Updated: Mar 24, 2019
Starting a new business is usually a daunting task. You might feel hesitant thinking of all the risks involved. Using a sound framework to think about all the issues is a good way to increase your confidence. A simple example could make things clear.
You find that that the store selling all kinds of stuff in your community is making a lot of money. And think that you too can make money by starting a store.
So you lease a building available at low rent and stock it with some merchandise. And immediately begin to feel uneasy. Can I make a profit by selling the stuff? For at least some items of the merchandise, you had paid a price that was almost the same that the existing store was charging.
Other problems soon begin to appear.Few people are coming to your store as it is located at an inconvenient locality (that's why the low rents). Customers are complaining about the poor service they get from the staff you had engaged.
These kinds of problems are not inevitable. Many of the problems could have been avoided had you used "framework thinking."
What is framework thinking? Framework thinking involves thinking about all "relevant" issues in a specific context. In the above example of a store, it would have involved such issues as:
What factors make people choose a particular store to buy what they need?
How can I attend to these factors? And do it at a cost that will leave a profit?
Do my competitors enjoy any special advantages that make it almost impossible for me to compete against them?
If the framework thinking approach had been used in the above case, you would have found that (i) the location with low rentals was one that is inconvenient to shoppers, (ii) existing store had their own manufacturing facilities for some of the merchandise and could offer low prices and (iii) sales staff need special training to provide great customer service. You would then have been in a better position to decide whether to risk your money in starting a new store.
Many theories and principles have been developed for managing businesses. These provide frameworks for thinking about different aspects of business.
For example, the Five Forces Analysis of Professor Michael Porter is a framework for assessing the attractiveness of an industry. It can help a new entrant to assess the potential for success in that industry before deciding whether to enter it. Let us take a brief look at the five forces that the professor has identified:
Competitive Rivalry: Answering the following questions about the industry could help you assess the possibility of competing successfully in it: How many competitors will you have to compete against? Has the product of the industry become a commodity product so that it is hard to differentiate your brand from all the other brands? Do customers stick with one brand or do they switch from one supplier to another?
Threat of New Entry: Even if competition is currently manageable, it could become intense if newcomers can enter the industry easily. Assess the ease of entry by answering questions like: Will a new entrant require resources like large capital outlays or hard-to-get skills and expertise? Do patents protect existing players in the industry?
Buyer Power: If your product or service has only a few (or even a single) customer(s), you are likely to be at the mercy of that buyer. So ask: Who are your customers? Do they consist of a few large entities like Walmart who can dictate terms that can even put you out of business? Or is there a large population of customers to whom you can sell directly?
Supplier Power: You need certain inputs such as physical ingredients or specialized skills to produce what you sell. Unless you own the source of the ingredient or have the specialized skill yourself, you will have to depend on outside suppliers for these. If there are only a few suppliers, they might dictate terms that can make your business unprofitable. Ask: How many suppliers can supply the inputs you want to produce your product? Are they too few so that they can dictate terms? Can you find substitutes for specific inputs in case these become too expensive or unavailable?
Threat of Substitutes: You would want to increase your prices under certain conditions, such as an increase in the costs of inputs. Could your customers switch to less expensive substitutes if you raise prices? Check: thus Can your customers find a substitute for your product or service? Or can they import it from other countries at lower costs?
As you can see, these are not theoretical issues but hard business realities. You could find it extremely difficult to succeed if you fail to do an analysis as above before entering any industry. Frameworks like Porters Five Forces Analysis provide practical help to entrepreneurs.
There are many other such frameworks, such as Balanced Scorecard that helps managers keep on top of day-to-day operations by checking that all critical issues are being attended to.
Using a framework to look at your business or idea is thus not an academic exercise. It is an essential, very practical, task.