Entrepreneurship & Innovation Titles - Selected Excerpts by Palgrave Macmillan Professional Business

inspiration for

innovation

a sampler of small Business and entrepreneurship Books from palgrave professional Business

Selected Excerpts from: Ă&#x153;berpreneurs Beyond the Business plan second stage entrepreneurship startup rising the power of Customer misbehavior governance in family enterprises

Contents 3 Ă&#x153;berpreneurs Peter Andrews and Fiona Wood 16 Beyond the Business Plan Simon Bridge and Cecilia Hegarty 23 Second Stage Entrepreneurship Daniel J. Weinfurter 31 Startup Rising Christopher M. Schroeder 46 The Power of Customer Misbehavior Michael Fisher, Martin Abbott and Kalle Lyytinen Koeberle-Schmid, Denise Kenyon-Rouvinez 54 Governance in Family Enterprises Alexander and Ernesto Poza

Palgrave Professional Business books are written by the best minds in business, combining topical writing, cutting edge research and strong industry case studies. In this sampler we have included chapters from our recently published Small Business and Entrepreneurship books. These books are about driving growth, development and creativity. With advice from experts that have been there and done it, these books provide the tools to help you and your organization lead, be flexible and break boundaries. To order any of these books, please visit www.palgrave.com and enter the promo code WORLDPALGRAVE20 to receive a 20% discount.

9781137376145 | December 2013 UK / January 2014 US ÂŁ22.99 | $35 | $40 CAN Hardback | 338 pages

Exploring the lives and achievements of 36 extraordinary individuals from across 18 nations and every continent, Ă&#x153;berpreneurs champions innovators: the disruptive individuals whose heroic visions and indomitable spirits are redefining the economic and social structure of our world. Available to order at www.palgrave.com. Enter the code WORLDPALGRAVE20 to receive a 20% discount.

4 â&#x20AC;˘ An Excerpt from Ă&#x153;berpreneurs

Chapter 2 SOFAS, SPIRITS AND SKIRTS

IN 1926, ECONOMIST GEORGE TAYLOR came up with a delightfully simple indicator for the health of the economy: the higher the hemline, the higher the stock market. And, at least for the next 50 years or so, he was pretty much on the money. In the early 1930s, in the depths of the Great Depression, hemlines plummeted to ankle length, rising slowly toward knee-level during the Second World War, before soaring to the dizzy heights of the miniskirt in the mid-1960s. But the booms in employment levels, birth rates and consumer demand that characterised the postwar recovery of Western economies were far from uniform. At the head of the pack was Sweden. Neutrality during both world wars meant its industrial infrastructure was still intact. And substantial devaluations of the krona strengthened export markets in the depths of the Great Depression and the aftermath of the Second World War. The "Swedish Model", introduced by the newly elected Social Democratic Party in 1936, further accelerated growth with its powerful combination of industrial privatisation and the notion of a classless society. By 1970, Sweden's GDP was the third highest in the world. In the United States, the Great Depression hit much harder, with unemployment rising to 25% in 1933, and as many as one-third of the

An Excerpt from Überpreneurs • 5

ÜBERPRENEURS

population lacking adequate food, clothing and housing. The drafting of 12 million American men, and the temporary employment of 6 million American women in armaments factories, boosted recovery during the Second World War, but the real economic growth came after the war. The Golden Age of Capitalism, driven by rapid industrialisation and wider access to tertiary education, lasted for 25 years. Spain was the last to recover - about a decade later than other EU countries. Handicapped during the Great Depression by ineffectual government and the 1936 - 1939 Civil War, the policy of national selfsufficiency (the Spanish Autarchy) introduced by General Franco in 1939 led to ongoing and severe economic depression for the next two decades. By the early 1950s, Spanish GDP per capita was less than half of the Western European average. It was not until 1959, when the economy was opened up to foreign investment, that the Spanish Miracle emerged, with economic growth rates second only to those of Japan for the next 15 years. So, by 1951, when New York Post columnist Sylvia Porter famously referred to the US postwar baby boom as "the biggest, boomiest boom ever known in history", Sweden's baby boom had already been running for ten years, while Spain's was still to come. But there was one critical change that they all had in common: the high employment levels and increased salaries that drove their burgeoning economies also kindled the aspiration that well-designed furnishings, quality clothing and fine spirits should no longer be the province of the rich alone. And pouring fuel on that fire were three men who knew the hardships of the Depression years firsthand: Ingvar Kamprad would make his mark by producing low-cost high-quality furniture for a new generation of Swedish homemakers; Chuck Feeney catered for the voracious appetites of first Americans and later the Japanese for luxury goods; and Amancio Ortega provided high fashion at affordable prices for the newly emerging Spanish middle class. They founded the largest furniture, liquor and fashion retailers of all time: IKEA, Duty Free Shoppers Group and Zara.

6 • An Excerpt from Überpreneurs

SOFAS, SPIRITS AND SKIRTS

INGVAR KAMPRAD

There are three things you need to know about shopping at IKEA. First, go with the flow. Any attempt to find a shortcut to the section that sells the gizmo that you came to buy will result in dismal failure. Follow the prescribed "natural" path and resign yourself to buying a selection of nicely designed and competitively priced items that you didn't know you wanted and may never use. Second, reward yourself with a delicious lunch of Swedish meatballs, potatoes and lingonberry jam. And third, reward the kids with an hour in the free crèche, where they can leap around the ball pit and watch movies to their hearts' content, while you get lost looking for that shortcut. Like many things at IKEA, the crèche has a charming Swedish name: Småland. Literally, it means "small land". Symbolically, but hardly metaphorically, it's named after Småland, the harsh and unyielding southern province of Sweden where both Ingvar Kamprad and IKEA were born. As the IKEA catalogue puts it: "Because thin soils can't be farmed in the same way as a fertile field, Smålanders have always had to work harder, adapt their ideas and do things differently". Ingvar Kamprad is the prototypical example. Kamprad's grandfather emigrated from Germany to Småland with his wife and three children in 1894, and established a farm near the village of Agunnaryd. Three years later, faced with a hefty mortgage and a scarcely viable farm, he took his own life, leaving Kamprad's grandmother to resurrect the business. She must have been a formidable woman, for she not only managed to bring the farm to profitability while raising her young family, but also, according to Kamprad, led him down the path toward his youthful flirtation with extremist right-wing politics.

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ÜBERPRENEURS

Ingvar Kamprad was born in the village of Pjätteryd, near Agunnaryd, on March 20, 1926. It's not clear when he first developed his voracious work ethic - his grandmother once again no doubt played a role - but by the time he was ten years old he was already running a business buying matches wholesale in Stockholm and reselling them to neighbours in the village at a tidy profit. Then, in 1943, when he was just 17 years old, Kamprad went into business in earnest. Impressed by his academic performance in his final year at school, his father had given him a small cash reward to use however he wished. Unlike most boys of his age, then and now, Kamprad chose not to put the money toward a car, but invested it instead in setting up a business which he named IKEA: the combination of his own initials with those of the family farm (Elmtaryd) and the village (Agunnaryd) where he grew up. Using his bicycle as a mobile convenience store, he peddled Christmas cards and other small luxury items that thrifty Smålanders could not previously afford. And his timing was perfect: Sweden's economy, insulated by its neutral stance from the rigours of the war, was beginning to boom. Over the next few years Kamprad expanded his range of products, developing a mail-order business capitalising on the spare space available in the local milkman's delivery van, and in 1947 he began to include furniture among his product lines. This proved so successful that by 1951 Kamprad made the decision to focus solely on furniture, and in 1953 he opened his first showroom, offering his customers the opportunity to buy quality locally made furniture at prices below those of his competitors. But the Swedish National Association of Furniture Dealers was not amused. Its members responded by encouraging their suppliers to boycott IKEA, and Kamprad was forced to begin sourcing materials, often from outside Sweden, and manufacturing himself. The success of this operation was vastly enhanced by the creative inspiration of one of IKEA's draughtsmen, Gillis Lundgren, who realised that removing the legs from a table that he was delivering not only enabled him to fit it into his car, but also provided the basis for what came to be known as flat-pack furniture. In a single stroke, IKEA was able to reduce

SOFAS, AND SKIRTS 8 • An Excerpt SPIRITS from Überpreneurs

shipping costs, minimise transport damage, increase store capacity and, most impressively of all, transfer the task of assembling furniture from the company to its customers. Kamprad called it "commercial dynamite". The flat-pack innovation, combined with unstinting commitment to quality design and affordable prices, led to phenomenal growth. In 1963 Kamprad opened the first IKEA store in Stockholm, followed by others across Scandinavia in the 1960s, Europe and the Far East in the 1970s, and the United Kingdom and the United States in the 1980s. By 2012, there were over 150,000 employees and more than 300 stores throughout the developed world. Total sales turnover reached €27.5 billion, driven by 200 million catalogues in 20 different languages and more than 1 billion visits to IKEA websites. And throughout that remarkable expansion, Kamprad's business model remained exactly the same. In typically blunt language, he summarises the philosophy behind the company with the comment: The temples of design in places like Milan or God knows where overflow with beautiful, original furniture that costs extortionate amounts of money. The vast majority of people don't have six figure amounts in the bank and don't live in enormous apartments … it is for just such people that I created Ikea. For everybody who wants a comfortable house in which to live well. A need that crosses all countries, races and religions.

The execution of the philosophy is equally straightforward. At the heart of the business is a team of designers, based in Småland, tasked with creating designs for top-quality furniture suitable for low-cost manufacturing from local timber and other raw materials in multiple locations, often in developing nations, around the world. The whole operation is conducted on such a huge scale that IKEA is now the world's third-largest consumer of timber. Transferred to massive warehouses outside city centres in more than 40 countries, the entire range of furniture is displayed in adjacent showrooms, through which customers are guided on a long "natural walk" to lead them past items that they might be tempted to purchase.

ÜBERPRENEURS An Excerpt from Überpreneurs • 9

As former (albeit disenchanted) IKEA executive Johan Stenebo observes: "Once you are inside IKEA, it's as if you have been grabbed by the hand and guided through the store to make you buy as much as possible. It's called mechanical selling - selling without a salesperson". And to aid those, like Kamprad, who suffer from dyslexia, individual items have not just the standard Stock Keeping Unit codes but also their own highly evocative names: bathroom furnishings are named after Swedish lakes; bookcases after occupations. By the end of the long walk, the average customer has spent between $50 and $100 on items ranging in price from a few cents to thousands of dollars. And then, in keeping with IKEA's cult-like commitment to hard work and frugality, they collect their flat-packs from the warehouse, the kids from Småland, and head home to assemble the furniture. But IKEA's cult of frugality doesn't stop there. In tune with Kamprad's view that "waste of resources is a mortal sin", the company was an early advocate of the principles of Corporate Social Responsibility. In particular, the Natural Step Framework, a widely adopted sustainable development strategy pioneered by fellow Swede Karl-Henrik Robèrt in the late 1980s, has played a key role in IKEA's environmental policy since its initial implementation in 1990. But, despite his social and environmental scruples, controversy has never been far from the IKEA founder - be it criticisms of the company's obscure ownership by a low-tax not-for-profit based outside Sweden, which Kamprad defended as the only way to secure true financial independence for the company, or his unrepentant admiration for the one-time leader of the extreme right-wing New Swedish Movement, Per Engdahl. Recalling the many mistakes he had made during his life, and particularly his involvement with extreme right-wing politics, he wrote a letter to IKEA employees in the mid-1990s, saying: "You have been young yourself, and perhaps you find something in your youth you now, so long afterward, think was ridiculous and stupid". The reply, sent in a letter of

10 • An ExcerptSPIRITS from Überpreneurs SOFAS, AND SKIRTS

support from several hundred IKEA employees, says a great deal for both Kamprad's philosophy and the IKEA family cult that it has spawned. They wrote: "Ingvar, we are here whenever you need us. The IKEA family". For Kamprad it is indeed all about family. Through his books as well as his frequent informal appearances throughout the IKEA empire, he has never ceased schooling his co-workers in the IKEA family in the virtues of Småland frugality and self-sufficiency. And his own famous frugality extends to driving a 15-year-old car, haggling over the price of vegetables in the local market, and buying all of his furniture from IKEA: "Why would I buy anything my customers could not afford"? CHUCK FEENEY

When Chuck Feeney first set foot on the Ithaca campus of Cornell University's School of Hotel Administration in September 1952, he must have found the environment a fascinating mix of the foreign and the familiar. Foreign, because unlike the vast majority of the Ivy League university's well-heeled students, Chuck came from a poor Irish-American family. He entered Cornell on a GI scholarship at the age of 21 after graduating from the local Catholic high school in his hometown of Elizabeth, New Jersey, and serving for four years as a volunteer in the American occupying force in Japan, including the first two years of the Korean War. Familiar, because the School of Hotel Administration was a breeding ground for entrepreneurs, and Chuck's entrepreneurial talents were already clearly evident. As a schoolboy, he always had one or more enterprises on the go, often hiring his schoolmates to do the grunt work as he drummed up business selling beach umbrellas, caddying at the local golf links, or shovelling snow. At Cornell, Chuck soon combined the foreign with the familiar. Observing the lack of local fast-food outlets capable of supplying wealthy Cornell students with midnight snacks, he set up a sandwich business, making and delivering up to a 100 sandwiches a night to his fellow students. It was the first example of a talent that would make

An Excerpt from Überpreneurs • 11 ÜBERPRENEURS

Chuck and his future partners super-rich: the ability to identify looming demographic gaps between supply and demand. Graduating from Cornell in 1956, Feeney decided to see the world. With four months of his GI scholarship still to run, he spent the winter in the French Alps, earning a master's degree in political science from the University of Grenoble before moving south to seek new business opportunities. They weren't slow coming. Within weeks he was running a summer camp for the children of US naval officers based at Villefranche-sur-Mer, and by the end of summer he was pioneering the business that would occupy him for the next 40 years: duty-free shopping. With fellow Cornell graduate Bob Miller, readily lured away from his desk job at the Ritz Hotel in Barcelona, Feeney sold liquor and cars to US servicemen returning home from the Mediterranean, established a one-stop shop in Paris that offered American tourists the opportunity to purchase luxury goods from anywhere throughout Europe, and finally set up a chain of stores selling duty-free spirits to any American civilian willing and able to take a day trip across the border into Canada. It was a lucrative business, made more so by the fact that there was never any need to invest capital in stock. They simply collected deposits, arranged for delivery from the country of origin to the customer's home in the United States, and banked the cheques. By 1964 they had 200 employees in 27 countries. Then, in 1965, came a double whammy. First, inspired by their success, fierce competition began to emerge. Second, US President Lyndon Johnston, under pressure from US retailers, introduced savage reductions in US dutyfree liquor allowances, bringing their business to the verge of bankruptcy. But Feeney and Miller were not that easily beaten. They reshaped the business, now named Duty Free Shoppers (DFS), eliminated car sales and other loss-making operations, and focused their attention on the duty-free concessions they had acquired in Hawaii and Hong Kong. And their timing was perfect.

