If are a self-learner, and have no business background, this is your book. This book teaches you all the basic concepts you need to handle to start, grow and manage any business.
Authors: Josh Kaufman
Originally published: 2010
Goodreads rating: ⭐️ 4.10/5
The Five Parts of Every Business
Roughly defined, a business is a repeatable process that:
- Creates and delivers something of value;
- That other people want or need;
- At a price they’re willing to pay:
- In a way that satisfies the customer’s needs and expectations;
- So that the business brings in enough profit to make it worthwhile for the owners to continue operation.
It doesn’t matter if you’re running a solo venture or a billion-dollar brand. Take any one of these five factors away, and you don’t have a business—you have something else. A venture that doesn’t create value for others is a hobby. A venture that doesn’t attract attention is a flop. A venture that doesn’t sell the value it creates is a nonprofit. A venture that doesn’t deliver what it promises is a scam. A venture that doesn’t bring in enough money to keep operating will inevitably close.
At the core, every business is fundamentally a collection of five Interdependent processes, each of which flows into the next:
- Value Creation. Discovering what people need or want, then creating it.
- Marketing. Attracting attention and building demand for what you’ve created.
- Sales. Turning prospective customers into paying customers.
- Value Delivery. Giving your customers what you’ve promised and ensuring that they’re satisfied.
- Finance. Bringing in enough money to keep going and make your effort worthwhile.
If these five things sound simple, it’s because they are. Business is not (and has never been) rocket science—it’s simply a process of identifying a problem and finding a way to solve it that benefits both parties. Anyone who tries to make business sound more complicated than this is either trying to impress you or trying to sell you something you don’t need.
The Five Parts of Every Business are the basis of every good business idea and business plan. If you can clearly define each of these five processes for any business, you’ll have a complete understanding of how it works. If you’re thinking about starting a new business, defining what these processes might look like is the best place to start. If you can’t describe or diagram your business idea in terms of these core processes, you don’t understand it well enough to make it worth.
The Iron Law of Market
Every business is fundamentally limited by the size and quality of the market it attempts to serve. The Iron Law of the Market is cold, hard, and unforgiving: if you don’t have a large group of people who really want what you have to offer, your chances of building a viable business are very slim.
The best approach is to focus on making things people want to buy. Creating something no one wants is a waste.
Core Human Drives
If you’re going to build a successful business, it’s useful to have a basic understanding of what people want. According to Harvard Business School professors Paul Lawrence and Nitin Nohria, the authors of Driven: How Human Nature Shapes Our Choices, all human beings have four Core Human Drives that have a profound influence on our decisions and actions:
- The Drive to Acquire. The desire to obtain or collect physical objects, as well as immaterial qualities like status, power, and influence. Businesses built on the drive to acquire include retailers, investment brokerages, and political consulting companies. Companies that promise to make us wealthy, famous, influential, or powerful connect to this drive.
- The Drive to Bond. The desire to feel valued and loved by forming relationships with others, either platonic or romantic. Businesses built on the drive to bond include restaurants, conferences, and dating services. Companies that promise to make us attractive, well liked, or highly regarded connect to this drive.
- The Drive to Learn. The desire to satisfy our curiosity. Businesses built on the drive to learn include academic programs, book publishers, and training workshops. Companies that promise to make us more knowledgeable or competent connect to this drive.
- The Drive to Defend. The desire to protect ourselves, our loved ones, and our property. Businesses built on the drive to defend include home alarm systems, insurance products, martial arts training, and legal services. Companies that promise to keep us safe, eliminate a problem, or prevent bad things from happening connect to this drive.
There’s a fifth core drive that Lawrence and Nohria missed:
- The Drive to Feel. The desire for new sensory stimulus, intense emotional experiences, pleasure, excitement, entertainment, and anticipation. Businesses built on the drive to feel include restaurants, movies, games, concerts, and sporting events. Offers that promise to give us pleasure, thrill us, or give us something to look forward to connect with this drive.
Whenever a group of people have an unmet need in one or more of these areas, a market will form to satisfy that need. As a result, the more drives your offer connects with, the more attractive it will be to your potential market.
At the core, all successful businesses sell some combination of money, status, power, love, knowledge, protection, pleasure, and excitement. The more clearly you articulate how your product satisfies one or more of these drives, the more attractive your offer will become.
Hidden Benefits of Competition
One of the most common experiences of a first-time entrepreneur is discovering that your brilliant business idea isn’t as original as you’d thought: other businesses are already offering similar products or services. This would shake anyone’s confidence—after all, why bother when someone else is doing what you want to do?
Cheer up: there are Hidden Benefits of Competition. When any two markets are equally attractive in other respects, you’re better off choosing to enter the one with competition. Here’s why: it means you know from the start there’s a market of paying customers for this idea, eliminating your biggest risk.
The existence of a market means you’re already on the right side of the Iron Law of the Market, so you can spend more time developing your offer instead of proving a market exists. If there are several successful businesses serving a market, you don’t have to worry so much about investing in a dead end, since you already know that people are buying.
The best way to observe what your potential competitors are doing is to become a customer. Buy as much as you can of what they offer. Observing your competition from the inside can teach you an enormous amount about the market: what value the competitor provides, how they attract attention, what they charge, how they close sales, how they make customers happy, how they deal with issues, and what needs they aren’t yet serving.
As a paying customer, you get to observe what works and what doesn’t before you commit to a particular strategy. Learn everything you can from your competition, and then create something even more valuable.
Perceived Value determines how much your customers will be willing to pay for what you’re offering. The higher the perceived value of your offering, the more you’ll be able to charge for it, which significantly improves your chances of succeeding.
As a rule of thumb, the less attractive the End Result and the more end-user involvement it takes to get the benefit, the lower the value your customers will place on the offer.
Focus on creating Forms of Value that require the least end-user effort to get the best possible End Result—they will have the highest perceived value.
The Iteration Cycle is a process you can use to make anything better over time. There’s nothing wasteful about the inevitable changes and revisions that these artists made to their creations: every iteration brought the project one step closer to completion.
Iteration has six major steps, which I call the WIGWAM method:
- Watch—What’s happening? What’s working and what’s not?
- Ideate—What could you improve? What are your options?
- Guess—Based on what you’ve learned so far, which of your ideas do you think will make the biggest impact?
- Which?—Decide which change to make.
- Act—Actually make the change.
- Measure—What happened? Was the change positive or negative? Should you keep the change, or go back to how things were before this iteration?
Iteration is a cycle—once you measure the results of the change and decide whether or not to keep it, you go back to the beginning to observe what’s happening, and the cycle repeats.
For best results, clearly define what you’re trying to accomplish with each iteration. Are you trying to make the offering more attractive or appealing ? Are you trying to add a new feature people will value? Are you trying to make the offering cost less without detracting from its value? The more clearly you can define what you’re after, the easier it’ll be to understand the Feedback you’re receiving and the more value you’ll extract from each Iteration Cycle.
Getting useful Feedback from your potential customers is the core of the Iteration Cycle. Useful Feedback from real prospects helps you understand how well your offer meets their needs before development is complete, which allows you to make changes before you start selling.
Here are a few tips to maximize the value of the Feedback you receive:
- Get Feedback from real potential customers instead of friends and family. Your inner circle typically wants you to succeed and wants to maintain a good relationship with you, so it’s likely that they’ll unintentionally sugarcoat their Feedback. For best results, be sure to get plenty of Feedback from people who aren’t personally invested in you or your project.
- Ask open-ended questions. When collecting Feedback, you should be listening more than you talk. Have a few open-ended questions prepared to give the conversation a bit of structure, but otherwise encourage the other person to do most of the talking. Short who/ what/when/where/why/how questions typically work best. Watch what they do, and compare their actions with what they say.
- Steady yourself, and keep calm. Asking for genuine Feedback (the only useful kind) requires thick skin—no one likes hearing their baby is ugly. Try not to get offended or defensive if someone doesn’t like what you’ve created; they’re doing you a great service.
