How to Find Profitable Business Ideas
Posted 4 years ago by capitalandgrowth
Startups
In an era of tech startups, angel investors, venture capital funds and unicorn hunting, an often-
overlooked avenue for entrepreneurs to create successful businesses with great long-term
potential is to discover viable Red Ocean business opportunities within established markets.
Generally, there are two ways that entrepreneurs can create a successful business by meeting a
market’s unmet needs – Blue Oceans and Red Oceans.
The first method, discovering Blue Oceans, is sexy and generates tons of press. It involves
identifying unmet customer needs within a market, and then solving those unmet needs with a
new, customized business solution.
Phrases like “Blue Ocean Strategy” and “business model discovery” are tossed around liberally to
describe this approach. If executed correctly, this method can yield entrepreneurs billions of
dollars. Examples of successful strategy type have been Google’s search engine, Apple’s iPhone
and the Ford Motor Company’s Model T. W. Chan Kim and Renée Mauborgne refer to this type of
business idea as a Blue Ocean Strategy.
The second method, finding a good Red Ocean business opportunity, is not particularly sexy, but
it is tried and true. Entrepreneurs can identify if a market problem is being underserved by the
current providers of solutions for that particular market problem.
If so, then entrepreneurs can replicate an existing business solution for that particular market to
address that unmet market demand. An example of this would be an entrepreneur opening a
casual, family-style restaurant in a small town with sufficient demand for that type of restaurant.
Casual, family style restaurants have been in existence for decades, if not centuries. The
entrepreneur is not creating a new, customized business solution to address the market’s
demand. Instead, the entrepreneur identified a “gap” in a market that already exists and is simply
filling that gap with a readily available business solution. W. Chan Kim and Renée Mauborgne
refer to this type of business idea as a Red Ocean strategy.
We have already discussed Blue Ocean Strategy in detail here on Capital & Growth. Now we will
focus in on often overlooked ways to discover Red Ocean business ideas. Red Ocean business
ideas can be uncovered through using either of both of the two following processes:
1. The Internal Approach
2. The External Approach
1. Observation
2. Focus Groups
3. Reverse Brainstorming
4. Market Growth
5. Matrix Charting for Insights
6. The “Slice of Life” Approach
7. The Market-Area Saturation Approach
8. The Competitive Matrix Approach
We will flesh out these two approaches in detail and demonstrate that successful entrepreneurs
often don’t need to discover a world changing business model, they often just need great insight
into the customer demand within a particular market.
The Internal Approach
Entrepreneurs often approach the task of coming up with a business idea by looking at their own
background, skills, passion and abilities. In using this approach, the entrepreneur basically
determines that they are the primary factor in whether they will succeed or fail in business.
Let your Skills and Experience Guide You
An entrepreneur’s prior industry experience is the most common single source of entrepreneurs’
business ideas. According to Inc. magazine, 43 percent of entrepreneurs reported they got their
business idea from the experience they gained while working in the same industry or profession.
The experience the entrepreneurs gained from working within their industry helped them identify
gaps in the industry’s market or provided the knowledge and insight to create a company that
could serve that industry’s market more efficiently.
Some entrepreneurs start businesses based upon their hobbies or avocational interests. They
turned their passion for a particular activity or subject into a business venture. Some
entrepreneurs start comic book or model train stores, small vineyards, or bed and breakfasts.
Often these businesses are not started to reap considerable profits, but instead to pursue a
lifestyle that brings joy and personal satisfaction to the entrepreneur.
Entrepreneurship by Braille
Stephen Harper, in his excellent book Extraordinary Entrepreneurship [link], argues that the hobby
or personal interest approach to starting a business is “entrepreneurship by braille.” This is only
pursuing opportunities that are within reach – namely what you know and like.
This could also be starting a business solely based on where you live or where you want to live.
Essentially, this is starting a business in search of customers. It is a very different proposition
than creating a business to serve readily defined customers who already exist. If what you like is
what the market objectively wants, then pursuing the business idea makes sense.