12 â&#x20AC;˘ An Excerpt from Ă&#x153;berpreneurs

SOFAS, SPIRITS AND SKIRTS

The 1964 Tokyo Olympics had not only opened Japan to the eyes of the rest of the world, but also the reverse. Encouraged by the lifting of restrictions on foreign travel that had been in place since the Second World War, millions of middle-class Japanese were raring to go. And Chuck Feeney, fluent in Japanese from his time in the air force, was waiting for them. Realising that most of the Japanese tourists visiting Hawaii would come in groups led by professional tour guides, and that all of them would be obliged by the culture of omiyage to buy gifts for family and colleagues at home, Feeney made the move that would form the basis for the remarkable subsequent growth of DFS: he offered Japanese tour guides and their parent travel agencies a flat fee for every customer they brought to his store. The business grew exponentially. In 1968, Duty Free Shoppers bid $1 million for the duty-free concession they had first acquired three years earlier for $78,000. In 1971, the concession was renewed with a bid of $69 million, and, on February 5, 1988, DFS made the highest bid ever received for a duty-free concession: $1.15 billion for the next five years. During that period, the Japanese travel market expanded by 19% per year, and the profits to Feeney and his partners from the Honolulu business grew to hundreds of millions of dollars per annum. But despite the success of the Honolulu operation, Feeney could see that the expanding Japanese tourism market would soon be seeking additional destinations, and he set out to be one step ahead. In 1969, DFS acquired a duty-free concession in Anchorage, Alaska, on the polar route from Japan to Europe, and in 1971 they moved into the duty-free business in Guam, just four hours from Tokyo. In 1975, in a striking coup, they rebuilt the airport in the US-administered trust territory of Saipan, a delightful tropical island 200 km north of Guam, in return for tax-free rights to all duty-free activities for the next 20 years! Japanese tourists, it seemed, followed wherever he led. But Feeney's knack for picking changing demographics went one stage further. In the early 1990s, observing that the tourists arriving in Hawaii from Japan were younger, less affluent and less inclined to buy expensive

An Excerpt from Überpreneurs • 13

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presents for their friends and colleagues back home, he decided it was time to get out. And in 1996 he sold his entire 38.5% stake to the French retail conglomerate Louis Vuitton Moët Hennessy for $1.6 billion, valuing DFS overall at $4.2 billion. Less than ten years later, plummeting sales had reduced the value of the company to an estimated $1 billion. In farewell "thank you" letters to 2,400 long-term employees, Feeney underscored his appreciation of their loyalty and commitment with cheques totalling $26 million. Feeney himself has never had any interest in money, at least for its own sake. He travels at the back of the plane in T-shirt and jeans and lives with his wife in an apartment block that he built for homeless families in San Francisco. But, throughout his life, he has maintained an almost obsessive addiction to paying minimal or no tax, claiming that he could spend the money much more effectively than any government. And that is exactly what he set out to prove in his next überpreneurial endeavour. When Feeney sold his share of DFS in 1996, only a handful of his family and friends, and none of his partners, were aware that he had actually transferred his DFS shares and most of his other assets to his charitable foundation, Atlantic Philanthropies, over ten years earlier. Apart from a small fraction of his wealth set aside to provide for his family, he had long since decided to use his fortune to change the world. And he has. By the end of 2010, Atlantic Philanthropies had made grants totalling more than $5.4 billion. Initially, the focus was on Cornell and other US universities, but in the mid-1980s Feeney began to explore opportunities in Ireland. Always willing to help the underdog, he had a strong sentimental attachment to the land of his forebears, and a firm belief that Irish Americans should be doing more to help rebuild its flagging economy. Feeney did that with a vengeance. All up, the foundation invested close to a billion dollars in research and education facilities in seven Irish universities, and Feeney himself followed up with funding for moderate elements within both Sinn Fein and the Ulster Defence Association. The

SOFAS, AND SKIRTS 14 • An ExcerptSPIRITS from Überpreneurs

latter donations, which fell outside the mandate of Atlantic Philanthropies and therefore had to be made by Feeney personally, are said to have played a key role in the cessation of hostilities in Northern Ireland. Likewise in Vietnam. As Feeney told his biographer, Conor O'Clery: "We owe it to the Vietnamese after the way we treated them". Working with the East meets West Foundation, Atlantic invested heavily in public health and education in Vietnam. At the same time, investments in medical research in the United States and Australia, all of them leveraged with equal or greater contributions from governments, were themselves used to further leverage the foundation's work in Vietnam. In 2011, in his 80th year, Chuck Feeney was back on the road in the United States and Australia, encouraging high-net-worth individuals and families to join him in The Giving Pledge, an international group led by Warren Buffett and Bill Gates. At a dinner attended by Feeney in Tucson, Arizona, in May 2011, Buffett praised Feeney as the spiritual leader of the group, all of whose members have pledged to give away the majority of their fortunes while still alive. Feeney, said Buffet, "wants his last check to bounce". AMANCIO ORTEGA

When Kate Middleton and Prince William stepped out of Buckingham Palace on the day after their wedding in April 2011, Kate was wearing a simple blue dress that she had bought a few days earlier for £49.99 at a high-street store named Zara. But the newly titled Duchess of Cambridge was far from alone among fashion-conscious young women shopping at Zara. The label can be found in stores in 400 cities across 5 continents. Overall, Zara's parent company, Inditex, has more than 5,000 stores in 84 countries and employs over 100,000 staff. But of the eight brands within the Inditex empire, it is Zara that accounts for the lion's share of the business.

ÜBERPRENEURS An Excerpt from Überpreneurs • 15

Amancio Ortega Gaona, the mastermind behind Inditex, was born in the province of León in the north of Spain in 1936, and moved with his family to the Galician port town of A Coruña when he was just eight years old. His parents, like many during General Franco's 20-year reign, struggled to make ends meet. Nonetheless, as Ortega recalls, they instilled in him a strong work ethic, telling him: "Don't ever complicate things. Work, and work with passion". His first job, at the age of 13, was as a delivery boy for an A Coruña shirtmaker, where he learnt firsthand of the benefits of delivering merchandise directly from the manufacturer to the customer. Over the following decade Ortega worked in all facets of the clothing business, rising eventually to the position of store manager. In the process, he drew a simple and far-reaching conclusion: the world of fashion revolved around supplying very wealthy women with very expensive clothes. Amancio Ortega resolved to change all that. He and his first wife, Rosalia Mera, set out to produce well-designed, fashionable clothing at prices the woman in the street could afford. They began in 1963, initially using cheap fabrics to make and market fashionable high-quality bathrobes and lingerie from their home, and later, in response to growing demand from wholesalers, establishing a dedicated garment-making factory, Confecciones Goa (Ortega's initials in reverse). But, as always in the fickle world of fashion, demand fluctuated, and when an international wholesaler defaulted on a major order, the Ortegas were left with a massive supply of lingerie and little choice but to sell it themselves. They opened a shop in downtown A Coruña, and called it Zara. It was an interesting choice of name, with an interesting history. Initially planning to call their new store Zorba, they had already invested their hard-earned capital in expensive neon lettering when they were prevented from using the name by the existence of a Greek restaurant operating under the same business name nearby. Never ones to waste cloth, they cut their losses, discarding o and b and purchasing another a. But there was no skimping on location. Like all of its successors, the first Zara shop was strategically placed on the best site in the best street in

16 • 22 An Excerpt from Überpreneurs

ÜBERPRENEURS

managers, clothing designers and store managers on a daily or even hourly basis, with all of it being integrated and analysed in "The Cube", the high-technology heart of Ortega's empire in A Coruña. And on the other hand, it's all about using it. By co-locating key design and marketing staff in huge open-plan areas, the company can design, produce and assess prototype garments within a few hours of receiving vital sales information. Small runs of selected garments are then manufactured and distributed to representative stores, where the customers' interest or lack thereof determines the next step. If they're not interested, the products are withdrawn, at minimal cost to the firm. If they buy the garment, large quantities of fresh stock are manufactured and delivered to stores within days. Which is why Zara stores around the globe were all stocked up and ready to go when Kate stepped out of Buckingham Palace in her little blue dress. Inditex went public in 2001, with Amancio Ortega retaining 59% of the stock, then valued at $6.6 billion dollars. His co-founder and former wife, Rosalia Mera, who held 7%, also became an overnight billionaire. But Amancio Ortega showed no sign of stopping. After celebrating the float with lunch in the company canteen, he went back to his daily routine, working "like a donkey" with the designers and commercial managers at the nerve centre of his business. Ten years and 4,000 stores later, on June 30, 2011, he stepped down as chairman. He still lives, happily and very privately, with his second wife, Flora Pérez, in a nondescript apartment block in A Coruña. As he told Covadonga O'Shea, an old friend and the only journalist who he has ever allowed to interview him: "I want only my family, friends and colleagues to recognise me in the street".

CREATING MARKETS, BUILDING ECONOMIES

Apart from their obvious frugality and reclusiveness, what do Ortega, Kamprad and Feeney have in common?

An Excerpt from Überpreneurs • 17 ÜBERPRENEURS

CREATING MARKETS, BUILDING ECONOMIES

Apart from their obvious frugality and reclusiveness, what do Ortega, Kamprad and Feeney have in common?

SPIRITS AND SKIRTS 18 • SOFAS, An Excerpt from Überpreneurs

More than anything else, all three of them have focussed single-mindedly on business models that they themselves created in their mid-20s, and that remained essentially unchanged throughout their careers. Each of them built their businesses from scratch on the foundation of their own cash flows. And each of their business models clearly addressed the same demographic opportunity: providing middle-class consumers with high-quality products at affordable prices. Kamprad referred to his business as democratising design; Ortega talked of democratising fashion. With over 200,000 employees and hundreds of millions of customers, they captured and accelerated the massive demographic changes following the Second World War, creating not just new industries but entire new markets, and helping drive decades of economic growth throughout the Western world. KEY SOURCES INGVAR KAMPRAD Oliver Burkeman, "The miracle of Älmhult", The Guardian, June 17, 2004. Lauren Collins, "House perfect", The New Yorker, October 3, 2011. Bob de Wit and Ron Meyer, Strategy synthesis: Resolving strategy paradoxes to create competitive advantage, Cengage Learning EMEA, 2010. Jonas Fredén, "Ingvar Kamprad - King of IKEA", The Swedish Institute, March 2, 2011. Ingvar Kamprad, The testament of a furniture dealer. A Little IKEA Dictionary, Inter IKEA Systems B.V., 2007. Ulf Mårtensson, "IKEA's Ingvar Kamprad", Nordic Reach, November, 2007. Johan Stenebo, "Ikea's flat-pack Fuhrer: Furniture chain founder is branded a tight-fisted former neo-Nazi in new book", Daily Mail, October 9, 2010. Simon Tierney, "Lost in Ikea - the last great challenge for mankind", The Irish Times, May 14, 2012. CHUCK FEENEY "DFS 50: The journey continues", Anniversary Supplement. The Moodie Report, November 1, 2010. Cathy Hayes, "Irish billionaire inspires Warren Buffet, Bill Gates to give it all away", Irish Central, May 10, 2011.

9781137332868 | October UK / November US 2013 ÂŁ19.99 | $32 | $37 CAN Hardback | 294 pages

This insightful practical guide argues that the traditional business plan may not be appropriate for many new ventures and presents an alternative, effectual approach that encourages flexibility and development through exploration and experience. The authors provide 10 useful principles which demonstrate how to respond better to uncertainty during the business development process. Available to order at www.palgrave.com. Enter the code WORLDPALGRAVE20 to receive a 20% discount.

20 • An Excerpt from Beyond the Business Plan

3 Are Business Plans Appropriate? The Essence of This Chapter • There is evidence that business plans do not help new ventures. • At the heart of business plans are sales forecasts – which are highly suspect. • There is now considerable scepticism about business plans and even start-up training based on business plan contents has been called into question.

CHALLENGING THE RELEVANCE OF THE BUSINESS PLAN The previous section described how the business plan has become the standard advice given by business professionals to anyone starting a new venture. The business plan approach, it seems, has achieved this dominance in professional thinking because it helps business professionals with their agenda and accords with their understanding of business, and because such professionals appear to see no alternatives. But the relevance and usefulness of business plans for new small businesses are now being challenged.

Illustration 3.1 ventures?

An Excerpt from Beyond the Business Plan • 21

Beyond the Business Plan

Do business plans help new

Many people who are starting new ventures do not feel that business plans are a help, and they either do them reluctantly or don’t do them at all. Babson College in Massachusetts, USA, is widely known for its entrepreneurship teaching. However, a survey conducted in 2009 of former students of Babson who had graduated between 1985 and 2006, and who had since then founded one or more full-time new ventures, found that in only about half of the cases had those former students prepared a written business plan before the business began operating. The survey also concluded that overall the subsequent performance of all the new ventures was not related to having such a business plan.1 Another survey was conducted by Tjan et al., the authors of Heart, Smarts Guts and Luck, who report that in the course of their research they asked entrepreneurs across the globe how they launched their businesses. ‘Of those that had successful exits’, they found, ‘nearly 70 per cent did not start with a business plan.’2 But the behaviour of the Babson alumni and these other entrepreneurs was not discovered until later, when specific research was done into the value of business planning. Indeed there are many other examples found by the authors in the course of writing this book which indicate that people who have not prepared business plans tend not to declare it publicly.

22 • An Excerpt from Beyond the Business Plan

Are Business Plans Appropriate?

Possibly they have kept quiet about this because they feel that they should have prepared plans when they are advocated by apparent experts. Or sometimes they want a loan or other support from the professional advocating the plans and they don’t want to offend them by disagreeing. Therefore they may just get on with doing things their way, thinking that they are a rare exception to the rule that a business plan is necessary. Thus they may think that, at least from their perspective, the emperor has no clothes – but they don’t want to appear foolish or give offence by saying so.

Business plans appear to be based on big business thinking but, as Edith Penrose pointed out over 50 years ago, small businesses are not small big businesses and do not behave like them. Nevertheless many of us seem to have been hooked by the word ‘business’ – automatically switching on and/or applying big-business-based thinking to anything that is labelled a business – and along with that big-businessbased thinking go business plans. But the value and the apparent hegemony of business plans are now being questioned – and for at least four reasons: • Firstly there is a lack of reliable evidence that business plans actually help businesses. Where research has been conducted into the efficacy of planning for businesses this has not been conclusive. Henry Mintzberg reviewed the evidence for

An Excerpt from Beyond the Business Plan • 23

Beyond the Business Plan

his book on strategic planning and found that, ‘at the very least … planning is not the “one best way” and that it certainly does not pay in general’3. Illustration 3.1 also includes summaries of two pieces of more recent research on the specific application of business plans to successful start-ups which also failed to find a conclusive link. • Secondly a number of academics who have worked with small businesses and business plans have queried the relevance of the latter. Some of this is summarised in Illustration 3.2 and comes mainly from their own observations rather than from after–the-event research looking for correlations. • Thirdly there are questions about the validity of the business plan process. At the heart of a business plan is a sales forecast upon which the estimates of future costs, revenues and profitability are based. But those sales forecasts are usually based on market research – which is not reliable (as Illustration 3.3 indicates). The only credible way to see if people will buy something is to offer it to them and see what happens. Without that sort of real-life testing the edifice of a business plan is built on sand. • Fourthly, as explained above, business plans are based on big business thinking, but, as Penrose pointed out, small businesses are very different from big businesses and do not behave like small versions of big businesses. Therefore it is not necessarily the case that what suits big businesses will suit smaller ones.

Are Business Plans Appropriate?

24 • An Excerpt from Beyond the Business Plan

Illustration 3.2 An academic paper:

An entrepreneurship educator:

An entrepreneurship professor and author:

An entrepreneurship professor emeritus:

Business plan scepticism ‘An intense debate emerged recently … on the value of business planning for established small and especially new firms.’4 ‘We have all heard the growing chorus … debating the proper role, if any, for teaching business plans. A valid criticism … is that the way business plans have been traditionally taught results in well-written “works of fiction”.’5 ‘I am more than ever convinced that entrepreneurship cannot be planned to any major extent in advance, and that planning even goes against the entrepreneurial idea. Entrepreneurship is rather about courage and willpower, being venturesome when experimenting and networking, and about exploiting necessary mistakes as moments of learning.’6 ‘My focus … is on a number of “elephants in the room” … such as the worship of the rational business plan in curricula.’7

Beyond the Business PlanPlan • 25 An Excerpt from Beyond the Business

An associate professor and participant in eight high-tech start-ups

‘We’ve now learned [that]…: • Business plans rarely survive first contact with customers. … • No one besides venture capitalists and the late Soviet Union requires five year plans to forecast complete unknowns.’8

Illustration 3.3 forecasting

The limitations of market

Often we think we can forecast the future, not least because, as Daniel Kahneman has pointed out, our ability to construct coherent narratives of the past leads us to think we could do the same for the future: Everything makes sense in hindsight, a fact that financial pundits exploit every evening as they offer convincing accounts of the day’s events. And we cannot suppress the powerful intuition that what makes sense in hindsight today was predictable yesterday. The illusion that we understand the past fosters overconfidence in our ability to predict the future.9

26 • An Excerpt from Beyond the Business Plan Are Business Plans Appropriate?

But even in a limited area like market research our ability to forecast the future is indeed more an illusion than a reality. In his book Consumer. ology, Philip Graves shows that ‘market research cannot work’. According to the book’s cover: Philip Graves, one of the world’s leading experts in consumer behavior, reveals why the findings obtained from most market research are completely unreliable. Whether it is company executives seeking to define their corporate strategy or politicians wanting to understand the electorate, the idea that questions answered on a questionnaire or discussed in a focus group can provide useful insights on which to base business decisions is the cause of product failures, political blunders and wasted billions.10 However, the basis of the business plan approach is a sales forecast often based on just such market research. Upon that sales forecast the production requirements, the staffi ng needed and the marketing plan are all established and on them the financial requirements are projected and the businesses viability assessed. Yet, according to Philip Graves: The fundamental tenet of market research is that you can ask people questions and that what they tell you in response will be true. [But] ... this is a largely baseless

An Excerpt from Beyond the Business Plan â&#x20AC;˘ 27

Beyond the Business Plan

belief [and] in fact it turns out that the opposite is far closer to the truth.11 This is because: The nature of a conscious response says much about a respondentâ&#x20AC;&#x2122;s conscious values and how they would like to perceive themselves, but can reveal very little about what really has driven their behavior in the past or what they will do in the future. For example, there are thousands of people each year who resolve not to overeat; they generate a well-intentioned conscious response to the tightness of a favorite pair of jeans, or their doctorâ&#x20AC;&#x2122;s health warning. However, only a small proportion of these people will develop sustained new eating and exercising behaviors. This is not because their conscious intention was insincere, but because the unconscious drive to eat in response to particular physical or emotional stimulus will cut in and trigger consumption irrespective of their conscious intent.12

Thus the apparent benefits of the business plan for start-ups are being queried. After reviewing the evidence it seems reasonable to conclude that, while business plans may help business professionals, they do not necessarily help actual new venture explorers.

28 • An Excerpt from Beyond the Business Plan

Are Business Plans Appropriate?

