A PRACTICAL APPROACH TO BLUE OCEAN STRATEGY - PART 2 (THE PMS MAP)

In every industry or business there are three distinct groups that can be identified with regards to their position in the market place. They are:

• Pioneers- Products and services that offer unprecedented value and are powerful sources of profitable growth. Their value curves are different from the competitions on a strategy canvas. All pioneers are blue oceans.
• Migrators- are in between pioneers and settlers. They offer improved value, but not innovative value.
• Settlers- do not contribute to much future growth and are stuck in a red ocean. Their value curves match the basic shape of the industry.

Businesses that are interested in profitable growth would need to first identify into which of these groups their current products and services fall into and determine which of these products has the most potential for a change in its current status. A useful exercise for such companies is to plot the company’s current and planned portfolios on a PIONEER-MIGRATOR-SETTLER (PMS) Map.

A PMS map can be described as pictorial description of the directions for getting from a point A to a Point B. It can also be defined as a graphical or pictorial representation of the current position of the products and services of a company with the relations to its competitors (i.e. pioneer, migrator or settlers) and the planned position of these products and services in the future.

These products and services are depicted on the map as circles the size of which depends on the total revenue that product or service brings in. i.e. the larger the sales revenue accrued from that product or service the larger the circle. As noted earlier in order to provide a more practical approach Polo Ralph Lauren T-shirts have been chosen as a case study an as such the PMS map would be applied to this product.

The objective of drawing a PMS Map for Polo Ralph Lauren T-Shirts is to help visualize, plan, and predict its future growth and profit. The PMS Map helps to identify the group each of these products fall into and the amount of sale revenue accrued from each of them and also to determine which of these products would benefit most from migration to the pioneer group in the future and why.

At this point we would like to note that the overall objective of the PMS Map is to create a blue ocean for the product or service. With regards to the Polo Ralph Lauren T-Shirt product range there are 7 different products which shown in the figure below:

In determining the choice of products to move to the pioneer segment in the future a number of factors were considered. They are:
1. Density of the segment i.e. how competitive is a particular segment in a particular industry: this is considered because it helps us determine how deep into the red ocean the product or service is.
2. Current ability of the product to generate revenue in its particular segment: this is considered because if the segment the product is in at the moment is highly competitive and the product still brings in a lot of revenue, if the blue ocean strategy is applied to this product it would markedly improve the revenue generated.
3. Value innovation potential of the product i.e. how easily does the current state of the product lend itself to value innovation

It is important to note that these factors are not applied in isolation but together. With the above in mind the following products were chosen to be moved from their current segment to the pioneer segment:

Polo RL from settler segment -->  Pioneer segment

POLO RL - At the moment the settler segment for T-shirts is highly populated and competitive. Notwithstanding Polo RL still does well. With this in mind we can only imagine the level of revenues that would be generated if the blue ocean strategy is applied and it is moved to the pioneer segment.

This is the first step in unlocking the blue ocean strategy creating a PMS map for whatever product or service that is of interest to you.  The next step is the creation of the "As Is" Strategy canvas and would be seen in part 3 of the series. Look out for it. 

A PRACTICAL APPROACH TO BLUE OCEAN STRATEGY - PART 1 (INTRODUCTION)

INTRODUCTION

Blue Ocean Strategy can be described as a planned sequence of events or processes designed to create uncontested markets and make the competition irrelevant.  This is done by encouraging companies to break out of the current market space which they described as the red ocean and instead of further segmenting prevailing market segments to concentrate on desegmentation of the market place and grow the demand creating what they refer to as a blue ocean. Though this notion is not entirely new, this is the only approach that provides a logical and scientific sequence of events that can be replicated leading to the establishment of uncontested markets each time this sequence is applied in the appropriate order. 

The corner stone of blue ocean strategy is VALUE INNOVATION. Value Innovation refers to increasing the value of a product while simultaneously reducing the price.

Blue ocean strategy is also unique as opposed to other business strategies as it provides guidelines for both strategy formulation and implementation. Most other trainings or business strategies on innovation provide only guideline for  strategy formulation or innovation. Hence apart from Value Innovation the other components of the blue ocean strategy are Tipping Point Leadership and Fair process.

W. Chan Kim and Renee Mauborgne stated that there are six principles to abide by in achieving the blue ocean strategy with the first four principle enabling value innovation and the last two ensuring it is adequately implemented with the processes of tipping point leadership and fair process.