But if the market for what you like, what interests you or where you live is too small or diffused to
support your business idea, then creating that business is a fool’s errand (unless you have money
to burn).
Developing “Organic” Ideas
In his fantastic essay, “How to Generate Startup Ideas,” Paul Graham advises that entrepreneurs
should conduct “entrepreneurship by braille” – uncovering business ideas that fall within the
experience and expertise of the entrepreneur. Graham counsels that the best way entrepreneurs
can develop startup ideas is organically by “noticing” market opportunities.
He claims that entrepreneurs “notice” startup ideas when they perceive solutions to urgent
market problems to which adequate solutions do not currently exist. Graham says that noticing a
market opportunity is essentially a passive process, and it is usually not achieved by actively
trying to create a great business idea. He remarks, “If you look at the way successful founders
have had their ideas, it's generally the result of some external stimulus hitting a prepared mind.”
Graham advises that entrepreneurs should focus on startup ideas in areas where they have
expertise, first-hand experience (which ensures the problem actually exists) or a deep
understanding of potential customer pain points. He claims that, “the best approach is more
indirect: if you have the right sort of background, good startup ideas will seem obvious to you.”
He also states, “ideas… that grow naturally out of the founders' own experiences are organic
startup ideas. The most successful startups almost all begin this way.”
The External Approach
The External Approach (or the “Outside-In approach”) to discovering viable business ideas looks
first to the external market (verses the skills, knowledge and tastes of the entrepreneur) and tries
to methodically discover market gaps that already exist.
The central idea of this approach – opportunity recognition – is that a business can succeed only
if it responds to, or creates, a need in the market. In plain English, the External Approach is about
finding a gap in a market. A “gap” in the market is where the market, at present, does not contain
a solution to a customer problem.
These market gaps are also called “white space.” Market gaps are everywhere. They are in a
constant state of flux, morphing and changing as technology, demographics, regulation, culture
and global influences shift.
It is up to entrepreneurs to determine how big these market opportunities are and why they exist.
The “white space” opportunity may be fleeting – a very short-term prospect – or the white space
market may not be big enough to sustain a profitable business. But then again, it may just be a
defensible, exploitable gap in the market, overlooked and waiting to be exploited.
Entrepreneurs must be able to scan their surrounding environment and recognize opportunities
(market gaps). This requires the entrepreneur to develop what Harper calls an “opportunity
antenna.”
Recognizing opportunities always seems easy and obvious in hindsight, but in the present – and
that’s what counts – it is a difficult and often infuriating process.
A wildly successful example of recognizing a large, sustainable market gap was Chipotle.
Chipotle filled a gap in the market between family style restaurants (good Mexican food with
fresh ingredients at modest prices) but in a convenient, informal fast food venue.
The outside-in approach is generally better than the inside-out approach because it attempts to
analyze market opportunities in an objective fashion. But the best approach is when it is possible
to combine both approaches – the entrepreneur has a deep knowledge and expertise in an
attractive market.
We will discuss and analyze the following outside-in techniques for discovering market gaps:
Observing the Market
Focus Groups
Reverse Brainstorming
Market Growth
Matrix Charting for Insights
The “Slice of Life” Approach
The Market-Area Saturation Approach
The Competitive Matrix Approach
None of these approaches is a silver bullet. Its best to use a combination of the methods
described below. The more of these approaches that an entrepreneur uses to evaluate a business
idea, the more likely accurate the entrepreneur’s analysis is going to be.
Observing the Market
This technique is deceptively simple and requires an entrepreneur to experience a “blinding flash
of the obvious.” The potential entrepreneur should look around and listen to what people are
complaining about. The entrepreneur should use their complaints and gripes to identify market
gaps that need solutions. An entrepreneur could listen to people in public places, observe
complaints on social media (Facebook, Twitter, LinkedIn… etc.) or traditional media and try to
formulate possible solutions to the problems those complaints identify.
