I began teaching entrepreneurship about fifteen years ago and shortly thereafter began seriously studying new business concept development. I now think the business concept development process has three steps.
- Developing the customer value proposition
- Developing the business model
3. Developing financial models and capital raising
My study began with capital raising and I usually explain my career as working at the intersection of strategy and capital. I built a billion-dollar company in Indonesia and that lead to a book[1] on business models. Today I run two incubators and an accelerator[2] at Florida International University where a lot of my time is devoted to defining the customer value proposition for startups. As you might be able to predict from my reverse exploration of entrepreneurship, my study of customer value proposition today is focused on the beginning — insight and opportunity.
Introduction
After working almost every day for the last two and a half years with startup founders, my experience suggests that the hardest part of developing a new business concept is to come up with an insight that leads to a large market opportunity. There are two parts to this process:
1. Developing the insight that solves a big problem
2. Converting the insight into a large opportunity
Insight
Perhaps the most well-known academic writer on entrepreneurship in the 20th Century was the Austrian School economist, Israel Kirzner.[3] Following FA Hayek’s profound early thinking on the role of information theory in markets, Kirzner defined an insight as a “positive asymmetry of information”. While this definition has precision, it usually creates a deafening silence when used in an auditorium of aspiring entrepreneurs. The best simple definition of insight I have found is to call it a “discovery” — finding something new. Now that we have defined the context for insight, let me give you a tool that can develop insights, which comes from design thinking.[4]
In Step 2 of design thinking one reframes the problem. One of the best ways I have found to reframe the problem is to look for a key assumption about a problem and change it. The change in perspective on a problem from changing a key assumption is the insight. Most major scientific discoveries illustrate my point. For example, Einstein redefined time and made it relative to the observer. What key assumption did he change? He changed an assumption from no less a luminary than Newton that time was absolute. Einstein launched a whole new physics with his theory of relativity, perhaps by the change in the assumption about time. Think about early dugout canoes and then think about sailing ships and how we got from dugouts to sailing ships. Everybody can quickly realize that someone wanted to save energy and put a sail in the dugout. Very few people realize that the more meaningful “insight” or discovery was to disassemble the dugout in pieces, which allowed for the bigger, safer open water boats that sailed the seven seas. This disassembling of a fixed object involves functional fixedness[5], and overcoming it in the case of the dugout involves a change in assumption that leads to a world changing insight.
The change in perspective from the insight also marks the transition in the discovery process from analysis to creativity. Creativity without insight rarely produces anything worthwhile and the recognition that a key assumption has changed is a good indicator that one can move to the creative stage. In design thinking, this creative process is Step 3 — ideation. With insight defined, now let’s move to the equally challenging objective to identify a large market opportunity.
Opportunity
Many who pursue creating a startup fail to recognize that entrepreneurship is about creating a better future for society. Wealth, jobs, industrial clusters, even products are all by-products. If you cannot reach that societal standard of a better future, then at least meet the Y Combinator requirement as explained by President Sam Altman.
“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.”
What this means is that we probably do not need another dog walking or textbook selling or dating app. In fact, some people say we do not need any more apps. Of course, the lesson might be not to focus on the technology of app building and instead focus on the original insight. Recognize that the objective for deriving the insight is to create value, what the economist calls utility and I call the “perception of purpose achieved” by the customer. To create value the entrepreneur must join insight with innovation to solve a customer problem. Innovation was defined by the famous economist Joseph Schumpeter as “invention commercialized”. Invention can be understood as a new, tangible process, method, composition or device. Therefore, innovation is the process to convert an insight into value through invention. This value created is the basis for both the customer value proposition (which completes Step 1 of new business concept development) and sustainable competitive advantage. Competitive advantage creates the protective “moat” popularized by Warren Buffett. It also therefore allows the entrepreneur to decide how much of the value is shared with the customer and how much value is captured by the business.
Customer Value
I think most entrepreneurs fail to create customer value and therefore do not find a large market opportunity. If we try to generalize to find insights that consistently create customer value, I return to information theory and physics. What Albert Einstein and Claude Shannon showed us is that reality can be understood in terms of information and energy. Therefore, we should explore fundamentals of information theory and energy to find insights and those insights fall into three categories.
1. Trust
2. Transparency
3. Transformation[6]
One advantage of this framework is that it pushes the entrepreneur naturally beyond product and services to invention and the processes and methods that define customer experience. Customers are increasingly using customer experience rather than product or service as the deciding factor in their purchases.
Trust
Increasingly the biologists and complexity scientists are showing us that community and sharing are the natural behavior of all living organisms, such as slime molds, ants and even plants. For sharing to function there is one necessary condition — trust. The greater the cognitive processing power of the organism, the greater the necessity for trust to permit sharing. If trust is such a fundamental concept, then in any business concept the entrepreneur needs to understand how the customer reaches sufficient trust in order to purchase. If one cannot demonstrate how trust is established, one does not understand the customer. Conversely, if you can facilitate trust or make it easier to arrive at, that is potentially the type of insight that can disrupt a large market. (Also remember, the easiest way to document a new business opportunity is to pick an existing market, which is what Bezos did with Amazon.)
