Why read this book?
Right now there are 2 million entrepreneurs in the UK actively engaged in starting a new business. Many of their ventures will never get off the ground. Of those that do, the majority will fail. There are more than 15 million entrepreneurs in the USA doing the same thing. Most of their ventures will fail, too. Of those who submit business plans to business angels or venture capitalists less than 1 per cent will be successful in raising the money.
This picture of entrepreneurship is not a pretty one. The odds are daunting, the road long and difficult. Why, then, are a stunning one of every 19 adults in the UK - and one in ten in the USA - actively pursuing entrepreneurial
`most opportunities are not what they appear to be, as the business failure statistics demonstrate `
dreams? In a word - opportunity! Opportunity to develop an idea that seems, at least to its originator, a sure-fire success. Opportunity to be one's own master - no more office politics, no more downsizing, no more working for others. Opportunity for the
thrill, excitement, challenge and just plain fun inherent in the pursuit of entrepreneurial ventures. I know, because I've been there, too.
But there's a problem. Most opportunities are not what they appear to be, as the business failure statistics demonstrate. Most of them have at least one fatal flaw that renders them vulnerable to all sorts of difficulties that can send a precarious, cash-starved new venture to the scrapheap in a heartbeat. An abundance of research makes it clear that the vast majority of new ventures fail for opportunity-related reasons:
■ Market reasons - perhaps the target market simply won't buy. ■ Industry reasons - if s too easy for competition to steal your emerging market.
■ Entrepreneurial team reasons - the team may lack what it takes to cope with the wide array of forces that conspire to bring fledgling
entrepreneurial ventures to their knees.
How can a mere book help you meet this challenge?
The research underlying this book suggests that the serious entrepreneur who wants to beat the long odds - who wants to work harder and smarter to beat their competition - should pause in their haste to write that great business plan. Yes, I'm referring to you. Before putting pen to paper, you should step back and give your opportunity a road test. Examine the seven crucial domains of attractive opportunities that this book illuminates. Find, if you can, the fatal flaw lurking in what looks like an attractive opportunity. Your prospective investors will be looking for it, so you'd better have looked first. Doing your homework - this book tells you how - is a way to avoid impending disaster and increase your chances for entrepreneurial success.
But why shouldn't a would-be entrepreneur simply skip the seven-domains road test this book advocates and proceed directly to preparing a business plan? There are two key reasons:
■ First, this book enables entrepreneurs to avoid impending disaster. For most entrepreneurs, that's the likely outcome - sad to say - according to the business failure data. Preparing a customer-driven feasibility study based on the seven domains - a concise memo addressed to one's self, really - affords the entrepreneur a chance to opt out early in the process, before investing the time and energy in preparing a complete business plan. Identifying the critical flaw early can save weeks or months of time that might be wasted on a fundamentally flawed opportunity.
■ For opportunities that do look promising, the feasibility study jump-starts the business planning process and provides a clear, customer-focused vision of why the proposed venture makes sense - from market, industry and team perspectives, viewed independently and collectively.
Thus, by ensuring that all aspects of the opportunity are examined, the ne business road test reduces the entrepreneur's risk of entering a venture t
simply has no chance. What entrepreneur wants to be the next contributor to the sorry statistics of business failures? Surely not you. And it enhances
the chances of starting a successful business that attracts both customers and capital.
`the feasibility study jump-starts the business planning process `
Further, from a societal perspective, doing the seven-domains homework - before writing and pitching business plans - can reduce the waste of
precious entrepreneurial resources now devoted to crafting business plans for fundamentally flawed opportunities. Entrepreneurs are the drivers of the global economy. Their firms create the new jobs and offer role models for others to follow. Let's be certain that today's entrepreneurs are working on ventures that have at least a fighting chance of success!
Who should read this book?
Principally, this book is for serious, opportunity-focused entrepreneurs:
■ People who are dying to get out of the big, stifling, inflexible businesses where they work today to strike out on their own. People who have identified one or more opportunities that might just be the ticket out, but who need a way to test them. People who want to run their own business and benefit from the significant upside potential that could bring them economic freedom.
