SummaryThe Operating Plan stage consists of three sections.
- Core competencies: Based on the proposed foundation for sustainable competitive advantage for the venture, this will be an analysis of the core competencies (functions and capabilities) that must be internal to the firm. This analysis will guide which functions can be outsourced or achieved through partnerships.
- Elements of the operating plan: This section is the heart of the analysis. There are three documents that together represent the companies operating plan:
Financing plan: How will this venture be financed? This work has three main elements.
- Company timeline: What things will the company accomplish and when?
- Staffing plan: Who will the company hire (i.e., what skills and experience) and when?
- Budget: The outline of the financial performance that will result from the company’s activities. This should also be summarized as pro forma income statements. The appropriate planning horizon depends on the business the company is in. Factors such as time to market and the volatility of the environment should be considered. Typically, a suitable timeframe will be between three and seven years.
- Cash needs analysis: How much capital does the company need and what is the timing of the need?
- Major milestones: What are the major events that will drive the staging of financing?
- Likely sources of capital: From whom should the venture seek funding?
This section will detail the questions the entrepreneur should be asking as he/she pulls creates an operating plan for a new venture. It is assumed that the elements of the ventures strategy are already in place. Although this presentation makes it appear that there is a linear sequence of strategy then plan, this process is, of course, iterative in real life. The planning process brings to light implications of the strategy, and this sometimes causes a revision of the strategy.
The first step in developing a plan is to lay out some principles for deciding what must be done within the company, and what may be achieved through a variety of business relationships with other firms.
In today’s business environment, there is no activity that cannot be contracted for. For example, contract manufacturing organizations can build the company’s products and distributors can sell it. One might ask why do anything in house.
The answer we suggest here is threefold.
- Does the activity relate directly to the sustainable competitive advantage of the firm? If, for example, the venture’s long term competitive advantage will rest in part of some elements of its manufacturing process, then those activities should be performed internally.
- Will the activity in question, whether due to incentives, knowledge or capabilities, not be performed adequately if left to third parties? For example, the stimulation of demand may be performed by a distributor. However, the incentives of the distributor’s employees may be such that they will not devote any meaningful time to this activity.
- Is the cost to perform this activity in house demonstrably less costly to the company than any know outside alternatives? In calculating this cost, the entrepreneur must keep in mind that his/her ability to project costs may not be reliable, and may certainly be much less reliable than a third party whose business is the service in question. In addition, the entrepreneur must take into account the start-up cost of any new activity. The cost to the firm of the start-up capital must be factored into the decision.
If the answer to anyone of these three questions is affirmative, then the venture should be planning to perform that activity internally.
If the answer to all of these questions is negative, then the venture should make performing the activity through a contract its first option.
Elements of the operating plan
Three primary documents comprise this section:
- Company timeline
- Staffing plan
The analysis that supports these documents is a set of projections and planned activities.
The projections are most importantly of the anticipated demand for the company’s product. But the company must also project cost of acquiring any materials or services needed.
The planned activities are those things the firm will do (either on its own or in partnership). Each planned activity has associated with it:
- A deliverable or output – the relevant result of the activity
- A cost
- A duration
This simple model may need to be stretched a little to apply to some of the ongoing activities of the firm.
It will be a plan of the activities and investments envisioned and what they will yield in terms of revenue and profit. The main elements of the plan will correspond to the main components of the income statement:
- Sales forecast: including addressable market, customer segmentation, revenue model.
- Gross margin: analysis of the costs to produce the product or service and the underlying assumptions.
- Sales and marketing plan: this is a complex set of things that can be further broken down into these main topics.
- Product definition, with enough detail to tie to the engineering plan
- Pricing, including sensitivity analysis
- Demand creation activities, including marketing programs
- Demand fulfillment, including sales model and sales productivity assumptions.
- Research and development: (if needed) including product release schedule, assumptions and required resources.
- Operations and manufacturing: where and how will the product be built, including assumptions about customer support and warrantee?
- General and administrative: what is required to run the company: people, systems, etc.
The key issue in building a plan is to recognize that the set of planned activities and projections must support each other and be consistent. When the pieces all tie together and the assumptions are all consistent, we say that the plan closes.
Cash needs analysis: The foundation for analysis is creating pro forma financial statements for the venture:
- Income statements
- Cash flow statements
- Balance sheets
Begin with the budget summarized as pro forma income statements for a suitable time horizon. Then derive the cash in-flows and out-flows. Consider in this analysis any borrowing or leasing opportunities.
Major milestones: The events or achievements that are relevant in this analysis are ones that will cause a significant step up in the valuation of the company. These are events that increase the likelihood of success (or reduce the probability of failure). Examples are validation of the technology or first customer acceptance.
These milestones should be based on the plan objectives created in the company strategy. These should be expanded and updated as necessary.
The financing strategy is to take in the least costly capital possible (consistent with other objectives). To implement the strategy, the total capital required is broken into “stages,” where each “round” involves raising enough capital to achieve the next milestone (if possible, with a small buffer).
Likely sources of capital: The purpose here is to identify a set of appropriate investors. These are investors whose investment objectives match the profile of the venture and who have other complementary capabilities.
- Investment profile: an analysis of the risk/return scenario and a characterization of the nature of the investment opportunity. (I.e., does it fit the venture capital model or some other investment model?)
- Company needs: In addition to capital, what does the venture need from its investors, e.g., industry experience, access to management talent, etc.?
- Potential investors: A set of 6 – 12 good investors (individuals or investment firms) for the venture.