Published in Business Strategy Series September 2010

A New Model for Unlocking

the Value of Entrepreneurial
Businesses Peter Skarzynski is a Senior
By Peter Skarzynski and Doug Schaedler Managing Director and founder
of Strategos, a global strategy

In December 2009, a student team
from MIT won the Red Balloon
Challenge organized by the Defense
Advanced Research Projects Agency
(DARPA), an agency of the U.S.
Department of Defense responsible
for developing new technology for
military use.1 The team took just nine
hours to track down the locations of
ten red weather balloons hidden
across the United States, exceeding
even the event organizers wildest
expectations. The teams innovative
reverse-Ponzi reward system that
encouraged knowledge owners to
participate in its social network will
be studied and replicated by many.
However, the even more impressive
feat was that the team took just
one week to design, plan and
operationalize the whole system.2
This teams success is a landmark
example of the power of open
innovation both in terms of the
productivity of a well-organized
network and the swiftness with
which such a network becomes
operational.
The success of the MIT Red Balloon
Challenge Team highlighted open
innovation as a maturing and
potentially powerful management and innovation consulting firm
practice, especially applicable for and the strategic services
entrepreneurial businesses without division of Innovaro. For over
rigid organizational lines and
ingrained business processes. 20 years, he has helped senior
Innovation pioneers are also managers set strategic direction,
successfully employing two other
management practices, namely capture new growth
experimentation-driven discovery opportunities and make their
and future-back migration mapping,
organizations more innovative.
with both techniques being widely
discussed and written about by Doug Schaedler is the former
management experts in recent years.3 CEO of Innovaro, a global
Used together in one integrated
management system, all three intellectual property licensing
practices open innovation, and innovation service provider.
experimentation-driven discovery,
and future-back migration He possesses deep operational
mapping could help dramatically experience in funding and
reduce the risks of nascent businesses, nurturing startup businesses
essentially unlocking their value.
The resultant unlocked value creates through his work as a founder,
a bigger pie that allows everyone operator and investor at a wide
a bigger slice a win-win for
businesses and their capital providers. range of startup companies.
Understanding Learn more about the authors,
Entrepreneurial Business Strategos, and Innovaro at
Risks www.strategos.com and
Before we get into the risk reduction
www.Innovaro.com.
prowess of management practices

1
From Defense Advanced Research Projects Agency (DARPA) website: https://networkchallenge.darpa.mil/default.aspx: To mark the 40th anniversary of the
Internet, DARPA has announced the DARPA Network Challenge, a competition that will explore the roles the Internet and social networking play in the timely
communication, wide-area team-building, and urgent mobilization required to solve broad-scope, time-critical problems. The challenge is to be the first to submit
the locations of 10 moored, 8-foot, red, weather balloons at 10 fixed locations in the continental United States. The balloons will be in readily accessible locations
and visible from nearby roads.
2
While the MIT Red Balloon Challenge Team used the open innovation approach, Googles internal team applied number crunching and image recognition tech-
niques (e.g., looking for images and posting of red balloon locations on the web). When MIT Red Balloon Challenge Team successfully identified all ten balloons,
the Google team had found nine. https://networkchallenge.darpa.mil/Default.aspx; http://socialcapital.wordpress.com/2009/12/11/behind-mits-darpa-weather-bal-
loon-challenge-win/ ; http://www.networkworld.com/news/2009/120509-layer8-darpa-mit-red-balloon.html?fsrc=netflash-rss; http://news.cnet.com/8301-1023_3-
10411211-93.html
3
See Discovery-Driven Growth: A Breakthrough Process to Reduce Risk and Seize Opportunity, by Rita McGrath and Ian MacMillan (Harvard Business School
Press, 2009); Unleashing Innovation: How Whirlpool Transformed an Industry by Nancy Tennant Snyder and Deborah Duarte (Jossey-Bass, 2008); and Innovation
to the Core: A Blueprint for Transforming the Way Your Company Innovates by Peter Skarzynski and Rowan Gibson (Harvard Business School Press, 2008).

