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Key Metrics:  Some places to start

1. Industry benchmarks.  In established industries, time and experience have created a consensus about what the current critical metrics are.  These become industry benchmarks.  In other countries and for new businesses, it’s harder to determine what the critical metrics are or should be. For instance, nobody knows yet what the critical benchmarks should be for many e-commerce businesses (should the model be a transaction based model?  An advertising model?  Will customers prefer fixed prices, or dynamic pricing?) Although this can be confusing and frustrating, it also creates the opportunity to take advantage of the uncertainty by creating a convincing set of key metrics. 

2. Analyses of your own company data.  Analyze your recent income statements and balance sheets and use sensitivity analyses to build a picture of which variables most influence your firms profit and profit growth. 

3. Analyst reports evaluating other firms in the target industry.  You may want to get investment bank and stock market analysts’ reports about the target competitors or the target industry and look at the metrics that they use to evaluate company and industry performance.  Cues as to the key industry profit metrics will appear in their comments about the reasons for industry profits.

4. Commercial bankers who specialize in loans to the target industry often keep ratios that they use to assess the riskiness of their loans to firms.  They also have industry level data that you can use as benchmarks.  So do factors, and sometimes even suppliers. 

5. If there is an industry association check to see if it maintains firm and industry level metric databanks. Also scan the association publications and target industry publications for indicators.

6. Data may also be available in publications like Value Line, Compustat and other online data services. The Wharton School has a user-friendly financial analysis service (WRDS) with many on-line databases

7. New industry and competitive information is also being loaded on the World Wide Web at industry specific sites, such as E-Steel, investment sites such as those run by E*Trade and information oriented sites such as Hoovers.com.

8. You can get insights by scanning business publications and the business section of major newspapers and periodicals, notably The Economist.  In particular look for commentaries about why the target industry is cooking – key cues to what the industry profit drivers are. 

9. The business sections of libraries and bookstores, and specific web-sites that cover business (such as Hoovers.com) will often discuss how to evaluate the numbers..

10. Periodically, industry reports from Federal or International agencies (like the UN or World Bank) on specific industries are published.

11. Don’t forget to take advantage of the vast information available through search engines.

12. Finally, many guides to smart investing discuss how to dissect an industry or company’s numbers at length.  You won’t go wrong with classics such as Benjamin Graham’s The Intelligent Investor (Graham, 2006, originally 1973).

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So if I were to use an example from a previous post (the dog-walking case), let’s see how that might play out with Discovery Driven Planning principles in mind.  So here you are, a Columbia Business School MBA, thinking about going into the dog walking business.  The first question you’d need to ask yourself is “what would make it worthwhile for me to start this business?” Our typical MBA’s graduate with the expectation of earning very nice (indeed, very very nice) starting salaries, mostly in the worlds of consulting or finance.  So at a minimum, if you were going to start an entrepreneurial business, you’d want to have the potential to earn at least what you’d earn by getting on the #1 train and getting off at the Merrill Lynch stop, right?  So let’s say our aspiring entrepreneur would set that desire at $120,000 per year before taxes. 

You’d then have to think about costs, which in the case of a dog walking business shouldn’t be all that substantial, so let’s say that an additional $30,000/year would cover insurance in the event a pooch has a mishap, advertising, booking costs and administrative overhead.  So that means the required revenue for our aspiring dog-walking business is $150,000/year. 

The next question to consider is what the ‘unit of business’ is for this business.  By unit of business, we mean literally what you are selling.  At this point, you can start to get creative.  You can get paid for dog-walking any number of ways.  You could charge a retainer that covers all dog walking necessary in a given period of time (say, weekly). You could charge by the walk itself.  You could charge a retainer plus a usage fee—you get the idea.  We strongly encourage people to think broadly about their unit of business before they jump into a new venture - often, that’s where the most creative ideas are to be found. 

To keep the example simple, let’s say that you are going to charge prospective cllients a flat fee for an hour walk.  How much will they pay?  No idea.  So I’m going to make an assumption (which will be wrong, and we all know it, so it doesn’t matter at this stage).  The easiest thing to do is hunt up comparables.  In this case, I found the web site for Peggie’s Pet Service out in California, who offer a whole range of doggie-related services.  Peggy will charge you $340/month (as of this writing) for a daily walk, which translates into roughly $11.33 per walk for one dog. 

So does that idea work?  Let’s run the numbers.  At $340/month, annual revenue per dog would be $4,080.  If we divide this into our required revenue of $150,000, we’d need about 37 contracted customers for daily walks to hit the revenue number.  But whoa - if each walk takes an hour, either we have to walk a rather large number of dogs at a time, or somehow suspend the laws of time to expand the hours available in a day.  Even if you double the charges (which is probably more than the market will bear), you’d still need 18 dogs per day to hit the revenue number.  You’d have to double the charges and walk 3 dogs at a time to get anywhere close to our desired revenue number. 

At this stage the point is not that the business is a bad business - just that it isn’t profitable enough given the assumptions that we’ve made to justify it as a career choice for Columbia MBA’s.  That doesn’t mean you should necessarily give up.  If you’re committed to the idea, there isn’t any reason you can’t think of a different business model to try, just as our friends with O’Hare pet-hotel business have attemped.

Should you come up with a model that’s viable, and benchmarked against prevailing norms or existing competition (as we did with Peggy), the next step is to think through operationally how to get the business going.  For a dog-walking business, you’d definitely need to think about how to market, first customers, building a web site and so on.  As you do that, you’ll be making assumptions about timing, cost, difficulty and so forth.  The critical thing is to write them down!  It’s all too easy to overlook them later on. 

The final step is to think through the major checkpoints (or milestones as we referred to it in earlier writings) in the business. For this rather simple business, representative milestones would include:

• Create company, brand, and advertising message
• Contract with first customer
• First service for customer

And so on.  At each of these checkpoints, you’ll be able to test more and more assumptions.  The key is to go back and re-plan.  Don’t be afraid to change direction as you learn, and try to put the least expensive milestones in early, leaving the more expensive or risky ones for later. 

Feel free to email me if you have questions.

You can download the original article Discovery Driven Planning here.

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As if forgetting assumptions wasn’t bad enough, we also have a host of cognitive and emotional biases which lead us to systematically disregard potentially important information.  One is the “confirmation bias” which leads us to accept and embrace data that confirms what we believe to be true, while rejecting new information that challenges our beliefs.  Another is bias that is introduced because we don’t want to look bad in front of colleagues, supervisors and subordinates.  In combination, they lead people to continue down doomed venturing pathways in a fruitless effort to prove themselves right.  Indeed, when you look at the great, big, historic flops in the venturing world (we’re talking WebVan at a $1.5 billion writeoff, or the AOL-Time Warner merger) what you see is a common pattern:

• untested assumptions
• taken as facts
• no opportunities for redirection
• few low-commitment tests of assumptions
• investment all at once, not sequenced
• pressure in terms of time or resources on the venturing team
• all or nothing outcomes

What Discovery Driven planning does instead is recognize that in a fundamentally uncertain situation, you aren’t right.  The goal is to do as much learning as you can while spending as few resources as you can to eventually figure out the right answer—or else to stop the project while it is still inexpensive.  The watchwords are, “fail fast, fail cheap, move on” as they say in Silicon Valley.  The technique also overcomes some of the social problems of conventional planning in that all participants in the plan give their best effort and ideas.  It’s “our” plan, not “my” plan.  The real emphasis is on learning as you go.  The whole plan is driven, therefore, by narrowing the assumption: knowledge gap as the plan unfolds. 

The original 1995 article describing the Discovery Driven Planning technique is available here.  See further posts for more information on the technique itself. 

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The lap of luxury

Quoting Business Week February 4, 2008 page 18:

Dogs of Chicago, rejoice. If your owner flies out of O’Hare International Airport, you can wait out the trip at a posh spot nearby-catching Animal Planet on a flat-screen TV and splashing in a dogbone-shaped pool. Paradise 4 Paws, a 24/7 “pet hotel,” will open a few miles from O’Hare on Mar. 1. The facility, which will also board cats, grew out of a 2005 entrepreneurship class at Northwestern’s Kellogg School of Management. (Students modeled P4P after a popular pet hotel near Japan’s Kansai International Airport.) Customers will pay up to $75 a night for dogs and $35 for cats. Backers, who include Kellogg professors, plan to open a second P4P near Chicago’s Midway Airport by September, and 10 more across the country after that.

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