CH 3.pptx

Chapter 3 Opportunity recognition and evaluation Learning outcomes Understand the foundations for opportunity evaluation Explain the role of cognitive biases and heuristics in opportunity evaluation Understand the different criteria used by venture capitalists to evaluate new venture pr...

Chapter 3 Opportunity recognition and evaluation Learning outcomes Understand the foundations for opportunity evaluation Explain the role of cognitive biases and heuristics in opportunity evaluation Understand the different criteria used by venture capitalists to evaluate new venture proposals Identify the characteristics of successful products and services Determine how new ideas can be analysed to filter out those that are obviously not feasible or marketable Assess the viability of product and service ideas Develop and implement a screening guide for establishing which product or service ideas to pursue. Introduction Evaluation stage is the most difficult Opportunities will be tested (decide is it an idea or a truly viable business opportunity) How do entrepreneurs do this? They need knowledge of the market they want to serve 3.1 Foundations of opportunity recognition and evaluation Difficult task Viable business opportunity: ‘a perceived means of generating economic value that has not previously been explored and [is] not currently being exploited by others and meets a need or desire’ Three central characteristics: Potential economic value Newness Perceived desirability When developing a viable business opportunity, the entrepreneur must use his or her cognitive abilities and develop objectivity to recognise and deal with risks 3.1 Foundations of opportunity recognition and evaluation (cont.) 3.1.1 The cognitive approach to opportunity recognition and evaluation Cognitive approach: Deals with the entrepreneur’s preferred way of gathering, processing and evaluating information Opportunities come from complex patterns of changing conditions in technology, the external environment (economical, political, social and demographic) and the entrepreneur’s personal situation The entrepreneur needs cognitive skills to gather, process, evaluate and use the information from these changing conditions to recognise and evaluate viable opportunities 3.1 Foundations of opportunity recognition and evaluation (cont.) 3.1.2 The role of cognitive biases and heuristics in opportunity evaluation Entrepreneurs tend to show systematic cognitive biases and overestimate their chances of success Cognitive biases: Common types of mental shortcuts used to make judgements about opportunities and the business Entrepreneurs who believe that they can predict how well the business will do, and perceive a low probability of failure, are likely to view a new idea as an opportunity that is feasible and worth considering Heuristics: Simplifying the conditions individuals use to make decisions, particularly in uncertain and complex conditions Entrepreneurs use heuristics more extensively in their decision-making than managers in large organisations Heuristics or shortcuts can be efficient because they aid judgements without high information-processing costs The biases of overconfidence, planning fallacy, belief in the law of small numbers, and an illusion of control directly influence risk perception and the decision to start a business venture 3.1 Foundations of opportunity recognition and evaluation (cont.) 3.1.2.1 Risk perception The subjective judgement of the amount of risk inherent in a situation Differs between entrepreneurs and non-entrepreneurs May explain why some people become entrepreneurs and others do not When an entrepreneur pursues an opportunity that a non- entrepreneur would ignore or neglect, it may be due to the entrepreneur’s perception of a positive outcome rather than a difference in the predisposition towards risk 3.1 Foundations of opportunity recognition and evaluation (cont.) 3.1.2.2 Overconfidence The failure to acknowledge or recognise the limits of personal knowledge, skills and experience Leads to overestimation of one’s certainty regarding facts 3.1 Foundations of opportunity recognition and evaluation (cont.) 3.1.2.3 Planning fallacy Occurs when there are strong tendencies to underestimate the amount of time needed to complete a given project, the amount of resources needed, or the amount of work that can be achieved in a given time Operates strongly in situations that are unique, filled with doubts, and where there is a necessity for a focus on the future Entrepreneurs need to forecast future prices of goods and resources and use intuitive judgement to gauge market potential These forecasts of future outcomes are often anchored on plans and scenarios of success rather than on past results, and may be overly optimistic 3.1 Foundations of opportunity recognition and evaluation (cont.) 3.1.2.4 Belief in the law of small numbers Occurs when an entrepreneur uses a small sample of information to draw firm conclusions A small sample usually lacks predictive validity Entrepreneurs do not use large random samples because these are rarely obtainable and they do not have the resources for systematic data gathering A strong belief in the law of small numbers creates a more than usually optimistic view of the business enterprise, and thus lower perceived risk This can lead to business failure 3.1 Foundations of opportunity recognition and evaluation (cont.) 3.1.2.5 The danger of using small samples Entrepreneur uses a limited