Strategic Failure: Profit

There’s a common Internet meme that has been around for some years now in which includes three step-by-step directions, to wit: 1. Buy Products; 2. Sell Products; 3. Profit! As far as I can tell it started out as a sarcastic comment on people doing things that shouldn’t normally gain a profit, either because one or two of the steps involve criminal/unethical behavior, or because at least one of the steps involves something for which no sane person would pay money. What may not be clear, especially now that the meme has become something of a cliché, is that this faulty strategic approach is responsible for a very large number of business failures every year, especially in the case of online businesses and websites that are intended to make a profit…

With the rapid expansion of online businesses in the late 1990s and early 2000s, a lot of people with brilliant technical and programming skills but limited business experience began creating websites that they believed would be an effective license to print money. I got to work with some of these folks during my time with the Small Business Development Centers program from the SBA, and almost inevitably, the founders of the company had created an amazing product or service, but had never considered how they would get paid for their work. Most net citizens at the time would not pay for content, and selling advertising on the site was difficult unless you could prove that the advertisers would be able to generate actual sales off those specific ads…

Even today, it remains difficult to get people to pay for online content unless it serves some function they can’t get in the real world or just steal off of any of the various pirate sites. Selling advertising is still a possibility, of course, if you have millions of visitors each day, but the presence of sites like YouTube and Facebook make that harder for a small business to achieve, not easier. Most internet advertisers today will only pay on the basis of verifiable “click-throughs” – people who saw their ad on your site and clicked on it – and some won’t even pay for that traffic unless it results in a verifiable sale. This has led to some to some desperate and often far-fetched approaches…

Consider, if you will, any of the Internet businesses that will allow you to use their basic services for free, and then attempt to get you to purchase an upgraded version or add-on features for the free version (or occasionally both) – the so-called “freemium” services. Pandora is probably the best-known example, but I can list dozens of others; one could actually see any of the media sites with a “paywall” arrangement as using the same tactics (e.g. newspapers that will allow you to read 10 articles a month off their online site, after which you have to pay). Some of these have met with limited success, but even something like Pandora, which provides a service to recording artists and music holding companies as well as consumers, has struggled to stay operational, and with the appearance of the App Store it’s increasingly difficult for anyone else to sell software…

My experience is hardly universal, and even the published research isn’t entirely clear on this point, but it has always seemed to me that this particular strategic failure comes about because people immersed in the challenge of building a new product or service aren’t usually thinking about the strategic aspects of the new business that their invention will create. Even within the business community itself, the kind of long-term strategic planning that is one of the staples of the management function is not widely appreciated by our colleagues from other disciplines. After all, why would anyone want to spend their time working on a musty old business plan, articulating the strategy that will make their business a success, when they could be coding, drawing, animating, welding, soldering, polishing or shipping their products? Or, for that matter, tracking sales, balancing the books, paying the vendors, managing the other stakeholders, or investing the proceeds? But unless there is some method by which people will give us money for doing whatever it is we are doing, the whole thing is a hobby, not a business – and it won’t last any longer than our hobby budget does…

Of course, failure to create an adequate business plan is a strategic failure in its own right – but that’s a discussion for another day…

The Ethics of Honesty

As most regular readers of this blog (assuming I have readers) already know, I spent a number of years as a management consultant, working with small and medium-size organizations, both for-profit and non-profit, and helping new ventures to launch and existing firms to get better at whatever they were doing. Unfortunately, most people have no idea what that actually means. Even with the best of intentions, some people can’t seem to grasp that writing is different from typing, that operational analysis involves an in-depth examination of a firm’s activities and comparison to the rest of their industry, or that what I do requires years of experience and training. As a result, a lot of people apparently believe that I can take a brief look at what they are working on and somehow just know whether their idea will work, and what efforts will be required to make that happen, without any particular effort. Although it would seem that some of them also believe that the same functions could be handled by any bum from off the street – or a particularly bright two-year-old…

It’s a peculiar situation, in which people who would never consider asking for a free ride from a taxi driver or a free cake from a baker, or even for free legal advice from a lawyer, will assume that despite the fact that they have not the slightest idea what I do, it must be easy (and require no time at all). From time to time someone will call me up and ask me to read over their plans for a new venture of some kind and tell them what I think of the project, assuring me that this will “just take a minute” and that no one else can help them with it. The question at this point isn’t so much whether or not I should do it (I really shouldn’t, but no one is going to understand that, either), as it is what do I tell them. This is especially true when the concept I’m looking at is so deeply flawed that I can see multiple ways in which it could get the idea person behind it divorced, savagely beaten, publicly ridiculed, or completed bankrupted if they even admit to originating the idea…

