11 Mar 2009
With the current economic storm raging, can a better understanding of business models make for smoother sailing for today's entrepreneur? What strategies can entrepreneurs adopt to help them weather this storm? John Mullins has researched entrepreneurial ventures and offers some valuable insights
In his new book (co-authored with Randy Komisar), Getting to Plan B: Breaking Through to a Better Business Model, he suggests there are five key elements in a well thought-through business model: the revenue model, gross margin model, operating model, working capital model and investment model. Each of these elements merits the entrepreneur's focused attention and each can often be copied from somebody with a similar - or not so similar - business who has gone before.
However, by putting these five elements together in unique ways, you can create a business that will very likely make things difficult for your competitors and potentially revolutionise your industry. That's exactly what Steve Jobs did in adapting the well-known razors and razor blades model and turning it upside down to create Apple's iPod and iTunes phenomenon.
Webvan was going to be the online grocer, and it raised $375 million to set up operations in nine US cities. It fizzled in 2001 when it could not generate enough volume from customers who wanted to buy milk by using a computer keyboard. Pets.com had a sock puppet mascot that was adored by millions during its 1998-2000 lifespan, only a relatively few of whom were attracted to the idea of buying kitty treats online. Even Flooz.com, which attracted the support of vendors such as bookseller Barnes & Noble, could not convert $35 million of investments into a winning idea for developing a new kind of online currency to be used only for Internet purchases. Flooz flopped in 2001 along with many other e-businesses.
What can we learn from all the dot.com ventures that went bust at the turn of the millennium? For starters, you can't make money shipping 50 pound bags of dog food, one at a time. Nor can you make money selling low-profit-margin groceries online from big, expensive automated warehouses. However, it wasn't that all those core business ideas were necessarily bad; the flaw lay in the business models that were chosen to pursue them. In other words, every new business will assuredly face "storms" in the form of, among other factors, unexpected operational problems, unanticipated competition, unknown customer behaviours and unpredictable economic turbulence. Is there a best way to make a start-up business more storm-proof? Without question, the answer is yes.
Start with the model
Entrepreneurs begin with a new "business model". What I mean by that term is the economic characteristics that define the heart of the business: how revenue and gross margin are earned, how operating expenses are taken out of that, how working capital happens and how the investment characteristics of the model come together. All those things have to happen in a well-integrated fashion so that the economics stack up. It is the first requisite for any new business.
Randy Komisar, my co-author for Getting to Plan B: Breaking Through to a Better Business Model, and I suggest that there are five key elements in a well thought-through business model: the revenue model, gross margin model, operating model, working capital model and investment model. Each of these elements merits the entrepreneur's focused attention and each can often be copied from somebody with a similar - or not so similar - business who has gone before. However, by putting these five elements together in unique ways, you can create a business that will very likely make things difficult for your competitors and potentially revolutionize your industry. That's exactly what Steve Jobs did in adapting the well-known razors and razor blades model and turning it upside down to create Apple's iPod and iTunes phenomenon.
Often with entrepreneurs it's not the initial plan that reaps success, but ideas that come to fruition much later in the process. In fact, most investors will tell you that the successful companies in which they put their money almost always made their money not on Plan A, the initial idea for which a business plan might have been written, but on Plan B or maybe Plan C, D or Z.
Randy and I studied the process by which an entrepreneur can go from Plan A (the one that probably won't work even though he or she is passionate about it) to a different kind of plan that actually might succeed handily. And we've learned that there is systematic way to do that. The essence of the process is contained in this observation: there isn't very much that's new in the world, but what is possible is a new combination of things that have gone before.
Gather analogs and antilogs, test the hypotheses
We advise entrepreneurs, when thinking about their Plan A, to ask what the analogs are, those related business ideas that have gone before from which they can remix elements into their emerging business model. They must also determine what we call antilogs, that is, things that have gone before their attempt at a new business but from which they know they want to do things in a different way.
Having done so, there will inevitably be some critical unanswered questions or untested assumptions about which the entrepreneur cannot be sure that prior knowledge will apply. We call these assumptions leaps of faith and they must be tested by doing market experiments or getting the business launched in a pilot sort of way. By testing and answering their commercial hypotheses, entrepreneurs find out quickly (and, hopefully, not very expensively) that quite probably Plan A won't work, so they've got to change something; and that takes them to Plan B.
