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.

Best Practice for Online Marketing

Posted in Entrepreneurship, Marketing
By David Kaplan
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The fast-moving world of online marketing has taken giant strides with the advent of social networking.  SEO and SEM are now the basics and MySpace, Linkedin, Facebook and Twitter are all the rage.  As new tools come on line, I pay close attention to what Guy Kawasaki is saying and doing.  He not only stays right on top of what’s happening, Guy is what’s happening.

So my idea of the best practice for online marketing is to keep a close watch on Guy. His blog is virtual textbook on how to use the latest Internet tools. For example, Guy’s “online magazine rack” called Alltop recently put up a video promotion for MyAllTop, a new version with customizable pages for the reader. Click over to Alltop and watch the video; a slick, sharp, and highly effective application of best marketing practices on the Internet. Guy is the man.

Click around through Guy’s various articles to see how he shares freely not only what he does, but precisely how and why.  His article How to Use Twitter as a Twool is a terrific read, not only for it’s content, but for the attitude it teaches and his delightful sense of humor. Guy makes clear how he has built his enormous and loyal following by sharing information.  If you market on the Internet, or anywhere else for that matter, keep an an eye on Guy!

Business Case Checklist

Posted in Business Plan Tips
By David Kaplan
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Perhaps the first issue an entrepreneur needs to face is “How strong is the business case for this new venture idea?” Every founder needs to answer that question to prevent over-investing themselves and to be prepared for the legitimate skepticism of others. The list that follows probes the strength of the business case systematically … if you answer the questions completely and candidly. Read the rest of this entry »

The Venture Quest

Posted in Venture Capital
By David Kaplan
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Many start-ups literally spend years chasing venture capital funding. Now, sometimes that perseverance makes sense, but often it does not. Still, once an entrepreneur has decided that her enterprise is suited to VC investment it can be difficult if not impossible to change her mind. Read the rest of this entry »

What is “In the Ballpark?”

Posted in Finances
By David Kaplan
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New entrepreneurs often wonder, “Are my numbers in the ballpark?” How can anyone reasonably project the revenue and expense figures to complete the set of 3- to 5-year financial projections that accompany nearly every business plan? Scientists, inventors, engineers and Internet innovators who have just become entrepreneurs often have little business experience and perhaps none in preparing financial statements; they just don’t know what numbers are reasonable. Read the rest of this entry »

Boston Venture Outlook 2009

Posted in Venture Capital
By David Kaplan
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During the darkest moments of the current financial crisis last January, some Boston entrepreneurs questioned whether they need to put off start-up timetables. They wondered if venture capital firms would retrench and wait for the economy to recover before funding any new businesses. Read the rest of this entry »

Two Meanings of “Business Plan”

Posted in Business Plan Tips
By David Kaplan
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The term “business plan” may be used to mean a set of ideas for starting or growing a business or the written document that describes those ideas. The two different meaning can create some confusion.  “Do you have a business plan?” may not mean what you think.  It is commonly assumed that entrepreneurs start with a fully developed concept and then draft the document. In fact, the writing and planning process are best accomplished interactively. Writing adds effective discipline to the planning process. It is much easier to analyze and critique an idea that you can study.  In “best practice” planning, the team meets and discusses a section or two of the plan and then one member drafts each section for the next meeting.  At the next meeting the team can evaluate any relationships between those two aspects of the plan.  For example, do the financial projections properly reflect the marketing and sales plan?  As new sections are written the team can alter sections to work together with the rest of the plan. You cannot do that in your head.  Further, a process of outlining, writing and critiquing and rewriting virtually always results in important new business insights. Only a systematic drafting process can vet and augment the original ideas as the team puts them to paper.  Interactive plan writing is a valuable tool for sophisticated planners; perhaps the most effective and efficient way to plan.

Business Plan Software

Posted in Business Plan Tips
By David Kaplan
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Investors generally read only a fraction of the many plans that entrepreneurs send them. They tend to take less seriously plans that appear amateurish. One sure sign of an amateur business planner is that the submitted plan appears in one of the familiar formats of business plan software. Format generally does not matter much in business plans, as long as it is easily read, nicely presented and well organized. The problem is that the well-known page lay-outs and formats of business plan software applications signal that the writer did not know how to write a business plan and so relied on a software package. It is a red flag that gets the plan off on the wrong foot.

