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A common explanation for the failure of a new venture to live up to its promise or even to survive at all is, We were doing fine until these other people came and took our market away from us. We dont really understand it. What they offered wasnt so very different from what we had. Or one hears, We were doing all right, but these other people started selling to customers wed never even heard of and all of a sudden they had the market. When a new venture does succeed, more often than not it is in a market other than the one it was originally intended to serve, with products or services that are not quite those with which it had set out, bought in large part by customers it did not even think of when it started, and used for a host of purposes besides the ones for which the products were first designed. If a new venture does not anticipate this, organizing itself to take advantage of the unexpected and unseen markets; if it is not totally market-focused, if not market-driven, then it will succeed only in creating an opportunity for a competitor. A German chemist developed Novocain as the first local anesthetic in 1905. But he could not get doctors to use it; they preferred total anesthesia (they accepted Novocain only during World War I). But totally unexpectedly, dentists began to use the stuff. Whereuponor so the story goesthe chemist began to travel up and down Germany making speeches against Novocains use in dentistry. He had not designed it for that purpose! That reaction was somewhat extreme, I admit. Still, entrepreneurs know what their innovation is meant to do. And if some other use for it appears, they tend to resent it. They may not actually refuse to serve customers they have not planned for, but they are likely to make it clear that these customers are not welcome. This is what happened with the computer. The company that had the first computer, Univac, knew that its magnificent machine was designed for scientific work. And so it did not even send a salesman out when a business showed interest in it; surely, it argued, these people could not possibly know what a computer was all about. IBM was equally convinced that the computer was an instrument for scientific work: their own computer had been designed specifically for astronomical calculations. But IBM was willing to take orders from businesses and to serve them. Ten years later, around 1960, Univac still had by far the most advanced and best machine. IBM had the computer market. The textbook prescription for this problem is market research. But it is the The New Venture 367 wrong prescription. One cannot do market research for something genuinely new. One cannot do market research for something that is not yet on the market. Similarly, several companies who turned down the Xerox patents did so on the basis of thorough market research that showed that printing companies had no use at all for a copier. Nobody had any inkling that businesses, schools, universities, colleges, and a host of private individuals would want to buy a copier. The new venture therefore needs to start out with the assumption that its product or service may find customers in markets no one thought of, for uses no one envisaged when the product or service was designed, and that it will be bought by customers outside its field of vision and even unknown to the new venture. To build market focus into a new venture is not in fact particularly difficult. But what is required runs counter to the inclinations of the typical entrepreneur. It requires, first, that the new venture systematically hunt out both the unexpected success and the unexpected failure. Rather than dismiss the unexpected as an exception, as entrepreneurs are inclined to do, they need to go out and look at it carefully and view it as a distinct opportunity. Shortly after World War II, a small Indian engineering firm bought the license to produce a European-designed bicycle with an auxiliary light engine. It looked like an ideal product for India; yet it never did well. The owner of this small firm noticed, however, that substantial orders came in for the engines alone. At first he wanted to turn down those orders; what could anyone possibly do with such a small engine? It was curiosity alone that made him go to the actual area the orders came from. There he found farmers were taking the engines off the bicycles and using them to power irrigation pumps that hitherto had been handoperated. This manufacturer became the worlds largest maker of small irrigation pumps, selling them by the millions. His pumps revolutionized farming all over Southeast Asia. It does not require a great deal of money to find out whether an unexpected interest from an unexpected market is an indication of genuine potential or a fluke. It requires sensitivity and a little systematic work. Above all, the people who are running a new venture need to spend time outside: in the marketplace, with customers, and with their own salespeople, looking and listening. The new venture needs to build in systematic practices to remind itself that a product or a service is defined by the customer, not by the producer. It needs to work continuously on challenging itself with respect to the utility and value that its products or services contribute to customers. The greatest danger for the new venture is to know better than the customer what the product or service is or should be, how it should be bought, and what it should be used for. Above all, the new venture needs a willingness to see 368 INNOVATION AND ENTREPRENEURSHIP the unexpected success as an opportunity rather than as an affront to its expertise. And it needs to accept that elementary axiom of marketing: Businesses are not paid to reform customers. They are paid to satisfy customers. FINANCIAL FORESIGHT Lack of market focus is typically a disease of the neonatal, the infant new venture. It is the most serious affliction of the new venture in its early stagesand one that can permanently stunt even those that survive. The lack of adequate financial focus and the right financial policies is, by contrast, the greatest threat to the new venture in the next stage of its growth. It is, above all, a threat to a rapidly growing new venture. The more successful a new venture is, the more dangerous is lack of financial foresight. Suppose that a new venture has successfully launched its product or service and is growing fast. It reports rapidly increasing profits and issues rosy forecasts. The stock market then discovers the new venture, especially if it is high-tech or in a field otherwise currently fashionable. Predictions abound that the new ventures sales will reach a billion dollars within five years. Eighteen months later, the new venture collapses. It may not go out of existence or go bankrupt. But