■ Entrepreneurs already running a start-up who are finding the challenges more daunting than they had imagined. Perhaps they are wondering whether their chosen path is a good one.
■ Engineers and inventors with ideas or technologies that can spawn something more than just a new product.
There are two other groups, too, that can benefit from the new business road test and its seven domains:
■ General managers, new product managers and business development professionals in businesses now mired in stagnant performance - or worse - in an unforgiving economy. They know their companies must find attractive new markets and develop successful new products in order to grow. Business as usual won't cut it. But how, they wonder, can their company be made more entrepreneurial?
■ Investors - whether family or friends or business angels or even newcomers to venture capital - who want to sharpen their skills and bring more than their money to the entrepreneurial table.
Independent clear-sighted advice from investors is more valuable to entrepreneurs than the money they bring.
` if you are serious about succeeding in your new venture -not simply starting one - this book is for you `
What are these people - perhaps you are one of them - doing today? Some are spending every waking moment looking for an opportunity to join the
ranks of today's growing entrepreneurial culture. Others are already engaged in conceiving or starting a new venture. Still others have recently done so, but the path to success remains unclear Whichever of these types of entrepreneur or would-be entrepreneur you are, if you are serious about succeeding in your new venture - not simply starting one — this book is for you. It will
help you avoid the disaster that's waiting to happen to the majority of new ventures. Yes, even to yours.
What will be the result of reading this book?
Entrepreneurs or managers having an opportunity in mind - whether it's still in the planning stages or already navigating the turbulent waters that early-stage ventures must sail - will reach one of three conclusions after finishing this book and putting their opportunity through the new business road test:
і Perhaps the most common outcome will be that the fatal flaw(s) will be uncovered. 'Whew! I'm glad I didn't write a business plan for that idea' is the likely sigh of relief. The disaster that would have ensued is now avoided, and all the time and energy that would have been invested in crafting the business plan can be invested more productively in a better idea. Those already in a new venture who reach this conclusion can plot a way to change the direction of the business - or sell it - before disaster strikes.
і Another common outcome will be that the flaws that axe identified can be fixed. Opportunities are malleable, and the entrepreneur is often able to reshape an opportunity to improve its attractiveness by:
- targeting a different market;
- offering a different product or service than the one originally planned;
- playing at a different level in the value chain - as a distributor rather than a manufacturer, for example;
- adding skills to the entrepreneurial team that were missing in the original conception.
Opportunities can evolve, and the thought process outlined in this book hastens and strengthens that evolution.
■ A third possible outcome - the happiest, but most rare - will be that the seven-domains test finds no fatal flaw. No matter how hard you look. Better yet:
- your homework identifies a real problem that someone - your prospective customer - has, and you offer a solution that's better, faster or cheaper than current solutions;
- your proposition stands a chance to establish sustainable competitive advantage;
- the market is large enough to make the effort worthwhile;
- the industry is sufficiently attractive;
- your entrepreneurial team has what it takes to succeed.
`i the seven-domains homework provides the evidence-based research foundation for a persuasive and compelling business plan `
The best news about this kind of outcome is that, in jump-starting the business planning process, the seven-domains homework provides the evidence-based research foundation for a persuasive and compelling business plan. A better business plan in half the time is the tangible result.
Why John Mullins? What does a business school professor know about starting an entrepreneurial business?
This book brings together, from a single author, the hands-on, done-it-before experience of a three-time entrepreneur with the research expertise found among faculties at only a handful of the world's leading business schools. Put simply, I've practised what I preach and I have the entrepreneurial badges and scars to prove it. I've learned the way most entrepreneurs learn, from both failure and success.
I served as vice president in the early high-growth days at a then young company with great clothing stores called Gap; I founded Pasta Via International and took it public before market and technological changes took our company down; and I pioneered chimney-type charcoal starters for American barbecue enthusiasts. From all these experiences and from the extensive research effort that underlies this book, 1 have drawn insights that deliver powerful lessons from which every entrepreneur - and many investors, for that matter - can learn.
