Emerald Group Publishing Limited
Copyright © 2009, Emerald Group Publishing Limited
Tools for planning new strategic growth initiatives
Article Type: The strategist’s bookshelf From: Strategy & Leadership, Volume 37, Issue 4
Rita Gunther McGrath and Ian C. MacMillan(Harvard Business School Press, 2009, 225 pp.)
Starting a new business is essentially an experiment. Implicit in the experiment are a number of hypotheses (commonly called assumptions) that can be tested only by experience. The entrepreneur launches the enterprise and works to establish it while simultaneously validating or invalidating the assumptions. Because some will be dead wrong and others partially wrong, an important goal of the business plan must be to continually produce and build on new knowledge. Managers must justify moving to each new stage or milestone in the plan on the basis of information learned in the previous stage (Zenas Block and Ian MacMillan).
Most observers agree that many corporate and industry landscapes will be altered radically by the current global economic crisis and that restructuring alone cannot be the only engine of recovery. Innovation and new business creation will be needed more than ever to help accelerate economic growth.
But the track record of corporate efforts at new business venturing to date have been very mixed. A recurring theme among advisors trying to improve the odds for success – such as Clayton Christensen and Michael Raynor in The Innovator’s Solution or Vijay Govindarajan and Chris Trimble in Ten Rules for Strategic Innovators – is that the planning approach and metrics used by companies to develop their core businesses can actually be harmful when simply extended to new business venturing. Neither the strategy nor the business model most likely to bring success tends to be clear at the outset, and the ratio of assumption-to-knowledge is typically high early on. How to reduce this ratio quickly and cost effectively over the course of any new venture’s development, is the primary challenge to which Discovery-driven Growth addresses itself.
When it comes to offering guidance on this topic, few are as well credentialed as Professors Rita Gunther McGrath of Columbia University and Ian MacMillan of the University of Pennsylvania’s Wharton School, the best-selling authors of MarketBusters: 40 Strategic Moves that Drive Exceptional Growth. They describe the genesis of their latest book offering as follows: “In our many years of working with such companies as Nokia, Air Products and Chemicals, 3M, DuPont, IBM and many others, we’ve distilled practices that allow managers to better choose strategic growth projects, reduce the risk of these projects, and either execute them with relentless success or discontinue them at a very low cost. This book is the result.”
Discovery-driven Growth is organized into three parts:
“The strategic considerations for growth,” with emphasis on the role of top management in framing the growth challenge for the company as a whole.
The challenges involved in the planning and implementation of specific ventures.
The organizational infrastructure needed to “support and sustain a discovery-driven mindset.”
The treatment opens with a “deliberately simple” illustration to demonstrate the power of the discovery-driven growth (DDG) approach and help the reader to get a firm grasp of its essential elements. These elements include: working backwards from desired outcomes, planning to learn as you go and benchmarking against key exemplars. Some years ago the authors were invited to comment on what they thought might be the prospects for a new toy store in Sacramento. The store was going to focus on old-fashioned toys, like model trains and board games, with its goal being to help children to rediscover the joy of creative forms of play. How might the use of a discovery-driven planning approach help to establish a firmer basis for evaluating this venture’s commercial prospects?
The starting point in DDG is to define and frame success. In this case, the authors begin with an estimate of what the entrepreneur would need to generate in terms of profit before taxes to make the effort worthwhile. The figure they pick is $250,000, which is not unreasonable for a sole trader. Assuming a return on sales of 50 percent (net of expenses), the owner will then need to generate at least $500,000 in annual sales to meet his profit target. If we further assume that the average price for the kind of toy he will be selling is $25, then he will need to sell 20,000 units per annum. If we assume that average purchase is two toys per customer, then he will need to get 10,000 buyers into his store to meet his goals. If we further assume that the bulk of his sales will happen in the eight-week run up to the major holidays, then he will need to be attracting 1,125 buyers every week during this peak period. If we also assume that only one in five visitors will actually make a purchase, then he will need to attract 6,250 people into his store every week for his business to be viable, or nearly 900 people a day, assuming that he opens seven days a week at peak (see Table 6.1 from Discovery-driven Growth).
Table 6.1 Reverse income statement for toy business
Given that the store has just 3,100 square feet, how realistic would it be to expect it, with a value proposition based on providing an “experience”, not just a product, to both attract and service this level of customer traffic? Also given that there are about 60,000 children below the age of nine in the Sacramento area, to move 20,000 units a year, one in every three of them would need to be customers of the store, or one in every six, if the assumption about two purchases per customer holds good. Even from these very preliminary calculations, serious questions are already beginning to arise about the potential viability of this project.
