Could this Business Idea Work?

Posted in feasibility
By David Kaplan
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One useful way to approach systematically the question of whether a novel business idea is feasible is to assume an investor’s perspective of the various risks.  There are only a handful of major categories of risk; some may prove central in the feasibility of one business idea while others may be most important to some other venture.  Building a useful risk profile starts by identifying the risks significant to the project at hand and then drilling down where issues emerge.  The list below lays out a set of generic risks worth considering.

Technology Risk: Can the product actually be made to work (or service actually be delivered)?  What evidence might illustrate that in a convincing way? Has it been done before?  Are the production inputs available and economical?  Does the production process raise environmental issues? Does any expert opinion or analysis support technical feasibility?

Regulatory Risk: What legal or regulatory barriers might significantly hamper an undertaking such as this? For example, could federal, state or local laws or regulations pose a barrier?  Does the business idea pose any dangers? If so, how might the company address these matters?

Business Risk: Would the proposed business generate substantial profits? Back-of-the-envelope numbers need to appear quite attractive because “things always cost more and take longer than we first imagine.” Compare the expected price to the estimated costs and describe the assumptions that underlie these calculations.

Financing Risk: This is a sub-species of business risk: It asks whether the proposed venture might require so much initial capital that it poses a substantial financing barrier. Estimate how much capital is needed.  What types of financing sources might be practical?  How attractive is the investment return compared to other new ventures?

Market Risk: Would the target customers buy the proposed products at the anticipated price?  Are there multiple constituencies that must be sold? What is the compelling value proposition for each target segment?

Business Environment Risk: How do major external forces affect the business climate for this idea?  Address the influence of relevant trends in this industry, its technology, regulation, consumer behavior on the proposed business.  Will other external forces such as demographics, climate change or scarcity influence success?

Management Risk: Not strictly a feasibility stage issue, most investors are especially keen on evaluating whether the management team appears likely to execute the plan successfully. Many smart investors bet on management teams even more than great ideas. At the feasibility stage, the inquiry needs to focus on what core skill profiles will be needed in the short and longer term.  Can the present team adequately plan the venture without that talent?

Answering these risk questions first is one approach to focusing quickly on the most productive avenues for assessing the feasibility of novel business ideas and helping to identify the specific issues.  A PowerPoint slide is about the right level of detail for the first pass at each of these.

What is the Value of Pro Forma Financials?

Posted in Finances
By David Kaplan
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A client emailed the other day to ask for help in preparing his pro forma financial statements, the three to five year profit and loss statement and balance sheet that generally accompany business plans. He told me that he knew the cost to have his product manufactured and packaged and the that he had also settled on a selling price, but from there he was stumped. He wanted to know how to produce an attractive but credible forecast. This is not an easy question, of course, exactly how to forecast future financial performance always presents a challenge.

Perhaps the best place to start is to understand the problem a little better. The literal Latin meaning of pro forma is “as a matter of form” (or formality). Pro forma has come to have two popular meanings today, (1) in a perfunctory or cursory way, as in “a rather pro forma investigation for such a serious matter,” and (2) informal information or data presented in advance of having any actual data.  For startups, the important point is that pro forma financial statements must be recognized to be both somewhat cursory and in advance of having any real data by their very nature. Startups also need to remember that investors fully understand this.

So, you may ask, why does it make sense even to attempt to estimate financial performance in advance? The threshold value is in illustrating that the entrepreneur has tackled the problem of producing a five-year forecast and wrestled it to the ground. Also worth noting is that running even back-of-the-envelope numbers will sometimes reveal flaws in a business model and help eliminate obvious non-starters. Perhaps most telling, smart investors will consider whether the entrepreneur has based the forecasts on well-grounded assumptions in order to narrow the error band. So, even taking into account the obvious limitations on accuracy that curtail their reliability and sensible application, pro forma financial statements can provide investors with important and actionable information.

