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The Hockey Stick Growth Model

A popular topic in entrepreneurship these days is the concept of ‘scaling’ or how to substantially grow your business.  Many articles are being written about a the ‘hockey stick growth’ phase (Recent Forbes blog post).  The hockey stick is an important phase that can elevate a firm or in many cases, destroy it, depending on how management handles the growth spurt.  With that said, there are some important caveats to many of the hockey stick models that different writers address.

  1.  The timing is hard to predict.  In most models presented, it shows the scaling phase as pretty smooth and sequential.  However, in real life the timing of when it occurs and how long it will last is very difficult to predict.  We like to show that smooth S-curve growth rate but rarely does this happen.
  2. False Signals – as Geoffrey Moore presented in  Crossing the Chasm, the market place may send false signals about if the hockey stick growth is really occurring.  Moore noted that companies may get false impressions from the early adopters or tech enthusiast segments of the market as the early excitement after a new product or service is launched may not transfer to the middle majority.
  3. Hard to estimate the market or growth rates.  Again, we tend to show a smooth S-curve growth rate when the hockey stick phase begins.  On paper, it looks rather simple to examine the rate of change in the slope and measure the growth rate of the sales.  However, in reality, they may be ‘fits and starts’ where exponential growth occurs for a month or so, slows down and picks up again.
  4. If the Hockey Stick is really happening.  It will attract new attackers quickly.  So what looks like a smooth path may change dramatically as competitors react and compete directly, usually dropping prices or some other steps to gain share.


Why is this important to understand?  It’s important for entrepreneurs to be cautious when the hockey stick growth phase occurs.  Depending on the type of product or service offered (for example, if it’s software program, scaling will be easier and less expensive), it’s key to remain lean and nimble ready to adapt as necessary.  Usually, it’s best to outsource as much as possible to avoid the heavy fixed investment that’s needed to support the sales.  You want to be in a position to unwind as quickly as you build up your infrastructure unless you realize that the growth is here to stay and greater infrastructure will be needed to support future products, etc.


The Theory of Your Business

In class this week on Entrepreneurial Management, we discussed what I believe is an important question for any startup and small business.  Using Peter Drucker’s article in the Harvard Business Review as the foundation, we discussed how to get a small business to identify “The Theory of their Business”.

Drucker notes that most businesses, especially when performance is suffering, focus on new management techniques or what he calls ‘how to-do’ tools.  In many cases, Drucker observes that the problem doesn’t lie in what the company is doing but more in what is happening outside the firm.  Example after example can be provided where at one time a company is doing well leading their industry then in a short time, becomes an industry laggard.  Nothing the firm is doing has changed but something in the outside environment has altered the conditions of the industry.

Drucker blames this on the business’ theory or the assumptions that the firm’s foundation was built on no longer fit reality.  These assumptions may include markets, customers, competitors ( both their values and behavior),  technology and the company’s strengths and weaknesses.   In other words, the Business Model is not as relevant.

The way to deal with identifying if your business theory is relevant is for the leadership of the organization to re-look at its  assumptions about the environment of the organization(society and its structure, the market, the customer, and technology), assumptions about the specific mission of the organization, and assumptions about the core competencies needed to accomplish the organization’s mission.  This should be done on a continual basis to assure that reality is not drifting from the business.  Additionally, the theory must be constantly tested and communicated throughout the organization.

While Drucker passed away several years ago, his writings still hold true.  Constantly evaluate the theory of which your business is based upon and it will assist your firm in making sure its still relevant.


Donald Trump – The quintessential Promoter Management Style?

With all the news of our Presidential candidates during primary season, it’s always interesting to view the potential leadership styles of those in the race.  One of the candidates, Donald Trump, exhibits many of the leadership traits we often see in entrepreneurs that we discuss in our entrepreneurial management classes at the University of Wisconsin – Madison School of Business.  That style, the Promoter leadership style, is one so often associated with entrepreneurs like Trump.

The Promoter leadership style was identified by the late Emeritus Professor Alan Filley at the University of Wisconsin – Madison School of Business as part of his work on characteristics associated with certain types of small businesses (i.e., organizational typologies).  Specifically, Filley identified one category of businesses,  as the Market/Innovation type firm.  According to Filley’s framework,  the Market/Innovation type form is based on exploitation of an innovative, success is based on the ability of the entrepreneur and employees to adapt to an uncertain, ever changing environment. Typically, such a firm experiences an S-shaped pattern in its sales growth as the new innovation is introduced to the market place. Initially, the company experiences rapid sales growth upon in a market that has few competitors.


In a Market/Innovation type organization, the leadership role is typically filled by a charismatic entrepreneurial leader where, in the initial stages of the firm, the entrepreneur is viewed as a ‘hero’ by many of the employees. They believe that the entrepreneur can perform in an exceptional manner to obtain the exciting goals established for such a firm. The entrepreneur is usually characterized by having a high need for achievement, as having difficulty dealing with authority, and as having the ability to make decisions under conditions of uncertainty. Also, many times the entrepreneur appears to have a difficult time differentiating the person from the organization, it is one and the same (i.e., the firm is the entrepreneur and the entrepreneur is the firm). Filley appropriately classified this type of entrepreneur as the ‘promoter-style’ of leadership.

The personal influence of the promoter/entrepreneur on the firm influences the organization structure that evolves in the Market/Innovation Centered firm. Usually there is minimal hierarchy with the entrepreneur having contact, visibility, and direct influence with everyone in the organization. She functions as the central communications center and a major source of decision-making in the organization. As a result, the structure tends to be quite flat, insofar as possible, everyone reporting to the entrepreneur.

The objectives and goals of the firm reflect the promoter with exaggerated and appealing objectives of what the firm wants to achieve. For instance, you may hear founders/managers/employees make claims such as “we’ll all be rich some day,” “our stock options will make us millionaires,” “we’ll be a billion dollar company some day,” or “we’ll all be driving Porsches some day.” The firm, especially in the early stages of development, establishes high expectations and enthusiasm for its members creating an excitement level that is rarely seen in other organizations. This passion and excitement is intoxicating and provides the early motivation for “the cause” of the firm.

As the organization gets larger, the promoter deals with the growth by working more hours, even weekends and holidays. Ultimately, the greater hours causes the promoter/owner to procrastinate with duties that don’t need to be completed on an immediate basis, only dealing with issues that are extremely urgent. Planning, never a strong suit of a promoter, becomes even less of an objective when, in fact, it should.

Finally, to deal with the time demands, the promoter/entrepreneur hires staff to serve as her ‘arms and legs’. Many times, these individuals are identified as an assistant, executive secretary, or a right-hand person. One day, the assistant is asked to make a phone call, the next day to open mail, the third day to find out the status of an order being built by the company. These individuals are not given any authority or responsibility, only to do the action that the promoter would normally have done based explicitly on the owner’s directions.

The formal mechanisms found in many firms such as policies, planning and procedures are minimal, if not non-existent, in Promoter-led firms. The tactics and day-to-day actions are improvised and subject to the whims of the leadership within the organization. Organizational charts and strategic plans may exist only on paper as the leaders in this type firm create the rules ‘by the seat of the pants’. Because the firm is typically smaller in size at the onset, the leader has personal contact with many of the employees so such tactics are not totally inappropriate as the team can communicate informally on a relatively easy basis.

This type of organization is designed, either explicitly or tacitly, to be able to change quickly to take advantage of the unique innovation as bureaucracy and cumbersome decision-making process impedes the need to move fast.

As the Promoter-led  firm grows, issues emerge. First, because the firm is set up to exploit some kind of innovation, a major problem usually develops on supplying the product or service to the customer. The unique structure of the firm where the promoter/leader is at the center of every decision makes it difficult to handle growth as the complexity and number of decisions needed to be made grow exponentially with higher sales. When small in size, the complexity can be handled by the owner and the few employees. However, when growth sales rapidly increase, employees hired, the promoter/entrepreneur is unable to make every decision for production, marketing and other functions in the company. Thus, employees constantly consult with the owner as to what he/she wants done which becomes untenable as the size of the firm increases.

Second, the firm typically experiences fast sales growth and high margins as their unique innovation protects against competitive pressures. As a result, the promoter/entrepreneur fails to see the need for budgets and other cost control measures as the company’s growth in sales and profits allows sufficient funds to pay for an extravagant lifestyle. However, once sales growth declines due to competition, the company has built an expensive, inflexible infrastructure comprised of mostly fixed costs. As a result, the financial losses are exaggerated as company experiences out-of-control expenditures continue to occur despite the lower revenue base.

Finally, as operations become out-of-control too much growth or a decline in business (combined with financial losses), morale of the employees is dramatically affected. In the initial stages of the company, the promoter/entrepreneur is able to attract a team and employees based on the excitement of the opportunity, the joy of a startup, and the charisma of the leader.

As time progresses, management and employees who seek responsibility for decision-making leave due to the control nature of the founder. Usually, those who remain are ‘followers’ who are attracted to a ‘hero-type’ leader that they can put on a pedestal for adoration. As long as success continues for the firm, morale of the remaining team remains high. It’s when the downtimes occur that major morale problems emerge. Also at this point, the effectiveness of the founder/entrepreneur as prime motivator and the center of decision making may decline through loss of charisma, loss of energy, or some other reason.

