Entrepreneurship in 8 Hours
This optional module presents Entrepreneurship. It is broken down into Day 1 and Day 2 but the reader can work at their own pace. It is designed so that in eight hours of reading and deliverables the student can acquire a basic understanding of entrepreneurship.
There are no explicit references here to social entrepreneurship or the differences between traditional and social entrepreneurship. If one defines traditional entrepreneurship as directed toward a market problem and social entrepreneurship as directed toward a social problem (such as the United Nations Sustainable Development Goals[1]), basically the same approach can be used with either type of entrepreneurship.
Day 1
There are three ways today that a person can think about managing their economic affairs:
1. Have a job
2. Be a contract worker, consultant or part time worker
3. Own a business
If you start or own a business there are basically two choices:
1. To be a small business owner
2. To be an entrepreneur
If you start a single dry cleaner to provide for your family and establish a lifestyle, then you are a small business owner. If you start a dry cleaner as a prototype and build and operate 1000 dry cleaners, then you are an entrepreneur. The difference between the two outcomes is that the entrepreneur is building a company that has scale. A scalable company might have an initial sales target of $100 million in annual sales within five years.
In order to achieve scale, the secret or key to successful entrepreneurship, starts with the opportunity that one selects to pursue. To explain opportunity, there are three concepts to understand and master to be successful in scaling:
1. Insight
2. Vision
3. Value
Israel Kirzner, a leading Austrian School economist and writer on entrepreneurship, said that entrepreneurs have a positive asymmetry of information, what is commonly called an insight. In his book Competition and Entrepreneurship the concept of insight is more fully developed. As an interesting observation, Michael Spence, Nobel Laureate economist, described poverty as a “negative asymmetry of information”. One can begin to see now that all economic activity can be understood in terms of access to information and asymmetry. An insight is the seed of an idea upon which to build a company, the unique perspective and interpretation of the information which is not grasped by many. Sam Altman at Y Combinator, a leading accelerator, describes insight as follows.
“We greatly prefer something new to something derivative. Most really big companies start with something fundamentally new (one acceptable definition of new is 10x better.) If there are ten other companies starting at the same time with the same plan, and it sounds a whole lot like something that already exists, we are skeptical.”
Having identified the insight, the challenge becomes even harder to then create a vision. A vision can be understood as how to “change the world”, the big picture motivating dream that explains why you are so passionate about the idea. Many have insights or ideas but much fewer have a vision and this is one reason why entrepreneurship takes hard work. One tool to develop and articulate a vision is the Golden Circle, shown in this video by Simon Sinek.
If you succeed in igniting a passion that produces a vision, the next hurdle is that the entrepreneur must create value for a customer and be able to capture that value (sell the product or service). Value is a customer perception, what economists call utility, and not a simple calculation of selling price and cost. Many entrepreneurs initially underprice their products because they fail to consider ‘perceived’ value. If one appreciates correctly the perceived value, and prices correctly, then this analysis is confirmed by a customer purchase.
In order to create value for the customer and capture value for the business, the entrepreneur must understand the problem or need of the customer. In order to make such a determination, one can use a 5-step process called design thinking, which is explained in detail by the Stanford Design School here. Design thinking begins with empathizing with the customer through in the field observation, survey and research of the customer. This first step is also called “putting yourself in the shoes of the customer”. It is a critical step where first time entrepreneurs typically invest inadequate time and spend insufficient time in the field.
The understanding of the problem is confirmed when one can describe for the customer three factors[2]:
1. The customer’s fears
2. The customer’s needs
3. The customer’s wants.
These three factors explain the emotional, rational and aspirational characteristics of the customer’s problems.
Step 2 in design thinking, reframing the problem, is a powerful tool to develop a complete understanding of the customer problem. Frequently the problem is reframed by changing a key assumption about the problem. For example, if we change the assumption that a boat is not one solid piece of wood (a dugout) but can be constructed from pieces of wood, we start building off shore vessels and launch international trade. After one develops an understanding of the problem, one then proceeds to create multiple creative alternatives through ideation (step 3 of design thinking) and then to select one to develop as the prototype, step 4.
A prototype is one way to test (step 5) a solution with customers. The prototype is not a perfect, finished solution but sufficiently developed to gain insight about whether a customer might use the product to obtain a solution to the problem. It is much more important to use rapid prototyping to test many solutions than focus on a single perfect solution. The story goes that the Wright Brothers were successfully because they realized they needed an airplane design that could be crashed and rebuilt quickly. This story illustrates successful rapid prototyping.
While defining a problem and solution is necessary, it is not sufficient to successfully build a company usually. The problem and solution must be surrounded by what Warren Buffett called a “moat”. The moat creates a sustainable or competitive advantage. The competitive advantage is how a company creates the value for the customers and the company stakeholders such as shareholders. One way to create a competitive advantage is to be innovative. (Another way to secure competitive advantage is to get a monopoly from a government.) Innovation is a term widely used but rarely understood.
