Friday, December 15, 2006

Best Business Books for Entrepreneurs

Business literature is really a contradiction in terms. Most business books are really just 8 page Harvard Business Review essays extended to 150 or so pages so that the author can have the ego gratification of seeing their words in hardcover.

There are, however, some exceptions. Here are my favorite business books:

  • Best book on the nuts and bolts vocation of Entrepreneurship. New Venture Creation by Jeffrey Timmons
  • Best book on how to run a company. Good to Great by Jim Collins
  • Best book on the strategy of innovation. Innovator’s Dilemma Clayton Christensen.
  • Best book on the how a startup’s strategy changes over time. Crossing the Chasm
    by Geoffrey Moore
  • Best book about the subjective startup experience. Startup, Jerry Kaplan
  • Best book about creativity. It’s Not How Good You Are, It’s How Good You Want to Be Paul Arden
  • Best book about leadership. Certain Trumpets by Garry Wills

Friday, December 01, 2006

Top 10 Business Idea Mistakes

“If I were to wish for anything, I should not wish for wealth and power, but for the passionate sense of the potential.” - Soren Kierkegaard, Either/Or

This document comes out of a course I recently taught a at the INSEAD business school on how to create, evaluate and improve business ideas. Think of it as a two page summary of this 8 week MBA course.

One of the toughest questions for a new entrepreneur is how to determine the potential for a new venture opportunity? How do you know if an opportunity is just okay or could be the next Google (not that the Google guys saw that one coming when they started out!)

Top 10 Business Idea Mistakes
Learning how to evaluate business ideas is a skill that takes practice, like any other business skill. To get you started, here are the top ten mistakes I saw in evaluating over 150 business ideas generated by INSEAD MBA students:

  1. Fox ideas – lack of focus is the single biggest idea-killer. The idea that you will do everything everyone else does only better is more of a utopian philosophy than a business opportunity. Pick one thing that you are going to do better than everybody else, what Jim Collins, author of “Good to Great”, calls the hedgehog strategy.
  2. Mini-me ideas – overestimating the number of people in the world who are exactly like you (a world full of mini-mes). Nerds always assume everyone is a nerd. MBAs assume everyone spends their lives in business hotels. Focus instead on a real and rapidly growing customer segment.
  3. Confusing theory with reality ideas – as the saying goes – “in theory, there is no difference between theory and practice. The best examples of this are failed internet-based delivery services like Kazoo. In practice, there is.” Physical delivery of anything is hard – good ideas minimize the number of moving parts.
  4. Grass is greener ideas – every business is hard, which makes it understandable that people always believe the businesses they know nothing about must be easier than the ones they know all too well. Working on business ideas in industries you know nothing about are like starting a fight with one hand tied behind your back.
  5. All by myself ideas – new ideas are like plants, they need sunlight to grow – if you keep them all to yourself they will end up stunted and pale. Find one or two people whose skills complement yours, who you trust and who you like to work with and develop the idea with them – two heads really are better than one!
  6. Go-along ideas – just like investments, successful ideas need to take a contrarian point of view (e.g., let’s start an internet search company). Good ideas don’t go along with the the crowd, they take a controversial point of view, have an opinion about where the market is going that challenges conventional wisdom
  7. Immaculate birth ideas – some ideas assume that somehow the business will just be born at a large scale (e.g., we will start with a worldwide chain of business hotels), completely ignoring the critical startup phase of the business. Every idea needs a clear idea of who will walk in and pay you your first dollar of revenue – what will they buy, where will they buy it, why will they buy it?
  8. Gee-whiz ideas – often the idea is focused around a new and innovative product idea, unencumbered by concrete customer benefits or market dynamics to drive growth (e.g., a light that hooks up to your computer and flashes when you get email). Don’t be too fascinated with the shiny newness of your product. Dig down and figure out how to solve a real problem for people.
  9. Disconnected dots ideas – every idea needs to be connected to a business model which tells a story about how the product gets created and delivered to customers in some new and compelling way. Many stories look good from a product and customer perspective, but don’t work at the market level (e.g., just try selling unpasteurized French cheeses in the US) If you can’t connect the dots between supply and demand, your idea isn’t ready.
  10. Humpty-dumpty ideas – highly fragmented markets are usually fragmented for many good reasons (e.g., let’s get all the doctors to sign up for a big system that ranks them all based on quality). If all the king’s horses couldn’t put Humpty Dumpty back together, there is no a priori reason that you will do any better.