Focus Groups
Focus groups are where an entrepreneur gets a sample of people together, lets say 5 to 20, and
poses open-ended questions to them to uncover “gaps” in their personal and professional lives.
By providing a guided discussion, the entrepreneur can focus in on the participants’ problems.
A list of problem areas can be recorded by the entrepreneur during the focus group. After the
session, the entrepreneur can attempt to create solutions for the identified problems. The focus
group does not have to be conducted face-to-face. An entrepreneur can use social media, such
as Facebook, to pose open ended qualitative questions to a particular circle of friends or
acquaintances.
Reverse Brainstorming
Reverse brainstorming is where a focus group is asked to consider a particular problem with a
product or service (such as smartphones) and identify possible solutions for it. The idea is to
basically crowdsource an innovative idea by soliciting a group of people for a creative insight on
how to fill in a gap in the market.
Once again, social media networks can be leveraged to solicit a group of friends or
acquaintances. Questions that can be asked to help solve pain points are:
1) Can it be made smaller, larger, better, or differently?
2) Are there other users, uses or ways to increase the usage rate?
3) Can it be combined with something else?
4) Can it be done more quickly?
5) Can it be made more convenient, available, attractive, quieter or last longer?
Matrix Charting
Matrix charting is a way to systematically search for opportunities by listing important elements
for each product or service along the left-hand vertical column of a grid and questions regarding
each of these elements along the top horizontal row of the same grid.
The entrepreneur then tries to fill in the grid boxes with answers for each attribute question. An
entrepreneur can use this technique by herself or with a focus group. Questions may include:
What can it be used for?
Where can it be used?
Who can use it?
When can it be used?
How can it be used?
Below is an example of a Matrix Chart for a Laundry Service:
What can it be Who can use When can it How can it be
used for? it? be used? used?
24-hour turn
around
Folded and
Ironed clothes
Home
Delivery
Industry Growth Rates
At any given time, there are dozens of industries operating within new and underserved markets
that are experiencing rapid growth. Some of these industries are growing at up to ten or twenty
times faster than the overall economy.
These industries are usually in their early growth phase and the companies within them are highly
profitable. Furthermore, these industries often have low barriers to entry. This almost always
represents a possible entrepreneurial opportunity.
To find out which industries are experiencing rapid growth, its often useful to look at secondary
research sources. Three great secondary resources to gauge industry growth are IBIS Industry Reports,
Dunn & Bradstreet and SageWorks [insert links for all three]
For example, IBIS offers comprehensive market reports on over 700 industries. IBIS’s media center on
their website is a great resource to find out what industries or industry segments are experiencing rapid
growth and high profitability.
In 2018, IBIS identifies the following as five of the fastest growing industries:
Medical and Recreational Marijuana Retail Stores: 40.2%
Medical and Recreational Marijuana Growers: 43.6%
Wind Turbines: 48.8%
Wireless Communications Carrier Industry: 8.6%
Armored Vehicles: 17.4%
SageWorks is a real-time database of private company financial information. It offers its information
services to lending institutions to help those companies gauge lending risk to their borrowers.
It too publishes a ranking of the fastest growing industries in the United States every year. The following
are its forecast of the top 10 growing industries in 2017.
The “Slice of Life” Approach
Richard White, in The Entrepreneur’s Manual, [insert link to resource] creating a decision tree that
divides life by time and experiences exactly in half. For example, White recommends a person
initially divide life between work and leisure.
If you choose work, then you could divide work between productive work time and unproductive
work time; if you choose unproductive work time, you can then choose between unproductive
work time at work before lunch or after lunch.
Once a “slice of life” has been sufficiently broken down into a discrete slice, the object is to
analyze that particular slice of life for problems people have during that particular slice of life.
The “Slice of Life” Decision Tree:
There are potentially hundreds of discrete problems people have with this particular slice of life.
For example, people could have trouble focusing on work because they are sleepy after lunch;
they may not be productive because they do not have access to small amounts of downtime to
let their brain rest; they may not be able to concentrate on work because they are hungry and
need a snack; they may be unproductive in the afternoon because they are stiff and sore from
sitting at a desk for hours by that point.
