Forget Business Plans; Here’s How to Really Size Up a Startup

October 18, 2013 Editor 0

If you want to really understand a firm’s strategy—whether it’s a start up or Fortune 500 firm–you need only two documents:  the compensation plan and the pricing plan.

Forget about business plans, PowerPoint presentations, executive speeches, media interviews, strategy memos, or org charts. Forget about brochures, YouTube videos, and blogs.  Most of that stuff isn’t meaningful—it won’t give you deep insights into the firm’s value proposition and the employee behaviors it really rewards. And in some instances, some of these documents can actually lead you astray and impede your ability to really understand the company.

In my work as an investor, an operating executive at growth companies, a mentor to startups, and a business school lecturer, I’ve come to believe that the quickest way to understand a company’s model is to look at these two documents.

Financial incentives are the key tools used to implement a strategy. How firms incent their employees–especially the sales team—and how they incent their customers and the marketplace are the true effectuation of their strategy. Yes, there’s a lots of managerial research suggesting that there are other motivations besides money that drive employee behavior, and that shoppers are driven by elements beyond pricing. But for most of us, money remains really important, and it’s the factor that’s easiest to observe when judging how well a firm’s strategy will work.

When I am meeting a company for the first time and I ask for the pricing and compensation plan upfront, I often get blank stares.  “Don’t you want to see our investor deck or business plan?” the founders will say. Yes, I reply, but later. These two documents are more important.

When I get my hands on these plans, I read them while imagining that I’m an actual employee or customer. If I’m an employee, I ask questions like: Are my earnings capped?  Am I incented to be constantly closing deals or delaying until new sales periods? Am I more heavily incentivized to up-sell, to support existing clients, or win new ones? If I’m a customer, I ask: What is this pricing plan encouraging me to do? Am I rewarded for buying more, and if so when?  Am I incented to buy one service or product over others, or a combination of products?

When I look over these documents, I’m frequently surprised by how the financial incentives do not align with publicly-stated strategy.  Sometimes they’re directly at odds. I am also surprised how often “C” level executives don’t know the details of those plans and can’t explain why they are what they are.  In my experience, if the C-suite doesn’t have a deep understanding of how it’s financially motivating employees to behave in ways that create value and exactly how its prices will attract and retain buyers, the company’s story is not going to end well.

Let me offer a few examples.

I remember taking over a large research firm’s sales organization.  The stated corporate strategy was to meet the needs of clients by providing world-class research to help support clients’ decision-making process in technology purchases. When I examined the compensation plan, however, it revealed that sales reps could not “make their numbers” (and earn bonuses) unless they had also sold certain quantities of other non-research services. This is the kind of mismatch I look out for when I try to reconcile stated strategy with a comp plan: In this case, selling research was our company’s core strategy, yet the sales staff was incented to divert energy to sell something completely different.

Or consider a B2B software company I know. Its stated strategy was to become ubiquitous, and to leverage their widely-used platform to sell new kinds of software and grow revenue. Yet when you look at the pricing plan, you’ll see it charges a flat rate for each copy of its application, regardless of the identity of the customer. A little research would reveal that customers hated the flat-rate pricing: They complained that there were “power users” and “occasional users,” and that prices should reflect that.

The company made no change in that pricing, and seemed disappointed when its market share topped out at 60%. But if you really understand the pricing problem, you instantly understand the limit to their penetration: The flat-rate pricing meant that clients couldn’t justify offering the software to infrequent users, whose usage wouldn’t provide enough value to warrant the price. Therefore, the company’s pricing didn’t really reflect their strategy of becoming ubiquitous. In fact, their real strategy was to try to boost short-term profits by maintaining margins on incremental sales. This strategy didn’t work our well: Eventually a competitor entered the market and offered an ‘enterprise license’ for unlimited purchases, and within three years the original company’s market share was under 10%.

At Intralinks, where I was CEO in the early 2000s, our team innovated a totally new pricing model to drive rapid adoption. Earlier in the company’s history, it had charged clients a certain fee for every use of our application, plus extra charges based on how much memory or storage each client used. That caused clients to be picky about how many users had access to our application, slowing adoption. We shifted to a model in which we sold a certain “inventory” of usages of our service–say 150, which was then drawn down over time, and then refilled. (Much like pay-as-you-go mobile minutes.)  With that simplicity, bookings went up over 600% in the first year and market share reached 72%.

So if you really want to understand what any company is really trying to accomplish, get your hands of the compensation and the pricing plan. The investor deck may tell a carefully-scripted story, but these two documents tell the real truth.

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Categories: HBR, Insights

Tags: Business, Business plan, Leadership, Strategic management