WHAT PLANNING AND GUIDANCE ARE RELEVANT? The Role of Planning Although the relevance of business plans for small businesses is being queried, even small businesses, and other enterprising ventures, still need to do some planning. As has been said: ‘almost all work, in order to be done at all, must be planned, at least informally and a few minutes ahead.’13 You can’t even make a cup of tea without determining, even if only from custom and practice, in which order to do things. If the kettle is not boiled before the water is added to the tea the brew doesn’t work. If you are boiling an egg, you need to allow enough time for the egg to boil if it is to be cooked. If you are sending a letter it needs to be written before it is posted. Thus even simple tasks like these need to be planned – even if only informally and only a little while in advance. Larger tasks, such as building a new sports stadium or carrying out a military invasion, such as that of D-Day, require much more planning. But there is a difference between planning activities like making a cup of tea or even building a new sports stadium and planning to invade France on D-Day – and that is the predictability of the conditions in which it will be done. Generally making a cup of tea is a very predictable event (although unexpected power cuts can happen), but D-Day was different – it depended on both the weather and German reaction, and both of those were very uncertain. In planning circles there are generally two main approaches to planning for uncertain conditions. One approach, exemplified by many business plans, is to

An Excerpt from Beyond the Business Plan â&#x20AC;˘ 29

Beyond the Business Plan

rely on prior analysis and market research to remove, or at lease reduce, any uncertainty. However, the future is inherently unpredictable (and Illustration 3.3 describes one area in which attempts to try to predict it are known to be unreliable). Sometimes, for a while, the future behaves as might be expected, where present trends are continued, but often, at some time or another, it is subject to turbulence and to sudden unforeseeable shocks. Thus the second approach to operating in uncertain conditions is to try to be ready to respond when the unexpected occurs. Planning can seek to provide or assist with several functions including thinking about the future, trying to control the future, making decisions and coordinating actions. But this chapter suggests that, at least for new small ventures, trying to reduce future uncertainty by analysis and research is unlikely to work and therefore plans based on such assumptions are unlikely to be realistic. However, small ventures need to do some checking and planning, even if only to ensure that what they are trying to do has some chance of working and is not fatally flawed by issues which could be checked. It does not take much planning, for instance, to verify that the price that might be charged for an item or service will be enough to cover the likely costs of producing it â&#x20AC;&#x201C; but going beyond that to assume how many will be sold could be stretching the validity of planning beyond its limits. Military plans, for instance, generally do not last unchanged beyond the first contact with the enemy â&#x20AC;&#x201C; then the forces concerned need to respond to the situation as it evolves, which requires different thinking. As General Sir Frederick Morgan, who was responsible for much of the D-Day planning, is reputed to have

30 • An Excerpt from Beyond the Business Plan

Are Business Plans Appropriate?

observed: ‘whereas anyone can make a plan, it takes something quite out of the ordinary to carry it out’. So the people concerned need to plan their preparation but then also be able to respond to the unforeseen. You can’t plan in advance the detail of how you will respond to the unforeseen – because it is unforeseen – and an over-reliance on planning can lead some into a sort of blinkered attitude which does not appear to recognise the relevance of anything unforeseen because it has not been forecast in the plan. Appropriate Guidance As its name suggests, the business plan approach provides businesses with a planning process. However, the standard business plan format is also used as an indication of the key considerations for a new start-up – and thus the issues on which some guidance might be helpful. Thus advice, guidance and training for new business start-ups are often based on the components of a business plan, and if something doesn’t normally feature in a business plan it doesn’t get advised or taught. (Compare Illustration 3.4 with Table 2.2 – while the lists in each case are not identical there is little in the guidance list in Illustration 3.4 that does not relate to one or more of the items in the business plan list in Table 2.2, p. 17.) Illustration 3.4 syllabus

The business plan as a start-up

The following are the chapter headings in a business start-up guide. It is suggested that they bear

An Excerpt from Beyond the Business Plan • 31

Beyond the Business Plan

a close resemblance to the components of a business plan and therefore that they were probably derived from business plan thinking: Introduction 1. Starting a business 2. Forming a business 3. Marketing and sales 4. Managing your money 5. Where to work 6. The legal bit 7. Selling yourself 8. Mentors and role models 9. Going for growth 10. Writing a business plan Conclusion Source: Prince’s Trust, Make It Happen: The Prince’s Trust Guide to Starting Your Own Business (Chichester: Capstone Publishing Ltd, 2011).

32 • An Excerpt from Beyond the Business Plan

Are Business Plans Appropriate?

But new ventures need some planning and guidance. Business plans, and any guidance based on them, may be relevant for big businesses, but, as pointed out above, small businesses are not small big businesses – and many new ventures are not (yet) even businesses. So what is appropriate for them? REVIEW Business plans are advocated not because they are actually best for new ventures, but because they are good for the advocates and suit their thinking. The previous section indicates that business professionals usually derive their understanding of businesses from studies of how big businesses operate. Big businesses use business plans and business plans are frequently helpful to those professionals. Therefore business plans are frequently advocated by business ‘professionals’ as necessary for any new business venture. They are advised as the only approach available and thus they also form the basis for much business start-up preparation advice and for training courses. Business plans clearly conform to the established view and are part of the conventional wisdom. They are widely accepted by the established authorities as being helpful for businesses. Thus anyone who advocates them is unlikely to be criticised by that establishment. As John Kenneth Galbraith, who is credited with inventing the term ‘conventional wisdom’, said: We associate truth with convenience – with what most closely accords with self-interest and personal well-being or promises best to avoid awkward effort or unwelcome dislocation

AnBeyond Excerpt from the Business theBeyond Business Plan Plan • 33

of life. … But perhaps most important of all, people approve most of what they best understand. As just noted, economic and social behavior are complex, and to comprehend their character is mentally tiring. Therefore we adhere, as though to a raft, to those ideas which represent our understanding. … It is why men react, not infrequently with something akin to religious passion, to the defense of what they have so laboriously learned.’14 But as Penrose indicated (see Illustration 2.2) small businesses are not like small big businesses – they behave and operate very differently – and big business guidance is not necessarily appropriate for them. Therefore, instead of just assuming that big business methods such as business plans are appropriate, it is relevant to look at what guidance those involved in new ventures might actually need. Summary of the Key Points of Chapter 3 • There is evidence that business plans do not help new ventures, even when those ventures take the form of businesses. • Business plans depend on sale forecasts – but such market research is often not reliable. • For these and other reasons the value of business plans is now being questioned. • Business plans provide not only a planning mechanism but also a syllabus for start-up training – so that syllabus is also suspect.

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Chapter 1

An Excerpt from Second Stage Entrepreneurship • 35

GROW OR DIE STARTING A COMPANY IS HARD WORK. Every entrepreneur can attest to that fact. Assembling the capital, creating systems, hiring staff, finding customers, keeping the momentum going to make it a success—these tasks are all-consuming. It is no wonder that owners become so invested in their start-ups that when it comes time to take the business to the second stage of development, they often hesitate, or even stall. The business is running well and making a profit. The staff is working at capacity and content. The temptation is to rely on the current systems, products, and talent to take the company to the next level. However, this is not a viable strategy for sustained growth. In order to reach second-stage development, much of what made your start-up a success will need to change. This is difficult, as there will be times when the entrepreneur does not know what he or she does not know. This is untraveled territory. Second-stage entrepreneurship involves the reevaluation of the entire organization, including your relationship with it. Once you’ve made the decision to expand, there’s no looking back. It has got to be: grow or die. TIMING IS EVERYTHING

The decision to grow the company is not a simple one. Certainly, a big question relates to timing. Is now the time to grow? If not now, when? The answer to this question has two parts. First, there is the personal part of the decision. Are you as the founder really ready to press ahead? Do you possess the capability, motivation, and capacity to take the company to the next stage? After all, the decision to drive toward second-stage growth involves significant risk of failure, possibly the loss of everything you’ve worked so hard to build. It’s not only a business decision; it is personal as well.

36 • An Excerpt from Second Stage Entrepreneurship

SECOND STAGE ENTREPRENEURSHIP

Part two of the question relates to the external business environment. Is the market for your products or services healthy and growing quickly enough for you to grow with it? What’s the state of the general economy? Can customers keep current with their commitments? How will current fluctuations in interest rates and inflation affect your bottom line? Is sufficient capital available to fund growth? Are changes in technology moving more quickly than you are? How aggressive are your competitors? Answers to these and dozens of other timing issues need to inform your decision on when to push the button on your strategy for growth. We have all learned over the years that timing, in fact, does matter. The following example of a successful health care services firm shows why timing is such a key factor in the decision to initiate second-stage growth. MIDWEST HEALTH CARE SERVICES FIRM

Consider the situation facing a Midwest-based start-up health care services firm that is owned equally by its two founding entrepreneurs. The mission of this firm is to transform health care by empowering individual employees to take control of their own health. It claims that if companies implement its suggested approach, they can reduce their overall health care expenses by more than 30 percent and still deliver a much higher level of health care and thus better overall health for their employees. There is a huge market opportunity for the services this company provides, and its initial locations have performed well from a financial perspective and have been very successful in the fulfillment of the company mission—for the employees and for the corporate sponsors. It would seem obvious that the entrepreneurs need to expand quickly to take advantage of their market opportunity. But this organization currently lacks both the financial resources and the human capital to execute a second-stage growth plan. It needs to take on outside capital to fund the necessary investments for more rapid growth. However, the two owners have a different view on taking on external capital. One fears the loss of control that comes from outside

GROW OR DIE

An Excerpt from Second Stage Entrepreneurship 11 • 37

investors. The other is deeply concerned that if they don’t execute a growth plan, they will miss the market opportunity with potentially disastrous results as their competitors are well funded and aggressive. The market is moving quickly. While the external factors indicate the time is right to grow, one partner is not ready to take the leap. BEING A SECOND-STAGE ENTREPRENEUR

No one becomes a second-stage entrepreneur overnight. It is a process in which you have to change your mind-set from being a scrappy start-up entrepreneur, involved in every aspect of your business, calling all the shots, each and every day, doing whatever it takes to make your company succeed. And your efforts have paid off. The business is finally taking off. Customers are pouring in. Everything is coming together. You’re even making money. Then it dawns on you. Your start-up is a success. And while you are growing, you know your business could be so much more: bigger, better, and grabbing more market share with new products and services. It’s time to make the move, to make plans to bring it to the next stage. As the plan becomes a reality, suddenly you can no longer keep abreast of every critical event and decision that occur, or need to occur, every minute of every day. There is more to do than you can physically accomplish on your own. It’s time to realize that you need a plan for growth and, more important, some outside help. Letting go is one of hardest lessons any founder has to learn about second-stage entrepreneurship. In the beginning, owners are involved in every decision concerning their businesses—from what color to paint the front office to how to structure the sales team. The second-stage entrepreneur has to focus on the bigger picture and not obsess over all the small stuff. This is not to say that certain details do not matter. After all, it was your vision and drive that got the business going. Now you must learn the importance of leveraging your unique skills to make the next leap. Organizational process, discipline, and

38 â&#x20AC;˘ An 12 Excerpt from Second Stage Entrepreneurship SECOND STAGE ENTREPRENEURSHIP

a sufficiently well articulated and widely understood vision for the future become critical to lead the company into second-stage success. Delegating responsibilities to the right management team and leading the charge must be your new role. THE IMPORTANCE OF A NEW BUSINESS PLAN

Things will move quickly once you make the commitment to grow your company. But how quickly do you want to grow? The timetable you make will shape the next step in the process: your new business plan. It shows both what can be done, but equally important, it also shows what must be done for the business to deliver the planned results on schedule. For instance, the decisions on the capital strategy and on the growth strategy are highly intertwined. Typically, growth comes from a series of individual investments that, when executed correctly, tend to pay off with a resulting increase in sales and profits. Decisions can be as straightforward as how many salespeople to add and when to add them (assuming a business model that grows through a professional selling organization) or as complicated as creating a new product line with all of the research, development, engineering, manufacturing, packaging, pricing, marketing, and selling efforts this will involve. Each step takes time. These types of decisions, when combined with staffing concerns, new systems and support, additional channels of distribution, facility expansion, and dozens of other considerations, make the business planning exercise one of the most challenging and complicated steps toward second-stage growth. CHANGING YOUR OPERATING STRATEGY

When the initial version of the basic business plan is done, the real work begins. Commitment to growth means commitment to changing

GROW OR DIE

An Excerpt from Second Stage Entrepreneurship 13 • 39

business as usual. Personnel changes are among the first considerations and often the hardest. Can the existing managers and employees propel the company to new growth? If new people are needed, will they be in addition to or replacements of the current staff? How much restructuring needs to occur to create effective new teams? A classic example of this kind of basic personnel change is the structure of an internal finance and accounting department. Startups rarely have multilayered financial departments. Typically, there’s a bookkeeper, an accounts receivable person, an accounts payable person, and a payroll person. Sometimes one person wears all of these hats. However, if a company plans to grow its organization and revenue significantly, this structure won’t work. A second-stage company will certainly require an accounting manager to oversee the balance sheet and financial reporting. Soon, a controller will be necessary, and at some point in the second stage, a CFO is likely to be necessary. And it is highly unlikely that the person who is currently wearing the many hats to keep your accounting operation running smoothly will also be the best fit for the CFO role. These are fundamentally different roles, requiring very different levels of skill, education, and experience. Preparing for second-stage growth will have you asking this same question for different roles throughout your organization. And, if you are honest, you will likely come to the conclusion that there are certain individuals that for some reason don’t have the necessary horsepower to go to the next level. This is a painful process that results in the loss of some of the key people who helped get you to your current position. However, making these decisions in a thoughtful fashion is a necessary process for driving future growth. How this new level of management will impact existing staff is a big consideration as well. BUST TO BOOM

When you talk with the owners of Founders Brewing Co., Mike Stevens and Dave Engbers, they will be the first to tell you that they

40 • An Excerpt from Second Stage Entrepreneurship

SECOND STAGE ENTREPRENEURSHIP

struggled to keep the doors of their fledgling microbrewery open. Ten years earlier, they had quit their full time jobs and decided to pursue their passion for beer by starting their own brewing business, commencing in typical beer industry fashion as a brew pub. After an extended start-up period, they experimented with different mixtures and created a line of good but not particularly remarkable lagers. Located in downtown Grand Rapids, Michigan, Founders Brewing Co. had a solid local reputation, but it could not draw a critical mass.1 Debts mounted; sales growth came slowly. Dave and Mike had to do something or see their dream disappear. They had to grow or die. In 2007, perhaps out of desperation, they decided to commit to a new strategy. Rather than compete with others for a piece of the lager market, they decided to use their expertise to create a line of totally new, premium-priced products that were more aromatic and had bigger, bolder tastes, such as Founders Brewing Breakfast Stout.2 This unusual beer contains coffee, chocolate, and oatmeal. It has an alcohol content of over 8 percent. With the help of some new capital, they changed the packaging and expanded their line to include unique beers with catchy names such as Double Trouble, All Day Pale Ale, Devil Dancer, Curmudgeon Stout, Bad Habit, and Dirty Bastard. This strategy was rewarded when they were invited to attend the invitation-only, Extreme Beer Fest in Boston, an annual event put on by BeerAdvocate, one of the most respected print and online publications of the microbrewery industry. This event was the defining moment for Founders Brewing. They had lines out the door for the entire event. The editors of BeerAdvocate came to talk to them to try to understand the tremendous buzz about this “upstart brewery.” When the Founder’s team drove back to Grand Rapids from Boston in Dave Engbers father’s Mercury Sable station wagon, the founders recommitted themselves to a last-ditch effort to take the company to the next level. The rest is history. It took Founders ten years to get to an annual production of 10,000 barrels of beer, a serious milestone

GROW OR DIE

An Excerpt from Second Stage Entrepreneurship • 41

for the company and well beyond the industry breakeven point of 3,000 to 6,000 barrels, according to Lueders Consulting, an industry expert.3 In the years immediately after the relaunch, annual production volume grew as follows: 17,000 barrels, 28,000 barrels, 43,000 barrels, 71,000 barrels, and now it tops 135,000 barrels. With a new production facility currently under construction, production capacity will grow to over 350,000 barrels. SHIFTGIG

The technology industry today operates by a set of rules different from those that govern other second-stage entrepreneurs. Like many who have started a business, entrepreneurs in this industry initially focus on building a minimum viable product and then learning the product’s strengths and weaknesses, the market it serves, and trying to build some initial user experience. Unlike the rest of the world, they don’t worry about revenue. Rather, in this stage, they focus on the number of users of their software and user feedback. This stage is often financed by the founders in an effort to keep full control of the company to maximize their opportunity for value creation. But time is compressed in the world of technology, and the second stage often comes after a number of months, not a number of years. Shiftgig was started in late 2011 by Eddie Lou. Eddie’s background is unique in that he started in the business world first as an entrepreneur, then became a venture capitalist, and then left that world to start Shiftgig together with two cofounders. The idea behind Shiftgig is to connect individuals who have experience in the hospitality industry as bartenders, waiters, and cooks with establishments that are looking to hire individuals with these skills. Think of Shiftgig as a cross between a LinkedIn platform focused on the hospitality industry and aspects of Facebook. Individuals can input their skills and experience on the Shiftgig platform much as they would do it on LinkedIn, but they can also add other elements, such as video, additional photos,

42 • An Excerpt from Second Stage Entrepreneurship

SECOND STAGE ENTREPRENEURSHIP

and their “social score” as demonstrated by showing the number of Facebook friends and Twitter followers. This provides a very efficient way for employers to find exactly the kind of person who will fit into their bar or restaurant. During the first six months of Shiftgig’s existence, the emphasis was on building the product and getting an initial user base, first in Chicago and soon thereafter in New York and Los Angeles, all cities with large numbers of bars and restaurants. But even while the product was in its initial launch phase, Eddie was hard at work developing the plan for a national rollout coupled with determining the optimal approach to set up a Series A round of funding to support this growth plan. In less than a year after the company’s founding, Shiftgig closed on a $3 million round intended to fund the next stage of the company’s growth.