As with other more conventional red ocean strategies which make use of analytical tools like SWOT Analysis, Porters Five forces e.t.c. Blue ocean strategy also possesses a set of analytical tools which are applied to unlock the blue ocean i.e. an uncontested market space. These tools are highlighted in the figure below.

The purpose of this series is to apply the blue ocean strategy to Polo Ralph Lauren T Shirts to help them break out of the red ocean and create a new market space. We did this by making use of the Blue Ocean analytical tools and frameworks following the principles of the Blue Ocean Strategy.

The series would be in eight parts including the introduction as shown in the figure below and would deal primarily with strategy formulation and not implementation. 

 So join me as we unlock the blue ocean, creating an uncontested market space for Polo Ralph Lauren T-Shirts.

Look out for Part II in which we begin the practical application of blue ocean strategy beginning with the use of the PMS (Pioneer, migrator and settler) Map. 

FINANCING OPTIONS AVAILABLE TO ENTREPRENEURS - PART IV (CONCLUSION)

CONCLUSION

As an entrepreneur myself, the decision on making use of debt financing and equity financing is faced on a regular basis and without a deep understanding of both options it would be very difficult to make a choice or very easy to make the wrong choice.

This series has taken a look at both options highlighting the pros and cons of each and arriving at the conclusion that one is not necessarily better than the other but depends in part to the entrepreneur’s personal preferences with regards to potential profitability, financial risk and degree of control and his or her understanding of debt and equity financing.

This series has also shown that the safest option is a combination of both debt and equity financing, maximizing profitability, reducing financial risk and retaining a reasonable amount of control over the company.   Utilizing both at the start of the business or separately in different stages of the business keeping in mind the difficulties of securing debt financing or if found the ability to negotiate a satisfactory interest rate. As such though the ideal option is to utilize a mix of both equity and debt financing, providing a definite formula or ratio is more subjective than objective.

Thanks for following the series. I hope it has been of benefit to you.

Look out for the next series - A PRACTICAL USE OF BLUE OCEAN STRATEGY (Creating a new market space and making the competition irrelevant)

REFERENCES

<!--[if !supportLists]-->1.      <!--[endif]-->“Access to capital: what funding sources work for you?” published by the U.S Chamber of Commerce Statistics and Research Centre 2005

<!--[if !supportLists]-->2.      <!--[endif]-->Benjamin G. and Margulis J. (2005). Angel Capital: How to raise early stage private equity financing. Published by John Wiley & Sons

<!--[if !supportLists]-->3.      <!--[endif]-->Bob Reiss (2002). Low risk High reward: starting and growing your small business. Free press

<!--[if !supportLists]-->4.      <!--[endif]-->Entrepreneurship. Reference for Business: encyclopedia of business 2^nd edition.Retrieved 23^rd June 2010.  http://www.referenceforbusiness.com/small/Di-Eq/Entrepreneurship.htm

<!--[if !supportLists]-->5.      <!--[endif]-->Equity Financing, Entreprneur.com Retrieved February 15, 2011 from http://www.entrepreneur.com/encyclopedia/term/82330.html

<!--[if !supportLists]-->6.      <!--[endif]-->Gleason, K. C. et al (2000), "The Interrelationship between Culture, Capital Structure, and Performance: Evidence from European Retailers", Journal of Business Research, 50, 185-191.

<!--[if !supportLists]-->7.      <!--[endif]-->Good S.W (2003). Building a Dream: A Canadian guide to starting a business of your own. Published by McGraw Hill.

<!--[if !supportLists]-->8.      <!--[endif]-->Hovakimian, A. et al (2001). The Debt-Equity Choice, Journal of Financial and Quantitative Analysis 36, 1-24

<!--[if !supportLists]-->9.      <!--[endif]-->Invsetwords.com (2011) Definition of Debt. Retrieved February 14, 2011 from  http://www.investorwords.com/1313/debt.html

<!--[if !supportLists]-->10.  <!--[endif]-->Jefferson, Steve. "When Raising Funds, Start-Ups Face the Debt vs. Equity Question." Pacific Business News, 3 August 2001.

<!--[if !supportLists]-->11.  <!--[endif]-->Longenecker  G. et al (2006). Small Business Management: An entrepreneurial emphasis, 13^th Edition. South-Western publisher.    