On the one hand, I’m not actually the world’s expert on anything. I’m a competent, capable analyst with a lot of experience both operational and consulting in a wide range of industries, but that hardly makes me the final authority on every conceivable type of new venture. If I give a valuable idea a hearty thumbs-down there’s a real chance my “client” could give up on something that could make the world a better place. On the other hand, five years with a consulting firm, two more with the Small Business Administration (through the Small Business Development Centers program) and several additional years freelance, not to mention two Master’s Degrees in Business and 20 years in Corporate America means that I’m not exactly Captain Kangaroo, either. If an idea is flawed enough that I can spot major problems with it in a cursory reading, that probably means that it needs further development before the entrepreneur proceeds with his or her business plan. The issue then becomes, what do I tell them?

An idea that someone has nurtured for years is a deeply personal thing. Frequently, it’s the one brilliant idea that they are sure will catapult them to the big time without needing any of the tedious intervening steps; their generation’s answer to Microsoft Windows, or Facebook, or sliced bread. In other cases, it’s their personal vision of a better world to come; the Utopia that could exist if only people were willing to let go of their blindness and pre-conceived notions and listen. In either case, crushing that person’s hopes and dreams seems heartless – except when we consider that aforementioned divorce, ruin, grievous bodily injury and/or public humiliation, in which case failing to point out those critical flaws would be far worse…

So you tell me: what is the ethical choice here, for me – or any other management professional in an analogous situation? Should we fulfill our obligation to the client as we would with any other customer and tell them the bald truth, even though they are friends and/or family and our answer will have difficult emotional freighting? Should we refuse to take any case with a personal connection, the way a doctor or a lawyer might, knowing that our friend/relative would never be able to afford a professional analyst of reasonable quality, and our refusal could doom the project right off the bat? Should we try to divert the client into additional research and/or development when we know their idea will never fly and there is next to no chance they can find a fix for any of its problems? Do we attempt to point them toward existing ventures that already do something of this kind – assuming such ventures exist? Or do we tell the truth, the whole truth, openly and clearly, and let the chips fall where they may?

It’s worth thinking about…

Writing a Business Plan: Summing It Up

If you’ve been following along at home through the last eleven installments, you already know most of the major steps involved in writing a business plan. Once you start actually doing the legwork – gathering the information, developing a budget and a timeline, working out your mission and vision, and deciding where to base operations and what those operations should be, and so on – you may find yourself revisiting different aspects of the plan in light of your new information. It isn’t unusual for people to reach the point where they are actually generating text for the business plan before they realize that some aspect of the venture won’t work, or won’t work as well as something else they’ve encountered along the way. In fact, if you’ve made it all the way through this process without changing anything from your original concept, it was either an exceptionally good idea, or else you’re kidding yourself about something fairly major, and probably need a wake-up call…

The real problem at this point in the proceedings isn’t changing the direction of your business model, its being too fixed on your original concept to make such a change. If, during the course of this adventure, you’ve identified something that will generate a much higher profit margin, require a fraction of the start-up funding, or generate far greater real wealth than your original business concept would have, you’d have to be out of your mind not to change your plans to incorporate whatever that something is. Or, alternately, you’d have to be the sort of egotistical idiot who would rather make less money, pay higher interest, or end up with less than admit that your ideas are less than pure genius. Unfortunately, that description fits far too many of the entrepreneurs I have met in my travels…

Astute readers (assuming I have readers) will recall that at the beginning of this 12-part series I told you that the most important reason for writing a business plan isn’t about showing it to anyone else; the business plan is your plan for what you will actually be doing, and all of the things you intend to accomplish. Writing it clearly and convincingly enough that a potential investor would be able to make an investment decision about your project may help you to attract venture capital, but I have urged people who don’t even plan to look for funding to create such a document anyway. In fact, I have encouraged clients and students to create multiple drafts, work through every possible detail until they are sure that they’ve accounted for every possibility and selected the options they like the best – and now I’m advocating that you do the same…

Once you have done so, you will be ready to write that last piece of the actual business plan: the Executive Summary. This isn’t usually a point-by-point summary of the entire work, although it can be if you feel that’s the best approach. What you are looking for here is a short explanation of what the project is about; what you are trying to accomplish, where you will operate, who you will employ, when you plan to begin, and why (if that isn’t obvious) you are doing these things. There’s some debate about how much detail to get into, and I won’t settle that question here, but a rule of thumb I’ve seen used to good effect is the “5-minute” rule. Let’s suppose you ran into somebody who could fund your project (at a party, in a coffee house, at the supermarket, doesn’t matter), and you had five minutes to tell him or her about the venture before one or both of you had to rush off. What would you say?

There’s also no way for me to settle all of the debate about how to print the final product, what sort of binding to use, how many colors of printing to use, whether or not to use graphs, charts, drawings, photographs, clip art, or any other form of styles or accessories; I can’t even tell you for sure that the business plan will be a physical document and not simply a .pdf file that you send by email (or post on your website) as we move further into this 21^st Century. What I can tell you for certain is that you don’t want to be doing that final production step bare minutes before you go into a key meeting with your top prospect – and you don’t have to go about this alone. My final advice to you is: Don’t be afraid to ask for help. Get all of the input you can; gather all of the opinions you can find; get as many eyes on the final product as possible. And then, make your own decision. It is only the first of many…

Writing a Business Plan: Budgets

Of all of the things that go into a business plan, the budget is probably the easiest – and yet it’s the part that most people are terrified by. Some of this we can probably put down to common math anxiety, but the truth is there is very little arithmetic, let alone mathematics, in assembling a budget section, and none at all in creating the narrative that goes with it. If you have done the research, figured out what resources your new venture will require and how much your employees should be paid, then you already know everything that will go into this section – and if you haven’t, how do you expect to set up a business in the first place? The only hard part is getting the information into a form that your readers can understand, and all you need for that is a spreadsheet and a text file; you don’t even have to be particularly convincing. You do need to be accurate, however…

First, gather up all of the costs you’ve worked out to set up your business. This might include real estate, building costs, building-out costs, equipment, fixtures, telephones, computers, inventory, or anything else that you need to have purchased and/or installed by the time you open for business. The level of detail you go into is up to you, but here again you want to try to see this document from the other side of the table. If you were lending someone money for a start-up business, how much detail would you want to see? A line item for “Computers” probably isn’t enough, but a detailed accounting of each of the 12 workstations you’re going to have, down to the last piece of software and the type of ergonomic accessories is probably excessive. It’s also helpful to group them, so that all of your office supplies and equipment are together, services and insurance are together, permits and applications fees are together, and so on…

Next, you need to work out what your monthly expenses are going to be, once the company is up and running, and group those into logical sections. At the very least, you’ll want to have a payroll section (broken out by individual for a small company, or by division/group for a large one) containing salary and benefit information, a section covering supplies or products you purchase, a section covering utility and telephone expenses, a section covering office supplies and equipment, and a section covering insurance, financial services, and anything you outsource to a subcontractor (including shipping and delivery, if applicable). Some people advocate producing two separate budgets: one for your standard month, and one for all of the things you plan to do before you start operations (sometimes called a “Time Zero” budget); you may also want to compile operating budgets for Year 1, Year 2, and so on that compile 12 months worth of budget and make provision for growth (e.g. Year 2 includes 20% more money for salaries, in case you hire more personnel and/or offer raises). As usual, it depends on your audience…

Once you have developed your budget spreadsheet – or sheets – it’s time to start on the narrative that goes with them. In this section, you will briefly explain the categories that appear on the spreadsheet and the amounts you have allocated to each one. Itemizing the individual purchases probably isn’t necessary for minor expenses; a few hundred dollars per year in office supplies for a company of a dozen people isn’t remarkable, but a few hundred dollars worth of paper clips per person per month probably requires an explanation. Keep in mind that for the most part no expense is out of the question if you can explain why you need it. If your field equipment is going to be struck by lightning, destroyed by vandals, or eaten by wild pigs, there’s nothing wrong with budgeting for replacements as often as you expect to need them. But you can’t automatically expect someone reading the business plan to know that there are wild pigs in your area of operations, or that you can reasonably expect them (the pigs, not the readers) to eat about 10% of your field equipment per month…

Some experts will suggest that you add a set of projections to the budget section, explaining how many sales you expect at which points, how much revenue you expect to generate, and how much profit you expect to have left; combined with your budget, this will give you an approximation of a profit and loss statement, and give your readers the basis for breakeven, net present value (NPV) and income analyses. If you elect to go that way, you’ll want to follow a similar style to your budget sheet; you’ll also want to include an explanation of how you intend to sell your products or services, and why you expect to realize those specific amounts of income and profit. Everyone knows that you can’t be precise about these estimates, of course, since the company isn’t in operation yet, but you can use the written section to explain why you are making these assumptions, and how confident you are that you’re right. And, of course, what you plan to do if you’re wrong…

