Visualizing your business model

The elements of the business model

If you haven't read my last post about the elements of the business model, do so now.  There's not much sense in reiterating what a prospect is, or how it fits with a product, etc.

Now, check out this picture:

The visual business roadmap

There is a great deal of information in this drawing.

Along the bottom you have the projects associated with your technology (product development) roadmap.  In the drawing I have here, you have two layers--real business can have many more, of course.  The bottom row represents core technology programs.  The layer above that represent product development projects.  Each product development project relies on one or more core technology program.   This is very typical.

Along the left side are market development projects.  These projects are intended to change the appetites and buying behaviors of the markets in general--whether or not you will capture the business produced.  For example, when Apple introduced the ipod the TAM for portable MP3 players exploded.

Along the right side are all sorts of projects.  In a real portfolio this is where most of the decisions really are.  These projects can be things like customer enablement programs, directed marketing programs, and anything else that will impact your expectations around your prospect.  That is to say, anything you think will impact the market share and/or pricing expectations for that product with that market.

Often a project will have impacts at multiple elements of the drawing.  

For example, adding a cool, new feature that has never been seen before may encourage people who would never have bought a product like yours to enter the market (TAM expansion), will help you increase your share of that newly expanded market (MSS expansion) at an increased price (ASP increase) but with the downside of an increased product cost (Cost increase).  In this case, you would be impacting markets, products and prospects all at once!!

modeling your business - projects, products, prospects, markets

What are the fundamental elements of modeling a business?

I often help people figure out how to model and value their business concepts.  A really common concern is "My business is different!"  That rallying call often serves as the number one roadblock people have when trying to build a business analysis.

The fact is this: No matter how different your business is, it's different in one of the same few ways.

All businesses expect to have customers.  All business hope to deliver something of value to their customers.  All businesses do some up-front work in order to have that valuable thing and to make sure their customers know about that valuable thing and to actually deliver the thing to them.  Whether the thing is physical (like a car, a microchip, a refrigerator, a satellite or a pencil) or a service (like a hair cut, consulting, vacation experience, healthcare), or something intangible like software doesn't matter.  The fundamental economics are the same.

If your business doesn't look like this--well you don't really have a business.

So let's take that "my business is different" issue another step.  How is your business not different?

Products

You have (or will have) something that you want to sell.  If it is a tangible, physical product, it probably has some sort of manufacturing cost associated with it.  You should get an idea of how much each unit you sell will cost to produce and deliver to customers.  This is the variable cost of manufacture, or "unit cost" for short.  Unit Costs will sometimes scale as a function of learning curves or economies of scale, and sometimes they'll just stay flat.  Sometimes (like software) this number will be zero.

Fixed Costs

In addition to the variable cost of manufacturing, you'll have overhead.  Maybe you need to build a factory in order to produce your product.  Maybe you need to build a brick and mortar store as a venue for providing haircuts.  Whatever it is, you will have some fixed costs.   This is often called PPE for Property, Plant and Equipment.  PPE will almost always scale with your expected volume, but with the critical distinction that you have to make your investment in PPE before your volume starts to realize.

Projects

Your business will probably require some spending up front that doesn't go into PPE.  Sometimes this is called RND (Research 'n' Development), sometimes it's called NRE (Non-Recurring Engineering), sometimes it's just called "Spending".  Whatever you call it, this is what you have to invest in time and people-hours and other expense items in order to get to the point where you're ready to start bringing your product to your customers.

Markets

You have customers who are (presumably) going to find your product valuable and pay you for it.  Smart companies undergo an exercise called "Market Segmentation", where they try to group their customers together into meaningful groups called markets.  Members of these markets have similar buying behaviors.  They typically value the same aspects of the products and are willing to pay similar amounts.  For purposes of business forecasting, you should take an "outside in" look at your markets and a great deal of your analytical work will be done just trying to size these markets.  How many potential customers are there in each market?  How many of them will make a buying decision in any specific quarter (or year)?

Prospects

To build a predictive business model you need to make forecasts about how well the products you're creating will be received by the markets you have characterized.  This is a "Prospect" -- the specific economic expectations for an individual product with an individual market.  You will spend most of your business analysis time on forecasting prospects.  When will this product hit this market?  How much market share can we hope to achieve?  How quickly do we think we will achieve our peak market share?  How long before we see that peak share get eroded away--either cannibalized by our own subsequent products or defeated by competitive ones?  What sort of prices will we be able to command for the products?  How will the price and the market share forecasts interrelate?