- Take what you hear with a grain of salt. Even the most discouraging Feedback contains crucial pieces of information that can help you make your offering better. The worst response you can get when asking for Feedback isn’t emphatic dislike: it’s total apathy. If no one seems to care about what you’ve created, you don’t have a viable business idea.
- Give potential customers the opportunity to preorder. One of the most important pieces of Feedback you can receive during the iteration process is the other person’s willingness to actually purchase what you’re creating. It’s one thing for a person to say that they’d purchase something and quite another for them to be willing to pull out their wallet or credit card and place a real order. You can do this even if the offer isn’t ready yet—a tactic called Shadow Testing.
Whenever possible, give the people who are giving you Feedback the opportunity to preorder the offering. If a significant number of people take you up on the offer, you’re in good shape: you know that you have a solid offering and you immediately boost your cash flow.
If no one is willing to preorder, you know you have more work to do before you have a viable offer—by asking why they’re not willing to purchase right now, you’ll discover their major Barriers to Purchase: what’s holding them back.
Everyone has slightly different values at any given time, but there are a few common patterns that appear when people evaluate a potential purchase. Assuming the promised benefits of the offering are appealing, there are nine common Economic Values that people typically consider when evaluating a potential purchase. They are:
- Efficacy—How well does it work?
- Speed—How quickly does it work?
- Reliability—Can I depend on it to do what I want?
- Ease of Use—How much effort does it require?
- Flexibility—How many things does it do?
- Status—How does this affect the way others perceive me?
- Aesthetic Appeal—How attractive or otherwise aesthetically pleasing is it?
- Emotion—How does it make me feel?
- Cost—How much do I have to give up to get this?
Marketing vs. Sales
Offering value is not enough. If no one knows (or cares) about what you have to offer, it doesn’t matter how much value you create. Without Marketing , no business can survive—people who don’t know you exist can’t purchase what you have to offer, and people who aren’t interested in what you have to offer won’t become paying customers.
Marketing is the art and science of finding “prospects”—people who are actively interested in what you have to offer. The best businesses in the world find ways to attract the attention of qualified prospects quickly and inexpensively. The more prospects you entice, the better off your business will be.
Marketing is not the same thing as selling. While “direct marketing” strategies often try to minimize the time between attracting attention and asking for the sale, Marketing and selling are two different things.
Marketing is about getting noticed; Sales, is about closing the deal.
Framing is the act of emphasizing the details that are critically important while de-emphasizing things that aren’t, by either minimizing certain facts or leaving them out entirely. Proper use of Framing can help you present your offer persuasively while honoring your customer’s time and attention.
Framing is a natural part of communication: some form of compression in any message is inevitable. It’s simply not practical to include all of the facts and context when communicating with others—we emphasize some details and leave out others to save time.
Since Framing is an ever-present part of communication, it pays to be conscious of it. By being mindful of what you’re emphasizing and what you’re minimizing, you can communicate the benefits of your offer to your prospects in a clear and concise way, which maximizes your persuasive power.
Framing is not the same as lying or being deceitful. Honesty is always the best policy, and not just from a moral perspective. Misrepresenting your offer may net a few more sales in the short term, but it dramatically increases the probability that your customer’s expectations will be violated, decreasing their satisfaction and permanently harming your Reputation.
Using Framing to your advantage will allow you to communicate the benefits of your offer to your Probable Purchasers persuasively, as long as you don’t leave out information that your customers have a right to know.
Asking for Permission to follow up after providing Free value is more effective than interruption. Offering genuine value earns your prospect’s Attention, and asking for Permission gives you the opportunity to focus on communicating with people you know are interested in what you have to offer.
Permission is a real asset. Reaching new people tends to be difficult and expensive. It’s far easier to follow up with someone you already know—all it takes is an e-mail, a letter, or a phone call, all of which are easy and inexpensive. If you ask the new prospects you meet for Permission to follow up, you’re making the most of your outreach activities.
The best way to get Permission is to ask for it. Whenever you provide value to people, ask them if it’s okay to continue to give them more value in the future. Over time, your list of prospective customers will grow, and the larger it grows, the higher the likelihood you’ll start landing more sales.
Use Permission once you have it, but don’t abuse the privilege. Getting Permission to follow up never gives you carte blanche to send them anything you like. Before asking your prospects for Permission to follow up, make it clear what they’ll be getting and how it’ll benefit them.
If you honor your commitments by continually providing value and refraining from spamming your prospects with irrelevant information, you’ll have a powerful asset that can help you build a deeper relationship with the people who are interested in what you’re offering.
A Hook is a single phrase or sentence that describes an offer’s primary benefit. Sometimes the Hook is a title, and sometimes it’s a short tagline. Regardless, it conveys the reason someone would want what you’re selling.
When creating a Hook, focus on the primary benefit or value your offer provides. Emphasize what’s uniquely valuable about your offer and why the prospect should care. Brainstorm a list of words and phrases related to your primary benefit, then experiment with different ways to connect them in a short phrase. Crafting a Hook is a creative exercise—the more potential options you generate, the more quickly you’ll find one that works.
Once you’ve created your Hook, use it! Place it on your Web site, your advertising, your business cards—make it one of the first things potential customers see. The Hook grabs Attention, and the remainder of your marketing and sales activities close the deal.
The better your Hook, the more Attention you’ll grab, and the easier it’ll be for your satisfied customers to tell their friends about you.
Common Ground is a state of overlapping interests between two or more parties. Think of your available options as a circle that surrounds you. Your prospects have a circle of available options as well. Your job is to find exactly where those circles overlap, which is much easier if you understand what your Probable Purchasers want or need.
Common Ground is a precondition of any type of Transaction. Without any areas of overlapping interest, there’s no reason for a prospect to choose to work with you. After all, it wouldn’t make sense to pay more for something than it’s worth to you. Why expect your prospects to accept your offer if it’s not in their best interest?
Aligning interests is critical to finding Common Ground. Sales isn’t about convincing somebody to do something that’s not in their best interest. Ideally, you should want exactly what your prospects want: the satisfaction of their desire or the resolution of their problem. The more your interests are aligned with your prospect’s, the more they’ll Trust your ability to give them what they want.
There are always many paths to a successful Transaction, which is the essence of negotiation. Negotiation is the process of exploring different options to find Common Ground: the more potential paths you explore, the greater the chance you’ll be able to find one in which your interests overlap. The more open you are to potential options, the higher the likelihood you’ll find an area of Common Ground that’s acceptable for all parties involved.
Value-Based Selling is the process of understanding and reinforcing the Reasons Why your offer is valuable to the purchaser. In the previous section, we discussed how the Value Comparison method is often the best way to support a high price on your offer. Value-Based Selling is how you support that price. By understanding and reinforcing the Reason Why a Transaction will be valuable to the customer, you simultaneously increase the likelihood of a Transaction as well as the price the buyer will be willing to pay.
Value-Based Selling is not about talking—it’s about listening. When most people think of sales, they imagine a pushy, smooth-talking shyster whose sole priority is to “close the deal.” In reality, the best salespeople are the ones who can listen intently for the things the customer really wants.
Asking good questions is the best way to identify what your offer is worth to your prospect. In the classic sales book SPIN Selling, Neil Rackham describes the four phases of successful selling: (1) understanding the situation, (2) defining the problem, (3) clarifying the short-term and long-term implications of that problem, and (4) quantifying the need-payoff, or the financial and emotional benefits the customer would experience after the resolution of their problem. Instead of barging in with a premature, boilerplate hard sell, successful salespeople focus on asking detailed questions to get to the root of what the prospect really wants.
By encouraging your prospects to tell you more about what they need, you reap two major benefits. First, you increase the prospect’s confidence in your understanding of the situation, increasing their confidence in your ability to deliver a solution. Second, you’ll discover information that will help you emphasize just how valuable your offer is, which helps you in Framing the price of your offer versus the value it will provide.
If you discover why, how, and how much your offer will benefit the customer, you’ll be able to explain that value in terms they’ll understand and appreciate. Understanding the value you can provide your customers is the golden path to a profitable sale.