Writing a Business Plan: External Analysis

In a perfect world, you could just work out the business you wanted to create, identify the amount of productivity required to make a good profit, and set things in motion. In this world, however, there’s quite a bit more than that involved, and most of the problems that remain at this point in the project are going to be coming from outside the company itself. An external analysis (also known as an environmental analysis) considers all of the factors beyond your immediate control; some of these may be positive, many of them will be negative, and some are just the nature of your business. But as with all of the other sections that make up the business plan, the key here is explaining all of the different people and things that have the potential to impact your new company – and how you plan to deal with them…

If you completed a Five Forces analysis during the research phase this would be an excellent time to pull out those issues and the answers you came up with. First of all, how will you manage the competition from other firms that do what you do? If you’re introducing a completely new product or service there may not be any direct competition when you begin operations, but you can generally assume that there will be some as soon as you have your first profitable quarter. How do you expect to gain market share over the companies already in your field, and how will you hold onto that share in the face of direct competition? Even if your potential investors didn’t want to know about that (and they probably will) you still need to work that out before you begin operations…

You should also have some idea of how you intend to manage your interactions with vendors and suppliers. If you are unusually fortunate all of your interactions may be fair and friendly, but it’s much more likely that your vendors will have some amount of influence on you, depending on how much you need each one of them, and how many possible sources you have for each need. It’s also possible (although much less common) that you will be one of a very small number of customers some of your suppliers can count on, and that you will be able to exert leverage on them. Of course, similar comments apply to your relationships with your own customers; your external analysis should map out how you plan to manage these issues – or eliminate them where possible…

Then you should consider how new forces could your business model from outside your immediate environment. The obvious one is new competitors, and here again, even if no investor ever asks you to account for how you intend to deal with them, you need to work out in advance what will happen if somebody opens a new business in your industry (or geographic area) and starts competing with you. Almost as important, however, is the question of what you intend to do if some new technology, process or legislation makes it possible for someone to create a substitute for your product or service – something completely different that can be used for whatever your customers expect to gain by doing business with you. If that happens, how are you going to deal with it?

You should round out your external analysis by covering anything else external to your company, such as local taxes and permit costs, size and composition of the workforce from which you will draw your employees, climate, customer demographics, cultural traditions, and anything else that might impact your operations. Keep in mind that no one has ever been able to account for everything that might fit into this category, and you probably won’t be the first, but if you’ve done your homework you should already know all about the industry you are breaking into, the geographic area in which you will operate, the legal systems, monetary systems, governmental systems, demographics of your workers and your customers, and a thousand other details. You probably don’t have to cover all of the minutiae, but take a moment and think about all of the things you’d want to know if it was your money that would be going to finance this venture – because very shortly now, it will be…

Writing a Business Plan: Marketing

Once you’ve established what your new venture is going to do, you need to explain how you expect to make money by doing that. After insufficient capitalization, the single most common cause of failure in new businesses is probably cash flow problems, and a lot of those come down to not understanding where the money is coming from – which is to say, who will pay you for doing what you do, and how much? As I’ve noted previously in this space, the science of marketing is an intensely complicated discipline, based even more on statistical analysis than management is, and I don’t even pretend to understand all of it. Fortunately, all that really matters at this point are the fundamentals, and those are simple enough that even a management scientist like me can explain them…

First off, who are your customers, and what do they want from you? Specifically, what strategy have you adopted to generate a competitive advantage within your new industry? If you’ve chosen a differentiation strategy you will be looking for customers who want whatever value you’ve managed to add to the product, and are willing to pay whatever markup you are charging for that. You will also need to figure out what advantages you offer over the existing products in the field, and whoever makes those. If you have decided on a low-cost strategy you need to establish parity with the competition, and explain how you are managing to produce a comparable product at a lower price. Either way, you need to define who your target audience is, and how many of them you expect to serve…

Ideally, of course, you would want to determine how big the market for your product is – that is, how many people in the community, state, country, region or world (as appropriate) want to buy what you make, and of that number, how many of them will actually be able to. But if your strategy is correct, you should either be offering a better product than the competition, offering a comparable product at a lower price than the competition, or offering a specialized service to a segment of the market that have never been specifically served before; the question of how big the market is in absolute terms is only important if there is more capacity than customers (which will drive down prices) or if you have more potential output than you can effectively sell. For the purposes of the business plan, what you need to establish is how many people you can reasonably expect to reach and what percentage of those people you expect to become your customers…

As previously noted, if you expect that one out of every 500 people you hit with spam emails will end up buying your product, and you need at least 1,000 sales each month to break even, you need to explain how you will reach 500,000 people with spam email each month; if you expect that one out of every 1,000 people who see your television commercial will become customers, you need to explain what sort of commercials you are going to make, where you will place them (channel, market, time slot, etc.), and why you believe that 1,000,000 people will see them. If you’re going to purchase a table at a local event or sponsor a local activity, you will need to account for how many people will see you, how many will want to do business with you as a consequence of such a sponsorship arrangement, and how many of those people will actually fit the profile of your customers…