` ignoring even one of the seven domains can be a road map to entrepreneurial disaster `
As chair of the entrepreneurship faculty at London Business School, where my entrepreneurship colleagues and I - most of us successful entrepreneurs in our
own right - develop world-class entrepreneurs and train and provide talent for the venture capital industry, I am uniquely positioned to have written what I hope you will find is an accessible and eye-opening book. Once you have read it, I believe you'll agree with me that ignoring even one of the seven domains can be a road map to entrepre-
neurial disaster. Entrepreneurs who start writing a business plan without putting their idea to the new business road test do so at their peril!
In 20 seconds or less
This book helps serious entrepreneurs and business professionals avoid impending disaster. It shows them what to do before they write a great business plan, to enhance their chance of winning both customers and capital and actually achieving their entrepreneurial dreams. And it reveals the seven key issues that astute investors examine before they invest. Intrigued? Read on.
The digital subscriber line industry
The speed with which Internet usage grew in the late 1990s created a large and rapidly growing market of Web surfers who needed all kinds of things, among them faster Internet access. By 2000, 375 million people worldwide had Internet access, of which a third were in the USA.30 All indications were that Internet usage would continue to grow worldwide. In the USA, forecasts indicated that by 2004, 75 per cent of all households would have Internet access.31
Not only did this market appear attractive at the macro-level, but towards the end of the decade a new technology sailed digital subscriber lines (DSL) made it possible to deliver data - including Internet data - over ordinary copper phone lines at dramatically higher speeds than the common 56k modems could deliver. At speeds of up to 1.6 million bytes per second -10-28 times faster than 56k modems - this technology offered dramatic benefits, including:32
■ For consumers, faster downloads, thereby saving the surfer's time.
Imagine - no more waiting for the file to load. Stock quotes, airline
reservations, movie tickets in seconds . . .
■ For small and medium-sized businesses of every kind, a chance to join
the Internet revolution.
■ For all, the ability to download audio and video, which was not very
practical on slower 56k modems.
“With benefits like these and a large and rapidly the growing market, DSL technology looked like a terrific entrepreneurial opportunity. But how
attractive was the DSL industry? Let's take a look at the American DSL
industry in 2000 from a five forces perspective.
Threat of entry
For an entrepreneur considering the DSL industry, a number of barriers to entry presented themselves. These barriers included logistical hassles, turf wars, technical knowledge and equipment costs. All difficult, to be sure, but great to have in place if one could somehow overcome them and enter. And enter they did. Armed with high-flying business plans that attracted buckets of venture capital, executives from telecom firms left their employers to set up DSL firms with names like Covad, Rhythms and NorthPoint Communications. With market growth like this, how could they go wrong?
By the end of 2000, Covad, Rhythms and NorthPoint Communications had won 442,000 subscribers, but they were finding one entry barrier far more difficult than they had imagined. To serve their customers, they needed to send their signals along the proverbial 'last mile' to the customers' premises, the twisted pair of copper wires owned by the incumbent telephone companies, or regional Bell operating companies (RBOCs). But try relying on another company for such access when that same company is a staunch competitor.
It seemed that the RBOCs also saw the potential for DSL, and they were busily deploying it on their own. How likely were they to allow the newcomers access to their copper and other facilities where the gear of the DSL upstarts had to be co-located? In spite of regulatory efforts to encourage such access, the reality was quite different. As AT&T lobbyist Peter Jacoby said, 'The basic problem, if you're a DSL provider, is you're relying on Baby Bell facilities to deliver
With little to gain by helping out the new DSL providers and, in some cases, a lot to lose, the RBOCs developed a reputation for being slow and stubborn. To compound the problem, once accessed, the copper wires were not always ready for DSL transmission. DSL was often incompatible with older copper phone lines. But carriers didn't know which lines would be incompatible - and costly to convert - until they started work in each neighbourhood.34 These problems took additional time to resolve and led to delays of up to six months in getting new customers' services switched on - not exactly what companies poised for high growth had in mind.