GROW OR DIE

Grow or die. This is quite a polarizing statement and, of course, if taken literally, some might take issue with it. Certainly there are many companies that either do not grow at all or grow very slowly. Many of these are great businesses that have been around for years, generate a great deal of cash, and provide a very nice lifestyle for their owners. I have met the CEOs of dozens of companies that are under $10 million in annual revenue, yet their businesses produce hundreds of thousands of dollars or even millions in profit each year, most of which is taken as a distribution by the owner. In many ways, it is hard to argue against this approach. It can and often does fund a very nice lifestyle. However, this approach has never been for me, and likely it is also not for the readers of this book. To have the desire to continuously and rapidly grow a business is very rewarding, and in many ways, at least in my view of the world, it is the only approach that will work over an extended period of time.

GROW OR DIE

An Excerpt from Second Stage Entrepreneurship â&#x20AC;˘ 43

Let me explain why. In a subsequent chapter of this book, I will explain that in the long run, talent is the only true sustainable competitive advantage. If you want to grow and prosper over time, you have to figure out how to get very talented people into the key roles in your companyâ&#x20AC;&#x201D;and keep them there. This tenet, I believe, is self-evident. But people of real talent, ones with considerable capability, potential, and ambition are also looking for growth opportunities, both personally and professionally. Most truly talented people will only stay in a role for so long unless they are continuously challenged, and along with this environment of challenge they want opportunities to engage in continuous learning and career advancement. It works the same way in sports, for instance. After all, does a really good tennis player want to play against someone he or she can easily beat? Or if you were a chess player, would you prefer someone as an opponent who is not very astute and you can easily beat? Or would you prefer to play against someone who is better, even if this means you are unlikely to win? Competitive people value real competition just as talented people demand to be challenged so they can learn and they can grow. Yes, compensation also matters, but it will likely be insufficient on its own to keep your very best employees on board. So, in order to provide opportunities for your most talented people to grow into roles and situations of increasing complexity, it is necessary for the entire enterprise to also grow. The growth of the business creates a need for someone to step up, and with talented individuals you have a cadre of folks to choose from who can stretch into these new roles and bring with them their unique capability, experience, and drive. This works far better than trying to convince the same person to do essentially the same job for the next two years. The real beauty of this entire cycle is that it is self-reinforcing. Really talented people tend to create great outcomes for customers and clients, whether by the product they design or make or by the service they deliver. The quality in the product or service delivery

44 • An Excerpt from Second Stage Entrepreneurship

SECOND STAGE ENTREPRENEURSHIP

results in significant improvements in the value as perceived by these customers and also in their overall level of satisfaction. Improvements in value received and overall satisfaction levels result in higher levels of growth for the business, and this growth in turn results in yet more opportunities for personal and professional growth for the employees. Yes, everyone is happy when you can pull this off. Of course, there is a potential downside to this strategy: if you have built your team by selling the growth story and for whatever reason you can’t pull this off or growth slows, you may be challenged to keep your best people as they will seek out alternative situations that can deliver a more compelling set of growth opportunities. PARTING WORDS

Making the decision to grow aggressively presents serious risks to any business, emotionally and financially. Make sure that the decision is based on solid business planning. Growth for growth’s sake is not a sustainable strategy. A successful start-up can remain just that if market conditions don’t warrant investment in serious growth. Second-stage entrepreneurship takes a commitment to a new vision for the future and the solid plan to accomplish it. It will mean fundamental changes to a company and the founder’s relationship with it. New money, new decision makers, new products, new systems will be necessary to scale up the business. With the total commitment of the founder and his or her team plus a well-reasoned business plan, executed under the right market conditions, your company can achieve successful growth. And when you do this, well, few things in life are more rewarding.

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46 • An Excerpt from Startup Rising

Chapter 1

Celebration of Entrepreneurship I sat, jet-lagged, in a small conference room, watching the desert sun sink toward the western horizon. It was my first trip to the Middle East in over a decade, and I had forgotten how hot it could get there even in November. Last time I had been a tourist—all antiquity, pyramids, and museums in Cairo. Now I was a seasoned internet investor, board member, and entrepreneur, attending one of the first region-wide gatherings of tech startups in Dubai. The looming skyscrapers and business towers before me had been barely an architect’s dream during my last visit. Now, only the heat was familiar. By the end of this conference, virtually all my preconceptions of the Middle East would be thoroughly altered. As if on cue, a flowing figure in black glided before me like a phantom. She sat beside me, shoulders proudly back, dressed in the traditional head-to-toe abaya that revealed only her face and hands. She said she was a university student in Saudi Arabia, and while there had designed a luxurious leather carrying case for mobile devices like smartphones and iPads—complete with a battery pocket to keep them charged. She asked whether I thought this was a good business idea.

2 Star tup Ri si n g

An Excerpt from Startup Rising • 47

I have happily listened to hundreds of ideas, investment pitches, and calls for mentorship throughout my career. It’s inspiring to meet people trying to start something from scratch, with the odds so strongly against them, and it’s gratifying to flatter myself that my nearly two decades of business experience might materially help these budding entrepreneurs. But on this day in 2010, my first mentorship experience in the Middle East was unnervingly different. Fumbling for a coherent answer, I asked a few questions about her background and the genesis of her idea and offered some generic encouragement about following her dreams. She nodded politely, but with a palpable sense of boredom. “Thank you for that,” she said. “It is very helpful. But I should have been more precise. I have a pre-order for a thousand units, and this leaves me with a dilemma. There are four low-cost manufacturers in China who are enthusiastic about doing business with me, but I am nervous about having my suppliers so far away. Should I risk manufacturing my idea with people I don’t know very well, or should I raise the roughly $45,000 I’d need for machinery and then hire a young woman I know locally to handle production?” I was stunned. Before me was a young, Saudi Arabia–based, techsavvy woman entrepreneur looking to expand her operations globally. This was not the Middle East that I had been taught to expect. It was not the Middle East that my Western peers, even the most sophisticated businesspeople, knew. In fact, her story shocked even many of my skeptical friends in the region when I later described her. One of the other young entrepreneurs in the room, the founder of a computer animation startup based in Syria, sensed my amazement. Eerily resembling a younger Leonardo DiCaprio with a ponytail, he winked at me. “There’s a lot going over here, right sir?” Right. I was in Dubai because I have been a successful entrepreneur and sometimes successful investor in many startup companies. I’ve played the roles of leader, board member, mentor, and amateur psychologist. I know the high of watching customers flock to a new product, and the gut-wrenching terror of realizing that even a small mistake on my part could cost my employees their livelihoods. When I talk with young

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entrepreneurs so passionate about technology and the internet that they can’t imagine doing anything else, I am conversing with a sister or a brother. I know what they’re in for, and I applaud them for it. It’s a life of bold choices; one that, as the legendary founder of Netscape and venture investor Marc Andreessen reminded me at the beginning of one of my ventures, yields only two emotions: total euphoria and abject fear. I was there primarily, however, because of an unusual journey. In the United States, I am frequently asked why I care about the Middle East. My answer is usually a baffled, “Why don’t you?” It’s hard to name two regions of the world whose mutual needs, tensions, misunderstandings, and mistakes have had more impact in shaping their fortunes than these two. When I was growing up, when we thought about the Middle East at all, we generally lumped its unique cultures and histories into some simplistic context framed around the Israeli-Palestinian conflict or the Iranian Revolution. In college, I had a brilliant roommate who had recently escaped civil war–torn Lebanon with his family. When our late-night bull sessions turned to the Middle East, he tried patiently to teach our dorm-mates about the nuances of the region and how we were viewed there. One night, one of our classmates turned to him, as if the West had had no responsibilities for the region’s challenges and said, “There is no hope. We should build a wall around the region and let you just figure your own shit out.” There was embarrassed silence, but none of the rest of us had anything more sophisticated to offer our exasperated friend. In the following decades, America’s economic and strategic connectedness to the Middle East continued to increase. The accompanying tension and confrontation reached their apex in the terrible and brutal shock that was September 11. By that time I was a well-travelled executive. I understood that engagement and problem-solving anywhere required sensitivity to the countless big and small distinctions on the ground—that the most creative solutions were rarely one-size-fits-all. I had just joined the Young Presidents Organization (YPO), which has nearly 16,000 CEO members from around the world. The group’s mission is less about business networking than building connectedness and

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understanding among senior executives. In 2003, a fellow U.S. member introduced me to other members from the Arab world. We collectively decided to form a sub-group of U.S. and Arab CEOs to help each other learn and understand our various cultural perspectives. “The purpose of our group,” as one Arab member more colloquially but accurately described later, “was to convince one another after September 11 that we’re not all assholes.” About two dozen of us met as often as three times a year—once in New York or Washington, once in Europe, once in the region. We got to know each other personally, and debated with outside experts. Most importantly, we learned about the unique problem-solving under way in both regions, well below the radar of the broader political narrative of economic aid and potential military conflict. Two members of this remarkable group stood out. LebaneseJordanian entrepreneur Fadi Ghandour had built Aramex, the region’s largest FedEx-like logistics and transportation company. Just over 50, he has the lean figure and tenacity of a man who swims two miles each morning regardless of what time zone he’s crossed that day. Arif Naqvi had founded the Abraaj Group and built it into one of the largest private equity investment firms among all global growth markets. His legendary twenty-hour days underscore his insatiable curiosity about newly opening and changing worlds. They met when Arif invested in Fadi’s company, and soon became close friends. They shared a passion for the broader societal impact of business, and led innovative corporate social responsibility initiatives around the Middle East. And as they compared notes on their teenage sons, how their lives were structured around and changing due to technology, they became convinced that they were witnessing an age of unparalleled historic opportunity. During our YPO gatherings, they championed the rise of young tech-driven entrepreneurs throughout the developing world—especially in the Middle East. They believed that there were now significant opportunities for young people to create and build businesses that did not exist just a few years ago. A rising generation was demanding a different and better life than their parents’, they argued, and they expressed these demands through the businesses they were creating. For Naqvi

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and Ghandour, embracing these entrepreneurs was nothing short of embracing the potential for a new Middle East. And they are putting their money and time where their mouths are. Both are leading go-to figures in the region, investing in, mentoring, and connecting regional tech-based startups. In the summer of 2010 they joined forces to hold what they called the region’s first “Celebration of Entrepreneurship” in Dubai, an event that perfectly symbolized their beliefs. “You have to come and see this for yourself, man,” they emailed me in invitation. I was skeptical, but most of our group knew we needed to be there. The sold-out gathering had all the earmarks of a typical Silicon Valley event: more than 2,400 eager entrepreneurs and investors—most of them young and tethered to their mobile devices—sharing, debating, and connecting. There was the requisite hip music. Been-there/donethat speakers mixed with kids who were new to the game, dashing out ideas on whiteboards and rallying each other to new ventures. Yet the participants weren’t familiar U.S. internet startups but a new generation of entrepreneurs from the Arabic-speaking Middle East. The music wasn’t LA hip-hop but Arif Lohar, a leading Pakistani folk/fusion artist, whose band’s vibrant rhythms combined with the vocals of Meesha, a stunning pop singer and top star in the region. They rocked the house with Urdu lyrics expressing love for and thankfulness to God. Nobody discussed politics, religion, or historic obstacles. Instead, all they wanted to do was invent and build new businesses. The Celebration of Entrepreneurship set me on subsequent journeys beyond Dubai—to Cairo, Amman, Beirut, Istanbul, even Damascus— and I saw similarly talented, successful, and intrepid entrepreneurs by the thousands, all driven to build, all willing to face the cultural, legal, and societal impediments inherent to their worlds. Just as importantly, I saw major global private equity and venture investors and tech companies like Google, Intel, Cisco, Yahoo!, LinkedIn, and PayPal among others making significant bets, and doubling down on earlier investments, despite uncertainty in the region. Fadi’s and Arif’s instincts were, of course, prophetic. Only three months after the Dubai event, many of these same young people we met

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were protesting in Tahrir Square and other cities throughout the region, demanding open societies that would allow them to prosper. l Before Dubai, my own instinct was to summarily dismiss the likelihood that Ghandour and Naqvi were right. In retrospect, I attribute this not only to my own regional bias, but also to the fact that I ignored everything I was witnessing in my own daily work running internet companies. I knew—as well as anyone—what level of innovation individuals are capable of when they build connections and share collaborative experiences through technology, no matter where they live. I should have known better. My start in the early days of the internet was deeply personal. Within eighteen months in the late 1990s, I learned that my best friend suffered from crippling bipolar disorder and my mother-in-law was diagnosed with lung cancer that had spread to her brain. I am the grandson of Italian immigrants, so depression was not a disease, but something to “suck up.” Cancer was only discussed in hushed tones among family and left in the hands of the doctors. Shocked by what turned out to be death sentences for both people I loved, I turned to the internet to try to understand things outside of my comfort zone. This was nearly a decade before social networks, but I found small communities of people online who were going through similar experiences. We never knew each other, but in the months to come we taught each other, pointed each other to resources, and supported each other in troubling moments. When my loved ones lost their battles, these communities helped me process and mourn. I was a smarter, better informed, more sensitive support to my family and friends because of these connections. And I had no doubt that technology was unleashing not merely tools of convenience, but entirely new ways to share insight, build relationships, and take action. “You are not alone. You are not crazy. Actions you take can make a difference because others like you did the same.” This has since become my stump speech on what this technology means

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for us. It was empowering and signaled a power shift. We as individuals could demand the transparency and make the connections to help us act. The world would change. Some years later, a group of like-minded entrepreneurs and I decided to put our personal and professional experiences to work. We launched one of the first social platforms in health, HealthCentral.com, to aggregate “patient wisdom” in safe and trusted environments. Our company consisted of nearly fifty individual web and mobile sites where people who had “been there” could share their condition-specific experiences. We convinced some of the leading investors in the internet and media worlds to back us. Through the tumultuous ups and downs that characterize most startups, our platform grew to engage over 15 million people monthly. We were inundated daily with stories of people emboldened to step up, help each other, and better their own health as well as that of their loved ones. It was on a chance trip during my tenure in my previous company— Washingtonpost.Newsweek Interactive—that the global ramifications of technology and collaboration hit me like a two-by-four. The Washington Post’s gracious and forward-thinking chief executive Don Graham asked me to visit Tokyo, Seoul, and Helsinki to get a closer look at these rapidly changing and advanced broadband and mobile societies. I spent several weeks with established CEOs and upstarts, thinkers, business professors, and students to see how they bought and used technology. The cultures, histories and approaches in these countries are quite different from those in the United States. But the groundwork for social networks, mobile e-commerce, mobile texting, and shared video were well laid there several years before they became the norm here. My greatest epiphany, however, was that in expecting to see everything technology—a tech-powered, Jetsons-like world—I was unprepared to see almost nothing. Technology in these societies had become like water or electricity. People assumed its availability and simply embedded it in their day-to-day lives. Many were puzzled as to why I had made these trips at all. A diffusion of innovation—due to exponentially increasing access to information technology—was allowing entrepreneurs to create,

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collaborate, and affordably scale business to solve local, regional and even global problems as never before. These societies were electrifying. And I began to wonder even then: what will happen when every country has similar access to these technologies? The West tends to look at the world through the prism of its own successes, and believes that it has a monopoly on innovative ideas and entrepreneurship. Nothing amuses the entrepreneurs I meet around the world more than when some U.S. politician refers to entrepreneurship as a “leading American export,” as if other, thousands-of-years-old entrepreneurial cultures have only recently discovered it. And one of the most common questions I hear from American entrepreneurs, investors, and policy makers as they consider looking at new growth markets is, what will be the “next Silicon Valley” of a certain region or country? For all the hype, hubris, wealth, and celebrity associated with “the Valley,” it remains an extraordinary place. It stands alongside Periclean Athens or eleventh-century Andalucía or Renaissance Florence for its raw, competitive, innovative zeal, which has utterly changed the world we live in. One cannot avoid stepping off a plane there without almost feeling the ubiquity of drive and innovation in almost every conversation in every restaurant, coffee shop, or bar. Ben Horowitz, the former CEO of the tech juggernaut Opsware and co-founder of one of the most successful venture capital funds, Andreessen Horowitz, told me that what people most often underestimate about the Valley is the pure network effect of talent that is drawn to it. “Extraordinary engineering, product, creative people tend to attract the same,” he told me, “to a point now that every company is tripping over themselves to attract the best—and the best really are in control of their own destinies here because of it.” Mike Moritz, chairman of the legendary Sequoia Capital—a pioneering venture capital firm responsible for backing the likes of Apple, Google, Cisco, PayPal and LinkedIn which are among the other most successful technology companies in the world—agrees: “We try to find the most promising companies but if they are even a few

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hundred miles away—say Los Angeles and San Diego—our number-one challenge is to get the best people to move there.” “Interesting businesses are and will be created outside of the Valley, in the States and around the world,” Horowitz readily concedes. “But think of the movie business. Great films are made in many locations, but there is a reason that the vast majority of successful films—certainly in aggregate dollars—come from Hollywood. That’s where talent wants to be. There is Bollywood in India but it pales in comparison. In fact, how many technology startups outside of Silicon Valley or the U.S. have built multi-billion dollar businesses?” When I pushed venture capital investors who have opened up offices in emerging markets about why they do so, two consistent themes arise. First, they look for large market opportunities—one may lose money in a place like China, but for all its challenges it’s too big to ignore. Second, emerging markets offer outstanding engineering and call-center talent, invariably much cheaper than in the United States. As for opportunities for regional or even global innovation from the emerging worlds? “It happens all the time, especially for services aimed at local or even regional needs, which explains Alibaba, Tencent, and Baidu in China,” notes Moritz. “But Silicon Valley has always been a magnet for immigrants. It’s the place where raw technical abilities will always be embraced by successful companies and worldly leaders.” But what happens when the vast majority of talented people don’t want to move—when they not only want to stay home, but are driven by almost patriotic passion to make change where they come from? The real question going forward won’t be whether Silicon Valley is the only game in town or where the next one will crop up. Rather, it will be how rapid and inexpensive access to its innovations in software and devices will create new, multiple “hubs” of innovation in every corner of the globe. This will also challenge the West’s definition of “innovation” as only the next shiny new thing. The word has different ramifications in emerging markets that are gaining ubiquitous access to software and devices for the first time. These markets create innovative solutions for their own

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challenges and opportunities. From their unique experiences and circumstances, in fact, their solutions may one day be adopted globally. What if information technology could make geographic proximity and network effects of talent less important? We know this is already happening in our day-to-day lives. Skype, group chat, social networks, collaborative software, and other, ever-advancing video connections are already mainstream and improving daily. They have had clear impact on the social and political dialogue in every country where they are embraced. They create hubs of action in many walks of life—like the health seekers on HealthCentral—unimagined even five years ago, and tweaked by individuals to better attune them to local and regional cultural needs and norms. These experiences may not yet be as ideal as face-to-face proximity, but for a new generation raised on them, and by breaking down barriers of distance, might they be plenty good enough? There is precedent for how local need-solving becomes globally competitive innovation in the hardware business. Certainly no one in the early 1980s would have expected Japan or Korea to become a dominant player in mobile devices and consumer gaming. Who would have imagined that Finland, a country known mostly for wood products, would create Nokia—a company that first used mobile communication to facilitate connections between forestry and milling locations hard to reach with traditional telephony? Safaricom in Kenya (40 percent owned by Vodafone) in 2011 launched the first step in a global roll-out of smart phones for less than $90. Their screens are smaller than the iPhone’s, their processing speeds lower, but they are genuine computing devices in the hands of people who never had access before. Over 350,000 were sold within several months. Basic cell-phone penetration in Egypt, a land of 80 million people with annual per capita GDP under $6,500, is over 115 percent. The penetration numbers hold true throughout the Middle East. Yet currently only 8 to 12 percent of these users have access to smartphones. Can we fathom what kind of innovation may come from countries—those that never even knew landlines—that attain mobile smartphone computing access of 50 percent or more of their citizens?

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Mobile experts told me we could see $50 smartphones within three years to help drive this adoption. Should we be surprised that Kenya, with no legacy of wired telephone service and limited banking services, would be the birthplace of the mobile payments company M-Pesa— representing today nearly half of all mobile payments in the world, and processing 20 percent of the country’s GDP? Moritz concedes upon further reflection, “I’ve found in my travels that if you put great entrepreneurs from any corner of the world in the same room with each other, they are quite similar even if their mother tongues, religions, and colors are different. They look at the world, problems, and opportunities the same way. Their minds, their energies, and their desires to succeed are a lingua franca. They talk to each other as if they’ve known each other their whole lives.” Peter Thiel, the provocative but undeniably successful venture investor—an early backer of payment innovation companies like PayPal and Square, as well as social networks from Facebook to LinkedIn— seeks what he calls, “unobvious connections.” Comfortable in the narrative of its own entrepreneurial success and relative absence of clear new competitors outside of its borders, the West may be missing an “unobvious” opportunity of historic proportion. We see innovation being harnessed in corners of the world all but until recently written off economically. We see rising middle classes across emerging markets. The ramifications should be clear. l Is any of this, however, truly possible and scalable in the Middle East? In the face of brutal oppression in some nations and political uncertainty throughout the region, it’s hardly an idle question. Added to political instability, the gap between the mega-wealthy and the desperately poor throughout the region remains shocking; education and literacy offer profound challenges. Corruption, high unemployment, heavy reliance on government largesse, archaic and often indecipherable rules of law, and cultural resistance to investing beyond fixed assets are all

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daily realities. For all the enthusiasm that came with the Arab Spring, Arabs are still debating vehemently the kinds of societies and governments they will create, what role religion and women will play, and how business practices will be proscribed. One need only spend a few days in Amman or Cairo, going through metal detectors in every restaurant, hotel, and tourist destination, to sense how the political and social realities can keep risk capital—and, indeed, business itself—sidelined. There is no doubt that the political apparatus and context still matter greatly. As Arif Naqvi told me, “The direction of the Middle East will be determined by whether regimes in the region realize that twenty-firstcentury developments should not be met by a nineteenth-century mindset—that political reform will be matched by the unquestioned economic reforms and opening-up processes of the past few years.” But while we must take these concerns seriously, they can also mask the three-fold hurricane-force wind these entrepreneurs have at their backs. First, technology offers an irreversible level of transparency, connectivity, and inexpensive access to capital and markets unprecedented only five years ago. A new generation in the Middle East, as elsewhere, has never known a world before information technology, and they have a keen understanding of how others like them live and create opportunity for themselves. They assume easy access to inexpensive technological, social, and collaborative tools to create businesses and affordably access once unreachable customers and markets regionally and abroad. Second, this generation benefits from regional and global capital now more comfortable with political risk. Twenty years of experience in other emerging markets such as the BRICs (Brazil, Russia, India, and China), all but dismissed as economic engines less than a generation ago, has laid important groundwork. Nearly all of these countries were, and remain, equally marred by political uncertainty, opaque governments, corruption, and weak infrastructures. Yet significant investor returns there have established a comfort level with emerging markets across all sectors, and suggests sustainable economic opportunity could happen in the Middle East even more rapidly.

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Third, changing market dynamics, growth, and opportunity in the Middle East were in motion well before the uprisings. As Vali Nasr, dean of John Hopkins School of International Studies, wrote in The Rise of Islamic Capitalism, his recent book on the macroeconomic rise of the Middle East, the demographics are staggering: “In 2008 the GDP of the economies of five of the largest countries in and around the Middle East—Egypt, Iran, Pakistan, Saudi Arabia, and Turkey, with a combined population of 420 million—was $3.3 trillion, the same size as that of India, which has three times the population.” He adds that the Arab world alone has over 350 million people, nearly twice the size of Brazil; a GDP larger than Russia and India, and per capita GDP nearly twice China’s. Disposable income has grown 50 percent over the past three years, to over $1 trillion in 2012. It’s a young market, with over 100 million people under the age of 15, who love their connectivity and mobile phones.1 Social media usage passed 25 percent in 2011, growing 125 percent year over year. The region has a tradition of entrepreneurship thousands of years old, and today more college and graduate students and engineers are turning to startups and medium-sized ventures than ever before. Even in countries with broader macroeconomic challenges, entrepreneurship has not only been a question of innovation but one of survival. And this new generation is hungry. If there was one universal sentiment that connected every young entrepreneur I met it was this: their revolution was not merely about overthrowing longstanding dictatorships, but challenging a generational premise and complacency of their parents that things could not change. “Why should we accept mediocre jobs in lumbering large companies or the government—assuming we can even find those?” one Jordanian founder told me. “In fact, I don’t understand why my parents accepted it!” One of the most common themes in emails I received during and after the Arab uprisings was a disdain for the word “stability.” As one Egyptian executive wrote me, “It’s not that we don’t appreciate stableness—that the most successful ecosystem for entrepreneurs has this at their foundations. It’s that the word ‘stability’ was used by the regimes and our parents as an excuse for accepting an unacceptable status quo. We can be better.”

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Even with all its fits and starts, recent events in Tunisia, Egypt, and elsewhere in the region have only convinced this generation that what once seemed impossible is, in fact, attainable. The protests have unified them in the conviction that what they are building is part of national and cultural missions. As one of the Egyptian entrepreneurs texted me from Tahrir Square during the protests, “I have always been proud to be Egyptian, but this is the first time I love my country. My work is Egypt’s work.” Another tweeted me more recently, “I will keep on saying this. Youth entrepreneurship is key in creating a long lasting impact in the Arab world!” These entrepreneurs come from every walk of Arab life. They are women and men; devoutly religious and culturally Islamic; college educated and self-taught; young and old and from literally every country in the region. They are above all realistic about the odds against them, yet unfazed by the political and infrastructural barriers. They view the recent political change as an unprecedented opportunity and, in some cases, confirmation of their efforts over many years. They are unleashing social and economic forces that will create the foundations of a new Middle East. These forces will build and evolve over years, but will be accompanied with a speed and transparency through technology that will hold any leadership, and themselves, to instant accountability. These entrepreneurs are not naïve. They expect setbacks. But they believe they are on the right side of history. So to me, the most interesting question of all is, why wouldn’t the Middle East be ripe to unleash a new era of tech-based entrepreneurship and innovation of the sort that has driven growth and job creation around the world? l I first began to piece together these questions sitting in the “network café” at the Jumeirah Hotel conference center on the second day of Celebration of Entrepreneurship, soaking up a large cappuccino amid young people head down over their BlackBerrys and iPhones. Dubai is a

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strange blend of familiar and surprising, a place one of my friends who recently moved there called “Vegas on steroids.” Everything in the city is new and opulent, and as convenient and organized as a newer American city. Western shops are fronted by elegant billboards plugging regional cell phones, airlines, and hotels. A nearby luxury hotel has that view of the Gulf with a helipad seemingly suspended in mid-air, famous from luxury magazine ad campaigns with celebrities like Tiger Woods hitting golf balls over the edge. Our conference center, like much of Dubai, was a wind-swept desert less than two decades earlier. Dubai City had grown from a few hundred thousand people to over two million in the same amount of time; currently less than 20 percent are indigenous Dubains, while the balance of the population hail from a hundred other countries. In a short time this multiethnic society had built the world’s largest skyscraper and indoor ski complex, and an artificial reef filled with luxury villas that is shaped like the world when viewed from space. It was almost impossible to find a restaurant featuring local food, and my hosts scheduled me for successive nights of Chinese, Thai, and French cuisine, and the first Argentinian churrasco I’d had since my last visit to Buenos Aires. Dubai is an entrepreneurial city built by and for entrepreneurial dreamers. It was a perfect setting for this gathering. At a table across from me was a young Kuwaiti, still amazed that more than a million people had downloaded his mobile game apps over the past two years—apps he’d created for his own amusement. He sat across from a 19-year-old coffee entrepreneur from Yemen who insists that every aspect of his operations (including packaging, which most producers outsource to China) be done in his own home community. Joining me for tea was that young, ponytailed DiCaprio lookalike whose Damascus-based computer animation company creates cheap, elegant short films for television, the web, mobile devices, and social networks. Running to a session speech, I was cornered by a stocky, affable thirtysomething Egyptian entrepreneur with a shaved head who has developed technology to blend air into shower water in order to dramatically reduce water consumption, an obvious advantage in the Middle East. He

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handed me his business card, of which I’d received over 100 in my first day, because he wanted to pitch me later and talk about how best to gain patent protection. I never found that young Saudi woman with the luxury charger in the packed crowd, nearly a third of whom were women with their own ideas. As I wandered through the long hallways lined with young people, I noted the energy of everyone—some in suits, others in jeans, still others in traditional Arab business dress and head scarves, all in animated chatter among themselves or on their mobile devices. There was a mobile text question-answering founder who wondered how much money he could raise. There was an entrepreneur with an innovative way to send and confirm documents securely on computing and mobile devices wondering when and how to staff up ahead of sales. The inventor of an iris-recognition technology wanted to know the best partnerships and reasonable business terms allowing him to offer his services to airports. All shared the common worries—do I have enough time? Will I make the right trade-offs? What if I fail? Upon my return to the United States, I wrote an article for my former bosses at the Washington Post describing what I had just seen. The reaction to the piece was one of the largest and most moving of anything I had written. Experts in the Middle East economies and policies from leading “think tanks” and successful global venture capitalists and investors asked me if what I saw was large-scale and sustainable. Countless people in the region wrote in appreciation of the piece, all saying in some form, as one entrepreneur from Ramallah did: “Finally someone is telling our story.” Apparently the U.S. Department of State was also paying attention, because a month later, I was invited to return to Cairo by State’s Global Entrepreneurship Program to be a judge for one of the first startup competitions there. My fellow judges included Austin Ligon, entrepreneur and founder of CarMax; Seth Goldstein, a successful serial Silicon Valley and New York entrepreneur and blogger who subsequently co-founded one of the hottest new music blog companies, DJZ; Faysal Sohail, a leading Palo Alto venture capitalist; as well as a top New York investment

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banker, an MIT management scientist, and other emerging market investors, among others. All were widely traveled, and had a sense that something new was happening in the region. Most had seen and even successfully invested in entrepreneurs in other emerging markets with their own versions of infrastructure, corruption, and cultural barriers. Over the course of four days we drilled into 32 presentations to find two winners, culled from hundreds of applications of web, mobile, and hardware startups throughout the country. The narrative I had seen in Dubai was in full force in Cairo. On January 17, 2011, I had an experience that suggested how the nascent entrepreneurial revolution in the region is interconnected with something bigger. I left my fellow judges in Cairo after the competition to visit Damascus, a historic city with its own brewing narrative of entrepreneurship. Young entrepreneurs were harnessing remarkable technology, despite government restrictions on mobile access for data and social networks like Facebook. Notwithstanding these limits, when I walked past the desk of the warm and stylish boutique hotel in the old city—one of over 65 that had been opened in recent years—I invariably saw young people with their Facebook pages opened. I remember one internet advertising startup founder telling me, “The rules are a pain, but we figure it out.” That evening, I met several young Syrian entrepreneurs and more senior business executives for drinks at the sleek, modern Four Seasons Hotel below the hills and a few miles from the Old City. The large bar area was thronged with a noisy crowd of executives from many countries, buzzing over their interests and dealings. All at once, silence fell. People studied their mobile devices, mouths agape. There was a pause for what may have been seconds, but it felt like minutes. Then everyone started speaking at once, saying the same thing in different languages: “He’s gone. He’s really gone.” Zine el Abidine Ben Ali, Tunisia’s dictator for more than two decades, had boarded a plane almost certainly leaving Tunisia forever. Within minutes, I received a text from Ghandour: “This is the biggest thing to happen in the region. Watch it closely. Bigger than your Iraq invasion. Bigger than the ‘67 Arab-Israeli War. People want change, and

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this will change things everywhere.” A few weeks before, a young, educated man with few economic prospects and no job had set himself on fire in protest to being fined for merely trying to open a fruit stand without a permit. That one act had spiraled into this moment. All my drink-mates were in awe that a seemingly small protest could lead to this. Anything seemed possible. Two days later I returned to Cairo for a last dinner before I was to fly back to the United States. At the table were experienced business professionals in their forties or older, a few government officials including representatives from the U.S. Embassy, and two young entrepreneurs from the competition. Tunisia was the central topic of conversation. “Sure this is big,” one U.S. official told me, “But Tunisia isn’t Egypt. Mubarak isn’t Ben Ali. The army will never allow anything like this to happen here.” I looked over at the young entrepreneurs, and one leaned over and said, “I don’t know. Maybe they are right. But I’m not certain why we are that different.” Within a month, after 18 days of demonstrations, Mubarak resigned as president. A year later, he was serving a life sentence in an Egyptian prison amid rumors of his imminent death. l Syria, of course, is also the cautionary tale—a country of globally competitive talent and passion stifled first by government control and then squashed, for now, by government brutality. The most talented and creative entrepreneurs I have met there have either left for Dubai or other countries in the region or have dived deeply under cover. Some have been killed. The narrative of civil war and sectarian violence, the go-to expectation of so many in the West, seems to be playing out—and may very well win. But I do not bet on this over time. “I have found that in the long run over history, when societies have a choice between taking their own destinies into their own hands or national suicide, it’s not a good idea to bet on the latter,” author and global policy expert Parag Khanna told me over a long afternoon of tea

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in the spring of 2012. He knows of what he speaks. Having lived in and traveled to almost every corner of the world—on the road 300 days a year—his books like The Second World are almost prophetic regarding the rise of emerging markets as central players on the world’s stage. “What so many fail to understand,” he says, as he stares hard into my eyes, “is that psychological barriers are dropping all over the world. The conspiratorial legacies of the Cold War—especially in the Middle East, Africa, and Latin America—are yielding to a new expectation of greater self-reliance.” He added with a smile, “When you no longer think of yourself as just pawns in a superpower battle, or playing a rigged game, you want to step up.” Clearly something is afoot. Business, investment, and political leaders in the region and around the globe have a historic, and perhaps unprecedented, opportunity to embrace these young entrepreneurs as good investments on the ground floor of a much bigger world. At the same time, they can embrace these innovators and risk takers as central to truly new societies and economies in the Middle East. They have an ability to side with a new generation which is tirelessly and unrelentingly committed to offering paths to different and better lives. And in the active encouragement of this new era of entrepreneurship in the Arab world lies the foundation of global innovation for and from the Middle East. Personally, I will look at the modern history of the Middle East as beginning at that conference in Dubai. While economic success is hardly assured there, the rise of a new generation of business entrepreneurs cannot be ignored. I decided to dedicate a year of my life to exploring the strengths and limitations of the rising entrepreneurial ecosystems of the region, and to shining light on a few of the thousands of young entrepreneurs. They are all not only innovating local, regional, and global enterprises, but they are also working to solve some of their long-ignored social and infrastructural challenges. I wanted to better understand the surprising power of the role of women and religion among these entrepreneurs. And I wanted to learn more about why many global technology juggernauts are doubling down in the region during this time of uncertainty. I hope that this book will encourage others to take a deeper look

20 Star tup Ri si n g

An Excerpt from Startup Rising • 65

at this historic regional change and in turn provide the “a-ha!” moments I have experienced, and open minds to the unprecedented possibilities arising in the Arab world. As such, Startup Rising opens itself up to challenges. As a matter of scope, I have focused on the Arab worlds—primarily Egypt, Jordan, Lebanon, Saudi Arabia, and Dubai—but mean in no way to give short shrift to similar remarkable and significant activities happening in the other Emirates, North Africa, the Gulf, Turkey, and even Iraq and Iran. The extraordinary ecosystem that is Israel has been well examined in Dan Senor’s and Saul Singer’s definitive Start-up Nation and many research studies and articles. Even so, experienced Middle East scholars and broader political scientists may argue that what I have seen represents a small fraction of Arab society and will be a sideshow to the traditional power politics of the region. Thoughtful economists and experts on emerging markets may well add that tech entrepreneurship cannot create enough jobs regionally fast enough, let alone compete globally with the more open societies of the West. Successful investors in emerging markets may argue that there simply are safer bets in other developing countries. And they may all be right. But they should reconsider. I offer no crystal balls here but, rather, hope only to challenge the traditional narrative of the Middle East in light of substantial and swiftly growing access to rapid technological change. To seek precedence and parallels in the past is safe, easy, and comfortable. But it is also what led some of the greatest minds to predict the strength of Mubarak’s position just weeks before he fell. As the great automotive visionary, Henry Ford, is said to have, perhaps apocryphally, noted, “Had I listened to the market at the time, I would have built a faster horse.” Contrasting the potential of these entrepreneurs with tumultuous and unsettling events in Cairo, Baghdad, and Aleppo, I have often thought of a quote in a different context from a more recent visionary and descendent of Syrian immigrants, Steve Jobs: “And no, we don’t know where it will lead. We just know there’s something much bigger than any of us here.”2

9781137348913 | November 2013 ÂŁ19.99 | $32 | $37 CAN Hardback | 200 pages

The Power of Customer Misbehavior explores the importance of customer driven innovation for top line and bottom line growth. It shows how companies should not only learn to identify how their products are being misused, but also how to use this knowledge to innovate new products and services that better meet customer needs and promote viral growth. These techniques also promote longterm customer loyalty and growth even in hypercompetitive environments. Available to order at www.palgrave.com. Enter the code WORLDPALGRAVE20 to receive a 20% discount.

An Excerpt from The Power of Customer Misbehavior • 67

1 Why is Viral Growth Important?

‘This is the honey badger. Watch it run in slow motion. It’s pretty badass. Look, it runs all over the place. “Woah, watch out!”, says that bird. Ew it’s got a snake? Oh, it’s chasing a jackal? Oh my gosh!’ If you read this and the voice in your head sounded like a high-pitched, effeminate male, then you’ve undoubtedly seen the YouTube video ‘The Crazy Nastyass Honey Badger (original narration by Randall)’. It was uploaded on 18 January 2011 by user ‘czg123’ and has been viewed over 56 million times.1 The video features original footage of the tough and ornery Honey badgers taken from a National Geographic special that aired in 2007. According to the New York Observer the ‘Crazy Nastyass Honey Badger’ video was the brainchild of Christopher Gordon2 (not a guy named Randall) – an actor, writer, comedian, and ‘Randall’s Personal Asst.’3 In an email interview by Michael Humphrey, Contributor at Forbes, we learn that Gordon’s inspiration for the video came from his father’s work on Marlon Perkins’ ‘Mutual of Omaha‘s Wild Kingdom’ as a cameraman.4 Between his father’s film footage and his twiceweekly trips to the zoo with his grandmother, he developed the habit of narrating everything. With memorable quotes such as ‘honey badger don’t give a shit’ or ‘honey badger don’t care’, the video became an instant hit. It was covered within the first 30 days by humor blogs such as ‘Funny or Die’ and ‘Huffington Post’ as well as mainstream entertainment sites like TMZ.5 The authors of this book became aware of the video in January 2011 when Marty’s friend posted the video on Facebook. He then passed it in email along to Mike and several other colleagues. Kalle (Marty and Mike’s doctoral advisor at the time) stared in disbelief, believing that the foundations of education were sure to crumble beneath him, as Marty showed the video to a group of academics between meetings. Marty singlehandedly invited dozens of people to view the video, many of whom could be seen later excitedly discussing the video amongst themselves and immediately sharing it on Facebook, or emailing a link to it to friends and colleagues.

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2005

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2007

2009

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Figure 1.1 Google Search for ‘Honey Badger’6 Source: Google and the Google logo are registered trademarks of Google Inc., used with permission.

While the video became a huge Internet sensation, its attraction as an entertainment destination was short lived. Figure 1.1 shows that prior to Randall’s video, not many people were searching for ‘honey badgers’ on the web. During 2011 the interest skyrocketed, while plateauing at the end of the year. After a year in the spotlight, interest in the web search term ‘honey badgers’ started to wane, falling almost as quickly as it rose. The Honey badger video teaches us several key points that we would like to present in this chapter about viral growth. First, it shows how ideas can spread from one individual to another very quickly. Marty alone was responsible for inviting dozens of people to view the video. Second, it helps us see the effect of virality without the power of retention. While the Honey badger video was wildly popular in 2011, by 2013 its popularity had disappeared. We’ll cover both of these points in more detail in this chapter as well as answer the question of why viral growth is important. First we need to define the term viral growth.

VIRAL GROWTH CLIFF NOTES Viral growth is achieved when the users of a product cause, on average, more than one additional user, per existing user, to use a product or service. In other words, each user of a product influences more than one additional user to begin using the product during some specified time period. If a product has five users at the end of time period 1, it will have more than ten users using the product in time period 2, more than 20 in time period 3, and so on. An existing user of a product influencing a friend, colleague, or relative to start using a product can occur in a variety of ways. One method is very direct. A user invites a bunch of friends to start using a product

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2005

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Figure 1.1 Google Search for ‘Honey Badger’6 Source: Google and the Google logo are registered trademarks of Google Inc., used with permission.

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a virus spreading through a population. Though in their everyday life people do not intentionally spread viruses, they can figuratively do so in their social networks by sharing information about rumors, services, features, benefits of a site, or just by telling others about their positive use experiences.7 Combining these two words we can form the term viral growth that we define as the increase in the user base of a product or service resulting from people’s action to induce other people in their networks to repeat their usage of the product or service. While viral growth has only reached the mainstream vernacular in the past decade when the hyper-growth Internet services made it popular, the idea of viral growth dates back to 1976, with Richard Dawkins’ publication of The Selfish Gene. Dawkins’ book analyzed evolution as a cultural phenomenon, where instead of genes controlling the evolution ideas called ‘memes’ would control the process. A meme is a framework for thinking about things – an idea, behavior, or style, such as wearing white after Labor Day, the phrase ‘You had me at “hello”’ from the 1996 film Jerry McGuire, or the Honey badger story. It can be anything passed from person to person where the rate of acceptance and proliferation are likely to depend on several factors such as entertainment value, news worthiness, educational value, or sheer popularity. One significant difference between biological evolution and cultural evolution is the pace at which cultural evolution can take place. Memes can spread much faster than genes can replicate, even when compared to the very fast ten-day metamorphosis cycle of a fruit fly. In that amount of time a meme can spread around the Internet and become old news. Viral growth is achieved when a meme spreads very fast, without the conscious plan and effort to spread it. At the same time the growth in a user base will follow a power-law distribution until the adoption reaches a point of non-displacement.8 A power law expresses a mathematical relationship between two quantities in which the frequency that an event occurs varies as a power (or exponentiation) of some attribute of that event. In the case of the Honey badger video, the upward curve of Figure 1.1 (the viral growth phase) is a power of the previous viewings and subsequent shares. To achieve the sharp incline in growth, the cumulative viewers for any given day have to share (on average) the video more than once. Powerlaw distributions are also sometimes called scale-invariant or scale-free distributions, because a power law is the only distribution that is the same whatever scale we look at it on.9

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Why is Viral Growth Important?

9000000 8000000 7000000 6000000 5000000 4000000 3000000 2000000 1000000

1 10 19 28 37 46 55 64 73 82 91 100 109 118 127 136 145 154 163 172 181 190 199 208 217 226 235 244 253 262 271 280

Figure 1.2 US City Populations Few real-world distributions follow a power law over their entire range, especially for smaller values of the event. For example, the population of cities follows a power-law distribution above the minimum population of 40,000. In Figure 1.2 we have plotted the populations of the top 285 US cities according to the 2010 US Census. As you can see, a few cities have the majority of the population and then the amounts drop off quickly. The top city, New York with 8.2 million people, has three times as many people as just the third city, Chicago, with 2.7 million people. Armed with this initial definition of viral growth and understanding of power laws, we next explore factors that define viral growth.

WHAT ARE THE COMPONENTS OF VIRAL GROWTH? While achieving viral growth can be elusive, calculating and predicting the growth under certain conditions can be accurately determined due to well-defined structural conditions that characterize such growth. In order to do so requires acquiring and estimating information about pivotal factors that affect the spread of the information or ideas. This process of spreading is known as contagion, which can be defined as rapid communication of an influence. It is also derived

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from an epidemiological term relating to the spread of infectious disease.10 Contagion simply deals with the rate at which infected new users become ‘converted’ to use a particular product or service. Factors that affect contagion, as known from epidemiological studies, include first fan-out and conversion, both of which we will discuss below. For a more complete coverage of how the term ‘viral growth’ was derived from the study of contagious diseases, see Appendix A. The viral growth of a product or service is determined by the extent to which current users send requests to their friends or colleagues to participate in a service and whether those individuals ‘convert’ and become users as well. To describe the rate of this process, Kalyanam coined the concept of a viral index11 or viral coefficient12 that predicts how quickly viral growth can occur for a service provider. The viral coefficient (Cv) predicts the number of new users that will be generated by one existing user through influencing, recommending, suggesting, sharing, and so on. It is a function of the fan-out (number of new users invited per existing user) multiplied by the conversion rate (number of new users converted to using the service) and is defined as: Cv = fan-out * conversion rate

(1)

Cv must exceed 1.0 to generate viral growth. The variable fan-out is the number of individuals an existing user introduces to the product or service. This factor can be influenced by a wide variety of factors including the ease with which users can share recommendations and linking existing users with potential new users through a process dubbed a ‘social cascade’.13 Conversion rate is the number of new users that convert to using the service or product after receiving an invitation (from the fan-out). It is affected by factors such as the perceived value, learning effort (ease of use),14 service quality,15 and perceived entertainment.16 From our Honey badger story, Marty initially was the recipient of another person’s transmission (or fan-out) of the video. He subsequently converted by watching the video himself. He then invited people via email and displayed the video in public settings. A number of email users converted, and by definition all of the people in the public viewing ‘converted’, because they watched the video. Therefore Marty was responsible for a Cv far greater than 1.0. The sum of all shares (all people like Marty sharing the video) divided by the number of sharing people and subsequently multiplied by the resulting conversion (or

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Why is Viral Growth Important?

views) for the month of January would be the Honey badger’s Cv for January of 2011. Although Cv measures service growth, it cannot identify a sustainable growth strategy for a product or service provider, because it fails to measure sustained growth – growth that takes into account a loss of users to competitors’ new services, or users dropping the service because of loss of interest or value. A high Cv without the new users returning to use the service results in the ‘Slashdot effect’ – so named after the popular technology news site, Slashdot.org. When an article on Slashdot mentions a small site, the ensuing traffic spike can cause the small site to slow down or fail. Once the article has run the news cycle and is no longer popular, the small site’s traffic returns to normal with no recurring or sustained traffic. This ‘moment in the spotlight’ might be thrilling, but it doesn’t produce a sustained growth in new readers or users for the small site. This effect can be seen in the ‘Honey badger’ curve of Figure 1.1, albeit in a somewhat biased way since the graph shows all searches for the term and not just direct views of the video. Clearly a large number of people shared and subsequently watched the video, but ultimately those users did not continue to return to watch the video over and over again resulting in the downward trend. For the growth to be truly viable, the product or service must increase its number of cumulative users, over a certain period. This requires new users to not only join, but to stick around. To calculate the cumulative users we must multiply the Cv by a retention rate and raise the product to the exponent of the frequency (number of times the service is used per cycle i.e. intensity of social exchanges in any social network, where the cycle is a fixed time period e.g. one day, one week, one month, which depends on the feature and nature of social exchange). The calculation of cumulative users is known as the viral growth equation: cumulative users = (Cv * retention rate)(frequency)

(2)

Obviously the Cv of the product or service expresses the total number of cumulative users if we can estimate all the factors that influence it. First, if viral coefficients remain below 1 the exponential growth is impossible. But similarly we must retain most of the users we convert. Therefore combinations of both rates need to meet specific threshold conditions in order for exponential growth to ensue. Figure 1.3 shows several examples of how alternative combinations of values for conversion rate and retention rate affect the number of cumulative users.

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Cv=0.9 R=100%

Cv=1.2 R=100%

Cumulative Users

Cv=1.2 R=70%

Time

Figure 1.3 Viral Growth Equation

The solid line shows Cv at 1.2 (well above 1 which is needed for viral growth) and retention rate at 100 per cent. This is the classic ‘hockey stick’ growth pattern, so named because the graph resembles the shape of a hockey stick, which we typically associate with the experienced viral growth of some products or services. The dotted line shows Cv again at 1.2 but the retention rate at only 70 per cent, still we have a cumulative users growth rate that any product or service provider would love to have. To show the massive effect of Cv, the dashed line shows the Cv of 0.9 and the retention rate back at 100 per cent. Notice that there is no viral growth in this last example. Despite retaining 100 per cent of users this last product cannot achieve viral growth, because it is not capable of bringing in one new user for every existing user. The equations 1 and 2 suggest a variety of ways the number of cumulative users of a product or service can be improved. Walking through the equation, when on average each user shares (fan-out) the product more than once and a majority of those users attempt to use the product (conversion) this will result in a Cv > 1.0. Furthermore if each of these users on average repeats the usage of the site (retention) over the course of the year (cycle) more than once (frequency) the result

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Why is Viral Growth Important?

will repeat itself. The viral growth equation tells us that by sharing information about new services, new features or benefits of services, or just telling others, either intentionally or accidentally, growth will be inevitably achieved. It sounds so simple, right? Accordingly product and service providers can utilize many strategies to increase the viral coefficient, most of which can be categorized under viral marketing (fan-out), or they can innovate with new features and services that increase the scope and intensity of user experience and cycle of frequency thereby affecting conversion or retention. This, in turn, requires investing in processes through which service innovation can take place quickly. Indeed, the question of how to influence factors that underlie the value of viral coefficient, conversion rate, and retention rate to ultimately achieve viral growth is the foundational question that our research began with. We are going to share our insights on this topic in the remainder of this book, but first we must address the question of why a product or service provider should attempt to achieve viral growth.

WHY DO WE WANT TO ACHIEVE VIRAL GROWTH? Whether your business is an online social network, an auction site, an e-commerce platform, or a real-world store, all these businesses will rely on consumer traffic – either clicks and eyeballs or feet and bodies. When a product or service is ‘sticky’ (in our equation the frequency is high for the defined interval length or ‘cycle’), the traffic translates to tangible business and growth. Think of this in terms of how many times you return to your local Target or Wal-Mart store (frequency) within a month, a quarter, or a year (cycle). Failing to achieve sufficient growth dooms a company to tepid business, poor financials, and ultimately to failure. Even if you achieve good growth, the market value of your company can tumble precipitously in a short period of time, if you cannot sustain it. Some online businesses have achieved hyper-fast viral growth, as exemplified by Twitter’s growth in 2009 at a staggering 1382 per cent.17 Products and services that display such viral growth are those that can be adopted by and passed between users incrementally, gaining exponential momentum in adoption rates as time progresses. Viral growth should therefore be a goal for an array of businesses launching today, because it is a way for a company to achieve significant market share faster, and with the flexibility to target new markets in the midst

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of growth. In turn, viral growth allows companies to achieve investor returns faster, assuming the company has figured out how to monetize the traffic. Simply put, for businesses that do not operate in natural monopolies or oligopolies, viral growth will most quickly enable them to create a defensible position.

Viral Growth on the Internet – Friendster vs. Facebook It is easy to understand and instructive to learn the importance of the principle of viral growth, if we consider the effects of the growth of social networking sites. A terrific example of the power of viral growth is the comparison of the fates of Friendster and Facebook. Both launched at almost the same time, were equally well funded, and both hired talented teams, but one ultimately achieved sustainable viral growth while the other did not. Consequently their fortunes differed markedly. Friendster was founded by Jonathan Abrams and Chris Emmanuel in 2002 in Mountain View, California, before the creation, launch, and adoption of Myspace, Facebook, LinkedIn, and other social networking sites. Friendster’s purpose was to establish a safer, more effective way to meet new people by browsing user profiles and connecting to friends, and friends of friends.18 This allowed members to expand their network more rapidly than in real life. Friendster.com went live in March 2003 and was adopted by three million users within the first few months. As its popularity increased, page load times slowed – users waited longer for each attempt to use the site. At one point, a Friendster web page took as long as 40 seconds to download. The main reason for this was that Friendster had a product feature, known as the friend-graph (or F-graph), that caused the site’s poor performance. The F-graph calculated the four degrees of connection for every user, every time a new connection between people was made. Technical difficulties in solving this computational problem proved too pedestrian for the Board of Directors to address and thus they were left to the engineers to resolve. Over the next three years the Board named four CEOs, some of them remaining in office for only a few months. During the five-year term of Kent Lindstrom, one of the earliest investors in Friendster, a new team was recruited, technical challenges were solved, and the company prioritized the Asian market. This resulted in Friendster becoming the leading social network in some Asian countries, and it received $30 million in additional funding from Kleiner Perkins and Benchmark Capital.

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In 2008, Friendster hired ex-Google executive Richard Kimber as the CEO and had a membership base of more than 115 million registered users. On 9 December 2009, it was finally acquired by MOL, a Malaysian company, for $26.4 million despite receiving funding in October 2003 at a reported valuation of $53 million. The story of Friendster seems like a relative success until we compare it to the meteoric rise of Facebook. Mark Zuckerberg founded Facebook with his college roommates and fellow computer science students, Eduardo Saverin, Dustin Moskovitz, and Chris Hughes, while they were students at Harvard University. The website’s membership was initially limited to Harvard students as a version of hotornot.com, but was expanded to other colleges, then to high school students, and finally to anyone over the age of 13. The site was ranked as the most used social network worldwide by monthly active users in 2009, and had over 500 million active members by 2010. In 2008 the fastest growing demographic was 25 years old and older, while in 2009 the fastest growing demographic was 35–54 year olds.19 In terms of usage – a key component in the viral growth equation – Facebook has over 900 million total users with 35 million users updating their status each day, uploading 2.5 billion photos each month, and sharing 3.5 billion pieces of content each week. The average user has 100 friends and 2.6 billion minutes are spent on the site each day.20 Facebook, having achieved exponential user growth, announced revenues of over $1 billion in 2011, going public in the summer of 2012, which raised $16 billion of capital and valued the company at over $104 billion. As noted, Friendster and Facebook were launched at almost the same time, had equally talented teams, and were both well-funded; yet one achieved sustained viral growth while the other did not. The resulting valuation for investors was $26.4 million for one and $104 billion for the other. This teaches us that with social networking, and anything on the web, failing to achieve viral growth dooms a company to failure. Even if one achieves good growth for some time, the market value of the company can tumble precipitously in a short period of time if one cannot sustain it.

Real-World Viral Growth – Tupperware It’s relatively easy to see how viral growth needs to be, and can be, achieved with online services such as Twitter and Facebook, where users are engaged in producing content such as 140-character pithy

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comments or pictures of their latest vacation, but what about the world of atoms – the physical products and services? Most of us are familiar with Tupperware, plastic containers used in our houses to store or serve food and various other items. What you might not know is that the Tupperware story is an example of non-Internet viral growth.21 Earl Tupper developed Tupperware in 1946 and patented the ‘burping seal’ for which the brand was known. However we can argue that not many of us would know the brand, if it wasn’t for the efforts of Brownie Wise, the former sales representative for Stanley Home Products, who developed the direct marketing strategy that made Tupperware a household name. The marketing strategy, also known as the ‘home party plan’, empowered women in the early 1950s who refused to ‘go back to the kitchen’ after World War II, and instead insisted on having a place in the workforce.22 These party plans were where women invited friends and neighbors to a combined social event/ sales presentation. This word-of-mouth model of direct sales relied upon trusted relationships primarily between women and proved incredibly successful. While many of us growing up in the 1960s and 1970s remember comedians joking about Tupperware parties, the result was just more free publicity. In 1958, Mr. Tupper sold the company for $16 million to Rexall Drug Co., renounced his US citizenship, and ended up living in Costa Rica until he died in 1983 at the age of 76. Unfortunately before the sale, Mr. Tupper ousted Ms. Wise from the company, believing that suitors of the company would have no interest in a female executive (according to Laurie Kahn, who wrote, produced, and directed the 2004 PBS documentary ‘Tupperware!’). The company spun back off as an independent company on 31 May 1996 and continues to thrive, relying primarily on the party plan. A few years ago, Rick Goings, the Chairman and CEO, boasted that a Tupperware party was held somewhere in the world every 2.3 seconds, but with a direct sales force of over 2.6 million, that rate is closer to a party every 1.7 seconds.23 In Figure 1.4, Tupperware’s performance is compared with a competitor, Rubbermaid, showing Tupperware up over 60 per cent, while Rubbermaid is down nearly 20 per cent over the 17-year period since the spinout. Hopefully, by this point you, along with every other 18-year-old would-be-entrepreneur, are convinced on the value of viral growth. However you’ve probably realized from these stories that viral growth is somewhat akin to catching lighting in a bottle. It is a rare event,

1998

TUP 64.85

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Figure 1.4 Tupperware vs. Rubbermaid Stock

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made more likely by the advent of the Internet or some specific social condition (such as suburbia housewives and their need for socializing), but still exceptional. So, where does that leave us? Should we give up or push on in the quest for viral growth?

WHAT IF YOU CAN’T ACHIEVE VIRAL GROWTH? While true viral growth, where the viral coefficient (Cv) is greater than 1, might be rare, there is still a lot we can achieve with viral replication of our products and services. We are going to refer to this type of organic – with a viral coefficient less than 1 but that is achieved by word-of-mouth – as sub-viral growth or organic growth. By using other means of growth such as marketing, advertising, and search engine optimization,25 we can leverage this sub-viral growth to amplify these into significant growth.26 Let’s look at how we can use organic growth to amplify paid-for growth, such as from advertisements. If we have a site to which we want to attract users, we can leverage non-organic growth by purchasing advertisements. We can then leverage our organic growth to augment the paid-for growth, resulting in higher growth rates. As an example, in Figure 1.5 we have plotted the monthly growth of users on our own site. The solid line is 100,000 new users per month, assuming a loss of 2 per cent of users each month. While the growth is impressive, we can do better. If we amplify our growth by including organic growth, with a viral coefficient of 0.70, we achieve three times the total users, plotted as a dashed line. This idea of using organic, sub-viral growth to amplify more traditional marketing is finding roots in quantitative research. Sharad Goel, Duncan Watts, and Daniel Goldstein – all three from Yahoo! Research – recently presented a paper at the 13th ACM Conference on Electronic Commerce that described the diffusion patterns of seven online services, including Yahoo! Voice, Friend Sense (a Facebook application), news stories sent via Twitter, and a psychological test called ‘The Secretary Game’.27 Despite the fact that each of these had very different profiles of how users shared, the vast majority of the sharing cascades were small, terminating within one degree of the initial ‘seed’. Adoption or viewing by users from a chain of referrals was extremely rare. But the good news, according to Goel et al, is that while most new services don’t go viral like the flu, they can get a 20 or

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Why is Viral Growth Important? 5,000,000 4,500,000 4,000,000 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 – 1

Figure 1.5 Amplification Growth – http://afkpartners.com 30 per cent boost in return, where for every ten adoptees of a conventional marketing effort, another two or three people will adopt something organically.28

CONCLUSION We started this chapter by defining the term ‘viral growth’ as the increase in the user base of a product or service, resulting from people’s action to induce other people in their networks to repeat their usage of the product or service. We learned the etymology of the concept and term. We also learned that viral growth with a viral coefficient greater than 1 follows a power-law distribution. We calculated the viral coefficient by multiplying fan-out (number of new users invited per existing user) by the conversion rate (number of new users converted to using the service). As it turns out however high viral coefficients aren’t enough. What we really need is viral growth with a high number of cumulative users. What is known as the viral growth equation can then be calculated by multiplying the viral coefficient by a retention rate (how many users continue using the product or service) and raising the product to the exponent of the frequency (number of times the service is used per cycle i.e. intensity of social exchanges) and length of the cycle (that is, a fixed time period,

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such as one day, one week, one month, which depends on the feature and nature of social exchange). Armed with this understanding of viral growth we next explored the question of why one would want to achieve viral growth. We examined two scenarios to answer this question. The first scenario compared Facebook and Friendster, two Internet-based social networks that started within months of each other, had seemingly similar opportunities, and yet achieved dramatically different results. The second scenario investigated Tupperware, a classic example of viral growth in the pre-Internet era, that achieved remarkable results for many individuals who were involved with the company over the past six decades. Finally we explored the idea of how we might leverage existing users to influence new users, even if we can’t achieve true viral growth. We found that even with a viral coefficient less than 1, we can achieve substantial growth amplification by following ideas of viral growth, and informed by the viral equation. One example demonstrated a total growth rate three times greater, with a viral coefficient of 0.70, than without this user-influenced growth. The conclusion drawn from these examples is that any amount of user-based viral growth is a good thing. While it works extraordinarily well for Internet-based products and services, the concept can be applied to any real-world commerce as well. Next we need to explore the factors that influence the viral coefficient and retention rate. Through our research we discovered that how companies respond to customers’ misusing of their product could affect the factors of viral growth. We also uncovered that an underlying motivation of customers to use, and possibly misuse, products and services is the creation and management of their self-identity. These and other factors will be covered in the next few chapters.

Summary •

Viral growth can be defined as the increase in the user base of a product or service, achieved by people inducing other people to repeat the usage.

•

The viral growth equation is: cumulative users = (viral coefficient (frequency) * retention rate)

9781137293893 | December 2013 ÂŁ29.99 | $40 | $46 CAN Hardback | 224 pages

Governance in Family Enterprises provides a highly comprehensive and global look at family business governance, incorporating financial, emotional, cultural, and family aspects, to achieve overall success. Featuring extensive interviews with renowned family enterprise owners and incorporating advice from family businesses all over the world, this expert book provides a range of practical ideas, tools, and frameworks to put in place, and actionable solutions to a number of difficult challenges. Available to order at www.palgrave.com. Enter the code WORLDPALGRAVE20 to receive a 20% discount.

ch ap te r

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Maximizing Success through Professional Family Business Governance*

”Family-owned businesses need to align their governance with that of public companies to some extent.” Interview with Dr. Jürgen Heraeus, Chairman of Heraeus Holding, Hanau, Germany Dr. Jürgen Heraeus, chairman of the board of directors at Heraeus Holding, gives an account here of how the most important aspects of leadership, control, and family structures are implemented in his company. Heraeus is a globally active precious metal and technology group based in Hanau, near Frankfurt in Germany. The company has been family-owned for more than

160 years. With more than 12,200 employees, Heraeus ge ne ra ted product revenues of €4.2 billion and precious metals trading revenue of €16 billion in 2012.**

* Alexander Koeberle-Schmid would like to thank Peter May, Peter Witt, Karsten Schween, Hans-Jürgen Fahrion, and Bernd Grottel for their support in developing this chapter from prior work on which they collaborated. ** This interview is translated into English and has already been published in the book Führung von Familienunternehmen (Leading the Family Enterprise) by Alexander KoeberleSchmid and Bernd Grottel, published by Erich Schmidt, Germany.

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A family enterprise that has reached a certain size needs to have its own family business governance. To what extent is this true for your company? We ﬁrst established a family governance code within our company in 2006, on the basis of which we then adopted the Heraeus family code in June 2011. In its function as the code of the shareholder families, it forms a common basis for all shareholders and furthermore provides a

knowledge base to all young and new shareholders. The board of directors takes a special position within the governance system. What signiﬁcance does this board have in your company? True to our motto, “Good governance at Heraeus,” we think it is important that the board is as professionally staffed as it would be in a public c o m p a n y. Also, we decided that owners must play an active part in our company’s boards, thus taking on a great deal of responsibility for the company. In order to be eligible, candidates must comply with a range of criteria such as suitability and qualiﬁcations as well as commitment and acceptance within the ranks of owners. You see, we have set the bar very high.

w th e th pr at t ink sta ofe he it i be ffe ssio boa s im co in d a nall rd i por m a p s it y s a ta pa u nt s w b ny lic ou ld

Alexander Koeberle-Schmid: Dr. Heraeus, governance in familyowned businesses differs from that in publicly-held companies. In your opinion, what is the most signiﬁcant difference? Jürgen Heraeus: The most important difference is the time factor, really. Owners usually have a planning horizon that is measured in generations, whereas to managers and shareholders of listed companies quarters and quarter ﬁgures matter the most. This fundamentally different perspective of family-owned businesses has a major impact on the requirements for and the development of governance.

You have about 200 shareholders. This results in some shareholders becoming less attached to the company as well as an increase

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How do you proceed if a shareholder wants to drop out? Our share price, a so-called ceiling price, is determined annually. This price is announced at our shareholders’ meeting. If a shareholder wants to sell his shares, he has the option of choosing a buyer from within the family or otherwise the shares are tendered. Should no shareholder be able to buy the shares, our asset-managing holding company will need to buy them. It is your wish that family members be represented within management. How do you

m e c ble ust om of be pa lea ny di n

ensure that the managing director in your family enterprise is suitably qualiﬁed? Before they can hold a position in the family company, family members must have proven themselves in other companies. They can then apply for a position two levels below group management level. The shareholder committee will determine whether that family member is a good match for the company in terms of character and experience. They must be capable of leading the company but also of communicating with the family.

in heterogeneity. How do you handle this situation? Our dividend payout corresponds to our system of values and is most appropriately characterized by the term “modest.” Therefore, the links that bind shareholders to the company are more emotional than monetary. There is a considerable vested interest in the company and its development. In addition to our annual shareholders’ meeting, we organize special activities such as young shareholders’ meetings, family weekends, and education days.

What can be done if there is more than one candidate from within the family for a certain position in management? It is obviously easier if only one family member is applying than if there are several applicants for a position in the company. If there is more than one it might be preferable not to allow any of those family members to join the management team, in order to avoid conﬂicts. So far we haven’t had this situation.

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Structures for Family and Business: Family Business Governance

Especially in times of crisis, a family enterprise needs to be able to rely on its management. We have seen family businesses overcome numerous crises over time. Do family enterprises cope with crisis situations more successfully? The best prerequisites for overcoming a crisis are sufficient liquidity, a sound equity basis, a broad, globally competitive business portfolio, and tailor-made governance. Speaking on behalf of Heraeus, I’m conﬁdent that, being an internationally operating familyowned group, we meet the most important requirements for coping with future crises. What kind of advice would you give to an entrepreneurial

family wishing to further develop their governance? Family-owned businesses need to align their governance with that of public companies to some extent; that is, complying with those regulations stipulated by the German Corporate Governance Code that make sense. That being said, some of those regulations don’t make sense for family businesses, in my opinion. For example, a retiring managing director should not have to take a two-year cool-off period before joining the supervisory board. If he is a family member, he should be allowed to join the supervisory board immediately to ensure the same standards continue because, after all, it is his own or his family’s money that is at stake.

