CHAPTER

DEVELOPING START-UP STRATEGIES2

Seize the day or look before you leap? Apparently, many entrepreneurs act before they analyze. Of the hundreds of thousands who "just do it" every year, only a few earn an attractive return. The great majority of start-ups fold or drag along in what one entrepreneur calls the land of the living dead. And although bad luck plays an important role, many failures are predestined and predictable. Then too, we find a great many individuals whose endless research precludes action: By the time they can fUlly investigate an opportunity, it no longer exists. Entrepreneurs may also lose their enthusiasm, as continued analysis engenders a corrosive pessimism.

Entrepreneurs don't need, however, a better manual for evaluating opportu­nities. The strategic and financial analytical frameworks used in large corpora­tions require more time, money, and data than entrepreneurs can muster. Finding an effective middle ground between planning paralysis and none at all requires a more fluid, ad hoc approach. To minimize the time and effort spent, the astute entrepreneur screens out obvious losers quickly. Ideas that do pass the screen are analyzed parsimoniously, focusing on just those issues that matter. And action is so closely integrated with analysis that, on the surface, we may not even see any formal planning.

So Much to Do ... The decision to launch anew venture rests on an assessment of its viability­whether it can earn a profit-and its attractiveness, as compared to other oppor­tunities that could be pursued.

Professor Amar Bhide prepared this chapter. Copyright © 1993 by the President and Fellows of Harvard College. Harvard Business School Note 9·394-067.

18

19

Tp

t before ly a few in what )Jays an ~'e find lie time lIS may simism. pportu­orpora­Fmding :ruires a ~ astute 't:en are lCtion is see any

"jliry-­'oppor-

Chapter 2 Developing Start·Up Strategies

Assessing viability requires analyzing a venture's ability to profitably com­pete for customers, capital, employees, and other resources. Entrepreneurs often focus on whether customers will buy their goods and services but not on why sales will lead to profits. Of course a start-up must attract customers; a viable enterprise must also enjoy higher prices or lower costs than its rivals so that its revenues exceed expenses.

Analyzing a start-up's competitive prospects, though, is daunting. A complete analysis must take a great many industry participants into account: As Porter and other strategy gurus have pointed out, a start-up faces competition not only from rivals offering the same goods but also pote~tially from substitutes, suppliers, buyers, and other new entrants. In bidding for employees and capital, a start-up even competes with firms totally outside its industry. Complementing the external analysis of competitors, internal core competencie~ndJ¥~aknesses should be probed. Entrepreneurs mu;tanaIYZetheir co~access to c~pitaCtechnology, distribution channels, and so on.

Experts recommend dynamic analyses because the when of competitive advantage is as important as the what. The development o{a: new technology may be sufficient to overcome competitive barriers if it is completed by January, but worthless if delayed till December. And, the compleat strategist deal~.iIl hE-_rd llI:!!!!1Jef&: WhaJ.-My_the d()II~!~~~_:~~r:!ts .. c_qst'!.dYantages_QLthei~.cllmj:Jent's scale? What R&D expenditures are likely to be needed to invent around the incumbent's patents and the advertising costs required to gain a point of market share? If the industry suffers from excessive rivalry, how much higher must our margins have to rise to be profitable?

Well-reasoned, deeply footnoted tomes that document these tasks have found a goodly following in the corporate world. For start-ups, however, meticulous ~~!yses are_~rely feasible or particula!ly useful even. Entrepreneurs typically lack the time and money to mteme-w·it representative cross-section of potential customers, analyze substitutes, reconstruct competitors' cost structures, project alternative technology scenarios, and so on. The few individuals who do have the resources often lack the imagination and gumption to start a business. Oppor· tunities are short-lived and, often, we find an inverse relationship bet":,,ee!l.the.c;lata a~a,i!@l~ t~.<lIlaly~~ .~n opportunity and its a~eness.--the m~re thoroughly the prospects of a start-up can be researched, the more intense the competition it is likely to face.

Not surprisingly, the evidence shows little relationship between planning and s.uccess. A National Federation of Independent Business study of 2,994 start-ups showed that founders who spent a long time in study, reflection, and planning were no more likely to survive their first three years than founders who seized

"\ \..--..j \ ( opportunities that came by without much planning. 1 In corporations where sys­

; ,/1_. tematic analysis is taken seriously, we often find a refined incapacity for seizing ".- ... "'",. opportunities. The demand for hard data on market size and industry profitability

lIne., July 1992, p. 49.

20 Part I Evaluating Opportunity and Developing the Business Concept

delays entry until the business is proven, popular, and hence unprofitable. Or diligent analysis generates many obvious objections ("customers are tied to their existing suppliers") that are used to kill the idea.

Comparing the attractiveness of a venture to alternatives that could be pursued can also prove perplexing.

Many large corporations use the discounted cash flow (DCF) they expect from a project as the standard measure of its attractiveness. DCF apparently elim­inates the biases inherent in other methods. Evaluating projects by their expected payback period, for example, will favor ventures that are expected to generate high but short-lived profits over those that promise sustainable profits after a long gestation period. DCF provides for a more reasonable trade-off ~tween longevity and a quick return of capital.

Entrepreneurs, however, can't just use DCF. Cash flows from a new venture are highly unpredictable as compared to those from, say, expanding the capacity of an existing plant. Small changes in (largely unverifiable) assumptions lead to huge differences in projected value.2 And, unlike a large corporation with rela­tively easy access to capital, entrepreneurs cannot back several projects simulta­neously. Indeed, they can't count on obtaining resources at an acceptable price for a single venture. An unexpected need for cash (because, say, one large customer is unable to make timely payment or raw materials have to be bought to meet an unexpected surge of orders) may shut down a venture or force the entrepreneur to give away an unreasonably large share of the equity to the one investor who is willing to provide the funds.

Therefore, a wealth-constrained, one-venture-at~a-tirne entrepreneur must use multiple criteria, favoring ventures with:

• Low capital requirements-ventures that can be launched with little external capital and have the profit margins to sustain high growth with internally generated funds.

• High margin for error-ventures with simple operations and low fixed costs that are less likely to face a cash crunch because of technical delays, cost overruns, and slow buildup of sales.

• Significant payoffs-ventures whose rewards are substantial enough to compensate for the future opportunities the entrepreneur can't pursue because of a commitment to see this one through.

• Low exit costs-yentures that can be shut down without a significant loss of time, money, or reputation. Thus, for example, ventures whose failure is known quickly are better than projects that are not expected to make a profit for a long period and therefore cannot be reasonably abandoned in

2Some theorists may question whether the DCF of a new venture is at all meaningfuL For example, Frank Knight in his 192 I classic Risk, Uncertainty, and Profit argued that entrepreneurs can expect a profit only to the extent that they bear unmeasurable and unquantifiable risk, which he called uncertainty; if the magnitude and volatility of a venture's cash flows can be reasonably esti­mated, it cannot be expected to yield a true profit.

Chapter 2 Developing Start-Up Strategies 21

,Ie. Or () their the interim. Similarly, short payback periods have value because the

entrepreneur's loss of self-esteem, reputation, and, of course, personal wealth due to the closing of a venture are lower if it has already returned the investment made in it.

expect

Ild be

o Options for cashing in-ventures that can be sold or taken public. An r elim­ entrepreneur locked into an illiquid business cannot easily pursue other pected more attractive opportunities and faces problems of fatigue and burnout. nerate Therefore, entrepreneurs should prefer businesses with a sustainable com­along petiti.Y.t: advantage, such as a proprietary technology or brand name, that gevity others would be willing to buy.

Evaluating the attractiveness of a start-up by these many criteria is much 'enture harder than applying a corporate rule of backing all projects with positive DCFs. ipacity Several criteria, for instance the opportunities for cashing in or the costs of exit, lead to cannot be quantified. And ventures that shine by one measure are often ques­h rela­tionable on another. For example, businesses with sustainable advantages that can multa­be sold easily may entail more investment and complexity than ventures with ice for quick payback. mer is

Inevitably, therefore, assessing an opportunity and developing a strategy toleet an

exploit it requires a number of judgments; entrepreneurs cannot rely on a mecha­IJeUf to

nistic flow chart or template. The entrepreneur has to judge which issues need who is careful analysis and what should be taken for granted_ Judgment is required to determine whether the start-up can overcome critical obstacles. Can the capabil­DStuse ities of the established competitors' direct sales force be topped by a creative plan to use distributors? Can customers' loyalty to their current suppliers be overcome with a new ergonomic product design? There is no common unit of measurement

nth to weigh the pros against the inevitable cons; equally experienced and astute entrepreneurs can easily disagree. The entrepreneur must make subjective assess­ments of attractiveness-whether, for instance, a quick payback provides ade­

elays, cd

quate compensation for low sustainability.

Ito e Armchair Reflection: Screening Out Losers

The first issue an individual with an idea for a business confronts is whether the Ilm-e II loss

venture is worth researching. Timely judgments about the viability and attrac­tiveness of a venture can save a great deal of wasted effort. SuccessfulIke a entrepreneurs, too, have many crazy ideas, but they discard or reformulate them quickly before drawing up financial projections, consulting experts, or inter­viewing potential customers.

