Monday, July 16, 2007

Business Strategy

One of the first things I look at when evaluating a deal is the business strategy that is being proposed. If I understand the strategy, I have a pretty good idea of whether the business will make money, and how likely it may be to succeed. Most of the business plans that I've decided to pass on have been because of a bad strategy, or having no strategy at all (or at least one that wasn't made clear).

So, I thought that a good thing to write about, at least over a few posts, would be to talk about some of the best things I've learned about strategy - marketing strategy, technology strategy, etc.

One of the simplest places to start is by examining the supply curve. The profit of a venture is shown in the green area. Q is the quantity of a good sold, P is the price of the good being sold, and C is the cost of delivering the good.

So, when starting any business, ask yourself, what can you do to make the green rectangle bigger? You can either increase the price by offering a premium product, decrease the cost, by being more efficient, or shift the supply curve to increase the quantity sold.

Once you have thought about how you are making money, the next question is - how is this sustainable? What can be done to ensure that these profits can be made over time.

The next model helps examine how easy it will be to protect profits over time. This is the famous five forces analysis (Porter). The five forces analysis helps determine where the value is likely to end up in the value chain. A mantra of management consultants is the notion of creating value and capturing value. Most inventors only think about creating value. One of the most important parts in determining the success of a business is its ability to capture value. This can be determined through the five forces analysis. These forces are:

Supplier power - The strength of a company's suppliers in negotiation.
Buyer power - The strength of a company's customers in negotiation.
Threat of new entrants - The ease by which competitors can enter the marketplace to compete with the company.
Threat of substitution - The threat that other, different, products can compete with the company's products.
Threat of competition - The strength of the company's competitors.

The higher each of these forces are, the less attractive the industry is for that company. When devising a strategy, it is important to work to weaken these forces. Reduce supplier power by purchasing commodities from multiple suppliers. Reduce buyer power by selling to several customers. Erect barriers to entry through IP protection, exclusive agreements, and switching costs to prevent other competitors from entering the market. Reduce substitution threat by developing unique products. Reduce the threat of competition through entering untapped markets.

All of this sounds easy to say, but understanding these frameworks can help entrepreneurs frame business strategy which is profitable and sustainable over time. And it is these business plans which are most attractive.

Stay tuned for further posts including a discussion of some of my favourite technology strategy books - Crossing the Chasm, the Innovator's Dilemma, and the Innovator's Solution. Lot's more to discuss!

2 comments:

Wendy Conn said...

Aaron
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Miss.R said...

People will always stress that having a well researched business plan is key before you start your business. Although creating a business plan is often an important step in the evolution of a business, particularly if you need financing or you are not experienced at running a business, it is not necessarily the essential first step.
There are two key elements that should be completed prior to the business plan:The business model, The strategy...
So thank Aaron so much.