Design Your Business End-to-End

The guy who invented the wheel was an idiot. The guy who invented the other three, he was a genius. 

Sid Caesar.

tl;dr:
an idea may be worth something, but a working business model around the idea is worth many orders of magnitude more.


How do you get from an idea to a working business model? 

Well, first you need to fully wrap your mind around the idea and think through as many perspectives as possible: who is your customer? what is the problem that you're solving? why you and why now? what's your particular competitive advantage? how is your basic business plan going to look like? what are your particular constraints and how do you plan to overcome them? This is how you design your business model from one end to another and make sure it "holds water".

Second, there's a lot of work involved, but that's for a different story. Let's get back to the end-to-end principle.

During my professional life, I have witnessed some resounding business model failures that can be entirely explained by the dismissal of the end-to-end design principle.

One that comes to mind is a proximity retail start-up in Romania who was built on a quite clever expansion model that would alleviate the investment capital burden and would ensure the P/L is scalable with the network expansion cadence. 

Yet, somewhere along the way, impatience or greed kicked in and the owner decided to start chasing some vanity metric (no. of new stores opened every month!) and of course this required a pivot of the business model into a very risky area, where more investment capital was needed (putting pressure on the working capital and triggering delays in payments to suppliers) and the P/L was immediately thinned by burgeoning network costs (triggering a swift departure from the committed budget). This led to a massive backlash from the suppliers and financiers and the retailer soon collapsed.

Choosing the wrong metric is of course not a capital sin in itself (everybody does it all the time), but the pivoting of the entire business model without a full end-to-end scenario play was what killed this ambitious project. Sadly, I joined too late - the turnaround was no longer possible without a massive capital injection, which turned out not to be realistic.

I have since then experienced several such "gut feel" business investment decisions but I was successful in stopping or blocking them before they could significantly hurt the business. 

While there is nothing wrong with "gut feel" decisions around great ideas, planning your entire business on the back of a napkin is crazy (and I have literally seen that!) - and most successful business models today require a bit more consideration than that.


So - carefully assess your business model and think it through - it will save you a great deal of pain and money later on, even if your business is not successful.


One might argue that "gut feel" is important when exploring completely new markets or business models. Yes, but then it is important to design the execution of your business model so that you start with something and grow as you learn, minimizing waste and risk (of which a new enterprise has plenty).

This is where the lean start-up thinking comes to rescue, with its famous Build-Measure-Learn cycle.

More on that, later.

Profit Driver #3: FUNCTIONS

“Capitalism has turned human beings into commodities. To the owner of a restaurant: the cook and a bag of potatoes are equally important.” 
~Mokokoma Mokhonoana


Well, of course a cook is much more profitable than the sum of the meals that could be cooked from all the potatoes in the bag (even if they may, sometimes, cost the same... :-) ). And this is because they fulfill radically different functions:
- a cook's function is to ensure quality meals, to manage a team of aides, to come up with new recipes, all in order to secure a repeatable positive customer experience etc.
- a potato's function is to be cooked and served in one single customer experience event.

That is the reason why a law firm will always earn more profits than a construction company with similar headcount - the market pays better for a perceived higher function that drives more value throughout the value chain.

Also, this is the reason why education is expensive - education amplifies a function so that it may earn more for its carrier.


Translating this to a lean start-up world, this gets very difficult to crack. A lean start-up has to make very tough choices not only about the risk priorities, about the assets to build, but also about the best functions to perform.

The original Business Model Canvas captures the function on the left-hand side: the Key Activities and the Key Resources.

The Lean Canvas instead replaces this with a different, more focused approach: the biggest areas on the left side of the canvas are called Problem and Solution. So a clear proposition emerges: split your start-up into a Problem Team and a Solution Team. 

Now, strictly in terms of business functions, Ash Maurya argues that a lean start-up should only employ the 3 most critical ones:
- Development (solution engineering)
- Marketing (customer understanding)
- Design (embeds design thinking into the functions above and makes them "sing" together in harmony)

Not coincidentally, the three quoted functions have the highest profit potential of all functions. Any other support function (finance, administration, legal etc), at the lean start-up stage, should be carried out by the founders.


So, don't start up by stocking up on your cafeteria supplies, by renting out the nicest office space or by buying that ever-present ping-pong table :)

Profit Driver #2: ASSETS

If I collected all the diamonds in the world, I'd have no 'income' but I'd have a lot of 'assets'. Would my company be worth nothing because I have no income? A lot of Net companies are collecting assets. They have to be measured with a new set of metrics.
~Vinod Khosla

Such is the case with a start-up. More specifically, a lean start-up collects a lot of diamonds: these are the nuggets of insights, knowledge and wisdom that are the main outcome of the experiments conducted on their business model.

Everything, in a lean start-up, is targeted at maximizing learning:
- formulation of falsifiable hypotheses
- splitting into problem team / solution team (same thing for the interviews)

The lean stack promoted by Ash Maurya is a very useful tool by which the knowledge gathering process is managed.

Knowledge may be the most important asset in this stage, but there are others too:
- the recruiting process is not merely important, but fundamentally vital - it can literally make or break the start-up;
- the ability to pivot the business model, to continuously weed out potential waste.


One more thing
You may have noticed that I have not included in here the "classic" assets: IT infrastructure, patents, products already designed / built etc.

That is because I believe that, at a start-up stage, such "hard" assets are actually liabilities - they hinder innovation, they are a trap of past thinking and habits, they entice you to reuse sunk (and maybe failed) efforts, they force your solution into an already existing mold.

This is the innovator's dilemma applied to start-ups: you may become captive not to your existing market (because you don't have one yet), but to your existing asset base.

You have to keep pivoting your asset base and you best do this when your asset base is intangible. Your "hard" asset base should, for the time being, stay on your P&L (as a rental cost), not on your Balance Sheet.

Next week, on Profit Driver #3: Functions!

Profit Driver #1: RISK

“To get profit without risk, experience without danger, and reward without work, is as impossible as it is to live without being born.”
― A.P. Gouthe


This first profit driver is a no-brainer for everybody and common wisdom is full of references about risk as an important way of accruing future gains in business.

In particular, start-ups are, by their nature, extremely risky undertakings. If you ever doubt this, try getting a bank loan based on a start-up business plan. Ok, I'm glad we've cleared that up :)

In a start-up, uncertainty is the only well-known attribute: you don't know exactly who is your customer, you don't know what is the actual need of that customer, you don't know how will you satisfy that need, you don't know if your product will ever work, you don't know if your team will hold during the runway phase, you don't know how long your runway really is.

Let's take the possible risk responses according to the T-A-R-A framework:
- Transfer - can you really transfer the start-up risk? Not really. I'm not aware of any insurance policy for this, other than the normal practice of ringfencing the start-up from other profitable endeavours you might have (if possible, protect your personal assets in the same way).
- Avoid - sure, you can simply cop out and forget we ever talked.
- Reduce - you can share the risk by going through seed rounds and accept contributions (cash and advice) from other VC's or investors. Since you know this will dilute your equity, you know then that reducing risk means also reducing possible future benefits.
- Accept - and that's the only interesting scenario that I want to bring up in this blog entry.

Once you've chosen to accept the risk of entrepreneurship, you might as well just manage it!

Strictly from that point of view, the lean start-up methodology is just that: a very smart risk management methodology for start-ups.

Let's just look at the main chapters of Ash Maurya's excellent book, Running Lean:
1. Document your plan A
2. Identify the riskiest parts of your business model
3. Systematically test your business model

If you want to build a low-burn start-up (and who wouldn't?), you have to read Ash's book. This is one book that compels you to take notes as you read it :)

The lean start-up methodology is grounded in the scientific method: you formulate falsifiable hypotheses (i.e. formulate them in a way they can be explicitly negated as a result of experiments), continuously test them (if possible, in caeteris paribus conditions), learn about customer responses from those experiments and seamlessly incorporate them in your next product iteration.

The more you can rinse and repeat this learning cycle, the less risk and waste will be incorporated in your start-ups early life. The lean start-up methodology teaches you to systematically navigate through the start-up's unknowns, discover them and translate them into your unique advantages in the newly discovered marketplace. Your assets.

On Assets (as Profit Driver #2), next week.

A Lean Start-up Perspective On Profit Drivers

Profitability is what makes a company real.
~Elon Musk



When I was still a relatively junior Finance Manager, I have learned from my dearest mentor that, for a business to be profitable, it must have a combination of three key drivers:

RISK
Any business needs to venture in the unknown. There is no money left where the markets have already priced in all the information, opportunities and events. Conceptually, the more risk you take, the greater the return you should expect.

