Monday, March 17, 2014

Conventional vs. Organic Model of Business Startup

By Omar Javaid

Since quite a while we have been exploring and experimenting an alternative methodology for a start-up for those who doesn't have much resources to initiate with. Though the method can be used by anyone. The conventional method taught in MBA programs where involving a venture capitalist is necessary also has a spectacular failure rate of more then 75% (see Shikar Ghosh's research) and according to some more then 90% (see Micheal Gerber's book 'E-Myth Revisited') in their first 5 year of inception.

This desperately demands an alternative method as well for the new comers who also can't afford to lose much. Besides the amazing failure rate of the conventional methodology itself is a good reason to find an alternative methodology. The following are some differentiating features for this alternative approach.

1. Idea centric vs. Resource centric
The conventional method requires the idea to be the next big thing! the revolutionary idea which would sweep the market, even if it is 10% of the next big thing, it is presented as if it really is. Every business plan competition is there is to reinforce this very concept, where the biggest, most innovative idea is getting the top prize. This prerequisite demands the concerned to make lots of assumptions about the possible demand of the proposed proposition based on market conditions and competitor information etc. and then allocate costly strategies to capture that demand. Here comes to role of a venture capitalist or a banker who would finance the business. Even if you are successful in getting the millions necessary for the start-up, do you have enough experience to handle the entire thing? If you have then go ahead, but if you are a beginner then obviously you would lack such an experience! Its like diving in a deep sea without learning how to swim! you would face lots of surprises and challenges big enough to knock you down!

On the contrary the alternative approach demands one to focus on for e.g. how much money one has at the beginning in his pocket, what skills one has, what resources are available in ones network which would be required at any stage of the supply chain (suppliers, buyers, vendors etc.), are there any angel investors in the network etc. Once all the resources are chalked down then one can workout with all these known variables that what kind of a business is possible now!. The most important resource is your network (family, relatives, friends, professional contacts etc.) who can share their experience and resources with you. This is a bottom up approach in comparison with the MBAs approach which is top down.

2. Lots of capital vs. Lots of contacts
Its a common misconception that lots of capital (millions if not billions) is needed to start a business, and if not available then eventually investment from a venture capitalist or borrowing from a bank is required. The idea is to invest millions to make millions in a very competitive market place. The idea is to capture market share which is occupied by other direct or indirect competitors, in the context of 'Social Darwinism' (Herbert Spencer's, not Darwin's idea), where the fittest survives. To build muscles quickly you need steroids or lots of fast money to penetrate into the market.

The experience suggests otherwise. Most medium size or small entrepreneurs says that you can start a business without capital, but you cannot start without having enough contacts. Pakistani society is peculiar feature in this context. The communities in Pakistan with stronger family bonds are more entrepreneurial then those which are not. Like Memon, Dehli Wala, Pathan, Dawoodi Bohra, or Chinioti community (etc.) have a business oriented culture, and the new comers have all the support from within the respective communities in which they belong to. If you don't belong to such a community then still you need to expand you circle of friends and get well connected with your relatives and neighbors as well. Darwin would agree that organisms (businesses, in the context above) with stronger communal ties have a better chance of survival, and those which are most adaptable to change. (Note: Jim Collins has suggested that theories of Darwin has more relevance in explaining organizational behavior in the market as compare to typical management theories, this why I have referred to Darwin here)

3. Advertising Expense vs. Word of Mouth
When the goal is to make hundreds of millions by investing million in a product proposition which is new to the customers then it is little surprise that lots of money needs to be spent on marketing of the product. The advertising expense is also built into the product cost hence raising its price. The method operates like a vicious circle while consuming lots of financial resources with little guarantee of success as suggested by past experience. Despite all the expense on advertising the customer loyalty is more dependent on the product quality and post purchase facilitation rather then its communication being done with the customer.

On the contrary the above is unthinkable for a start-up with little budget. Some basic communication with potential buyers is necessary however it is important that in the beginning the focus should be on the product quality and ensuring customer loyalty so that your happy customers generate word of mouth for you. If your product is generating word of mouth and every happy customer is sending more customers then your product penetration will grow exponentially in a short period of time. If you start with only one customer and assuming he brings in two more, and each of these two brings two more, then the rest is simple math. from 1 to 2, to 4, to 8, to 16, to 32, to 64, to 128, to 256, to 512, to 1024.... this is of course a very hypothetical, however in real the curve would grow much faster perhaps and within a a few month you would become unstoppable, only if your product or service satisfies the customer needs. (Check this HBR article for more insight)

4. Fixed assets vs. working capital
The conventional approach insists on having a brand image to impress which would be build through a very nicely decorated office and lots of employees etc. Also when it talks about generating lots of sales volumes then a warehouse and a manufacturing setup (if it is required) becomes mandatory.

The alternative approach doesn't require any of this to start. You can start from right where you are standing or sitting right now. Since you are working within the people you know i.e. your friends, relatives etc. therefore you don't need to spend much to impress them. Furthermore you are also not required to invest in heavy machinery unless it is extremely necessary, it is better to outsource any manufacturing process to any of your friends or family members (remember the bottom up approach we talked about earlier). Your most of investment would go into working capital which would be recycled as soon as you sell of your inventory. This way lots of risk can be avoided and you can better focus on learning about the challenges in your replenishment cycle. Once you are through the learning phase and have build a network of buyers, now you can move toward acquiring fixed assets as per your business needs.