Exactly how to proceed in a particular venture depends on that individual case. Investors generally accord rather little weight to the pro forma financial outcomes of startups with their “hockey stick” sales curves. Instead they will scrutinize carefully the underlying assumptions to evaluate how well management has thought through the challenge of preparing the statements, estimating major expenses such as cost of goods, marketing and sales, relating revenues (in time and magnitude) to marketing activities and so forth. In short, the question is not so much whether the numbers are believable as whether the thinking that produced them is credible, sensible and thoughtful.

Start-up Myths Exploded

Posted in Uncategorized
By David Kaplan
1 comment

Do economic cycles of boom and bust affect the number of start-ups? Most analysts have linked entrepreneurial activity to economic growth as though it was a given … and conversely, believed that when recession struck, start-up activity slowed substantially.  A recent study by the Ewing Marion Kaufman Foundation concludes that both theories are pure bunk.  And as though that bombshell was not enough, the Kaufman study goes on to explode several other theories about what factors stimulate new business formation.

Do start-ups increase in proportion to the availability of venture capital? Nope.  Kaufman Foundation researchers Dane Stangler and Paul Kedrosky dispel that myth as well.  The authors note that the doubling of start-ups from the period 1960-1978 to the decades since may indeed have been due to the advent of the personal computer and the expansion of the venture capital sector.  (One wonders if the baby-boomers coming of age may not have contributed to this step-change as well.) However, the constancy of recent start-up data belies the influence of venture funding.  Start-up activity fluctuated by only 3% to 6% each year between 1977 and 2005; but the data shows that venture investment varied by as much as 500% during the same period.

Do tax or bankruptcy law changes, technological advances or entrepreneurship education affect the number of new ventures? No again!  The report, Exploring Firm Formation: Why is the Number of New Firms Constant? also finds no correlation between start-up activity and tax policy or any of these other factors; so much for the theories of our most vocal politicians.  Instead it documents the same steady half-million start-ups per year, give or take a 3 to6 percent.  The authors discuss a few possible explanations for the unexpected constancy, some rather arcane, but they do not seem to buy into any of them.

Common sense suggests that certain of the factors discussed in the Kaufman report must have at least some influence on the number of start-ups, even if they do not affect substantially the total for a given year.  For example, limited amounts of available venture investment must surely delay some particular start-up decisions.  I have been involved in a few such decisions.  Similarly, high interest rates and tight credit must also have an effect on many decisions, especially those involving sole proprietorships and mom-and-pop operations.  So perhaps a study with greater granularity would reveal that while the total number remains relatively constant, the mix of start-up types changes, maybe even substantially.  Perhaps in recessions when venture funding declines, a fall in interest rates turns entrepreneurs toward credit sources.  It could also be that more innovation-based entrepreneurs test their business innovations when the economy is booming, and that more laid-off workers start enterprises when unemployment is high during recessions.  I suspect that the “mix” of different kinds of start-ups changes a great deal even though the total number may not change much.

The Stangler and Kedrosky study does not encompass the current Great Recession, of course, it is too soon.  Yet surely this anomalous economic epoch will surely add some telling figures.  The investment portfolios of the wealthy individuals and institutions that comprise the limited partners of venture firms declined substantially since 2007 and venture investment has fallen by 40% or so since then.  At the same time, credit tightened historically and unemployment soared into double figures.  Will start-up totals for this period continue the constancy that Kaufman reports?  And if not, how will it vary?  Will the limitations on available capital drive start-up numbers down, or will necessity and cheap assets power them up?  Or will past constancy persist despite alterations in the mix?  Only a study based on more granular data could reveal that.  I doubt that such data is available or could be economically derived, though that information could prove useful to an economy so reliant on small businesses to create jobs.

