Saturday, November 29, 2008

The 3Cs of Business Plan

[NOTE: An abridged version of this post was published by the Business Times (Singapore) on Nov. 17. ]

One question I’m asked most frequently by budding young entrepreneurs is, “What does an investor look for in a business plan?” I get asked this in my various capacities – as an entrepreneurship educator, as the director of NUS Entrepreneurship Centre, which provides seed funding to entrepreneurial start-ups by NUS professors, students and alumni, and as an active business angel investor, having invested in about a dozen start-ups in Singapore, Silicon Valley, China and India over the last decade or so.

There are of course literally thousands of how-to books about business plan writing that will offer you checklists on what a business plan should cover. Having been pitched business plan hundreds of times, I have learned to distill the essence of what I personally look for in a business plan down to three core questions, which I have dubbed the 3 C’s. Just as many of you have heard of the 4 P’s of marketing (product, price, place and promotion), I hope that many of you will remember the 3 C’s of start-up investing after reading this -- whether you are (or plan to be) an investment professional evaluating start-up business plans, or an entrepreneur pitching plan to investors.

So what are the 3 C’s? Here they are:

How does the venture CREATE value ?
How does the venture CAPTURE value ?
How does the venture COMMUNICATE value?

At the heart of any new venture is the identification of a potential opportunity, and a plan of actions to exploit it. So any good business plan must tell us how good the opportunity is, and how and why the people behind the plan can exploit it better than others. I believe the 3 C’s help discipline our thinking about the opportunity and its exploitation, by providing three sets of tests for the viability of any proposed business.

Value CREATION

Every business, no matter what it does, can only exist because it creates value for some customers. So the opportunity that a business plan seeks to exploit must be translatable into very specific answers to the following series of questions:

• What is the customer problem (“pain”) or need that you have identified ?
• How big is it – how many such customers are there ?
• Who will pay for it to be solved/fulfilled, and for how much?
• What specific products/services are you going to offer to solve/fulfil these pains/needs?
• By how much would the value of these products/services exceed the total cost of providing the solution?

I’m afraid that many business plans that I have come across fail to pass even this first test – while they talked about the wonderful technical inventions or business ideas they have discovered, they either failed to demonstrate the existence of real paying customers who will want to pay for them, or they did not take into account the full cost of converting their ideas into actually usable products, which will render the venture financially non-viable.

Value CAPTURE

Many entrepreneurs, particularly techies, think that they have a viable business just because they have developed something that people actually want. Unfortunately, this is often not true, because you may not be able to capture much of the value that you create due to the existence of competition. And competition comes from not just other companies offering similar products or services – as Michael Porter has summarized it nicely, there are five sources of competitive pressures that any business needs to watch out for:

• Existing Rivals offering similar products
• Potential New Entrants
• Close Substitutes
• Powerful Buyers
• Powerful Suppliers

In combination, these competitive pressures drive your price down, or squeeze your margins to nothing. To pass the value capture test, a business plan needs to (a) convincingly show why some of these competitive forces are absent (AND will remain so even after you have entered the market) ; or (b) clearly identify the unique competitive advantages that your venture has to counter each of these competitive forces.

It is usually a bad idea for a business plan to proclaim that there is no competition, as many naïve business plans do. To the experienced investor, this may mean either that the entrepreneur has not done his/her homework, or that the business opportunity is actually non-existent or so tiny that nobody else bothers to enter. From an investor’s perspective, the existence of competition is actually a good thing, for it provides a validation that the market potential is real, not imagined. The challenge is for the entrepreneur to show that his/her offering is so good that it can capture a viable market share, despite the competition.

Value COMMUNICATION

Even after a business plan has passed the above two tests, we are still not home free yet – there is the remaining test of how the venture can communicate its value convincingly to its customers and resource partners. This is of particular concerns for new start-ups trying to offer radically new products/services that are not familiar to the customers.

First of all, there is the liabilities of newness – if the new venture needs to sell to large enterprises (or to sell through large distribution channels), this is usually a big warning sign, for many of these establishments tend to be conservative and will not buy from an unknown entity with no prior track-records, no matter how good the product is. Secondly, when the product/service itself is novel, as is typically the case with new start-ups trying to commercialize new technologies or business ideas, a lot of educating of the users (as well as the relevant partners such as component suppliers and sales channels) is usually needed, which will not only raise the upfront cost, but also delay the revenue stream.

While the above examples highlight the go-to-market challenge, I have used the word communication to embrace the broader range of credibility and visibility challenges that a new venture needs to address – you may have a great product innovation, but unless people are aware of it, understand what it does, and have trust in your organization to deliver it, there will be great resistance to first adoptions – everybody is waiting for other credible reference customers to prove its viability first. What is worse, if your innovation disrupts the existing business ecosystem and requires new distribution channels or adaptations by existing suppliers, you are unlikely to get the complementary resources to help you get started. You will also have difficulty attracting top talent to join your venture if you cannot communicate a compelling vision to them.

Unless a business plan clearly addresses how it is able to overcome these value communication challenges – and still shows viability even after factoring these communication costs and time delays into its financial projection -- it is still not fundable even if it passes the earlier two tests. For example, I personally view more favourably a start-up plan that allocates stock options to attract credible people to join its board of directors and management team – besides showing that the venture is serious about attracting the right resources to enhance its execution capability, it also signals that the founders recognize the need to address its credibility challenges.

I use this 3Cs framework not only to screen business plan pitches, but also to monitor and advise the companies that I’ve invested in. I would be interested in any suggestion you have on how to refine it.

18 comments:

Sean Seah said...

Hi Prof, I agree with the points mentioned in the 3Cs framework. Just to add on my view is that the framework address the viability and relevancy of a business plan to the market. I totally believe marketing is King and should be revolving around it. However, I felt the team behind the business plan is even more important than the plan itself. The market is always changing and a sounds business plan today might be not be feasible in the future. However, a team with the right mindset and never-say-die attitude will turn the business around, evolve and adapt.

Connect-the-dots@Singapore said...

Thanks for your great comment -- indeed investors pay just as much, if not more, attention to the entrepreneurs and the execution team behind the plan -- please see my future blogs on the 3H's of entrepreneurs and 3S's of execution team...

Lobang said...

Hi Prof, the 3Cs framework does make sense and this is great for my current business plan which I am proposing to any interested venture capitalist or business angels. But if you can guide me along, how to I find the right suitable VC or business angel to fund for my business idea/plan?

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