What are the three steps found in the opportunity recognition process?

TOPIC 2: OPPORTUNITY RECOGNITION AND EVALUATION

Creativity and Idea Generation

Entrepreneurial creativity is regarded as the driving element behind the present-day vibrant business environment and socio-economic growth. It is one of the key ingredients of entrepreneurial behaviour, as it is related to the identification of opportunities (Ko & Butler, 2007). Amabile (1996) defines entrepreneurial creativity as the implementation of novel, useful ideas to establish a new business or new program to deliver products or services. Entrepreneurial creativity differs from the general concept of creativity: it is about the production of not only new, but also useful ideas, as entrepreneurial creativity implies taking action on new ideas. This is done by either implementing new ideas for the creation of new ventures, initiating new programs or synergistically embedding novel changes into existing entrepreneurial ventures (Amabile, 1996).

Creativity can be viewed through different lenses: process, people and product. The process view is characterised by goal-orientation and aimed at achieving solutions to a problem, whereas the people aspect serves as a resource to find a solution to a problem. The product view is the expression of the outcome essentially manifesting through process and people aspects (Frederick et al., 2007; Amabile 1996).

Creativity is neither merely a natural born talent or a rare gift, only found in a select few. Everyone possesses creative capabilities to some degree, and creativity can be nurtured and developed (Frederick et al., 2007). Creative people have the capability to see things from different perspectives and connect disparate and unrelated pieces of information together to achieve a novel combination, a process referred to as bisociation (Ko & Butler, 2007). It essentially highlights the difference in the context of the thinking process, as people using bisociation employ multiple reference planes of information to generate creative and new ideas. Idea generation is the integral component of the creative process.

The creative process has been largely expressed as a four-stage process including: (1) preparation, (2) incubation, (3) idea experience and (4) evaluation and implementation, with the first three considered of greater importance to entrepreneurial activities (Ko & Butler, 2007; Fererick et al., 2007).

Preparation: This stage entails investigation and information gathering. Preparation involves leveraging on (a) work experience and learning; (b) information seeking from social networks; and (c) alertness and opportunity identification. The tacit knowledge acquired through work experience and education broadens intellectual space of entrepreneurs. It helps entrepreneurs to understand the need and a possible solution, and discover opportunities. The entrepreneurs use social networks to enlarge their information pool and by remaining alert to the environment, use these pieces of disparate information to connect them to opportunities.

Incubation: This stage is characterised by processing the information gathered in the preparation phase and is typically referred to as “connecting the dots”. In what is essentially a mental process, entrepreneurs study the related and unrelated information and connect the dots to identify the available opportunity.

Idea experience: This phase marks the discovery of an idea, which is sometimes perceived as the only component in the creativity process. Here new ideas often emerge through a slow and gradual process. Idea generation may not always result in the discovery of intended workable solutions, but often results in discovering solutions for unintended outcomes.

Evaluation and implementation: This stage requires entrepreneurial action to evaluate and implement the new idea and is characterised by uncertainties and difficulties necessitating self-discipline, courage and steadfastness. Many entrepreneurs fail several times before successfully implementing their new ideas, or transform their ideas and give them a new direction during the implementation process. Sometimes they abandon them completely. Evaluation of ideas before implementation constitutes another important activity in this phase.

Opportunities and Ideas

Christensen, Madsen and Peterson (1989, p.3) define opportunity recognition as “either (a) perceiving a possibility to create new businesses, or (b) significantly improving the position of an existing business, in both cases resulting in new profit potential”. Opportunities are chances to do something different and better (Wickham, 2006). Entrepreneurial opportunities refer to favourable business circumstances for the introduction of new products, services or a combination of both, new processes, new production techniques, new marketing techniques, entry to new markets and acquiring of new resources. Innovation is at the core of entrepreneurial opportunities.

A common view of the entrepreneurial process as a means to take advantage of the opportunity is starting a new business venture. The advent of Internet and electronic commerce has spurred new trends in the exploitation of entrepreneurial opportunities. With boundaryless organisations, competitive dynamism, and global reach, the process of recognising and evaluating entrepreneurial opportunities has become more complex and sophisticated.

