Rules 10 to 16
Critical mass
The essence of technological advance in the twentieth century was encapsulated in the phrase: "To know the future is to invent it". The dotcom bubble illustrated how this philosophy is not appropriate for the Information Age.
Inventing the future, implies that clever people, with good ideas, can determine what the future holds. Many well funded dotcoms tried to do this and failed miserably. What they proved is that the future, in a rapidly expanding technological environment, is beyond the power of humans to control. The future may evolve out of inventions, but, it isn't invented.
Perhaps a new phrase might be more appropriate for the Information Age: "To know the future is to GROW it". This would involve admitting the future is unpredictable and basing business strategy on the notion of providing businesses with the ability to grow, adapt and evolve by themselves.
This philosophy is anathema to the twentieth century, Industrial Age mind set. It suggests a lack of control, a lack of organisation, a lack of leadership - an inefficient system that is random and aimless. But, nothing is further from the truth: it is just a question of knowing how to control it.
The key to controlling a self-organising, evolving business it to understand the concept of critical mass. Critical mass is a single number. It may be expressed as a number of participants, a number of customers or a number of orders. It is the number that defines the point at which a business breaks even.
For every business there is a break even point, where the income is just sufficient to take care of the outgoings. If income is above this point, the business is profitable and can develop and evolve from its own resources. If income is below this point, the business runs the risk of spiraling downwards out of existence. This much is common sense, but, somewhere in between, there is a quasi state: where a business might go through a period of negative cash flow during a transitional stage in its growth.
Negative cash flow - or capital burn rate - most commonly occurs at the start up stage, or, during a period of expansion, or, at a time of redirection. The nature of e-business is such that it is continually in one of these three phases - due to constant technological change and unpredictable competition initiatives. This makes the haemorrhaging of a business's capital base the single most important problem an e-business strategist has to deal with. Not least because it is an ever present danger.
Seed capital, loans, past profits and various stages of equity capital are traditional sources of funding used to finance negative cash flows. Such funding is assumed to be bridging finance, used to achieve new levels of business profitability with sound business plans aiming to meet well defined targets.
However, planning and making projections involve anticipating the future. This is not reliable in an environment so unpredictable as e-business. It puts the business strategist in much the same position as a marksman trying to fire at a fast, random moving target. There is nothing stable to focus upon.
The only predictable metric is critical mass. It is this, rather than future targets, that should form the focal point of an e-business strategy. Unlike targets, critical mass is not the aim of a strategy but represents a minimum acceptable performance. This requires a large paradigm shift for anyone used to conventional business planning because anticipated results are not specific, but vague and open ended. Not an easy thought for anyone with a managerial mind set.
The trick to understanding why critical mass is a better basis than targets for e-business strategies is to imagine a high jumper, jumping over a bar. If the high jumper isn't sure whether or not he can jump over it, he can spend more time training to perfect his technique. He may then succeed, but, a far surer way of jumping over the bar would be to set the bar lower. The point is that critical mass is knowable. It can be calculated. It is also adjustable. If it seems too high, it can be lowered to a point that makes it easier to achieve profitability..
This provides a tenth rule to apply when deciding upon an e-business:
Rule 10: The critical mass must be easily adjustable.
Note: It must be emphasised that critical mass is the single most important metric in e-business. It is the only figure that is certain, controllable and calculable in a bottom up strategy. Almost all other metrics are vague and unpredictable
Business strategy
The dotcom bubble provided ample evidence that even the best laid plans can fail or be thwarted by changing technology and unpredictable competitive action. The question then becomes, "What takes the place of plans"? The answer is strategy.
Strategy isn't about trying to plan the future. It is about using concepts to achieve goals in situations of uncertainty and competition. Concepts are in the mind so they cannot easily be written down on a piece of paper. However, once the concepts are in place, strategies can be employed and orchestrated using very simple calculations. These are often described as "back of the envelope calculations".
Back of the envelope calculations are not inferior forms of planning. They represent top level understanding and control that deal with only the most important and critical aspects of a business situation. This is particularly applicable in highly complex areas of business where vast amounts of information, and a plethora of incomprehensible detail, can easily cloud the more important issues. With bottom up strategies - the essential approach in these conditions - back of the envelope calculations are vital for fast reacting control.
The main focal point, for back of the envelope calculations in e-business strategies, is critical mass. A business direction can be guided according to the ease of achieving critical mass: moving in directions where critical mass is most easily achievable and away from areas where it is not. Such a strategy can be controlled and monitored by means of a simple model that uses only three business metrics:
Total overheads (O)
Gross profit per sale (P)
Total sales costs (S)
The critical mass (number of customers or orders needed to break even) can then be calculated using the formula:
Critical mass = (O + S) divided by P
From this simple formula, it is easy to calculate the minimum number of customers or clients needed for a particular business opportunity to be viable. If this number seems achievable then the business opportunity is deemed worth pursuing. This obvious fact provides a means of choosing between various business options: the easier it is to achieve critical mass, the more likely the business is to succeed in being profitable. This allows a business to be steered through a route of development that offers the least chance of failure.
The value of this formula is that it can show where flexibility and adaptability are needed. It can be used to guide the company into more profitable business areas and take it out of hazardous situations. It will let you know when your overheads are too high; tell you when they have to be drastically reduced if a sticky patch or a discontinuity occurs. It will let you know if increased marketing or reduced prices are likely to improve results or whether it might be wisest to pull out of a situation altogether and move on to greener pastures.
In essence, this formula can be used to enable a company to be flexible, adaptive and fast reacting. If a more powerful competitor comes on the scene, it will tell you to move on. If an new opportunity arises it will provide a way of judging whether or not to take advantage of it.