There are hundreds of problems that exist within this slice of life. Life can be sliced up according
to geography, time, activity, objects, experiences or people.
After you identify the problems, begin searching for solutions. You can do this by coming up with
solutions yourself or asking a focus group. For example, a possible solution for “crashing” after
lunch may be a simulative energy drink (like coffee, Red Bull, Five Hour Energy) that is natural and
won’t harm your body.
Each of these problems offer scores of solutions, but they these problems may already be
addressed by other firms in the market or the solutions may not be profitable. It is up to the
entrepreneur to sift through these potential solutions and look for one that satisfies two
conditions:
1. the solution must be potentially profitable and
2) the market currently does not have a solution addressing that problem (or at least one not
addressing it well).
Note: This technique is derived from a fantastic book by Stephen C. Harper called Extraordinary
Entrepreneurship. I highly recommend this book if you want to explore this opportunity
identification method further. Harper derived the Slice of Life approach from Richard White’s
classic book, The Entrepreneur’s Manual.
The Market-Area Saturation Approach
The Market-Area Saturation Approach is used to find potential market gaps within a specific
geographic area. The Market-Area Saturation Approach “is based upon the premise that for a
town with X number of people, there should be Y number of businesses of Z type.”
Basically, entrepreneurs can analyze particular population centers and then try to identify if the
current brick-and-mortar retail or service enterprises are underserving those markets.
This could be determined by taking the number of specific establishments (say pizza parlors) in
your state and divide it by your state’s population. Then, multiply that fraction by the population of
the geographic area you are analyzing (say 100,000 people).
That product would be the average number of establishments, in your state, that a particular
geographic area could support.
For example, a certain town (or a collection of towns within a given geographic radius) you are
analyzing may have roughly 100,000 people.
After conducting some research, you discover that in your state, you may roughly expect that a
population of 100,000 people would contain, on average, 11.3 pizza restaurants, 2.0 florist shops,
1.6 tanning salons, 4.0 gyms and 1.0 bowling alley. A great resource for conducting this research
is SimplyAnalytics. Another resource is the Business & Industry section of the U.S. Census
Bureau at http://www.census.gov/econ/index.html.
After completing this task, you would then survey a specific geographic area with a similar
population profile (100,000 for instance) and count the number of establishments serving
customers within this area.
A resource you could use for this is Google Maps. Your search may turn up that your target
geographic area contains nine pizza parlors, three florist shops, two tanning salons, one gym and
one bowling alley.
According to this analysis, it would appear that the particular geographic area and population you
analyzed has significant unmet demand for gyms and modestly unmet demand for both pizza
parlors and tanning salons.
Your analysis also determined that bowling alley demand is currently being met while there is
probably an oversupply of florist shops. Based upon these findings, it would probably be a good
bet that there is enough demand within this particular geography and population to justify
opening a gym.
The market-area saturation approach should be seen as a rule of thumb, not a precise scientific
instrument. The size, location, competitive strength and qualitative factors of each establishment
are not considered with this analysis. But this broad brushstroke approach may find potential
business opportunities that deserve closer scrutiny.
Create a Competitive Matrix:
If a prospective entrepreneur has already decided what general product or service she wants to sell within
a niche market space (geographic and otherwise), then the Competitive Matrix may help identify potential
gaps in the market.
The Competitive Matrix is an attempt to quantify the existence of a potential market gap, but the value of
that quantification relies on the quality of the entrepreneur’s analysis of the market.
An entrepreneur should divide the market that they want to enter into corresponding market segments.
These market segments can be characterized by geography, demographic and psychographic
characteristics, and behavioral patterns.
For each of these market segments, the entrepreneur will create a matrix. The top horizontal row will
identify the current businesses that currently provide value proposition(s) (goods and services the
entrepreneur seeks to provide) to the market segment.
The left vertical column of the matrix will list key factors important to the business’ value proposition(s). A
blank customer segment competitive matrix example is shown below.
