Let’s face it, most entrepreneurs are impatient and restless. Within the process of strategic planning, they tend to be dissatisfied with incremental improvements.  Most seek the Holy Grail through some form of market disruption that will provide  competitive advantage. Not every strategic plan will unearth the next iPad. Yet innovation can be manufactured, and provide a clear path for exponential growth.

There are four primary types of innovation a company can pursue:

1. Finance – Entire businesses are built on float and spreads etc. (such as American Express)
2. Process – Creating systems that streamline operations, reduce cost or offer customers an enhanced experience
3. Offering – Companies that develop unique product/design innovations or who offer comprehensive selection (one stop shopping)
4. Delivery – Companies with a unique distribution/come-to-market strategy (which is proliferating now as e-commerce reshapes many industries)

Timing is just as important in considering various innovation alternatives.  The effectiveness of certain strategies will vary dramatically based on industry stage.  When companies enter a white space with a product innovation, risk and return are high. Incumbents interested in volume will ignore such entrants pursuing niche markets[i].  When upstart Under Armour developed undergarments for football teams, they were largely ignored by larger apparel makers. Before Nike knew it, Under Armour was selling golf shirts at Dick’s Sporting Goods.

Once new products are accepted and a market is made, opportunities shift to service innovation.  The fro-yo craze (frozen yogurt) represents a current example of ingenious innovation (higher consumption coupled with lower labor costs).  Once the industry was established, the ingenuity offered was through service delivery (self-serve) as the product was framed in an entirely new context.

Another element the entrepreneur must consider is the organization’s risk tolerance and other factors that may motivate a management team. For example, a company with private equity investment may have additional burden and may be more inclined to take bigger risks; faster.

Companies can consider growth investment  in their core, adjacencies or in more transformational innovation[ii].  What is often counter-intuitive to entrepreneurs is that in most businesses, the next dollar of investment is more likely to provide an ROI when invested in the core business, than it would in disruptive innovation  (which has a much higher risk to fail). In order to optimize ROI and reduce risk, one potential strategy is to straddle your wagers across all three (core, adjacent, transformational) as each has a different risk profile and timeline.  While one could make incremental improvements to the core immediately, transformational innovations (such as an abrupt change to a business model) could take years to execute, and may require a separate LLC, management team and P&L.

Some companies are equipped to ignite and manage innovation and others think of innovation more casually. But to stimulate innovation in any systematic way requires a mindset and management structure that encourages investment. Many companies employ R&D specialists whose role is to develop new products and services. Many establish task forces to constantly consider new ideas and establish customer advisory boards to provide color on what shifts in a market may foster opportunity.

Continuous innovation does not happen on its own, it requires an enterprise wide commitment, investment and an appetite for change.  Do you have the will?

As the business press is buzzing about companies bringing back call centers and other services to the U.S., businesses should be thoughtful about what services they outsource and which they keep close to the vest.  Much has been written about keeping within a company’s core competency, but this trend is waning as evidenced by the rebirth of vertical integration. As margins are squeezed, companies are looking to recapture profit upstream and downstream.

In assessing which services to keep in-house, entrepreneurs need to look past their core competencies, and to those functions that their customers deeply value.  In the case of a call center, it is not only the quality of the service that needs to be considered but also the relevance of it.  If the purpose of a call center is for upselling and counseling customers, it has more inherent value than one that replaces warrantied parts. In the case of the former, it may make more sense for the business to insource. Services that require some specialized knowledge (known as “tailored services”) may require more finesse and are appropriate for insourcing.

One must also weigh the strategic consequences of such decisions.  Will any short-term savings in costs (through outsourcing) be countered by any long-term ramifications?  Costs cannot be considered in a vacuum. Cost savings can only be considered relative to any price premium that can be realized through more meaningful customer touches and the like. A vast majority of the time, when a business outsources a function, it loses uniqueness (as any provider could do the same).

The topic of what is “core” and what is not is somewhat misunderstood. Many businesses have tried to boil core competencies down to the bare minimum under the premise that to do so improves execution.  The premise may be correct, but the question becomes, execution against what? If the core offering is perceived to be the same as all other competitors in a given market space, there is no competitive advantage. Competitive advantage is realized when the tailored services provided are the ones that most deeply resonate with a client.