it is suddenly awash in red ink, lays off 180 of its 275 employees, fires the president, or is sold at a bargain price to a big company. The causes are always the same: lack of cash, inability to raise the capital needed for expansion, and loss of control, with expenses, inventories, and receivables in disarray. These three financial afflictions often hit together at the same time. Yet any one of them by itself endangers the health, if not the life, of the new venture. Once this financial crisis has erupted, it can be cured only with great difficulty and considerable suffering. But it is eminently preventable. Entrepreneurs starting new ventures are rarely unmindful of money; on the contrary, they tend to be greedy. They therefore focus on profits. But this is the wrong focus for a new venture, or rather, it should come last rather than first. Cash flow, capital, and controls come much earlier. Without them, the profit figures are fictiongood for twelve to eighteen months, perhaps, after which they evaporate. Growth has to be fed. In financial terms, this means that growth in a new venture demands adding financial resources rather than taking them out. Growth needs more cash and more capital. If the growing new venture shows a profit, it is a fictiona bookkeeping entry put in only to balance the accounts. And since taxes are payable on this fiction in most countries, it creates a liability and a cash drain rather than surplus. The healthier a new venture and the faster it grows, the more financial feeding it requires. The new ventures that are the darlings of the The New Venture 369 newspapers and the stock market letters, the new ventures that show rapid profit growth and record profits, are those most likely to run into desperate trouble a couple of years later. The new venture needs cash flow analysis, cash flow forecasts, and cash management. The fact that Americas new ventures of the last few years (with the significant exception of high-tech companies) have been doing so much better than new ventures used to do is largely because the new entrepreneurs in the United States have learned that entrepreneurship demands financial management. Cash management is fairly easy if there are reliable cash flow forecasts, with reliable meaning worst case assumptions rather than hopes. There is an old bankers rule of thumb, according to which, in forecasting cash income and cash outlays, one assumes that bills will have to be paid sixty days earlier than expected and receivables will come in sixty days later. If the forecast is overly conservative, the worst that can happenit rarely does in a growing new ventureis a temporary cash surplus. A growing new venture should know twelve months ahead of time how much cash it will need, when, and for what purposes. With a years lead time, it is almost always possible to finance cash needs. But even if a new venture is doing well, raising cash in a hurry and in a crisis is never easy and always prohibitively expensive. Above all, it always sidetracks the key people in the company at the most critical time. For several months they then spend their time and energy running from one financial institution to another and cranking out one set of questionable financial projections after another. In the end, they usually have to mortgage the long-range future of the business to get through a ninety-day cash bind. When they are finally able again to devote time and thought to the business, they have irrevocably missed the major opportunities. For the new venture, almost by definition, is under cash pressure when the opportunities are greatest. The successful new venture will also outgrow its capital structure. A rule of thumb says that a new venture outgrows its capital base with every increase in sales (or billings) on the order of 40 to 50 percent. After such growth, a new venture also needs a new and different capital structure, as a rule. As the venture grows, private sources of funds, whether from the owners and their families or from outsiders, become inadequate. The company has to find access to much larger pools of money by going public, by finding a partner or partners among established companies, or by raising money from insurance companies and pension funds. A new venture that had been financed by equity money now needs to shift to long-term debt, or vice versa. As the venture grows, the existing capital structure always becomes the wrong structure and an obstacle. Finally, the new venture needs to plan the financial system it requires to manage growth. Again and again, a growing new venture starts off with an excellent product, excellent standing in its market, and excellent growth prospects. Then suddenly everything goes out of control: receivables, inventory, manufacturing costs, administrative costs, service, distributioneverything. Once one area gets out of control, all of them do. The enterprise has outgrown its control structure. By the time control has been reestablished, markets have been lost, customers have become disgruntled if not hostile, and distributors have lost their confidence in the company. Worst of all, employees have lost trust in management, and with good reason. Fast growth always makes obsolete the existing controls. Again, a growth of 40 to 50 percent in volume seems to be the critical figure. Once control has been lost, it is hard to recapture. Yet the loss of control can be prevented quite easily. What is needed is first to think through the critical areas in a given enterprise. In one, it may be product quality; in another, service; in a third, receivables and inventory; in a fourth, operating costs. Rarely are there more than four or five critical areas in any given enterprise. Managerial and administrative overhead should, however, always be included. A disproportionate and fast increase in the percentage of revenues absorbed by managerial and administrative overhead means that the enterprise is hiring managerial and administrative people faster than its potential for growth. To live up to its growth expectations, a new venture must establish today the controls in these critical areas it will need three years hence. Elaborate controls are not necessary, nor does it matter that the figures are only approximate. What matters is that the management of the new venture is aware of these critical areas, is being reminded of them, and can thus act fast if the need arises. Disarray normally does not appear if there is adequate attention to the key areas. Then the new venture will have the controls it needs when it needs them. Financial foresight does not require a great deal of time. It does require a good deal of thought, however. The technical tools to do the job are easily available; they are spelled out in most texts on managerial accounting. But the work will have to be done by the enterprise itself.