Barriers to Purchase
Selling anything is largely the process of identifying and eliminating Barriers to Purchase: risks, unknowns, and concerns that prevent your prospects from buying what you offer. Your primary job as a salesperson is to identify and eliminate barriers standing in the way of completing the Transaction. Eliminate your prospect’s objections and barriers, and you’ll close the deal.
There are five standard objections that appear in sales of all kinds:
- It costs too much. Loss Aversion makes spending money feel like a loss—by purchasing, the prospect is giving something up, and that naturally makes people hesitate. (Some people even experience this sense of loss after they make a purchase decision, a condition called “buyer’s remorse.”)
- It won’t work. If the prospect thinks that there’s a chance the offer won’t (or can’t) provide the promised benefits, they won’t purchase.
- It won’t work for ME. The prospect may believe that the offer is capable of providing benefits to other people but that they’re different—a special case.
- I can wait. The prospect may believe they don’t have a problem worth addressing right now, even if it’s very clear to you that they do.
- It’s too difficult. If the offer takes any effort whatsoever on their part, the prospect may believe that their contribution will be too hard to manage.
To overcome these objections as quickly as possible, it makes sense to build them into the structure of your initial offer. Since these objections are very common, anything that you can do to alleviate them before the prospect considers the offer will make the sales process much easier.
Objection #1 (“it costs too much”) is best addressed via Framing and Value-Based Selling. If you’re selling a piece of software to a business that can save them $10 million a year, and you’re asking $1 million a year for a license, your software isn’t expensive—it’s effectively Free. If it’s clear that the value of your offer far exceeds the asking price, this objection is moot.
Objections #2 and #3 (“it won’t work” / “it won’t work for me”) are best addressed via Social Proof—showing the prospect how customers just like them are already benefiting from your offer. The more like your prospect your stories and testimonials are, the better. That’s why Referrals are such a powerful sales tool—customers tend to refer people who have similar situations and needs, and the Referral itself helps break down these objections.
Objections #4 and #5 (“I can wait” / “it’s too difficult”) are best addressed via Education-Based Selling. Often, your prospects haven’t fully realized they have a problem, particularly in the case of Absence Blindness. If the business doesn’t realize it’s losing $10 million in the first place, it’s difficult to convince them that you can help. The best way to get around this is to focus your early sales efforts on making your customers smarter by teaching them what you know about their business, then helping them Visualize what their involvement would look like if they decide to proceed.
Once you have the prospect’s Attention and Permission, there are two possible tactics if they still have these objections: (1) convince the prospect that the objection isn’t true, or (2) convince the prospect that the objection is irrelevant. The approach you’ll use depends on the objection raised, but some combination of Framing, Value-Based Selling, Education-Based Selling, Social Proof, and Visualization will usually do the trick.
If the prospect still doesn’t buy, that typically means there’s a Power issue—your negotiating partner may not have the budget or the authority to agree to your proposal. Always try to negotiate directly with the decision maker—that way, if they refuse your offer, you know that it’s because it wasn’t a good fit for them, and you can move on to more promising prospects as quickly as possible.
Value Delivery involves everything necessary to ensure that every paying customer is a happy customer: order processing, inventory management, delivery/fulfillment, troubleshooting, customer support, etc. Without Value Delivery, you don’t have a business.
The more happy customers a business creates, the more likely it is that those customers will purchase from the company again. Happy customers are also more likely to tell others about what you do, improving your Reputation and bringing in even more potential customers.
A Value Stream is the set of all steps and all processes from the start of your Value Creation process all the way through the delivery of the end result to your customer. Understanding what your offer’s Value Stream looks like is critically important if you want to be able to deliver value to your customers quickly, reliably, and consistently.
You can think of the Value Stream as a combination of your Value Creation and Value Delivery processes. Very often, your offer moves directly from the first into the second. Even though the purposes of these core processes are very different, treating them as one big process can help you improve your ability to deliver the value you create.
The best way to understand your Value Stream is to diagram it. Tracing the steps or transformations your offer goes through from the beginning to the end is an extremely enlightening process that can show you just how efficient your Value Delivery process is. It’s very common for processes to contain unnecessary steps or awkward transitions. Creating a complete diagram of your entire Value Stream takes effort, but it can help you streamline your process, making the entire system perform better.
In general, try to make your Value Stream as small and efficient as possible. As we’ll examine later in the book when we discuss systems, the longer your process, the greater the risk of things going wrong. The shorter and more streamlined your Value Stream, the easier it is to manage and the more effectively you’ll be able to deliver value.
Scale is the ability to reliably Duplicate or Multiply a process as volume increases. Scalability determines your maximum potential volume. The easier it is to Duplicate or Multiply the value provided, the more scalable the business. Scalability is typically limited by the amount of required human involvement in a process.
If your goal is to create a business that doesn’t require your direct daily involvement, Scalability should be a major consideration. Products are typically the easiest to Duplicate, while Shared Resources (like gyms, etc.) are easiest to Multiply.
Humans don’t Scale. Individual people only have so much time and energy each day, which is a Constraint that doesn’t change with the volume of work to be done. On the contrary—as we’ll discuss later in Performance Load, a person’s effectiveness usually goes down as the demands on them increase.
As a result, Services are typically difficult to Scale, since they tend to rely heavily on the direct involvement of people to deliver value. As a general rule, the less human involvement required to create and deliver value, the more Scalable the business.
One of the things that make humans unique is our ability to create and use tools. Tools are important because they Multiply the effect of physical force, thought, or attention. The more a tool Amplifies or concentrates your effort, the more effective the tool.
Investing in Force Multipliers makes sense because you can get more done with the same amount of effort. If you need to dig the foundation to build a new house, a $10 shovel from your local hardware store will certainly work, but a backhoe will get the job done faster and easier. If building homes is your business, buying or leasing a backhoe is worth the cost.
Force Multipliers can be expensive—the more effective they are, the more expensive they tend to be. Factory production and distribution systems are examples of large-scale Force Multipliers—they make it possible to deliver value to thousands (or millions) of paying customers in a very short time. They may cost thousands (or millions) of dollars, but they can give you capabilities that would otherwise be out of reach.
As a general rule, the only good use of debt or outside capital in setting up a system is to give you access to Force Multipliers you would not be able to access any other way. If your business requires tooling up a factory, you probably don’t have $10 million sitting in your bank account. Taking a Loan from a bank or accepting Capital from an outside investor may be your best option, provided you use those funds to purchase and maintain Force Multipliers, not to pay yourself or maintain rent on a fancy office.
Always choose the best tools that you can obtain and afford. Quality tools give you maximum output with a minimum of input. By investing in Force Multipliers, you free up your time, energy, and attention to focus on building your business instead of simply operating it.
Finance is the art and science of watching the money flowing into and out of a business, then deciding how to allocate it and determining whether or not what you’re doing is producing the results you want. It’s really not any more complicated than that. Yes, there can be fancy models and jargon, but ultimately you’re simply using numbers to decide whether or not your business is operating the way you intended, and whether or not the results are enough.
Every successful business must bring in a certain amount of money to keep going. If you’re creating value, marketing, selling, and delivering value, there’s money flowing into and out of the business every day. In order to continue to exist, every business must bring in Sufficient revenue to justify all of the time and effort that goes into running the operation.
The very best businesses create a virtuous cycle: they create huge amounts of value while keeping their expenses consistently low, so they make more than enough money to keep going without capturing too much value. As a result, they’re able to simultaneously pad their pocketbooks and improve the lives of their customers, since the continued existence of the business makes everyone involved better off.
Finance helps you watch your dollars in a way that makes sense.
Value Capture is the process of retaining some percentage of the value provided in every Transaction. If you’re able to offer another business something that will allow them to bring in $1 million of additional revenue and you charge $100,000, you’re capturing 10 percent of the value created by the Transaction.
Value Capture is tricky. In order to be successful, you need to capture enough value to make your investment of time and energy worthwhile, but not so much that there’s no reason for your customers to do business with you. People buy because they believe they’re getting more value in the Transaction than they’re spending.
The more value you capture, the less attractive your offer becomes. Capture too much, and your prospects won’t bother purchasing from you. Movies are great, but would you pay $5,000 for two hours of entertainment?