As you write this section, you need to explain to your audience why you have selected each type of promotional activity, and how you expect to gain customers through each one. Even if all of your assumptions are good, and you are reaching all of the people you wanted to, none of that is going to matter if you don’t have some means of generating revenue at the end of the process. Putting product or service information up on the Internet serves no purpose if there is no way for customers to purchase anything from you once they have viewed the information, and running television ads serves no purpose if the spots don’t tell people where or how they can obtain your product. You can’t sell people anything if they don’t know you’re there, but no matter how well you publicize your product or your company, you’ve still got to sell it…

Here again, the key question to ask yourself is what would you want to know if you were being asked to invest your own money in such a venture. If it’s not clear to you how you expect to make money on the venture, then it’s also not clear how an investor could expect to make back their money, let alone turn a profit. You may not be able to show a simple equation of this many people will read our ads online, this percentage will be interested, and this percentage will call us, resulting in this many pitches, this many sales, this many returns, and this many stolen credit cards and cases of identity theft – but that’s no reason not to try…

Writing a Business Plan: Operations

Most people assume that the Operations section of the business plan will be the easiest one; after all, you’re just telling the reader what you are going to do. And, unless you are making a bold entry into an industry in which you have never worked, you probably know a great deal about what your new business will do and how it will do those things. Unfortunately, this is where most business plans break down, and also why: YOU know what your company will do, in great detail, but your reader doesn’t necessarily – and your reader is the one who decides if you get the resources you’re asking for. Let’s go over some of the critical points you will want to include…

First, you will want to complete the classic “W5” questions that any reasonable person would want to know before offering anything to your new venture; you’ve already answered What you want to accomplish (the Mission statement) and probably Why (the Vision statement), but now you need to address where, when, and with whom you will do these things. So tell us: where are you going to set up operations? Do you have a location (industrial space, retail space, a suitable vacant lot) picked out? If so, tell us what makes that location ideal (or at least optimal); if not, tell us how you will find one. If you’re going into retail or food service location may be your single most important factor; if your operations are entirely online you may only need access to high-speed Internet connections and a post office. Either way, you need to explain where you’re setting up shop…

Then you should consider when you will start operations, and how much lead time you will need to get ready. We’ve talked about critical path management (CPM) in this space before; it’s the process of working out which steps in your development have to be completed before you can continue (and which ones can be completed concurrently while you get to that point); we’ve also discussed the use of a Gantt Chart (it’s not an acronym; the chart is named for its inventor, Henry Louis Gantt) which lays out the critical path graphically. As usual, neither technique is mandatory, but you will find this part of the plan much harder without them or the equivalent…

With whom is also critical; you will need to lay out how many people you will need for each of the company’s functional areas; if you are planning a divisional structure you should discuss each division separately, and if you are planning for multiple shifts you will want to consider how many people (and which ones) will be on each shift. Some departments (payroll, sales, PR) may not need a second or third shift; others might increase your profits assuming they don’t cost more to operate than you will make during those hours. You should probably include details about benefits, salaries and employee retention plans that you’ve already worked out, although those aren’t as important at this stage…

Once you’ve completed all of those details, it’s time to get into what company operations will actually accomplish. What we’re looking for here is an overview of how the company will go about its daily (and monthly/yearly) operations; how many people, doing what tasks at how many workstations, producing how much product out of how much raw material. If our day shift employs 100 people to run presses and lathes on five different production lines, each of which can turn out 250 widgets each day, then we need to explain how much we can sell 1,250 widgets for, how much the raw materials for 1,250 widgets will cost, and how much we will be paying our 100 operators. If we expect to start a swing shift after a year or so (once we’ve had time to train up supervisors and foremen) and a night shift after two years (if there’s enough demand to support one) we need indicate how much additional input and output we expect, and we should also discuss how we will train and promote new management personnel, as well as any additional facilities we will need to handle the increased workforce (and output)…

Finally, this section should discuss your plans for the future. Do you plan to expand at some point; are you going to move into other products or services, other geographical areas, new products or new technologies? You don’t have to account for all of the possibilities now – especially if there’s a possibility of game-changing technology emerging in your industry during the foreseeable future – but very few of us intend to just set up shop and perform the same operations until we retire. Once you have accomplished all of the things you’re planning to do, what will you do next? This is especially important if you are bargaining for an equity share in your business (e.g. selling stock or taking on silent partners) as opposed to just borrowing money that you promise to pay back – but that’s a discussion for another day…