Dogs Walking On Their Hind Legs: Tales Of What Happens When You Don’t Know Your Business Model’s Numbers

 

 

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from:  http://tinyurl.com/przwj3o

I have seen several businesses now that don’t know themselves via numbers.  They may be founded by highly relationship-focused entrepreneurs, which can be a great thing, or they may be focused by people who are not numbers savvy.  However, I can’t tell you strongly enough about how important it is to know key metrics for your business and to follow them.  

 

Sometimes, my colleagues and I have seen businesses that, when we finally look at the numbers, appear as dogs walking on their hind legs.  That is, these are businesses that currently shouldn’t be doing what they are doing and probably cannot do it for very long.  One of the key techniques we focus start up teams on to achieve a sustainable position was discussed in an earlier entry.  The business model canvas is one of the techniques we recommend to set up a condition where you can know your business by the numbers and follow it over time to get a sense of where you really are.

 

The business model canvas can be used to create a pictorial history of the business.  The business model canvas can then be considered at different meetings and revised.  Then, over time, we obtain a history of the business and can look back on this to gain certain insights.  It will focus us on those areas on which our business rests.  Next, we need to establish and focus on key metrics for the business.  Many new businesses are highly dependent on new customer acquisition.  In those cases, we recommend getting metrics together about that key sector.  Whatever parts of the canvas are key we recommend putting some metrics in which you can believe attached to that.  

 

However, often there are several areas of the business on which we should focus. One of these is cash-flow.  Cash is, in fact, king as the the saying goes.  This is because it is highly liquid and very transportable.  Cash-flow is incredibly important to businesses and, although I was told that in business school, I didn’t fully appreciate it until situations arose in one of the first businesses I helped co-found.  

 

In short, I learned important lessons like:  it is possible to grow the business so much so quickly that the business actually grows its way into bankruptcy. That can be because, although the business is very worthwhile and profitable, it is unable to meet its current obligations owing to cash-flow restrictions. So, for that reason, I can’t stress enough the importance of knowing your businesses’ key metrics and establishing these upfront. 

 

There are multiple sources you can go to in order to discover what key business metrics there are for startups.  Some of the key metrics we look at to prevent the dog-on-hind-legs-syndrome (or DOHLS, because, being in healthcare, it seems I have to attach an acronym to everything) are business financial ratios.  These can tell you about the current financial health of the business. 

 

Some of the most important ones include the acid test ratio, which focuses on your businesses’ ability to meet its current obligations. The acid test ratio is called that for the very important reason that it is one of the most central, key metrics for how your business is doing. However, these are not the only lenses through which you should view your business.

 

One of the other important things is the days in accounts receivable. If it is taking you too long to collect on outstanding bills you may need to incentivize customers to pay those bills faster.  Taking too long to collect on invoices can directly inhibit your cash flow and ability to meet those current obligations. For a more in depth discussion on financial ratios and associated metrics, including the classic three levers of financial control, I invite you to read a brief primer on financial ratios, either available from Amazon for Kindle or many online sources.  

 

Some of the key ones we use include the acid test ratio and the ROIC (return on invested capital).  However, you should recognize that startups need different ratios than established companies.  For startups there are other metrics which are no less central to understanding the quality and life of the business.  Sometimes when we give talks to surgeons and other physicians about their startups we even use the analogy of the business as the patient and focus on some of the metrics we use as if they are vital signs. This is a useful exercise and my colleagues and I do this routinely at our yearly seminar.

 

The yearly seminar really helps both physicians, non-physician caregivers and other providers in healthcare get their minds wrapped around how to know how well their business, patient, or business model canvas is performing.  There are some other useful metrics that are indigenous to startups.  For example it is very key to highlight a customer-specific metric.  Some startup books advise that the core team actually focus mostly on customer development at the onset of the business.  That means the entrepreneurial team spends a great deal of its time developing the market and focusing on techniques such as evergreening.  

 

Evergreening is a classic technique that focuses on obtaining more or repeat business from a client pool.  This evergreening technique references trees and tree growth where the tree is green all year long. This is the focus for techniques collectively called evergreening.  Beyond evergreening there are also other useful areas of focus for business metrics of the startup.  Some of these include the number of new potential customer contacts and the attrition rate of customers.  How much time, effort, and ability does it take to convert a set number of calls to a new customer.  Related to this there can be costs associated with customer acquisition. If you ever watched the show ‘Shark Tank’ this is one that you have seen repeatedly question by some of the sharks.  If a startup knows its cost of customer acquisition this tells us a great deal about the startup.  First, it tells you that the startup is focused on bringing in new business and really has focused on it to the point where they can name a price associated with the cost of acquiring new customer.  It shows that they have spent time working on it. And it shows they have thought about the inflow to their company to an appropriate degree.  