In fact, the early days of e-commerce illustrate the point about trust. Comp-U-Card was one of the first successful online merchants. Why did they have success selling branded televisions and cars but not fashion? The customers knew what the Sony TV was because they had seen it in a store, but fashion merchandise always had fit issues and little standardization. Comp-U-Card succeeded because they picked merchandise where customers had little concern. The story goes that E-Bay got product-market fit when they added customer reviews. Up until that time the customer did not know if they could trust the seller. Customer book reviews added a new dimension to trust at Amazon and Yelp further documents the power of trust as a basic requirement for a successful new business concept.
Transparency
If you understood the earlier references to asymmetry and trust, then the importance of transparency will be easy. Many commentators say that information doubles every 18 months and that information will soon double in hours within 10, 20, or 30 years. Fake news, Facebook and Equifax seem to be on the front page every day recently. Government transparency is another issue that makes the front page regularly, particularly with a President unpopular with parts of the media. Transparency is perhaps a self-evident norm for behavior, a means for sharing what needs to be known by government, businesses, non-profits and individuals. However, in the Internet era, great wealth has been created by Facebook and others through their profitable control of access to information, what commentators call a bottleneck. What is perhaps the greatest tool to aid transparency is arguably either the printing press or Google search. I will talk about Google because Gutenberg did not blog. Effectively, Google showed us the world’s information curated by topic, the topic selected by user. After curating text, Google went on to curate video, maps, images and now who knows what the artificial intelligence (AI) is curating.
Some would say that the big challenge in AI is getting the information to train the algorithms to understand the important variables so we can accurately do predictive analytics. To me, that sounds like a modern form of transparency. Many experts on technology say that every company should be incorporating AI into their business. Perhaps the better advice might be to look at where transparency would create the greatest value for the customer. Today we tend to be distracted by the new technologies of the Fourth Industrial Revolution[7], but a better approach is to look for new opportunities where fundamental principles such as transparency can create customer value. Such an example might be the Blockchain, which combines a strong feature set for both trust and transparency.
The increasingly popular Blockchain and the other distributed ledger technologies (DLT) can be understood as the “technology of trust”. The Blockchain is a hacker-proof distributed ledger that captures every detail of a transaction or piece of information. It creates trust firstly because the transaction records are stored on multiple computers that cannot be hacked, with no control by a middle man who charges a direct or indirect access fee. Secondly, the Blockchain provides transparency by recording the entire history of, for example, a house that has been sold six times. This combination of trust and transparency makes Blockchain a powerful new technology. Of course, we have probably not yet found a commercially successful use case for the Blockchain technology (think Office for personal computers). My view is the use case will happen in a domain with a lot of detailed information and rights like music or in personal security where, for example, my college record will be my asset and not a university’s.
Transformation
Transformation is an odd concept because physics explains it so simply. Every object eventually breaks apart into smaller and smaller units, atoms and eventually particles according to entropy. Therefore, if we are looking for an insight, one might begin by breaking things apart. If this is too dramatic an idea, think about how Einstein defined creativity as a “combinatorial process”. That which can be combined, can be broken apart or transformed.
One of the easiest ways to apply transformation is to use Michael Porter’s 3-step value chain concept[8]. The process of creating value in a business includes:
1. Creating or sourcing the product,
2. Distributing the product to the customer
3. Customer experience
Each of the three steps involves multiple processes where additional value can be created for the business or shared with the customer[9]. An excellent book on creating innovation in the value chain is Larry Keeley’s Ten Types of Innovation: The Discipline of Building Breakthroughs. Outsourcing a part of the value chain where the process is a commodity is potentially an opportunity for innovation and value creation. The provider of the outsourcing may do it better than your company and create additional value for the customer. (Combining processes, what some call coproduction, is another way to create value by improving the processes by joining them in one process.)
Notable examples of breaking apart or transformation abound. Airbnb broke apart houses and apartments into rental units, cloud computing transformed computer infrastructure and continues to transform under the pressure to provide better performance for AI, and countless examples exist where we strip out the driver from cars, lawn mowers and even tanks and fighter aircraft. Transform by identifying an insight that allows one to break apart an existing process to release new value through innovation, preferably in a large existing market.
Conclusion
Innovation is the process to convert an insight into value through invention. Invention can be understood as a new, tangible process, method, composition or device. The three Ts (trust, transparency, and transformation) help you decide where you might start the analysis to find the insight. As noted earlier, large existing markets document the market size. With that in mind, you should now be ready to start the process, embrace entrepreneurship and find that large opportunity.
[1] Billion Dollar Company: An Entrepreneur’s Guide to Business Models for High Growth Companies
[3] Competition and Entrepreneurship
[4] The d.school Operator’s Handbook
[5] Functional fixedness is explained in more detail in this Medium article, The Foundation of Entrepreneurship: Large Market Opportunities that have Repeated for 40,000 Years
[6] Transformation is used here in the vernacular rather than as a short hand for Lorentz Transformations.
[7] https://www.weforum.org/agenda/2016/01/the-fourth-industrial-revolution-what-it-means-and-how-to-respond/
[8] https://www.mindtools.com/pages/article/newSTR_66.htm
[9] Value Creation Versus Value Capture: Towards a Coherent Definition of Value in Strategy, Cliff Bowman and Veronique Ambrosini