Clearly much of the foregoing is based on assumptions, most of which are unlikely to be accurate, but this will be true with most new ventures. The primary purpose of carrying out such a reverse financial analysis is to “help keep a discovery-driven plan coherent and connected to reality.” The DDG approach is “like buying an option” in that “you don’t want to take on any more risk than is warranted by the information that you have available to you” at any point in time.
Having primed us in the basics, the authors then set out to present a comprehensive framework for embedding the DDG mindset into a company’s strategic management system, and the book offers a number of specific discovery-driven planning (DDP) tools to support this process. Part 1 focuses mainly on the corporate level, and the role of senior management in “creating a focus for strategic growth.” The essence of the DDG approach, of first specifying success and then working backwards, begins at the top, and “helps the senior team clearly articulate what kinds of opportunities are likely to be worthwhile, and, equally important, which kinds will not be worthwhile.” The main elements of effective framing at this level include the articulation of a core mission, the development of a number of screening statements to specify what would make any given opportunity under consideration attractive, the specification of permissible growth domains, and a commitment to provide the time, resources, and organizational changes necessary to support the growth initiatives.
One of the main tools on offer to help in corporate-level framing is the “opportunity portfolio” (see Figure 3-2 from Discovery-driven Growth), a visual mapping of a company’s growth initiatives based on two dimensions of uncertainty, technical and execution on one axis and market and organizational on the other. Opportunities closest to the core are typically low on both technical and market uncertainty, while opportunities that are moderately uncertain on either or both dimensions would usually be extensions of the core into relatively close product or market adjacencies. Positioning options are those for which the market opportunity is clear to all, but what still remains unclear is which technology and/or business model is most likely to win mass market acceptance. Scouting options are those which involving trying to find new “white space” market opportunities for current capabilities. The stepping stone opportunities are the most risky, but potentially among the most promising, and “options reasoning” provides the conceptual underpinning for this technique as it does for DDG as a whole. Using such a mapping, significant gaps between rhetoric and reality soon become apparent, as illustrated in the example of a company, given the pseudonym of ESCO, where the contrast between the 2006 and 2007 versions of the map demonstrate both its diagnostic and its direction-setting powers.
Each major strategic initiative at corporate level is likely to include a number of discrete “real options type projects.” So the next main step is to link the overall corporate framing exercise to that for each individual strategic initiative. In doing this, corporate leadership is advised to follow the following five steps in line with the general “reverse financials” approach: Identify the expected contribution to profits by the time the project reaches steady state, determine the required revenues, specify the project’s profitability in terms of Return on Assets (ROA), create a proposed project scope specification and calculate a BareBones Net Present Value (NPV), in order to “get an early indication of whether it is likely to be at all worthwhile to continue with the plan” (BareBones NPV is “a handy little Excel-based calculator” that provides “a number analogous to an NPV,” and is available from the authors on the Web).
These steps are illustrated using the second of the book’s two main extended examples, a company, with the pseudonym of MC Chem, looking to break into the biotechnology market with a new kind of disinfecting fluid, named BioBarrier, which appears to be about 50 percent more effective than current offerings. Following the initial framing for the specific project, the next step is the development of the “business model architecture.” Key elements here include the choice of a tentative “unit of business,” the analysis of the “nearest competitive offer” (NCO analysis) and the identification of “the key metrics” (all developed in more depth in The Market Busters). The selection of the unit of business, which is “quite simply what you decide the customer is going to be paying you for,” is the fundamental step around which the rest of the business architecture evolves, and many innovations today are “essentially business model, or unit of business, innovations.” An example taken from the ready-mix concrete sector is the shift in pricing structure of Cemex from product quality to on-time delivery. The authors offer a four-step guide to identifying alternative units of business.
Having established the unit of business the next step is to benchmark against the nearest competitive offer. The primary tool on offer here is the “consumption chain” (which is also treated in more depth in The Market Busters). The key point is that “you want to understand your impact on the customer’s experience” by systematically thinking through their “total interaction with your solution, from awareness to selection, payment, financing, usage, service and eventual disposal.” Breakthrough ideas have to meet at least three criteria:
They differentiate massively on some dimension of performance that enough customers really care about.
They radically change the cost-benefit ratio for customers.
They change the criteria that customers use to judge value.
“Often, problems in a new business arise because some major gap in the customer’s experience nullifies the usefulness of the whole business,” and “entrepreneurs are almost always excessively optimistic about the enthusiasm that prospective customers are going to display on the basis of a product’s technical merits.”