number of informational inputs (a small sample of information) to draw firm conclusions May only ask friends or family who will give positive input If pitch idea to wrong target market, the business will fail 3.1 Foundations of opportunity recognition and evaluation (cont.) 3.1.2.6 The illusion of control Occurs when the entrepreneur overemphasises the degree to which their skills can increase performance in situations where chance plays a great part and skill is not essentially the deciding factor Occurs when entrepreneurs believe that they can control largely uncontrollable events and that they can accurately predict the outcome of the events Entrepreneurs with this bias have a higher expectancy of personal success They usually think that their skills are superior to those of others Persists because: When individuals are encouraged to take charge of their environment, the resulting sense of competence may lead to a sense of power over the uncontrollable Skill and chance factors are strongly connected and it is generally difficult to discriminate between chance and skill elements Entrepreneurs should guard against heuristic and conceptual biases as they may impact on their ability to identify the best viable business opportunity 3.2 Venture capitalists’ evaluation criteria for new ventures Entrepreneurs tend to evaluate initial opportunities and apply for funding prior to opportunity exploitation Venture capitalists usually evaluate an investment opportunity after the entrepreneur has decided which opportunities to exploit 3.2 Venture capitalists’ evaluation criteria for new ventures (cont.) When evaluating business opportunities, first-time entrepreneurs use these criteria: Potential growth in the target market Demonstrated market acceptance The likelihood of a ten times return on assets in the next five to ten years The entrepreneur’s ability to react well to risk But investors look for the following when considering new venture proposals: Experience and a good management team Proprietary product or service Marketability Personal commitment and involvement of the entrepreneur Openness and honesty Knowledge and experience Realistic financials Return on investment (ROI) Intellectual property 3.3 Opportunity assessment and screening 3.3.1 The characteristics of successful product or service ideas The right product or service can propel your business to fortune, while the wrong product or service can even make your most exhaustive efforts unprofitable Characteristics or attributes of the potentially excellent product or service: The new product or service should fulfil a need or want The new product or service should have either a niche-market appeal or a mass-market appeal The product or service must render an income and profit The customer should replenish or repurchase the product or service on a regular basis There should be compatibility with existing attitudes and beliefs The product or service should be simple so that the buyer will understand it It should be easy to communicate the results or benefits of the new product or service to potential users The product or service should be made available to potential customers for a trial period The product or service should be readily available once the buyer decides to make the purchase 3.3 Opportunity assessment and screening (cont.) 3.3.2 Feasibility of products or services A second screening test should be of the feasibility of the product or service The technical requirements for producing a product or service should be identified and evaluated as well as the technical skills of the entrepreneur or the venture team in relation to the product or service 3.3.3 Marketability The test for marketability can be divided into four categories: Customers Competitors Suppliers Marketing of the product or service 3.3 Opportunity assessment and screening (cont.) 3.3.4 The entrepreneur and entrepreneurial team Include the following in any evaluation of business ideas or opportunities: Personality and personal preferences Skills Traits and attributes Relevant experience Synergy Exit plans (harvesting) The more experience, education and skills the entrepreneur and entrepreneurial team have and the higher the synergy between them, the greater the probability of success 3.3 Opportunity assessment and screening (cont.) 3.3.5 Resources The main resources for new ventures include: Financial Social Human Physical Technological Organisational Aspects to include when you evaluate the resources you need for each idea or opportunity: Accessibility of resources Optimising resources Sustainable advantage Type and nature of industry Capital requirements 3.4 The idea-screening guide An instrument that entrepreneurs can use to choose between different ideas and find the one or two that they can pursue First step in developing the screening guide: Establish the criteria to be used These could differ for each entrepreneur and even for various products or services Then give a weighting (1 to 10) to determine importance Scales could be qualitative or quantitative Qualitative measurement: Describes qualities or characteristics of the aspects that are measured Quantitative measurement: Addresses the ‘what’ or ‘how many’ aspects of a question and is data that can either be counted or compared on a numeric scale Because the assigning of weightings and scores is very subjective, entrepreneurs could easily abuse it by giving higher weightings or scores to a predetermined, favoured project or idea