These are the fundamental elements of analysis for any business.  

Before folks should start thinking about how their business is different and how their model won't fit into a typical analysis, they should address these questions and frame the business through these lenses.  After these basics are sorted out, you should start worrying about things like competitive timing, synergies and roadmap effects, market saturation and disruptive effects, complex pricing structures and so on.  Normally those sorts of details won't move the needle on the big analysis.

This isn't to say that the more detailed analyses aren't necessary.  If you're in the middle of negotiating tiered pricing discounts with an important customer you should really figure out what those will mean to your revenue and NPV expectations.   Those things can wait until later.

Next time I'll put up some materials one the mechanics of using these essential entities to create an NPV.

Politics and Market Segmentation: Why is Trump/Sanders a surprise?

The current primary season had me thinking about market segmentation this morning.  In particular, I was thinking about how the US population is traditionally understood:

If we assume that people are basically normally distributed along this one-dimensional scale, you end up with a distribution that would look sort of like this:

Where each of those little blue dots represents some voters (the data is made up, with a random, normal distribution).  There are some way to the right and there are some way to the left, but most of them are clustered in the middle, with increasing density as you move toward the middle.  The two major parties basically jockey over where the dividing line is and try to establish their candidates to capture as much territory as possible while playing chicken on the issues they think they can slide by on.

The fundamental problem is that this market segmentation is based primarily on how American politics is organized and not on how American individuals actually think.  For example, let's assign some typically assumed attributes to each party:

Do these clusters make sense?  If I believe strongly in Christian values does that mean I have to be opposed to affordable health care?  If I think that affordable education is important, does that mean that I must also be opposed to gun control?  This is a market segmentation strategy that is "Inside Out" -- it is based on how the governing parties are organized.

Smart market segmentation is "Outside In" and starts with the criteria people use to make decisions and then organizes around that.

Instead of this one-dimensional approach to segmenting voters, let's consider some two-dimensional approaches.  For example, let's consider some classics, such as personal freedom v. national security or government size v. economic stability.

Or, let's make this very simple and assume the same old Left/Right continuum and add a single new dimension of "Anti-establishment".  In this case, I might argue that the population looks more like this (this data is completely made up):

The distribution along the X-axis is the same here as in the previous drawing.  What's different is that I now have that Y-axis to represent that person's opinion regarding the political establishment.  With a wild majority of people effectively sick of the status quo candidates and more interested in finding an anti-establishment candidate than a traditional left/right candidate.  This is why Sanders and Trump are popular.  Both of them represent a break from the traditional choice that voters are given and are a chance to vote on a different (more meaningful) decision vector.

It's easy to chalk up Trump supports as racists and Sanders supporters as crackpots -- and maybe there's some truth in each, but the reason for their popularity is that the two choices that are available fail to satisfy the buying public.

Will your project survive in a big company?

This is based almost completely on work by this guy:
http://www.thomasthurston.com/

He found 8 questions that will effectively predict whether your new business line will succeed in a large organization.  I've paraphrased them and reworked them a little according to my experiences.  It has been a while since I've seen the originals...

1. Are the margins big enough to be interesting?  (Interesting >= current margins)
2. Are the markets you're serving big enough to be interesting? (Revenue contribution >= current revenue * 1%)
3. Does the project help sell products the biz is already selling?
4. Is the product in a market category we already participate?
5. Does the program help combat a top competitor?
6. Is the target market available through current primary channels?
7. Is there no perceived threat to an existing top customer?
8. Is there no perceived threat to an existing, power internal group?

If you can answer "YES" to everything, congrats!  You may survive the business funding cycle!

If you score one "YES" you're looking at a 50/50 chance of surviving each funding cycle.

If you score two "YES" answers... well, forget about it.

You might have a great business concept, a wonderful go-to-market strategy, and competitive products that serve a real market need.  If the corporate anti-bodies are going to reject you... you'll be rejected.

I have seen this happen several times.  There are reasons for a lot of this behavior.