Ideas are the building blocks of opportunities. They can just happen, or can be searched for consciously, they are like tools to recognise opportunities. However, not every idea can be transformed into value-based propositions (Timmons & Spinelli, 2007). Frederick et al. (2007) point that the difference between ideas and viable opportunities lie in the thinking process, as opportunity recognition would be the outcome of lateral thinking and richness of knowledge capital.

Entrepreneurial opportunities have many forms and sources (for comprehensive up-to-date reviews see Companys and McMullen, 2007; and Plummer, Haynie and Godesiabois, 2007). Technological disruptions (see Christensen, 1997; Christensen and Raynor, 2003), market, environmental and societal changes (e.g., industry deregulation, climate change and obesity), and ‘incongruities’ embedded in existing economic structures, such as gaps between perceived and actual customer needs (Drucker, 1998), are all sources of opportunities. It is also helpful to think of opportunities in terms of what Richard Rumel calls ‘value denials’ – insights into potential demand and supply of products and services that are both desired and feasible but are not currently being supplied by the market (Lovallo and Mendonca, 2007).

Opportunity Recognition and Evaluation

Opportunity recognition and evaluation are key elements in the entrepreneurial process. Hills et al. (2004) note that a wide variety of factors from controlled (such as alertness, job selection, study, moonlight venturing, and lifestyle) to uncontrolled (such as cultural, social, economic, and personality) which impact the opportunity recognition abilities of entrepreneurs. Bhave (1994) classifies opportunity recognition process into two categories: externally stimulated and internally stimulated. Externally stimulated opportunity recognition occurs when the decision to establish a new venture is made prior to opportunity recognition. In the internally stimulated opportunity recognition process, the entrepreneur determines the problem and need for the solution first and then decides to establish a new venture to fulfil the need (Hills et al. 2004).

The opportunity evaluation phase occurs after the opportunity recognition phase. There are three commonly identifiable stages in new start-ups: pre-start-up, start-up and post-start-up. The first phase involves opportunity recognition and setting up a business. The next phase is marked by sales and product/service delivery activities till the business firmly establishes itself in the market and is not posed with any threats to survival. The final phase continues till the termination of the venture or until the surviving business is no longer controlled by the entrepreneur who established the business (Frederick et al., 2007).

Frederick et al. (2007) suggest that opportunity evaluation has to be done against the measures of success of the new venture, and so the following five factors deserve consideration at pre-start-up and start-up phases:

Relative uniqueness: Innovation is the distinguishing element here, and should be based on a need for newness in products, processes and technologies. The length of time the newness element needs to be maintained and continued are further considerations.

Investment: The initial financial investment and the length of time it would be required for is another factor to consider. This largely depends on the industry, business and environment needs. 

Sales growth: The expected sales output, sales growth, rate of growth, and expected sales patterns need to be considered.

Product Availability: Ensuring sufficient product and service availability especially at the start-up of business is critical. Rushing through or delaying the product availability can result in image and quality problems for the business.

Customer availability: Another important consideration in opportunity evaluation is to know the customer base of the new venture. Knowing the customer base and their buying habits, and time taken in such assessment would be critical.

Several frameworks have been developed in the academic literature to evaluate entrepreneurial opportunities. Practitioners, such as venture capitalists or private equity partners, also use proprietary frameworks to assess whether an opportunity is attractive. The POCD framework used at HBS (Sahlman, 1996) represents one such tool, which includes Person/People; Opportunity; (external) Context and Deal. Another tool has been developed by Hindle (2004) who presents a four-stage process for opportunity assessment with 10 questions to be answered. This 4/10 strategy is suitable for a business of any size, as well as for new ventures and established businesses (Table 2.1). 

Table 2.1: Four-Stage Process of Opportunity Assessment

Two existence questions

  1.   What’s going on out there?
  2.   What’s changed since last time?

Two discovery questions

  1.   What do we already know about this potential opportunity that is   different to what everyone else knows?
  2.   How can our distinctive competencies add a perspective that creates   value for both a customer and us?

Two evaluation questions

  1.   Is it possible to create a viable business model?
  2.   Who could best implement it?

Four exploitative questions

  1.   Is this opportunity for us?
  2.   If ‘Yes’ do we entrepreneur (Corporate venture) or intrapreneur (Do it   in house)?
  3.   If ‘No’ can we sell the business model or any other intellectual property?
  4.   If we reject the opportunity but somebody else spots it and implements   it, how much will this hurt our existing business?