A barrier to entry that's high enough to keep out competitors is good. A barrier so high that you can't get over it is a problem. Access to the 'last mile' was such a barrier.
Siemens, Lucent, Nortel, Cisco, Nokia, Ericsson, Alcatel, NEC, Fujitsu - the DSL suppliers read like a laundry list of the most reputable high-technology firms in the world. While some of these suppliers offered highly differentiated products that could command high prices, much of what the DSL companies needed was available from multiple suppliers. The result was that few suppliers had significant influence over the DSL industry. In general, supplier power was not a significant problem for the DSL industry.
DSL buyers came in all shapes and sizes. While DSL was an attractive option for residential customers, especially those who were heavy Internet users, it was also an appealing choice for small and medium-sized businesses. It permitted high-speed Internet access at a fraction of the cost of older Tl lines used by large businesses with heavy telecom usage. The good news for the DSL providers was that these kinds of buyers had little power. They knew the advantages of high-speed Internet access and were prepared to pay for it, especially if the service were moderately priced, which it was.35 Buyer power was not a problem either.
Threat of substitutes
DSL was one of several methods of connecting to the Internet at significantly faster speeds than when using a traditional 56k modem. The most significant substitute for DSL in residential markets was the cable modem, which, like DSL, offered comparable service at a reasonable monthly price. Unlike DSL, cable modems used coaxial cable, the same cable that carried television to most American homes. Cable broadband providers advertised connection speeds of 1-3 Mbps, 15 or more times faster than a 56k modem and faster, in some cases, than DSL.
In the residential market, cable operators got the jump on DSL due to a variety of factors, the most significant of which was the inability of telcos, particularly in the USA, to provide DSL service at distances of greater than two miles from the central office.36 Since cable companies existed long before the advent of broadband Internet connections, cable companies also had the benefit of an established customer base and access to millions of residential homes and neighborhoods. By the autumn of 2001, there were approximately 5 million cable-modem subscribers.
There were, however, some shortcomings of cable modems. First, the personal computer had to be located near a TV cable, which meant additional cabling in most homes. Second, a cable employee had to hook up the system.37 And, because cable networks operated on a shared basis, some users were concerned about the safety and privacy of their Internet data and about slower service when the systems were busy.38 Nonetheless, with cable television already present in most American homes, cable was a powerful substitute for DSL, limiting the prices DSL providers could obtain, with a consequent effect on margins.
For the business market, cable was typically not a viable substitute, as cable often didn't serve commercial areas. Alternative Internet connections, like fixed wireless, were comparably priced and provided similar speed to DSL, but they required line-of-sight transmission, restricting many businesses from its service. Sharing a Tl line with one's neighbours was also a possibility, assuming there were neighbouring companies that wanted high-speed access. Thus, for the commercial market, the threat of substitutes was relatively low, and this is where most newcomers like Covad, Rhythms and NorthPoint Communications focused their efforts.
Not so long ago, the American telecommunications landscape looked very different. With no competition and a virtual monopoly on telephone service, the Baby Bells and AT&T dominated the local and long-distance markets. All this changed as the trend towards deregulation took hold in the USA. In 1996, US Congress passed the Telecommunications Act, intended to increase competition in the telecommunication industry, encouraging service-provider start-ups and long-distance phone companies to enter local markets previously dominated by the RBOCs.39 Greater rivalry was the intent, as well as the result.
The act set off a stampede of competition. It opened lucrative local telephone markets to new players. At the same time, the Internet was booming, and technology prophets predicted that high-speed networks
would be needed to satisfy growing demand for digital traffic. A gold rush ensued. Nearly400 telecom companies raised $489 billion on the stock market and took on an additional $389 billion in debt.40
Without question, however, the incumbent operators had a distinct competitive advantage. The long-distance companies, themselves products of earlier deregulation, and the Baby Bells had abundant resources. They owned most of their infrastructure - including the 'last mile' - and they could offer a comprehensive array of communications options. They also had direct contact with prospective DSL customers. NorthPoint Communications' own research showed that fewer than one-third of consumers even knew there were alternatives to the Baby Bell.41
The Baby Bells proved vigorous competitors indeed. In 2000, when Covad, NorthPoint Communications and Rhythms served 442,000 subscribers combined, SBC (a Baby Bell serving the southwestern USA) alone served 767,000 subscribers, Verizon had 540,000, Qwest had 255,000 and BellSouth had 215,000.42 Rivalry was intense!