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We have no Competition

Posted in Business Plan Tips, Entrepreneurship, strategy
By David Kaplan
1 comment

Entrepreneurs sometimes think it is great idea to claim that they have no competition.  They suppose that investors will be impressed with the originality of their business idea and its potential to make money where there are no pesky competitors to take market share.  Don’t ever write that in a business plan.  Nothing could be further from the truth; for lots of reasons:

  • Even if your startup idea has no direct competitors, you probably have some indirect competition.  That is, some other kind of product or service is competing for the same dollars.  For example, even though no one else sells chicken wings in a particular neighborhood, someone may indirectly compete with hamburger and other fast food.
  • On the slim chance that you actually have no indirect competition, be mindful that buyers always have the choice of doing nothing.
  • Note that investors prefer startups that leapfrog competitors in an established market, and so claiming “no competition” may suggest to them that that no demand exists for the product or service.
  • Startups that take on larger sized competitors and succeed may find themselves an acquisition target of that competitor.  That could be an attractive exit strategy.

Now some clever people might reply that government agencies and monopolies have no competition.  Well, perhaps that is so in some instances, but rather few.  FedEx and UPS have shown the Post Office that they can compete quite well with a government agency.  There are few real monopolies any more, and those such as utility companies find themselves heavily regulated.  The point is that competition is not a bad thing at all.  In fact, it is an essential component of the capitalist system.

Competitors keep one another on their toes; forcing producers and suppliers to focus attention on consumer needs.  Every competitive analysis asks why the target market segment buys from company A or company B.  That answer to that question underlies every business success.  Competitors verify the existence of demand, help scope that demand and illustrate ways to satisfy it.  The question is not whether you have any competitors; it is whether you have learned what they can teach you about winning customers.

The Ground Floor Trap

Posted in Entrepreneurship, strategy
By David Kaplan
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Entrepreneurs naturally look for growing markets.  The opportunity to “get in on the ground floor” in a fast emerging market is certainly attractive.   Most business analysts would agree that the easiest way to grow any business is to position it to serve a growing market.  Still, fast emerging markets also present a set of predictable strategic risks that entrepreneurs will want to consider with care.

Sharply rising demand drives up prices and so induces incumbent firms to increase production and new firms to enter the market.  Some new market entrants will have had no prior role in the industry, and others may have been suppliers who wish to forward integrate and/or distributors who decide to go directly to OEM suppliers in order to control a larger segment of the value chain. During this rapid growth in the industry, most new players must rely on outdated industry intelligence.  Neither existing players nor new entrants can know of all the others and so they plan their own production capacity based on dated, under-informed projections of supply.

No industry can long sustain an increasing number of competing firms.  Inevitably excess capacity creates market over-supply.  Whether growth in supply exceeds the ongoing growth in demand or demand flattens out or diminishes, the result is the same: The market place becomes saturated with goods and prices fall.  Competition intensifies throughout the industry.

Financially stronger players will deploy manufacturing efficiencies and short term price competition to drive the weaker ones out of the market.  Increasing price competition will eventually drive prices down to commodity levels and only the makers of exceptionally desirable products and the lowest cost producers will survive.  Lower margins will force some players into insolvency. Larger players may acquire the protected, novel technologies of a few small competitors, but most small companies will fail;  their expensive capital equipment now worth practically nothing in an over-supplied industry.  By all these mechanisms the industry will contract.  Increasingly cutthroat competition, sustained price wars, and company failures will continue until supply falls sufficiently to meet demand and enable price stability.

What is the lesson of this predictable cycle of fast growth in emerging markets?  Do not jump in without a clear understanding of how to compete effectively.  Large companies will often watch the emerging market for opportunities to acquire small firms with proprietary technologies that make the best and cheapest product.  Small firms and especially start-ups need to think particularly hard about competitive differentiation. It makes no sense to enter even a fast growing market in direct competition with the big established players and a whole host of new small competitors.  Start-ups must take special care not to over-rely on their innovative technologies; a fast growing emerging market may spawn lots of new product ideas.  Not all of them can be winners.  Entrepreneurs may want to focus on developing a unique business model; one that takes advantage of the forces driving the market growth without needing to confront all the mainstream players. Find a niche and own it!