The entrepreneur will need to conduct first hand research (by using polling research and/or focus groups
of the market segment’s customers) to determine:
1. Competitive Factor Importance – The level of importance that members of a market segment place on
each competitive factor (value proposition). This number is measured as a whole number from 1 to 5,
with 1 being the worst and 5 being the best. This number is placed within the upper left-hand box in each
Competitive Factor/Business # cell.
2. Competitive Factor Satisfaction – How well each current business meets its customers’ needs for each
competitive factor (value proposition) to the customers within a particular market segment. This number
is measured as a whole number from 1 to 5, with 1 being the worst and 5 being the best. This number is
placed within the upper right-hand box in each Competitive Factor/Business # cell.
A market gap exists within a market segment when existing businesses that cater to it are not supplying
the type or quantity of value that the market segment demands. In other words, market gaps exist where a
business is underserving a competitive factor to their customers relative to the level of importance
customers in that market segment place on that competitive factor.
For example, if quality is important to a particular market segment (5), but the current businesses catering
to that market segment are providing goods with mediocre quality (3), there is then a gap in the market
related to this competitive factor.
For each competitive factor, gaps of only one point of separation between what the segment considers
important but existing businesses do not provide the level of value demanded by the market segment
indicates a small gap in the market. But existing businesses can usually adapt to cover this gap without
much effort.
For each competitive factor, gaps of at least 2 points of separation between what the segment
considers important but existing businesses do not provide that level of value to the segment will
require those businesses to make significant changes in the existing business’ strategy. This is a market
gap ripe for exploitation.
Items of Note:
If the difference between the Competitive Factor Importance and the Competitive Factor Satisfaction is
a gap of one point, it will be signified within each bottom right box of its competitive matrix cell by a *.
If the difference between the Competitive Factor Importance and the Competitive Factor Satisfaction is
a gap of two or three points, it will be signified within each bottom right box of its competitive matrix cell
with either ** or ***.
The combined score for each competitive factor is the product of the business’s Competitive Factor
Importance and the business’s Competitive Factor Satisfaction. For example: 3 x 4 = 12. The number
signifies how well each current business satisfies the customer segment for a particular competitive
factor.
The Business’ Relative Strength for the Customer Segment row (at the bottom of the matrix) is an
aggregate approximation of how well each current business serves the market segment.
Gaps of two points or greater represent significant market opportunities for market entrants.
If a whole row has asterisks, then none of the current businesses is meeting the segment’s
expectations.
Example: Casual Dining Market
Market Segment – University Faculty and Staff, Establishments within ½ mile of an urban university
Survey and/or Focus Group Results
Competitive Factor
Competitive Factor
Importance
Price 3
Quality 4
Selection 5
Promotion 2
Customer Service 4
Facilities/Atmosphere 4
Location 3
A Note of Caution in using the Competitive Matrix Approach
This method may take considerable time, money and market research to complete. If an entrepreneur
uses this approach, he or she should confine the analysis to a few select market segments within a
market.
The Competitive Market Approach can be a powerful tool, but its effectiveness is solely dependent on
the quality of data collected from the customer segment’s being analyzed. If the quality of the collected
data is low, the resulting analysis could be wildly off the mark.
Why Red Oceans Matter
In today’s tech-centered vision of entrepreneurship, where everyone is intent on inventing and proving new
business models and discovering new markets, its important to remember and carefully consider the
proven value of Red Ocean ideas.
For every tech unicorn tech story like Uber or Airbnb, there are a hundred Red Ocean success stories (like
Papa Johns, Peets Coffee or Motel 6). While these Red Ocean ideas may not (and probably won’t) result in
creating multibillion dollar companies within a ten-year period of time, they do offer entrepreneurs the
opportunity to create excellent, successful businesses that can lead to riches and personal autonomy.
By Christopher Sheppard. Chris is an an investment banker with ACT Capital Advisors. Looking to sell your
business? Talk to him.
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