 

Regardless of what the specific number is, Mark Cuban’s typical question on Shark Tank indicates that the startup has a good sense of how it brings in new customers and there is a ready-made stream of inflow developed. For startups, again, it is very key to have an understanding of metrics associated with customer acquisition and business acquisition so as to prevent dog walking on hind legs syndrome.

 

Have you ever seen any business that has this dog walking on hind legs syndrome (DOHLS)?  It happens all the time that, when a business finally looks at its numbers, it becomes clear that it can’t continue onward doing what it’s doing for very long just like that wobbly dog. 


To share a personal story, I have been very fortunate with at least one of the startups in which I have participated.  My cofounder and I were not as focused on our business model’s metrics at the beginning of the startup, and instead took the route of the very personal, very relationship-oriented startup.  This had many upsides.  However there were a few downsides including the fact that we began to encounter cash-flow problems etc. and quite nearly did grow ourselves into a bankruptcy-type situation where we could not cover our costs.  This was because of cash-flow as the company grew.  Each time the company grew into a new venue we had to be able to have approximately 20k cash on hand to be able to pay our first independent contractors who worked at that site before that site was required to pay us.  This 20k of float, or floating money, was not something we appreciated as well as we could have initially.  Fortunately, owing to excellent work on the part of my cofounder and the business team associated with the project the company has gone on to do well.  However, we were almost too late when it came to appreciating our financial metrics.  We had to pay more attention to our days and accounts receivable etc, and this was something that it took sometime to get a feel for in our business.  So there are multiple business metrics on which we can focus for our startup. 


Learn from my mistake:  regardless of the specific ones you choose to believe in and rely upon it is essential that there be some on which you rely.  I recommend some of these include customer-focused metrics so you have a sense of how to develop a continuous, effective, cost-conscious pipeline for new customers into your business model.  For more information regarding financial ratios, including those focused on profitability, cash-flow and inventory I direct you towards any of the classic primers on management by financial ratios which you can find on Amazon.com or the Google.  Also, remember to look at one that is startup-focused.

 

Thought Leadership Has An Upside And A Downside

A thought leader is similar to a bellwether:  it is a person who is sort of a leader of the pack.  They are people who are often at the forefront of a movement or a set of ideas.  It is important to realize, though, that being a thought leader has upside but also has downside risks.  For example, the cutting edge idea that you may espouse may not make it to prime time.  Being at the forefront of your field has a lot of benefits and it’s important to recognize the downside risks of you possibly getting behind an idea that fails spectacularly.

 

How does one become a thought leader?  A thought leader is often someone who represents a non -consensus viewpoint.  Note the key elements of this include that they represent this idea or cutting-edge thought.  They need, in short, an audience.  Finding and growing an audience is one of the biggest challenges of becoming a thought leader.

 

In healthcare, particularly Surgery, there are many mechanisms in which to do this.  In Trauma and Emergency Surgery, for example, giving talks at professional meetings, participating in committees within professional organizations such as the Eastern Association of the Surgery for Trauma (similar national trauma surgical society), or networking via online communities can help you establish yourself as a thought leader.  Other routes include social media visibility, and yet another includes publishing papers in journals or even becoming an editor for a journal.  These are just some of the ways to be at the forefront of research in trauma and emergency surgery, and in healthcare being at the forefront of research is often equated with being a thought leader.  However, these are not the only ways in which you can become a thought leader.  You can even provide consultant work to hospital service lines, be the messenger or proponent of an idea that is already in existence or basically establish your name and reputation as someone at the forefront of the field.

 

As mentioned, one of the other important elements of becoming a thought leader is representing a non-consensus viewpoint.  That is, if every speaker represents the same view point it is unlikely that anyone will be perceived as a leader.  Looking at a problem or issue in a new way, focusing on an issue that is common to people in the field, and clearly representing this non-consensus viewpoint in a non-confrontational way can help establish you as a thought leader.  Representing a unique viewpoint makes being a thought leader very different than just being an expert on some topic.

 

In our angel investment practice, one criterion on which we evaluate new potential business models is the presence of a non-consensus viewpoint.  We are interested in a team that thinks the market, or a solution to some issue a consumer has, is going in a different direction than what many others think.  They need solid data (experiential or otherwise) to substantiate their claim.  If a business team demonstrates a non -onsensus viewpoint that has sustainable competitive advantage, that is it, the position can be protected, established, and grown, the idea is much more attractive.  Clint Korver, from Ulu Ventures, also described the search for non-consensus viewpoint in a recent online course on NovoEd.com entitled Venture Capital 101.

