Tag Archives: business value

A business that can endure the future

Even if your business can sort of escape competition by crafting a monopoly, it is only a great business if it can endure the future. Is one of the statements in the book Zero to One by Peter Thiel and Blake Masters.
A great business is defined by it’s ability to create cash flow in the future. In other words, the value of a business today is the sum of all the money it will make in the future.

Most value of low-growth businesses is in the near term. Valuation of technology companies follows another trajectory. They often lose money in the first years: it takes time to build a valuable thing. This means delayed revenue. For this to happen a company mustn’t just grow it most also endure. In other words, will this business still be around a decade from now?

Characteristics of a business that can endure the future

Companies with a large cash flow far into the future usually share a combination of the following characteristics:

  1. Proprietary technology
  2. Network effect
  3. Economies of scale
  4. Branding

Proprietary technology

Proprietary technology is the most substantive advantage a company can have. It makes it difficult or impossible to replicate the product. As a rule of thumb proprietary technology must be at least 10 times better than its closest substitute in some important dimension. If it is perceived lower it is harder to sell the product especially in a crowded market.

The clearest way to a 10 times improvement is to invent something completely new. In that case the increase in value is theoretically infinite.

Amazon made a 10 times improvement by offering at least 10 times as many books as any other bookstore. The Apple iPad made the tablet go from almost unusable to useful.

Network effect

The network effect make a product more useful as more people are using it. However this will only work if the product has value for the first customers. Paradoxically businesses based on the network effect must start in small markets. Facebook started with just Harvard students.

In general network effects businesses aren’t started by MBA types, since the initial markets are too small to appear as a business opportunity at all.

Economies of scale

With economies of scale the fixed cost (engineering, management, office space) of creating a product can be spread out over greater quantities of sales. Software startups enjoy an hughe economies of scale because the marginal cost of producing another copy of the product is close to zero. Service businesses, like consultancies, yoga studios, etc, gain limited advantages as they grow.

Branding

Creating a strong brand is a powerful way to create a business that can endure. However techniques for polishing the surface don’t work without strong underlying substance. Starting with a brand without substance is dangerous. Coolness is interesting bus what products and value will the business create?

Theory of constraints

The Goal - Theory of ConstraintsThink it was back in 1993 I first read The Goal by Eliyahu Moshe Goldratt. The book was one of the first and most notable in the genre of business novels. The book – The Goal – introduces the theory of constraints (TOC) process for improving organisations. The book is set in a manufacturing company. However the book provides the context for a more generic approach to continuous improvement.

Theory of constraints

The theory of constraints is a paradigm that states that the output of a process is limited by a very small number of constraints. In a process there is always at least one constraint. TOC offers a process to determine the bottleneck/constraint and than restructure either the constraint or the work around it so the constraint can deliver it’s maximum output. Since the bottleneck’s output determines the output of the business process, other optimisation are local suboptimal interventions that do not generate any real business value.

The theory of constraints boils down to:

A chain is as strong as its weakest link.

More verbose: An organisation (especially a process or a business) is only as strong or powerful as its weakest activity or person. A group of associates is only as strong as its laziest member.

Constraint

A constraint is anything that prevents the system from achieving its goal. In TOC, the constraint is used as a focusing mechanism for management of the system. The concept of the constraint is analogue to the one in mathematical optimisation. In optimisation, the constraint is written into the mathematical expressions to limit the scope of the solution (X can be no greater than 5).

Types of (internal) constraints:

  • Equipment: The way equipment is currently used, is the limit to the ability of the system to produce more saleable goods/services.
  • People: Lack of skilled people limits the system. Mental models held by people can cause behaviour that becomes a constraint.
  • Policy: A written or unwritten policy prevents the system from creating more output.

Throughput

In general the throughput is seen as the movement of inputs and outputs through a production process. Bottomline it can described as the rate at which a system generates its products or services per unit of time.

In the theory of constraints throughput is the rate at which a system achieves its goal. Mostly this is a monetary revenue and not the items or volume created to be sold or kept as inventory.

Continuous improvement

Goldratt - on-going improvementAs said before the theory of constraints offers an approach for continuous improvement. Optimising the utilisation of the constraint is an important part of the process. Of course this could lead to the discovery that another resource became the constraint. So we continu the optimisation.

As Goldratt states in The Race:

In the midst of a competitive race we should not look for an improvement, we should look to implement a process of on-going improvement.

Beyond manufacturing

IT Operations

The Phoenix Project borrows both content and genre from The Goal. It is a business novel that explains how the theory of constraints can be applied to IT operations. The Phoenix Project describes the problems that almost every IT organisation faces, and then shows the practices (based on the Theory of Constraint, Lean and more) of how to solve these problems.

Design for outcome-oriented teams

While developing an organisation structure for an Agile or Lean business, there is a strong focus on teams being responsible for business outcomes (outcome-oriented teams). These teams are opposed by so called activity-oriented teams (teams responsible for an activity).

To understand the why of the focus on outcome-oriented teams, we need to understand what is a business outcome. Selling a product and generating revenue is an example of a business outcome. This outcome is the result of a chain of activities, like marketing, lead generation, product development, testing and support. To achieve an outcome we often need to break the chain and define suboutcomes. These suboutcomes aren’t that valuable on their own, only in context. If the division continuous, we end up with merely contributory activities. The difference between outcomes and activities is similar to that between user stories and tasks. Activities serve outcomes, like tasks serve the purpose of a user story.

Activities that are no longer directly bound to business outcomes are more likely to be trapped in the pitfall of local optimisation. Activity optimisation is a common cause of silos and of lengthening cycle times. This is because when we organise by activity, no single team can own the outcome (since it broke the being independable requirement).

Careful splitting a business outcome

So we need to be careful how and to what extend we split outcomes. We want to keep both meaning (sense of purpose) and value. How to determine whether a division leads to a suboutcome of an activity? Good business outcomes are:

  • Testable
  • Valuable
  • Independently achievable
  • Negotiable

While splitting into suboutcomes we keep asking whether these suboutcomes remains independent and valuable business outcomes.

Is there still room for activity-oriented teams?

Some support functions in an organisation don’t own independently valuable business outcomes. They are activity-oriented teams, think of departments like HR, admin, legal, finance, controlling. Does this mean that they automatically become silos and should be disbanded?

If the realisation of an outcome is dependent on repeated successful iterations through some core value stream, these activities should not be conducted in activity-oriented teams. Activities that aren’t an integral part of a business outcome’s core value stream could be placed into separate teams without much risk.

However we should remain cautious. Activity-oriented teams tend to “standardise” their operations over time. Their focus moves away from offering custom solutions. Complaints from other teams about rule books and bureaucracy will be your signal.

Definitions

Definitions used in this post are found in Agile IT organisation design:

  • Outcome – An independently valuable and achievable business outcome.
  • Outcome-oriented team – A team that has autonomy and accountability for an outcome. For example a cross-functional product team.
  • Activity – Action that contributes to an outcome.
  • Activity-oriented team – A team that is responsible for a single activity. Usually a team of specialists (marketing, finance, testing, sales).
  • Cross-functional team – An interdisciplinary, outcome-oriented team. It may consist of hard-core specialists, generalising specialists, or generalists.
  • Value stream – A series of activities required to deliver a business outcome.
  • Silo – A unit (team, department) that tends to protect itself and doesn’t work well with other units.