What quick check for viability can an entrepreneur apply? A start-up's ability

OOln

EIIr.i to compete depends on the creativity of the underlying concept and theIich be

entrepreneur's capacity to execute. (See Figure 2-1.) Creativity involves inno­,. esti­vation or special foresight. Innovations change the existing order; entrepreneurs who would make waves in a mature industry must invent a new product or

From:

22 Part I Evaluating Opportunity and Developing the Business Concept

Figure 2-1

How Start-Ups Overcome Competitive Barriers

• Direct rivals/entrants • Substitutes/inertia • Buyer.;/suppliers

"Doing things right" • Resource marlcetsExceptional ability to acquue

& manage resources due to Icnowledge. zeal. contacts. skills. etc.

process to wrest business from established competitors. Foresight leverages external change. Entrepreneurs who want to ride a new wave must have a special insight about the direction, longevity, or consequences of the changes they expect to capitalize on. The gold rush made paupers of the thousands caught in the frenzy; however, Levi Strauss started a legend by recognizing the opportunity to supply rugged jeans to the prospectors.

But entrepreneurs can't just rely on inve_nting a new product or anticipating a trend; entrepreneurs must also haye the capacitY-to'execute well. Through ilieir zeal, knowledge. contacts:'personal commitment, and skill, entrepreneurs must persuade customers, investors, employees, and suppliers to support an uncertain enterprise and then manage competently what resources they can rustle up. Execution is especially critical when concepts can be easily copied. For example. if an irmovation carmot be patented or kept secret, entrepreneurs must acquire and manage the resources needed to build a brand name or other barrier that will deter imitators. Superior execution can also compensate for a me-too concept in emerging or rapidly growin'g industries where doing it quickly and doing it right is more 'important than a brilliant strategy.

Many ventures obviously lack an irmovative or far-sighted concept as well as any special capacity to execute. These can be discarded quickly, without much research or data collection. The entrepreneur should already be familiar with the basic facts about competitors' channels, customer behavior, technologies, and so on needed to judge whether a venture has prima facia merit. Lack of such knowledge constitutes a red flag. My research suggests that good ideas generally arise out of prior experience. Successfulve:ntures solve problems their founders have personally grappled with as customers, employees, or bankers. Ventures like

,Federal Express, which reputedly grew out of founder Fred Smith's senior thesis in college, are rare.

23 Chapter 2 Developing Start-Up Strategies

Start-ups need not, however, possess an edge on every front. The creativity of successful entrepreneurs varies considerably. Some implement a radical idea, some modify, and some show no originality. Their capacity for execution varies as well. Selling an industrial niche product doesn't call for the charisma required to

, Q- .~-;

, " pitch trinkets through infomercials. There is no ideal entrepreneurial profile: (\ Successful individuals may be grega~~9.!tS or, taciturn; analyticaJor intuitive; guQd _

or terrible with detaiis; risk-averse ~r!l1rillseeking; delegators or control f!~a.k~; pillars of the community or outsiders and outcasts.

The necessary creativity and capacity to execute depends on what the' entre­preneur hopes to accomplish and how. For example, ventures that seek to effect a revolution demand great creativity and an exceptional capacity to execute.

./.j;!.<'i.1

Launching a Xerox or Federal Express requires a blockbuster new product or service rather than a marginal tinkering with carbon paper or existing delivery ser­

-~

.,.',. {-;~ )~ vices. Revolutionary offerings usually require new processes or manufacturing

techniques; competitive markets rarely fail to provide valuable products or ser­vices unless there are serious technological problems involved in providing them. For example, Federal Express founder Fred Smith may not have been the first to

~ges think of the need for reliable overnight package delivery, but he did pioneer the pecial hub-and-spoke logisti<::~ needed to get the job done.3 ....

:xpect -' Requirements for e~ecution are also stiff. Revolutionary ventures consume in the vast resources. They require, for example, significant capital to develop new tech­liry to nology; build new facilities (Federal Express, for example, had to acquire its own

fleet of aircraft); market a totally new product; and sustain losses during a long paring ramp-up period. Entrepreneurs therefore require exceptignal charismaand evan­1 their gelical ability to attract and retain the support of investors, customers, employees, ; must and-s~ppliers for a seemingly outlandish vision. :ertain Entrepreneurs require unusual competence in managing resourc.es. Often Ie up. forced to make rather than buy, the entrepreneur must have the organizational and IIlple, leadership skills to build a large, complex firm quickly. In addition, the Ie and entrepreneur may require considerable technical skills in deal making, strategic I deter planning, managing overhead, and so on. The revolutionary entrepreneur, in other ~lin words, would appear to require almost superhuman qualities: Ordinary mortals [ right need not apply.

Entrepreneurs who seek to build a niche business require less radical con­fell as cepts. They do require some ingenuity to design a product that will draw cus­much tomers away from more mainstream offerings and overcome the cost penalty of :th the serving a small market, but, too-novel features can be a hindrance, A niche mdso market will rarely justify the investment required to educate customers and . such distributors of the benefits of a radically new product. Similarly, a niche erally venture cannot support too much production or distribution innovation; unlike lDders :s like

3Revolutionary concepts do not, however, involve much foresight regarding external change, The lbesis revolutionary start-up generally throws a stagnant, mature industry into tumult instead of riding external changes. In fact, with great external uncertainty. customers and investors may be hesitant to

back a radical product and technology until the environment settles down.

24 Part I Evaluating Opportunity and Developing the Business Concept

Federal Express, the specialty food manufacturer cannot afford its own fleet of trucks.

Moreover, a creative view of changing markets or technologies can com­pensate for the lack of independent innovation. For example, the personal com­puter revolution created opportunities to provide a variety of complementary goods and services such as add-on boards, math coprocessors, and software training videos and books. Entrepreneurs who recognized these opportunities quickly could build profitable businesses without an original technological breakthrough.

Entrepreneurs do not require exceptional ability to raise funds because the investment that can be justified by a niche market IS limited. Nor do they require the revolutionary's ability to build and lead complex organizations. Rather the entrepreneur must hav~.the capacitx to make do with less-for example, to nego­tiate favorable terms with 'sli"ppliers or use guerrilla marketing and word of mouth instead of national advertising to build brand awareness.

Creative concepts play an even smaller role in the success of propagators of an emerging technology or product who race to dominate a new market. For example, a new generation of microprocessors can spark a race in new down­stream products, such as personal computers. Or a new downstream market, such as laptop computers, creates a race to produce new components, such as long­lived batteries. Successful ventures in these hot markets don't rely on an inno­vative concept; target customers and their needs are common industry knowledge. Choices about components, technologies, and distribution channels are limited, and the advantages and disadvantages of the alternatives are well known. Adopting an unconventional approach-for example, by departing from industry standards~an actually scare off investors and potential customers.

Success depends mainly on superior execution: the ability to design and produce a quality product on time and on budget and then sell it effectively. Losers usually fold because they lack a product that works, not because they have pursued a poor strategy. Investment requirements, though substantial, merely rep­resent the entry fee for the race; more money rarely provides a competitive advantage. Correspondingly, entrepreneurs need superior skills in managing engi­neering, production, and marketing experts, and adequate competence in fund­raising and deal making.

Ventures based on "hustle,,4 in fragmented service businesses such as in­vestment management, investment banking, he'tcl-hunting, or consulting al~o rely mainly on execution. Innovative strategies count for little in fields where imitation is easy an(nf£l?~rceivedquality of the service provided is more critical than a unique technology, installed base, or captive distribution channel. The nature of superior execution is, however, different: Engineering, production, industrial mar­

. keting, and fund-raising are of little import. Rather, the entrepreneurs' personal , selling skills, network of contacts, reputation for expertise, and ability to convince clients of the value of services rendered are crucial. A capacity for institution

4For a detailed discussion, see Amar Bhide, "Hustle as Strategy," Harvard Business Review, September-October 1986.

Chapter 2 Developing Start-Up Strategies 2S

fleet building-recruiting and motivating stellar professionals, articulating and rein­

com­ forcing firm values, and so on-is also invaluable. With few natural economics of

com­ scale, the entrepreneur cannot create a going concern out of a one-man band or ad hoc ensemble without excellence in organization development. :oods

Entrepreneurs who speculate in, for example, oil and gas properties when theining energy market has collapsed or in office buildings in a real estate slump require :ould foresight·about the out-of-favor asset. The entrepreneur merely anticipates that the confusion or panic will pass; the concept does not entail significant innovation.· :e the

To execute, 'entrepreneurs must have the ability to raise funds for a contrarian quire bet; the entrepreneur's willingness to risk personal capital, connections with 2' the

!)ego­ investors, and deal-making skills can be crucial. Successful execution does not however require exceptional managerial capacity. Organizational development, llOuth engineering, or marketing abilities add little value when an entrepreneur buys assets at a low price, expecting to sell them at a high price. )TS of

L For Gauging Attractiveness Iown­

,such Entrepreneurs should also reflect on the attractiveness of their ventures from a long­ personal point of view--does the venture fit what they want to do as well as what inDo­ they can do? Surviving the inevitable disappointments and near disasters requires edge. passion for the enterprise; ability and desire are inseparable. Projects that enthuse oiled, one individual may well leave another cold, depending on their personalities, age, IOwn. wealth, and so on. luslry Therefore, entrepreneurs should know what they're looking for and the sacri­

fices they're willing to make. Do I want to make a fortune, or will a small profit 11 and suffice? Do I seek public recognition? The stimulation of working with exciting !vely. technologies, customers, and colleagues? Am I prepared to devote my life to a 'have venture, or do 1 want to cash out quickly? Can 1 tolerate working in an industry , rep­ with questionable ethical standards? High uncertainty? What financial and career :litive . risks am I prepared to take and for how long? engi­ These deeply personal preferences determine the type of ventures that will fund- enthuse and fortify an entrepreneur. For example, revolutionary ventures fit

entrepreneurs who want to win or lose on a grand scale. Success can create IS in­ dynastic fortunes and turn the entrepreneur into a near cult figure. But the risks orely also are substantial. Revolutions may fail for any number of reasons: The product laIion is flawed, cannot be made or distributed cost effectively, serves no compelling ban a need, or requires customers to incur unacceptable switching cost. Worse, the mre of failure may not be apparent for several years, locking the entrepreneur into an Imar­ extended period of frustrating endeavor. Even revolutions that are successful may :sonal not be financially rewarding for their founders, especially if they encounter delays l\ince en route. Investors may dump the visionary founders or demand a high share of bdion the equity for additional financing.

The founder of a revolutionary venture must therefore anticipate recurring disappointments and a high probability that years of toil may come to naught. ... Unless entrepreneurs have a burning desire to change the world, they should not undertake revolutions.

26 Part I Evaluating Opportunity and Developing the Business Concept

Niche ventures often hold greater financial promise. Although, compared to a successful revolutionary venture, the niche venture may create less total wealth, the entrepreneur can often keep a higher share. Niche ventures require less capital and can achieve financial self-sufficiency faster; therefore, the entrepreneur's equity interest is less likely to be diluted through multiple rounds of financings. However, entrepreneurs must be willing to prosper in a backwater; dominating an obscure niche can be more profitable than intellectually stimulating or glamorous. Niche enterprises can also enter the "land of the living dead" because their market is too small for the business to thrive, but the entrepreneur has invested too much effort to be willing to quit.

Ventures that propagate a new technology can provide considerable thrill from racing against determined rivals in a hot field. The entrepreneur's downside is cushioned by the sometimes irrational willingness of investors to bear most of the risk. And, ventures that don't work out get put out of their misery quickly, freeing the entrepreneur to move on. The odds of winning big, however, are also low. Controlling investors may oust the founder in a panic. Competition is fierce and the winner of the current race may be overtaken when a new upstream com­ponent or downstream product sparks a fresh contest. Exit options are subject to the vagaries of the IPO (initial public offering) market: When the venture is hot, the IPO market might not be.

Hustle ventures also provide the satisfaction of working with talented col­leagues in a fast-moving market. Capital requirements are low and investments can be staged as the business grows. Entrepreneurs can therefore avoid significant personal risk and meddling by outside investors. Although a hustle business can provide attractive current income, great wealth is elusive: Hustle businesses, which lack a sustainable franchise, cannot be easily sold or taken public at a high multiple of earnings. The entrepreneur must therefore savor the venture enough to make a long-term career of it rather than enjoy the fruits of its quick harvest.

The speculators' enjoyment lies in outwitting the market rather than building a firm or introducing an innovation to the world. The financial risks and returns depend on "the terms of the deal"-the capital the entrepreneur puts at risk, the conditions and amount of borrowing, and, of course, the price of the asset acquired. Risks are generally not staged-the entrepreneur is fully exposed when the asset is acquired. Liquidity or exit options often tum on the success of the speculation: If, as expected, prices rise, the speculator can expect many buyers for the asset owned,· but if prices decline or stay depressed, market liquidity for the asset will be generally poor. All told, such ventures appeal most to entrepreneurs who enjoy deal-making and rolling the dice.

Pitfalls Avoided

Timely reflection should force entrepreneurs to confront a basic flaw in many start-ups: the lack of any special idea or capacity to execute that could provide a competitive edge. In their enthusiasm many entrepreneurs dilute the much-better­than-your-rivals imperative to an as-good-as standard. Perhaps they have been

27 Chapter 2 Developing Start-Up Strategies

ed to a vealth, conditioned to believe that failure is the consequence of a pathological hubris or capital ineptitude. Just as we expect every healthy newborn to survive infancy, entre­fleur's preneurs assume that their ventures will naturally succeed. But, in fact, compe­ICings. tition makes the demise of start-ups normal, to-be-expected events; expectations tingan of profitable survival must be predicated on a superior idea or capacity for mous. execution. Darket Entrepreneurs may also find a poor fit between what they have and what a ,much particular venture takes. Common problems thus flagged include:

• Relying on hustle or a minor idea against entrenched competitors. High :thriII

levels of operational excellence won't sustain a new hamburger chain'mside

against competition from rivals who enjoy nationai purchasing economies, lOst of

brand names and high-traffic locations. Good management-listening toJickly,

customers, maintaining quality, and paying attention to costs-which can Ie also

improve the profits of a going business, can't propel a start-up over "struc­fierce

tural" barriers. A creative new process or product is a must. I com­

• Launching revolutionary products in niche markets. Steve Jobs introduced ject to truly user-friendly personal computing through the Lisa in 1983. is hot, Positioned as a high-end $10,000 product, it couldn't attract the critical mass of software writers, value-added resellers, distribution channels, and III col­users it needed to survive. When the same technology was reintroduced ments for a broader market as the Macintosh, however, the product was a ifieant smash hit. ss can

IeSses, Entrepreneurs should, however, use the initial screen to drop only truly dead­• high ended projects, not to kill all ideas by identifying their every shortcoming. And, gghto with the right attitude, reflecting on entrepreneur-venture fit can, in fact, give it. courage to the waverers. Except perhaps in revolutionary ventures, success does Iildrng not usually require extraordinary ideas, resumes, or talent, as the following exam­ctums ples illustrate: it. the

• The advent of a new distribution option (such as home shopping channels) asset or a new regime (as in Eastern Europe) creates great opportunities for the \Tonen determined novice. Entrepreneurs who are willing to act quickly can of the create profitable niche or hustle businesses with just a little ingenuity

::IS for because they don't face entrenched competitors and customers tolerate Dr- the imperfections and inexperience. Even buttoned-down IBM turned to a :oeurs college drop-out, Bill Gates, to source the operating system for their first personal computer.

• In some service businesses dominated by fly-by-night or unreliable oper­ators, modest professionalism can provide a meaningful edge. For

many instance, superior execution in providing transportation services for rock

ride a bands may simply require showing up on time.

1eIIer­ • In a new technology race, native talent can prevail over qualifications and : been experience. In the work-station market, for example, Sun Microsystems

beat over a dozen start-ups including Apollo, a text-book venture launched

28 Part I Evaluating Opportunity and Developing the Business Concept

by industry stars. Sun's four 27-year-old founders, who had virtually no business or industry experience, simply out-engineered and outsold their rivals.5

Parsimonious Planning and Analysis To conserve time and money, entrepreneurs must minimize the resources they devote to researching the ideas that pass their initial screen. Unlike the corporate world, where foil-mastery and completed staff work can mak.e a career, the entrepreneur only does as much planning and analysis as seems necessary and useful.

How much effort should an entrepreneur devote? The appropriate analytical "budget" that a start-up merits depends on several factors: Ven~ures~that require signijicant capital haye. to be better researched and documenteaihan ve_ntlir~s that ca;; be~-e!rfiriance-ci: Prof~ssionallnvesto;:s ~sually requir~-;: ~ritte~ b~siness plan because-it proVlctes clues about the entrepreneur's seriousness of purpose, concern for investors, and competence, and it can be conveniently evaluated on airplanes. Entrepreneurs must cobble together a plausible book, even if they are skeptical about its relationship to subsequent outcomes. The degree of iIUlOvation attempted also affects the utility of analysis. For example, focus groups and surveys have little value in predicting demand for products that closely resemble existing offerings or products that are so novel that customers can't express a useful opinion. Market research helps most with intermediate levels of innovation.

Businesses with more complex operations or development tasks require more analysis and planning. Complexity increases the costs of poor coordination or timing; besides, the process of jointly thrashing out a plan can help build cohesion in the multifunctional teams that such ventures require.

Changing technologies, customer preferences, regulations and so on militate against extensive analysis. Entrepreneurs cannot rely on research conducted under conditions of such turbulence; and besides, if they expect to take advantage of the external changes, they can't spend time dotting i's and crossing t's. This is not to imply, however, that start-ups in a stable environment merit leisurely investi­gation. Entrepreneurs can't allow the availability of time and other resources to stimulate more analysis. With spreadsheet software, for example, it's easy to chum out detailed but not particularly insightful analyses of a project's break-even point, capital requirements, payback period, or DCE

Given a limited budget, how should entrepreneurs set their analytical prior­ities? The entrepreneur may be tempted to touch lightly all of the innumerable issues that might be analyzed or to spend a lot of effort in areas where data is most readily available. Parsimonious analysis, however, entails a triage: With issues where the impossibility of obtaining data precludes analysis, entrepreneurs simply

5See "Vinod Khosla and Sun Microsystems," HBS case no. 9-390-049.