But the real issue is content. Business plan software treats all chapters and sections as equal; market size here, target customers there; competition over here. It has all the right buckets. Unfortunately, buckets of arbitrarily parsed information don’t do a great job of story-telling. A business plan needs to get right to the point of this specific business and then back it up with solid evidence and details. Many good ideas never obtain funding or attract other needed resources because they fail to communicate the plan in a way that is clear, effective and impressive. Starting with a generic format cannot help. Each business idea has unique priorities that must drive the presentation of the plan’s content, not some generic, one-size-fits-all format. Too many entrepreneurs learn this lesson the hard way.

The Business Plan as Marketing Vehicle

Posted in Business Plan Tips, Marketing
By David Kaplan
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Race car photo

Winning requires the right vehicle. Plans that exaggerate markets overstate sales forecasts, over-hype the business idea or underestimate the competition will not cross the finish line. Investors expect an honest, evenhanded assessment of the opportunity and the risks. Hyperbole will not sell them on you or your business. In fact, it may turn them off entirely. Everyone that you might want to “sell” on your idea, including investors, strategic partners, prospective employees, advisors and board members wants to evaluate your plan on the strength of facts, frank assessments and honest analysis.  That is not to say that you should not convey enthusiasm, just don’t overdo it.

An investment grade plan must identify a management team with required core competencies (including as yet unfilled positions). It must engender confidence that management recognizes the predictable business challenges and that it is capable of handling unforeseen contingencies. The marketing section must address thoroughly the target market, analyze relevant trends, set out strategies based on realistic goals for its marketing, advertising and sales and estimate reasonably the cost of customer acquisition. The plan must realistically evaluate the competition (including even quite dissimilar rivals for the target market’s budget line item). It must state clearly how it intends to establish and maintain advantageous market differentiation. A plan must illustrate that the entrepreneur has anticipated competitive reactions that result from own market entry. It must show that management has developed integrated strategies and a comprehensive tactics for staying a step ahead. Management must also show that it can muster all the necessary human and other resources to execute. To pitch professional investors with confidence, plans must include appropriate levels of analysis and detail in a readable, well-organized plan supported by credible financials. If you leave out important parts, your plan will go off the road. If you exaggerate people won’t take you or your plan seriously.

Look at Your Venture as an Investor Would

Posted in Business Plan Tips, Entrepreneurship
By David Kaplan
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When you buy candy, you think of it as something sweet. When you sell candy you think of it as a product. A similar dynamic is at play when entrepreneurs write business plans, except that all too often it works backwards. The seller (entrepreneur) sees the sweet upside and the potential investor views the risk as well as  the reward potential. Learning to view your own business plan through an investor’s lens is valuable and necessary lesson for every business founder. It is not an easy adjustment to make, but it is crucial.

Perhaps the most compelling reason to learn to look at your own venture as an investor would is that you will always be its major investor. Outside financial investors will invest discretionary capital that they can afford to lose. You will end up investing years of your life, enthusiasm, energy and credibility. Your friends, business colleagues, family and many others will either watch you succeed or fail.  You will probably spend a good deal of your own money and make many material and other sacrifices.  If the venture stumbles along for three to five years, it is likely that you will be the first one in and the last one out. No one has more invested in your start-up than you do. The years, money, self-esteem, sleepless nights, personal reputation and spirit that you put at risk is a huge investment.

The first step in the process is to stop focusing on the great new product or service that you dreamed up and shift to laser sharpness on whether and exactly how a company built around such a product would make money. Learn to question your assumptions and seek proof as professional investors surely will. Have you adequately laid out the business case?  Have you accurately estimated the market or have you made the Red Sneakers mistake or used Chinese Math?  Will people actually want what you sell enough to spend the amount you need to yield a profit? How much must they spend for a competing product? Do you have solid figures to back up the cost of making the product, acquiring customers and closing sales?  Great ideas are a dime a dozen. Businesses succeed by executing well on sound business strategies. Can you demonstrate that your management team has the vision, skills and relevant experience to do that?

These are hard questions indeed, but you need to ask and answer them to protect your investment.  If you fail to ask them now, it is very likely that you will wish later that you had paid them more attention. Moreover, if you think these things through carefull before an outside investor asks about them, you will not only be prepared, but you will see the importance and relevance of the questions much more clearly.