At this stage, the entrepreneur goes from hero to anti-hero based on a number of factors. One, the exaggerated promises made early can seldom be realized, creating disenfranchisement and disappointment. Further, as the company suffers, management systems are installed to control the problems usually increasing accountability through tighter authority. Many times, this occurs with outsiders brought in to turn things around. With the inclusion of outsiders, the emotional bond that developed between employees and the founding entrepreneur is strained with the advent of greater authority.


Finally, charismatic leaders seem to attract people who want to be changed, save, or enriched in some way and the followers of this sort will continue to attach themselves to presumed charismatic leaders, only to move on in disappointment when the leader turns out to be fallible. In summary, the high to low morale patter is common, creating loss of long service personnel, bad feelings, and attempts to subterfuge or unionize when it happens.



Values Entrepreneurship teaches young Children? What about PROFIT?

On the Huffingpost -Canada site, an blog was posted about the values that entrepreneurship teaches young children (Values Eship teaches young children).  The short article makes some solid points but in my very humble opinion misses one key component that I also see in many of today’s entrepreneurs from many backgrounds.  That point is – the process of making a profit for the venture (assuming it’s a for-profit venture).

The profit-loss aspect of entrepreneurship is critical to the concept of starting a venture and hopefully sustaining it and growing it for the long-term.  It’s the ultimate way score is kept by business people and is a major driving force as to how you will allocate resources in your business as the founder/CEO.  Trying to decide whether to hire employees, lease new office space, spend money on new equipment, etc. are all decisions that have to be weighed against the long-term financial goal of earning and growing profits.

Why can this be a valuable value for kids to learn?  First, it shows kids that math is important – not just how to add/subtract/divide/multiply but to understand what is the driving force(s) behind profit making.  Second, and so important, is that it shows that with any decision, there are many benefits and costs to the venture that can be measured.  This shows young kids a very important axiom in economics – unlimited wants, limited resources – that not all things can be done.  This experience can have a direct impact on developing self-discipline for people of all ages (something always discussed as a key part of leadership development, i.e., the marshmallow test).

I’m not sure why people are fearful of discussing the importance of profit and loss in businesses.  It’s not the only factor but an important one that can provide a great learning tool for folks of all ages.

Valuation of High Tech Firms, a ‘new concept’?

In the latest McKinsey Quarterly, one of the articles is an excerpt of an updated Valuation book (Link:  Valuing High Tech Firms) suggests that investors should return to more traditional methods of valuing early stage high tech firms including the use of Discounted Cash Flow (DCF).  The article notes the issues with using multiples like Price-to-Revenues, Price-to-R&D Expenses, etc. in that they consistently overvalue the true value of a firm due to market conditions.

The article is a good reminder but a bit late and too simplistic.  Using the process suggested for many years by Professor Bill Sahlman of the Harvard Business School and others (especially in the Jim Southern case), it’s important to use a variety of valuation techniques to obtain a range of values.  More importantly, it’s important to distinguish between a company’s Intrinsic Value, Market Value and its Price.

The Intrinsic Value (or worth) of a company should be valued using methods like Discounted Cash Flow or asset valuations (depending on if you’re buying the assets or equity of the company).  DCF is a well-tested theoretical method that should be conducted under current management and under your management (after you’ve made the investment).  Doing so under the two separate conditions will help an investor identify if they can bring additional value under their ownership versus the current management.

Of course,DCF has its limitations.  What Discount Rate?  What Conversion Rate of customers from users to payers? (they use Yelp as an example). What growth rates to use (especially five years out)?  What will be the exit value?    All important parts of a DCF forecast that have lots of variability, especially when taking all components together. The authors suggest multiple scenarios at various weights to take variability into account but still there is a lot of room for error.

When ascertaining the market value of a firm (or at least estimating it) you want to incorporate market multiples pertinent to that industry.  For instance, many commercial brokers use a Price to Sellers Discretionary Earnings multiple to provide a rough market estimate for privately-held small businesses.  Other industries may use a Price-to-Book value, Price-to-Patient Census (health care), or Price-to-# of Rooms (hotels) to gauge value.  Whatever multiple is used, it is important to gauge market conditions.  If we are in a significant market expansion and rising stock market values, prices of privately held businesses tend to follow (including gold fever situations).  On the other hand, when we are in a recession or a tight money environment, market values will trend downward with the public markets.

Finally, just because you have a DCF and a market value estimate, it doesn’t necessarily mean the price that is negotiated, especially when dealing with privately held companies, will be close to the rationale values developed using intrinsic and market methods.  Emotions can play in negotiations.  How badly the venture needs capital also enters into the equation.  Finally, how much PR has the venture received creating a competitive investment strategy between multiple investors that may drive up prices?