For example, if this margins are too small, it will drag down the company's margins and starts to look like a growth trap.  From a strict-finance perspective, you're lowering the effective return for shareholders.

Most of what you see there are questions that are associated with diversifying the business.  Expanding into new markets, serving new customers (or pissing off old ones), attacking new competitors, etc. -- these are all outside the core and scary and difficult to do.

This is why big companies often fail to thrive.

The tyranny of an agenda

or, "How I learned to stop worrying and love the chaos"

or, "Don't cancel that meeting yet!"

If you work in a big company, chances are you have a lot of meetings.  I have lots of meetings.  I use Outlook religiously for meetings--even meetings with people outside my company.  Hell, I use my Outlook calendar to book time for things like dates with my wife, time with my kids, etc.  This is basically the only way I can ever remember to show up for anything.

I also have lots of work to get done on a regular basis.  I use Outlook to block out time to do that work.  If I think something will take me two hours of uninterrupted time to do it, I find a block of two hours and put a placeholder there.  Sometimes, when I'm in the middle of something I'll drop a block of work time on my calendar with "Todo" in the title, and in the body will be a bunch of other things I need to to block out time to do.  Blocking time to block time.  It's all very meta.

When that calendar starts to fill up, the first thing I usually try to do is skim it over, looking for optional meetings.  It usually goes like this?

1. Did I organize this meeting?  Am I running it?
2. Ok, I'm not running it, but will people be asking me for my opinion?
3. OK, I probably won't say anything, but will I learn something at this meeting?
4. double book right over it...

Sometimes though, I have a meeting that I did organize but doesn't have an agenda.  I might have booked the meeting a few weeks ago, expecting something to pop up.  Alternatively, the reason I booked it in the first place might have been taken care of.  These are really tempting candidates to cancel and get the time back.

Don't cancel them.

These sorts of no-agenda meetings with people who I apparently had sufficient cause to book a meeting at some point often end up the best conversations I have.  Ad-hoc meetings with no agenda are free to ramble a little.  They don't follow a script, so unanticipated topics organically bloom.  Some of my best projects have erupted from these unpredictable volcanoes.  I'm running out of metaphors to mix here.

Common Pitfalls - part 2

Last time I wrote about common problems in business plans that are associated with market sizing, forecasting and especially about estimating market share.

Other common issues are associated with pricing and margin expectations, defining the target market, project risks and customer contact.

Pricing forecasts are too aggressive

We see two sides of this coin.  For established products, we rarely test the limits of pricing for product line extensions, roadmap refreshes and similar product introductions that have the possibility of increasing our asking prices.  In these cases our models will always hold pricing flat, and thereby underestimate the revenue potential.

On the flip side, for new products in currently unserved or underserved market spaces we regularly overestimate the likely selling prices.  A common method to estimate these prices is to do a value chain analysis, some sort of should-cost and required margin analysis and then to determine how much profit pool is left in the portion of the value chain that the product will displace.  This makes a lot of sense and gives a good feel for how much the product could sell for.  Then, when it's finally ready, sales has a volume quota to meet, leadership gets worried about failing to land anchor customers and everybody sort of loses their spines.  The result is that we ask a laughably low price and the customer readily agrees!  This is a real "Flaw of Averages" sort of problem -- you will never get a higher price from your customers than the one you ask.

Margins are unrealistic for a new product

This one happens when we do a lot of market benchmarking to try and estimate prices based on our expected production costs and the product margins reported by competitors who are playing in the same (or comparable) markets.  Benchmarking is a great place to get started, but eager analysts and business managers often overlook the fact that incumbent competitors have had a head start to work out their cost structures, to improve their manufacturing flows and to feel out the best price points.  Their margins probably have improved over time--our first few years will not be so fat.  Similarly, fat margins happen in low-competition environments so by our very entry, everybody will have to tighten their belts and margins all around will probably come down.

Serviceable Market is too broadly defined

Often we will do market surveys that start with a "Total Available Market" this is broadly defined and we draw our numbers from commercially available sources like IDC or Gartner, etc.  For example, if we're working on a part intended to be included in new home construction as a sort of OEM Smart Home product, we will buy research around new housing starts for the next 10 years or so.  Ignoring the fact that these reports are almost never stochastic (they almost never include estimates of uncertainty or ranges for their estimates), they also almost always describe a very broad potential market.  For this reason, we try to define a portion of the total market as a "Servicable" market.  This is the subset of that market that could hypothetically meet their needs with the product we're intending to develop.  Often this segmentation is just as broad as the Total Available segmentation and we overlook the nuances in purchasing decisions between members of that sampling.

