In Depth: How to Test Your Business Idea

It’s the fundamental question: will my idea work? And in my career as serial entrepreneur and investor, I’ve seen many different ways to analyze opportunities. But it wasn’t until I met John Mullins, Professor at London Business School and entrepreneur, and heard his approach, called the 7 Domains, that I had that feeling: Ah, HA! Quickly followed by, “Darn (or perhaps something stronger). This could have kept me out of trouble once or twice…”

So when young or new entrepreneurs ask my opinion of their business ideas, or ask “Can you connect me to someone who will tell me if this is a good idea?” I explain my view: no one single other person should ever determine whether you pursue an idea or not. The only person who can figure out if it’s a good idea is you.

But you’re not without help – there are some tools for analyzing your idea. The 7 Domains is one of the best I’ve seen.

John Mullins has graciously shared his thinking and writing with NEN, so you can check out his framework, and see if you find it useful for your analysis.

– Laura Parkin, former CEO, NEN

The New Business Road Test by John Mullins

Passion! Conviction! Tenacity! Without these traits, few entrepreneurs could endure the challenges, the setbacks, the twists in the road that lie between their often path-breaking ideas – opportunities,   as they call them – and the fulfillment of their entrepreneurial dreams.

The very best entrepreneurs, however, possess something even more valuable – a willingness to wake up every morning and ask a simple question about their nascent opportunity: ‘Why will this new business work when most will fail?’ Or, to put it more realistically, ‘What’s wrong with my idea, and how can I fix it?’

Overview: The Seven Domains, a Great Tool for Entrepreneurs

At its heart, successful entrepreneurship comprises three crucial elements: markets, industries and the one or more key people who make up the entrepreneurial team.

The seven domains model brings these elements together to offer a new and clearer way to answer the crucial question that every aspiring entrepreneur must ask themselves every single morning: ‘Why will or won’t this work?’

The keys to seven domains framework:

img_ind_overview1

At first glance, the seven domains model appears simply to summarize what everybody already knows about assessing opportunities. So it does. Upon more careful scrutiny, however, the model goes further to bring to light three subtle but crucial distinctions and observations that most entrepreneurs – not to mention many investors – overlook:

  • markets and industries are not the same things
  • both macro- and micro-level considerations are necessary: markets and industries must be examined at both
  • the keys to assessing entrepreneurs and entrepreneurial teams aren’t simply found on their resumes or in assessments of their entrepreneurial character.
Markets and Industries: What’s the Difference?

Moreover, the model’s seven domains are not equally important. Nor are they additive. A simple scoring sheet won’t do. Worse still, the wrong combinations of them can kill your venture. On the other hand, sufficient strength on some factors can mitigate weaknesses on others. Good opportunities can be found in not-so-attractive markets and industries.

To understand the diagram, it’s worth starting by addressing a very common confusion. As mentioned above, markets and industries are not the same thing. But very often entrepreneurs and even investors blur the definitions. This leads to trouble.

What Do We Mean by Market?

Markets consist of buyers, not products
A market consists of a group of current and/or potential customers having the willingness and ability to buy products – goods or services – to satisfy a particular class of wants or needs. Thus, markets consist of buyers – people or organizations and their needs – not products.

Example: One such market, for example, consists of businesspeople who get hungry between meals during their workday. We’ll call this the market for workplace snacks.

What Do We Mean by Industry?

An industry consists of sellers – typically organizations – that offer products or classes of products that are similar and close substitutes for one another.

Example: What industries serve the market for workplace snacks? At the producer level, there is the salty snack industry, the candy industry and the fresh produce industry, to name but three. There are also industries providing the distribution of these products to workplaces, including the supermarket industry, the restaurant industry, the coin operated vending machine industry, the coffee bar industry and so on. Clearly, these industries offer varying bundles of benefits to hungry workers. Some of these industries are more attractive than others to would-be entrants seeking to serve the workplace snack market.

Market, Industry – Why Care About the Difference?

Why is the market-industry distinction important? Because judgements about the attractiveness of the market one proposes to serve may be very different from judgements about the industry in which one would compete.