In this course we use the Timmons and Spinelli (2007) framework, which provides perhaps the most comprehensive checklist of factors which jointly contribute to making the opportunity attractive. The checklist helps us to evaluate the venture’s industry and market, economics and harvest issues, competitive advantages, the quality of the management team, personal criteria, strategic differentiation and any fatal flaws that may be evident in the venture.

Risk and Uncertainty

Inherent in new venture opportunities are uncertainty and risk. Uncertainty has been defined from different perspectives but generally means ‘sense of doubt’ and when considered in the context of action, “it is a sense of doubt that blocks or delays action” (McMullen & Shepherd, 2006, p.235). Uncertainty stems from risk and unpredictability of the outcome, especially because entrepreneurial ventures involve novel solutions. Uncertainty impacts decision-making and judgment qualities of entrepreneurs. McMullen and Shepherd (2006) describe three types of uncertainty applicable to individual as well organisational units:

State uncertainty: occurs when managers perceive the environment to be unpredictable;

Effect uncertainty: this describes an inability to predict what the nature of the impact on a future state of the environment or environmental change will be to the organisation;

Response uncertainty: this defines a lack of knowledge of response options and/or an inability to predict the likely consequences of a response choice.

Entrepreneurial action would be impacted by response uncertainty. Two sets of theories exist which link uncertainty to entrepreneurial action: the first set looks at entrepreneurial action as the outcome of less perceived uncertainty; and the second looks at entrepreneurial action as the outcome of more willingness to bear uncertainty (McMullen & Shepherd, 2006). When synthesising theoretical contributions, McMullen and Shepherd (2006) suggest a two-stage model of relating perceived uncertainty and motivation to entrepreneurial action. Stage I considers attention aspect and is characterised by radical uncertainty (ignorance) about the opportunity. Stage II considers the evaluation aspect of opportunity, and denotes action-specific uncertainty.

Perhaps the best distinction between risk and uncertainty is in Knight (1921/1971) who clarifies the meaning of ‘risk’ and ‘uncertainty’ with reference to three different types of probabilities (p. 224):

A priori probability – homogenous classification of instances completely identical except for really indeterminate factors. This judgment of probability is on the same logical plane as the propositions of mathematics;

Statistical probability – empirical evaluation of the frequency of association between predicates, not analysable into varying combinations of equally probable alternatives;

Estimates – there is no valid basis of any kind for classifying instances. This form of probability is associated with the greatest logical difficulties.

These three types of probabilities describe three types of uncertainty (see Sarasvathy & Kotha, 2001). The first one – now generally accepted as the notion of risk – consistsof a future with a known distribution; the second one – generally known by the term uncertainty – involves a future whose distribution is unknown, but can be estimated; and the third one that Knight called true uncertainty – now also known as Knightian uncertainty – consists of a future whose distribution is not only unknown, but unknowable (see Table 2.2). The key difference between Knightian uncertainty and the other two types of uncertainty is that Knightian uncertainty involves dealing with a future that has no discernible distribution, not even in theory. Several researchers in entrepreneurship and economics have identified the management of ‘true’ uncertainty with the core issue of the existence, value and fundamental role of entrepreneurship as the driver of the economy.

Table 2.2: Three Types of Uncertainty and How to Deal with Them

Type of uncertainty

Risk

Uncertainty

Knightian uncertainty

The distribution of the   future

The future has a known   distribution

The future has an unknown   distribution

The future has no   distribution – it is unknowable

Type   of probability

A   priori

Statistical

Unclassified   instances

Example

Urn contains 5 green balls   and five red balls. Drawing a red ball wins $50

Urn contains unknown number   of balls. Drawing a red ball wins $50

Urn may or may not contain   any balls – event the existence of the urn may be in doubt

Methods   to deal with uncertainty

Analysis

Estimation

Effectuation

Source: Sarasvathy & Kotha (2001)

In attempting to understand how entrepreneurs cognitively solve problems involving Knightian uncertainty, Sarasvathy (2001) discovered that expert entrepreneurs (founders of companies ranging in size between $200M and $6.5B) inverted specific principles of causal reasoning. These inversions constitute a new logic – termed effectuation – that forms a basis for the management of Knightian uncertainty. Effectual reasoning proceeds outward from individual actions and tasks to emergent outcomes and goals that become evident only in the unfolding of decision-action-events over time (Sarasvathy & Kotha, 2001). The logic for using effectuation is: To the extent that we can control the future, we do not need to predict it. By contrast, causal logic used to deal with analysis and estimation suggests: To the extent that we can predict the future, we can control it.

