Chapter 3
In This Chapter
Defining a business plan
Understanding strategic plans
Writing a white paper business plan
Writing a new venture plan
In Book VI, Chapter 2, I describe how to create a pro forma plan of business financial forecasts by using the bizplan.xls workbook, which can be downloaded from www.stephenlnelson.com/bizplan.xls. If you do create a forecast, you probably also want to create a companion business plan. For this reason, you also need to know about writing such a plan. I don’t go into tedious detail about how to do this. I just provide you some useful information about business plans, and I give you some tips about how to more easily write a workable business plan.
In truth, the term business plan actually refers to three separate things:
I talk a little bit about each of these plans — some more than others — in the following pages.
Unfortunately, I’m not really equipped to provide you detailed information about how to construct a strategic plan. Of course, neither are most of the other people who willingly offer advice. That said, however, I can provide you some useful starting points for constructing your strategic plan.
First off, the way that you’re using the word strategy is very likely wrong because you aren’t talking about strategy at all. For my source on this perspective, I rely on what Michael E. Porter, a Harvard Business School professor, said in his strategy classic Competitive Strategies: Techniques for Analyzing Industries and Competitors (published by Free Press).
The really interesting thing that Porter says in his book (and something that’s worth repeating over and over again) is that practically speaking, only three basic business strategies exist:
Because understanding these strategies is critical to writing a good strategic plan (and to correctly using the term strategy), in the following section I briefly discuss in my own words what Porter means by limiting possible strategies to only three. I demonstrate each of these strategies by using example firms in an industry that we’re all pretty familiar with: bricks and mortar retailing.
Successful retailers rely on a cost strategy. Firms such as Walmart and Costco excel at providing products to their customers economically. They pass along a lot of the benefits of this economy to their customers in the form of lower prices. Not all the cost savings get passed along to the consumers, however. A significant portion of the cost savings, achieved through incredibly efficient operations, are retained by the business and, therefore, become profits.
Such cost leadership or low-cost operation is one of the three basic strategies. And it’s a strategy available to any business — and particularly those businesses that have achieved economies to scale.
The key thing to note about a low-cost strategy, however, is that the firm needs to retain some of the cost savings in order to earn a higher profit level than its competitors. Thus, simply being a low-cost producer isn’t enough. A firm needs to be a low-cost producer and still be able to price products and services at a level high enough that some of the cost savings are retained as profits.
The second basic strategy is product differentiation. Product differentiators often sell a very unusual product or service. The Nordstrom department store chain is a good example of this because it offers unsurpassed service, and often (although not always), it offers a great and high-quality selection of items. Nordstrom goods cost more. But consumers happily pay the extra amount. Why? Because they get so much more for their money.
A firm that relies on a differentiation strategy competes on the basis of the special features of its products or services. The key to making this strategy work is being able to charge your customers more for those special features than the special features cost you. Differentiation needs to produce increased revenues in excess of increased costs.
The focus strategy is really a hybrid of the cost and differentiation strategies. This strategy states that in some ways, a firm is really good about managing costs; and in other ways, this firm is really good about differentiating products or services. A firm may choose to take this hybrid approach because it understands a particular audience or niche of customers or category of products; in other words, the firm can, through this focused approach, serve a particular market better than anybody else. This firm is going to be the best at serving a particular niche. Again, as is the case with other strategies, the focus strategy must produce increased revenues that are greater than the increased cost of the strategy or cost savings (to the business) that are greater than the lower prices passed along to customers.
So who’s a focus strategy retailer? I would say that Target is. Target, in my opinion, focuses on suburban middle-class customers by offering those consumers almost the perfect combination of cost savings and differentiated products.
This all probably sounds like gobbledygook if you haven’t been exposed to much strategic thinking before. However, the strategies and their strengths become very clear when you compare firms that have these strategies — cost leaders such as Walmart and Costco, differentiation leaders such as Nordstrom, and focus leaders such as Target — to firms that lack a clear strategic focus.
Perhaps the best-known current example of the retailer that, in my opinion, lacks a clear-cut strategy is Kmart. This becomes very clear when you start comparing Kmart with the leaders in each of the three strategies. Consider the following three problems that Kmart is plagued by:
So now you can see how the word strategy is misunderstood and used incorrectly. Strategy isn’t a way to refer to some idea you have; strategy, in business, refers to an approach (probably one of the three generic approaches) toward beating your competition: cost, differentiation (probably in terms of product excellence), and focus.