Summary of industry attractiveness
Severe threat of substitutes in the residential market. Brutal rivalry for residential and commercial customers alike. To top it off, the entry barrier to the 'last mile' posed by the RBOCs was difficult to breach. Is this the kind of industry where you'd like to play?
The results were not Peasant, especially for users who had subscribed to the DSL services of the new entrants. Investors weren't happy either:
■ NorthPoint Communications, a DSL leader with more than 100,000 customers nationwide, closed in March 2001, leaving its customers scrambling for online access.
■ Soon afterward, Winstar Communications and Teligent went into Chapter 11 (insolvency).
■ By June of 2001, over 20 major providers of DSLs had shut down, filed for bankruptcy or found themselves dangerously short of cash.43
The market for DSL services was attractive, to be sure. Customers loved DSL, with its blazing speed that was always turned on. But unfavorable forces in the USA had rendered the industry so unattractive that many new entrants had failed quickly.
What investors want to know
A common myth is that investors invest in good ideas and good management teams. While there is an element of truth in both parts of this statement, the essence of venture capital investing, according to Silicon Valley investor Bob Zider,44 is this:
The reality is that [venture capitalists] invest in good industries - that is, industries that are more competitively forgiving than the market as a whole.
What Zider's statement means, in five forces terms, is little threat of entry (i.e. high barriers to keep future competitors out), weak supplier and buyer power, little threat of substitutes (thereby limiting competition from other industries), and little competitive rivalry. Since these are crucial issues to investors, entrepreneurs seeking capital would do well to have invested some time and effort to understand them fully for the industry they propose to enter.
Most professional investors have already made clear and conscious decisions about the industries they will and will not invest in. Many go so far as to make this information public in various venture capital industry directories or other guides.45 If the industry you want to enter with your new venture is one that a particular investor has already identified as within their scope, then the chances are good that they will already know a great deal about the industry, perhaps far more than you do. Thus, doing your industry analysis homework, using the lessons of this chapter, can help you establish your own credibility as one who understands the game you seek to play.
In this chapter, we've looked in detail at two industries, one quite attractive, with profits to show for it, and the other a killing field, where almost no new entrants survived. Case Study 4.1 tells the tale of another industry, cinemas, where unfavourable conditions led to widespread bankruptcies in spite of the large and growing markets it served.
case study 4.1
The film industry takes a dive
In 1998, cinemas looked liked money machines. The industry had grown profitably for 20 years, attendance was up, and the drinks and snacks they sold generated huge gross margins. Smart people at Kohlberg Kravis Roberts & Company (KKR), a prominent leveraged buyout firm, saw all this and bought the Regal Theater Chain in the USA. Other investment firms saw it too, and bought other cinema companies. Shortly thereafter, according to Perry Golkin, a partner in KKR, their deals 'all went bankrupt'.
Following the debacle, the cinema companies explained their errors by saying, 'We overbuilt after we bought. Regal built in AMC's territory and AMC built in Sony's. We cannibalized each other.' But, as Golkin pointed out, all this 'misses the most important point. What the investment firms had failed to recognize was simply that movie theaters are not a good business. A theater is a commodity. It's a room with a screen. There are no barriers to entry. The consumer decides which theater to patronize based on `what movie do I want to see, where and when`. The smart people never stepped back and asked: `What am I buying?`.'
What went wrong? Moviegoers may constitute an attractive market, but the cinema industry is a different story in five forces terms. There are no barriers to entry: anyone can build a cinema, and 'you can get whatever films you want', says Golkin. There are numerous substitutes for the consumers' weekend outing, from restaurants to clubs to sporting events to the great outdoors. And it's hard for cinemas to build customer loyalty, a buyer power problem, since customers choose the movie they want to see and care little about the cinema where they see it.