The Planning Conundrum

Posted in Business Plan Tips, Uncategorized
By David Kaplan
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Despite obvious benefits, only the very smartest
and most disciplined managers actually write and follow business plans

Nearly every professional manager knows that planning is crucial to business success.  Still, few people actually act on that knowledge.  In over 15 years of helping businesses plan their growth, it has become increasingly clear that only a small percentage of managers draft formal plans in order to create a disciplined strategic road map for success.  Instead, the motive that drives the production of most business plans is the need to raise capital, either bank loans or equity funding.  Everyone has heard some version of the old adage that “Failure to plan is a plan for failure” but few realize the actual consequences of deciding to “get by” without a carefully thought through, written business plan. The statistical evidence of that folly is overwhelming.

The Top Ten Reasons That Businesses Fail

No, this is not one of those David Lederman jokes; unfortunately it is deadly serious.  The business statistics surrounding business failure are widely published.  A Dunn and Bradstreet research report cites managerial incompetence as the cause of 96% of American business failures.  Many Internet sources have their own “Top 10” reasons for business failure in the U.S. and although they differ somewhat in detail, the vast majority of relate directly to inadequate planning.[1] Here is the Small Business Administration’s rather typical Top 10 list:

1.  78% lack a rigorously-developed business plan keyed to the realities of their market, including sufficient research on the business before launching it.

2.  73% fail because the owner is wildly optimistic about projected sales, break-even point, and capital required.

3.  70% fail because the optimistic owner believes he/she can wing it on important issues with which he/she is ignorant, and ” can’t afford ” to hire the expertise to get it done right the first time.

4.  63% of new business owners simply don’t have the required business experience to make a success of the enterprise.

5.  82% lack cash-flow management skills. They don’t understand the importance of controlling cash flow.

6.  79% launch with a bright idea and little or no capital.

7.  77% don’t have a rationally-developed pricing model for their products or services.

8.  64% don’t have a clue as to how to aggressively promote their business, nor do they understand its importance.

9.  55% don’t understand their competition, or assume it can be safely ignored.

10.  47% rely too much on one customer/client.

Clearly, a rigorous project to write a comprehensive business would reveal most if not all of these top 10 problems in advance.  Especially if the project involved actively seeking criticism of the plan from experienced business people, investors, managers, academics and mentoring organizations such as SCORE and the Small Business Administration.

Don’t Bother Me with Facts

Few operating businesses write plans despite all the accumulated evidence that a written business plan – built on sound market and competitive research and including operational and financial plans – is crucial to business success.  Temple Porter once remarked to me that people only take business planning seriously when business pain forces them to do so.  Foresight simply does not motivate the vast majority of managers.

Mostly at the early stages of business development when businesses need capital and MUST write a business plan to attract investment, or when they require additional financing in later stages, will they grudgingly write one.  Generally, even in those situations entrepreneurs and managers sell their businesses short by producing a document designed more to “sell” outside investors on their idea than to actually plan for their own future success.  They seem to forget that the founders and owners are the people most invested in the business.  Outside investors stand to lose only some discretionary capital: Owners and founders risk years of work, dreams, foregone opportunities, the cost of loans they personally guaranteed, perhaps their business credibility and certainly their jobs.

Every management team can recite a laundry list of plausible sounding reasons not to write a business plan for use a road map for growth.  “Time, resources and money” they will explain, “are better spent on running the business.”  Another familiar favorite is “We have a business plan but it’s not written down.” Yet no one can keep all the details of a real business plan in their head all at once.  So yes, even though 78% of businesses fail due to a “lack a rigorously-developed business plan keyed to the realities of their market” they all have plenty of reasons.  Only the other 22% have decent odds of survival, to say nothing of achieving prosperity.

Business Planning Best Practices

Every business needs to review its business plan annually.  That does not mean that they must right a new one every year, of course; in most cases that would overstate the need.  If a business has a written plan less than three years old, the executive team should review and discuss each strategy in light of the changing market place, available resources and external trends such as those in technology, regulation or demographics.  Management must place special emphasis on updating their competitive analysis and marketing strategies at least every year.  Still, operational plans and financial strategies warrant annual re-evaluation too.  Rather than write a full new plan, management can write an update and add it to the plan.  Update should include new factual findings, the reasons for making changes and specific new strategies and tactics.  When reviewed and approved by appropriate stakeholders, managers should communicate the plan, its central strategies and especially reasons for changes to the company’s employees.  When everyone knows and understands the overall plan, it is much easier to make individual day to day decisions and obtain “buy-in” and the sense of teamwork and shared mission that goes with it.

