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Buying and Selling a Small Business - Part 5 Analyzing the Market Position of the Companyincluding Chapter 12 - The MarketIntroduction: Market AnalysisEVERY BUYER, and indeed every seller, should have some measurement of what the future will offer. This includes not only the possibility of maintaining the same volume of sales as in the past, but also the opportunity to increase sales.The buyer must have some idea of what he is acquiring besides the physical assets of the business. He is, in fact, investing in or obligating himself to the continued operation of the business. The true value to him lies in the ability of the business to generate sales at lease equal to its current position in the market. This calls for a careful investigation and analysis of two factors: (1) the past growth of the company within the market of which it is a part, and (2) a forecast of the future sales pattern. The seller also needs a market analysis for the business he proposes to sell. He wants the best possible price for the business--and the better the outlook, the more likely the buyer is to agree to the asking price. Who Does the Work?Will a single market analysis fill the needs of both buyer and seller? Separate studies are probably better. The seller has access to data about the business that are not available to the buyer. Unless the buyer has had wide and recent experience in the same kind of business, he may--rightly or wrongly--tend to rely on the seller's statement of the market position of the company.No two studies of the same company will produce exactly the same results. The buyer's analysis is almost certain to be on the conservative side, and a compromise will be necessary. Another question is whether the buyer and seller should conduct their own market studies or hire specialists to do it. The detailed and complex type of investigation conducted by a professional market analyst is valuable, of course, but the cost is considerable. The basic purpose of a market analysis in the buy-sell situation is to get a clearer picture of the company in the marketing scheme and some indication of the general direction in which it is moving. The buyer and seller should be able to gather and analyze the basic data they need for this purpose--if they avoid a highly statistical approach. Organizing the StudyPart 5 includes five series of questions and a checklist to guide the buyer or seller in his analysis of the market position of the business.Sample rating chartsYear sales change 2000.................................. $__________ ___________ 2001.................................. ___________ ___________ 2002.................................. ___________ ___________ 2003.................................. ___________ ___________ 2004.................................. ___________ ___________ Dollar increase 2004 over 2000........ $__________ ___________ Percent increase 2004 over 2000................... ___________ How satisfactory? 1 2 3 4 5 SHARE OF MARKET: Share of Industry Company market Year sales sales (percent) 2000................ $____________ $______________ ___________ 2001................ _____________ _______________ ___________ 2002................ _____________ _______________ ___________ 2003................ _____________ _______________ ___________ 2004................ _____________ _______________ ___________ Change in share of market 2004 over 2000.......... ___________ How satisfactory? 1 2 3 4 5The list of questions is not complete, and not all of those given will be equally useful for all types of businesses. The nature of the business determines what kind of information is needed and in what detail. The questions will, however, call attention to some aspects of the market that might otherwise be overlooked. Determining how important to the business a specific market characteristic is presents a problem. What is vital to one company may be unimportant to another. And some system should be worked out for rating each characteristic. A possible method for this is to list the major subject areas in the study, showing their relative importance, and then to rate them according to a uniform system--a rating scale using numbers, for instance, or words such as "high," "medium," "low," and "not significant." An example of how a numbered scale might work in rating the company's sales over time (one of the characteristics most likely to be studied) is shown in the box above. Chapter 12 - The MarketTHE STRENGTH OF A MARKET depends on three elements: population, income, and motivation or attitude. The first two can be measured with some accuracy and predicted statistically. Motivation, being subjective, cannot be easily observed and is largely unpredictable.Population in the Market AreaPopulation, particularly the pattern within the given market, is a dominant element in the market prospects of a business. Changes in age distribution of the population will be important to some types of businesses. Migratory factors such as shifts from rural to urban and from urban to suburban may determine the future growth of others.Many businesses, such as food stores, will be influenced principally by the total growth in population. Others will feel the impact of structural changes--the older group with its special requirements, the increase in the infant market. Rapidly growing communities show a larger-than-normal proportion of young families; areas with a static or declining population, a larger-than-normal proportion of older families. How permanent the population in the market is must be considered. In areas where employment is seasonal or cyclical, a large part of the population may be only semipermanent. An analysis of population consists of more than simply counting noses. It requires a careful study of both qualitative and quantitative characteristics. Questions in the Analysis of Population1.What has been the change in total population in this market area over the past 10 years?A comparison of census figures will show these changes. The use of census tracts in major metropolitan market areas is helpful. Many city and county government units compile population figures on various geographical bases. 