 

In short, being a thought leader requires multiple facets including finding and reaching an audience with your unique, non-consensus viewpoint in a non-confrontational way that demonstrates the utility of this non-consensus viewpoint. Having a novel or interesting viewpoint on a topic that doesn’t matter about which you can tell no one is exactly the opposite of becoming a thought leader.  In business model innovation, becoming a thought leader can have significant utility as you look to influence stakeholders to get on board with your business model.  Representing a non-consensus viewpoint in an effective way can help propel you into a position where you are much more likely to get funding for your business model or be looked up in your field as an important thought leader. Such a visible position has a strong upside yet also has downside risk.

Scalability Is A Key Concept For Your Business

One of the most challenging elements in business model innovation is the concept of scalability.  When the team and I evaluate new business model ideas, one of the parameters on which we evaluate them is scalability.  Scalability is the term attached to how easily the business grows up as its inflow grows.

 

As a general rule, service-intensive companies are tougher to scale up.  An example of a service-intensive company may be one, for example, that is contingent on the individual talent / professional knowledge of some core team member such that replicating that position in the business model is difficult.  Specific examples include a law firm, physician’s office, or an architectural drafting company.  When the initial team member, let’s say a physician in this case, becomes busier with administrative tasks as the company grows, it is difficult to replicate that physician’s participation in providing the actual service that the company is meant to do.  So, issues with scalability arise.

 

Said differently, it is much harder to scale businesses that are services in part owing to the reason that an individual team member’s talent provides the core for the business.  Usually when we find a business model where scalability is a challenge or when we design a new business model that is a service, we focus, intentionally, on ways to make the business more scalable.  Some of these include planning for the volume of business at which we will add employees or independent contractors to be able to provide the service as the initial team member becomes progressively busier with administrative work.  It can become very difficult if we wait for a team member to be overloaded before offloading tasks from them, and so a clear discussion about how to scale up, at the onset of the business, is useful.

 

We usually say that an issue with scaling up is one of the “good problems to have” because it indicates the business is growing and the model is likely reaching a customer need / market.  So when we perceive issues with scaling we try to remind ourselves that this set of issues is better than the set of issues where no one is buying the product or service.

 

Non-service business opportunities maybe much more easily scalable.  A model that sells an online info product, for example, may be much easier to scale.  A recent online search for examples of highly scalable models revealed www.providerlifestyleexperts.com as a nice example.  Startups that focus on a website for sales are often contingent on band width, server speed and other issues such as those.  Where scalability is more dependent on technology things maybe scaled easier.  This is not to say that it is straightforward to scale business models that have inventory associated with them.

 

Business models where an object is built or an object has value added to it and is then sold can also be very challenging.  CEO’s such as Tim Cook from Apple and Jeff Bezos from Amazon are masters at logistics and this highlights the importance of those functions in a modern business model that wants to scale up.

 

When you have an idea for a new business it should be fairly clear by now that much more goes into a successful idea than having a good idea.  A good idea is key to success but there is much more around it that makes the idea move forward in a sustainable fashion.  In later posts we will discuss more on typical factors that are associated with the business success or failure.  (FYI The “we” seems to be creeping into the blog a lot.  That is because sometimes, here, I’m speaking for our team of investors and “startup mechanics”.) Interestingly there is a great deal of research, much of which is statistically rigorous, about what makes successful startups across multiple different industries.  These have always been a personal interest of mine and I look forward to sharing those with you in future blog post.

Compound Annual Growth Rate vs. Blue Ocean Strategy: Also-Ran Versus Whole New Class?

 

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One of the typical markers taught in business school to evaluate entering a new market is the compound annual growth rate or CAGR (pronounced kay-jer). A compound annual growth rate of 15% or greater is considered a favorable market and one you may want to consider entering.  There are lots of complex formulae to calculate the CAGR however there is a relatively straightforward one in a book entitled Harvard Business School Secrets by Emily Chan.  Don’t be taken in by the table she lists at the end of the book with the CAGR trick.  Unless I have misread it, Emily, or Emily’s editor, actually rearranges the fast formula for CAGR likely on accident.

 

The quick formula for CAGR is 0.75 divided by the amount of time the market takes to double in size.

 

So, if the market takes 3 years to double in size, the CAGR would be 25% and this would be a favorable market.  This is one pole of strategic thinking which is sort of an also-ran strategy.  Meaning this focus on entering a market that is already doing well is a nice way to try to move in the same direction as everyone else and obtain a return.

