How scientific experimentation checks strategic uncertainty in business

Five years ago, Scott Anthony started an enterprise in Bangalore called Razor Rave, which was essentially three trucks with barbers' chairs deployed all over the city, offering men a sanitised grooming experience at a price far lower than salons. A former McKinsey consultant and a protege of 'disruptive innovation' guru Clayton Christensen, Anthony had then recently shifted base to Singapore, in the belief that the great innovations of the future would come out of Asia.
With the idea that consultants need to practice what they preached, Innosight, his consulting firm, had a venture finance and incubation arm and Razor Rave was one of its first ventures. It closed down in a year. Razor Rave's business model was based on the assumption that barbers are a commodity and customers didn't care who shaved them or cut their hair. As it turned out, barbers have a fair level of brand equity.

"Once he recognised he was the hero of the business, the barber either demanded high wages or left to go to a different shop. Our sub-scale delivery model just couldn't support the wages demanded by a great barber," says Anthony.

With an investment limited to $75,000, Razor Rave failed at the experimental stage. In his new book, 'The First Mile', Anthony uses it as an example of a lean startup and scientific management of strategic uncertainty.

Defining innovation as 'something different that creates value,' Anthony says a project needs to start by clearly addressing a customer need in a compelling way: "Documenting an idea helps to understand critical assumptions. It's the first step, but you shouldn't spend too much time on it because your initial idea is going to change."

The second step every innovation goes through is evaluation. Spreadsheet fans will be happy to hear that there is no escaping financial modeling. Anthony favours what he calls the 4P calculation, based on target population, planned pricing, expected purchase frequency and required penetration to achieve an identified revenue threshold. "These are back of the envelope calculations that take only a few minutes, but the 4Ps provide rich insight into the viability of the business model," he says. This approach also helps estimate how sensitive outcomes are to changes in variables.

Here, The First Mile presents the example of the Godrej battery operated ChotuKool refrigerator, to which Innosight was a consultant when it was launched in 2009. Around 80 per cent of Indian households do not own a fridge and Innosight estimated that while some of these households simply could not afford it, others had other constraints like lack of reliable power.

"We built a simple spot sensitivity table that showed the relationship between household penetration, unit price and revenues. The uncertainty lay in the percentage of non-consuming households that could really be targeted and whether they had sufficient purchasing power to support the desired price points," says Anthony.

The pilot studies turned out favourable and ChotuKool continues to be sold in the market. While the end result of innovation can seem simple, the process in anything but. The First Mile urges innovators to focus on the strategic uncertainties, especially 'deal killers' that have the potential to derail the business and 'path dependencies' that affect subsequent strategic choices.

For a medical device maker, uncertainties associated with getting approval from regulatory bodies can be a deal killer and the company needs to estimate the probabilities associated with various outcomes. Path dependency, on the other hand, may lie in the choosing the target customer, which determines marketing channels and pricing. "You need to be humble when you assess how much you really know, you need to get a grounded view of how confident you should be about the robustness of your idea," says Anthony.

The scientific method starts with a hypothesis and a prediction related to it. Scientists then design an experiment to test the prediction. Document, evaluate and focus form the first three letters of a process Anthony calls DEFT, the fourth letter of which stands for test. In the context of business innovation, an experiment can be test marketing or a pilot plan.

Anthony advises companies to keep the teams involved in these projects small and not include people from departments which are not relevant at an early stage. Experiments are expensive and The Last Mile provides some rules of thumb for keeping costs down: prototype before you build; fake it before you make it; borrow before you buy; contract before you hire; outsource before you ramp up.

A prototype can be created using available materials and even if it's not true to the final aesthetics envisioned in the product, it should get the idea across to potential customers cheaply. The First Mile also provides a list of low cost or free web tools that might come in handy for the garage entrepreneur at the experiment stage.

They include Google Sketch, which can create mock-ups; SurveyMonkey, for market research; and Basecamp, for project management. "These solutions might frighten people in large organisations but they are affordable and extremely effective," says Anthony.

Most first mile decisions are made in what Anthony calls "the fog of innovation", where companies have to decide which projects to fund and the prime objective is not to squander money. That means organisations perform multiple layers of reviews before committing resources to a project. "The uncertainty that characterizes the first mile requires an approach that is experiment encouraging," says Anthony. "It has to be biased towards action rather than analysis and the quantitative and qualitative results of the experiments are constantly reviewed."

Of course, at some stage, you have to quit failed projects. If allowed to linger, they turn into zombies, not quite alive, but not dead either. Razor Rave in Bangalore was one project that was killed early, but large corporates sometimes let such projects linger. "Zombie projects multiply because no one wants the scarlet 'F' that comes from failure pinned to his or her resume. That is why reward systems have to encourage smart risk taking and not overly penalise failure," says Anthony.