The process of due diligence is something that is customarily done in the venture capital community to evaluate the potential of ventures and startups, and it consists of analyzing and validating the information that is contained in the business plan. This process is valuable for entrepreneurs, startups and companies of all sizes to use for any new product idea. Because of the thorough approach normally used during the process, every aspect of the idea is examined, from market potential to customer fit to technology solution to the financial forecast. This cross-functional evaluation means greater potential for the ideas that pass this scrutiny and ultimately results in greater profitability as the idea is developed and then launched. Any company can use due diligence principles to evaluate new product ideas.
Think like an investor
The best way to objectively approach the due diligence process is to assume the perspective of an investor. What would you look for in order to be assured some return on your investment? It might be a very large market, a ready customer, a sustainable competitive advantage, short-term profitability, or all of these things. Even if the new product will be developed inside a company, it’s important to view each idea as a new business. Basically, you need customers with a compelling problem, a product that addresses the problem, resources to develop and launch the product, and profit in order to sustain the business.
A good set of due diligence criteria can be found in Chapters 3 through 8 of my book, From Idea to Launch at Internet Speed. There is one chapter for each of the following six criteria: Strategic Fit, Customer, Competition, Market, Resources and Profit. The book has a lot more detail about how to gather information for each of the criteria and how to do analysis, but I’ll provide a brief summary here.
Start with the customer
Unfortunately, the vast majority of companies first develop products and then look for a market, not the other way around. However, if companies could first think about customer problems and how they could use their core competencies to solve it, market pull is created, and it’s a lot easier to achieve early sales and grow market share quickly. Even if you already have a product concept in mind, it may not be too late to use this approach. For instance, you probably have some idea as to the type of customer that might be interested in your idea. That’s where you start, by actually talking to a target customer. You will want to find out as much about the customer as possible, as if you were creating a biography of them. You’ll want to know how they might currently solve the problem that you think you will be solving with your new product. Sometimes, you find that a customer is interested in a slightly different product, and if your company can still build it, you may end up with a more lucrative opportunity than your original idea.
Once you have an idea of how you can solve the customer’s problem, then you must determine what it’s worth to the customer. How much are they willing to pay for it, and what are the business benefits to them? This is called defining the value proposition. When you’ve found your target customer, then it’s time to figure out how many customers are out there who might be willing to buy this product; that’s how you estimate the market size. You also need to look at market trends to determine whether the target market is shrinking or growing, and by how much per year.
The customer and market are only half the battle
So you have a potential customer and you know the value proposition. The next questions are: can you develop a product that will fit the value proposition, and can you build and sell the product at a price the customer can afford? This is the point when you need to objectively look at your new product idea; is it really what the customer needs to solve their problem? Sometimes new product ideas are “ahead of market,” meaning that the customer isn’t ready for the product your company has in mind. The customer may, however, need something similar or some of the functionality, so there may be a fit.
If there is a fit, do you also have the capacity to deliver the product to the market and achieve your target market share? To determine your target market share, you first need to take a look at the competition.
Don’t look now, but there are competitors lurking
No matter how brilliant your product idea, there will always, always be competition. There’s no getting around it, so the best thing to do is just plan for it. Competitive analysis should be done at three levels: competitive environment, company level and product level.
The competitive environment is a high-level look at your target market. Who else is there? Are there one or two major companies, lots of companies, or none at all? The competitive strategy as well as the market entry costs will be driven by this characterization of the competitive environment. Fragmented markets with lots of competitors require a strong differentiation strategy. If there are no established competitors in the market, it may require more money to educate the target customer about the product. Competitive analysis should also be done at the company level and product level. Examine the company factors such as financial health, history, mission and vision, partners, and size of the companies that you will compete with. At the product level, do a one-for-one comparison of features and function. Create a matrix that shows the comparison at a company and product level. Once everything is on one chart, you will then have a better idea of how much market share is possible.
Strategic Fit and Resources also need to be examined. Sometimes, a new product idea is so radically different from its organizational culture or the way the company does business that it requires too much radical change. Technology and human resources also have a bearing on whether the idea can be fully productized. Intellectual property protection and technology know-how are critical for developing the product idea. The availability of the right types of human resources during the new product cycle are also key; do they exist, or will significant hiring need to be done in order to fully develop the idea?
The bottom line
Profitability is not often projected or analyzed during the idea phase of the new product cycle, but it certainly can and should be. You need to take a look at the end-to-end costs for the whole product cycle to evaluate the cost side. You need to project the sales over a period of years to evaluate the revenue side. Plot the costs and the sales, and where the lines of the graph cross, that’s the point in time when the product becomes profitable. The amount of divergence between the two lines on the graph is the profit, and investors should ask: is this enough profit, soon enough, to warrant the investment?
Gather the data and think it through
Using the six categories of criteria, gather all the data together and analyze. The next step is to think it through as a business. When the business plan is developed and the presentation is made to internal or external investors, it should be presented as a business case, not just a great idea.
The quick and quirky example
Here’s a hypothetical example of how to use due diligence for new product ideas. Let’s assume you have just been transferred from the marketing department to a product group in your company. Your first assignment is to put together the internal business plan for the most promising product idea in your group, which consists of twenty engineers and developers. They have submitted ideas for ten new products, and your boss has prioritized them. You decide to do detailed analysis for two of the product ideas and then develop the business plan for the idea that will generate the most profit in three years. Your boss agrees with your approach.