 

However, there is another extreme on the spectrum of strategic ideas called Blue Ocean Strategy.  If you haven’t heard about Blue Ocean Strategy I invite you to consider reading a book also entitled Blue Ocean Strategy which has really been fascinating in my opinion. It is one of the more interesting business-related books I have seen in the last 10 years.  Blue Ocean Strategy is the name given for what was originally an Eastern idea of blue and red oceans.  Red oceans are depicted as ones in which there are multiple competitive entities that bloody the ocean with the products of their competition.  A blue ocean, by contrast, is a here-to-fore unseen market created with a game changing product, service, or business model.

 

A nice example of Blue Ocean Strategy is the counter-intuitive idea of the gaming console that makes us get up and move.  Where originally gaming consoles were thought of as static things that favored sedentary lifestyle, the Nintendo Wii and now other consoles such as Microsoft XBox with Kinect have really completely changed the market to where now a substantial degree of motion is expected in certain gaming consoles. Nintendo’s game changing move to the Wii resulted in substantial sales, first mover advantage, and an incredible blue ocean for some time until the rest of the predators were able to enter that same field.  So, Blue Ocean Strategy sort of reflects a first mover advantage until copy-cats arrive. However it is more than that as it focuses on innovation as an important deciding factor in gains.

 

Blue Ocean Strategy draws a contrast to the older business school thinking that leads us to the idea of the CAGR and the also-ran strategies. I take these as two spectrums in product development and invite you to read more about both Blue Ocean Strategy and typical tools to evaluate a market such as the compound annual growth rate.  Each has its place and utility.

MVP Does Not Just Stand For Most Valuable Player

We haven’t directly discussed this during our previous blog entries but many of the tools we have been mentioning are part of a start-up style called the Lean Startup.  Typical tools of the Lean Startup include the business model canvas and strategies to reduce initial outlay of capital in order to demonstrate that the business experiment works.  These Lean techniques are in line with similar thoughts on Lean production, Lean six sigma and Lean development.

 

Lean, however, is more than just a catchphrase.  It gives us some useful concepts.  Lean strategies focus on the 8 sources of waste in most systems.  These 8 sources of waste may be represented by the acronym DOWNTIME.  This is meant to reference downtime for machines and other capital pieces of equipment that cannot function to produce output when they are down or offline. The acronym DOWNTIME reminds us:  D=defect, O=overproduction, W=waiting (where one step waits on the next step), N=non utilized talent, T=transportation, I=inventory, M=motion (wasted movement), and E=excess processing.

 

This focus on the elimination of the 8 sources of waste, sometimes called “muda”, are classic techniques in creating a new start up.  One of the concepts unique to the implementation of lean methodology in startups is the creation of the MVP.  This doesn’t stand for the most valuable player or any of the typical ways you may have heard MVP utilized previously.

 

MVP, in this context, stands for minimum viable product. In other words, when a company that is going to sell a product or services goes live it is useful to try to strip away every single thing down to the minimum viable product that a consumer will accept and pay for at an appropriate level. This is a very tricky concept.  Often product teams are attempting to throw everything but the kitchen sink (or even including it) at the potential customer.  However the minimum viable product is a useful idea given that it often requires the least amount of time to prepare, is typically able to be held in inventory longer, requires the least intensive expenditure of capital to create, and is often the most agile in terms of flexibility for redesign etc.

 

The minimum viable product is a useful thought tool in creating a new startup that is going to sell a business or product.  You may have seen this with 3D printer manufacturers such as Makerbot.  I have one of the earliest Makerbot Replicator models and let me say this model has much more austere appearance than the eventual Makerbot Replicator 2.  For example, the earlier replicators for Makerbot had a wooden case and were very straightforward and simple in term of design and manufacture.  They often came as kits which end user were to build on their own. If you wanted an assembled Replicator it was more expensive.  Now the Replicator 2 is a product that has advanced beyond the minimum viable product stage.  It comes assembled, has a metal case, and overall looks very different than the initial replicators.  Again, I invite you to read more about it and learn about some of the interesting lean startup tools that can be utilized to create your new startup business, usually with nothing more than the funding available on one of your credit cards.

 

Our Angel investment team has found that a typical capital expenditure of between 5-10k is able to establish and fund an excellent service type business model canvas with a runway of approximately 5-6 months.  This is based on Lean startup techniques and interesting utilization of certain tools that allow a business to go live as an effective going concern with a runway of between 5-6 months.  Take a minute and read about Lean startups.  You will find it is worth your time.