5. Foresightedness vs. Agility
According to Ricardo Semler (in one of his talks at MIT titled 'Leading by Omission') the conventional business plan method is the legacy of the military industrial complex which dominated the industry during the world wars, where planning was based on intelligence reports. The trend has continued till date and the MBA way of starting a business requires the concerned to gather market data to identify profitable gaps, gather competitor information and then accordingly design the product, and its pricing promotional & placement strategy. This requires massive data gathering exercises and spending lots of money to do the same as well. The philosophical justification of such a method comes from the objective of making tons of money in the shortest possible time and that isn't possible unless a market segment with low competition and high demand is identified. But the problem is market intelligence reports are seldom correct about market behavior or customer acceptance, also that the conditions in the market changes often rapidly, making the predictions or forecasting irrelevant.

The alternative method emphases more on response readiness! if marketing conditions changes then one should be able to adapt and change according to the changing trends of market. This isn't really easy particularly when some venture capitalist has invested large sums in your business. The pressure in this case would force concerned to remain inflexible hence often leading to failures.

6. Financial Dependence vs. Financial Independence
The large sums of money which are required to setup your business the MBA's way isn't often available with you. This means you have to meet some venture capitalist in most cases who would invest. This is rather like being a slave of the venture capitalist or bank till the time break even isn't achieved and till the time the business isn't transformed into a cash cow. This doesn't happen in 75% of the cases as mentioned above, means the fear of failure traumatizes the entire process of business development, and rather becomes a crippling forces which itself contributes to the failure of business startup.

The Organic Alternative requires that you start preferable with your pocket money and roll the sum of your investment many times over in a month to get you returns. This means you would start from a trade based model. In a service oriented business the only cost incurred is of advertising and if you have a large network available then this is also negligible. You grow slowly by reinvesting your sums. This seems like a very slow process but it has a potential of exponential growth if you have been able to prepare the foundations well. There are many successful examples in Pakistan of this alternative approach. 

7. Linear growth vs. Organic growth
When there are large investments involved and the break even point is a few years down the line then the conventional method requires sustained growth for 5 - 10 years in the direction outlined by the business plan. What if there are new opportunities which emerge down the line? what if the preconceived ones begin to diminish on the way? What if market trends shifts in some other direction? All of this makes the conventional method quite inflexible.

The organic model goes with the nature, as the opportunity arrives, you try to capitalize on it! But of course you need to be financially independent in order to do so. You need to follow the path of least resistance. With smaller team and business size you can do this, and that's exactly what you have in the beginning.

8. Risk Taking vs. Risk Aversion
There is a common misconception that great entrepreneurs are risk takers, however there is a difference between risk taking a gambling, and also there is a threshold of the risk which one can afford.

We need to calculate how much loss we can afford, which would allow us to sleep at night in case if we are struck with it. Also operating within your network of friends and family allows you to start with people you already know therefore the fundamental most significant risk is reduced if not eliminated that is of dealing with new people and trusting with them with payments and supplies. Nature has a design for our growth, our experience grows incrementally over the period of time as we take small steps forward. Giant leaps often lead to big falls leading to financial and psychological loss big enough to leave a devastating blow which might cripple you for the rest of your life. One step at a time, one step at a time, moving forward in baby steps is the way to go. But no excuse for laziness and lethargy...

9. Arrogance vs. Humility
Business schools pumps arrogance in their MBAs. This might be necessary within a premise of cut-throat competition, where humility is rather seen as a weakness. Furthermore the ideology within which this is justified ideals individuals who are at the top of hierarchy, are wealthy and independent in all aspects of their lives. Being arrogant over ones successes is therefore understandable. Those who aren't yet on the top would rather act like one just to impress others.

This mindset again a killer for start-up spirit which rather requires one to remain humble, as in the beginning one has to do all things himself, learn from mistakes and accept failures, while maintaining a good relationship with all partners and stakeholders. Starting up is a business is not about getting ahead as an individual, but collaborating with lots of people for everyone's benefit. Humility doesn't here means that one begins to compromise on his goals to make other happy... Jim Collins has identifies (see his book Good to Great) that top corporate leaders also possess this quality coupled with a super strong will to get results. Upon good results they reward everyone around, and upon failures they prefer to look in the mirror. Arrogant attitude can only leads to self-immolation. 

10. Financial Management vs. Relationship Management
MBAs assume even individuals working for them as mere numbers on their balance sheet. During normal circumstances their attitude toward others might be normal, but when pressure mounts on the head then the true face becomes visible to others. For typical MBAs the bottom line is the only important aspect of the business and everything else is a means toward that end. Once anything becomes a barrier it needs to be removed ASAP. With such a mindset the relationship with the team members is only artificial and cosmetic. Arrogance in ones attitude adds salt to the wounds in this context.

On the other hand, the team is an entrepreneurs greatest asset. The relationship building and sustaining mindset has to prevail as it would even extend to the customers, and all stakeholders. The financials are important however one can financially survive only when he is able to establish an enduring relationship with all his stakeholders and clients. To build trust and repute with others, significance of honouring commitments and giving respect to all, deserves no mention. Humility is a necessary virtue in this context. 

The author is In-charge Center of Entrepreneurial Development at PAFKIET, he tweets at @javaidomar

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