29 Chapter 2 Developing Start-Up Strategies

, have to take their chances. Other issues deserve only passing attention, because although lots of data can be collected, the analyses can't be acted on. Entrepre­neurs should concentrate on issues that they can reasonably expect to resolve and that determine whether and how they will proceed. Resolving a few big questions-understanding what must go right and anticipating the venture­destroying pitfalls, for instance-is more important than investigating many nice­to-know matters.

tid

:s they An entrepreneur cannot use a standard checklist or a one-size-fits-all rporate approach to analysis; issues most worthy of analysis will depend on the type of er, the venture undertaken.6 To illustrate.consider that in revolutionary ventures, market II)' and size and growth is notoriOlg;ly. difficult to predict. At best, entrepreneurs may

satisfy themselves that their novel product or service delivers considerably greater llytical value than current offerings; how quickly it catches on is a blind guess. Leverage ~uire may be obtained, however, from analyzing how customers might buy and use the ~.that product or service. Understanding the purchase process can help identify the right :s:s plan decision makers for the new offering-in the case of Federal Express, for oncern instance, it was important to go beyond the mailroom managers who traditionally planes. bought delivery services. Similarly, understanding how products are used can q>tical reveal obstacles that must be overcome before customers can realize the benefit :mpted from the revolutionary offering. rs have Another important issue for revolutionaries lies in the appropriability of mting returns from their innovation. Many concepts are difficult to prove, but once useful proven, easy to imitate. Unless the pioneer is protected by sustainable barriers to

IL entry, the benefits of the hard-fought revolution become a public good rather than emore the source of entrepreneurial profit. Given the magnitude of the organizational Don or building task in a revolutionary venture, entrepreneurs may also address issues lbesion such as the values members of the firm will uphold, how they will communicate

with each other and how they will resolve disputes. Resolving these corporate Dilitate culture issues early can protect the organization from the subsequent stress of I WIder rapid growth. ~ofthe Niche start-ups often fail because the costs of serving a specialized niche I DOt to exceed the benefits to customers. Entrepreneurs should therefore analyze carefully avesti­ the incremental costs of serving a niche, taking into account their lack of scale and IfCeS to the difficulty of marketing to a small diffused segment. Especially if the cost dis­:asy to advantage is significant, entrepreneurs should determine whether their offering ~~\'en provides a significant price or performance benefit. Established companies may

vie for share through line extensions or marginal tailoring of their products and I prior­1III:Rb1e

tYrhe types of ventures I have described are not intended to be mutually exclusive or collectively is DlOSl exhaustive. Nor do I suggest that entrepreneurs should maintain purity of style and avoid hybrids. I issues For example, there is nothing intrinsically flawed about a venture to establish a network that pro­

vides a revolutionary service to participants. I offer the typology merely as an aid to prunmg the ana­lytical task efficiently. If a venture straddles two types, entrepreneurs should construct an analytical approach that combines the relevant features of both or think of another analogy that is more appro­

priate. What should be avoided is a laundry-list approach, in which all possible issues are half­

heartedly analyzed as well as a blind just-do-it attitude.

simpl~'

1

30 Part I Evaluating Opportunity and Developing the Business Concept

services; the start-up must really wow its target customers. A marginally tastier cereal won't knock Kellogg's com flakes off supermarket shelves.

Another significant risk with niche ventures is that their payoffs are too small. For example, a niche venture that can't support a direct sales force may not gen­erate enough commissions to attract an independent broker or manufacturers' rep. Entrepreneurs too will eventually lose interest if the rewards aren't commensurate with their efforts. Therefore, the entrepreneur should verify that everyone who contributes may reasonably expect a high, quick, or sustainable return even if the total profits of the venture are small.

The most critical issue for the propagators of a new technology-their ability to outpace rivals-s-cannot be easily analyzed. Who could have forecast, for example, that the inexperienced founders of Sun Microsystems would beat out Apollo's veterans? Entering a race basically requires faith in one's ability to finish ahead of the pack. Analyzing whether the rewards for winning are commensurate with the risks, however, can be more feasible and worthwhile. In some technology races, success is predictably short-lived. In the disk drive industry, for example, firms that succeed with one generation of products are often leap-frogged when the next generation arrives. In engineering work-stations however, Sun was able to realize relatively long-term gains from its early success because it established a durable "architectural" standard.

Operational analysis and planning usually deserves more attention than strategic planning, because getting a product that works out quickly is crucial. For example, Sun's business plan, one founder recalls, was mainly an operating plan, containing specific timetables for product development, opening sales and service offices, hiring engineers, and so on.

In ventures ~le, a detailed analysis of competitors and industry structure is rarely of much value. The ability to seize short-lived opportunities and execute them brilliantly is of far more importance than a long-term competitive strategy. Analysis of specific clients and relationships dominates general market surveys. Partnership agreements, terms for offering equity to later employees, per­formance measurement criteria, and bonus plans are important determinants of firm success and are best thought through before launch rather than hastily impro­vised later on. Although projections of long-term cash flows are not meaningful, back-of-the-envelope, short-term cash forecasts and analyses of break-evens can keep the entrepreneur out of trouble. Overall, though, the analytical preparation required for such ventures is modest.

With speculative ventures, two sets of analysis are crucial. One relates to the market dynamics for the asset being acquired, or, more specifically, why the prices of the asset may be expected to rise. Entrepreneurs should try to determine whether prices are temporarily low (due to, say, an irrational panic or a temporary surge in supply), in secular decline because of permanent changes in supply or demand, or merely correcting after an irrational prior surge. The other analysis is of the entrepreneurs' ability to hold or carry the asset till it can be sold at a profit, because it is difficult to predict when temporarily depressed prices will return to normal. Carrying capacity depends on the extent of borrowing used to purchase

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Chapter 2 Developing Start-Up Strategies 3~

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the asset, the conditions under which financing may be revoked, and the incorm produced by the asset. Rental properties or a producing well that provides ongoin] income, for example, can be carried more easily than raw land or drilling rights For certain kinds of assets-for example, mines and urban rental properties-s-tlu entrepreneur should also consider the risks of expropriation and windfall taxation

Integrating Action and Analysis Standard operating procedure in large corporations usually entails a clear dis tinction between analysis and execution. In contemplating a new venture, estab lished firms face issues about its "fit" with ongoing activities: Does the proposec venture leverage corporate strengths? Will the resources and attention it require: reduce our ability to build customer loyalty and improve quality in our con markets? These concerns dictate a deliberate, "trustee"? approach: Before the) can launch a venture, managers must investigate an opportunity extensively, see] the counsel of higher-ups, submit a formal plan, respond to criticisms by bosses and corporate staff, and secure a head count and capital allocation.

Entrepreneurs who start with a clean slate, however, don't have to obtain at the answers before they act. In fact, they often can't easily separate action ane analysis. The attractiveness of a new restaurant, for example, may depend on the terms of the lease-low rents can turn the venture from a mediocre proposition te a money machine. But an entrepreneur's ability to negotiate a good lease cannoi easily be determined from a general prior analysis; he or she must enter into, serious negotiation with a specific landlord for a specific property. Performing a lot of other analyses without first testing the ability to get a good lease car be a serious waste of time and money.

Acting before an opportunity is fully analyzed has other benefits. Doing something concrete builds confidence in oneself and in others. Key employees and investors will often follow the individual who has committed to action by, for instance, quitting a job, incorporating, or signing a lease. By taking a personal risk, the entrepreneur convinces others that the venture will proceed and, if they don't sign up, they could be left behind.

Early action can generate more robust, better informed strategies. Extensive surveys and focus group research about a concept can produce misleading evi­dence: Slippage can arise between research and reality because the potential cus­tomers interviewed are not representative of the market, their enthusiasm for the concept wanes when they see the actual product, or they may lack the authority to sign purchase orders. More robust strategies may be developed by first building a working prototype and asking customers to use it before conducting extensive market research.

7See Howard Stevenson and David Gumpert, "The Heart of Entrepreneurship," Harvard Business Review, March-April 1985. . ...,

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33 Chapter 2 Developing Start-Up Strategies

research and statistically significant results, but the resource-constrained entre preneur doesn't have much choice. Besides, in the initial stages, the deep knowl edge and support of a few is often more valuable than broad, impersonal data.

Flexible Perseverance Entrepreneurs who act on sketchy information and back-orthe-envelope plan: must stand ready to change their strategies as events unfold. Successful venture: don't always proceed in the direction that they initially set out along. A significan proportion develop entirely new markets and products and sources of competitive advantage. Therefore, although perseverance and tenacity represent valuablt entrepreneurial traits, they must be complemented with 'flexibility and willingnes, to learn. If customers who should be placing orders don't, the entrepreneur shouk

---e consider reworking the concept. Similarly, the entrepreneur should also be pre pared to exploit opportunities that didn't figure in the initial plan.

The apparently sketchy planning and haphazard evolution of many successfu ventures doesn't mean that entrepreneurs should follow a ready-fire-airr approach. In spite of appearances, astute entrepreneurs do analyze and strategize extensively. They realize, however, that businesses cannot be launched like space shuttles, with every detail of the mission planned in advance. In fact, to para phrase Cardinal Newman, the quest for the perfect start-up plan is often the enemy of the good. Initial analyses only provide plausible hypotheses, which must be tested and modified. Entrepreneurs should play with and explore ideas, letting their strategi.es evolve through a seamless process of guesswork, analysis, ane action,

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