SOPHISTICATED FINANCE

A Value Capture Pivot??

Eric Ries is the creator of the Lean Startup methodology and the author of the entrepreneurship blog Startup Lessons Learned. In his most recent post he said about Slideshare:

"Realizing it had taken a wrong turn, SlideShare rethought its approach to premium accounts and ultimately performed what we’d call a "value capture pivot", one where the company changes the way it collects revenue from customers."

If you do not know what a "value capture pivot" is it is a change in "pricing models". As described in my new book, Billion Dollar Company , there are 15 different pricing models. I guess in Ries speak that would mean you could pivot fifteen times.

Having had a little fun, I would now like to discuss "value capture" and its sister concept "value creation". The two concepts are popular in academic discussions of entrepreneurship and competitive advantage and were perhaps first introduced by Bowman and Ambrosini in their 2002 article Value Creation Versus Value Capture: Towards a Coherent Definition of Value in Strategy.

(Note to Colleen: if this is not the first significant article please correct me in the comment section.)

Value creation is the notion that every organization creates social utility. In economic terms, utility is a measure of relative satisfaction. In Hacker speak value creation is "satisfying customer need". Value capture is easier to understand. It is the monetization of value creation or as Ries says "the company... collects revenue from customers". In Hacker speak it is the "pricing strategy".

So far all of this discussion of value looks overly complicated, which is why I translated it into Hacker speak. However, this conceptual framework has an interesting application in understanding where different types of organizations place their emphasis. Let's say that emphasis can be determined at three levels--"ignore", "satisfice" and maximize. In the chart below I show different types of organizations and how much emphasis they place on value creation and value capture. (Click to see full image.)

As shown, a social entrepreneurship organization maximizes value creation (does the most good possible) and satisfices for value capture (a break even cash flow to stay operating). A for-profit company satisfices for value creation and maximizes for value capture. Yes--for-profits create social utility--but maximze cash flow to satisfy shareholders. The example I really like is the criminal organization--ignore value creation and maximze value capture. Of course, the for-profit that forsakes its social responsibilities (ignores) looks just like a criminal enterprise. Note: the shades of gray are where I am not sure. A government with a balanced budget may be satisficing for value capture and without a balanced budget they would be ignoring value capture. ( Note: I would appreciate comments on whether this way of looking at different organizations is helpful. I am thinking of using it in my next book.)

Just to clarify--I like Eric Ries' blog and his way of thinking about start ups very much and recommend it. Sometimes he just talks funny :)

My new book, Billion Dollar Company: An Entrepreneur's guide to business models for high growth companies, is available on Amazon. See the fourth strategy Porter should have added, determine if the market opportunity is large enough to interest venture capital and learn the 5-step process to really develop a business model. Book website.

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Why I Teach

I have written before about why I teach (here). One of the keys to being a good consultant or teacher is to identify and work with people who listen to your advice and follow it. Clients, students and early stage companies that I advise show their buy-in to my way of approaching business in different ways:

1. some read this blog faithfully
2. some read the books I recommend
3. some come to my workshops 2-3 times
4. some read my book--Billion Dollar Company
5. the most devoted send me articles to read
6. the most successful (so far) operate their promising early stage companies according to the ideas in my book (what use to be my workshops), facetiously referred to as HUTM

Today I found new evidence of commitment. Every semester in the first class I show a TED talk by Richard St. John on the "8 Secrets of Success". At a meeting today an executive showed me the screen saver on his iPhone, shown below. St. John's 8 secrets to success.

Free lunch to anyone who produces the first HUTM or book video.

My new book, Billion Dollar Company: An Entrepreneur's guide to business models for high growth companies, is available on Amazon. See the fourth strategy Porter should have added, determine if the market opportunity is large enough to interest venture capital and learn the 5-step process to really develop a business model. Book website.

The Future of Professional Services

One of the questions I have been pondering for awhile is the future direction of professional services--doctors, lawyers, Indian chiefs, accountants, consultants, PR etc. Part of my interest in the subject is, of course, due to the fact that I earn much of my living providing strategy and financial services.

The trends I see which concern me are the following:

1. So much information is now easily available on the web that potential clients have access to high quality free services, templates and sample documents
2. So much of professional services can be outsourced using technology to lower labor cost countries, such as tax return preparation, reading diagnostic images, preparing standard legal documents,etc.
3. IT technology is developing so quickly that in five years an entire audit or SEC filing could be automated through APIs such that the professional may only be required for signing

Effectively technology is reducing or replacing the value added in professional services. Professional judgment has been automated away in many services for all but the most complex tasks. So what is the professional service provider to do?

