Evaluating the Feasibility of Business Opportunities

Agdex#:	811
Publication Date:	06/03
Order#:	03-051
Last Reviewed:	06/03
History:	Replaces OMAFRA Factsheet Evaluating the Feasibility of Business Opportunities, Order No. 95-023
Written by:	Bill Baxter - Feasibility Analysis Program Lead/OMAFRA

Table of Contents

1. Introduction
2. The Feasibility Analysis Mindset
3. Setting Goals
4. Establishing Criteria
5. Stages of Evaluation
6. Feasibility Process
7. Writing the Business Plan
8. Financing the New Enterprise
9. Summary
10. Recommended Reading

| Top of Page |

Introduction

Feasibility Analysis is a tool business owners can use to evaluate a proposed change in a business. This change may involve developing a new product, improving an existing product, changing marketing strategy or expanding or contracting the business. One dictionary defines feasibility as "capability of being used or dealt with successfully". It is that word — successfully — that gives feasibility analysis its real value as a planning and risk management tool. In business terms, success is usually defined as some measure of profit or increased value. An entrepreneur may have other goals, such as expanding the business to allow a family member to join the firm. Even in that scenario, the expansion must provide sufficient extra income to compensate for the additional cost. If the feasibility analysis indicates that the goal may not be met, the entrepreneur can abandon the idea before investing heavily in the expansion. In other words, the feasibility analysis provides a means whereby the entrepreneur can justify, to him or her and others, why he or she will proceed with or abandon a business proposal.

A change in business always involves some degree of risk. The chance that an investment may be made and that sufficient added income may not materialize can leave an entrepreneur unable to meet payments, or unable to reach the goals that were originally set out for the business. A thorough feasibility analysis identifies the factors that contribute to the risk, the probability that these factors will happen and the effect they will have on the proposed business opportunity and on the entrepreneur. This analysis allows the entrepreneur to develop an advance plan to mitigate the risk factors and to establish appropriate contingencies, such as insurance or alternate markets.

The Feasibility Analysis Mindset

A feasibility analysis is conducted in several stages. The more complex the business proposal, the more stages of analysis are needed. At the end of each stage, the business planner is required to do two things:

• set criteria by which the project will or will not proceed to the next planning phase
• make a decision to proceed to the next stage or to abandon the idea at this point 1

| Top of Page |

¹Some of the information in this Factsheet is based on principles outlined in the Stage-Gate® process. See Robert G. Cooper, Winning at New Products, Third Edition, Perseus publishing, Cambridge Ma, 2001. Stage-Gate ™ is a registered trademark of RG Cooper and Associates Consultants Inc., Oakville ON.

These criteria will depend on the goals set down at the beginning. For example: if the entrepreneur sets a goal for this venture to increase profit by $50,000 per year, the criteria may be that profit must increase by at least $25,000, or it is not worth proceeding. The market assessment then shows the business is unlikely to net more than $10,000 extra from added sales. So, the entrepreneur decides to abandon the project, looking for a different opportunity.

Setting Goals

Often, a single goal is set against which the performance expectations of a new enterprise may be measured. At times, a long-term goal and 1 or 2 shorter-term goals by which start-up performance may be measured are set. These goals should conform to the S.M.A.R.T. model, (Specific, Measurable, Achievable, Realistic, Timely) as the decision to proceed or abandon will be based on the ability of the proposed enterprise to actually reach these goals.

The ability to remain objective is imperative in the setting of goals and throughout the feasibility study. Every step in the process is designed to move the entrepreneur closer to a goal. It is important the goal be clear and remains static and that the entrepreneur is able to clearly define whether an activity will meet the objective.

In a feasibility analysis, it is necessary to have 2 sets of goals. The first set defines what the business is expected to achieve in a given time period. But if the analysis shows it may not reach that goal, at what point does the entrepreneur decide to abandon the plan? A second goal defines the minimum acceptable criteria that must exist in order to proceed with the project.

For example, the entrepreneur may decide a new enterprise should gross $50,000 in its first year of production, $125,000 in year 2 and $200,000 in year 3. At these rates of return, it would be expected to lose $50,000 in year 1, break even in year 2 and net $50,000 in year 3.

| Top of Page |

These financial goals would be reached if the venture could sell 10,000, 25,000 and 50,000 widgets at $5 each respectively in the first 3 years of operation. These are the production goals for the enterprise.

The above goals are specific, measurable and timely. The study will reveal whether they are realistic and achievable.