Copyright 2010 Strategos. All rights reserved.

like open innovation, experimentation-
driven discovery, and future-back
migration mapping, lets first look at
the risks themselves. While every
business operates in a unique
situation and has a set of risks
specific to it, there are four types
of risks common to virtually all
entrepreneurial businesses, whether
they are venture-backed startups or
new businesses within established
companies: customer demand,
product or technology development,
profitability of the business model,
and competitor response or product
obsolescence.
Customer demand risk Does
the business offer a product and/or
service that addresses a customer
problem or need? Will customers
be willing to pay (with money or
time) for the product or service?
Are there enough paying customers?
Because many innovative
businesses new products or
services address unmet needs that
most customers dont even know
they have, its often extremely
difficult to determine customer
demand levels for them. For
example, before the introduction of
the Apple iPod, consumers couldnt
take their entire collection of
entertainment content with them.
So, market data to gauge the
potential size of the market for
the iPod didnt exist. For other
businesses, their new products or
services offer better solutions over
current offerings or work-arounds.
Here, new customers would incur
switching costs in addition to new
product/services costs. Many
better mouse traps never leave
their inventors garages because
they couldnt overcome switching
costs.
Product / technology
development risk Many great
inventions start with a big promise
but never develop into successful
commercial endeavors. So,
business innovators must assess
and manage the risk of evolving
the invention from concept to
commercial product. In parallel,
they need to figure out how to
Copyright 2010 Strategos. All rights reserved.
scale up the business and if the
end-product or technology can
withstand the wear and tear of
daily use. Twenty years ago,
multiple corporate network
software companies were working
on word processors that would
allow dispersed team members
to collaboratively edit the same
document in real time. Despite the
potential benefit, this capability
still eludes corporate productivity
software even now.
Profitability (business model)
risk Ultimately, all businesses
need to generate sufficient profits
to be sustainable. So, innovators
must determine the specific
economic business model for their
businesses. In addition to the
simplistic perspective that the cost
of delivering the product or service
must be lower than the revenue
received from same, there are
many business model issues. These
range from customer awareness
and delivery to complementary
revenue sources and specific
pricing schemes. Many startup
businesses like Netflix are centered
on innovation in the business
model, not just the fruits of
technological inventions.
Innovators must understand and
manage the risks associated with
the novel aspects of their particular
business model.
Competitor/market/product
obsolescence risk Assuming the
entrepreneur can successfully
launch the product or service,
competitors will respond. Because
the distinct advantage of any
A prime example is the University
product or service will ultimately
be overtaken by newer products
and services, every product and
service faces the threat of
obsolescence.
Mitigating Entrepreneurial
Business Risks and
Unlocking Value
The MIT Red Balloon Challenge
Team is just one recent example of
the victory of open innovation. Add
to this the success of Linux and
Wikipedia (and all the derivative
Wikis), and its clear that the practice
has demonstrated its power to
dramatically improve the productivity
of massive development projects and
its effectiveness in solving complex
problems. It should come as no
surprise that open innovation can
help reduce the risks of startup
businesses and intra-preneurial
ventures. Experimentation-driven
discovery and future-back migration
mapping have also helped both
established and nascent companies
mitigate the risks of innovative
businesses. Lets look at how
innovators can use these three
management practices to reduce
entrepreneurial business risks and
unlock value.
Crowd-Sourcing/Open Innovation
allows a group of people, often
volunteers or self-nominated, to
jointly work on a complex problem
or project, with little or no pre-
specified group hierarchy. How does
this work in practice?
Estimating customer demand and
market size remains an imprecise art.
Practitioners generally collect a wide
range of data, including potential
customers impressions of the new
product/service, and then benchmark
that pre-launch data against previous-
ly collected pre-launch data for past
new products/services. They use the
comparisons to estimate the potential
successes of new products/services.
However, prediction markets have
proven to be extremely accurate
without the need to collect extensive
data or construct a benchmarking
model.
of Iowa Electronic Market (IEM),
which has been accurately
forecasting the outcome of U.S.
elections since 1988 via on-line
futures markets. According to Tom
Rietz, associate professor of finance
at the University of Iowa, the
prediction error for presidential
elections between 1988 and 2000
was 1.37%, and in other elections
(such as Senate, House, and
primaries) averaged 3.43%.
Compared to major polling
organizations, IEM was more
accurate 76% of the time in
predicting the outcome of elections.
Hewlett Packard has applied this
technique to supplement its printer
sales forecast, and Google has used
it to estimate product launch dates.
Even DARPA has explored applying
the technique to estimate the
likelihood of a terrorist attack.4
Inventing novel techniques for
solving complex problems is
potentially the best strength of
crowd-sourcing. One example is the
Netflix Prize, an open competition
for the best collaborative filtering
algorithm to predict user ratings for
films, based on the users previous
ratings. (This allows Netflix to
recommend movies that a given user
would be more likely to rate high.)
The grand prize of $1 million was
reserved for the entry which would
best Netflixs own algorithm by 10
percent. Although it took three years
before a multinational team over-
came the 10% threshold, Netflixs
own internal engineers probably
would have taken even longer and
done so at a substantially higher
cost.5
Experimentation-Driven Discovery
is a practice where elements of a new
business concept are tested and then
refined, in real or simulated market
conditions.
Many companies have applied a wide
range of experiments and tests to
gauge customer demand. One
example is Googles Gmail, a highly
popular web mail application.
Google first evaluated customer
demand by testing it with users
inside its own firm. Once it was clear
that employees found Gmail useful,
Google slowly invited the public to
try it out, limiting invitees to a select
few. As word spread about the
advantages of Gmail over other web
mail applications, demand swelled,
and invitees auctioned off their
Gmail invitations on eBay for
4
Business intelligence worth betting on, ZDNet, 7/13/2003, http://news.zdnet.com/2100-10532_22-296373.html
5
And the Winner of the $1 Million Netflix Prize (Probably) Is , New York Times, 7/26/2009; Netflix Prize, Wikipedia
6
Best Buys Trade-In Plans: Why Let eBay Have All The Fun? , StorefrontBacktalk, March 4, 2010, http://storefrontbacktalk.com/e-commerce/best-buy-prepar-
ing-to-buy-back-used-products-envisions-profitable-untouched-lifecycle-potential
7
McDonalds sold the majority of its stake in RedBox to partner Coinstar in February 2009.
Copyright 2010 Strategos. All rights reserved.
hundreds of dollars. Google
gradually tested its ability to deliver
the product to a mass audience by