Joseph Schumpeter was a famous economist who did the early thinking and writing about innovation and entrepreneurship. He is well known for calling innovation “creative destruction” but perhaps a more useful concept was his idea that innovation was “invention commercialized”. Inventions are original, tangible devices, processes, methods and compositions that have “purpose”. By purpose we mean that something completes a job or provides functionality. Once the purpose is established we commercialize by bringing it to market and testing it with customers.
There are four kinds of innovation, three of which can be the basis to form a new company. There is a 2-part framework of market-technology that defines innovation, as shown below.
Credit: Jim Kalbach
Incremental innovation is the small changes that increase revenue for an existing business, not a startup venture. Disruptive innovation was a term coined by Harvard Business School professor Clayton Christensen. Disruptive innovation is when one takes an existing product in the market, reduces its feature set and cost and opens up a much larger market (moving to the right on the market scale (x). (Every new type of computer after the original mainframe has been a disruptive innovation.) Breakthrough innovation is typically a never seen before technology, such as Google glasses. In such a situation the entrepreneur and any investor are taking both the technology risk (will it be perceived as a reliable, full featured technology) and market risk (sufficient customers to build a large company). In a game changer innovation, the entrepreneur successfully picks a new technology that is widely adopted in the market. Google’s use of artificial intelligence to improve the search experience would be a good example of a game changer innovation.
After developing an innovation, or as part of the exercise to shape the innovation, an entrepreneur should do a detailed competitive analysis. A key factor in analyzing competition is to explore the current, alternative ways to solve the same problem. Steve Blank’s Competitive Petal is an excellent tool to do competitive analysis. From the competitive analysis, the entrepreneur is refining their understanding of what features, benefits and customer experience will successfully position their product or service, which provides the basis to define a customer value proposition (CVP) which is the last topic in day 1. However, one point first on competition. The presence of many competitors may be good news. First it confirms that “now” is the time to launch a new venture because many companies are trying to solve a similar problem. A second benefit of competition is that multiple companies are investing to build the new market, which is perhaps more capital efficient. Lastly, competitive information helps the entrepreneur to develop their approach to sustainability.
The customer value proposition or CVP is a major milestone in the development of a new venture. A CVP combines the initial analysis of problem, solution, innovation and competition. At any point the CVP is a work-in-process, updated and refined in a constant iterative process of testing and evaluation. A simple way to look at CVP is shown below[3].
The CVP is a critical step where one begins the transition from analysis to creating value for the customer and the development of the features, benefits and customer experience of a product. An example of a feature is the touch screen on the iPhone, a benefit would be the “access to the Internet” and the customer experience might be defined in part by the App Store.) Many writers on entrepreneurship now believe that a company should be selling a customer experience and not just a product or solution. Determining the CVP is where the customer experience starts to take an initial shape.
One important concept in the early development of a new scalable venture still remains to discuss — sizing the opportunity. We begin day 2 with this topic.
Deliverable — Day 1
At the conclusion of the material above, the student should prepare the Why — How — What analysis from the Golden Circle for a new business concept. Such an exercise should allow the student to test their understanding of all the concepts covered so far. Such an exercise may be more effective if done with a partner or a small group, where ideas can be presented, analyzed, and refined. Entrepreneurship is a “team sport” and this exercise is a good time to start building collaboration skills and learn more about how groups work.
Day 2
With a CVP tentatively developed, two critical analysis should now be prepared:
1. Is the business concept a feature — product — or company?
2. Is the opportunity sufficiently large to build a $100 million company in five years?
The results of either analysis might prompt one to return to Day 1 and start over. Do not be concerned. Entrepreneurship is an iterative process and there will be many times when one goes back to a previous step.
Not every new idea for a company is really the basis for a company. Consider Dropbox, the file backup and synching service. Many companies have tried to buy Dropbox and their plans for the acquisition demonstrate my point. If Apple had bought Dropbox, they would have treated it as a feature in their product infrastructure, similar to iCloud. If Microsoft had bought the company they would have treated it as a product similar to Office or Sharepoint. The Founder of Dropbox had the vision to make Dropbox a successful standalone company. If the initial analysis shows that the idea is a feature or product, one might return to the CVP for further analysis or start over.
Sizing the market opportunity frequently helps to determine the answer to feature — product — or company. Many venture capitalists say that a market opportunity must be at least $500 million and preferably $1 billion to attract outside capital. Not everyone builds their entrepreneurial venture using outside capital, but the professionals have these guidelines for several reasons. One should probably heed this advice. Many times a market is too small because the business concept is only a feature or product.
In order to size a market one needs to have a clear idea of who the customer or persona[4] is. This view may change throughout the entire process of starting and growing a company and should be considered a hypothesis requiring validation at this stage. Amateurs generally size markets top-down. Professionals typically size markets bottom-up. The reason is multiplicative systems[5], which simply stated says that one bad assumption at the top of the model ruins the entire result. Bottom up, we might start with a single store, determine the store traffic per day, decide days open per week, assume a purchase percentage for potential customers and an average transaction and calculate annual revenue for a single store. Then one validates each of these assumptions and then considers how many potential stores could be opened to finally size the opportunity. All the energy and analysis is easily focused on understanding single store performance (the economic unit) and any error is less likely to totally ruin the market sizing exercise. Most market sizing exercises involve the concept of an economic unit. Economic units are what drives sales growth and can be stores (locations), distributors, salespeople, site visitors (e-commerce), plants (utilities), etc. It is important to understand what the economic unit is in the entrepreneurial venture.