This should not be – but often is – surprising, for the questions asked to assess market attractiveness are different from those for industry attractiveness, a point easily obscured when words like ‘sector’ and ‘space’ are used indiscriminately or carelessly in the opportunity assessment process. (Does the user of these terms mean ‘market’ or ‘industry’?)

So, if market and industry attractiveness are both important, how should each be assessed?

Is the Market Attractive? How to Assess?

All else being equal, most entrepreneurs and investors would prefer to serve attractive rather than unattractive markets, of course. How might such market assessments be made?

Market Assessment – a Common Mistake

Many aspiring entrepreneurs make the mistake of examining only the macro-level. This behavior appears to be especially common in technologically driven firms. Through failing to identify the first customers who will buy – almost by name – and why they would benefit, and in ignoring how entry into this segment might create one or more options for growth into other market segments, they risk pursuing a dead-end path on two counts:

  • without differentiated benefits, most customers won’t buy
  • without a pathway to growth, most investors won’t invest.
HOW TO: Macro-level Assessment, Market

It is actually quite straightforward to conduct a macro – level market assessments. One first assesses – usually by gathering secondary data from trade publications, the business press and so on – how large the market is. Market size can be measured in many ways – the more the better.

Questions to ask:

  • How many customers in the market?
  • How much aggregate money is spent by these customers on the relevant class of goods or services?
  • How many units of relevant products or usage occasions bought annually?

Trend identification:

One also collects recent historical data, to ascertain how fast the market has been growing, together with any available forecasts about how fast it is likely to grow in the future.

One then assesses broad macro-environmental (macro for short) trends – demographic, socio-cultural, economic, technological, regulatory and natural – to determine whether things are likely to get better or worse in the future. Do the trends favour the opportunity, or will the entrepreneur be swimming against a powerful tide?

Why does the size of the market matter?

The broad, macro-level market assessment is important to the entrepreneur, for he or she risks investing years committed to an idea that, in the end, may not be large enough to be worth all the time and effort.

HOW TO: Micro-level Assessment, Market

No matter how large and fast-growing a market may be, entering it in the face of other competition is likely to be difficult, since customers are probably already satisfying their needs – though perhaps not optimally – in some way. In this sense, there’s no such thing as a new market in customer terms.

Aspiring entrepreneurs who say ‘We have no competition’ are simply naïve.

Aspiring entrepreneurs who say ‘We have no competition’ are simply naïve. Thus, most successful entrepreneurs, rather than targeting the entire market, identify a much smaller segment of customers within the overall market. The micro-level market assessment involves asking four key questions relevant to such a segment.

Questions to ask:

  • Is there a target market segment where we might enter the market in which we offer the customer clear and compelling benefits, or – better yet – resolve their pain at a price he or she is willing to pay?
  • Are these benefits, in the customers’ minds, different from and superior in some way – better, faster, cheaper or whatever – to what’s currently offered by other solutions? Differentiation is crucial. With the possible exception of niche markets in which small entrants can safely fly ‘below the radar’ of competitors, the vast majority of me-too products fail.
  • How large is this segment, and how fast is it growing?
  • Is it likely that our entry into this segment will provide us entry to other segments we may wish to target in the future?

Where do I get the answers?

Most commonly, a combination of first-hand primary data (gleaned from talking to or surveying prospective customers) and secondary data (data collected previously and available on the Internet or in libraries or from other sources, to determine segment size and growth rate) can deliver the understanding that the entrepreneur needs.

Is the Industry Attractive? How to Assess?

img_ind_industry_macroJust as serious entrepreneurs prefer to serve attractive markets, so they also prefer to compete in industries in which most participants are successful and profitable, rather than in industries where many firms struggle to survive. Serious entrepreneurs also prefer to compete on the basis of some sustainable advantage that their competitors do not enjoy. How might these crucial judgments be made?

HOW TO: Macro-level Assessment, Industry

Michael Porter, in the late 1970s, identified the forces that determine industry attractiveness. These forces – five of them – are powerful determinants of the overall profitability of any industry, not a bad thing for an aspiring entrepreneur to know:

  • threat of entry
  • buyer power
  • supplier power
  • threat of substitutes
  • competitive rivalry

Assessing these forces and any ongoing or likely future changes therein lies at the heart of a macro-level assessment of industry attractiveness.

