This article was written by Mike Capsuto, SCORE Orange County Business Mentor
If you see a bandwagon, it’s too late. James Goldsmith
Another aspect of due diligence is an evaluation of a business as a “going concern”. A “going concern” is an accounting term for a business that can function without the threat of liquidation for the foreseeable future. Key factors are the product life cycle, consumer buying decisions, and competition.
Every product or service has a life cycle. The cycle can be as long as years or decades for products such as farm equipment or can be measured in months for high technology products such as smart phones. Life cycles are influenced by the economy, changes in buying habits, technology, laws and regulations. The buyer should determine what stage of the life cycle the product or service is in. Each stage has marketing and financial implications which can affect its ability a going concern.
• The Initial stage of a product or service is building the demand and establishing the market for the product. The key emphasis will be on promoting the new product and developing the right distribution channels to get the product to market. In the initial stage, additional funding will be required to market the product or service. However, there is also the risk that the market will reject the product or service.
• The Growth stage is a period of rapid growth. Sales increase as consumers become more aware of the product or service and their benefits. However, profits may not be as great as anticipated due to the need to reduce selling price and to reinvest some of the profits into marketing and promotional activities to continue growth and reduce the threat from the competition.
• The Maturity stage is the longest of the four stages. It also presents challenges. With sales reaching their peak and the market becoming saturated, it can be very difficult for businesses to maintain their profits. During this stage, businesses must look for innovative ways to make their product or service more appealing to the consumer to maintain their market share. It is necessary to determine how much time is left before it goes into the decline stage. This is similar to purchasing a used car. Has it been driven 10,000 miles or 1,000,000 miles?
• Products or services going through the Decline stage will experience a shrinking market along with falling profits. In the Decline stage inventories risk becoming obsolete and may have to be liquidated below their cost. Clients requiring your service will become difficult to find. For some businesses it will simply be a case of continuing to provide the product or service as long as it is profitable, but withdrawing it as soon as that is not the case.
Another factor is to be aware of buying into a business fueled by “fads”. Their life cycle of quick, dramatic sales powered by inflated consumer zeal and then followed by a sharp, drastic decline in consumer interest differs from the five stage product life cycle concept. The Hula Hoop, Pet Rock, and Cabbage Patch Kids were all crazes known as fads. More recently is the gourmet food truck craze which was built up from a popular television program but whose numbers have dropped significantly in the last two years due to sharp decline in consumer interest.
Wants are unlimited but the resources to satisfy those wants are limited. It is important that the purchaser of a potential business have a basic understanding of the consumer buying process in relation to the products or services being sold. This includes how consumers identify their needs, collect information, evaluate alternatives and make the purchase decision. These actions are determined by psychological and economical factors, and are influenced by environmental factors such as cultural, group, and social values.
Abraham Maslow, an American psychologist, crated a hierarchy predicated on the various needs a consumer seeks to fulfill in the purchasing decision. He proposed five levels of motivation culminating in self-actualization.
1. Biological and physiological needs - food, drink, shelter, sex, sleep, etc.
Products: Health foods, medicines, exercise equipment.
Example: Cheerios – I hear it is good for your heart.
2. Safety needs - protection from elements, security, order, law, limits, stability.
Products: Smoke detectors, insurance, seat belts, home protection alarms.
Example: Toyota – our cars are equipped with ten airbags.
1. Belonging - desire for love, friendship, group acceptance
Products: Personal grooming, religious groups, professional organizations, gangs
Example: Shriners International
4. Esteem – Fame, prestige, attention, self confidence.
Products: Clothing, hobbies, mode of transportation.
Example: BMW - - The ultimate driving machine.
5. Self-actualization – This is the top of the hierarchy. Realizing self fulfillment and potential.
Products: Education, sports, gourmet foods.
Example: U.S. Army – Be all you can be.
Maslow’s concept is useful to understanding consumer needs and wants and that a product or service promotion is consistent with the way consumers relate to that product. Supermarket firms develop value brands to meet the psychological needs of hunger and thirst. Nordstrom develops products and services for those who want have met their esteem needs. Purchasing decisions evolve as consumers move up the hierarchy. Food for survival is at the lowest tier, but by promoting it as a gourmet experience can place it at the opposite end of the spectrum.
Another concept that requires close evaluation is the marketing strategy related to the consumer involvement in selecting the company's products or services. There are four types of buying behavior:
1. Complex buying behavior occurs when the consumer is purchasing something expensive or risky, such as a personal computer. The consumer learns about the product line, is highly involved in the buying process, and perceives significant differences among brands. Marketers must differentiate their products' features from other brands.
2. Dissonance-reducing buying behavior occurs when an expensive or risky purchase is being made, but the consumer perceives no difference in brands. They may purchase the brand that offers the best price or that is the most convenient to buy. Make sure that:
• The website is easy to navigate
• Appears at the beginning of a search.
• Prices are competitive.
3. Habitual buying behavior involves low consumer involvement and little concern for brand differences. The individual buys a product out of habit such as a daily newspaper, sugar or salt.
4. Variety-seeking buying behavior is characterized by low consumer involvement but significant differences in brands. Consumers displaying this type of buying behavior often switch brands to experience variety rather than because of dissatisfaction.
Culture and social status also, impact consumer behavior. Culture is defined as our attitudes and beliefs influenced by family who may teach them what is wrong or right. These factors will influence their purchase behavior however other factors like groups of friends, or people they look up to may influence their choices of purchasing a particular product or service.
People's social role within society will also impact their purchase decision. Are they doctors, office workers, teachers or parents. The type of job may mean the need to purchase more formal clothes. Income has an impact. The lifestyle of someone who earns $250,000 would clearly be different from someone who earns $25,000. Also characteristics have an influence on buying decision. Whether the person is extrovert (outgoing and spends on entertainment) or introvert (keeps to themselves and purchases via online or mail order) again has an impact on the types of purchases made.
Competition is a rivalry in which every seller tries to get what other sellers are seeking by offering the best practicable combination of price, quality, and service. Casual knowledge of business competitors is insufficient. Competitors should be systematically analyzed as part of the buying decision process. Knowledge of competition both real and potential is important to determine their strategy and their resources and capabilities that impact future sales.
• Make a list of the three chief competitors.
• Search the internet. Competitors can be local and international.
• Are they known personally.
• Do they have more resources?
• If the competitor is publicly traded information on their financial status can be found by using the SEC's EDGAR system.
• If not, contact the Better Business Bureau or Economic Development Agency in their area.
• How do they price their products or services?
• Are they higher or lower than the seller's business?
• What are their particular payment terms?
• How do the competitors obtain business (direct advertising, internet, market awareness)?
• What are their strengths and weaknesses compared with the products or services the seller offers?
• Can their weaknesses be exploited to your advantage?
It is important that potential buyers of a business consider all the above factors that can affect the going concern of a company. Most of it is not quantifiable. One might need the opinions of experts to help make decisions in this area. The risk of not evaluating these areas could cause one to buy into a business that will not last long enough to recoup their investment.