How to Prepare Innovative Feasibility Study in transitional economy
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Technical Training and Coaching Material on How to develop a feasibility studies within transitional economies, and how to assess project feasibility and investment climate in the West Bank and Gaza Strip
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How to Prepare Innovative Feasibility Study in transitional economy
- 1. Preparing Feasibility Study By Khaled Ayesh, MBA World Bank, InfoDev-funded Business and IT Incubator, Islamic University, Gaza
- 33. Consider price elasticity of demand before changing prices
- 57. Use break even analysis to determine sales volume needed to become profitable
- 60. Value of a firm is equal to the present value of its expected cash flows
- 61. Example: Valuation of Coca Cola using DCF method
- 62. Main components of an income statement Net income Taxes Net income before taxes Total operating expenses Operating expenses Gross profit Cost of goods sold Sales
- 63. Main components of a balance sheet Liabilities and Owners’ Equity Assets
- 67. Comparative Financial Analysis: Key Ratios 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 ROE
- 69. Exercise: 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 ROA 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.
- 80. External Environmental Analysis Strategic Intent Strategic Mission The External Environment Analysis of general environment Analysis of industry environment Analysis of competitor environment The External Environment
- 89. Five Forces Model of Competition Threat of New Entrants Bargaining Power of Suppliers Bargaining Power of Buyers Threat of Substitute Products Rivalry Among Competing Firms Five Forces of Competition
Notas do Editor
- 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.
- 2 How 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?