All these factors play into the valuation process.  The McKinsey does a nice job suggesting the tried and true but yet so much more is needed in valuing high tech or any venture when dealing with the privately held business arena.

Why keep VC-Backed enterprise alive when it should be shut down?

Recently, I had a conversation with a local Midwest entrepreneur who made the comment that he could not understand why the venture capital, angel investors, and bank lenders wanted to keep putting money into his enterprise when he felt the company should close up shop?  It was an interesting comment that I had to think about for a bit but there may be a reason for it.

One reason, especially for venture capital funds and bank loan officers, has to do with incentives.  If faced with closing down a business or keep it alive, mainly providing just enough funding to keep the lights on.  Let’s look at a simple example.  Assume a loan officer (and this could be a venture capitalist as well managing a portfolio) at a bank has a portfolio of 3 loans – Company A for $100,000 at 10% interest; Company B for $200,000 at 5%; and, Company C for $500,000 at 8%.  Assuming all is well and the companies are making their payments on time, annual interest income would be $60,000 (A=10,000 + B = 10,000+ C =40,000) on total portfolio of $800,000 or an average annual rate of return (assuming that the loan principal stays the same) of 60/800 or 7.5%.

Many loan officers managing a portfolio of loans are measured, at least in part, by their loan portfolio performance (annual interest income/average loan principal).  Assume that during the year, Company A runs into trouble and looks like it may have to default on its loan.  If Company were to default at the beginning of the year and the loan was deemed non-performing or uncollectible, the loan portfolio loses both the interest and the principal of the loan.  In other words, the loan officer sees her loan lose $10K in interest income and a loss (reduction of income from the portfolio) of $100,000.  In total, the portfolio performance will have interest income of $50,000 less the $100K in principal loss generating $50,000 net loss divided by $700,000 in principal left from B and C.

If the compensation package for the loan officer is based on loan performance, she will typically have an incentive to either keep the loan alive and try to restructure so the firm can sustain or at least push off killing the loan until the next year or later.  The loan officer will try to restructure interest rates, lessen the annual principal repayments and/or other steps to put off formally announcing the loan as non-performing taking a hit to current year loan performance (and missing a potential bonus).

With a venture capital portfolio, a similar situation may exist.  A VC fund is generally judged by either Cash-on-Cash Return to Limited Partners (LPs), the Internal Rate of Return (IRR) or the Net Present Value at a certain rate.  While they won’t want a company to a fail and lose the entire investment in a firm, they have the general understanding that a certain percentage of firms won’t make it.  Instead, a VC portfolio has an incentive to defer the loss as long as possible to lessen the time value impact of the lost investment on portfolio performance.  Similar to banks, if they sense that a company in their portfolio is not going to make it, the will provide just enough capital to keep it alive on fumes hoping things may change, another company will buy it at ‘fire-sale’ prices, or at the least, keep deferring the inevitable of shutting it down and taking the loss at a later year before the fund needs to close.

So much behavior in business, management, investing and other functions can be explained, at least in part, by incentives.  Using incentive systems as a guide may explain some of the behavior of investors in young companies.

Millennial not starting companies due to…

Student debt?   A short article on suggests that the Millennial generation are not starting companies due to the load of student debt.  “Currently, 8% of millenials own a business, 16% are making plans to start a business, and 27% want to start one someday but have no current plans to do so.’  Of those who want to start a business, almost 40% are putting such plans due to student debt.

This is an interesting phenomena that has been previously discussed in many other venues.  And, it is a bit scary how much debt students are incurring due to the ever-increasing education costs at undergraduate and graduate institutions.  My thought is ‘so what’?

Most entrepreneurs will tell you of stories of having mortgages, student loans for their kids, and other debts that exist in their lives.  Yet, they still find a way to start their business.  Critical is that they develop a business model that will generate enough wealth to provide them with enough money to cover their lifestyles and/or have to be creative in finding ways to seek external financing from banks and investors to get the business going.

Is this not in fact what a startup should be?  Not just a lifestyle choice but taking on the responsibility to generate an idea that will create wealth for all stakeholders involved.  What it means is that not all businesses need to be started when your 21 and that not all ideas are meant to be businesses as they can’t sustain enough cash flow to pay employees, pay suppliers, pay the investors, etc.

This student debt thing is real but it shouldn’t be the limitation as to starting a business.  If you’ve got an idea that can generate wealth through providing true customer value that they will pay for, go for it.  Otherwise, cut out the excuses.  Starting a business ain’t for everybody.  What I’m most worried about is that the student debt issue in relation to entrepreneurship and starting a business is becoming part of the political discussion of debt forgiveness and receiving votes for our politicians.