Sunday, July 18, 2010

Planning to Succeed (Part II)

Yesterday, in Planning to Succeed, I shared one of my experiences in writing a business plan. Today, I'm going to walk you through the basics of creating your business plan.

Why Develop a Plan
Whether you're a high-tech entrepreneur or a low-tech family services practitioner, whether you're in it for the gold or in it for the soul, whether you envision an international corporation employing thousands or a local, mom-and-pop shop employing just you and your kids, a well constructed business plan can make a huge difference in how well you do, how quickly you achieve your goals, and how much fun you have in achieving them.

In constructing a business plan, you'll become an expert in whatever area of business you intend to enter. Your expertise will serve you in enlisting the support of others, soliciting funds from investors, and navigating potential pitfalls before you even encounter them. A clearly written business plan makes it easy for others to understand what you intend to do and seem how they fit into your picture. It's a great recruiting vehicle for partners and employees.

Probably most important, constructing a business plan will let you know whether or not the business is right for you without having to go through the costly trial and error approaches that often leave investors and partners with a sour taste in their mouths.

Step 1: What is Your Motivation?
Before even getting to the what of your business, it's important to answer the why. There are no good or bad reasons for starting a business. However, not being clear about your reasons can lead to confusion, bad decisions and failure. Further, even though our motivations tend to be a mixed bag, it's important to identify the most important first, the one that trumps all the others.

So, what's your core motivation: fast cash? ...long term wealth? ...fulfilling a childhood dream? ...saving the world? ...creating a company that's a great place to work? ...being the best at what you do? Whatever it is, it's important to get in touch with your most basic, core motivation. It will become the hub around which all other decisions revolve.

Intimacy with your core motivation will help you make good decisions quickly and help you avoid long, time-wasting explorations of "opportunities" that ultimately won't get you where you want to go. The process is simple: when considering alternatives, first ask yourself the question: how would thus and such help me achieve my primary goal?

It the answer is anything like: it wouldn't or I'm not sure or maybe, then drop it. Don't waste even one moment thinking about it.

Step 2: What Problem Are You Going to Solve?
Although most of us would start with what we want to do, I'm going to suggest that you start with what problem you're going to address. The reason is that this causes you to immediately focus on what you will do from the customer's perspective. So often I'll hear someone say something like, "Wouldn't it be great to have a company that did thus and such?"

The answer to this question is always another question, "Great for whom?"

Successful businesses require customers. To have customers (outside your family and supporters), you need to solve a problem for the customer. The problem might be where to get dinner tonight, or taking vacation that is actually restful when accompanied by an autistic child, or protecting a data network from hackers who seem to be getting smarter and smarter. The problem might be highly sophisticated and rare or simple and common. It might be something that only a few people on the planet can figure out or something that anyone with Google can do. Whatever it is, before getting to what you're going to do, define the problem that you're going to solve.

As you define the problem, you'll also focus in on who the customer is. Is it a corporate executive, an IT manager, a social services practitioner, a doctor, a parent, a student? Characterize the person or group who is trying to solve the problem.

Step 3: Your Solution
Now that you've identified the problem that you'll address with your business, it's time to determine how you're going to solve it: your great idea! In this case, it's important to think about the entire customer experience, from the time they hear about your product to the time they've determined to purchase your product to the time they've satisfyingly employed your product to address their challenge.

In this case, I've found scenario planning to be the best approach: create a time-line that walks your customer through the process of finding your product (web search, hearing about it from a friend) to deciding to buy your product (talking to a sales person or reading a brochure) to purchasing your product (on-line, in a store) to obtaining it (carrying it in a bag, receiving delivery via mail, attending a class) to using it (swallowing a pill, eating a meal, wearing a t-shirt), to what happens when not everything goes to plan.

In addition to the time line, I've often found it useful to create the product brochure and product announcement/press release prior to actually developing the product. This brings clarity and specificity. However you do it, it's important to define your product to the point where there's nothing left to the imagination of the person reading or viewing your description.

In addition to defining your product, you'll want to define the price and how someone might pay for it. Is your product something that is purchased once in a lifetime, or something that is purchased weekly? Are payments made on a subscription basis or an ad hoc basis?

Step 4: The Competition
OK, you're in touch with your core motivation, you know the problem you're solving, for whom you're solving it, how you're going to solve it, and how much you're going to charge for your solution. Now it's time to consider your potential customers' alternatives to your solution.