If your company or start-up venture does not have a business plan, write one immediately.  Spend the time to do it right and completely, with a full analysis of your business model, product or service, target market, value proposition, industry, competitors and financial plan.  If you decide to fly blind instead, in all likelihood you will eventually crash.  Look really hard at those statistics above.


[1] One original source of many of these published lists is a study authored by Jessie Hagen of U.S. Bank titled “Top 12 Reasons Why Businesses Fail.” No less authorities than the SBA and SCORE publish “Top 10” versions of the Hagen/ U.S. Bank list.  The version above was “compiled” by consultant Temple Porter.

Monster Competitive Intelligence

Posted in Intelligence
By David Kaplan
2 comments

I had lunch last week with Ed Melia of P3 Capital Ventures.  A couple of months ago, Ed had introduced me to a wonderful opportunity to volunteer at Boston’s Career Collaborative and we got together after helping out there last Friday morning.  Ed has a fascinating perspective on human capital and is a leader in the use of technology-driven solutions in the areas of screening, assessment and candidate selection instruments and their use in partner acquisitions and other human capital related strategies.  Ed did pioneering work in this field in his role at Monster.com and so he naturally connects online hiring and business strategy in thoughtful and sophisticated ways.

Ed asked me if I had seen the April 30, 2009 Wall Street Journal article In Major Shift, Apple Builds Its Own Team to Design Chips.  I had not.  Ed summarized it for me and later sent me a copy.  He found the article interesting, “not only because Apple is fascinating to watch – but also because when you read the article, most of the intelligence gathered is from job postings on their web site (and the skills/type of technologists they are seeking) and from the human capital they are bringing in house.”  Ed told me that for years now, many savvy business strategists watched their competitors’ job postings to glean reliable competitive intelligence.  This WSJ article was nice primer on how to do it and on how much detail it can provide. 

The title of the article trumpets its conclusion that Apple is implementing a new strategy to add in-house capability to design computer chips for its various consumer products.  For many of us regularly engaged in competitive analysis the message is much broader: You may learn a great deal of “secret” competitive information by monitoring the public job postings of competitors.  The methods used by the WSJ reporters and the intelligence that these techniques yielded are instructive:

  • Keeping track of high-level new hire announcements by your competitors’ may reveal important data about their product plans: Apple recently hired Bob Drebin and Raja Koduri, both ex-CTOs of the graphics product group of chip-maker AMD.
  • Published job descriptions in job postings may contain gems. Apple’s postings reveal a broad search for people with experience relevant to “testing the functional correctness of Apple developed silicon.” Other Apple job descriptions “involve handwriting recognition technology … [and] managing displays.”
  • Researching a competitor’s recent job postings may also connect to their publically announced acquisitions. Apple earlier had purchased chip-maker P.A. Semi. In discussing that acquisition, Steve Jobs had remarked that “You can’t just go out and buy the chips off the shelf” to run increasingly sophisticated software on iPhones and iPods.
  • Industry insiders expect that P.A. Semi engineers could “help create ARM-based chips that could improve the performance and battery life of future iPhones” and these are well-known goals for those products.
  • Competitor participation in job fairs can provide more clues. Apple recruited “soon-to-be-unemployed engineers at memory chip company Spansion, Inc.,” which was headed for bankruptcy.
  • Targeted networking on Linkedin may produce valuable competitive data. Linkedin contains “more than 100 people listing current Apple job titles and past expertise in chips, including veterans of Intel Corp., Samsung and Qualcomm, Inc.”

Thinking about the online search techniques that the WSJ writers used led me to wonder about using other searchable social media such as Facebook, Twitter and the new Google Profile for competitive insights.  Perhaps searching those sites with key words that relate to competitors’ hiring just might turn up idle chatter containing useful increments of additional “secret” information.  So I searched Twitter with the keywords Apple chip design to give it a try.  The shear number of results surprised me, but the timing of the earliest ones was an even more unexpected discovery.