Thus the outsourcing question must be considered in the overall ecosystem of the business. Business owners are always looking to optimize the deployment of their resources but such considerations need to be made within the context of what services deliver unique benefits.

Adapted from Understanding Michael Porter by Joan Magretta

Since Gartner introduced the “Hype Cycle” in 1995, technologists have been using it to evaluate emerging technologies.  Yet today, entrepreneurs can utilize the Hype Cycle principle more broadly to consider how technologies can combine within an organization’s ecosystem to foster competitive advantage.

The Hype Cycle has 5 phases; and it takes about 2 years for technologies to shift from one phase to the next:

Phase 1-The Technology Trigger

During the trigger phase there is significant media interest in a new technology. For internal systems, users fall in love with the perceived efficiencies or customer impacts. Current examples: Crowdsourcing, Big Data

Phase 2- The Peak of Inflated Expectations

In the second phase, users are unrealistic about the capabilities of a technology, how long it will take to implement and the return on investment.  Current Examples: 3D Printing, Private Cloud Computing

Phase 3 – The Trough of Disillusionment

In reaching the trough, users realize that technologies do not realize their potential, and become cynical about them. Current examples: Cloud Computing, Home Health Monitoring

Phase 4- The Slope of Enlightenment

During the next phase, users readjust their expectations so that they can realize more realistic outcomes and find more real world applications of various product features. Current examples: Mobile OTA Payments, Media Tablets

Phase 5- The Plateau of Productivity

Finally, when a technology is adopted, its bugs are repaired and users are trained. Over time, it becomes more stable and nuances are better understood.  Current examples:  Speech Recognition and Predictive Analysis

The promise of the Hype Cycle is to help executives filter through the noise and decipher which advances will be applicable to their businesses. The term “hype” is aptly titled given our nature (as entrepreneurs) to be intellectually curious about things that are not fully proven.  The theory of the hype cycle suggests that first mover advantage has a dreadful downside; those who implement technologies too quickly are apt to be disillusioned.  As the saying goes, “the devil is in the details.”

Our clients are constantly evaluating new tools, before they are fully understood.  Managers should be more thoughtful in vetting such opportunities and fully understanding their implications. Especially as companies move to a higher level of integration, they will be more selective on how they use technologies that must coexist with ERP systems and the like.

In evaluating a new technology, a sound cost-benefit analysis should be conducted by the managers who will use the product. The days of IT executing technology in a vacuum are over.

There are times when larger companies have a distinct competitive advantage as a function of their systems or scale. It is intuitive to entrepreneurs that their advantage is driven by their ability to adapt and drive innovation. Yet, on the path to innovation, the structure of a smaller company can be limiting.

What is true in all companies (large and small) is that they are typically organized in functional departments (such as accounting, engineering, and sales). It is the objective of each of these departments to create systems and processes that further the effectiveness of the status quo.  So how can you overcome these inherent limitations and be best-in-class in terms of innovation?

Clearly smaller businesses are more impacted by resource constraints than larger organizations that have entire departments dedicated to strategic planning, R&D and innovation.  Further; the strength of functional managers in solving operational problems can be a weakness when it comes to innovation. For example, a company may spend a year or more implementing lean manufacturing which may be game changing in terms of profitability but does not revolutionize the business or open it to new markets.

Recent articles written by Kotter, author of Leading Change, and Kahneman of Thinking Fast and Slow suggest that people and organizations have two parallel tracks of thinking: one that is left brain (logical and detail oriented) and right brain (more innovative and intuitive)[i].  Further, the structure of organizations puts these two tracks in conflict.  In other words, it is impractical to believe that people who are responsible for preserving a company’s existing competitive advantage are capable of leading the charge to reshape it.  The theory is not an indictment of the capabilities of managers, but of an environment where people are working at or above their capacity, and on many initiatives at once.

Kotter calls for companies to operate “two systems”, one building out the capabilities within the core business and another tasked with exploring external opportunities. For most entrepreneurial companies, it is all hands on deck in terms of growing the business within a core competency while satisfying customers and remaining profitable.

Thus, it is incumbent upon the entrepreneur to drive innovation and to be purposeful in doing so.  Such thinking only reinforces the need to have strong C-level management (such as COO’s and CFO’s) so that the CEO can lead forward thinking initiatives that transcend incremental improvements (such as implementing a CRM or ERP).

Another issue is brain trust (reinforcement of the need for peer groups.)  If you do not have innovators within your business, you may need to create a group of confidants and advisors who can assist with the formation of your strategy.

Once these resources are in place, the team responsible for innovation must have a forum for research, vetting new ideas and seeing through various opportunities so that they can be incorporated into the business.

When considered as an industry sector, the internet contributes 4.7% to U.S. GNP. Some have characterized that as a big number, bigger than all of the spending of the Federal government combined.  Not to be a contrarian, but one could argue that 5% is a small number when you consider that the internet is still in its infancy.

It is time to change the narrative on technology. All successful businesses will ultimately become technology companies.  Failure to understand this context will be catastrophic to those who are asleep at the wheel as the next wave of computer technologies emerge. Conversely, technology has become the most effective lever for gaining competitive advantage.

Many entrepreneurs get caught up in the buzzwords: cloud, big data, take your pick. Some even ignore technology because of their lack of understanding. Most think of technology in incremental terms.  We look for ERP systems to inform us, and portals to improve the experience of our customers. My view is that thinking incrementally isn’t enough in today’s environment.

Today’s entrepreneur must harness the energy that technology offers us; to disrupt industries and make markets. While technology might be the great equalizer, it can also be the ultimate barrier to entry. It can cost millions to adhere to security and privacy standards required by large customers.  But these technologies are small ball, they keep competitors at bay, but do not reframe the conversation.

The most formidable technologies are yet to come. Large B2C companies like WalMart and Amazon are building sophisticated algorithms to predict consumer behavior, such as what utensil a housewife will buy next. What happens when B2B companies are able to predict client behavior with similar accuracy? These technologies already exist and “Big Data” will only further enable such inter-connectivity.  IT cannot just be the place where we figure out how to allow customers to order their products online.

While logistic engines and portals are somewhat known, the ability to analyze streams of data is spreading like wild fire. For example, social media tools provide the ability to calculate return on marketing investment unlike any of the marketing tools used by past generations. B2B is on the cusp of a new dawn, where business analytics will be so powerful, that winners and losers will be dictated by who has the best information.

One of the sea changes that will occur is that access to information will change the way we manage. Today, decisions are forced to the top because relatively few people in small companies have access to information . When the minions have the same information as senior management, they will make better fact based decisions.

It is time to set the information free. Data needs to be treated like a strategic asset, the fiber of intellectual capital.  It is not uncommon for our firm to have clients who spend 1-2% on technology and 8-10% on marketing.  As technology and marketing morph into one, and the cost of technology falls, companies will have to recalibrate how such investments drive profitability.

We will also have to change the way we think about how our employees use technology. In the old world, IT dictated what technology we would use. Today, the employees decide which tools they need and on what devices. They can download them for free from an app store of their choosing in real time. We cannot harness technology if we are restricting it.

Will you be participating in the next Revolution?

As a strategic planning facilitator, I am in the room while hundreds of strategic decisions are made each year.  Naturally, entrepreneurs need to understand their environment in making fact-based decisions, a process made difficult when the political environment is tenuous and volatile.

With the advent of social media and real time information, the hype surrounding the presidential election is unlike any other we have experienced. Many industries are bracing for the implications of potential sea changes in policy. It is as if the country believes the outcome will provide two very different sets of market conditions.

Consider the business of gun manufacturing and gun retailing. Before the first presidential debate, Smith and Wesson increased its forecast, citing a 30% gain in volume out of fear that the President will restrict the purchase of guns in his second term[i].  Bass Pro Shops is preparing for a “ramp up” of gun sales going into the election (the law of unintended consequences is clearly at work).

For industries such as guns and ammo, health care and others, organizations engaging in strategic planning must consider multiple scenarios. In each scenario, the organization can map out a separate set of assumptions, regulatory and otherwise.  The key to useful scenario planning is considering numerous variables at once and then analyze the implications of how certain combination will impact industry demand, pricing power, etc.  Many organizations create multiple versions of budgets that reflect varying levels of demand.

In this particular election, there seems to be more angst about the regulatory environment as the current administration has exercised its will over numerous agencies through executive order.  While the current environment is something like a Sumo wrestling match, the fear is that the executive branch can change the dynamics of an industry with the stroke of pen.

The problem with all of this is that there is significant lag between the time that a President is elected and his policies are enacted.  The process for approving regulators on boards and commissions takes months (some are never filled at all).  Waiting for regulatory action can create a form of paralysis.