1. Do not rely on state and federal licensing requirements to protect your market. If the client is not inclined to sue for malpractice if there is a problem, then why cannot an attorney in India prepare all the documents for a property acquisition.
2. Realize that competition for the complex transactions that cannot be automated (M&A, IRS audits, etc.) will increase and probably drive down pricing; also note that the definition of complex is changing as people routinely go to Caracas or Bombay for plastic surgery and organ transplants.
3. Expect clients to have fully researched an issue before they consult you because high quality information is so plentiful on the web; the requirement for depth of expertise is going to increase significantly.
4. Realize that the "market" has changed to be basically the world; inquiries from Russia or India and even Africa are no longer just crackpots or con men; every year now I see 2-3 good looking financings that come in through this blog and if I had expertise in Russian or Indian capital markets I would have considered them seriously.

None of the four comments above answer the all important question of how to establish a sustainable competitive advantage in these new market conditions. What I would do if I was McKinsey or Deloitte & Touche or any other professional services firm is the following:

1. Integrate lower cost people and technology as a standard part of all services and constantly be working to add services that can be done through this lower cost infrastructure; essentially professional services needs to follow Porter's low cost strategy
2. Be investing in the development of the technology that replaces or enhances your services, e.g. Deloitte should be building the software to totally automate an audit with the target of no human involvement and possibly develop a bigger business in software than auditing. Hedge fund use of sophisticated computer trading models might be another example.
3. Focus the business on the most complex problems, e.g. building a data network for a business' locations throughout Latin America or due diligence for a multi-country acquisition or ransoming kidnap victims. The growth of litigation support for audit firms would be an example. The more complex the problem the less likely it is to be replaced by low cost workers or technology.

My new book, Billion Dollar Company: An Entrepreneur's guide to business models for high growth companies, is available on Amazon. See the fourth strategy Porter should have added, determine if the market opportunity is large enough to interest venture capital and learn the 5-step process to really develop a business model. Book website.

New Book Website: Billion Dollar Company

 

Today I am officially launching the website for my new book, Billion Dollar Company: An entrepreneur's guide to business models for high growth companies. The site contains book reviews, videos and a lot more information about me. If you have never seen me speak there is a part of a video from the uVu WPBT2 archive. You can purchase the book on Amazon here.

Business models are like marketing, frequently mentioned but rarely understood. In my book I develop my way to define a business model--focusing on the five growth drivers in any business, the 15 alternatives for pricing and the role of sales and distribution. I also show how the business model assumptions make developing a financial plan quite easy. Much of the book is filled with practical advice and stories that illustrate the points, but this book is meant for practitioners and is not a disguised autobiography. I think it could be used to spice up an entrepreneurship or finance class at the undergraduate or MBA level and it is going to be used at the MIT Sloan School of Management this fall.

I will be launching a blog for Billion Dollar Company soon to promote the book, which will focus exclusively on business models. In the mean time I would ask that readers feel free to tweet and post about the book on Facebook and other sites. After you have read the book you might want to write a review on Amazon (here).

Two people were especially helpful in this book project. Colleen Post read an early draft and was very helpful in identifying the missing pieces of logic in the narrative. Gary Lattke of Ideatomica designed the website. In addition to a good sense of design and art, Gary is the best listener of any artistic type I have worked with. Jeff Stamp also did a great video book review, but he always does great videos.

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Why Technology Fails--Shame on the New York Times

A New York Times story today makes the point that technology's ability to bring about social good is overstated, as evidenced by some anecdotal data. The most prominent example of failure in the story is a group of women in remote Guyana who built a thriving online business selling fashionable hammocks, only to have it shutdown by jealous husbands threatened by the shifting power balance in their marriages. The behavior of these uneducated men in remote Guyana apparently proves that technology will not produce social good. Hmmm...

Now let us contrast this behavior with the work of the UN in the West Bank of the Palestinian Territories. The UN has thousands of staff helping to augment social services such as education, health and food supplies. The biggest problem the UN faces is that the local people initially perceive them as Yankee Zionist imperialists. Whenever the UN starts a major new project the first thing they do is engage the local community in a dialog to build trust and understanding. The second step is to develop mutually agreed objectives and a timetable. First engage the community and understand their issues and then deploy the program, technology and resources.

Technology is always potentially disruptive, especially in developing countries with uneducated people. As the UN approach makes clear, first one socializes and then one deploys the technology. It's not the technology that is failing. It's the engagement with the community that failed. Shame on the NYT.