There are two dominant philosophies behind Value Capture: maximization and minimization.
Maximization (the approach taught in most business schools) means that a business should attempt to capture as much value as possible. Accordingly, the business should attempt to capture as much revenue in each Transaction as possible—capturing less than the maximum amount of value possible is unacceptable.
In the short run, it’s easy to see the appeal of maximization—more Profit is a good thing for the owners of a company. Unfortunately, the maximization approach tends to erode the reason customers purchase from a business in the first place.Would you spend $999,999 in order to make a million? It may be rational (after all, you’d be $1 ahead), but most people won’t bother. Customers purchase from you because they’re receiving more value than they’re giving up in the purchase. The less they receive, the less they’ll want to buy from you.
The minimization approach means that businesses should capture as little value as possible, as long as the business remains Sufficient. While this approach may not bring in as much short-term revenue as maximization, it preserves the value customers see in doing business with the company, which is necessary for the business’s long-term success.When something is a “good deal,” customers tend to continue to patronize the business and spread the word to other potential customers. When a business tries to maximize revenue by “nickel-and-diming” their customers or trying to capture too much value, customers flee.
As long as you’re bringing in enough to keep doing what you’re doing, there’s no need to fight for every last penny. Create as much value as you possibly can, then capture enough of that value to make it worthwhile to keep operating
Four Methods to Increase Revenue
Believe it or not, there are only four ways to increase your business’s revenue:
- Increase the number of customers you serve.
- Increase the average size of each Transaction by selling more.
- Increase the frequency of transactions per customer.
- Raise your prices.
Imagine you’re operating a restaurant, and you want to increase the amount of revenue that your restaurant brings in. Here’s how to apply these strategies:
Increasing the number of customers means you’re trying to bring more people in the door. This strategy is relatively straightforward: more visitors to your restaurant will equal more tabs, which (assuming the average transaction size stays the same) will bring in more money.
Increasing average transaction size means you’re trying to get each customer to purchase more. This is typically done through a process called upselling. When a customer purchases an entrée, you offer them appetizers, drinks, and dessert. The more of these items the customer purchases, the more they spend, and the more revenue you collect.
Increasing the frequency of transactions per customer means encouraging people to purchase from you more often. If your average customer comes in once a month, convincing them to patronize your business once a week will increase your revenue. The more frequently they visit your establishment, the more revenue your restaurant will bring in, assuming the average transaction size stays the same.
Raising your prices means you’ll collect more revenue from every purchase a customer makes. Assuming your volume, average transaction size, and frequency stay the same, raising your prices will bring in more revenue for the same amount of effort.
Always focus the majority of your efforts on serving your ideal customers. Your ideal customers buy early, buy often, spend the most, spread the word, and are willing to pay a premium for the value you provide.
The more ideal customers you can attract, the better your business.
Pricing Power is your ability to raise the prices you’re charging over time. The less value you’re capturing, the greater your pricing power. Serving customers takes time, energy, and resources—the more you earn per customer served, the better your business. Changing your prices can help you maximize your results while minimizing your effort and investment.
Pricing Power is related to a concept economists call “price elasticity.” If customers are very sensitive to the price of your offer, you’ll lose many customers with even a slight increase in price, meaning demand is “elastic.
Pricing Power is important because raising your prices allows you to overcome the adverse effects of inflation and increased costs. Historically, currency issued by any government tends to decrease in value over time—there are many strong incentives for officials to increase the supply of currency, which debases that currency’s purchasing power.
As a result, it takes more currency to purchase the same products and services necessary to stay in business, increasing your business’s Sufficiency needs. Without adequate Pricing Power, your business may not be able to remain Sufficient in the face of higher expenses.
The higher the prices you can command, the more reliably you’ll be able to maintain profit Sufficiency. If you have a choice, choose a market in which you’ll have Pricing Power—it’ll be much easier to maintain Sufficiency over time.
Lifetime Value is the total value of a customer’s business over the lifetime of their relationship with your company. The more a customer purchases from you and the longer they stay with you, the more valuable that customer is to your business.
The higher your average customer’s Lifetime Value, the better your business. By understanding how much your average customer purchases and how long they tend to buy from you, you can place a tangible value on each new customer, which helps you make good decisions. Losing a single lemonade stand customer isn’t a huge deal—losing an insurance client is.
All told, it’s much better to operate in markets where customers have a high Lifetime Value. The higher the Lifetime Value of your customer, the more you can do to keep them happy, and the more you can focus on serving customers well. Maintain a long-term relationship with profitable customers, and you win
Allowable Acqusiton Cost (AAC)
Allowable Acquisition Cost (AAC) is the marketing component of Lifetime Value. The higher the average customer’s Lifetime Value, the more you can spend to attract a new customer, making it possible to spread the word about your offer in new ways.
To calculate your market’s Allowable Acquisition Cost, start with your average customer’s Lifetime Value, then subtract your Value Stream costs—what it takes to create and deliver the value promised to that customer over your entire relationship with them. Then subtract your Overhead divided by your total customer base, which represents the Fixed Costs you’ll need to pay to stay in business over that period of time. Multiply the result by 1 minus your desired Profit Margin (if you’re shooting for a 60 percent margin, you’d use 1.00 - 0.60 = 0.40), and that’s your Allowable Acquisition Cost.
Here’s an example: if your average Lifetime Value is $2,000 over a five-year period, and the cost of Value Creation and delivery is $500, that leaves you with $1,500 in revenue per customer served. Assuming your Overhead expenses are $500,000 over the same five-year period and you have 500 customers, your Fixed Costs are $1,000 per customer, which leaves you with $500 in revenue before marketing expenses. Assuming you’re shooting for a minimum 60 percent profit margin, you can afford to spend 40 percent of that $500 on marketing, which gives you a maximum AAC of $200 per customer. Knowing that, you can test various forms of marketing to see if they work—if your assumptions are correct, any customer you can attract for $200 or less will be worth the investment.
The higher the Lifetime Value of your customers, the higher the Allowable Acquisition Cost. The more each new customer is worth to your business, the more you can spend to attract a new customer and keep them happy.
Overhead represents the minimum ongoing resources required for a business to continue operation. This includes all of the things you need to run your business every month, regardless of whether you sell anything: salaries, rent, utilities, equipment repairs, and so on.
The lower your Overhead, the less revenue the business requires to continue operation, and the more quickly you’ll reach your point of financial Sufficiency. If you don’t spend much, you don’t have to make much to cover your expenses.
Overhead is critically important if you are building your company on a fixed amount of Capital. Venture capitalists and other forms of investment can provide “seed capital”—a fixed amount of money you can use to start the business. The more money you raise in capital and the more slowly you spend it, the more time you have to make the business work.
The faster you “burn” through your capital, the more money you need to raise and the more quickly you need to start bringing in revenue. If you burn through all of your start-up capital and can’t raise more, game over. That’s why investors and savvy entrepreneurs watch the business’s “burn rate” very closely—the slower the burn, the more time you have to create a successful business.
The lower your Overhead, the more flexibility you’ll have and the easier it will be to sustain your business operations indefinitely.
Costs: Fixed and Variable
Fixed Costs are incurred no matter how much value you create. Your Overhead is a Fixed Cost: no matter what you do in any given month, you still have to pay your salaried employees and the lease on your office space.
Variable Costs are directly related to how much value you create. If you’re in the business of creating cotton T-shirts, the more T-shirts you produce, the more cotton fabric you’ll need. Raw materials, usage-based utilities, and hourly workers are all Variable Costs.
Reductions in Fixed Costs Accumulate; reductions in Variable Costs are Amplified by volume. If you can save $50 per month on your phone bill, that savings Accumulates to $600 per year. If you can save $0.50 on each T-shirt you produce, you’ll save $500 on every 1,000 T-shirts you make.
The better you understand your costs, the more likely you are to find ways of producing as much value as possible without spending everything you make.
Breakeven is the point where your business’s total revenue exceeds its total expenses—it’s the point where your business starts creating wealth instead of consuming it. Assuming the business keeps bringing in $100,000 each month and expenses stay the same, it’ll take twelve months to pay down the initial investment. After that, the business will really be making money—before that, it just looks like the business is profitable.