The final step in NCO is to benchmark against the performance on key metrics that the nearest competitor is already generating. The key metrics are based on the main drivers of value, and these tend to differ across different market sectors, for example, passenger yield and fixed cost per passenger mile in the airline industry, or sales/profits per square foot and same store sales in retailing. The overall aim is to try to be specific about the measures “that you would like to meet in terms of competitive standard, and those that you need to beat.” If this analysis struggles to come up with any clear basis for competitive differentiation, then there is a need to redefine the project (by changing the unit of business and running the NCO analysis again), or to redirect the effort onto other options.
If the results of the NCO analysis are promising, then the next part of the process is to “set up the plan to learn,” which is built upon four closely related documents, the reverse financials, the deliverables specification, the key assumptions checklist and the check-point review chart. “When you put all of these together, you have assembled the blueprint for a well-designed experiment to test the assumptions in your hypothesized growth initiative.”
Whereas the initial framing exercise helps to establish the minimum desired impact on the company’s future growth and the “allowable” costs and assets to deliver it, the more detailed reverse financials developed at this stage in the process includes the specification of the key outcomes required for each link in the consumption chain to deliver “a customer experience superior to competitive offerings.” In the toy store example, this includes projections about how much advertising will be needed, the anticipated levels of inventory, rent expense, salespeople and their compensation, and so forth (see Table 6.1). “The goal is to make sure that you are not setting yourself up to fail by building unrealistic operating assumptions into your plan or by neglecting a major cost or asset commitment that is going to be needed to deliver the business.”
So an important by-product of this exercise is the development of the “critical assumptions checklist.” At the beginning of any uncertain high growth initiative, assumptions are likely to be made across all key aspects of the project, the business model, the market, the competition, the development of the product or service, manufacturing and production and finance. Some of these will have to be estimates, while others can draw on existing industry benchmarks, and there are “no hard and fast rules about which assumptions you choose to emphasize – part of the skill of doing a discovery-driven plan is figuring out the rhythm of different businesses.” Spelling out your “best-guess critical assumptions” in this way, and keeping them open continuously to challenge, helps to accelerate the learning process that DDP is specifically designed to promote.
The final tool in the DDP toolkit is the check-point review chart. Sometimes opportunities to check assumptions will “happen naturally, as fresh information comes to light,” and sometimes you will have to “deliberately create them” through the use of market feasibility studies, prototype development, beta testing, pilot plant development, and other such experiments. Putting all of this onto a review chart allows the team to spot more easily “where moving checkpoints that can be reached cheaply to an earlier point in the plan” might save “a lot of unnecessary expense.” A key decision is how frequently and regularly the milestones should be reviewed. The calendar-oriented cycle of conventional planning is “rarely appropriate” for uncertain growth projects, so reviews “should happen when enough learning and development activity has been completed” or when “a significant decision to invest in, reorient, or shut the business needs to be made.” Each decision to move to the next major checkpoint is akin to buying an option, and the authors show how the BareBones NPV tool can be used to estimate the risk-adjusted allowable incremental investment required to fund the project to each succeeding milestone. Moreover, this approach has the added advantage of being able to highlight the range of options still open when each critical milestone is reached. “You can stop the project, change its direction, break it apart in some way, spin it off, put it on hold, fold it into another business, or more aggressively move it to launch.” It also allows the option of disengagement to be considered in more dispassionate and less pejorative terms, encouraging more timely decisions on withdrawal, while also focusing on how to use the learning to advantage elsewhere in the company, so that the knowledge and experience gained are fully valued as potentially transferable and exploitable outcomes in their own rights.
The final part of the book is devoted to consideration of the key implementation challenges facing any company looking to adopt the DDG approach and embed it in a sustainable way into its corporate mindset, structures and practices. Overall, while most of the basic ideas offered in Discovery-driven Growth have already been developed by the authors in previous publications going back several decades, their latest book provides a comprehensive framework for integrating their well-regarded tools for discovery-driven planning into a very practical overall approach to the process of new business venturing. This makes for a welcome addition to the strategist’s bookshelf.
Brian Leavy AIB Professor of Strategic Management at Dublin City University Business School (email@example.com) and the co-author of Strategic Leadership: Governance & Renewal (Palgrave Macmillian, 2009).
1. “Milestones for successful venture planning”, Harvard Business Review, September-October, 1985, p. 184.
Table 6.1 and Figure 3-2 from Discovery-driven Growth: A Breakthrough Process to Reduce Risk and Seize Opportunity, Rita Gunther McGrath and Ian C. MacMillan (Harvard Business Press, 2009). Exhibits © 2009, reproduced by permission.