I just finished reading "Discovery-Driven Planning" in the July-August 1995 edition of Harvard Business Review. The article addresses the problem of flawed assumptions when planning a new venture.
I have found many start-up or expansion minded entrepreneurs begin preparing their business plan with a high ratio of assumptions to knowledge. Existing businesses have a track record on which we can reasonably predict future performance. That track record can be verified and validated. New ventures require a company to make assumptions, hopefully correct ones. The authors recognize deviations from assumptions often occur and it is when a company tracks and responds to those flawed assumptions that losses can be avoided. The Euro-Disney venture is cited as one example of using existing business experiencees as the assumptions for a new venture.
Start-up and expansion projects must include these basic disciplines:
I. Begin With Your Objective in Mind
Determe the "required profits" from the venture. You will end up calculating the amount of revenue necessary and allowable expenses to achieve the required profit level. For example:
1. Profit Required: $xxx, representing at least a 10% increase for your expansion or an absolute amount for your start-up.
2. Margin or Return Required: xx%. This margin should be greater than your existing business as compensation for the your risk.
3. Determine the gross level of sales at the mandated margin (2) to achieve the profit level required (1).
4. Determine the competitive price point to gain market share and next determine the level of units at this price necessary to achieve the gross sales level (3).
5. Establish the magnitude of the venture by comparing the level of units (4) to the size of your market. This will help your company determine the anticipated market share and the strategy by which you compete.
6. Knowing your required profit (1), the gross level of sales (3) and required margin (2), you next establish what your allowable costs will be.
II. Define Your Operation
Your next discipline is to define every activity required to market, produce and deliver the product to the customer. You need to compare the compilation of these operational costs to your allowable costs.
How can you model these activities and their related costs when you have no track record to validate the numbers?. This is where you need to use industry standards and performance ratios from the industry you are in or from a similar industry. To distinguish your firm from others in your industry, you'll want to identify where your firm will match industry standards and where you will perform better.
III. Test Your Assumptions
Every assumption in planning for a start-up or expansion is just that, an assumption. Until you have validated each of the assumtions, you will never really know if your venture is performing "as planned." How can you test all the assumptions at once? You can't. But you CAN begin by testing the critical, riskiest or most challenging assumptions first. Defer major capital expenditures until your assumptions and performance standards are where you want them to be. Keep checking the performance to assumptions until your venture is meeting the standards necessary to achieve the profit objective. Using this discipline will alert you to problems, flawed assumtions or the necessity to abandon this venture before investing more capital.
I hope you found this helpful. Once or twice a month, I write down my observations or thoughts from material I've read, business ideas I've learned or questions in the marketplace. If you would like to receive your personal copy of this column via e-mail (including non AOL users), send me an e-mail (DGAlcorn@aol.com) message with the heading "Subscribe OnLine Column".