Here’s the key: If you can do a strategy better than anybody else can, you win. If you try to do a little bit of this or a little bit of that, or if you ignore or can’t bring yourself to pick a particular strategy, you’re going to be continually beaten up by firms that have picked a strategy. You lose the cost game to the cost leaders. You lose the differentiation game to the differentiators. And you lose out at competing in particular niches to those firms that focus on those niches.
I won’t talk any more about this strategy business, but I have a couple of comments about tactics. Most of the time when you hear people talk about strategy, they’re not really talking about strategy; they’re usually talking about tactics.
Tactics refers to choices that firms make in an attempt to successfully execute strategy. The irony is that the people who misuse the word strategy (by referring to tactics as strategy) often don’t really have a strategy. This is my first comment.
My second comment is that tactics, predictably, don’t work and don’t make sense except as support for a particular strategy. For example, to pursue a strategy of cost leadership, all your tactics need to support that strategy. You undermine your success in executing that strategy if some tactics support a cost strategy, some tactics support a differentiation strategy, and some tactics support a focus strategy. This makes sense, right? In this situation, you become a jack of all trades but a master of none.
Before you move on to the next topic, be sure that you understand these key points:
People often write a white paper business plan when they know that they need a strategic plan but don’t really want to make the hard decisions necessary for a strategic plan. The person in this conundrum writes a lengthy white paper business plan to camouflage the absent strategic plan.
Perhaps the most important thing to know when you write a white paper business plan is this: This process is well documented in a bunch of other places. If you have QuickBooks Premier or QuickBooks Enterprise Solutions, you can choose the Company⇒Planning & Budgeting⇒Use Business Plan Tool command to start a wizard that steps you through the process of writing a white paper business plan.
Figure 3-1 shows the first page of the QuickBooks Business Planner, but I’m not going to talk more about the wizard here. You can use the wizard to see what it does.
You can also get detailed information on writing a business plan in both English and Spanish from the U.S. Small Business Administration (SBA) website at www.sba.gov.
Figure 3-2 shows the home page of the SBA website. You’ll find this page easiest to get to (because all you need is the domain name), so you may want to start your exploration of the SBA’s business planning resources here. If you click the Starting & Managing link and then choose Create Your Business Plan in the list of links displayed, you see a page of information that the SBA website offers about writing a business plan (see Figure 3-3). It provides links to additional pages of detailed information about the process of writing a business plan, such as a page that provides advice on doing strategic planning and a page that supplies step-by-step instructions for the actual work of writing your plan.
I should also point out that Microsoft Word and Microsoft PowerPoint (which many computer users own because Word and PowerPoint are components of just about every version of Microsoft Office) supply a detailed outline for creating a white paper business plan. (To get to these business plan outlines, choose File⇒New and then poke around in the template libraries.) These business plan templates provide very good starting outlines, so don’t be misled into thinking that something that Microsoft has provided for free to Word or PowerPoint users is in some way inferior to what real businesses use. Microsoft has done an excellent job of showing what information belongs in a white paper business plan.
After you create a good, solid strategy and at least a rough white paper business plan, you may also want to create a new venture plan. The next section describes how to do this.
To write a new venture plan, you take a different approach from the one you take to write a white paper plan. New venture plans answer five basic questions, which provide prospective investors the necessary information to determine whether they should further investigate your venture as a possible investment. The next sections detail these five questions.
In some cases, this question is unnecessary to ask. However, it’s important to consider in any case in which a firm may invest in a new, unproven idea. This situation is most clearly illustrated in the case of a firm that plans to build and then market some newfangled technology. For example, if you’re thinking of starting a firm that will produce a better mousetrap, a key question to ask is whether you really can build a better mousetrap. You can answer this question in a couple of ways, practically speaking. Obviously, the best way to answer this question about feasibility is to build the better mousetrap first. Having built the better mousetrap, you’ll find it easy to prove to prospective investors that yes, the product is feasible. You can set your mousetrap on the desk and demonstrate how it works. Perhaps on some … no, no, let’s not go there.