How good ideas go bad
Here are some additional thoughts to improve your business ideas:

  • Novice entrepreneurs are often fascinated with the novelty of a new idea, while experienced entrepreneurs focus on fundamental market factors likely to influence success.
  • The most important element of a business idea is focusing on a market that is growing and changing. If you get the market right, you can always change or refine the idea. If you get the market wrong, no idea can save you.
  • This should be obvious, but have someone proofread your work. People will judge the quality of your idea by the quality of your spelling and grammar.
  • Learn how to brainstorm – the world has more than enough kill-joys. Learn how to make ideas better rather than pecking them to death with a wave of criticisms. Think of what you liked best about the idea, then tweak it to make it better.
  • People who know how to throw rocks are easy to find. People who can put rocks together to build something of valuable are rare. Pick partners who make you laugh.
  • Appeal to their dreams. Know what their personal goals are and appeal to them – money is almost never the reason people make big decisions.
  • Think hard about the opening line of your email – what can you say that will make someone want to read more?
  • Think hard about a good business analogy – how can you make it easy for people to understand what you are trying to do?

Saturday, November 18, 2006

How to Cut Off A Dog’s Tail – Reducing Costs In Startups

Let us take as a give that nobody wants to do something as painful as reducing costs (or for that matter, cutting off a dog’s tail). However, if you do find yourself in a situation where you need to take a painful action, it is better to do it well than poorly.

This document discusses a series of observations on the most effective ways to reduce costs in a startup. In particular, it walks through the steps for achieving a cost reduction:
  1. Cut enough: determine the overall percentage of the budget to be reduced (e.g., 30%) but make sure it is enough so that you don’t have to repeat the exercise in 6 months!
  2. Work with top-down budgets: start with a top-down version of the budget broken out by department (e.g., sales, marketing, G&A, R&D) and by expense item (e.g., salaries, rent, travel).
  3. Reduce non-salary costs. For the non-salary items like rent and travel, come up with a realistic cost reduction amount.
  4. Restructure the bonus costs and timing. Determine how much savings you can get from changing the bonus plans
  5. Delegate the salary reduction decisions. For the salary reductions, come up with a departmental target based roughly on the percent of budget allocated to each department, then let the department heads be responsible for recommending which salaries to cut in their department.

Having to reduce costs is one of the most painful tasks any manager can undertake. For eternally optimistic, growth oriented entrepreneurs, cutting costs and laying off people feels like a betrayal of your deepest values. Yet there are times when it must be done and done well for the survival of the company.

It’s easier to cut the dog’s tail only once
The first and often most emotional question to answer about a cost reduction is how much to reduce. There is always an amount that seems fairly easy to reduce (typically 10-15% of current budget) and an amount that seems almost impossible to reduce (typically 20-30% of budget).

There is a basic rule of thumb for cost reduction in companies with revenue – you should cut costs to break even over the trailing 12 months of revenue. For companies without revenue, the rule of thumb cut costs to keep the company alive for another 12 months without additional funding.

As painful as it is to make this kind of deep cuts in the organization, it is much more painful to make a series of shallow cuts. The analogy is that it is better to cut the dog’s tail only once, rather than having to cut it off several times.

Work top-down
Most finance department budgets are bottom-up: they build up the organization’s costs from a very detailed level to an aggregate level. These kinds of spreadsheets are useful for fine-grain budgeting but bad for the kind of fast, what-if analysis needed for cost reduction.

Start with the top-down budget and then create a detailed list of the savings that are going to be made to get to the new budget number. Once you have a clear top-down picture of how the costs are going to change, make the appropriate changes to bring the bottom-up detailed budget into alignment. If you try to work from the detailed budget you will get bogged down and lose momentum in the process.

Reduce non-salary costs
In a typical startup, there are usually not too many non-salary costs to start with and limited scope for reduction. The best bet is usually trying to renegotiate your rent with a landlord. This usually requires a good relationship with the landlord and a reasonably flexible lease, so think ahead when you sign that lease!

Be careful here of making promises you cannot keep. Cutting the travel budget in half may seem like a good idea during cost cutting but may not prove feasible if every sale requires travel to the customer.

Restructure bonus costs and timing
One of the most promising cost reduction areas is bonuses. As a rule, 80% of bonuses go to executives, so in practice this means some serious discussions about the nature of a bonus plan. The starting point in the discussion to decide whether it makes sense to pay bonuses in a company that is unprofitable. If so, that means that the VCs are funding the bonus plan and the executives are reducing their incentive to run a profitable company.

The best bonus plan is one which pays annually, based on the company achieving its goals, including sufficient profit to pay out the bonuses! A good alternative is to split the bonus between an objectives-based bonus (MBO), say 30% of the total bonus, paid quarterly based on personal achievement; and a profit-sharing bonus, the other 70%, which is paid annually or quarterly providing there is enough profit to fund the bonus and other objectives have been achieved.

The profit-sharing bonuses create a great deal of company alignment around achieving profitability. They are also very helpful in conserving cash when the company doesn’t achieve its revenue goals.

