May 25, 2008

ENVC exercise 2

In lesson 3 the Business Planning concept is introduced describing as long as the PORES analysis, this intends to asses the merit of a business idea and the ways to exploiting it.

In this blog, we will analyse a case in which there is a committee evaluating strategic developments on the basis of business plans which at the same time it is concerned because it could be too risk averse.

Here it is important to note that “strategic development” is a kind of transformational value proposition (Helmer 2005) which is under some degree of uncertainty due to its “uniqueness”.

Uncertainty does not come from the lack of a probability function but from the inability to state it (Savage, 1972). The committee makes “subjective assessments” making use of the information available in the business plan but also using its own knowledge and experience hence revealing a subjective probability function.

That explains why the entrepreneur and the committee can have different views about the inherent risk related to the strategic development, even when they are presented, in theory, with the same information (the business plan).

So risk aversion can derive from the fact that when the business plan lacks explicit knowledge on particular areas, the committee makes use of its own knowledge and experience deriving on different views for the same subject.

We’re proposing to the committee the use of the PORES analysis to evaluate the business opportunity and try to overcome the issue of lack of knowledge previously stated that can derive in an incorrect risk evaluation.

This framework consists on several stages:

1. Identify key assumptions and check its valid ness.

In developing the market plan, the entrepreneur may have used some assumptions that have to be written down to be confronted against the committee’s knowledge and own assumptions.

2. Establish if there is a market for the product or service.

In particular assessing the size and characteristics of the buyers, the competition (including availability of substitutes) and the price the customers are willing to pay.

3. Establish if the entrepreneur has the capability to satisfy the previous market

This explores production, distribution, human resources, financial management..etc.

4. The last step performs a deeper analysis on competition

Among other things, this tries to anticipate the reaction and strategies than other competitors can follow to exploit the same profit opportunity, how the industry will evolve and opportunities for cooperation.

Following the PORES analysis, helps in getting a better view on the feasibility of the new venture. This information is useful for the entrepreneur to reflect on several aspects that he maybe initially he didn’t consider, in this way, the committee can be sure that the entrepreneur has evaluated those aspects thus reducing the inherent risk for the new venture.

On the other hand, the critical information affecting the profitability of the venture is made explicit thus it can be confronted by the committee’s own knowledge and experience, reducing the uncertainty and resulting in a better evaluation of the risk especially when evaluating industries where the committee is not familiar with.

The committee could use PORES by demanding a business plan to have PORE analysis in it or just asking the submitter to answer the questions derived from PORES not included in the original business plan.

Also, the committee could ask the entrepreneur to try to convert uncertainty to risk under several scenarios (in a kind of sensitivity analysis). In example:

Question: how many potential buyers are?

Probability of occurrence

Number of buyers

Impact on ROI

20%

> 100.000 

90%

50%

> 10.000 & < 100.000

30%

30%

< 10.000

-10%

Using stochastic methods, several answers can be combined to evaluate the potential outcomes around the expected return, which correlates to degree of risk.

However, the inherent uncertainty of the new ventures can make this risk assesment difficult to undertake and sometimes innacurate or incorrect, but at least a method that makes use of a lot of common sense can be used to evaluate different proposals under the same framework.

References

A, Burke, K. Mole (2008). The Warwick MBA for IBM: Entrepreneurship and New Venture Creation. Warwick.

H,W.Helmer (2005). A Lecture on Integrating the Treatment of Uncertainty in Strategy, Journal of Strategic Management Education

Savage, L. (1972), The foundations of Statistics, New York, NY: Dover Publications, Inc.


- One comment Not publicly viewable

  1. Kevin Mole

    Sergio,
    Again, this was a good answer. Your points about the differences in the interpretation of the same information are well made; indeed, you might have repeated this point in the conclusion. How were the probabilities derived for the scenario planning?

    30 May 2008, 15:36


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