There were quite a number of Tweets referring to What’s Apple Building in There? by John Paczkowski.   On April 27, a few days before the WSJ revelations, Paczkowski posted his article connecting Apple’s P.A. Semi acquisition to the Bob Drebin hire.  I raise this not because the WSJ may have drawn from the Paczkowski article without attribution; that may or may not be so.  The larger point is that keeping an eye on blogs about an industry, a specific competitor (such as Apple) or selected competitive trends trends (such as chip design) might also yield valuable inside information – even if the WSJ never covers the company or the issue.  

All these competitive information gathering techniques will work for any company, large or small. These methods could help your company avoid getting blind-sided by an unexpected competitive challenge.  Should you be watching more closely the company web sites of your competitors and the job boards, blogs, PR releases that refer to them?  Perhaps most companies need to establish a procedure for systematically searching the web at regular intervals for this kind of crucial information.  Check Useful Links on our HOME page for a well-researched list of resources for conducting competitive intelligence.

Red Sneakers

Posted in Business Plan Tips, Marketing
By David Kaplan
2 comments

Several years ago a client asked me to read a business plan he had written to raise the funds needed to take his invention to market.  The plan described a kind of helper spring to improve the handling of heavily-loaded pick-up trucks. In the marketing section of the plan, he referred to the market opportunity as “within the nearly $100 billion auto aftermarket.”   When I asked what segment of that market was made up of pick-up truck parts, he had no idea. Nor had he researched what proportions of the total market derived from after-market accessories versus replacement parts or what percentage of pick-up trucks were subject to being overloaded.  He made it clear that he knew that helper springs and all other suspension upgrades for pick-ups comprised a tiny fraction of the $100 billion.  Still, he though that the big market size would impress potential investors.

Some years before, a woman had presented an idea for hand-embroidered sneakers as “tapping into the multi-billion dollar shoe market.”  When I questioned whether that figure was genuinely relevant, she noted that athletic shoes accounted for more that a quarter of the total market.  The sample pair that she had with her that day were red with floral embroidery.  In that meeting, we discussed whether investors might be more interested in the market for hand decorated red sneakers than for shoes generally. I came to call her hyped-up market size reference the “Red Sneakers” problem.  I wish that these were the only too examples that I knew about, but unfortunately, the Red Sneakers problem shows up in far too many business plans.

Red Sneakers market descriptions wave a red flag. It suggests that you are given to gross exaggeration, that you simply did not bother to do the necessary research and analysis to determine the size of the relevant market segment and/or that you do not know how to estimate the appropriate niche for your product.  Each of these reflects poorly on the plan and the writer.  The only market size estimate that makes any sense is one determined by the “100% of sales” rule.  How many dollars in revenue would the company produce if it made 100% of the sales in its market segment or niche?  Calculating that figure, even if it relies on a few (explicit) assumptions constitutes some evidence of sound business analysis; offering up overall industry figures is vacuous hype.

Of course, plans that then estimate their share of a Red Sneakers market are guilty of the further offense of “Chinese math.”

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Writing a Business Plan is Hard

Posted in Business Plan Tips
By David Kaplan
1 comment

No wonder most entrepreneurs and small businesses don’t have a business plan.  Writing a useful business plan requires…

  • Taking substantial time away from other responsibilities to concentrate on growth, competitiveness, planning and writing
  • Ability to “scope” correctly so that the plan contains neither too much or too little information
  • Substantial and relevant research into markets, customers, competitors and industry dynamics
  • Credible strategic thinking that sets the direction of major business activities
  • Integrating strategies so that all the plan sections fit together logically
  • Writing plan sections in clear, concise, grammatically correct language that is lively to read
  • Writing with enthusiastiam without over-selling the product, market and business opportunity
  • Anticipating challenges to your basic premises about the product, market and opportunity
  • Levels of detail and process that typically lie outside an entrepreneur’s comfort zone
  • Identifying all the crucial (and tough) strategic choices and making them wisely
  • Systematically seeking criticism from skeptics to refine the plan and address perceived weakness
  • Reevaluating strategies that others see as weak and deciding whether to change them or not
  • Summarizing the most important aspects of the plan in a two-page-or-less executive summary

