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.