Your Breakeven point will change constantly. Revenue naturally fluctuates, as do expenses. Keeping a running tally of how much you spend and how much revenue you collect from the start of your business’s operations is the only way to figure out whether or not you’ve actually made money.
The more revenue you bring in and the less you spend on an ongoing basis, the more quickly you’ll reach Breakeven, making your business truly self-sustaining.
Purchasing Power is the sum total of all liquid assets a business has at its disposal. That includes your cash, credit, and any outside financing that’s available. More purchasing power is always better, as long as you use that power wisely.
Purchasing Power is what you use to pay your Overhead and your suppliers. As long as you continue to pay them, you’re in business. As soon as you run out of Purchasing Power, you’re finished. Game over.
Always keep track of how much Purchasing Power you have available. How much cash do you have in the bank? How much available credit do you have access to? The more Purchasing Power you have, the better off you are.
Keeping track of your available Purchasing Power makes it much easier to run a business. Instead of constantly worrying about paying the bills, Purchasing Power gives you room to breathe, secure in the knowledge that you’re not going to suddenly run out of money. That frees up a great deal of mental and emotional energy you can put to better use—figuring out how to improve your business.
Always pay close attention to how much Purchasing Power you have left—it’s the difference between a business that stays open and a business that fails.
Cash Flow Cycle
The Cash Flow Cycle describes how cash Flows through a business. Think of your business’s bank account like a bathtub. If you want the water in the bathtub to rise, you add more water and keep it from leaking out via the drain. The more water that flows in and the less that flows out, the higher the level of water in the tub. Revenues and expenses work the same way.
Receivables are promises of payment you’ve accepted from others. Receivables are attractive, because they feel like a sale—someone has promised to give you money, which is great. There’s a catch, however: Receivables don’t translate into cash until the promise is fulfilled. IOUs are not cash—the more quickly that promise is translated into payment, the better your cash flow. Many businesses have closed with millions of dollars of “sales” on the books.
Debt is a promise you make to pay someone at a later date. Debt is attractive because you can benefit from a purchase now while holding on to your cash until later. The later you pay, the more cash you have at your disposal. Debt can be useful, but there’s also a catch: Debts typically cost additional money in the form of interest. Very often, you’ll also have to pay back a portion of your Debt over time, which is called “debt service,” which you can treat as another type of expense. If you can’t cover your debt service, you’re in trouble.
Maximizing your cash tackles the issue directly: bring in more revenue and cut costs. Increasing your product margins, making more sales, and spending less of what you bring in will always improve your cash flow.
To bring cash in more quickly, it’s best to speed up collections and reduce the extension of credit. The faster you get paid, the better your cash flow situation. Ideally, try to get paid immediately, even before buying raw materials and delivering value.
Compounding is the Accumulation of gains over time. Whenever you’re able to reinvest gains, your investment will build upon itself exponentially—a positive Feedback Loop.
A simple example of Compounding is a savings account. Let’s say your bank account earns 5 percent interest. After a year, $1 in your bank account is going to be worth $1.05. In year two, you don’t start with $1—you start with $1.05. In year three, you’ll have $1.10. In year four, you’ll have $1.15. Fourteen years after you make the initial deposit, you’ll have $2.
That doesn’t sound like much until you consider that this relationship Scales. If you start with $1 million, you’ll have $2 million after fourteen years. Not bad at all.
Compounding is important because it creates the possibility of huge gains in surprisingly short periods of time. If you reinvest the revenue your business generates and your business is growing rapidly, you can multiply your original investment many times over. Compounding is the secret that explains how small companies that reinvest their profits become large companies in a few short years.
Accumulating gains inevitably produces huge results over time. The trick is to be patient enough to wait for the reward.
Sunk Costs are investments of time, energy, and money that can’t be recovered once they’ve been made. No matter what you do, you can’t get those resources back. Continuing to invest in a project to recoup lost resources doesn’t make sense—all that matters is how much more investment is required versus the reward you expect to obtain.
Sunk Cost is easy to understand conceptually but much harder to put into practice. When you sink years of work into a career you realize you don’t want, or millions of dollars into a project that unexpectedly requires millions more, it’s difficult to walk away. You’ve invested so much that it feels wrong to “give it up for nothing.” In reality, there’s nothing you can do about your past investment—it’s gone. All you can do is act based upon the information you have now.
Don’t continue to pour concrete into a bottomless pit—if it’s not worth the additional investment, walk away. You never have to earn back money in the same way you lost it. If the reward isn’t worth the investment required to obtain it or the risk, don’t invest.
The Onion Brain
Think of the Brain as an Onion—it has several layers, which sit on top of one another. At the core is a structure called the hindbrain, which is essentially responsible for keeping you alive. The hindbrain is responsible for all of the physiological functions necessary for survival: heart rate, sleeping, waking, reflexes, muscle movements, and biological urges.
Located at the base of the brain, the hindbrain is sometimes called the “lizard brain” because this basic neurological structure appears in all of our biological precursors, including reptiles and amphibians. The hindbrain is primarily responsible for generating signals that are passed down through your spinal cord and nerves to every part of your body, resulting in your physical actions.
Above your hindbrain is the midbrain, which is responsible for processing sensory data, emotion, memory, and Pattern Matching. Our midbrains are constantly (and automatically) predicting what will happen next, then sending that information to the hindbrain, which readies our body for immediate action. The midbrain is the radio announcer, and the hindbrain is the radio.
Sitting just above the midbrain is a thin, folded layer of tissue—the forebrain. This small sheet of neural matter is responsible for the cognitive capabilities that make us distinctly human: self-awareness, logic, deliberation, Inhibition, and Decision.
Most of the time, our midbrain and hindbrain run the show—we’re operating on instinct and autopilot. That changes, however, when we face something unexpected or unfamiliar, which confounds the midbrain’s ability to predict what will happen next. That’s when the forebrain kicks into gear, gathering data and considering options.
After some deliberation and analysis, the forebrain decides what to do based on what appears to be best at the time. Once a Decision is made, the midbrain and hindbrain assume normal operation and carry out the decision.
One of the best things you can do to get more done is to dissociate yourself from the voice in your head. The radio announcer has the attention span of a two-year-old after drinking a triple espresso. Its job is to highlight things in your environment you may be interested in paying attention to—things that may fulfill one of your Core Human Drives or present some danger. That doesn’t mean the voice is always right, or that you must take everything it says as gospel truth.
Meditation is a simple practice that can help you separate “you” from the voice in your head. There’s nothing mystical or magical about meditation—you simply breathe and watch what your “monkey mind” does without associating yourself with it. After a while, the voice becomes quieter, improving your ability to keep yourself on the course you choose.
Motivation is an emotional state that links the parts of our brain that feel with the parts that are responsible for action. Using the Onion Brain as a basic model, Motivation is the link between the midbrain (which perceives the world) and the hindbrain (which sends the signals to our body to take action). In most cases, Motivation is automatic—our mind perceives a difference between the way things are and the way we want them to be, and the body automatically acts to eliminate the difference.
You can break down the experience of Motivation into two basic desires: moving toward things that are desirable and moving away from things that aren’t. Things that fulfill our Core Human Drives appear desirable, so we experience an impulse to move toward them. Things that appear dangerous, scary, or threatening are undesirable, so we naturally experience an impulse to move away from them.
In general, “moving away” takes priority over “moving toward.”
Eliminate the inner conflicts that compel you to move away from potential threats, and you’ll find yourself experiencing a feeling of Motivation to move toward what you really want.
Four Methods of Completion
There are really only four ways to “do” something: completion, deletion, delegation, and deferment.
Completion—doing the task—is the option most people think about. If you keep a to-do list, you’re probably assuming that those tasks are all your responsibility to get done. That’s not quite true—completion is best for important tasks that only you can do particularly well. Everything else can be handled in another manner.
Deletion—eliminating the task—is effective for anything that’s unimportant or unnecessary. If something on your task list is unimportant, don’t feel bad about eliminating it. If it’s not worth doing, it’s not worth doing well or quickly—don’t hesitate to get rid of it.