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Family enterprises are special Three brothers jointly run their businesses.1 They form a unit; a powerful team. They have divided up the tasks among themselves. One is responsible for finance, controlling, and human resources. The other runs the internet companies. The third takes care of the manufacturing businesses. The situation today is clear. But in the next generation, six cousins – the children of the three brothers – take up roles in the business. The brothers ask the following governance questions: Will all children inherit the shares equally? Which of the six cousins will manage the enterprise in the next generation? What happens when conflicts arise? How should the children be best prepared for their future role as owners? How can we ensure cohesion between the cousins? Here is another example. An entrepreneur has five children from two marriages. He plans to retire from management in three years’ time. A daughter from his first marriage and a son from his second marriage are interested in taking on a management role in the company. The company is just big enough for two managing directors and owners. The daughter, aged 35, has already made a career outside of the family enterprise and would like to start in a year’s time as managing director. The son, 23, has just completed a university degree. The father considers the following governance questions: Shall the shares be handed over to both children; and at what time? How can he compensate the children who do not get shares in the company, if he has no personal assets? What if conflicts occur between the half-siblings? Should a board of directors with external members be created? What succession plans do we have? A third family runs a mechanical engineering firm. It has developed a technology with great potential. The entrepreneur has ambitious plans: sales are expected to rise over the next five years from €150 million to €500 million. For expansion in France and the establishment of subsidiaries in the USA, India, and China, an external minority investor has joined forces with the company. The relevant governance questions for this family enterprise are:

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Structures for Family and Business: Family Business Governance

do of min w on an in ith e o t ow te a nt dy r m ne io na ore rsh n sti fa ip c m ilie s,

What changes in the management and control structures need to be anticipated? What role should the new investor play on the board of directors? How can appropriate control systems prevent wrong decisions? How can we ensure that employees in all subsidiaries comply with the legal rules and compliance standards? These three enterprises have the common features that they are under the dominant ownership of one or more families, with a dynastic intention or generational approach.2 However, the three family enterprises differ in ownership and management structure, whether they have a focused or a diversiﬁed business, and in size, culture, and whether or not they have nonfamily owners.3

Family enterprises differ not only among themselves, but also from other types of businesses. For instance, publicly-listed companies have dispersed ownership of unknown shareholders that can buy and sell their shares at any time. Family enterprises also differ from state-run organizations, those held by private equity firms, or cooperatives. Family enterprises constitute a unique and special category of businesses, with features that include: long-term strategic orientation, low disclosure obligations, and the increased continuity in management positions. Some of these characteristics give them competitive advantages; on the other hand, family enterprises face enormous risks, such as internal family conflicts destroying the business. In this book we seek to create a practical resource for approaching governance in family firms to help equip companies to face these issues. Below we highlight some of the principal opportunities that family firms enjoy, linked to the related risk factor: Family values can create competitive advantages, but continuous conflicts among family members undermine this. Family managers are more engaged with the company, and do not need so much control, but family managers may be less qualified and competent, act in their own interests, and require more control. Family members are oriented towards the long term, but some family members often want to maximize short-term dividends.

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Em w plo de ith ye in mo a co es w fo crea nst rpo ho r t se ra r he d te ate can m a ir i jo oti n cult den b ur tif va e y tio n

Family enterprises focus on a sustainable business model, but family enterprises have risks associated with the business life-cycle. Some family enterprises are highly successful and able to increase their value over generations, while others fall prey to internal disputes and crisis. The difference is that those that fail do not react properly to the challenges, do not have common vision and mission, a sound strategy or appropriate governance structures, and the roles of family members are not clearly deﬁned and incorporated by each family member. The following chapters set out approaches for different aspects of governance, both for the family and the business, addressing not just the structures, but matters such as values, conduct, and principles.

Sound family business governance Empirical analyses show that family enterprises are more successful when they have established optimally designed management, control, and family structures.4 Despite this, many family enterprises neglect governance. A report published in 2010 indicated an alarming number of insufficiently governed family enterprises.5 This neglect exposes them to considerable risks. Indicators of inadequate governance are: No obligation for family members to prove their competence when working in the business. No clear deﬁnition of the board of directors’ competences for exercising control. No management of opportunities and risks in the company. No rule regarding an exit mechanism. No rule regarding interactions with nonfamily shareholders. Limited family cohesion. No arrangements for managing conﬂict in the family and the company. It is surprising that family enterprises pay insufficient attention to governance, because this began to be discussed many years ago. In 1996, Craig Aronoff and John Ward published Family Business Governance.6

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Structures for Family and Business: Family Business Governance

This laid the foundation for a structured discussion about the professionalization of governance in family enterprises. Between 1996 and 2003, only about 10% of published work about family businesses in academic journals was about governance in family enterprises, whereas today that has risen to about 20%.7 A governance model for a family enterprise was comprehensively presented for the first time in Family Business Governance – Successful Management of Family Enterprises.8 Nonetheless, family firms are now paying more attention to governance, partly reflecting the fact that there are, internationally, 12 governance codes for family enterprises. The world’s first formal code for family enterprises only was published in Germany in 2004.9 As a result, around 60% of owners’ families in Germany know the code, and 90% think that good governance influences the performance of the family business.10 The aim of good family business governance is to set the basis for a sustainable increase in economic value and emotional well-being.11 Family owners want “deep pockets and warm hearts.” A study published by Ernst & Young established that the value of a family enterprise consists of around 70% economic value and 30% emotional value.12 It is disquieting to note, however, that the emotional value can become negative when conflicts erupt, which in turn can reduce the economic value. However, with the help of sound family business governance, both economic and emotional value can be maintained.

Economic and emotional value

fa m

ily

Pa tte x

A higher economic value is demonstrated by higher sales, better results, a higher company value, and increased dividend payouts. Emotional value has been called the “family Pattex” (Pattex being the brand of a glue produced by the German family business Henkel). Some family business owners say that it is not the dividends but the emotions that create an attachment to the company; the individual family members are proud to belong to a business-owning family that has no conﬂicts. Further indications of a high emotional value are:13 The family owners have common values and goals, which followed and passed on from generation to generation.

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A family business governance system14

ea its ch op ow ente a tim n g rpr fa m ally ove ise h ily s rn a co um an s to c ns m tit ari e, w est ut ze hi ab l io d c in h is ish n

Speciﬁc family traditions and rituals are performed by all family owners. The family owners have a strong willingness to learn. Participation in joint family activities is a pleasure for all family owners. The family owners support each other. There are clearly deﬁned boundaries between the rights and duties of the owners in relation to the family enterprise.

Effective governance helps a family business to achieve both economic and emotional value. Because family enterprises are different, each enterprise has to establish its own governance, which is optimally summarized in a family constitution. A structure for doing so is the family business governance model (Figure 1.1). Governance in family enterprises consists of two overlapping components:

business governance, which deals with establishing appropriate structures of management and control within the company; and family governance, which deals with managing the family and establishing cohesion among family members. Better business governance increases economic value by transparency and accountability with regards to management and control of the enterprise.

Family governance

Business governance Responsible owners Annual general meeting/owners’ meeting

Family council

Board of directors

Chief family officer Family philanthropic foundation

Chief executive officer Family office

Control instruments and control systems

Family constitution

fig 1.1 The family business governance model (adaption of the model by Alexander Koeberle-Schmid, Peter Witt, Hans-Jürgen Fahrion, and Bernd Grottel)

Structures for Family and Business: Family Governance An Business Excerpt from Governance in Family Enterprises • 93

This fosters long-term success through the professional conduct of owners, the board of directors, and managers. In addition, a management system covering risk, control, and compliance allows managers to ensure that monitoring can be carried out throughout the whole company. Additional supporting roles are played by the auditor and the internal audit function. Ethical codes, regulations about liability, and an appropriate remuneration system are also important governance instruments. Good and adequately formulated family governance can increase the emotional value owners associate with their company by strengthening the cohesion of the business-owning family, by increasing the engagement with the company on the part of the family, and by reducing the likelihood that emotional conflicts will arise. To do so, a family council and family manager (also known as a chief family officer) play an important role by organizing family activities, by implementing a family intranet, or by being the first point of contact if conflicts arise. In addition, a family philanthropic foundation and a family office play important parts in increasing emotional value and in organizing the business-owning family. One could also think about a family bank, a family assembly, a family residence, a family history book, a conflict-management procedure, rules about dealing with each other and with the public, and family development programs, where the next generation is prepared for becoming future CEOs or board members. Not all family enterprises, however, will need all family governance instruments. How the individual aspects of family business governance are configured depend on the individual circumstances of the family enterprise and their challenges (see Chapter 2). It depends on whether the business is owned by a sole owner, a sibling partnership, or a cousin consortium, and whether it is managed by the owners only (owner-managed), by some of the owners (family-managed), or is only supervised – not managed – by the owners. It also depends on the size of the business, its culture, and whether there are nonfamily owners or not. According to the classifications and the various factors listed above, different aspects of family business governance are necessary. Figure 1.2 shows how these different aspects of family business governance may become relevant. It is important to note that family

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Ownership structure

Management structure

Sole owner • Ownership succession plan • Board of directors

Owner-managed • Management succession • Board of directors • Risk control compliance management system

Sibling partnership • Annual general meeting • Ownership succession plan • Conflict management

Family-managed • Management succession • Board of directors • Risk control compliance management system

Cousin consortium • Annual general meeting • Conflict management • Chief family officer • Family meeting/assembly • Family educational programme • Family philanthropic foundation • Family office

Family-monitored • Management succession • Board of directors • Family council • Risk control compliance management system

fig 1.2 Deﬁnitions of the different stages in family business governance solutions for various types of family enterprise

business governance needs to be individually formulated by each family enterprise in order to ﬁt the situation of each family and business. Sound family business governance depends upon strong decision-making by the owners about the values and goals of the family, and about family ownership and the enterprise. Important family values include tolerance, respect, honesty, and mutual responsibility. Business-owning families should also set values for the business. It also helps to establish strategic principles, such as being an innovative market leader, maintaining an equity ratio of more than 40%, or prioritizing organic growth. Families should decide what they want to give the company (such as responsible ownership, and reinvestment of proﬁts) and what they expect from the enterprise (fair processes, interesting business model, dividends).

Responsible ownership and fair process The principles of family business governance are ”responsible ownership”15 and ”fair process.”16 ”Responsible ownership” consists of four fundamental roots: family values, stewardship, emotional ownership, and

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Structures for Family and Business: Family Business Governance

patient capital (see Chapter 4 for full deﬁnitions). In practice, a responsible owner has the following traits:17 He/she acts like a long-term affiliated owner. He/she wants the family enterprise to survive long term, preferably in family hands. He/she identiﬁes him/herself with his/her own company. He/she maintains a relationship between family and business. He/she is fully informed about the current situation of the company. He/she wants to transfer his/her knowledge to the next generation. He/she wants both the family and the company to be successful.

“F th air p lea at d roc co d t eci ess si ” nﬂ o ict em ons mea ot do ns s io na no t l

”Fair process”18 consists of three aspects. First, there should be individual arrangements or rules. These are set within the governance system and documented in the family constitution and articles of incorporation. These cover rules for succession, for distribution, or for exit. The rules must be clearly formulated, changeable, and consistent with the goals and values of the family business. They must be communicated to all owners and they need to be accepted. The second aspect of fair process is that compliance with the rules is to be ensured by a deﬁned institution, such as the board of directors. The nonexecutive and nonfamily board members can, for example, objectively decide whether the agreed requirements for the new CEO are met by the candidate from the family. Third, transparency about all rules needs to be assured for all involved family members such that that they accept the decisions taken. “Fair process” means that decisions do not lead to emotional conﬂicts, because they follow clear and formally accepted rules.

Business first or family first? The culture and the country of origin have significant influences on family business governance.19 Western cultures are more business-oriented, and Eastern cultures more family-oriented. In Western countries, few family members may work in the company. In Eastern countries more family

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members do so – sometimes they all do. Word pairs can illustrate whether a culture is more ”business first” or ”family first.” Examples are: meritocracy versus representation most competent leadership versus personal growth ownership rights versus family membership equality efficient versus effective individual responsibility versus collective responsibility accountability versus protection results versus process formal versus informal legal contract versus moral commitment controlled versus open decisive leadership versus participatory profit versus fun high trust in outsiders versus low trust in outsiders independence versus security. Families have to decide whether governance – both of the family and of the business – is oriented more towards the family’s or the business’s interests. In a ”family-first” business, the CEO is usually a family member; family members can work in the business, sometimes without limit as to their number; remuneration and dividends depend on family needs. If the approach is ”business first,” the position of the CEO is held by the most competent person, and often only one family member can work in the company and only as CEO; remuneration is market-based, and dividends are only paid out if the company is profitable.

fa co mil of nsid ies s h “r es er t ou po he ld ns tw alw ib le o p ay ow rin s ne cip rsh le ip s ”

Irrespective of the company’s orientation, families should always consider the two principles of “responsible ownership” and “fair process.” This is especially important when the culture is more familyoriented, because otherwise conﬂicts can easily arise and the family might end up destroying the business.

An Excerpt from Governance in Family Enterprises • 97

Structures for Family and Business: Family Business Governance

B R

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Business-owning families should implement a strong and healthy governance system.

2 When developing appropriate family business governance, owner families should consider their individual challenges (Chapter 2).

3 Owner families will ﬁnd that strong governance can help build emotional value as well as economic value.

4 Business-owning families should consider that the business needs appropriate strategies, structures, and rules, both for the business and for the family.

5 Owner families should develop their family business governance individually according to the ownership, family, and management structure as well as the size of the company, and if there are owners other than the family.

6 When designing family business governance, businessowning families will ﬁnd it helpful to be guided by the principles of “fair process” and “responsible ownership.”

While every firm will have a tendency towards being oriented more towards the business or the family in its overriding culture, governance should encourage the business towards an orientation of “business first”, and the family to the principle of “family first.”

8 Business-owning families are advised to document their family business governance in a family constitution.

Business-owning families should regularly review their family business governance, and further reﬁne it if there are changes to the family or business.

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I D

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Annual general meeting (AGM): The meeting of the owners once a year where important decisions are made, such as the election of the board of directors, the approval of the annual accounts, or a decision about proﬁt distribution. In some countries, it is also called an owners’ meeting or shareholders’ meeting. Board of directors: A governing body of a company that consists of executive and nonexecutive members. The latter provide advice and/or monitor the executive members. In some countries, the board may consist only of nonexecutive members with clear monitoring tasks; it is then called a supervisory board. When the board has no or little formal decision power, it is often called an advisory board. Business governance: Structural organization of management and control in a family enterprise aiming to ensure the longterm success and term continuity of ownership in family hands. Chief executive officer (CEO): Person who manages the enterprise. As well as developing and implementing corporate strategy, s/he is also responsible for the implementation of business governance and the family business culture, a lean organization, and ensuring that company policy aligns with the family’s goals and values. Chief family officer (or family manager): The person who is mainly responsible for family governance issues. The chief family officer manager performs the function of chairperson or president of the family council and helps to keep family members united. S/he often acts as a mediator, facilitator, and communication conduit for a family. S/he is responsible for ensuring family cohesion, and organizing family activities. Chief investment officer (CIO): Person in charge of all investments in a family office. The CIO heads the family office when its sole purpose is to manage the ﬁnancial investments of a family. However, when the role of the family office is larger, it is usually headed by a chief executive officer (CEO).

AnBusiness Excerpt from Governance in Family Enterprises • 99 Structures for Family and Business: Family Governance

Conflict management: Procedures that are used to resolve problems when conflicts arise. Family activity: Joint activities of the owners’ family to increase cohesion and commitment, such as family weekends, youngster days, and family meetings. Family bank: A way to provide family members with financial support under specific conditions. It can help individuals create their own entrepreneurial endeavors. Family constitution: A document that clarifies the relationship between a family and its business, and defines the strategy and structure of the enterprise. Mission, vision, important issues about the owner business model, governance, as well as rules that apply to family members, are normally documented. Other terms often used for a family constitution are family protocol, family code, family charter, generation contract, etc. Family council: A governance body that focuses on family and ownership matters. The family council represents an institutionalized form of periodically holding family meetings. The primary advantage of this formal format is the disciplined approach to holding these meetings, even when they appear not to be needed. Family councils primarily promote communication, provide a safe harbor for the resolution of family conflicts, and support the education of next-generation family members in responsible ownership, family dynamics, financial issues, and philanthropic issues. Family residence: special occasions.

Historic place where the family gathers for

Family education: Activities to educate business-owners in a sense of responsible ownership, such as education days, development programs, or seminars. Family enterprise: An enterprise that is predominantly owned by a family with the aim of handing it over to the next generation. Family governance: Organization of the family owners aimed at strengthening cohesion within the family as well as their identiﬁcation with the business, and therefore family solidarity across generations.

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Family history book: A comprehensive book about the history of a family, preferably with many pictures and written in a journalistic way. Family meeting or family day: Meeting of owners and other family members where issues about the family and the business are discussed. It is often combined with an AGM as well as fun activities. Family office: The family office is the person, desk or legal entity that manages the wealth of a family. It usually also provides legal and fiscal advice to family members related to their wealth. Family owners: The owners of a company, originating from the owner family. Family philanthropic foundation: A family philanthropic foundation, or family charitable trust, is an institution that organizes and funds the charitable activities of a given family. It can be set for the lifetime of a person or a specific generation, or may be an enduring entity. Management board: The group of executives who manage a company. Those are the executive directors. Owner family: The family who owns an enterprise. The boundaries of the owner family need to be defined. Normally it consists of the owners, their partners, and their children. Owners: The shareholders, partners, or limited partners of a company. Risk, control, and compliance management: Instruments that allow for control of the processes in the company. They help monitor risks and to ensure that employees comply with laws, rules, and regulations.

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