The lesson for would-be entrepreneurs? Attractive markets are one thing. Attractive industries are quite another.
What can entrepreneurs learn from these case histories? The first and foremost lesson of this chapter is that markets and industries are different things. Don't confuse them! When you see an attractive market, don't get so enamoured of it that you forget to ask whether the industry is one in which you want to compete. As Warren Buffett noted at the outset of this chapter, the characteristics of the industry are likely to outweigh your prowess as an entrepreneur.
Lessons learned from the pharmaceutical industry
As the pharmaceutical industry example shows, regulatory issues can have powerful effects on industry attractiveness and the profitability of the firms that comprise it. Where regulation makes it difficult for competitors to enter and compete, and other forces are also favourable, it's worth an entrepreneur’s trouble to find a way in, as the biotech companies have done.
Both the long-established players and the biotech newcomers have prospered.
The pharmaceutical industry example also shows that high barriers to entry are good. Love and cherish them. And, once you get in, work to keep the barriers high. The same is true of weak buyer and supplier power, and of little threat of substitutes, as we've seen here. Even significant changes in some of these forces were insufficient to detract significantly from the drug industry's overall performance.
Finally, entrepreneurs should note that industry performance data, like those cited in this chapter for pharmaceutical industry performance, are readily available in business libraries in most developed economies. It's well worth a look at such data in the early stages of assessing an opportunity. If an industry is a poor performer overall, you should take a critical look at your opportunity to ask why it should fare differently. Without a persuasively positive answer to this question, I would suggest moving on to something more attractive.
Lessons learned from the DSL industry
We've just said that barriers to entry are good, to be loved and cherished. But one must be sure that there's no barrier that's insurmountable, as was the case for DSL firms' lack of access to the 'last mile' of copper to the customers’ premises. It takes only one insurmountable barrier to put you in deep trouble.
A second lesson to be taken from the DSL story is that substitutes - in this case, cable modems can place strict limits on the prices you can charge. Plastic containers cap the prices that aluminium or glass packaging companies can charge, and so on. You must look outside your own industry to see what other industries might bring to your market. The once stealthy but now steady advance of digital technology into the realm of traditional silver halide chemistry in the photography industry does not bode well for companies like Kodak, Agfa and Fuji, whose aging technologies may not last very much longer.
It is also worth repeating that large and fast-growing markets like the Internet population are not sufficient to ensure a successful venture. DSL entrepreneurs were enticed by the predictions that, by 2001, DSL-enabled phone lines would reach as many as 10 million American homes.46 It's worth noting that research companies make money peddling rosy forecasts in all sorts of markets and industries. Take them with a grain of salt, and don't forget to examine industry attractiveness too. If it's easy to enter the game you hope to play, then you can be sure you'll have company sooner or later. And if the industry is structurally unattractive, as was DSL, then most entrants will probably fail.
Can one make money in an unattractive industry?
The lessons of this chapter are sobering. The unfortunate reality is that most industries are not nearly as attractive as the pharmaceutical industry, although many are better than DSL. Can one make money in unattractive industries? In the case of DSL in the USA, conditions were so onerous that survival for new entrants was all but impossible. In other cases, where conditions are bad but not that bad, can an entrepreneur fare better? Can you make money in a business of the kind Warren Buffett described at the outset of this chapter - one with a reputation for bad economics? We turn to this question in Chapter 5.
The new business road test: stage three -the macro-industry test
What industry will you compete in? Define it carefully.
■ Is it easy or difficult for companies to enter this industry?
Do suppliers to this industry have the power to set terms and conditions?
Do buyers have the power to set terms and conditions?
Is it easy or difficult for substitute products to steal your market?
■ Is competitive rivalry intense or genteel?
■ Based on all five forces, what is your overall assessment of this industry? Just how attractive or unattractive is it?
■ If your industry is a poor performer overall, are there (based on the lessons
of Chapters 2 and 5) persuasive reasons why you'll fare differently? If not,