Delegation—assigning the task to someone else—is effective for anything another person can do 80 percent as well as you can. In order to delegate, you must have someone to delegate to. Employees, contractors, or outsourcers can all help you get more things done by completing tasks on your behalf.
Deferment—putting the task off until later—is effective for tasks that aren’t critical or time dependent. Don’t feel bad aboutputting some things off—the best way to bog yourself down is to try to handle too many things at the same time. Saving noncritical tasks for later is a good way to keep your attention and energy focused on what’s most important.
Use all four options when processing your to-do list, and you’ll get more done than you ever thought possible.
Most Important Tasks (MIT's)
A Most Important Task (MIT) is a critical task that will create the most important results you’re looking to achieve. Everything on your plate is not critically important, so don’t treat everything on your task list equally. By taking a few minutes to identify a few tasks as particularly important, you’ll make it easier to focus on achieving them first.
When creating your list of MITs, it’s useful to ask a Self-Elicitation question: “What are the two or three most important things that I need to do today? What are the things that—if I got them done today—would make a huge difference?” Write only those tasks on your MIT list, then try to get them done first thing in the morning.
Combining this technique with Parkinson’s Law by setting an artificial deadline is extremely effective. If you set a goal to have all of your MITs done by 10:00 a.m., you’ll be amazed at how quickly you can complete the day’s most important tasks.
Having a list of two or three MITs helps you maintain a Monoideal state by giving you permission to say no to interruptions that aren’t as important.
Achieve your MITs as quickly as possible, and then you’ll have the rest of the day to handle anything else that comes up.
Well-formed Goals accomplish two things: they help you visualize what you want and make you excited about achieving it. A Goal is a statement that clarifies precisely what you want to achieve, which makes it easy for your brain to use Mental Simulation to Visualize what achieving that Goal looks like. If the End Result you’re looking for is vague or fuzzy, you’re making it difficult for your mind’s automatic planning systems to find ways to get what you want. Well-formed Goals also play a key role in Motivation—the more clearly defined your Goal, the easier it is to get excited about doing the things required to get what you want.
Well-formed Goals pass the “Everest Test.” Useful Goals look like this: “I want to climb to the summit of Mount Everest before my fortieth birthday, and take a panoramic picture to frame on my wall as a trophy.” This Goal is easy for your brain to simulate—Mount Everest is in Nepal, so you’ll have to arrange travel. You’ll also have to improve your climbing skills, find a guide, buy equipment, purchase a suitable panoramic camera, etc. Once you make a conscious Decision to achieve the Goal, your mind automatically starts finding ways to get it done.
Goals are most useful if they’re Framed in a Positive, Immediate, Concrete, Specific (PICS) format:
- Positive refers to Motivation—your Goal should be something you move toward, not away from. Goals like “I don’t want to be fat anymore” are a recipe for Threat Lockdown—you’re reinforcing the negative instead of using Reinterpretation to change your mind’s prediction to get excited about improving. For best results, eliminate Conflicts first, then move toward what you want to achieve.
- Immediate refers to time scale: your Goals should be things that you decide to make progress on now, not “someday” or “eventually.” If you don’t want to commit to working on a particular Goal now, put it on your someday/maybe list and focus on something else.
- Concrete means you’re able to see the results in the real world. Goals are achievements—you should know when you’ve accomplished what you set out to achieve. Setting Goals like “I want to be happy” won’t work because they’re not concrete—how would you know when you’re done? When you reach the top of Mount Everest, you’ve achieved something concrete in the real world—that’s concrete.
- Specific means you’re able to define exactly what, when, and where you’re going to achieve your Goal. Climbing Mount Everest on a certain date in the near future is specific, which makes it easy for your mind to plan exactly how you’ll go about accomplishing it.
For best results, make your Goals actions that are within your Locus of Control, like doing a minimum of thirty minutes of exercise every day and controlling the number of calories you consume.
To track your Goals, any simple notebook or reference system will do. Personally, I capture all of my Goals in a simple text file, which I print out and keep in my to-do notebook. Whenever I’m thinking about what I need to do, I have my list of Goals handy for easy reference, which makes it easy to determine which tasks are most important.
The Five-Fold Why is a technique to help you discover what you actually want. Instead of taking your desires at face value, examining the root cause of what you want can help you define your core desires more accurately.
Applying the Five-Fold Why is easy: whenever you set a Goal or objective, ask yourself why you want it. If you want to become a millionaire, ask yourself why you want to have a million dollars.
Don’t try to force an answer—just ask yourself the question in a spirit of curiosity, and wait until your mind generates a response on its own. When your mind provides an answer, ask “why?” again. Continue to ask yourself why until you get a “because I want it” response, which indicates you’ve reached the root cause of your original Goal.
Here’s an example of how to apply the Five-Fold Why to the classic Goal, “I want to be a millionaire”:
- Why do I want a million dollars? Because I don’t want to be stressed about money.
- Why don’t you want to be stressed about money? So I don’t feel anxious.
- Why don’t you want to feel anxious? So I feel secure.
- Why do you want to feel secure? So I feel free.
- Why do you want to feel free? Because I want to feel free
Discover the root causes behind your Goals, and you’ll discover new ways to get what you actually want.
The Five-Fold How is a way to connect your core desires to physical actions. Let’s use the previous example: the core desire is to feel free. How would you go about doing that?
- Paying off an outstanding debt
- Reducing your work hours, finding another position, or becoming an entrepreneur
- Moving to a new city or country
- Breaking off a restricting personal relationship
Once you find a “how” that looks like a good idea, ask “how” again. Continue asking “how” until you’ve clearly defined your plan in terms of Next Actions. The purpose of the Five-Fold How is to create a complete chain of actions from your big idea all the way down to things that you can do right now.
Connect your big Goals to small actions you can take now, and you’ll inevitably achieve what you set out to accomplish.
The Next Action is the next specific, concrete thing you can do right away to move a project forward. You don’t have to know everything that must be done to make progress on a project—all you need to know is the very next thing you can do to move the project forward.
David Allen, the author of Getting Things Done, coined the term to describe one of the core steps of his “fundamental process”:
- Write down a project or situation that is most on your mind at this moment.
- Now describe in a single written sentence your intended desired outcome for this problem or situation. What needs to happen to mark this “done”?
- Next, write down the very next physical action step required to move the situation forward.
- Put those answers in a system you trust.
According to Allen, these questions help you clarify exactly what “done” and “doing” look like. If you define what “done” looks like, you can focus your attention and energy on “doing” the things that will get you to “done.”
To keep yourself from feeling overwhelmed, track your projects and tasks separately. Here’s what I do: I always carry around a notebook that contains a 3 × 5 index card. The card contains a short list of my active projects. The notebook contains my to-do list: the next actions that will move my projects forward, which I process using a system called “Autofocus,” which was created by Mark Forster. The system helps me use my intuition to identify what I can do right now to make progress. As long as my projects are tied to my Goals and are aligned with my preferred States of Being, it’s only a matter of time before I complete them.
Focus on completing the Next Action, and you’ll inevitably complete the entire project.
In 1955, Cyril Northcote Parkinson wrote a humorous essay in the Economist based on his experience in the British civil service. In that essay, Parkinson proposed what became his eponymous law: “Work expands so as to fill the time available for its completion.”
If something must be done in a year, it’ll be done in a year. If something must be done next week, it’ll be done next week. If something must be done tomorrow, it’ll be done tomorrow. We plan based on how much time we have, and when the deadline approaches, we start to make Choices and Trade-offs to do what must be done to complete the task by the deadline.
Parkinson’s Law is best used as a Counterfactual Simulation question. What would it look like if you finished the project on a very aggressive time scale? If you had to build a skyscraper in a day, how would you go about doing it? Answer the question the way you would a counterfactual, and you’ll discover techniques or approaches you can use to get the work done in less time.
For small tasks, use what I call Ingvar’s Rule—assume each task will take no more than ten minutes to complete, then begin. This includes meetings and phone calls: for some reason, the default time period for meetings is an hour—whether you need it or not. Often you can get just as much, if not more, done if you assume that the basic unit of time for a meeting is ten minutes. Ingvar’s Rule is a counterfactual—what would you do if you only had ten minutes to get something done? Act accordingly.