slowly raising the number of
invitations and steadily increasing the
amount of storage space provided to
each user. Gmails interface and
security evolved as developers
worked their way through the
learning and development process.
Another example of experimentation-
driven discovery is Best Buys
Trade-In program, which encourages
customers to bring in certain used
electronics in exchange for Best
Buy gift cards or free/low-cost
environmentally safe disposal.
Shortly after conceiving the idea,
Best Buy tested the concept in a few
stores with temporary tents in store
parking lots. To market the service,
employees left flyers with neighbor-
hood households. These low-cost
experiments provided valuable data
that confirmed the customer demand
for and overall business model
soundness of this new line of
business. Now, Best Buy is rolling
out the program across its entire
network of stores. Interestingly, one
of the surprising lessons learned was
that disposal of the used electronics
can also be a profit center. Since
then, Best Buy acquired Deal Tree
and its subsidiary Cow Boom, and
its investing in Cow Boom to sell
the used goods collected from the
Trade-In program.6
Experimentation is not just about
proving the business founders
original hypothesis; its also a
powerful practice for revising the
core business concept until a winning
one emerges. An example of this
is McDonalds experience in
developing the RedBox business. At
first, McDonalds envisioned setting
up self-service vending machines in
its restaurant parking lots, offering a
choice of goods similar to those sold
in convenience stores. Its initial test
uncovered multiple operational
issues, such as securing permits for
connecting power to a free-standing
device in a parking lot. More
importantly, it learned that among the
150 or so products offered, ranging
from batteries to milk, DVDs really
drove sales. So, McDonalds
morphed the concept from a general-
purpose convenience store to a DVD
rental kiosk. They then conducted
additional experiments to test
pricing, assortment, and various
operational issues. They also realized
that they could expand the concept
beyond the physical locations of their
restaurants. Now, there are over
15,000 RedBox DVD rental kiosks
across the country, many of them in
supermarkets and other non-
McDonalds properties, making
RedBox the largest operator of DVD
rental kiosks in the U.S.7
Jumping head first into the pool
without testing the water can be
dangerous. One example of
launching a full-scale business
without appropriate confirmation of
the business model assumptions also
happens to be one of the Internet
bubbles spectacular failures,
Webvan, which consumed over a
billion dollars of start-up capital in
just a few years as it flailed in the
business of home grocery delivery.
While expectations were high, the
concept had two business model
risks, how much customers were
willing to pay for the service and the
right model for actually delivering
groceries to consumers. Instead
of first conducting low-cost
experiments, Webvan immediately
constructed proprietary warehouses
in multiple cities. At the same time,
Peapod (US) and Tesco (UK) were
conducting low- cost experiments
through their own existing
supermarkets, diligently testing and
refining the business model of home
delivery of groceries. By the time
Webvan learned that it would take an
average consumer purchase of $200
for its proprietary warehouse model
to break even, it had already burned
through its IPO cash, and went
bankrupt shortly after that.
Meanwhile, Peapod and Tesco
continued to experiment and then
apply the lessons learned to refine
their delivery model into a workable
solution. Now, they are not just
surviving, they are viable and
growing in the business of delivering
groceries to peoples homes.
Future-Back Migration Mapping,
a practice that organizes a group of
similar ideas, delivers a game-
changing benefit to the customer, in
logical sequential paths. Instead of
relying on a single breakthrough
product, innovators think of a
collection of products that together
greatly transform the customer value
the company delivers. Then, they
construct a migration map from the
end-state transformative ambition
back to a set of lower-risk early-stage
products. Essentially, a company
starts with its vision of the future,
and then maps a path back to it from
where they are now.
A good example of the use of future-
back migration mapping is the
development of the Apple iPod.
Imagine that you were a top
executive at Apple at the turn of
the millennium, and that you were
presented with the opportunity to
develop a Macintosh-only digital
music player. Would you have
devoted your companys top
engineers and designers to this
project? If you say no, you are not
alone. On the surface, a Mac-only
anything seemed to be a small
opportunity, and MP3 players were
simply not a core business for
computer makers. Most seasoned
managers would also have said no.
Fortunately for Apple, thats not the
whole story. The initial iPod product
and iTunes service were just the first
steps in Apples ambitious Digital
Hub strategy, where the ultimate
goal was to allow users to have all
the entertainment content they want
accessible to them whenever and
Figure 1 Hypothetical Illustration of the iPod Migration Map
wherever they want it. See Figure 1
above for a hypothetical illustration
of the Digital Hub strategy and a
retrospective illustration of Apples
Digital Hub platform migration map.
From this strategic perspective, the
Macintosh-only digital music player
was a low-risk entry point, where
Apple could refine its business model
while getting major music labels and
other partners to collaborate. The
migration map approach helped
Apple identify a starting point that
mitigated many of the business
model risks.
Additionally, the migration map
approach helped Apple evolve its
products and reduced development
risks. Specifically, while great design
and ease of use have always been a
core value and a key competence of
Apple, the early lessons learned from
the first few generations of iPod and
iTunes helped Apple refine its points
of differentiation. Apple also learned
early on how to generate consumer
buzz. When it launched the first three
generations of iPods, Apple centered
its marketing efforts on touting the
expanded array of functions and
features (what it could do). Out in
the marketplace, the buzz came from
the slick click8 wheel (how its
done), as early owners busily showed
off their cool devices to their friends.
Apple learned that the collision of
sophisticated technologies with
coolness generated consumer buzz.
So it painstakingly built nifty ways to
perform ordinary tasks in later
editions of everything, from scrolling
miniature pictures of album covers
for browsing the music library to
jiggling icons when customizing
the home-screen on an iPhone.
Amazon has also used future-back
migration mapping. In the early days,
Amazon.com was a true Internet
company. Not only was it without a
physical storefront, it didnt even
handle the books it sold, instead
relying on book distributors as
partners for processing the actual
orders. Then, as eCommerce took
off, Amazon saw eCommerce
infrastructure as a potential long-term
growth space. Amazon formulated a
strategy that positioned it as the
eCommerce platform provider,
handling its own transactions as well
as providing online storefronts and
order processing capabilities for
other retailers, large and small.
With this end-state vision in mind,
Amazon raised capital and
constructed proprietary warehouses
and distribution centers, along
with sophisticated warehouse and
distribution management software,
to handle the delivery of products for
itself and its partners. In parallel, it
also invested heavily in eCommerce