You'll not that we're looking at competition not from the product perspective, but from the customer's perspective: a perspective of alternatives. The reason we do this is that the biggest competition to your solution may not come from similar solutions. For example, one of the biggest competitors to air travel is not other modes of travel, it's video conferencing.

When I think from a product perspective, I can miss customer alternatives that might sink my business. Bands don't only compete with other bands, they also compete with pre-recorded music and DJs. Restaurants don't compete only with other restaurants, they compete with frozen pizzas and pre-packaged meals. If you think from the perspective of customer trying to solve a problem, you'll gain a better view of who your competition is.

For each of your competitors, identify their products and what they cost. For each product, specify what it does and what it doesn't do. List product strengths and weaknesses. Specify why people use the products: is it cost? availability? ease of use? effectiveness? brand recognition? belief regarding efficacy? Remember that having a new and better product may not be enough when people strongly believe in an existing brand.

As you collect information on customer alternatives, do you best to coalesce it into a table or grid that lists the products on the left column and categories across the top. Column one might be the manufacturer, column to the product name, column three the description, column four the price, columns five through ten specific features. As you do so, don't sugar-coat or dismiss anything. If an existing alternative is really great, say so.

Now that you have list of your competitors, it's time to see how you stack up against them. Take your product and add it to the table you've created. How is your product like the others? How is it different? Where is your product stronger than the others? Are you the cheapest, the most expensive, or the best value? Does your product work better than anything available? Is it the easiest to use? Do you provide the best customer experience? Become intimate with customer alternatives knowing where you're better, where you're the same and where you're weaker.

There's nothing that will turn off a potential investor faster than someone who simply insists that their product is the best across all categories being seemingly unaware of their own weakness or competitors' strengths.

As you view the competition, you'll probably find yourself making changes to your product: improvements to the feature list, reduction in price, changes in service delivery model. A business plan is a living and breathing document that will change significantly over time.

Step 5: Costs and Revenue
OK, here comes the part that many people avoid or sugar coat: answering the question of whether or not your business can actually make money. Although revenue and profitability models can get quite complex, the basics are simple. At the end of the day you're going to sell some number of products or services at some price. The number of products times the price determines your revenue. At the end of the day, you're going to pay for the products and the people required to produce, deliver, market, sell and account for them. These payments represent your costs.

Step 5A: Revenue
To build your revenue model, open your spreadsheet program (Excel or Numbers). Across the top starting in the third column, list months starting with the first month that you start your business. Down the left column starting in the second row, list the products and services that you plan to sell. In the second column, next to each product or service, list the price.

Now, starting in the third column (under the first month), put a number representing the number of products you plan to sell. Do this for each month and for each product. This first table now represents your sales volume projection, how many of each product you plan to sell in a given month.

Below the sales volume project table, once again enter the name of each product in the left column. In the adjacent cell, set the value equal to the price cell from the table above, e.g., type "=B2" in the price cell for the first product, "=B3" for the second product, and so on.

Now we're going to determine the revenue for each product for each month. In each cell, we're going to multiply the number of items sold by the price. To do this, starting in the third column of the first product enter "=C2*$B2", in the fourth column, "=D2*$B2", and so on. Move to the next row (the next product) and continue similarly. In the third column for the second product, enter "=C3*$B3", in the fourth, "=C4*$B3". If you do this for all the months and all the products, you'll have a revenue projection for each product per month.

Finally, it's time to tally your monthly revenue. To do this, you simply sum the revenue for each product for each month. To do this, go to the row just below your last product and select the cell in the third column. If the first product of your revenue table begins on row 7 and the last on row 10, then you'll go to the third column of the eleventh row and enter "=SUM(C7:C10)". In the fourth column, "SUM(D7:D10)". In the fifth, "SUM(D7:D11)". As you complete each column, you'll see the projected revenue for that month.

Step 5B: Costs
To determine whether or not your business is going to be profitable, you have to compare your revenue with your costs.

As you start your business, you're going to have start-up costs that go away over time: initial product development costs, basic brochures and marketing collateral, equipment, computers, registering your business with the secretary of state, etc: costs that are largely one time.

As you run your business, you'll have costs that don't change much regardless of how much business you do (fixed costs) and costs that change with the volume of business (variable costs).

What is variable and what is fixed will depend upon your business. For example, if your sales and payment processing are all conducted online, then you'll have fixed sales costs. However, if sales of your product involve people talking to customers, then your sales costs will be variable: the more you sell, the more sales people are required. If you send out lots of printed collateral, then you printing costs will vary with the volume of business, but your personnel costs for marketing will be relatively fixed.

Your cost model depends a lot on what your business is and how you determine to market, sell and deliver products and services. Fortunately, you have your product/service time line that you created in step 3. To build your model, walk through your customer experience time line identifying everything that is going to cost you something; don't worry about exactly how much each item costs, but instead, focus on what the items are. Try to think of everything: office supplies, insurance, accounting fees, materials, consultants, advertisements, product, your time.

Going back to your revenue spreadsheet, begin your cost table just below your revenue table. Enter each of your cost items in the left hand column. Google ads, referral compensation, sales person, marketing brochure, etc.

Now, next to each item, determine the cost per month or the cost per item as appropriate. For example, if you're going to pay a sales person $48,000/year (including taxes and benefits), enter $4,000 next to sales person. If a single Google ad costs $5/month, enter $5. In some cases, you may have per product costs: the amount you pay a supplier for a t-shirt or a sub-contractor to provide a service. In that case, put the per item cost in the second column.

Now, here's where we put it all together. For each cost item, it's time to determine how much you'll need each month. For your fixed costs, the number is going to be the same each month: for example, the number for office managers will likely stay at one for some time regardless of your sales volume. The same is likely to be the case for payments to yourself. One you, one office manager.

For your variable costs, the number will change. For example, if you're hiring sales people, determine how many sales each person can make in a month. The number of sales people required each month will be equal to the number of sales planned (from your sales projection table) divided by the number of sales a person can make. Note: for now, we'll allow fractions of sales people.

If a t-shirt cost you $3, then all you need to do is set the cells for t-shirt purchased to be equivalent to the number of t-shirts sold from your sales projection table. If you pay a counselor $60 to deliver a session, then the number of counseling sessions paid for is equal to the number of sessions sold. Working in this manner, you can determine all the payments that you will need to make in a given month.

Now, similar to the way we computed revenue totals we'll compute cost totals. We take the number of payments times the cost per payment and create a cost table. Then we sum each column of the cost table to determine our monthly costs.

Step 5C: Profitability
OK, now that you have your costs and revenue, the next step is to determine your profitability. To do this, simply subtract your costs each month from the revenue each month. If you have a relatively high fixed cost, it may be that your business isn't going to be profitable for some period of time, the time required to get to a high volume of sales. If you have a relatively high variable cost, it may be that your business is never going to be profitable.

Depending on the profitability, you may determine to cut costs somewhere or, if the price of the competition permits it, raise prices.

Step 6: Marketing and Market Sizing
There are volumes that can be written about marketing and market sizing. The important thing to do as you build your plan is to determine what your addressable market looks like: how many people are there who would actually be interested in purchasing your product. You'd be surprised how many people develop business plans that would require 150% of the market purchasing their products to be successful.

Market research data can be quite expensive. However, by combining publicly available statistics, you can get a pretty good idea. For example, if you know that one in five families purchase toothpaste once per month and you know that there are 500,000 people living where you plan to sell your toothpaste and you know that there is an average of four people per household, then you can compute how many sales are possible where you plan to sell.

Once you've determined your addressable market size, you see if your plan requires just a small fraction of the potential or a miracle to be successful.

Step 7: Step Back and Review
The process of creating a business plan is iterative. It takes time to think through all the details and, as you learn about your clients, the competition and cost factors, you'll find yourself changing the plan to accommodate what you learn.

Don't be surprised if your first attempt yields something that will never make money. That's par for the course. The thing to do is take what you learn, revisit your plan and change it, always keeping in mind your core motivation.

As a rule of thumb, try to maintain a consistent level of detail across your business plan. Don't spend all your time getting really deep on the product while ignoring the revenue model or competitive analysis. Instead, get a basic idea of the product and pricing, then build a simple revenue and cost model. Refine as you go across the entire document.

As you develop your plan, ask others to review it. What do they think of the product? What about the price? Do your numbers make sense? What are the competitive threats that you haven't considered? Be open and listen to the feedback you receive.

Have Fun!
For some reason, many people shy away from building a business plan. I'm not sure if they consider it to be too difficult or they don't really want to see whether or not it adds up or what, but developing a business plan is something people don't do. However, if you really dive into the process and stay open to learning everything you can, you'll be amazed at how exciting and fulfilling it can be to develop a plan. It can be a lot of fun!

Anyway, that's enough fun for this morning. If you'd like to know more or dive into specific areas, please let me know.

Happy Sunday!

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