Opportunities in the incubator

GUEST COLUMN/ Companies diversifying for growth can run this test to evaluate new businesses

In today's dynamic environment, the rate of change has accelerated greatly. There are changes in industry structure, customer preferences, the regulatory environment, technology and so on.

Changes by their very nature bring in their wake both opportunity and uncertainty.

While earlier, organisations could afford to stick with their businesses and business models for years, perhaps even decades together, today they are being increasingly compelled to constantly review their current businesses and examine the potential new businesses that they could enter.

Consider the case of a typical engineering company that increasingly finds margins and growth in its core EPC business under pressure. Its key stakeholders would, however, like to continue to have their expectations fulfilled.

Shareholders want their wealth to be enhanced. Its employees seek growth and prosperity. The firm decides to explore new business opportunities, both related and unrelated.

When it sets out on this initiative, it is soon able to generate several dozen ideas, some of which appear to be worth pursuing. How should it decide what to do with different ideas?

Firms often swing from one extreme of discarding the ideas with uncertainty altogether and thus losing out on value creation opportunities, to the other extreme of betting the whole farm on them. Is there a more structured methodology to approach this whole process?

In evaluating these ideas, there are two key variables that need to be considered. This presumes that the basic viability of these ideas has already been ascertained and the unviable ones have been filtered out.

For ideas in Quadrant 1, given the fact that the market uncertainty is low, it is likely that these are already established industries and hence the best means of entry is through acquisitions.

For example, any company wanting to make a serious play in the IT services space today, when it does not have the capabilities at present, would be best advised to make an acquisition, because its basis of entry is only that it has surplus cash.

Ideas in Quadrant 3 are those that could lend themselves to immediate entry and rapid ramp-up as there is limited uncertainty on both dimensions. (in fact, the question to ask is why have these remained on the "blind side" of the firm so far) Consider a firm, which has sound engineering design skills and strong delivery capabilities.

The outsourcing of engineering design services is already an established phenomenon.

For this firm, any experimentation would only take away time, making it more difficult for the firm to enter this space. It would be well advised to devise a quick entry strategy with a rapid ramp up.

Acquisitions could be considered as a means of gaining customers or achieving scale, rather than acquiring capabilities, in this case.

The challenge is really in Quadrants 2 and 4. A good way of dealing with uncertainty is to try out a pilot or an experiment in real life with real customers.

Consider the business of organised retail in the food sector some years ago. There were several questions about the business "" would customers be willing to switch from their neighbourhood kirana store?

Is there a viable balance between the size of the catchment area for each store and the distance customers would have to travel to reach the store? Would the economies of scale justify the higher investments in infrastructure, back-office operations and so on? There were others that would be more related to the firm's capabilities "" would it be able to set up a store with the right cost structure? How effectively would it be able to handle logistics?

The company seeking to pursue a Quadrant 2 idea like organised retail, needs to first state its hypothesis of which business model will work and the key assumptions that need to be tested during the experimental stage, based on the questions raised above.

By the very nature of experiments, they need to be run in a controlled environment, with key milestones and timelines.

Thus, if the company decides to experiment by setting up one food store in a particular location in a city, it is imperative that measures are set up by which the status of the experiment can be reviewed. These measures could include: the number of footfalls per month, the ratio of purchases to footfalls, the average bill value per purchase and so on.

The hypothetical business model would set out what the expected values for these measures are, and the experiment would provide actual values against them.

Quadrant 4 opportunities would have uncertainties to be resolved on internal capabilities and the measures would reflect these uncertainties rather than any external ones.

A company entering the three-star hotel category today has few uncertainties to resolve on the industry viability itself.

Its questions are more related to the brand awareness that it can create for its hotels, the cost structure of the hotels, its ability to attract the customer profile that it is seeking, away from other competing hotels and so on.

The company also needs to design the experiment in a manner that it is representative, in a small scale, of the eventual business model. So scalability (would it still work if the volume were five times the present volume) and replicability (can this be replicated across multiple locations/products?) are also important aspects of the design of these experiments.

The objective of pilots or experiments in an uncertain environment is to mitigate risk. A firm running a retail pilot would, therefore, set up criteria of go/ no go, based on which it would decide whether to proceed with ramping up, or experimenting with a modified business model, or even exiting from the opportunity altogether.

Here, a balance needs to be struck between continuing with the experiment to gain more information and hence reduce risk, and timing the entry correctly so that the window of opportunity still remains open. The risk profile of individual companies would dictate at what stage they would like to make a judgment.

Increasingly, the time for which the window of opportunity remains open is shrinking from several years to a much shorter period, forcing companies to make a more rapid judgment about their entry.

The approach of controlled experiments can be applied not just to new business opportunities but to existing business activity such as entry into new product categories, new markets and so on.

In the sequential process of idea generation, through experiments, ramped-up ventures to growth engines, the rate of attrition at each level is high.

Given the stream of new opportunities emerging from the rapidly changing environment, companies would do well to create a pipeline of such experiments to assure themselves of sustained growth and prosperity.

The writer works on corporate strategy at Eicher Goodearth Ltd, New Delhi