Testing is the act of trying something new—a way of applying the scientific method and the Iteration Cycle to your own life. The most happy and productive people I know all have something in common: they’re always trying new things to see what works. You can’t make positive discoveries that make your life better if you never try anything new.
Testing doesn’t have to be complicated. All that’s required is choosing some part of your life to focus on, then trying new ways to get what you want. You can Test random approaches or read about what works for others, then test the approach yourself. Externalizing your results in a notebook can help you keep track of what you’ve tried, what works, and what doesn’t.
Here’s a simple structure that will help you plan and track your Experiments:
- Observations—What are you observing in your life or business that you want to improve?
- Knowns—What have you learned from past Experiments that might be related to your observations?
- Hypotheses—Based on what you’ve observed, what situations or factors might cause or contribute to your observations?
- Tests—What will you try or change to improve your situation? Which hypotheses will this experiment Test?
- Results—What happened after each Test? Does it support or disconfirm the hypothesis?
Once you’ve found a Pattern in one of these areas, it’s time to start Experimenting. Consciously change your approach to one of these areas of your life and Externalize your results. If you find a change useful, keep doing it—if not, stop doing it and try something else.
Testing is the best way to ensure that your life gets better over time. By constantly trying new things, you’re learning what works for you and what doesn’t. Over time, you’ll discover Patterns—things that make your life better and things that make your life worse. The results of your Experiments , until they inevitably produce the results you want.
The Growth Mind-set
Using the Growth Mind-set, if you experience a challenge or difficulty, you’re likely to keep going—you might not be good at it yet, but you’re always getting better.
The way you choose to respond to challenges determines how successful you ultimately will become. It’s important to realize that you have no “fundamental defects”—there’s nothing that you’re fundamentally incapable of learning or doing. It may take time and effort, but you’ll improve eventually if you make the effort.
Viewing your mind as a muscle is the best way to help it grow
The Golden Trifecta is my personal three-word summary of How to Win Friends and Influence People. If you want to make others feel Important and safe around you, always remember to treat people with appreciation, courtesy, and respect.
Appreciation means expressing your gratitude for what others are doing for you, even if it’s not quite perfect. Imagine that you’re designing a product, and your lead designer shows you some mockups that you believe won’t work. Bluntly responding, “This is totally wrong—do it again,” is a good way to make your colleague feel unimportant and insecure. Instead, express Appreciation: “Thanks—it’s clear you worked hard on this and I appreciate that. I’m not sure if we’re there yet, so here are a few ideas that may help... ” It’s the same content, but delivered in a very different tone.
Courtesy is politeness, pure and simple. I once heard Courtesy defined as “accepting small inconveniences on behalf of another person,” and I think that’s a very useful definition. Opening the door for another person is a small inconvenience, but it can have a major impact on how they perceive you. There’s no need to make every petty issue a big deal.
Respect is a matter of honoring the other person’s status. No matter how you relate to the person you’re communicating with, Respecting them as an individual is critical if you want to make them feel Important or safe, no matter how high or low their social status.
It’s important to apply the Golden Trifecta to all of your interactions with other people, not just the people you’re particularly interested in. If you’ve ever had lunch or dinner with someone who was nice to you but rude to the waitstaff, you know what I mean. Treating other people poorly sends a clear signal to everyone that you can’t be trusted.
If you make it a policy to treat people with Appreciation, Courtesy, and Respect in all circumstances, other people will feel Important and safe in your presence
Management is simple, but not simplistic. In essence, Management is the act of coordinating a group of people to achieve a specific Goal while accounting for ever-present Change and Uncertainty.
Based on what we’ve learned thus far, here are six simple principles of effective real-world Management:
- Recruit the smallest group of people who can accomplish what must be done quickly and with high quality. Comparative Advantage means that some people will be better than others at accomplishing certain tasks, so it pays to invest time and resources in recruiting the best team for the job. Don’t make that team too large, however—Communication Overhead makes each additional team member beyond a core of three to eight people a drag on performance. Small, elite teams are best.
- Clearly communicate the desired End Result, who is responsible for what, and the current status. Everyone on the team must know the Commander’s Intent of the project, the Reason Why it’s important, and must clearly know the specific parts of the project they’re individually responsible for completing—otherwise, you’re risking Bystander Apathy.
- Treat people with respect. Consistently using the Golden Trifecta—appreciation, courtesy, and respect—is the best way to make the individuals on your team feel Important and is also the best way to ensure that they respect you as a leader and manager. The more your team works together under mutually supportive conditions, the more Clanning will naturally occur, and the more cohesive the team will become.
- Create an Environment where everyone can be as productive as possible, then let people do their work. The best working Environment takes full advantage of Guiding Structure—provide the best equipment and tools possible and ensure that the Environment reinforces the work the team is doing. To avoid having energy sapped by the Cognitive Switching Penalty, shield your team from as many distractions as possible, which includes nonessential bureaucracy and meetings.
- Refrain from having unrealistic expectations regarding certainty and prediction. Create an aggressive plan to complete the project, but be aware in advance that Uncertainty and the Planning Fallacy mean your initial plan will almost certainly be incomplete or inaccurate in a few important respects. Update your plan as you go along, using what you learn along the way, and continually reapply Parkinson’s Law to find the shortest feasible path to completion that works, given the necessary Trade-offs required by the work.
- Measure to see if what you’re doing is working—if not, try another approach. One of the primary fallacies of effective Management is that it makes learning unnecessary. This mind-set assumes your initial plan should be 100 percent perfect and followed to the letter. The exact opposite is true: effective Management means planning for learning, which requires constant adjustments along the way. Constantly Measure your performance across a small set of Key Performance Indicators—if what you’re doing doesn’t appear to be working, Experiment with another approach.
Do these well, and your team will be highly productive. Do them poorly, and you’ll be fortunate to get anything useful done at all.
Here’s Gall’s Law: all complex systems that work evolved from simpler systems that worked. Complex systems are full of variables and Interdependencies that must be arranged just right in order to function. Complex systems designed from scratch will never work in the real world, since they haven’t been subject to environmental selection forces while being designed.
Uncertainty ensures that you will never be able to anticipate all of these Interdependencies and variables in advance, so a complex system built from scratch will continually fail in all sorts of unexpected ways.
Gall’s Law is where environmental Selection Tests meet systems design. If you want to build a system that works, the best approach is to build a simple system that meets the Environment’s current selection tests first, then improve it over time. Over time, you’ll build a complex system that works.
Gall’s Law is why Prototyping and Iteration work so well as a Value Creation methodology. Instead of building a complex system from scratch, building a Prototype is much easier—it’s the simplest possible creation that will help you verify that your system meets critical Selection Tests.
Expanding that Prototype into a MEVO allows you to validate your Critically Important Assumptions, resulting in the simplest possible system that can succeed with actual purchasers. Iteration and Incremental Augmentation, over time, will produce extremely complex systems that actually work, even as the Environment changes.
The performance of a System is always limited by the availability of a critical input. Eliminate the Constraint, and the system’s performance will improve.
In order to find and eliminate a Constraint, Goldratt proposes the “Five Focusing Steps,” a method you can use to improve the Throughput of any System:
- Identification: examining the system to find the limiting factor. If your automotive assembly line is constantly waiting on engines in order to proceed, engines are your Constraint.
- Exploitation: ensuring that the resources related to the Constraint aren’t wasted. If the employees responsible for making engines are also building windshields, or stop building engines during lunch-time, exploiting the Constraint would be having the engine employees spend 100 percent of their available time and energy producing engines, and having them work in shifts so breaks can be taken without slowing down production.
- Subordination: redesigning the entire system to support the Constraint. Let’s assume you’ve done everything you can to get the most out of the engine production system, but you’re still behind. Subordination would be rearranging the factory so everything needed to build the engine is close at hand, instead of requiring certain materials to come from the other end of the factory. Other subsystems may have to move or lose resources, but that’s not a huge deal, since they’re not the Constraint.
