Developing a business plan for an existing line-of-business (LOB) is quite different than planning for a new initiative. To plan for an existing LOB, one could extrapolate future results from past experiences. But for a new initiative – whether a new business, new market or new product – extrapolation rarely works, because, the predictions for a new initiative are based upon assumptions and not past knowledge. So what is the best planning approach for a new initiative?
Few years back Prof. Rita McGarth of Columbia and Prof. Ian MacMillan of Wharton introduced, Discovery-Driven Planning, a tool that converts startup assumptions into knowledge that, they argue, grounds the planning for a new initiative in reality.
Their tool imposes planning discipline through four documents. A ‘Key Assumptions Checklist’ identifies the business hurdles and assumptions for the initiative. A ‘Reverse Income Statement’ models the business economics. The ‘Pro-Forma Operations Specs’ defines operations needed to run the business. And, ‘Milestone Planning Chart’ specifies when the assumption needs to be tested.
Let’s build a simple case to see how it works. Let’s consider the proverbial widget making company, which is contemplating entering a new market with a new product. Its return on investment and other directives call for a profit of $400,000 for the first year from the new initiatives. Some of its other key assumptions may look like:
Reverse Income Statement
Next we develop initial Reverse Income Statement. In discovery-driven planning one starts with the required profit and works up to determine how much revenue is needed and the cost allowed to generate that revenue. In our example required revenue would be $4,000,000 giving us allowable cost of $3,600,000. Also $4 million of sales will call for a 2.5% market share.
Pro-Forma Operations Specs
Then we develop the Pro-Forma Operations Specs.
Update and Revise Reverse Income Statement
Then we update the income statement.
Milestone Planning Chart
Finally we need to develop a Milestone Planning Chart, which could look this.
This entire process is looped and there is continuous feedback from one stage to next. One could see that such a planning tool allows for a rigorous testing of the assumptions that necessary for a new initiative throughout the initiative. It has strong potential to reduce the uncertainty in planning for a new business. It enforces a planning discipline that creates checkpoints before significant commitments are made that could help the management determine whether it is prudent to go forward or not.
If you want to download the Excel Spreadsheet used for this example then click here.