Establishing Criteria

The last activity in each stage of analysis is to set the criteria against which the results of the analysis will be judged. These criteria are based on the goals that the entrepreneur has set for the project. This allows the entrepreneur to decide whether to proceed to examine the idea further or to abandon the idea altogether. In the example above, the entrepreneur may decide that returns of $25,000 in year 1, $75,000 in year 2 and break even at $150,000 in year 3 is tolerable. These are the minimum acceptable criteria against which the enterprise is evaluated. If the planning process fails to justify these results, the entrepreneur will abandon the project. Minimum marketing criteria would be any combination of sales volume and price that would result in a lower gross income. At this point, the entrepreneur should reexaminethe methods that were used to obtain the results. Here are some sample questions to ask in assessing the results.

• Was the technique used appropriate for getting accurate results?
• Did the people surveyed accurately represent the customer base?
• Do these cost figures represent accurately the cost of production and distribution?

Decision to "Proceed"or "Abandon"

By establishing "minimum acceptable" criteria in each stage, the entrepreneur has made the decision-making activity easier. Either the project meets the minimum criteria or it does not. If it does not, the decision to abandon the project is made. If the project meets or exceeds the criteria, the entrepreneur will proceed to analyse the next stage. This is where the ability to remain focused and objective reaches its peak of importance. If a "maybe" enters the decision, the goal or the information is not defined well enough. It may be necessary at this point to re-define the goals and start over or to do the activity more thoroughly.

| Top of Page |

Stages of Evaluation

Feasibility Analysis is a practical process. It forces the entrepreneur to examine the real circumstances that the venture is likely to encounter. This is where the entrepreneur's understanding of business management is challenged. The more thoroughly he or she can examine the various business factors, the more reliable will be the conclusions of the feasibility study.

Stages of Feasibility Analysis

1. Examine the Idea
2. Examine the Management Capabilities of the entrepreneur
3. Examine the Technical Capabilities of the organization
4. Examine the Marketing Potential for the product or service
5. Examine the Cost and Financing needs
   

These stages are the same as the components of the business plan, so the information gathered during the feasibility study can be transferred directly to the business plan, resulting in a more effective and accurate business plan.

Feasibility Process

The flow chart on the next page illustrates a process for conducting a feasibility analysis. It can be altered according to the complexity of the project and the amount of risk involved, but the process is adaptable to any business development situation.

Figure 1. Feasibility Process Flow Chart

| Top of Page |

The Idea

Every idea has some merit and some drawbacks. At this stage, the entrepreneur will concentrate mostly on the obvious benefits and limitations.

• Does the idea appear to meet my goals?
• What factors could prevent it from being successful?
• Are my family and I prepared to make the sacrifices necessary to make this project work?

It is difficult to remain totally objective through this stage. A healthy level of skepticism is required to allow the entrepreneur to discover the warning signs and pitfalls that lie in wait to sabotage any good idea.

Criteria considerations:

• Are the benefits from this idea sufficient to justify the cost as measured in terms of finance, personal stress and family sacrifice?
• What is the minimum ratio of benefits to cost that I am willing to tolerate?

Management Capabilities

Management experts agree that the most important factor for success by far in any business is the management team that makes the decisions, yet it is the factor most often overlooked in determining the feasibility of a venture. The entrepreneur can take the opportunity at the beginning of a feasibility study to answer 4 questions about him or herself:

What management skills do I lack in order to have effective control over this enterprise?

Am I able to acquire or hire these skills?

What effect will my involvement in this project have on my family and my other enterprises?

Will this new enterprise produce the lifestyle that I want for my family and myself?

There are several entrepreneurial skills evaluation exercises available on the marketplace. Western Economic Diversification Canada has an on-line quiz called, "Am I an Entrepreneur" on their website.

| Top of Page |

Criteria considerations:

• What specific skills do I need to develop or hire?
• At what point does the lack of available skills become an obstacle?
• On a scale of ten, how much support do I have from my family for pursuing this opportunity.

Technical Realities

An assessment of the idea must consider the question, "Can it be done?" This question must be answered considering whether the entrepreneur and the organization have the capability of producing the product and taking it to the marketplace. Specific questions might include:

• Do we have access to the required raw materials
• What technology, equipment and processes are required?
• Do we understand the required technology, equipment and processes?
• Does it appear that the production system is workable and affordable?

Criteria considerations:

• How much time can I devote to this project at the expense of my other enterprises?
• How much change am I prepared to make to accommodate this project?
• At what point do I decide it is not worth the effort?

Market Realities

The success of any venture depends on the ability to get the right product into the right marketplace at the right time and the right price. The marketing world is littered with failed products that could have been successful if the formula for success had been different. Effective market research is the most important activity that an entrepreneur can undertake to reduce risk.

Key areas to research

• Features and benefits of the product or service Target market (Who is most likely to buy?)
• Distribution options (Best way to reach the target buyers)
• Market demand (How many possible buyers, what volume and price?)
• Competition (What products and companies compete?)
• Trends (What is the expected life of the product?)
• Expected Price (Highest, lowest and most often prices)
• Expected Sales (Volume and market conditions)

| Top of Page |

It is important to understand that the customers rule the marketplace. They alone determine whether the product will sell in sufficient numbers and price to be viable. Market research can reveal the probability of product success.

