Simplify. Richard Koch
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they can grow exponentially, while also being very profitable and cash positive.
Stars comprise only about one or two out of every hundred businesses, yet they account for more than 100 percent of cash generated over the lifetime of the product (because some non-star businesses absorb more cash than they generate). Hence stars are the businesses where entrepreneurs, venture capitalists, and other investors make all their money.
It is possible to create a new star business by overtaking the early leader in your market, by inventing a whole new business category from scratch, or by re-segmenting into a new business category that is a subset of the original market.1
By applying the Star Principle to my investments I have built up my personal wealth.2 Over the past twenty-three years I have invested in 16 startups or young companies, of which eight have returned at least five times my original capital. This has created returns of about 20 percent a year compounded — far above the average attained by professional venture capitalists.
How have I managed to do this? By following the Star Principle. I now invest only in businesses that are stars or have the potential to become stars in their particular markets.
There is, however, a problem. The Star Principle tells you whether an existing business is already a star. But it does not tell you how to create a star business, nor how to overtake the market leader in a high-growth market and thus become a star.
So is there another principle that can tell you how to do that, reliably and with a high chance of success?
I have spent the last four years trying to find out.
Working with the venture capitalist Greg Lockwood — my co-author on Superconnect — and supported by top-quality research from OC&C Strategy Consultants, I believe we have an answer. Dare I say, the answer?
And that answer is to simplify a business and a market.
If you wish to learn why that’s so important, and how to do it, read on.
GREG LOCKWOOD
My job is to invest in businesses, so I am a professional sceptic. Instinctively, I dislike simplistic mantras and the latest management fad. I am predisposed to think that there is a lot of detail and nuance required to make businesses successful, and that the personalities who run a new company are all important. So, in many ways, I’m an odd co-conspirator with Richard, whose world-view is much more reductionist than my own — or that of just about anybody else I know!
Yet, during the fourteen years I’ve known Richard, he has helped me to understand that certain crude rules of thumb — while not invariably true — often contain concentrated insights and predictive power. The Star Principle and the 80/20 Principle are two well-validated examples. Richard’s rules are always easy to grasp, easy to communicate and, perhaps most importantly, create the philosophical resolve that leads to action. In business, being mostly correct and decisive typically yields better results than taking the time to figure out what is perfectly correct.
The simplification of business, by reducing innovation to two alternative strategies — proven in practice — is a natural extension of Richard’s 80/20 and Star principles. He simplifies the practice of strategy as well as the art of making businesses simple and highly effective.
A final attraction of the subject is that it deals with innovation in its most impactful sense. We often think of innovation as invention. There is rightly a cult of the inventor: after all, it takes a very special person to extend the bounds of knowledge, to create something fresh, or to conquer an unsolved problem. However, the first creation of knowledge touches few people. Those who deliver the most economic benefit to humanity are the simplifiers, the people who bring the fruits of invention and discovery to mass markets.
Benefit × People affected is when the world really changes, and where the highest economic rewards reside. The inventors deserve their pedestals. Equally, though, we should celebrate those who bring extraordinary value-for-money to millions. This is the cult of the simplifier.
In my Preface, I (Richard) talked about the importance of simplifying your business and your market. Why is this so desirable? Well, it turns out that it is the secret of creating a very large market, and of generating a very profitable business.
I first realized this when I was twenty-five and came across the Boston Consulting Group (BCG). I’d been to Wharton Business School, where I pursued an “individualized major,” which was a fancy name for studying everything that interested me, including cooperatives, which were in vogue at the time but taught me nothing about creating a super-profitable business. In truth, I was in a bit of a panic as to who would employ me when I graduated, because I had not specialized in a narrow skill, such as corporate finance or marketing. Moreover, although I knew a lot of arcane things about business, I knew nothing that was particularly useful. So imagine my relief when I met the recruiters at BCG, who said that they were looking for young and frankly wet-behind-the-ears people like me, because they could train us using their model of business success, which involved categorizing a client’s business as a star, a cash cow, a question mark or a dog, and then telling them what to do with it. I didn’t need to know anything myself; I just had to learn how to do that kind of analysis.
Apart from relief, though, what struck me was what a really peculiar business BCG itself was. Here it was, charging some of the top companies in America and around the world a fortune for advice that could be mass produced by a handful of smart but totally inexperienced, newly minted MBAs. I came to discover that the work was very valuable to companies as they could sell or close firms with little potential, while concentrating on the few really good businesses that they had — the star businesses. Yet, what impressed me the most was how BCG could grow like billy-o and also generate extremely high margins because its own “costs of production” were so low. The simple principles behind the Boston Box made it possible for BCG to train almost unemployable people like me and then trust us to turn out original and useful analysis in a very short period of time.
How could BCG do this? Because it simplified. It boiled down the libraries of worthy work on business strategy into one dinky little model that could be replicated for any business at relatively low cost, but which could be sold at a very high price, because it had great benefits for the customers — the large industrial corporations that were BCG’s market.
What were the benefits from the customer’s viewpoint? The Boston Box was something that was so simple that it could be grasped by everyone throughout an organization, and so useful that it told all the firm’s managers exactly what to do. It was easy to use, highly practical, elegant, and memorable. It could be used as a simplifying and unifying communication device throughout the client organization.
Is your business a star? Get your Star Principle score in sixty seconds at www.simplify.fm.
That set me thinking that perhaps the most successful companies were ones that were not only the market leaders in a high-growth market (the Star Principle), but also the most simple. In hard economic terms, simplifying has two great benefits:
it can lead to high growth in a business and market; and
it can do so at high margins, because simplifying can lead to low costs of production and high prices at the same time.
What a neat trick to pull!
Throughout my career, I had always been on the lookout for simple answers, but I had never applied the principle template to simplifying in the same systematic way as I had with the 80/20 and Star principles. Then, about five years ago, Greg pointed out this gap in my thinking. That was how we started the journey that culminated in the book you are holding in your hands.
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