So, how should a five forces analysis be done? What should be its outcome?

Questions to ask:

The aspiring entrepreneur first identifies what industry his or her new business will be in – retailing, food manufacturing, software, or whatever. Doing this is not a trivial exercise. Industries can be defined broadly or narrowly.

The entrepreneur then asks a series of questions about each of the five forces to determine whether that force is favourable or unfavourable on balance. The more forces that are favorable, the more attractive the industry, and vice versa.

As it turns out, most industries are not very attractive.

Where do I get the answers?

As in the case for the macro-level assessment of market attractiveness, gathering secondary data is necessary here, but such data tell only part of the story.

Additional, first-hand industry knowledge or primary data are usually required to develop a clear understanding of how the industry works and how it is changing. You will have to find a way to talk to people who know the industry.

HOW TO: Micro-level Assessment, Industry

Identifying and assessing the sustainability of the proposed new firm’s competitive advantage is necessary to fill in the micro-level industry piece of the opportunity assessment puzzle.

How might these micro-level industry judgements be made?

Questions to ask:

Assessing the sustainability of the proposed venture’s competitive advantage requires examining, in relationship to its competitors, the proposed venture itself – whether a new firm or a venture within an existing firm. These factors can be assessed with following questions:

  • Does the venture have proprietary elements – patents, trade secrets and so on – that other firms are unable to duplicate or imitate?
  • What will be the likely presence of superior organizational processes, capabilities or resources that others would have difficulty duplicating or imitating?
  • Is there an economically viable business model – one that won’t quickly run out of cash

The third factor, in turn, involves a careful look at some more detailed issues:

  • threat of substitutes
  • competitive rivalry
  • revenue, in relation to the capital investment required and margins obtainable;
  • customer acquisition and retention costs, and the time it will take to obtain customers;
  • contribution margins and their adequacy to cover the necessary fixed cost structure to operate the business;
  • operating cash cycle characteristics, i.e. how much cash must be tied up in working capital such as inventory, how quickly will customers pay, and how slowly may suppliers and employees be paid, in relation to the margins the business generates.

Where do I get the answers?

Information on the economic structure of most industries can be found from published sources such as the Risk Management Association’s Annual Statement Studies, available in most business libraries and on the Internet, e.g. the Risk Management Association’s website, www.rmahq.org

However, it’s worth noting that first-hand experience in the industry makes all the difference in addressing these issues. Entrepreneurs who know the territory will have the necessary answers.

Those who don’t must find people who do. Adequate answers for most of these issues are not likely to be found on the Internet.

Pick up the phone and call those who you know can help is a good way to get some answers. And it helps build your network, to

Can the Team Deliver?

When pressed to name the single most important factor in their investment decisions, many of the venture capitalists we interviewed said, simply, ‘Management, management and management.’

But we learned that assessing ‘management’ involves more than judging character and reading CVs.

Questions to ask:

Our research identified three domains relating to the entrepreneur or entrepreneurial team. Examining these domains is necessary in order to complete the opportunity assessment task.

  • Does the opportunity fit the team’s business mission, personal aspirations and risk propensity?
  • Does the team have what it takes, in a human sense – in experience and industry know-how – to deliver superior performance for this particular opportunity, given its critical success factors?
  • Is the team well connected up, down and across the value chain so it will be quick to notice any opportunity or need to change its approach if conditions warrant?

Let’s take a look at each of these three domains.

The team’s business mission, personal aspirations and risk propensity

For a variety of reasons, individual entrepreneurs and investors come to the opportunity assessment task with certain preconceived preferences, often defined in terms of:

  • markets they wish to serve (Nike’s founder, Phil Knight, an athlete himself, wanted to market to athletes)
  • industries in which they are willing to compete (for Knight, athletic footwear)
  • their own aspirations (how big a venture, how soon, if at all, do we wish to exit, are we committed to this opportunity or are we buying an option to see whether it pans out?)
  • risks they are willing to undertake (with how much money, how certain must we be of a successful venture, must we have control, or are we willing to share it?)
The Team’s Ability to Execute on the Critical Success Factors

The backgrounds and prior experiences brought to the venture by particular entrepreneurs and investors make them better prepared to execute on some sets of critical success factors than on others.

Understanding the critical success factors relevant to a particular opportunity and the industry within which it will compete and matching them against the team’s ability to perform on them is among the most compelling questions most investors ask in assessing opportunities. Entrepreneurs should do the same.

The team’s connectedness up, down and across the value chain

A favorite saying among venture capital investors is: ‘I’ve made more money on plan B than I ever made on plan A.’ In other words, the ability to combine tenacity with a willingness to change course – typically due to changes in the marketplace, fortuitous or otherwise – can make all the difference.

Thus, good luck can help a new venture, but those best prepared to take advantage of good luck are those whose leading-edge information connections enable them to respond to market changes quickly and adroitly.

Entrepreneurial teams should ask how connected they are, both up and down the value chain – with suppliers and customers – and across their industry to address this concern.

How can they get connected if they are not? One partial answer: network, network, network.

Putting The Seven Domains Model Into Action

Using the seven domains model requires a considerable amount of data. Mere opinions that an opportunity is attractive will not suffice and will destroy the credibility of the aspiring entrepreneur in the eyes of others.

Where Do We Get All The Data We Need?

Much of the data the model calls for can be obtained quickly from secondary sources: trade and other business publications in the library or on the Internet, government reports and so on.

pick up the phone and get some feedback!

Typically, though, some primary data – from interviews, observation, focus groups or surveys of prospective customers and/or industry participants, or market experiments – are necessary for the two micro-level assessments comprising the lower row in the model and for understanding the industry’s critical success factors. View the seven domains model <>

So, build a simple mockup or prototype, pick up the phone and get some feedback! Make the connections up, down and across the value chain that your team will need to assess fully your opportunity and to run a successful venture.

How Do We Interpret All The Data?

Using the model is not a simple matter of constructing a score sheet that adds scores for the seven domains. The domains are not additive and their relative importance can vary. Thus, a simple checklist will not suffice.

The wrong combination of factors can kill your new venture, and enough strength on some factors can mitigate weaknesses on others. So, if a checklist is not sufficient, then how should the entrepreneur who completes a seven domains analysis draw conclusions about what it means?

Why Won’t This Work?

Along the seven domains path, concerns inevitably crop up that may be potentially fatal flaws that can render one’s opportunity a non-starter. The key task in answering the crucial question ‘Why won’t this work?’ is to find that major flaw that cannot be resolved, the opportunity’s Achilles heel.

The crucial things to look for on the downside are elements of the market, industry or team that simply cannot be fixed by shaping the opportunity in a different way.

Most business plans should have been abandoned before they were written

If flaws that cannot be fixed are found, then the best thing to do is to abandon the opportunity at this early stage and move on to something more attractive.

Case Study: Nike Wins at the Micro-level

The story of Nike’s origins is now a familiar one. Phil Knight, a distance runner, and his track coach Bill Bowerman used Bowerman’s wife’s waffle iron and some latex to develop a running shoe for distance runners that was lighter (benefit: faster race times), had better cushioning (benefit: fewer shin splints and stress fractures from miles and miles of training), and had superior lateral stability (benefit: reduced chance of ankle sprains caused by running on uneven terrain).

At the macro-level, the market for athletic footwear was stagnant at the time. Most people had only one or two pairs of sneakers and saw no need for another.

From a micro-perspective, however, distance runners loved Knight’s and Bowerman’s new shoes, and their success in the distance running segment led to later successes in tennis, basketball and other sports that have made Nike one of the world’s leading brands.

In opportunity terms, what Knight and Bowerman saw initially was a chance to offer a demonstrably superior product that customers – distance runners – would prefer and pay for, one that could then lead to similar success in other sharply targeted footwear niches.

Their sport-by-sport advance across the formerly stagnant athletic footwear market, accompanied by astute marketing that made high-priced athletic shoes a fashion item, led to that market’s stunning growth (how many pairs of different athletic shoes are in your closet today?) and to Nike’s leading position in today’s athletic footwear industry.

 



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