<!--[if !supportLists]-->12.  <!--[endif]-->Modigliani, F. and Miller M. H. ( 1958). The cost of capital, corporate finance and the theory of investment, American Economic Review, Vol. 48, 261-297.

<!--[if !supportLists]-->13.  <!--[endif]-->Roger S. (2009) Entrepreneurial  Finance: Finance and Business Strategies  For The Serious Entrepreneur, 2^nd Edition. Published by McGraw Hill.

<!--[if !supportLists]-->14.  <!--[endif]-->Smith J. (2008) The 7 Major Types of Equity Financing. YchangeInternational.com. Retrieved February 15, 2011 from http://www.ychange.com/ychangeblog/equity-financing/

<!--[if !supportLists]-->15.  <!--[endif]-->Sullivan R. (2000). The small business start-up guide: Practical advice on starting and operating a small business. 3^rd edition. Published by Information International.

<!--[if !supportLists]-->16.  <!--[endif]-->Thefreedictionary.com (2011) Defintion of Financing. Retrieved Febuary 14, 2011 from http://www.thefreedictionary.com/financing

<!--[if !supportLists]-->17.  <!--[endif]-->Barney, J.B. (1986) Factor Markets: Expectations, Luck, and Business Strategy. Management Science 32, 1986, pp. 1231-1241.

<!--[if !supportLists]-->18.  <!--[endif]-->Sandberg, C.M. et al (1987) Financial Strategy: Planning and Managing the Corporate Leverage Position. Strategic Management Journal 8, 1987, pp. 15-24.

FINANCING OPTIONS AVAILABLE TO ENTREPRENEURS - PART III (CASE STUDY - PRACTICAL EXAMPLE)

CASE STUDY

In order to fully understand how the choice between debt and equity affects potential profitability of a business let’s consider a fictitious company called ABC  a new firm that is still in the process of raising funds/capital to start up their business.

In this case the owner already has N 100,000 of their own money and need an additional N 100,000. They are considering two options to raise the additional capital. One of which is to approach investors to provide N 100,000 for a 30% share of the firms outstanding stock or approaching a bank that would lend them N 100,000 at an interest rate of 8% so the interest expense would be N 8,000 (0.8 X N 100,000).

The firms operating income (earnings before interest and tax) is expected to be N 28,000 as determined as follows:

With the additional N 100,000 in equity or debt the balance sheet would appear as follows:

In order to keep things simple for this case we would assume there are no taxes and so with the above information we can project the firm’s net income when the additional N 100,000 is financed by equity or debt as follows:

From the above it is clear that the net income is greater if the firm’s finances with equity as opposed to debt but the owners have to invest twice as much to avoid an N 8,000 interest expense to get the higher net income.

The question then is “do owners always need to finance with equity to get a higher income?” the answer is not necessarily as the return on investment or return on equity is a better measure of the performance than the absolute Ringgit amount of the net income.

The return on equity from equity financing is 14% while that of debt financing is 20% as seen below:

 It can be seen from the above that Company ABC’s return on equity is higher if half of the funds comes from equity and the other half from debt. By using only equity ABC’s owners will earn N 0.14 for every N 1 invested but will earn N 0.20 for every N 1 if financed with debt. So in terms of return on investment/equity ABC’s owners get a better return on investment by borrowing money at 8% interest than using equity financing.

As it has been shown that debt financing is beneficial to a start-up business, some might ask why the owners of company ABC do not use more debt financing and if possible 100% Debt financing which would make the rate of return on owner’s equity investment much higher or even unlimited if they did not invest anything at all.

The problem with this scenario is that increased debt financing though tempting is very risky. In the event that the firm fails the creditors still demand payment and in extreme cases can force a firm into bankruptcy. In this regard equity finance is less demanding as if the firm does not reach its profit goals and equity investor must accept the disappointing results and hope for better the next year.

Another attraction to debt financing to the owners of company ABC would be the fact that it enables them full ownership of the company without having to give out a part of the company.  As stated in the first chapter this would depend sole on the personal preferences of the owners of company ABC.

LOOK OUT FOR PART IV - THE CONCLUSION

FINANCING OPTIONS AVAILABLE TO ENTREPRENEURS - PART II (DEBT VS EQUITY FINANCING)

DEBT FINANCING

Debt is defined as an amount  owed to a person or organization for funds borrowed. (investwords.com, 2011) while financing is defined as - to provide or raise the funds or capital (thefreedictionary.com) and as such debt financing can be described as to borrow funds from a person or organization for the purpose of raising funds or capital for a business.

Walter S. Good (2003) in his book Building a dream: A Canadian guide to start a business of your own defined debt financing as borrowing of money that must be paid in full, usually in periodic payments with interest. He also stated that it involves 3 important parameters: 

1.      The amount of principal to be borrowed

2.      The interest rate of the loan

3.      The maturity of the loan

It iIt is important to note that until the debt has been repaid the provider of the loan has legal claim against the assets and cash flow of the business. 

  

Contrary to the widely held notion that debt financing involve only banks there are different types of debt financing available. There are three major categories of sources for debt financing which are:

1.      Banks

2.      Government Initiatives

3.      Others ( further highlighted in the table below)

Debt financing as a means of funding a start-up business has both advantages and disadvantages and as stated in the last article the decision to make use of debt financing would depend on the preference of the entrepreneur. The table below highlights the advantages and disadvantages of debt financing.

EQUITY FINANCING

Equity financing can be described as a method of financing in which a company issues shares of its stock and receives money in return. Depending on how you raise equity capital, you may relinquish anywhere from 25 to 75 percent of the business. (Entrepreneur.com, 2011).

Such funds may come from friends and family members of the business owner, wealthy "angel" investors, or venture capital firms. Venture capital is one of the more popular forms of equity financing used to finance high-risk, high-return businesses. The amount of equity a venture capitalist holds is a factor of the company's stage of development when the investment occurs  , the perceived risk, the amount invested, and the relationship between the entrepreneur and the venture capitalist. Venture capitalists are private investors who provide venture capital for promising businesses.  (Smith J., 2008)

As with debt financing, equity financing also has its advantages and disadvantages which are highlighted in the table below.

DEBT FINANCING VS EQUITY FINANCING

Studies have shown that a 81% of start-up businesses by entrepreneurs are funded by personal savings as a form of debt financing from the owner of the business to his/her business.(U.S Chamber of Commerce Statistics and Research Centre, 2005)  In the event that these savings are in adequate or unavailable the choice of which form of financing is very critical to the success of the business.

It is a well-known fact that majority of entrepreneurs start-up businesses in order to escape from the shackles of working for a boss and as such ordinarily should be less inclined to consider equity financing as it dilutes the ownership of the business and  reduces their control over the business by involving investors who might have to be considered in the decision making process for critical decisions in the business and in the event that these investors hold a greater amount of shares than the owner of the business can easily over-rule the entrepreneur or in the worst case fire him or buy him out.

Having said this, the benefits of equity financing cannot be overlooked as have been highlighted above which clearly spells out the fact that apart from providing the much needed capital infusion into the business it also enhances the company’s credibility, net worth, financial strength and borrowing capacity in the future if need be, not to mention the wealth of experience and advice brought to the table by the investors who because of their vested interest in the company would do their utmost best to ensure the success of the business venture. (Benjamin G. and Margulis J.,2005).  Equity investors are looking for a partner as well as an investment, or else they would be lenders," venture capitalist Bill Richardson explained in Pacific Business News (Jefferson S, 2001).

As an entrepreneur embarking on a start-up business venture debt financing is also an attractive option as funds are provided while ownership of the company is still retained. It is also attractive because the debt may be acquired from a variety of lenders with the tem of the debt generally limited and loan payments predictable in addition to providing tax benefits. (Good S.W., 2003)

Eric Mais, Professor and chairman of the finance department of UH Manoi in the article When raising funds, start-ups face the debt vs. equity question in the pacific business news described the benefits of debt financing over equity in three words: Taxes, Leverage and Control (Jefferson S,2001). He further went on to explain that First, interest expenses on debt can be deducted from your tax liability. Secondly debt creates financial leverage as payment on debts are fixed and If a company has a good year, all they owe is their promise to pay interest, whereas if the same company used equity and had a good year, they would have to share all of that with investors. Leverage is both good and bad. Lastly, there is the degree of control the entrepreneur retains over the company. (Jefferson S, 2001)

On the other hand debt financing can also be seen as doubled edged sword that can cut both ways in that it is not without drawbacks.  For one it is extremely difficult to obtain as most financial institutions look at financing a start-up business with no track record and assets as risky and shy away from such obligations. The business also stands the chance of taking on more debt than the business needs which can be a burden on cash flow and if funds are not used judiciously might lead to a difficulty in repaying these loans. (Good S.W., 2003)

The most prudent course of action is to obtain capital from a variety of sources, using both debt and equity, and hire professional accountants and attorneys to assist with financial decisions. Ideally, experts suggest that businesses use both debt and equity financing in a commercially acceptable ratio. This ratio, known as the debt-to-equity ratio, is a key factor analysts use to determine whether managers are running a business in a sensible manner. Although debt-to-equity ratios vary greatly by industry and company, a general rule of thumb holds that a reasonable ratio should fall between 1:1 and 1:2.