Great Ideas

In a recent post I made the point that it is the quality of the idea that creates the scale of the new venture. The obvious question is where do great ideas come from. I know it's not just a function of intelligence or insight. It's also not just a matter of hard work. A quote from R.W. Hamming provides the critical feature of great ideas.

Hamming, a world class scientist in his own right, became interested in why some scientists make breakthroughs and others just languish. (A previous post on Hamming is here.) Hamming said:

“Once you get your courage up and believe that you can do important problems, then you can.”

Most of us do not make great contributions in our fields because we fear the public ridicule from failing on large problems. Why can we not invent a green, electrical trans-continental airplane ? Answer: fear...only fear of failing.

For the last year I have worked with a man who tackles large problems and does it on the world stage. I now realize that it is the courage to think about big problems that separates him from the rest of us. He thinks at a different level because he has the courage (and confidence) to do so.

Another quote from Hamming provides the caveat the entrepreneur must consider: "If you are to do important work then you must work on the right problem at the right time and in the right way." Picasso would not have been successful with his style in 14th century Amsterdam. Google would probably not have succeeded in 1995 when people were struggling with browsers. It's about intellectual courage but is equally important market timing.

The first quote from Hamming comes from the blog Study Hacks. The whole article is well worth reading. The second quote comes from this speech, also well worth reading.

My new book, Billion Dollar Company: An Entrepreneur's guide to business models for high growth companies, is available on Amazon. See the fourth strategy Porter should have added, determine if the market opportunity is large enough to interest venture capital and learn the 5-step process to really develop a business model.

Stress in Startups

I am always amused by the frequent discussion of the high stress levels in startups. The following story may put stress in perspective.

1. On September 7 President Santos was inaugurated as the President of Colombia
2. On September 8 his new Vice President had a heart attack requiring quintuple by-pass surgery
3. On September 7/8 Hugo Chavez, the President of Venezuela, requested an immediate meeting to discuss relations between the two countries; Chavez has constantly exacerbated issues between the countries as part of his political agenda. Meeting was held September 9, the first business day of the Santos presidency
4. On September 11 the first terrorist car bomb in eight years exploded in the Colombian capital of Bogota

Three or four (if you count the inauguration) high stress events in just the first four days of the presidency and 45 million Colombians are expecting good decisions. That's stress.

My new book, Billion Dollar Company: An Entrepreneur's guide to business models for high growth companies, is available on Amazon. See the fourth strategy Porter should have added, determine if the market opportunity is large enough to interest venture capital and learn the 5-step process to really develop a business model.

Ideas and Execution

Today's post comes from an interesting article by Derek Flanzraich in which he discusses the importance of the idea versus the importance of execution for a successful new business. Two interesting quotes from the article.

"As Colin Bruce (COO of Geocast) puts it: execution is by far the most important determinant of success, however the scale of the success is determined by the idea.”

The difference between entrepreneurship, small business and self-employment is that in entrepreneurship one should be pursuing big market opportunities. Finding such opportunities is the really hard part where most prospective entrepreneurs fail, in my opinion. As Bruce correctly points out it is the quality of the idea that provides the scale. Focus on the idea before investing capital.

Taneem Tee (Founder of Topollo Systems) states: “the idea IS the execution.” “Good products don’t have some clean separation of concept from execution. Execution requires continuous decision making, a lot of which is directly dependent on having a strong vision to drive the decisions.” Vision and execution, he argues, “are completely intertwined.”

I agree with Tee that vision (idea) and execution are intertwined but what I really think he is saying is that the idea must include the execution plan. The idea must include a concept of product features and customer service, a business model or preferably both.

One of the interesting thing from talking to people who have read my book, Billion Dollar Company: An entrepreneur's guide to business models for high growth companies (available on Amazon), is that people are starting to understand the power of consciously thinking about their pricing strategies. Which of the 15 pricing methods works best for their business concept. Pricing methods is an excellent example of how ideas combine with execution to develop powerful business concepts.

Now You Have to Use RSS

RSS Feed Icon

A surprising number of people still do not know what RSS feeds are. About half the readers of this blog still get their posts through email. RSS is an excellent technology for providing frequently updated information. If you use a feed reader such as Google Reader it is very easy to manage subscriptions to hundreds of blogs.

Today I discovered that the SEC has started using RSS feeds for public company filings. Want to follow all the documents for the proposed Skype IPO, just subscribe to the feed, as shown below.

Now if the U.S. government can understand the value of RSS isn't it time you started using RSS.