Some of our clients actively engage in advocacy measures that provide them greater access to information about pending legislation or shifts in regulations.  It is actually rare for small businesses to see an ROI in hiring lobbyists. However, having access to information about where the political winds are blowing can provide competitive advantage.  Involvement in trade associations and other industry groups is pivotial is seeing around the bend.

The business press is buzzing about the impending “The Fiscal Cliff”, painting a daunting picture of the tax increases slated to go into affect on midnight, January 1^st. Seemingly every year, our elected officials find a way to overt the latest disaster such as the perpetual raising of the debt ceiling.  It is like something from a Batman movie, where the hero pulls a rabbit out of his hat at the last minute. It appears as though there is no hero in this story, and tax rates for small business owners are certainly primed to be dramatically higher, regardless of the outcome of the election.

At year’s end, when the Budget Control Act and other legislation takes affect, it will bring about the[i]:

• End of various business tax breaks
• End of the temporary payroll tax
• Escalation of the alternative minimum tax
• Conversion of Qualified Dividends to Ordinary Income
• Escalation to marginal tax rates, capital gains, and gift taxes
• Imposition of various fees from the Patient Protection and Affordability Act (Obama Care)
• Automatic cuts to over 1,000 federal programs from defense to Medicare

In total, the estimate for “Taxmaggedon” (as some have put it) is a tax increase of more than $300 Billion, the largest in the history of the United States. To make matters worse, the federal government faces an unnerving choice; it must see through deficit reduction or renege on promises to pare debt. [ii] Failure to reduce the deficit could affect confidence in the U.S. government. Moody’s has indicated it could further cut its rating of U.S. debt if a budget compromise is not reached this year.  The Congressional Budget Office is predicting a recession in 2013 should the current slate of tax increases go into affect. What a tangled web we weave.

Even if Mitt Romney should win the so called “battle ground states”, his ability to reverse these trends will be limited. Either candidate would need to make last minute deals to keep the government operating, which will require negotiation on things such as taxes, military spending and Iran. My sense is the reason that Romney holds back on some details is he knows he will have to negotiate with the other side of the isle, and various deductions and” loopholes”  affecting small business owners will be subject to debate.  If Obama wins the election, he will be emboldened to preserve his tax policy, including higher marginal rates, and capital gains. Business owners are clearly on the wrong side of reform.

So it is time for us to face the reality that regardless of the outcome of the election, tax policy is going to look very different than it has in the past. While several economic indicators such as real estate demand have turned more positive of late, business owners will clearly have to earn more to keep less.

In particular, the net cost of capital will be higher, as new depreciation rates will apply, having a material affect on profit and tax liabilities.  It is said that higher tax rates restrict investment, but there is a flip side to the argument.  While one may not feel incented to invest, each incremental dollar of investment offsets earnings taxed at a higher rate.

Clearly entrepreneurs should be consulting with their advisors to consider any tax implications within their business and individual investments. There are many nuances and implications for estate planning, tax planning and the like.  This is a time when entrepreneurs have to be proactive and prepared.

Holy tax increase Batman! Where is Robin when you need him?

[ii] The Kiplinger Letter September 21^st, 2012

In my travels I have talked to many entrepreneurs who are standing pat, and waiting for the economy to start growing again. Our expectations may be somewhat distorted. Between 1991 and 2011, the U.S Gross National Product increased between 2-6% in every year (with the exception of 2009 and 2010)[i].  An economy growing at only 2% feels entirely inadequate, even though it presents a meager statistical difference from a booming economy, where we perceive consumers and businesses to be spending more freely.

Entrepreneurs tend to follow the business news with fascination, looking for any possible insight as to the pace of economic growth. Economic news has become a crutch; it is the rally cry when results are good, and the excuse when they disappoint. The opportunity is to create companies that are resilient and relevant, regardless of economic and industry conditions. In most businesses, the value proposition must be dynamic (and not static) because the status quo is an economy flattened like a pancake.  Most of the time, the benefits that won business 3 years ago, will not be the same ones that will resonate 3 years from now.

Clearly, some sectors of the economy (such as technology and finance) are heating up.  Yet, any objective view of the economy should temper enthusiasm. The European economy contracted in the last quarter, 25% of U.S. mortgages are still under water and depressed wages (and unemployment) hinder the middle class from participating in any recovery. We as business leaders can not act as victims to these circumstances.

Further, a single economic cycle is something of a misnomer.  Industry demand is affected by a myriad of factors including the economic cycle, monetary cycle, the industry life cycle and company life cycle.  Conflicting reports about the economy create confusion and fear, and much of our sentiment about the economy is irrational.

U.S. history is riddled with periods of growth and decline steered by the mood of the nation. After the panic and fear of the Great Depression, the U.S. settled into a period of profound optimism and growth. With scant warning, the JFK assignation inflicted a deep wound, a precursor to two decades of violence and the crisis in Iran.  On the heels of the U.S. Hockey Team Gold medal in 1980, Ronald Regan proclaimed it was “’morning in America”[ii]. In the ensuing decade, the Dow Jones Industrial Average increased by a value of 8 times. Our human tendency is to overact to stimuli in the form of euphoria or despair.

It is time for businesses to plan for growth independent of the momentum of the overall economy. In many sectors, the loss of pricing power, and margin erosion are not a result of the economic cycle. The confluence of Moore’s Law, globalization and hyper-competition has permanently altered the competitive landscape. Instead of waiting for a fundamental shift in the economy, entrepreneurs should recognize the structural changes in our economic ecosystem, and take advantage of them.

For example, a recent study suggests that the rate of change in technology is escalating faster than Moore’s Law (Gordon Moore’s theory that processing speed would double every two years while prices decline)[iii]. This trend has profound implications for markets, as the rate of technology change is directly linked to the race to the bottom (commoditization).  It is probable that pricing power will deteriorate further, requiring that companies fight to demonstrate their value and better leverage the technological advances that are changing the way we live and work.  “Big Data” will enable companies to mine data and integrate systems in ways that were inconceivable just 2-3 years ago.

The businesses that are succeeding today (clearly Vistage members are outpacing the market) are not satisfied with the status quo, and are retooling their value propositions. For companies who may have been spoiled by annual price increases in the past, growth will not come through traditional means. Companies will have to manufacture growth by taking share, doing something new, or acquiring businesses in other sectors. When revenue and margin are eroding, and there is not a clear strategic impetus to reverse the trend, it is incumbent on the entrepreneur to make bold moves.

These principles may sound familiar, but the economic malaise may provide newfound motivation for entrepreneurs to seek transformational investments.  The dilemma for many businesses is the specter of new investments into new products and services, not knowing how much demand there will be. Perhaps business owners can take solace in knowing that developing new business or attacking adjacent markets is enabled by lower marketing costs, and access to tools such as e-commerce.

While U.S. earnings are strong, public companies are clearly far more reliant on revenue and profit from their operations overseas. As they ran out of runway, many looked for new markets to exploit, and small companies will need to do the same.

Of course every business is different, some are still growing and others are looking for answers. Regardless of a company’s rate of growth, entrepreneurs should not just wait out a fundamental shift in the economy, because it may not come for many years. Be bold, the future of your business may rely on it.

I just recently wrote in this space about the housing market’s affect on our broader economy. It appears as if real estate is the Pareto principle at work. Five states (Arizona, California, Florida, Michigan and Nevada) have generated a shocking 46% of the nation’s foreclosures[i].

While there are a number of forces as work, there is one explicit predictor of foreclosure activity. States where judges must approve foreclosures in writing have 260% more activity than in other states.  As homeowners and banks wait for the government to take action, markets spiral downward, only diminishing the value of properties that have positive equity.

In the states where foreclosures are dealt with quickly, the market has already begun to turn.  Each of us can reach our own conclusions about the role of government (this is not the appropriate venue for such a debate).

The broader point is that the U.S. real estate market, like many other markets has vast regional differences and elements within it moving in different directions.  The concept of the “business cycle” is a bit of a misnomer. Traditional cycles have been disrupted and replaced with a series of variables that drive markets very quickly, sometimes without pretense or warning.

The events that created the recent housing bubble created the perfect storm.  The recovery will be another type of storm, with regions and even areas within regions recovering more quickly than others. We see similar phenomena in employment and growth in various industries.

It used to be that selecting the right industry was enough to ensure some level or prosperity. Today, entrepreneurs and investors need to find very specific opportunities and niches where growth and profit are plausible.

Like everything else, choose your real estate carefully.