Although this is described as a "back of the envelope" calculation, it is more usefully employed as the basis for a simple spreadsheet model. This will provide a simulation of the business as various consequences of adjusting the metrics are observed.
The three adjustable metrics are overheads, gross profit and sales costs. These can be constantly monitored and adjusted to suit current conditions. Gross profits and sales costs are easily adjustable, but, overheads can be more difficult to change. For this reason, a business infrastructure that requires the lowest possible overheads is preferred.
This provides an eleventh rule for a business:
Rule 11: The essential infrastructure required must be such as to entail very low overhead costs.
Having a low level of essential overheads does not rule out the possibility of strategic expansions in favourable conditions. However, it will facilitate rapid contraction in times of change or adversity.
Competition
Although critical mass is the only metric that can be relied upon, it is subject to continuous change. For example, critical mass is affected by competition: if competition becomes intense, it becomes more costly to compete and critical mass goes up. If there is less competition, critical mass goes down.
Using the formula in a spreadsheet model, it is easy to estimate relative competitiveness. If a competitor has a smaller critical mass they will be in a stronger position. It will give them more scope for reducing their prices, increasing their marketing efforts, improving customer service and support or enable them to put more funds into product development.
By far the most threatening aspect of e-business is the ease with which competitors can come up with a superior or less expensive product or service. The difficulty of achieving critical mass offers some protection as it may require a substantial capital investment to persuade a large body of customers to switch loyalty. This would be particularly true if the customers themselves were an important part of the product or service (such as an employment agency).
In warfare, opposing sides may fight a war of attrition, where each side depletes the other side's resources at the expense of their own. Usually, such wars are won by the side whose resources last out the longest. Similar battle can be fought in the arena of e-business, where businesses may be prepared to sustain heavy losses until they have won over all the clients. However, such victories carry a high penalty because the losses have the effect of increasing the winner's critical mass as these losses have to be recouped (or higher equity earnings allowed for).
In warfare, there will be an advantage to the side that has the more efficient armour or firing power. In e-business competition, the advantage will lie with the business that has the lowest critical mass. This provides another important rule:
Rule 12: The business should have a lower critical mass than its competitors.
Initiatives
It is too obvious to spend much time discussing the importance of product or service reliability, competitive pricing, customer satisfaction and after sales support. These are fundamental to any business situation. The only difference the Internet makes is that any improvements in these areas are not only noticed by customers or clients, they are just as easily noticed by competitors. This allows them to catch up or surpass any new initiatives very quickly.
This puts early movers at a disadvantage because if their initiatives are seen to provide a competitive advantage, they can be copied by competitors who would have the distinct advantage of not having to carry the costs of development or educating the customers or clients. This provides another rule for choosing a suitable business opportunity:
Rule 13: There should be no substantial development or pioneering costs.
Switching in an out of opportunities
A bottom up strategy that follows the direction of lowest critical mass will require high flexibility and involve fast switching between situations. As already covered, this will require the business to have low overheads, with many of the business functions being out-sourced rather than carried out internally.
However, even with low overheads and a flexible business organisation, switching around can be costly in terms of the disruption it causes. Partners, affiliates and contractors need to be considered. New hardware, different techniques and software might be required. There may be a need for retraining or learning new areas of technology. Also, a change in direction might require different contacts, making some valuable contacts redundant. These are important matters to be taken into consideration.
The cost of switching out of an unprofitable area of business into another that holds out better prospects can be costly. This cost, and loss of efficiency during the change, might outweigh the advantages of moving on to greener pastures - effectively limiting flexibility and inhibiting strategic switching opportunities.
The only way to avoid these kind of problems is to be involved in a business environment that offers many opportunities for switching into new opportunities without the need to make any major organisational changes. This provides a fourteenth rule to influence the kind of business opportunity to take:
Rule 14: The business environment must be such as to allow switches in direction without too much disruption.
Potential for growth
As a business in an unpredictable environment necessitates a bottom up strategy, it relies upon there being ample scope for evolutionary, organic growth. There has to be sufficient opportunity to expand. It is no good creating a business in a small niche because it would become trapped and limited in the ways it can expand or evolve. This sets a fifteenth rule to influence the choice of business opportunities that can be taken:
Rule 15: The business environment should offer ample scope for evolutionary growth and expansion.
Funding
Bottom up strategies follow the line of least resistance, so, choice is determined more by facts and events than rational decision making. Particularly this applies to funding. Funding cannot be planned or predicted. It either happens or it doesn't and is always obtained on the basis of some understanding of what the business is about and how it is to be conducted.
A conventional business approach will be able to offer up a detailed plan, to let an investor see how their money is to be spent and how they can expect to see the results turn their investment into profit. An entrepreneur using a bottom up strategy hasn't got this option as there is no plan and no way of predicting the course of events.
The late Sir "Billy" Butlin, who became a multi millionaire by creating the first packaged holidays in the UK just after World War 2, had a dream of building "holiday camps" that provided cheap accommodation around a purpose built entertainment complex. He went to hundreds of different banks throughout the UK, looking for financial backing. They all turned him down until he came to a small bank in a run down suburb of South London: Barclays Bank in Tooting Bec.
The manager of this bank recognised the potential and, probably at the risk of his career, loaned Billy Butlin the money to get his scheme off the ground. A decade later, when the Butlin Holiday Camps had spread all over the UK, Billy Butlin was still using this same small bank to handle the millions of pounds the business was turning over every week. Despite many advantageous offers from larger banks to handle his cash flow, Billy Butlin steadfastly refused to move his account away from the small bank that had given him his initial start.
The point of this story is that if an idea has any real merit, there will be a financial source somewhere that will recognise it. The more possibilities for funding there are, the greater the chances of success. This provides another rule for choosing a business: