Discovery Driven Planning:  Debunking dumb entrepreneurial ideas

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Wired magazine runs a regular column by “Mr. Know-It-All” in which the great mysteries of our time—such as how to retrieve porn from a laptop you’ve loaned to a friends’ child and what the correct protocol for breaking up on Twitter—are sweepingly resolved.  In the September, 2008 column a reader writes to ask how he can talk his ‘pigheaded’ brother out of investing in a venture to generate energy from hog manure.  Mr. Know-It-All had some pretty good suggestions, including checking out the people involved in the venture to see what their track record is like and remembering not to invest your life’s savings in an uncertain business.

To that, however, I would add that anybody even considering investing in something like this should really do a discovery driven plan, particularly in situations in which what we call the unit of business isn’t clear at all.  .  Just as we saw with the example of the toy store we looked at earlier, being forced to detail assumptions about costs, who the customer is, and in this business, the price of future energy and raw materials inputs is highly likely to show that the business is highly unlikely to succeed.  Of course, that much being said, there are always wonderful exceptions.  The problem is, they’re rare. 

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Discovery Driven Planning:  Getting a handle on key metrics

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A critical part of a discovery driven plan is understanding your assumptions about what makes some assumptions more important than others.  This gets into the question of what we call your ‘key metrics’ - the few numbers that really matter to your unfolding business. 

It starts with the reality that for many offerings, revenues and expenses don’t track each other contemporaneously.  They can flow at completely different rates over the life of the offering.  So, as opposed to selling things in units, like shoes (though few would buy less than by the matched pair!) ships (sold by the unit) and sealing wax (sold by weight or packet) many modern businesses derive their revenues and profits differently. 

For instance with consulting services, charges can be per project or per cumulative hour.  But here revenues and expenses tend to correlate pretty well.  You incur costs per hour to do business, and you incur revenues for doing the same.  However the unit of business is very different in the insurance industry. With insurance, you get your revenues in the form of premiums, and operating costs are incurred over time, but you incur the bulk of your costs (consisting of claim reimbursements or death payments) only after some time.  Indeed, many insurance companies make no money on their underwriting at all - they make their profits on investing the money they hold during the time between receipt of a premium and reimbursement of a claim. With luck, in the case of life insurance this is hopefully decades for both the insurer and the insured. 

More challenging still is software, in which there are a number of viable models.  One traditional approach is to sell a basic package for a modest price (or even for free), but hope that customers will upgrade to a for-pay more advanced version.  This is the strategy Adobe has used to become a dominant platform for document exchange.  Another strategy is to bundle software with hardware purchases.  Players as diverse as Microsoft, Norton Anti-virus and McAfee have pursued this approach.  More recently popular strategies have been to offer a subscription to a software service (often offered over the web).  NetSuite, for instance, offers a pay-as-you-go on-line business automation package for smaller business users.  Even more new models involve giving the use of the software away for free, and making money through other sources, such as through advertising.  Google’s entry into office software follows this model.

Depending on the model you choose, the critical variables and key dimensions of performance will differ.  The architecture of your plan, in other words, all depends on this critical choice. 

Since it is such a critical choice, it is worth spending time exploring alternative units of business, because this could allow you come up with very different profit generating structures than are normal in your industry.  Sometimes, these can dramatically please your customers and vex the competitors because their embedded systems may not easily accommodate a new way of doing business.  Indeed, research by MacMillan and his colleagues found that even theoretically easy to imitate products were not copied quickly when doing so would require system changes.  See MacMillan, I. C., McCaffery, M. L., & Van Wijk, G. 1985. Competitors’ Responses to Easily Imitated New Products - Exploring Commercial Banking Product Introductions. Strategic Management Journal, 6: 75-86.

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Discovery Driven Planning :  Calculating a “BareBones” Net Present Value (NPV)

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Although Net Present Value calculations are often blamed for companies’ under-investing in innovation projects, and are a big problem for people trying to drive growth into new areas, it can be useful to get some sense of what the potential NPV of a prospective project might be.  My colleague, Ian MacMillan, working with Alan Abrahams and several other folks have come up with a nifty idea they call the “BareBones” NPV approach.  Essentially, it asks you to assemble the following information for a project:

1.  Launch Time: How long will it be before the project begins to generate its first revenues?

2. Ramp up time:  How long will it take from first revenues to reach steady state?  The BareBones NPV estimator will assume there is a linear ramp up in revenues from the period of first revenue to the period of steady state.

3. Competitive response time:  How long after launch will it take for competitors to respond?

4.  Competitive erosion time:  How long will it take for the competitors to erode your profits to the point that you are only just recovering your fixed costs?  The BareBones NPV estimator will assume that profits drop off linearly from the start of the competitive response time to the end of the erosion time.

5.  Total investment.  What is the total investment expected to be?  The BareBones NPV estimator will assume that this is a one-time investment incurred at the end of the launch time.

6.  Discount rate.  This number is used to discount future cash flows to account for the fact that if you weren’t doing this project, you could just as easily leave your money in a bank account and earn interest.  The idea is that a sum of money in your pocket today is worth more than the same amount 5 years from now, because today’s money could earn interest.  If you don’t know the rate for your firm, your finance guys should be able to give you this (and they might insist that you adjust it upward for risk, as well).  They might refer to it as the cost of capital but the idea is the same – using money for your project means you can’t use it for something else, and unless your project offers better returns than a savings account, it’s a value-destroyer for your firm. 

They have very kindly offered to allow me to put this idea together with a tutorial and software tool, up on this site.  If you would like to give it a try, you can download two files:  the first is a tutorial which explains how the software works, and the second is a ZIP software file that you can download to play with the actual software.  This is a demo version—if you’d like to use the real thing, there are instructions in the zip file for how to get a full copy. 

Feedback and suggestions on this are most welcome!

This is the tutorial file:  BareBonesNPV_Tutorial.doc

This is the software ZIP file:  BareBonesNPV.zip

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Discovery Driven Marketing Planning in the Health care area

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Here’s another group using Discovery Driven Planning - in this case to develop better marketing plans for health care information technology clients.  What I found interesting about their approach is that they contrast the DDP methodology with the ‘classic’ nine step marketing plan approach.  You might find that helpful - check it out!

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Another application for discovery driven planning:  Business Intelligence Projects

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One of the neat things about discovery driven planning is watching how it has become popular with quite a large set of consultants, venture managers, entrepreneurs and other people for whom conventional planning is just not working.

I was therefore interested to see a consultancy (Coded Vision Consulting) blog about their approach to discovery driven planning in pursuing business intelligence projects.  Essentially, they argue that projects such as those that can’t produce a definable ROI calculation are often hard to justify under conventional planning, but which make a lot of sense for the corporate long term. 

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