The next step after confirming that the market size is sufficient to build a large company is to consider the new venture’s ‘business model’. The business model provides an opportunity to more clearly articulate the business strategy, but equally important allows the entrepreneur to consider:
· Additional ways to create value for the customer
· Additional ways to create competitive advantage
· Additional opportunities to improve the economics of the business
Peter Thiel provides four rules[6] that show business model thinking to create a successful company:
1. Build Proprietary Technology That Is 10x Better (a competitive advantage or moat)
2. Look For Network Effects (may create a monopoly)
3. Create Economies of Scale (creates cost advantage)
4. Build a strong brand (helps to develop the all-important customer requirement for trust)
William Osterwalder did much of the original work[7] to popularize business models and his canvas is shown below. Michael Porter’s work[8] on value chain actually serves the same purpose and many other writers[9] have a concept of business model.
Many books and articles have been written on business model. The value of any of the approaches is that they provide a systematic way to analyze and determine how the new company will do business. Two particularly useful concepts highlighted by Osterwalder (and often overlooked) are channels and partners. Channels focus on how the product reaches the customer, what might be called distribution. Partners opens up the entire consideration of expertise and outsourcing. In the simplest case, a company should only retain what creates the most value for the customer and outsource everything else (after considering cost, risk, timing, customer experience, etc.). Such an approach increases the likelihood that the company focuses all its resources on what creates the value for the customer.
The last step in the analysis of a new venture is building a financial model for the new venture. A financial model serves many purposes:
· It articulates simply through its assumptions the business model
· It demonstrates the founder’s business logic
· It demonstrates the scale of the opportunity
· It demonstrates a path to profitability
· It shows the capital required to build the company
A financial model should include a minimum of four parts:
1. Balance Sheet
2. Income Statement
3. Cash Flow Statement; and
4. Assumptions tab with a financial summary
Any introductory accounting textbook can further explain balance sheet, income statement and cash flow.
A sample model is shown here. A model should be self-explanatory. There should be no need today to walk a reader through a model. Remember, you are building the model to answer the reader’s questions and not to show off Excel skills or how complicated you may think the business is.
A common logic for building a company and the financial model is to think in terms of milestones or deliverables. In doing a startup, examples of deliverables might be:
· Reaching a significant number of e-commerce customers, say 10,000
· Reaching “breakeven cash flow” (where monthly cash received from customers and all expenses paid out are equal)
· Reaching $1 million in annual revenues (a level of annual sales widely regarded to demonstrate “product-market fit” or traction)
At this point the entrepreneur has initially validated the problem, solution, customer and size of market largely through research in the field with prospective customers. They have also prepared a CVP, a business model and a cash flow model to determine how much cash they need to reach the first milestone. The entrepreneur is now ready to raise the initial funding to start the company and launch in the market. Capital raising, company launch and legal matters are outside the scope of this module. A tip — family and friends are a frequent source of initial capital.
Deliverable — Day 2
At the conclusion of the day 2 reading, the student should prepare a business model canvas, as shown above, for their new business venture. Particular attention should be paid to opportunities to create additional value for the customer.
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There is additional required reading in the Reading List that accompanies the LCD that further details many of the concepts in this document and also much supplemental reading and videos to further advance your understanding.
[1] https://sustainabledevelopment.un.org/content/documents/21252030%20Agenda%20for%20Sustainable%20Development%20web.pdf
[2] https://strategyzer.com/canvas/value-proposition-canvas
[3] Many people can claim to have developed the value proposition canvas and subsequent improvements, as shown above. Perhaps Alexander Osterwalder has done much to promote the concept.
[4] http://www.tronviggroup.com/wp-content/uploads/2015/06/A-Helpful-Starter-Guide-to-Thinking-Like-Your-Persona.pdf
[5] https://www.fs.blog/2016/08/mental-model-multiplicative-systems/
[6] http://www.creativitypost.com/business/peter_thiels_4_rules_for_creating_a_great_business
[7] https://www.amazon.com/Business-Model-Generation-Visionaries-Challengers-ebook/dp/B06X426D4F/ref=sr_1_3?s=books&ie=UTF8&qid=1518087569&sr=1-3&keywords=osterwalder+business+model+generation
[8] https://www.amazon.com/Competitive-Advantage-Creating-Sustaining-Performance/dp/0684841460/ref=sr_1_2?s=books&ie=UTF8&qid=1518087358&sr=1-2&keywords=competitive+advantage
[9] https://www.amazon.com/Billion-Dollar-Company-Entrepreneurs-Companies/dp/3838373316/ref=sr_1_2?s=books&ie=UTF8&qid=1518087471&sr=1-2&keywords=billion+dollar+company