If a product hasn’t already been built or a service hasn’t already been proved to be deliverable, the next-best approach — and the one commonly used by technology start-ups — is to assemble a team of people who’ve built similar products in the past. The logic of this approach is that if you have a team that has built similar technologies in the past, investors can probably rely on this team’s track record of success. For example, if a team of talented engineers has built new and improved mousetraps, it’s very easy for investors to prudently believe that this team may be able to build a better mousetrap in the future. The engineers understand the technology. They understand the problem. They’re experienced in creating new solutions to address the problem. You see how easy it is to buy into the possibility.
Assuming that you do have a firm with a practical, feasible product or service, you need to ask another big question right up front: Do people really, truly want the product or service? Is there public demand for the firm’s offering? This business about demand seems kind of tricky to ascertain. Ideally, a new venture proves that demand exists by already having customers buying the product. If a new venture hasn’t yet finished the product or service, such hard-and-fast proof of demand is impossible to come by. In this case, you have another option: You can prove market demand by running independent market research studies to say, “Yes, we’ve run several focus groups, and people say they’ll buy a better mousetrap.”
Sometimes, you can also prove market demand by showing that consumers or businesses already purchase a similar product or service and would, logically, purchase a clearly improved version of the product or service. For example, in the case of the better mousetrap, people are already buying a lot of mousetraps. So if you truly did build better mousetraps, you could pretty much prove market demand by demonstrating the new product’s superiority.
Okay, the first two questions ask whether a product or service is feasible and whether people want the product. Is that enough? No, actually it isn’t. The third, critically important question is whether the product that you’re selling can be sold profitably. You must run rough numbers to prove that products or services revenue less the cost of goods sold produces a gross margin that is adequate not just to pay the operating expenses of the firm, but also to retain something for profit. This proof that the firm can profitably sell its product or service is really achieved by the business pro forma financial forecast (as described in Book VI, Chapter 2). This forecast proves that the firm can be profitable by selling the product or service.
I won’t say a lot more about this profitability issue, but basically, all the accounting stuff discussed throughout this book comes into play here. In order to do a decent new venture plan, you need to understand enough accounting to produce a set of forward-looking financial statements that persuasively argue a profitable venture.
Curiously, simply proving that a firm’s venture will be profitable often isn’t enough. A firm also needs to deliver profits at least equal to and, ideally, in excess of the return on investment that the investors desire. In the case of a new venture, investors have pretty firm expectations of what a risky investment should deliver. Angel investors commonly require rates of return in the neighborhood of 20 to 25 percent annually. Small-business entrepreneurs and business owners often require similar rates of return. Institutional and professional venture capital investors (the sort of people that you read about in The Wall Street Journal and in Inc. magazine) often require annual rates of return of 45 percent to 55 percent — or even 65 percent annually.
If you think about what all this means, you can quickly see that even a pretty darn good business that delivers the 30 to 35 percent annual rate of return — and that’s really good if you think about it — won’t be enough for some investors. An institutional venture capital investor who needs, for example, a 50 percent annual return on his investment isn’t going to look seriously at anything that produces only a meager 30 percent annual return.
Essentially, in a new venture plan, you provide information that lets the prospective investor figure out the rate of return. Then the prospective investor can compare this return with his or her requirements.
Even if you have a venture based on a feasible product or technology, even if you have customers who are hysterically excited to purchase your product, even if you have a product or service that will bring in a massive profit, and even if your investors will be able to earn a wonderful return on their investment, that’s still not enough. A new venture plan must ask and answer one other critical question.
Any new venture plan needs to sell prospective investors on the idea that the existing management team — which includes the founder or president and his or her lieutenants or vice presidents — can successfully operate the business. In other words, even a great business opportunity requires a good management team in place (or almost in place), ready to execute the business plan.
Here are a couple of ways that you can prove that the management team isn’t going to be a problem:
Okay, I have a handful of final comments to make about new venture business planning:
Having said that, however, note that answering any of the five questions with a definite “No” means that the new venture won’t work — or at least it won’t work for you as the business owner or as the manager. Each of the five questions is a link in the chain of success. Break any link — regardless of which one — and the chain breaks.