ADVICE TO SMALL BUSINESS OWNERS
ADVICE TO SMALL BUSINESS OWNERS
What Every CEO Should Know About Creating New Businesses, Markets and Products
I have been looking for a resource that would outline to business owners the macro challenges of new ventures. I found an older article from the Harvard Business Review by David A. Garvin, July -August 2004 issue.
Starting a new venture is time consuming and can be costly. If you have questions on assessing risk and return and your personal or in-house capability to be successful please let us assist you in answering these questions. Following is the article.
“Some problems,” wrote Laurence J. Peter, the business humorist, “are so complex that you have to be highly intelligent and well informed just to be undecided about them.” Top-line growth is one of those, especially when it comes to creating new businesses within large, complex companies. The challenges are vast, and it’s diﬃcult to know how, or even whether, to move forward. Most CEOs would beneﬁt from having a few rules of the road.
Fortunately, scholars have studied the problem for decades. And whether they’ve called it “new business creation,” “corporate venturing,” “corporate entrepreneurship,” “corporate innovation,” or “intrapreneuring,” their observations have been remarkably similar. Yet these ﬁndings have seldom been summarized or presented in an easily accessible form. Here, then, is a primer on the topic--the ten things every corporate venturer should know.
1 Ultimately, growth means starting new businesses.
Most ﬁrms have no alternative. Sectors decline, as they did for Pullman’s railroad cars and Singer’s sewing machines. Technology renders products and services obsolete—the fate Polaroid suﬀered, as digital cameras decimated its instant photography franchise. Markets saturate, as Home Depot is now ﬁnding, after establishing more than a thousand stores nationwide.
2 Most new businesses fail.
New businesses may be necessary for long-term growth, but successes are hard to pull oﬀ. The numbers are downright depressing. In the 1970s and 1980s, 60% of small-business start-ups failed in their ﬁrst six years. Large companies did only a bit better. A study of sizable corporations during the same period, which included such household names as DuPont, Exxon, IBM, Procter & Gamble, Sara Lee, 3M, and Xerox, found that they divested or closed 44% of their internally generated start- ups and 50% of their joint ventures in the ﬁrst six years.
3 Corporate culture is the biggest deterrent to business creation.
New ventures ﬂourish best in open, exploratory environments, but most large corporations are geared toward mature businesses and eﬃcient, predictable operations. When a company’s leaders recognize and support mavericks, encourage diverse perspectives, tolerate well-reasoned mistakes, and provide resources for exploratory ventures, employees are apt to embrace entrepreneurship. When leaders reward conformists and rule followers, insist on acceptance of the party line, demand error-free performance, and tightly ration resources, employees are likely to shun exploratory projects. New ventures whose operating sponsors are close to the action and know their businesses intimately tend to do better than those championed by the CEO alone.
4 Separate organizations don’t work—or at least not for long.
If new ventures require a new environment, the reasoning goes, they should be in a separate unit. Accordingly, from the 1960s through the 1980s, such companies as Boeing, Exxon, GE, Gillette, Levi Strauss, and Monsanto set up separate internal venture divisions. In the 1990s, companies like Bertelsmann, Chase, Intel, and UPS favored corporate venture funds that would act like Silicon Valley venture capitalists, nurturing nascent businesses by oﬀering managerial oversight, funding in stages, and technical advice. But allowing a diﬀerent culture to ﬂourish in either type of separate organization eventually leads to repeated power struggles and culture clashes, which members of the mainstream organization invariably win. Interest in the new ventures tends to be cyclical. Brief surges of enthusiasm, triggered by abundant resources and the desire to diversify, are followed by sharp declines. The life spans of both internal venture units and corporate venture capital funds, therefore, tend to be short —on average, only four to ﬁve years.
5 Starting a new business is essentially an experiment.
New ventures can go wrong in so many ways. They can encounter customer failures (insuﬃcient demand or unwillingness to pay for the product or service), technological failures (inability to deliver the promised functionality), operational failures (inability to deliver at the required cost or quality levels), regulatory failures (institutional barriers to doing what’s desired), and competitive failures (a competitor’s entry changes the rules of the game). These setbacks are unavoidable, and no amount of TQM or eﬃcient management will anticipate them all. There’s usually no alternative: A new venture simply has to prototype its initial concept, get it into the hands of users, assess their reactions, and then repeat the process until it comes up with an acceptable version. IBM calls these eﬀorts “in-market experiments”; scholars call them “probe-and-learn processes.”
It follows that perfectionist cultures (and planning-oriented managers) are in for a rude awakening, since it’s seldom possible to ﬁgure out product designs or business models fully in advance. Repeated investments in rigorous, fact-based planning or quantitative research inevitably produce diminishing returns. Motorola found this out the hard way. In the mid-1970s, when cellular telephones were in their infancy, managers mailed out a survey to several hundred thousand potential users and then ranked the leading market segments; salespeople ranked 31, way down the list. Yet when prototypes were handed out, salespeople proved to be among the most devoted users, leading the adoption process and purchasing phones in large numbers.