As explained by Sarasvathy and Kotha (2001), the logic of effectuation (as opposed to causation) is particularly useful in areas where human action (locally or in aggregate) is the predominant factor shaping the future. For example, instead of defining a market as the universe of all possible customers, an effectuator would define his/her market as a community of people willing and able to commit enough resources and talents to sustain the particular enterprise. In the former case, the market is assumed to exist independent of the firm or entrepreneur; and the task of the entrepreneur is to corner as much of this market as possible. In the latter case, however, the founder, along with others, creates the market by bringing together enough stakeholders who ‘buy into’ the idea to sustain the enterprise.

Real Options

Many entrepreneurs are faced with inherent risk of loss of their investment when they initiate new ventures. In addition, companies in every type of industry have to allocate resources to competing opportunities. In existing businesses or new ventures, they have to decide whether to invest now, to take preliminary steps reserving the right to invest in the future, or to do nothing. Each of these choices creates a set of payoffs linked to further choices down the line, so all management decisions can be thought of in terms of options (Leslie & Michaels, 1997, p.8).

Real options are somewhat similar to financials options. Leslie and Michaels (1997, pp.7-8) draw parallels between financial and real options. In financial markets, purchasing an option bestows the right, but not the obligation, to buy or sell stock at a fixed price within a fixed period. For example, on January 14, 1997, when Merck was trading at $83, a buyer could have paid $17 for a one-year option to buy Merck stock at an exercise price of $70. If the buyer had exercised the option on the same day, the payoff would have been $13 (the NPV); however, having spent $17 on the option, the buyer would be $4 out of pocket, this sum representing the premium he or she paid for the flexibility to wait and exercise the option if and when the stock increased later in the year.

Advocates of real options suggest that the thinking behind financial options may be extended to opportunities in real markets that offer, at a fixed cost, the right to realise future payoffs in return for further fixed (i.e., independent of the asset value) investments, but without imposing any obligation to invest. Real options are important in strategic and financial analysis because traditional valuation tools such as NPV ignore the value of flexibility. Ultimately, the option valuation recognises the value of learning as a means to reduce uncertainty. For a specific example of how one can evaluate investment opportunities, see Leslie and Michaels (1997).

Even though in this course we think of the entrepreneurial process (see Topic 1) as a trifecta of opportunity, resources, and the founding team, the real options perspective may offer a complementary lens of the entrepreneurial process as ‘decision-making under uncertainty’ (Choi & Shepherd, n.d.). Choi and Shepherd (n.d) propose that the entrepreneurial process of starting, exiting, and growing a business forms a chain of real options and thus a path dependent evolution of new firms. In other words, the entrepreneurial process is viewed as a nexus of uncertainty, learning, and value creation, in which real options reasoning could be used to manage the process. According to Choi and Shepherd, the model of a chain of real options provides a way to better understand firm evolution in its earliest phases: entrepreneurs resolve an uncertainty and create an underlying asset. This way of organising the process minimises the downside risk, while maintaining the same upside potential for the new opportunity.

 

What are the 3 steps in identifying business opportunities?

3 Ways to Identify Business Opportunities.
Identify Your Pain Points. When searching for potential market needs, start with yourself. ... .
Conduct Market Research. Another way to prove whether a business idea is viable is by conducting market research. ... .
Question Processes..

What are the three major factors in opportunity recognition?

In this regard, opportunity recognition is based on three important factors: (1) the active search for an opportunity, (2) the alertness to perceive an opportunity and (3) prior knowledge of and experience in an industry.

What are the 3 ways to evaluate an opportunity?

How to Evaluate a Business Opportunity.
Market Analysis..
Product Evaluation..
Budget and Finances..
Risk Assessment..

What is the third stage of opportunity recognition?

Bhave (1994) develops a three-stage entrepreneurial process model consisting of opportunity recognition, organization-creation, and exchange.