8
Click wheel was a feature for the third generation iPod.

Copyright 2010 Strategos. All rights reserved.

technologies for presenting its own
and its partners products to
consumers. This long-term migration
enabled Amazon to remain viable
despite constant competitive threats.
Conclusion
Google, Netflix, and Amazon.com
were successful ventures that started
in the dot-com era, and their
successes rewarded investors and
their entrepreneurial founders
handsomely. Despite the successes
of these three stars and other well-
known venture capital-backed start-
ups like eBay, Apple, and Intel, many
good business ideas, in both venture
capital and corporate environments,
dont get funded. At the same time,
Copyright 2010 Strategos. All rights reserved.
many poorly conceived ventures therefore unlocking the value, of
should be terminated long before entrepreneurial businesses.
they burn through so much investor
Although these practices will not
money or corporate capital. A
assure that all new business ideas
systematic approach to assessing
will grow and prosper, they will
and mitigating risks associated
help management and funding
with innovative business is highly
providers in both VC and corporate
valuable for business managers and
environments weed out unviable
their funding providers.
ideas while nurturing promising
If we extract lessons from the opportunities that evolve into
experiences of successful startups successful businesses. The end result
and innovative ventures from should be that more good ideas will
established firms, it seems the be funded, creating greater returns
practices of open innovation, for capital providers and opportunity
experimentation-driven discovery, managers.
and future-back migration mapping
can form the foundation of a
systematic toolset for assessing
and mitigating the basic risks, and
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