• What are the minimum values on sales volume and price needed to be viable?
• Is the potential for growth in sales adequate?
• Is this product the best option available to me?

Cost and Financial Realities

As each of the previous analyses has been conducted, the anticipated costs and expected returns have been transferred to a ledger. From this ledger 3 statements can be generated:

• Pro Forma (Projected) Income and Expense Statement
• Cash Flow Statement
• Opening Balance Sheet

These statements are essential to creating a solid business case to justify the proposed venture.

In the original goals, return on investment (ROI) might have been stated. It is possible to calculate a projected ROI. The entrepreneur is seeking answers to the following questions:

• Does the profit level meet or exceed my goals?
• Is the cost of establishment within my range of financial options?
• Will this proposal provide sufficient return on investment?
• How will this investment affect my net worth?

Criteria considerations

• Is the cost of sales acceptable relative to the product price?
• Does the venture meet or exceed the profit goals?
• Does the expected return meet or exceed the minimum acceptable level?
• Is there a better way to reach my financial goals?

| Top of Page |

Risk Realities

Investments are made in the expectation of a return to the investor. In general, the greater the return expected, the more willing the investor will be to invest. People vary in their ability and their willingness to take risks. The ability varies with the extent of the cost and the wealth or asset value of the investor. The willingness varies with the amount of those assets that the investor is willing to place at risk. These risks may be financial or social. In either case, they can have a significant effect on the entrepreneur and his or her family.

Managing risk is a function of controlling the factors that contribute to possible losses against the investment. Feasibility Analysis is a risk-management tool, because it helps the entrepreneur identify the risk factors involved in the project. Other risk management tools are those practices that contribute to consistent quality and safety of the product being sold or that contribute to a low unit cost of production.

The feasibility analyst might ask the following questions:

• What can go wrong with this project?
• Is there a way to prevent any of these from happening?
• What is the probability that any of these will factors go wrong?
• What is the probability that two or more of these will go wrong?
• What will be the effect on the project and the family if they do?
• Can the effect of these risks be reduced through insurance and at what cost?
• How able and willing is the entrepreneur to assume these risks?

Risk control is the utilization of systems that minimize the effect of a negative occurrence.

• Quality Control and Safety programs
  Reduce the risk of injury or harm to customers
• Production Efficiencies
  Competitive advantage through low cost of production
• Thorough Market Research
  Improved chance of marketplace success
• Accurate Cost Estimates
  Improve the accuracy of estimating profit and return

| Top of Page |

General insurance agents carry insurance programs covering many kinds of business risks. These come at a significant cost to the business, so if more factors can be controlled through management and production, the cost of production will be lower. OMAFRA Factsheet 00-041, Farm Business Insurance, contains an extensive list of kinds of insurance available to Ontario farmers.

Criteria Considerations:

• Do the risks involved in this venture exceed the benefits that I hope to gain?
• What specific risks do I need to avoid or control?
• Is the cost of risk abatement through prevention and insurance affordable?
• What is the maximum amount of risk that my family and I are willing to take?

Writing the Business Plan

The information that has been collected to this stage is sufficient to allow the entrepreneur to write a complete business plan. Business plan forms and electronic business plans are available wherever business books and software are sold. These may come in a variety of different formats, but all require essentially the same information. A straightforward business plan outline is suggested in OMAFRA Factsheet 99-011, Preparing Business Plans.

Financing the New Enterprise

The business plan is a key tool for obtaining financing for a new business venture, but it is not a guarantee a financial institution will lend the necessary money to finance the capital and operating costs of the enterprise. The information acquired during the feasibility study will make the business plan more attractive to investors and lending institutions. There will be one more "proceed or abandon" decision to be made at this stage. If several financing sources reject the business plan, the entrepreneur must reexamine the business case, and decide whether to proceed with the proposal. One option is to review all sections of the feasibility analysis and determine whether improvements can be made. Another is to reject the idea completely and begin to look for a better idea.

 Criteria Considerations

• How much funding do I need to operate the enterprise effectively?
• Do I need to improve the business case and keep trying?
• Does this proposal put too much at risk for my family and me?

| Top of Page |

Summary

Feasibility Analysis can be conducted on any business proposal, from growing a new variety of sweet corn to the building of a processing plant. The amount that is at risk determines the intensity and the thoroughness with which it is conducted. The quality of the information and analysis determines the accuracy of the resulting business case.

Recommended Reading

Robert G. Cooper, Winning at New Products (Third Edition), Product Development Institute Inc.,

Assessing Market Potential for Value-Added Products ISBN 1-894148-62-2. Canadian Farm Business Management Council, Ottawa.

| Top of Page |