The need for speedy feedback is not, however, an excuse for sloppiness. Managers must think hard about the design of their experiments. Scientists like to talk about an experiment’s “discriminating power”—its ability to distinguish between two competing hypotheses. All too often, in-market experiments do not. Managers manipulate too many variables at a time: A computer manufacturer simultaneously changes a product’s features, marketing, and pricing and then struggles to determine which was the critical success factor. Or they fail to build in controls: A retailer tries out four diﬀerent store formats, in four diﬀerent locations; because each location has a diﬀerent socioeconomic proﬁle, there’s no baseline for comparing proﬁtability from store to store. Or they fail to agree on the deﬁnition of success: A bank tries out a variety of branch layouts and ﬁnds that some increase traﬃc, others attract new customers, and still others increase the sales of more proﬁtable services. Executives can’t decide which layout to choose because they had not previously ranked the value of each outcome. Good experiments begin with clear, explicit objectives; they’re designed to produce targeted insights and rapid feedback; and they generate measurable, actionable results.
Scientists like to talk about an experiment’s ability to distinguish between two competing hypotheses. All too often, trials of new ventures do not.
6 New businesses proceed through distinct stages, each requiring a different management approach. Experimentation is only the ﬁrst step in an extended, multistage process of business development. Each stage introduces a diﬀerent set of questions and challenges.
THE RIGHT QUESTIONS
New businesses go through three main stages, and in each, the critical questions executives need to answer are very different.
What products or services should we offer? Are they technically and economically feasible? Can we make money?
How rapidly should we expand the business? How should we grow? By expanding into new offerings? New customers? New geographical areas? What financial and human resources are required? How will they be obtained? How should the new business be organized and managed to ensure short term success?
Each stage also demands diﬀerent talents and perspectives, and new leaders usually have to be brought in as businesses progress. The visionary who is well suited to leading a new business through its early experimental stages is often poorly equipped to guide the venture through the expansion and integration stages, when sales and organizational skills become more important than bold thinking and creativity. Nor can performance measures remain immutable. Because new
businesses are seldom proﬁtable in their early, formative years, ﬁnancial metrics make little sense as a starting point for evaluation. Instead, milestones of various sorts—the number of prototypes in customers’ hands; the number of times analysts mention a hot, new technology; the number of salespeople bringing in leads—are more useful indicators of early progress. During expansion, measures of market penetration and market share become important; as the business becomes established, traditional ﬁnancial measures can be installed.
7 New business creation takes time—a lot of time. In most cases, the three stages of business creation take years to unfold. Experimentation, in particular, is extremely time-consuming. concepts are diﬃcult to validate, and customers’ ﬁrst reactions are not always good predictors of long-term sustainability. Home Depot opened its ﬁrst Expo Design Center in 1991, built seven additional stores over the next few years to explore diﬀerent formats and layouts, and didn't roll the concept out on a large scale until late in 1998. Managers hoping for quick returns are certain to be disappointed. The best study on the subject, which examined nearly 70 corporate ventures in the 1960s and 1970s, found that new businesses took an average of seven years to become proﬁtable. None of the businesses had a positive cash ﬂow in its ﬁrst two years.
8 New businesses need help fitting in with established systems and structures.
Probably the greatest concern of new-business leaders is that they and their ventures will become organizational orphans. Especially when they combine oﬀerings from several divisions or target markets that fall into the white spaces of the organization chart, ventures ﬁnd it diﬃcult to secure an organizational home. They frequently ﬁnd themselves shunted from one division head to another, as reporting relationships constantly change. The trick, says one experienced venturer, is “to achieve the right balance between identity and integration.” Too much independence, and the business will be an orphan; too tight a link to established divisions, and the business will fail to diﬀerentiate itself.
On other occasions, support fails to materialize because of a perception that the new business will never become big enough to “move the needle” and make a substantial contribution to revenues or proﬁts. The problem is, ﬁnancial predictions are tricky because of high levels of uncertainty. Large forecast errors are common—in one study, ﬁrst-year sales forecasts were oﬀ 80% and ﬁrst-year proﬁt forecasts were oﬀ 116%—making new businesses easy targets for critics. Go/no-go decisions should seldom be based on whether a new business has large initial returns or has met its budget targets.
9 The best predictors of success are market knowledge and demand-driven products and services.
When you launch a new venture, pick a product or service close to the ones you already oﬀer. Success rates rise substantially when new businesses target familiar customers and are staﬀed by people well acquainted with the market. New businesses launched simply to commercialize research ﬁndings rather than meet market needs are best avoided. Unfortunately, most engineers prefer working on the latest and greatest technology. It’s therefore wise to ask: “What’s the pain point for customers, and how does our oﬀering overcome that pain?” Without such discipline, new ventures are likely to end up as solutions looking for problems.
10 An open mind is hard to find.
The biggest hurdle for new businesses is mental—the way senior managers think about products, services, technologies, customers, and competitors. Every established company is based on an implicit theory—a largely unstated view of how the business works and money is made. Polaroid is a telling example. As my Harvard colleagues Mary Tripsas and Giovanni Gavetti have reported, its powerful business model was based on the concept of razors and blades. Cameras (the razors) were viewed as a necessary evil; the real money came from sales of ﬁlm (the blades). Digital cameras looked like razors. Senior managers kept asking, “Where’s the ﬁlm? There’s no ﬁlm?” recalls an employee in Polaroid’s electronic-imaging division. “So what we had was a constant ﬁght with the senior executive management in Polaroid for ﬁve years.”
Sadly, many executives view all new businesses through the same ﬁlters and judge them on how well they conform. But few new businesses can meet that test—nor should they. If they do, every new business will look just like the old.