Delegate decisions to reduce personnel decision
The CEO and CFO decide what the cost reduction targets are, the VPs for each area decide who is affected. It is very counterproductive to have VPs taking pot shots at each other’s people. The VPs are responsible for making their organizations work with a reduced staff – pay them the courtesy of letting them make recommendations for how to achieve the cost savings.

Each executive in turn should do a force ranking of their employees, from most valuable to least valuable. The ranking should be based both on hard skills as well as soft skills (attitude, contribution to team morale). In addition, the ranking should take into account value for the money – is this person performing at the level they should given their cost?

In general, a cost reduction should not drive a change in strategy. For example, deciding to eliminate the sales team and use only indirect channels is something that should be decided as part of a rethink of the entire strategy, not as an opportunistic cost reduction.

Never fire your stars or your songbirds
There are always some “A” people in the company making lots of money and delivering lots of value. If you start firing your “A” players, you are dooming the company, because you will never re-start a company with a mediocre staff.

Similarly, there are always a few people people who contribute greatly to the morale and ambiance of the company but who are at risk during cost reductions because they are in non-critical jobs. People who contribute to the spirit of a company can be even more important than people who bring strong skills to the company.

Work quickly but do the right thing
Regardless of how good you think your secrecy is, your people know something is going on. Every day is agony to an organization waiting for the hammer to fall. Don’t rush decisions but work as quickly as possible.

Although working quickly is important, do not neglect to follow all the proper steps from an HR and legal perspective, both to protect the company and to protect the employees who are being let go. Treat the people who are leaving with respect and compensate them fairly – how companies treat people who they have “discarded” is one of the truest tests of company culture.

Talk to your company
After you announce the reductions, call a company meeting to tell them what has happened. This is not a cheerleading session, but a chance to let people ask questions and a way to keep a feeling of togetherness during a difficult time for the company. In the week after the reductions, go out of your way to communicate the strategy of the company, to give people a vision for how the company will restart the growth process.

Cost Reduction Examples
This example shows a cost reduction exercise for a software firm with trailing 12 month revenues of $6M (averaging $1.5M/quarter). The current budget calls for total costs (expenses + cost of sales) of $2M for the next quarter. The current budget also calls for revenue of $1.8M for the next quarter, but this number is optimistic.

Initial budget (departmental) $’000 % tot costs
Revenue 1,800
Cost of Sales (prof svcs) 100 5%
Sales 500 25%
Marketing 400 20%
R&D 600 30%
G&A 400 20%
Total Expense 1,900
Total costs (exp+COS) 2,000 100%
Income (200)

The next table shows the budget broken out by expense item.
Initial budget (by expense item) $’000
Revenue 1,800
Cost of Sales 100
Fixed salary (incl taxes) 1,000
Sales commissions 200
Bonuses 300
Rent 100
Travel 200
Fees (legal, etc) 50
Phone 50
Total Expense 1,900
Total costs 2,000
Income (200)

Steps to cut budget
1. Cut enough: assuming revenue for last 3 quarters averaged $1.5M, will need to reduce total costs by $500K, or 25%
2. Work with top-down budgets: budgets are shown here – note that the number to focus on is total costs, which includes cost of sales. Most CFOs break out cost of sales separately; make sure to include it because it affects your break-even point.
3. Reduce non-salary costs (50K). For the non-salary items like rent and travel, come up with a realistic cost reduction amount. Here, a reduction of 50K may be realistic.
4. Restructure the bonus costs and timing (210-300K). Changing the bonus plan for this company has a huge impact. Simply making the bonus contingent on profit can reduce the break-even point for the company by 210 - 300K or 15% of total costs, depending on whether the whole bonus is contingent on profit or only 70% of the bonus. Note that if the profit-sharing bonus is not paid in a given quarter, it can be deferred to the next quarter, giving the company a huge incentive to have a big Q4.
5. Delegate the salary reduction decisions (150-240K). For the salary reductions, come up with a departmental target based roughly on the percent of budget allocated to each department. Assuming the reduction salary reduction target is 200K, this would be assigned as follows: sales 25% x 200 = 50K, marketing 20% = 40K, R&D 30% = 60K, G&A 20% = 40K, Prof Services 5% = 10K. It is up to each executive to propose salary reductions to reach their target number, then negotiate these reductions with the CEO and CFO.

Monday, October 02, 2006

How to build a board

The board of directors for most startup companies is an accidental and ineffective club. The board members don’t really know why they are there, the CEO doesn’t really know how to use them, so mostly everybody just goes through the motions (no pun intended). It is time for some clear talk on how to build an effective board.

Given that board of directors is the only group that can fire the CEO, it is extraordinary how little thought CEOs give to the composition of their boards. A typical startup board consists of several venture capitalists, a couple of people chosen purely for their impressive resumes and a smattering of founders.

The accidental board
Now, given that the purpose of a board is to provide advice to the CEO, how effective is this “accidental” board likely to be?