- Elevation: permanently increasing the capacity of the Constraint. In the case of the factory, elevation would be buying another engine-making machine and hiring more workers to operate it. Elevation is very effective, but it’s expensive—you don’t want to spend millions on more equipment if you don’t have to. That’s why Exploitation and Subordination come first: you can often alleviate a Constraint quickly, without resorting to spending more money.
- Reevaluation: after making a change, reevaluating the system to see where the Constraint is located. Inertia is your enemy: don’t assume engines will always be the Constraint: once you make a few Changes, the limiting factor might become windshields. In that case, it doesn’t make sense to continue focusing on increasing engine production—the system won’t improve until windshields become the focus of improvement.
The “Five Focusing Steps” are very similar to Iteration Velocity—the more quickly you move through this process and the more cycles you complete, the more your system’s Throughput will improve.
There’s an enormous difference between risk and Uncertainty. In the immortal words of former U. S. secretary of defense Donald Rumsfeld:
There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. These are things we don’t know we don’t know.
Risks are known unknowns. If you’re planning to pick up a friend from the airport, the probability that their flight will arrive several hours late is a Risk—you know in advance that the arrival time can change, so you can plan accordingly.
Uncertainties are unknown unknowns. You may be late picking up your friend from the airport because a meteorite demolishes your car an hour before you planned to leave for the airport. Who could predict that.
Don’t rely on making accurate predictions—things can change at any time. Planning for flexibility in response to Uncertainty via Scenario Planning is far more useful than pretending to be a seer.
Key Performance Indicator (KPI)
Some Measurements are more important than others: Key Performance Indicators (KPIs) are Measurements of the critical parts of a System. Measurements that don’t help you make improvements to your System are worse than worthless: they’re a waste of your limited Attention and energy. If your intent is to improve the system you’re examining, you don’t have to pay Attention to everything—just a few key Measurements that actually matter.
Typically, businesselated KPIs are directly related to either the Five Parts of Every Business or Throughput. Here are a few questions I use to identify a business’s KPIs:
- Value Creation: How quickly is the system creating value? What is the current level of Inflows?
- Marketing: How many people are paying Attention to your offer? How many prospects are giving you Permission to provide more information?
- Sales: How many prospects are becoming paying customers? What is the average customer’s Lifetime Value?
- Value Delivery: How quickly can you serve each customer? What is your current returns or complaints rate?
- Finance: What is your Profit Margin? How much Purchasing Power do you have? Are you financially Sufficient?
Any Measurements directly related to these questions are probably KPIs. Anything that’s not directly related to a core business process or a system’s Throughput is probably not.
Try to limit yourself to only three to five KPIs per system. When collecting Measurements, it’s tempting to build yourself a “dashboard” that contains every piece of information you’d ever want to see. Resist the temptation: if you overload yourself with too much data, you’ll be far less likely to see Changes that are critically important. You can always dig deeper into the data at your disposal if necessary.
Find your system’s KPIs, and you’ll be able to manage your system without drowning in data.
Sampling is the process of taking at random a small percentage of the total output, then using it as a proxy for the entire system.
Sampling can help you identify systemic errors quickly without testing all of the output of the system, which can be time-consuming and expensive. Random “spot checks” are also a form of Sampling. Sampling is prone to bias if the sample is not truly random or uniform.
If you need to test for quality, Sampling can help you collect good data without incurring enormous costs, provided you stay on the lookout for potential bias that can skew the data.
A Confidence Interval is the probability a particular analysis is correct. It’s probably worthwhile to make sure your results are accurate before jeopardizing the magician’s good name.
The more samples you take, the higher the Confidence Interval of your Measurement. Each coin flip makes your sample size larger. The larger your sample, the more confidence you can have in the accuracy of your Measurements.
Beware of misleading Measurements based on small sample sizes. Whenever you’re presented with an average or a percentage based on data you’re not familiar with, it always pays to investigate the size of the sample and how it was collected. Sample sizes that are too small can significantly influence the final results.
When it comes to analytical confidence, more data is always better—collect the largest samples you can.
Optimization is the process of maximizing the output of a System or minimizing a specific input the system requires to operate. Optimization typically revolves around the systems and processes behind your Key Performance Indicators, which measure the critical elements of the system as a whole. Improve your KPIs, and your system will perform better.
Maximization typically focuses on the system’s Throughput. If you want to earn more money, create more units to sell, or serve more customers, you’re Optimizing for Throughput. Making Changes to the system that increase Throughput means your system is performing better in a specific, measurable way.
Minimization typically focuses on in-process inputs required for the System to operate. If you’re trying to increase your Profit Margin, costs are one of the key inputs. Minimize your costs, and your margins will increase.
By definition, if you’re trying to Maximize or Minimize more than one thing, you’re not Optimizing—you’re making Trade-offs. Many people use the term Optimization to mean “making everything better,” but that definition doesn’t help you actually do anything.
In practical terms, trying to Optimize for many variables at once doesn’t work—you need to be able to concentrate on a single variable for a while, so you can understand how the Changes you make affect the system as a whole. You’re trying to find Causation (not Correlation) in your Changes, and hidden Interdependencies can make it difficult to understand which Changes produced which results.
Remember: you can’t reliably Optimize a system’s performance across multiple variables at once. Pick the most important one and focus your efforts accordingly.
The Critical Few
In any complex System, a minority of the inputs produce the majority of the output. This Pattern of persistent nonlinearity is now called the Pareto principle, or the 80-20 rule. Personally, I prefer to refer to it as the Critical Few.
Find the inputs that produce the outputs you want, then make them the focus of most of your time and energy. Ruthlessly weed out the rest.
Automation refers to a System or process that can operate without human intervention. Factory production lines, utility networks, and computer programs use Automation to minimize the amount of human involvement necessary to complete a task. The less human effort required to operate the system, the more efficient the Automation.
Automation is best for well-defined, repetitive tasks.
Find a way to Automate your system, and you open the doors to Scale via Duplication and Multiplication, improving your ability to create and deliver value to more paying customer.
A Checklist is an Externalized, predefined Standard Operating Procedure for completing a specific task. Creating a Checklist is enormously valuable for two reasons. First, Checklisting will help you define a System for a process that hasn’t yet been formalized—once the Checklist has been created, it’s easier to see how to improve or Automate the system. Second, using Checklists as a normal part of working can help ensure that you don’t forget to handle important steps that are easily overlooked when things get busy.
Even simple processes can benefit from Systemization and the use of Checklists.
Checklisting can produce major improvements in your ability to do quality work, as well as your ability to delegate work effectively. By taking the time to explicitly describe and track your progress, you reduce the likelihood of major errors and oversights, as well as prevent Willpower Depletion associated with figuring out how to complete the same task over and over again. In addition, once your Checklist is complete you can use it as the basis for full or partial Automation of the system, which will allow you to spend time doing more important things.
For best results, create explicit Checklists for the Five Parts of Your Business, then make sure they’re followed every single time.
Scenario Planning is the process of systematically constructing a series of hypothetical situations, then Mentally Simulating what you would do if they occured. You may not be a seer, but Counterfactual Simulation gives you a powerful capability: imagining things that might occur, then figuring out what you’d do if they did. Scenario Planning is essentially detailed, thorough, and systematic Counterfactual Simulation applied to major decisions.
Scenario Planning always starts with a simple question: “What would I do if... ?” The “what if ” part is the Counterfactual, and it’s what kicks your planning brain into gear, helping you imagine possible responses. By writing down all of your potential courses of action in that circumstance, it’s possible to develop several responses to any situation you can imagine.
Scenario Planning is the essence of effective strategy.
Scenario Planning is easy to skip, particularly if you already have a lot of work to do. The time you spend in Scenario Planning can be some of the most valuable time you spend building your business, but it’s easy to overlook if you’re constantly struggling to simply keep your head above water. Regularly setting nonnegotiable time to step back and plan for the future is always time well spent—don’t skip it.
Don’t waste time trying to predict an unknowable future—construct the most likely scenarios and plan what you’ll do if they occur, and you’ll be prepared for whatever actually happens.