You roll up your sleeves and do preliminary research on each idea: collecting information from the Internet, the corporate market research group, the research and development team, and one of the company’s financial analysts. Now you’re ready to assemble the information for each product idea as follows on the next page.
The first idea is for a medical records card, HealthCard, which would contain laboratory and other test results that patients can carry with them for doctors to use. This is similar to the embedded chip concept, except this is not an invasive procedure and the thinking is that more people would be willing to carry a card than having a chip implanted. A card would give the patient more control as to who has access to it, and how the data is used. Information would be added to the card each time new test results were made available to the patient. The card would be updated using a programmable card read/write device in the lab, clinic or doctor’s office. The patient could choose which data to add to the card.
Strategic Fit Rating 5
Since your company is in the business of software and database applications, this idea complements the company’s strategy and provides a way to enter the healthcare market, one of the company’s longer-term goals.
Customer Rating 4
For the HealthCard, there are two types of customers. The primary customer is a consumer with personal medical information. The value proposition is that the HealthCard will give consumers greater control of their medical information in terms of how and when it is shared with their healthcare providers. According to your research, most people would prefer a card than an implanted chip because a card is less invasive and can’t be accessed without the person’s knowledge. The secondary customers are the medical services providers, such as clinics, laboratories or doctors. These providers would be updating the patient’s card with test results, diagnoses, and other information. They would have to purchase equipment to read from and write to the card. The value of this system to the providers is in reducing the time it takes to retrieve and update patient records.
Competition Rating 3
There are a broad range of competing solutions here, including the chips that can be implanted under the skin, insurance credit cards that could carry medical info, and bar code systems. With all the competition, your primary differentiator will be the claim that the patients have greater control. The medical offices will still need to purchase some unique equipment for scanning and updating the card, so there is no particular advantage to them.
Market Rating 3.5
Because there are so many competing solutions, your ultimate market share will be limited. However, that may be offset by the fact that there are millions of patients out there who are potential customers, so the target market is pretty large.
Resources Rating 4
With your company’s software and database savvy, the network and software infrastructure for the product will be relatively simple. However, the card scanning and reading technology will require hardware, which means that a technology partner would have to be found to build that end of the solution. Other than that, you have all the resources you need to carry this out.
Profit Rating 3
With the help of the financial analyst, you have estimated the end-to-end costs of designing, developing and selling the HealthCard system. There will be relatively high costs for initial marketing and sales because it will require selling on two fronts: the consumers and the medical office staff. On the revenue side, the numbers look very large from sale of the cards and look average for sale of the card scanning devices because you will be a reseller of the hardware built by your strategic partner. You estimate being profitable in the third year.
The second idea is an online portal for the bereavement and funeral industry, which would link charities with people who wish to make donations to memorialize the deceased, which is often done in lieu of sending flowers. It’s called Memorial Pathways, and the business model would consist of donors paying a fee to record and submit a donation, and the receiving charity also paying a transaction fee to receive the donation. The online portal would link funeral homes, newspapers and other publishers who print obituaries, and charities.
Strategic Fit 4
The company has been successful in web-based deployment of software applications and databases but not specifically with portals, so this would be a new experience. The company has had a lot of experience in developing partnering relationships, however, which would be required to pursue this idea.
There are two distinct customer groups that are sources of revenue: individual donors and charities. Although funeral homes may be involved in the business model, they more likely would provide referrals and links to you for their clients. Your company would be responsible for: providing a website for donation notices (bereaved family requesting donations); listing donations (that state the donor and the person being memorialized); creating links to newspapers for obituaries; handling the transactions from the donor side, and processing the notifications and transactions for the charity side. In terms of numbers, the only two things in life that are certain are death and taxes. So, there will be a continuous supply of grieving families and friends who will want to memorialize their loved ones. Today, many families request that people make donations to their favorite charities instead of flowers; it’s a growing trend.
This is a fairly new concept, so you’d probably be the first to provide this set of services. Charities themselves could be considered competition, but sometimes it’s difficult for individuals to find out how to contact charities for making donations and, in effect, they might get more donations if somebody set up a portal system. Newspapers might also be partial competition because they post funeral notices and obituaries. So, this would be a new market, which means spending money to develop it and educate people about how the service works.
By being first to market and with a steady market demand, the combined market factors look good as long as you can set up all the business relationships to make it work.
Your company may need to bring in a specialized consultant for portal systems and some other domain experts who know something about charities and the funeral industry. Other than that, you will have enough resources to complete the product.
On the cost side, your biggest expense will be engaging a consultant with portal expertise to set up the system. Once the portal is in place, your ongoing expenses should be minimal. On the revenue side, the transaction fees will be relatively small, so there will have to be considerable volume in order to break even and be profitable. This product might not create high revenues in the longer-term because the market may be slow to develop into sustainable volume.
The Final Comparison
Drum roll, please. The average score for HealthCard is 3.75 and the average score for Memorial Pathways is 3.58. So, based on this rather unscientific, gut-level scoring system, you will spend your time doing a full business plan for HealthCard, satisfied that you did at least some high-level due diligence for each new idea.