Assumptions to Knowledge

I am currently participating in the initial planning phase of a new business venture with a company I have previously done some consulting work for. While the early phase conceptualisation is exciting it also fraught with tons of planning challenges, typically caused by padding your plans with well thought out assumptions.

 Having been here a few times before, I am convinced that conventional business plan and financial projections are nothing but best estimates. Sure they give you the benefit of having to rigorously think through strategy, business model and financial logic which clearly helps refine assumptions and expectations.  Ultimately however your plans get wrapped up in a set of financial projections that set the tone for the quantum of the opportunity.  My experience is that this is where things start going awry.  If we can reduce our thinking to a set of numbers we are able to apply lots of proven investment appraisal techniques that will reduce the chance of us investing in a financially unviable venture. By upping the amount of number crunching, scenario planning, sensitivity testing we lull our self into believing the numbers. The more thorough the amount of deductive and inductive “cleverness” we apply the safer we feel! Somehow this manages the bad assumptions risks that we have baked into the numbers.

New ventures usually have significantly less certainty around key planning constructs like: actual need states, relevance of your value proposition, acceptance of your pricing model and amounts, adoption rates, technology readiness, sales cycle length and complexities, ability  to attract talented people, competitor reaction etc. In order to deal with this realty and the shortfall of the conventional approach we have assumed that most of our assumptions are incorrect and that the level of uncertainty we face makes iron clad business models and strategies an illusion. We have thus decided that we need to build the conversion of “assumptions into knowledge” into the heart of the new venture planning and early execution process.   With this in mind, we have chosen to adopt an approach developed by Rita Gunther McGrath and Ian C. MacMillan called Discovery-Driven Planning

In summary, DDG allows potential to be developed as the plan unfolds. If the potential you are expecting does not manifest, you are able to fail quickly and cheaply. (Many businesses and entrepreneurs, myself included, have done it long and expensive) The approach is thus milestone driven allowing investors to commit just enough resource to meet the first milestone. Once achieved (or not) you are able to re-evaluate assumptions, re-plan and set the next milestone. While not failsafe, it does bring together some very useful planning techniques.

The approach has three additional elements that are very useful for new venture creation:

  • Reverse Income Statement – The manner in which you develop the numbers is in reverse order i.e. from the bottom of the income statement to the top. By building the required profits (return) that investors require into the plan from the start we are able to spec the allowable costs and thus revenues needed to get to the number. Metrics like prices, margins, units required, rate of adoption are pegged to allowable costs and required profits. The end result is that the top line elements and their logic are stress tested very early in the planning phase. Having to sell 1000 units a day may be pie in the sky.
  • Pro-forma Operations Specs – Given the allowable costs, prices and volumes required to succeed, planning the performance requirements of the key processes becomes easier and more specific. Metrics like productivity, resource levels, lead times, capacity etc are made explicit. Can we realistically process 1000 documents a day or call on 20 new prospects with 5 sales people
  • Assumptions checklist – Every financial, operational and milestone assumption is documented together with its underlying logic. Assumption logic is thus adjusted as you progress through each milestone. The plan is to test all necessary assumptions as you progress.

I like the approach because it not only combines, but improves the up-front thinking required to formulate your strategy and business model, with the understanding that imperfect information, changing market dynamics and natural resistance will have made your plans incorrect to some degree. Founder and investor expectations are managed from the outset encouraging and expecting business plan deviation as assumptions are turned into knowledge.