options in the wild: part II

At the very beginning, I did a straightforward ROI type of analysis.  The decision seemed very clear from that perspective.  There was one line that took a little more work to get to, but was half as long and had twice as many windows operating.  It should have moved twice as fast.  Easy choice!

I hadn't considered the uncertainty in the model.

The people in line "d" were long a call option on all of the windows to the right.  If any of the windows from "e" through "h" opened up, they could easily exercise that option by walking over and moving to the new line.  I hadn't thought of that until it happened!

Once window "e" opened up, I sat there considering moving to line "e", thinking they might open up "f" or "g" or "h" and I didn't want to miss that opportunity, even though it meant moving to the back of the line.  I decided I was pot-committed to "b" when the other option in the mix made itself known...

The crew of any plane that happened by was long a call on window "a" and "b"!  Since I was in line "b", I was effectively the counterparty and short a call on those windows.  When the crew turned up and took over the windows, they exercised their call and my line came to a stop.

This story is a pretty good representation of the value of using a real options decision framework for a couple of reasons.  The most obvious reason is the importance of involving uncertainty in your decision.  If nothing had changed, my first choice was unquestionably the best.

The second reason is the importance of having a dynamic decision framework that can adapt to new information.  It's easy to make a straight-forward ROI type decision when you ignore the changing world.  One line was served by two windows and was half as long!  That's an idiot-proof decision!  A few minutes later, the decision was more complex.  I was at the end of a line that was roughly the same length as the others, but didn't have the advantage of more windows possibly opening up.  A few minutes after that, I was at a stand-still.  A robust, options-based decision framework that encapsulated the upcoming decisions would have helped.

From an executive decision making perspective, this sort of decision tool is almost never available.  What can be available, however, is some intelligence about what the inflection points are.  If I had any idea about the chances of another window opening up, or what the chances of a crew showing up, I could have produced some heuristics about comparative lengths of each line and made dynamic adjustments to my strategy when the real world changed in front of me.

Options in the wild

A few weeks ago I was travelling on an international business trip.  On the way back I came to the top of an escalator to face the immigration / passport check area.  It looked like this:

(only the lines were a lot longer)

I just jumped into the line that was right in front of me and then sort of observed the lines.  The mental schematic I put together was this:

So I moved through the crowd to line "b" because it was the shortest one I could join (since I don't hold a EU passport).  Also, I realized that there were to windows serving that lane... both window "a" and window "b".  No wonder the line was shorter!

A minute later, the situation looked like this:

As the efficient, German airport had recognized a long line and opened window "e" up, and a mad dash had taken place as people near the end of the line for window "d" scrambled to be at the front of the new line.  My old location at the end of line for window "d" would have put me in pole position for the newly opened window!

Then, a minute later, this happened:

When the crew for some flight showed up and took over priority on window "a" and window "b".

Being a ridiculous person I thought "This is fantastic!  What a great example of real world options analysis!!  I can't wait to write this up!"

What are the options?  Take a few minutes to think about it.  In a few days, I'll publish my thoughts on it, but I would really like to hear what others say, too...

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.