Sticking with our smart home example, if the key features of this product are all associated with climate control (like Nest or something) then you should anticipate that it won't be very attractive to new home builders in mild climates.  You can also safely assume that builders below a certain price point (like KB) will have a much lower sell-in rate than custom builders or luxury builders (like Toll Brothers).  It's common that a business manager won't consider all this and will just say "let's just assume we can address 80% of the market".

This approach is not only guaranteed to misjudge the size of the market that we could really address, it also skips past one of the most important parts of building up a business plan; actually talking to customers.

Business Plan never learned about actual customer preferences

I almost forgot this one is on the list, and in retrospect I'm not sure how I could forget it.  This is the case where an entire business plan is built up around a perceived use for a product that we already have--it just takes some modification or rebranding--with a new group of customers that we have little or no experience with.  It can be surprising how quick people can be to extrapolate their own experiences into conjecture about a broad segment of the buying public.  Compounding this problem is that (typically) between our business plan and that hypothetical buying public is a constellation of partners, manufacturers, retailers, channels, and co-travelers, any of whom can throw up a "I don't get it" roadblock.  We should have a really good answer to that objection before we even start to get serious with the rest of these forecasts.

Project risks are ignored

For most of the analyses I see, the actual Project spending isn't material to the overall NPV of the project.  By this I mean that the amount of the NPV is de minimis when compared to the margin dollars involved.  For this reason, it's common for teams to ignore project risk when building up their forecasts.  The business development managers involved will pulse the project managers for a general idea of how long it should take to develop and how many heads will be required and some real primitive multiplication-type analysis will take place and the RnD budget for the project is roughed out.

This approach really leaves a lot to be desired.  For one thing, "a failure to plan is a plan to fail" and RND project management really needs have at least the major serial stages of development roughed out, with the parallel activities in each stage identified and some sort of risk register built up.  Even this basic analysis will often show that the back-of-the-envelope timeline proposed above will really underestimate how long the project will take.  Sometimes the project timeline balloons to as much as 2x when taken in this sort of risk-adjusted, expected value perspective.

Whether or not the spending itself becomes material, there are usually other projects waiting for those people to finish up and move on to the next thing.  Even more importantly, a product that hits the market months (or even years) after the expected launch date is very likely to experience a very different competitive environment than the original forecasts of market share and market pricing called for.  Competitors may have produced improvements to their products, new competitors or new substitute products may have appeared, in some cases the very ecosystem purpose for the product may have rendered it obsolete.

Common problems in business models - Market Share

Common Pitfalls when estimating Market Share

There are a few things that seem to pop up on a regular basis when a business analysis / business plan is being developed.  More often than not, these are the product of biases and short-circuited heuristics on the part of the analysts and business owners involved.

When I'm doing an analysis review (and especially when I'm doing a long day of these reviews) I start with this list and immediately look to make sure these problems don't exist:

Competitive environment is poorly understood

Most of our business decisions address a competitive environment in which we are the incumbent.  This sometimes trips up business managers who are looking to extend our business into adjacencies or into transformational arenas.  If the plan doesn't comprehend the current competitive situation as well as how that competitive environment is evolving, it's time to go back and break out Porter's Five Forces again.

Market share ramps too quickly

I occasionally see some really enthusiastic projections.  I mean, really enthusiastic.  For example, a brand new product, that serves a market we're not familiar with, customers we don't currently do business with, through channels we're unfamiliar with, but we'll ramp up our volume faster than the last iPhone.

Peak market share is too aggressive

I see this one a lot.  The logic seems to be "if we can't capture first place in the market, why would we even enter?"  This might be true, but it doesn't mean that we will capture first place in the market.  If the peak market share for a product introduction is not consistent with the competitive environment, it needs to be adjusted.  Similarly, if the peak market share makes volume assumptions that we can't physically produce with our current manufacturing facilities, supply chain and channel structure, it needs to be adjusted, too.

(more to come)