2. Using a given year in the past as a base, what has been the annual and cumulative percent of change in population in this market area? The cumulative percent of change is found by dividing each succeeding year by the first year. It shows as a percent how each year up to the present compares with the base year. Plotting the figures on a graph helps to visualize the progressive change. 3. What is the average family size? Has this been increasing or decreasing? In many consumer-goods businesses, the size of the average family unit may be more important than total population, particularly where there are observed changes in family size. Increase in the size of the family unit has had a profound effect on many classes of consumer goods, from station wagons to outdoor gym sets. 4. What is the population in this market measured in family units? The rate of change in family units will not be the same as the rate of change in total population if the size of the average family unit is changing. 5. What is the current distribution by age groups in the market? How has this distribution changed in the past 10 years? Nationwide, the age distribution of the population is not the same as it was a few years ago. The under-5 and over-65 groups probably show the greatest rate of change. The buyer should know whether the seller has been alert to these changing patterns and is taking advantage of them. 6. What percent of the population in this market can be classified as urban, suburban, rural? How has this changed over the past 10 years? Changing living patterns and habits change the demand patterns for various types of goods and services. If population shifts are changing the market or shows signs of being about to do so, the businessman must try to determine how much effect this has or is likely to have on his operation. 7. What percent of the family units in this market have only one person? Two? Three? Four? More? A breakdown of family units by number of persons in the family has value for businesses whose sales volume is at least somewhat related to family size. A manufacturer of outdoor portable swimming pools, for instance, would be interested in family sizes because this would influence the production of various sizes of pools. 8. What percent of the total population or family units are potential customers for this kind of business? This is particularly important for businesses whose goods or services are related to the way people live. The demand for three-horsepower garden tractors will depend on the number of families living on small acreages. Septic tank sales will depend on the families not eligible for public sewerage services. An analysis of the market for specialized goods and services may be the key to evaluating the future of the business. 9. How has the total population been changing over the past 10 years? Is it-- Increasing at an increasing rate? Increasing at a decreasing rate? Showing no change? Decreasing at a decreasing rate? Decreasing at an increasing rate? Population may be continuing to increase, but at a slower rate. This would probably suggest less in-migration and more out-migration, or perhaps a reduced birth rate, though this would probably occur over a fairly long period of time. Analysis of vital statistics of the market (births over deaths) is advisable. 10. What is the level of education in the market? Is it increasing? What is the rate of increase? What is the level of education by age groups in the adult population? Education of the male population? Female population? Generally, the higher the education level, the higher the income level is likely to be, with correspondingly greater capacity for goods and services. Trends in the level of education, particularly when correlated with income, may indicate future potential. Income in the Market AreaIncome as used here refers to net spendable income rather than gross earnings. Of the spendable income, the primary concern is with that which remains after fixed or relatively fixed obligations have been met--rent or home payments, utility payments, insurance premiums, and the like. The amount left is the income over which the consumer has some control--whether to spend all of it or some.How each consumer spends this income is largely a matter of personal motivation. The total amount available for consumption in the market, however, depends on the economic factors influencing income. Variations in total income and the resulting purchasing power stem largely from two sources: (1) changes in the average income of the family unit, with the same general level of employment prevailing; and (2) changes in the level of employment with the average income constant. The difference between earned income and real income must also be recognized. If the cost of living is increasing at a rate about equal to the purchasing power, there is no gain in purchasing power. Dollar purchases may increase, but each dollar buys less. The net difference between the increase in income and the increase in prices reflects the true gain or loss in income converted to purchasing power. Some classes of goods and services show no positive relation between demand and income levels. For example, when incomes rise, more dollars are spent for food, but the percent of income channeled into these goods is smaller. Income is important in market analysis because changes in income are reflected in the demand patterns for goods and services. No business is free from this effect. As barbershop prices increase, the interval between haircuts increases and the sale of hair clippers for home use rises. The demand for funerals in a rising market does not change, but the degree of ornateness in the casket or services decreases. Questions in the Analysis of Income1.What is the total spendable income within the market area? What is the average per capita income? Average per family income?2.What has been the rate of change in income (per capita, per family) over the past 10 years on both a year-to-year basis and a cumulative basis? Changes in income reflect the changing status of the market. The change is most likely to be an increase, but the extent of the increase should be known. 3. How does the rate of change in income in this market compare with changes in the Nation as a whole and in similar markets? The economic factors affecting the income status of a given market may differ from those at work in the economy as a whole, but it is helpful to know how changes in this market compare with trends in other markets. 4. What is the distribution of income and purchasing power by income class in the market? A frequency distribution such as this can be used to analyze income and purchasing power: Percent of Percent of total
Dollar Percent $0 to $4,999 ______________ ________________ $5,000 to $7,999 ______________ ________________ $8,000 to $13,999 ______________ ________________ $14,000 to $19,999 ______________ ________________ $20,000 and over ______________ ________________ The $8,000 to $13,999 income group, for instance, might represent 32 percent of all family units and 38 percent of the purchasing power; the $20,000-and-over group, 5 percent of the family units and 11 percent of the purchasing power. The higher-income groups will ordinarily be smaller, but they will have a higher-than-proportionate purchasing power. 5. How has the distribution of income and purchasing power by income classes changed over the past 10 years? This information should be reduced to year-to-year and cumulative percentages. 6. What are the types of employment and the percentage of the working force in each class? Here, again, changes over time should be studied. 7. Have there been any significant changes in the forms of employment in this market over the past 10 years? What changes in industry and employment in this market are foreseeable? 8. What is the level of unemployment in this market area? Is unemployment increasing? Decreasing? Showing no appreciable change? Knowledge of the unemployment trend is important because of the direct effect it has on purchasing power and the psychological effect of the threat of unemployment. 9. How much do consumers typically spend for various classes of goods and services in this kind of market? Competition in the Market AreaThe buyer of a business not only acquires the physical property of the company; he also inherits its competition. He will probably be able to do little or nothing to lessen the competitive pressure operating against him, but he can develop a clear working knowledge of what he will face--the state of competition, the relative strength of the business within the market, the general patterns of development and change. A detailed analysis of the competition is highly desirable in deciding whether to buy an existing business.Attention should be given first to competitors of about the same type and size as the business in question, since they are on a more realistic level of competition. A small clothing store would be wise to concern itself with other small clothing stores rather than with a high-volume department store. In time, a small operation might grow to the point of competing successfully with major firms, but the immediate pull of competition will come from other businesses of about the same size and description. Investigation of large businesses, if any is made, should concern the extent to which they enlarge the total market, stimulate demand, or otherwise open up market possibilities to the smaller business. Questions in the Analysis of Competition1.How many competitive businesses are there within the market area of this business? Where are they located? What can be found out about them? From whom?The market area in this sense is the trade area in which the business operates. In a retail, wholesale, or service business, this trade area may be rather narrowly defined. In a manufacturing or mail-order business, there may be a number of markets--regional, national, and perhaps even international. Markets can be further defined as either consumer-goods markets or industrial goods markets, depending on the nature of the business and the goods or services with which it deals. The market or markets must be carefully identified to avoid any waste of time and effort in making the analysis. 2. How many competitive businesses have gone out of business or moved out of the market area within the past year? If there has been a decline in the number of competitors, an attempt should be made to find out why. If the decline has been significant, it may indicate that there are too many businesses of that type for the potential sales volume. If other areas of the analysis tend to indicate a declining market, exodus of competing businesses may help support those findings. 3. How many competitive businesses have opened in this market area within the past year? Is this increase in competition more than should normally be expected? What circumstances have been responsible for the increase in competition? Can the market support all these businesses? Unless the market grows in proportion to new competitive entries, the net result is a smaller share for each competitor. 4. What is the total known or estimated volume of competitive business within the market area? This should give a cross-check on the volume of business done by the company up for sale. The total sales estimate for the market less that done by the company gives a reasonably accurate estimate of the volume going to the competition. Or the sales of the company can be estimated by subtracting competitors' sales from total sales in the market. 5. What sort of sales effort does the competition make? How do the competitors advertise, promote? What advertising media are used? How much? What is the quality of competitors' sales forces? Could business be drawn from competitors by improving on their sales ability? There is likely to be considerable variation in the level of sales effort between competitors in the same market, from those who are highly aggressive to those who simply "follow the crowd." The person investigating the market should analyze competition from this point of view as intensively as possible. 6. What is the total footage of all competitive businesses within the market area? From the total gross footage and total estimated volume, it is possible to get an overall sales-per-square-foot average to compare with the company under consideration. 7. What is the general physical appearance of competitive establishments in the market area? Generally speaking, alert, progressive firms present an up-to-date physical appearance and use the newest techniques of operation. A generally high level of overall appearance gives some indication of the aggressiveness of the competition. 8. What other competitive businesses are known to be for sale within the market area? If general business conditions are such that other competitors are seeking to get out of the market, the prospective buyer should know it. It may signify that the area is not a good one for entering business. On the other hand, a lessening of competition leaves to the business in question a larger potential volume. The reasons why competitors have left the market area should be learned. A decision to purchase assumes economic health in the market. 9. What other kinds of businesses are in indirect competition--that is, deal at least to some extent in the same kinds of goods or services as the business being considered for sale or purchase? Businesses are constantly adding lines of merchandise, expanding services offered, and creating new products. As a result, the pattern of competition changes rapidly. The buyer, and presumably the seller,
should be aware of these changes and their likely effect on the business in question.
10. Can the competitive businesses be rated, taking all factors into account, from the strongest or most dominant to the weakest? 11. What kinds of services to customers are competitors offering that this business does not? Customer services are becoming a dominant force in attracting and holding customers. Services offered to customers by competitors should be investigated carefully to determine the effect these have on attracting sales volume. 12. What are the general pricing policies of competitors? An actual price comparison of specific products or services should be made. Attention should be concentrated on general price levels rather than specific items--the purpose is to compare this company and its competition, taking into account cost of merchandise, relation with sources of supply, cost of operation and so on. 13. How influential has the competition been in enlarging the overall market? Demand is classified in two ways: primary demand, which is the demand for certain kinds of goods or services, and selective demand, which is demand for a given brand or desire to purchase from a specific company. Competition, through promotion and sales effort, must be able to enlarge market capacity for a product by type or class. The combined sales effort of all appliance stores in a market, for example, will expand the primary demand for air conditioning. Thus the separate but total force of competition may have the positive effect of expanding the basic market. 14. How does the competition compare with the business in the buy-sell transaction as to the amount apparently spent on sales effort? The nature and extent of advertising and promotion is often a strong indicator of the competitive intensity of business within a market. As the market becomes more competitive, sales-effort costs as a percentage of sales tend to rise. A study of competitive advertising and promotion--the media and methods used, the form the promotion follows--would be of value in the market analysis. 15. Is there evidence of concerted or cooperative effort on the part of the competition to increase the total market? |