Image: RSS Feed subscription icon Image credit: Wikipedia

Morality vs Legality

As long time readers know I studied philosophy in undergraduate school and then went over to the "dark" side to business. As I always tell my entrepreneurship students theory is the basis of complex decision making. Frequently ethics plays a role in business decisions and meta-ethics is the guiding theory... On further thought maybe ethics plays a role in every business decision, which increases the importance of meta-ethics.

Since the time of Plato and Aristotle western philosophers have studied meta-ethics and almost every great philosopher has written on the subject. Meta-ethics is the study of the absolute nature of normative moral values. In other words morality is not relative and based on culture, events or other factors. There are certain absolute moral truths. The moral systems in most religions assume that morality is absolute and not relative. For example, the Ten Commandments did not offer any exceptions, carve outs or explanatory appendices. One of the interesting things for me is that many writers on meta-ethics did not refer to a concept of a higher being or God. They assumed that that there were absolute moral values and then tried to describe them or prove their existence. This approach of absolute moral values is my view of morality. Perhaps naive but very workable.

Legal systems, which I have studied much less than philosophy, are essentially rules adopted by communities that reflect cultural practices, values or economic events. Much of legal system development evolved when people needed punishment to insure orderly behavior in the best interest of the community. Further additions to legal systems were inspired by an apparent need to discriminate against certain parts of the population or to establish unequal property rights. Over time the law self-corrected in many countries.Whereas meta-ethics is absolute, legal systems are situational and reflect the needs of a community at a point in time. By their nature legal systems evolve and change to reflect the community, but the better legal systems develop wide ranging principles that guide their development.

Legal systems never reach the standard of ethical systems. There is nothing absolute about a legal system. One can behave in a perfectly legal way and still be immoral. For example, few legal systems punish adultry. I believe that our standards of behavior in business should be what is moral and not the lower standard of what is legal. Do you agree? Leave a comment.

What McKinsey Missed in Tech Trends

I am a great admirer of McKinsey, the international consulting firm. I particularly like their thought pieces on international business. McKinsey uses these articles as a way to differentiate themselves into a very select group of professional service providers who have original thinking on complex issues. In the August 2010 issue of the McKinsey Quarterly an analysis was presented of Ten Tech-enabled Business Trends to Watch. The article describes certain implications from IT technology in the areas of organization management, new business opportunities and emerging IT technology. I think they overlooked or paid insufficient attention to two important trends.

1. McKinsey correctly highlights the rapid growth in data, which is doubling every two years. McKinsey correctly identifies the increasing trend for companies to resell their transaction data from customers to interested third parties. What I think McKinsey overlooked is the ability of large intermediaries to use their data to re-price third party services. For example your company arranges shipping for clients all over the world. You hopefully have ten years of data on every ship you have booked, the tonnage, the delivery distance and the rates paid. You now have better information on shipping rates than any shipping company. Develop a good algorithm and you now have the ability to set the price for your client's shipping business. A similar approach could be used by insurance brokers, almost all transportation services and any other free market service where third parties are used as arrangers. What the hedge funds have done in financial markets on debt is not so different from what I am describing.
2. McKinsey correctly highlights how technology is changing the way organizations work in terms of collaboration and co-creating. What McKinsey misses in their organization analysis is that volume and speed of data creation and data capture is drastically reducing the time for decision making. Remember the early stories about news events that broke first on Twitter and how every card carrying geek loved this fact. Organizations need to adapt to this trend of rapid information flow and establish autonomous, non-bureaucratic response teams. Some people are saying that the meltdown of 2008 was really only averted because the Federal Reserve did not have to ask for anyone's permission before they reacted. I think that governments and large corporations are going to need to set up autonomous organizations that respond at the first sign of disaster, whether it be financial issues, natural disasters or public relations problems. The bad news is becoming very viral and organizations need to adapt for rapid decision making.

Coast Guard Day

Image via Wikipedia

Several of my boating friends sent me reminders that today is Coast Guard Day. The U.S. Coast Guard was founded in 1790 by an act of law initiated by Alexander Hamilton. It's founding pre-dated the U.S. Navy by approximately ten years. Today the Coast Guard has primary responsibility for law enforcement, environmental protection and search and rescue along the coastal waters of the U.S. The Coast Guard was the first on the scene federal government response to the earthquake in Haiti, hurricane Katrina and the BP oil spill. The Coast Guard station at Miami Beach is the most active search and rescue location in the U.S., handling over 700 cases per year.

I have been involved with the U.S. Coast Guard Auxiliary for about seven years. The Auxiliary is a volunteer organization that is actively recruiting new members. If you are interested to support the U.S. military, enjoy boating or are just looking for a worthwhile community service opportunity, let me know.