers benefit from high percentage margins, which are moderate in absolute dollar terms.

It's estimated that the new venture will capture ¼, 1, 2 and 5% of the market in years 1, 2, 3 and 4 of the venture. The business goal is 10 % of the market, with sales of S$2M, in 5 years. The product cost represents 36% of the sales price, gross margin is 36% of the sales price, fixed costs are 16% of the sales price and profit before tax is 12% of the sales price. Resource needs to launch the company are modest. The cash flow conversion cycle has been forecasted and a preliminary cash flow analysis has been created. The break-even chart shows that the venture needs to ship three consignments every couple of days (or 28 consignments per month) to break even.

Capital will be raised for the business in two stages, at launch and after three years of operation by way of an IPO. The launch capital of S$100,000 is to be invested by the company owner. The market capitalization for the IPO, after 3 years, is estimated to be S$2M. This is based upon forecasted earnings (net profit after tax) of S$0.1M for 2007 and S$0.2M for 2008, giving a P/E ratio of between 10 and 20. The IPO opportunity will attract investors from Singapore government agencies, institutions and individuals. The company owner intends to harvest the venture by means of selling the company via the IPO. This is estimated to occur in three years time, in January 2007. The harvest prospects are good if the forecasted growth and required margins can be achieved. The company would be source of strategic value to exporters of other products based in Singapore, or to importers based in the UK. As there are no other firms currently delivering this product and service mix, a company contemplating entry may be a logical buyer. The business asset requirements are low and, if the owner decided to exit, it would cost less than S$20,000 in lost lease deposits and depreciated fixtures, fittings, equipment and other venture launch expenditures. This amount seems reasonable, with respect to the venture's potential and risk. Expenditure after launch can be adjusted to match the level of sales activity witnessed, so as not to run out of cash before securing enough profitable customers to sustain a positive cash flow.

The strategic analysis of the competitive landscape estimates that the four competitor categories are large UK importers with warehousing, specialist UK manufacturers, UK manufacturer's brokers and internet hobbyists with no marketing who have market shares of 50%, 25%, 20% and 5%, respectively. Marketing tactics for each competitor vary. Profiles of the competition in year 2003, for price/quality and market share/profitability have been created. The main manufacture of the handcrafted products, by definition, is not subject to technological change. However, the required quality assurance, fumigation and humidity control processes involve technology that will take six months to two years to develop, implement, install and maintain. The new venture has the competitive advantage of being in close proximity to the suppliers of the goods and an additional advantage can be gained by hiring staff who speak Mandarin and Indonesia Bahasa. The new venture is also able to work with its suppliers to assure quality and meet fumigation and humidity control requirements. The new venture can be price competitive if the advantages of low fixed costs, zero/low inventory costs, low supplier costs and higher customer value (through increasing their inventory turnover) more than compensate for the new venture’s higher distribution costs of delivery by air parcel. The new venture’s marketing positioning, relative to the competition, has been chosen. UK specialist manufacturers and manufacturer's brokers are vulnerable to competitors, like the new venture, being able to offer good quality substitute handcrafted product designs from Asia. Once penetrated, this section of the market will always remain vulnerable to the new venture’s competitors and they will lose market share if the quality of the new venture’s products can be maintained. Another vulnerability of the new venture’s competitors is in the creation of awareness in UK retailers that handcrafted Asian goods can be procured direct from the new venture.

The founder's vision is to change the way many goods are exported from Singapore, by offering superior customer service and good quality products, using staff skilled in CRM and by using new business processes. The company aims to inspire its staff through leading by example, on the job training and by continual employee attendance at CRM business management training seminars and courses. The founder has many years of international business management experience with a large MNC throughout America, Asia and Europe and many years of experience in project management and engineering in Europe with various companies. He is very knowledgeable about logistics, procurement and sales and possesses the skills required for the venture's success. Additional bilingual personnel are required in Mandarin, Bahasa and English. These new staff members will be attracted to the venture after the first six months of launching the company. The founder has previously managed procurement and export of industrial products from America, Asia and Europe.

Significant assumptions are made in the screening of the new venture. It’s assumed that the sales projections are realistic and that customers will purchase the goods without first being able to touch and see them, apart from the photographs and specifications in the new venture’s catalogue. The ability to recruit local staff with good customer service skills and understanding of UK dialects, names and customs is assumed. It’s also assumed that the implementation of supplier quality assurance will be successful and that customers accept the new venture’s terms of payment. The downside consequences of invalidity to these assumptions are lost growth opportunities if sales projections prove to be unrealistic and the company could be forced to cease trading if it is found not to be possible to recruit local staff with good customer service skills and UK knowledge. If product quality cannot be controlled then customer returns and lost trade could cost several tens of thousands of dollars in refunds to the credit card companies, who demand 100% customer refund guarantees. The maximum cost of liquidation, to the founder, is less than S$80,000 and is tolerable. Bankruptcy is not tolerable by the founder for participation in this venture.

The risk of the venture is rated as medium as it is managed by financial bootstrapping and with the use of milestones. Before the IPO in three years time, the business is initially funded by the founder. The founder's investment is moderate and break even is estimated to occur in the 15^th month of trading. Bootstrapping is used between break even and the IPO listing to minimize the company's exposure to financial risk. Borrowing could be used to promote growth, but this would increase the risk. Milestones are placed along the venture's path to the IPO, as checkpoints, before further resource commitments are made. The first milestone is placed after the first six months of operations. This marks the transition of the company into leased premises with a shop front and a commitment to engage two staff before the end of the first year. The precondition for passing this milestone is that the direct mail and telemarketing campaign have generated more than one hundred positive responses or enquiries and that the receipt of the first few purchase orders is imminent. Similar milestones are placed every six months to match additional resource commitments with previous, current and future sales activities. A schedule for week-by-week action steps, during the first six months, has been created.

The value proposition can be enhanced by communicating to retailers the true cost, to them, of their currently low inventory turnovers and how the new venture company could assist them to increase their inventory turnovers, thereby reducing the amount of their capital tied up in stock. The new venture could improve their value proposition by appointing agents or distributors in the UK to penetrate the 90% of the target market that they don't envisage infiltrating by direct mail and telemarketing alone. The sequence of customer database generation, direct mailing and telemarketing batch sizes could be changed to improve the fit by focusing on a pilot study. The sequence could be changed so that 500 targeted customers are contacted four months ahead of the plan to statistically infer the likely response from 5000. Staff could be added earlier than planned to divide the tasks of CRM database creation, direct mail and telemarketing between staff and the founder. The fit could also be improved by eliminating the need for premises with a shop front for local sales. Local sales are expected to be low, so more economic business premises could be used in an out of town industrial area. The free cash flow characteristics are at their optimum with advanced payment commitment and retarded payment for logistics and resources. However, the value chain could be extended to manufacture the products ourselves. The major risk, after venture launch costs, is that the initial marketing investment of S$10,000 does not create customer awareness, enquiries and orders at the magnitude planned by the new venture. The risk/reward balance could be adjusted by increasing or decreasing the marketing investment.

Russell Davison - venture_opportunity_screen

Venture opportunity screening