Difficult as these challenges may be, sound leadership requires that businesses face up to them.  There are good reasons that the old maxim still survives that says “Failure to plan is a plan for failure.”  According to a U.S. Bank study, 78% of businesses fail because that do not have a well-developed business plan.  At the risk of quoting another ancient truism, “Each hour spent planning is worth two hours saved during implementation.”  Planning pays off better than most management activities and is the most reliable way to improve business performance.  Business gurus continue to recite these old saws because they are true.  Make a detailed plan, write it down, have the smartest people in and outside your organization read it, edit and correct it and then follow it!

Chinese Math

Posted in Business Plan Tips, Marketing
By David Kaplan
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At the peak of Silicon Valley ‘s bubble, back in January of 2000, Guy Kawasaki wrote an irreverent article for Forbes Magazine about the poor quality of business plans that inexperienced entrepreneurs were submitting to venture capitalists back in those days.  The article notes a number of common mistakes, most articulated in Guy’s signature tongue-in-cheek style, but none have enjoyed the virtually universal applause and staying power of his admonition against “Chinese math.”  Kawasaki put it this way;

… lose the “Chinese math.” Chinese math is the argument that goes like this: If just 1% of the people in China bought a Macintosh, Apple would be the largest computer company in the world. Many plans cite a study that “proves” that a market will be $20 billion by 2003 and state that all the company needs to do to be profitable is to get 1% of the market.

There are problems with Chinese math: 1) there’s never been a consulting study that didn’t predict a multibillion-dollar market size. (Do you think consulting firms can sell studies that predict small or down markets?) 2) Getting 1% of a market is easier said than done. 3) If you say that you need to get only1%, does this mean you’re conceding the 99% to others? 4) You label yourself a bozo because only bozos would try this line of reasoning on sophisticated investors.

Kawasaki’s reason #1 continues to ring true, especially in emerging markets. Still, let’s focus on reasons #2 and #4.  They are closely related.  Reason #4 warns that if your presentation or business plan relies on Chinese math, sophisticated readers will think you are a bozo.  Why? Because of #2!  Naively taking for granted a 1% (or worse yet a 5%, 10% or more) market share simply sweeps the real world difficulties of marketing and sales under a flimsy statistical rug.  Let’s assume that a reasonable case can be made that your market comprises a million individual buyers. Capturing a mere 1% of that market means selling 10,000 customers.  If you enjoy a typical closing rate around 25%, then closing 10,000 sales requires making 40,000 sales presentations to qualified prospects, i.e., people who need what you sell, have the means to buy it and will give you a reasonable opportunity to sell it to them.  To find 40,000 qualified prospects, you may need to start with 100,000+ leads; that is people who express some kind of interest, such as visitors to your web site. 

These numbers put a little flesh on the bare bones of a 1% market share.  How will you attract all those visitors?  Does your business plan have an adequate marketing budget and strategy to reach them?  Does it describe an efficient means to qualify prospects out of the 100,000 leads?  Who in your company will make the 40,000 sales presentations? If it takes 12 minutes to fill out a sales slip and run a credit card, then the 10,000 sales will require 120,000 minutes or 2000 hours … just to cash out all those customers, to say nothing of selling them!  Investors want to know how you plan to do all these things. They will dismiss  an empty market share forecast that fails to comprehend such challenges.  To run your business, you will need to know the answers.  Consequently if your plan forecasts some small share of a large market, discuss that in terms of the actual numbers and how you will capture and service them.

Neophyte entrepreneurs continue to write business plans containing Chinese math.  They submit them to investors and to potential strategic partners and use them to recruit seasoned managers, executives, board members and advisors.  Many entrepreneurs have no idea what role Chinese math has played in the failure of these important initiatives.