  • Venture capitalists: The venture capitalists are there purely because they invested money in the company, not because they have a relevant business background that gives them insight into the strategy or operations of the company. They may even have objectives around growth and liquidity that are counter to the best interests of the company. Most importantly, VCs have famously itchy trigger fingers – if a VC decides the CEO is not executing well enough, they often push to replace the CEO rather than coaching them.
  • Impressive people: The people who are on the board purely because of their resume are not much more likely than the VCs to be helpful. Their experience running a big company may have little to do with the challenges facing a small company. Their time commitment to the company may be minimal. Finally, if things start going poorly, they may worry more about the impact on their reputation than on how to help the company overcome its challenges.
  • Founders or executives: Small company boards often have company executives sitting on the board. If you consider that the purpose of the board is to advise and if necessary replace the CEO, it is bizarre to think that executives who report to the CEO would also be determining the CEOs fate. For example, a current executive or former founder may have an incentive to make the CEO look bad so that they get a shot at the top job. This is not to say that executives should not attend parts of the board meeting, just that they should not be formal board members, nor should they attend the opening or closing session of the board.

What should a board do?
The CEO’s job is to create a strategy that maximizes the value of the company and then manage the execution of that strategy. In this context, the job of the board is simple: to help make the CEO successful in creating and executing a strategy.

The board has three ways to do this:

  • Challenge the existing strategy: the board’s most valuable role is to provide input into the strategy – is it sound, is it realistic, what are the potential risks?
  • Raise difficult questions that the CEO is not focused on: the board’s second role is to probe how well the strategy is being realized – are the metrics right, are they being achieved, what is being overlooked?
  • Suggest ways to grow the CEO: the CEO role is an impossible job – nobody has all the skills required to handle every aspect of the job. The board should be looking ahead and constantly helping the CEO build skills that they will need 12 to 18 months from now. The board should also be looking out at the point where it will be necessary to bring in new CEO skills and start a dialogue for a smooth transition well before it needs to take place.

Boards and CEOs often fall into somewhat adversarial roles that are damaging for the company and ensure that the CEO shares a minimum of information with the board. Given the disruption caused by replacing a CEO abruptly, an effective board should see its first and foremost role to support the CEO.

The 3 people you need for an effective board
Boards should have five to six members, but as a CEO you need three people on the board who play very specific roles. These are:

  1. Investor: Venture capitalists are pack animals and the venture capital world has very clear hierarchies. On any board, there should be one venture capitalist who all the other venture capitalists respect and who can effectively speak for the others. As a CEO, you should create a good relationship with your strongest VC and look to them to represent the overall voice of the investors
  2. Customer: it is very important to have a person on the board who can speak for the customers. This person is not necessarily an actual customer, but someone who can give the customer’s point of view on the company strategy, industry trends and competitor actions. Having someone who can speak for the customers on the board eliminates a great deal of second-guessing during board meetings.
  3. Experienced CEO: the most important member of the board from the CEO’s perspective is a person who has been a successful CEO of a comparable company. They should suggest ways to build the CEOs skills to meet the company’s next challenges. This is the person who has the credibility for example to suggest alternatives to firing the CEO when the VC’s are frustrated with the company’s progress. Ideally, this person should also be chairman of the board.

A board that has these three roles will give the company a huge advantage over the more common accidental boards. Having clear leadership among the investors ensures that future funding and liquidity events will happen smoothly. Having a respected customer perspective on the board greatly helps in assessing company strategy. Finally, having an experienced CEO on the board helps ensure that the company CEO is building the skills needed to be successful for the next phase of company growth.

A typical board agenda
Board meetings have very specific objectives. One of the most important elements of a meeting is to have a closed session at the beginning and the end for candid discussion with the board.

  • Board introduction (closed session, no executives other than the CEO): the CEO gives state of the union, a very candid assessment of where the company is right now. The CEO asks board members for any issues that they want to make sure are addressed during the rest of the meeting. 15 minutes.
  • Strategic review: the CEO or an executive make a presentation on a major element of the company strategy. 60 minutes.
  • Functional reviews: the executive staff make short presentations on their objectives from the last board meeting, their progress against those objectives, and their objectives for the next board meeting. Four 15 minute sessions.
  • Board business: this is where formal motions are passed, usually having to do with stock, audits, legal documents and benefit plans. 30 minutes.
  • Board close (closed session, only external board members): the Chairman meets without the CEO and probes the board members for how they thought the meeting went, and what concerns they may have that should be addressed before the next board meeting. It is critical that the CEO not attend this session, so that board members can be candid with concerns. It is equally critical that the Chairman meet with the CEO afterwards to share these concerns and discuss how to address them. This is the mechanism for defusing board concerns before they become critical enough that the board. 15 minutes.
  • Total time = 3 hours