The financial ratios indicate something about a company's activities, such as the ratio between the company's current assets and its current liabilities or between its debtors and its turnover in the case of a start-up business the projected current assets and liabilities. The basic source of these ratios is the company's projected profit & loss account and balance sheet that contain all kinds of important information about that company. The ratios really help to bring those details to light and identify the financial strengths and weaknesses of the company. (Hovakimian et al., 2001)When assessing ratios, it is important that the results are compared with other companies in the same industry and not to be taken in isolation. What may seem like a poor ratio at first glance may well be normal for that industry and, of course, the reverse applies, in that what may seem a good ratio on its own, could be below average for that industry. The most common ratio used to measure equity to debt and debt to total asset:

Equity to Debt =    Total Owners Equity /  Total Debt

Debt to Total Asset =      Total Debt  / Total Asset


LOOK OUT FOR PART III OF THE SERIES - A CASE STUDY SHOWING A PRACTICAL DEMONSTRATION OF WHAT HAS BEEN DESCRIBED ABOVE.
Ps: A list of all references would be provided at the end of the entire series.

FINANCING OPTIONS AVAILABLE TO ENTREPRENEURS - PART 1 (INTRODUCTION)

INTRODUCTION

Entrepreneurs are seen as folk heroes of business able to overcome insurmountable odds to make a business work. In reality this is not so as majority of start-up businesses actually fail. So who then is an entrepreneur?

The definition of the word entrepreneur has evolved over the ages beginning from the basic definition by the Oxford English Dictionary which is “one who owns and manages a business”. The above definition is a very rudimentary definition of the word and does not capture its essence. Various authors have given a more detailed and concise definitions of the word and below are some examples:

An entrepreneur is one who starts a new business in the face of risk and uncertainty for the purpose of achieving profit and growth by identifying opportunities and assembling the necessary resources to capitalize on those opportunities starting with nothing more than an idea. (startingonlinebusiness.com)

Bob Reiss, successful entrepreneur and author of Low-Risk, High-Reward: Starting and Growing Your Small Business With Minimal Risk, says: "Entrepreneurship is the recognition and pursuit of opportunity without regard to the resources you currently control, with confidence that you can succeed, with the flexibility to change course as necessary, and with the will to rebound from setbacks." (Bob Reiss, 2002)

An entrepreneur is one who organizes a new business venture in the hopes of making a profit. (referenceforbusiness.com)

From all the above definition there are some unifying factors which are:
• Entrepreneurs start new businesses
• Entrepreneurs own and manage a business for the purpose of making a profit
• Takes initiative
• They are risk takers pursuing opportunities without regard to resources at hand

From all the above unifying factors it can also be said that all the other factors hinge on the fact that entrepreneurs are responsible for starting a new business i.e. a business not previously in existence. In order to achieve this they need capital or funding without out which there is no chance of the businesses survival.

The entrepreneur therefore faces a very important question - “SHOULD HE FINANCE WITH DEBT, EQUITY OR BOTH?” Keeping in mind that his choice of financing would have a major impact on the survival of the business.

The Answer to the above question thus depends in part to his or her personal preferences and in part to the recognition of the trade-off that exists between debt and equity with regards to:

1. Potential profitability
2. Financial Risk
3. Voting Control

The need for an entrepreneur to be his own boss plays a critical role in his decision to start up a business and as such it is important that he understands the fundamental distinction between equity and debt.

A survey by the United States Chamber of Commerce Statistics and Research Centre asked business owners to report where they obtained start-up funds and the table below reflects their various sources in percentages.

LOOK OUT FOR PART II - WHAT IS DEBT FINANCING AND WHAT IS EQUITY FINANCING WITH REGARDS TO START UP BUSINESSES

Dr. Ebi Ofrey (MBBS, MBA)