ASSETS
By definition, an asset is something of a long-term value that is held by a business with an implied expectation that the asset will accrue future benefits to the business. Again, theoretically, the more assets you can leverage (and think of assets in the broadest way possible), the more profits you should expect as an entrepreneur.

FUNCTIONS
It also matters what type of activities the business undertakes. The more sophisticated the activities, the greater the likely return. For example - engaging in basic web design will earn you far less than creating a web platform with an embedded network effect.

I will tackle, in the next few posts, some opinions on how to maximize the combination of the three drivers to reach profit as a lean start-up.

By the way, the 3-driver concept is now a major methodology used in international tax planning.

Process Re-design, Challenge #02

Always an art, never a science?

Art and science have their meeting point in method.
~Robert Bulwer-Lytton

What makes BPM different than scientific management approaches (like project management, six sigma etc)?

1. There is no global optimum
There is no best way to execute a process, it all depends on availability of resources (time, money, talent) for execution. It is an illusion to think that one may ever reach a global optimum in any process.

2. BPM is a continuous deployment framework
There is no best time to improve / change / upgrade a process. Or rather, the best time to do that is "as soon as possible". A business process must be agile, i.e. must be able to adapt to new conditions (shift in strategy, legislative changes etc). Therefore on-the-go tweaking should be part of the process design philosophy.

Hey, this sounds a lot like the lean start-up philosophy!
1/ start small with a minimum viable process and with a few process metrics that matter,
2/ continuously test your model's falsifiable hypotheses along the way until you get it right and avoid local optima,
3/ tweak it on-the-go based on the learnings above.

Actually, there are at least two major differences:

1. Approach on customer problem
A lean start-up defines how a new product solves an existing / emerging customer problem.
A business process redefines how an existing organization addresses entire classes of existing problems (effectiveness, efficiency, segregation of duties, activity cost, information distribution, asset / function redundancy etc).

2. Build-Measure-Learn cycle
A lean start-up iterates the product. One product iteration may be deployed almost instantaneously. Customer reaction can measured reliably in direct relation with that specific iteration.
A business process iteration manages the change to the process (employee education, transition, organizational feedback, integration into an existing business model). Therefore, a business process iteration needs a significant soak period before it starts to perform as intended.

So... how do we reconcile this?...

More to come :-)

Lean Processes, Tip #04

Reduce the Batch Size

"We are what we repeteadly do. Excellence, then, is not an act, but a habit"
- Aristotle.

We have discussed previously (Tip #02) how minimizing the number of handoffs will make your process more agile and more straightfoward. Today we'll be discussing the virtues of minimizing the size of the handoff - and, since the handoff contains a batch of work done, the size of that batch.

Historically, companies have built up manufacturing systems to be efficient in terms of cost-per-product. Traditional management science views the products as cost collectors and therefore one of the way of minimizing unit costs (like overhead) was to increase batch size. More products in the same batch accumulate same absolute overhead (say, for QA), therefore less overhead per unit, right?

Not necessarily. Toyota has long time ago turned this concept upside down with their TPS (the predecessor of the lean manufacturing concept). The actual cost drivers are the activities, if you want to reduce costs per unit, you are better off optimizing activities within processes.

By minimizing the batch size you get several key benefits, crucial especially in an intangibles production system (like, services and software):

1/ smaller batches = faster feedback. In a lean start-up, the build-measure-learn cycle needs to run many times before the invention of a valid business model. Ability to iterate as fast as possible is vital to success. Ideally, the batch size should get as close as possible to 1. If we build excellence by repeating what we do, then let's repeat what we do a whole lot more, and then we'll be excellent much earlier.

2/ smaller batches = less overhead. You will find that, with the right batch size (depending on your size of business), your QA/testing overhead will actually decrease significantly. That's because the QA/testing function will get much more responsive, much more automated, much faster in identifying issues - you would need less QA resources overall, and they will be more evenly allocated across your product cycle.

3/ smaller batches = less risk. You will be able to check your work much faster and correct errors much earlier in the process, before they become ticking bombs in your value chain.

More to come :-)