Every entrepreneurial plan, then, includes ideas that can be sorted into three categories: (a) ideas tried by others in the past that have some analog value to what's being tried in the new business model, (b) ideas tried by others in the past that are clearly not worth adapting or emulating in the prior way and (c) ideas that are untested, untried and (possibly) a real breakthrough - they are "leaps of faith" that an entrepreneur intuits will work but need to be tested.
Thus, what entrepreneurs should do is craft an initial plan that posits clearly the leaps of faith that have to be tested: if those pan out, great, then they can go forward; if they don't pan out, that's also great, because then they've learned something and can change plans. So our suggestion is that, rather than writing a business plan that's so committed to Plan A, why not just step back a little and ask, what are the crucial questions that must be answered to know why an idea might not work and how can those questions get answered as quickly and as cheaply as possible?
It's a fact: most new companies fail, so rather than blindly trying to overcome all the obstacles, we think it's wiser to think about the entrepreneurial path as one of testing hypotheses. Think about the five elements of the business model and how they are going to work together, identify relevant analogs and antilogs, then test the things you're not clear about or that you think are leaps of faith that the prior history can't answer, and do that in a systematic, measured, but passionate way.
Nail what's critical
After the entrepreneur has begun to make progress in this way, it's smooth sailing from then on, right? No, not at all. First, new leaps of faith will inevitably arise, and they, too, must be tested. Second, there is something else that is critical for success. That "something else" is a management team's ability to execute on the few critical success factors (CSFs) - no more than a handful, usually - that account for much of the difference in performance in companies within an industry. A key difference between winners and losers is that the winners figure out the factors critical to succeeding in their particular industry and then build their teams accordingly.
Knowledge of the CSFs for an industry resides in the experience of those who have learned (often the hard way) which things must be done right or they might sink your business. Whether you have such experience or you must access that of others who have it, there are two key questions to ask to identify your industry's CSFs:
Which few decisions or activities will, if done incorrectly, almost always negatively affect company performance, even if most other things go right?
Which decisions or activities, done correctly, will almost always deliver disproportionately positive effects on performance, even though other mistakes are made?
To identify the CSFs in your industry, ask the two questions above of 15 or 20 thoughtful, successful entrepreneurs and executives in your industry. You'll get a variety of answers, of course, but a consensus will likely emerge on the same few themes. That's what you are looking for.
Do investors care about the execution of the critical success factors? Absolutely, they do. It's what keeps them awake at night. It's the best protection they have after they've decided to invest in a nascent entrepreneurial venture. No wonder they'll ﬁxate on it before they settle up.
As one leading investor noted, "We really dig into the management team. We want to be totally conﬁdent that this team can deliver on the promises they have made. We do that by looking at their experience, by assessing how well they understand their industry and their customers. We want to know about their leadership in terms of the CEO and the heads of engineering, R&D, and marketing, or whatever the most important functions are for any given opportunity."
What investors look for in people they back is simple, really, but not obvious to most aspiring entrepreneurs. Investors want to know:
That the entrepreneur has identiﬁed and understands the CSFs in the industry he or she proposes to enter, as well as the market and competitive environment the company will encounter. A credible, fact-based assessment of the seven domains of attractive opportunities can provide the evidence: that's step one.
That the entrepreneur has assembled a team that can demonstrate by past action (not word-packed promises!) that its players, working together, can execute - that the team can do what it says it's going to do. Or, alternatively and equally satisfactory, that the entrepreneur has identiﬁed what's necessary as well as what's lacking on the entrepreneurial team and signed on to ﬁll that gap, perhaps with the investor's help, before starting operations.
After an entrepreneur has developed his or her thinking by using the process outlined above, identified and addressed the CSFs of the industry he proposes to enter, and assembled an experienced team that can work together, he can set his new venture's sails for the first part of the journey. It won't always be smooth sailing ahead, but his preparation will enable the venture to better handle any storms it encounters.
John Mullins (firstname.lastname@example.org) is Associate Professor of Management Practice at London Business School and holds the David and Elaine Potter Foundation Term Chair in Marketing and Entrepreneurship.
Kent German, "Top 10 dot-com flops", http://www.cnet.com/1990-11136_1-6278387-1.html.
John Mullins, The New Business Road Test: What Entrepreneurs and Executives Should Do Before Writing a Business Plan, FT Press, 2006.
John Mullins and Randy Komisar, Getting to Plan B: Breaking Through to a Better Business Model, Harvard Business School Press, forthcoming 2009.