The Personal MBA

Please Note
The following book summary is the result of a collection of personal notes, highlights and thoughts extracted from the book. Most of the content is a direct quotation from the book and original authors work.

The Personal MBA (Master of Business Administration) is an endeavour by Josh Kaufman in order to make business and management knowledge more accessible to people that didn’t get a chance to gain a formal education in this ambit.

Management is simple, but not simplistic. In essence, Management is the act of coordinating a group of people to achieve a specific Goal while accounting for ever-present Change and Uncertainty.

Takeaway Points

Value Creation

Business Definition

Every successful business (1) creates or provides something of value that (2) other people want or need (3) at a price they’re willing to pay, in a way that (4) satisfies the purchaser’s needs and expectations, and (5) provides the business sufficient revenue to make it worthwhile for the owners to continue operation.

If you want to improve your value as a businessperson, focus on improving skills related to the Five Parts of Every Business.

It doesn’t matter if you’re running a solo venture or a billion-dollar brand. Take any one of these five factors away and you don’t have a business—you have something else. A venture that doesn’t create value for others is a hobby. A venture that doesn’t attract Attention is a flop. A venture that doesn’t sell the value it creates is a nonprofit. A venture that doesn’t deliver what it promises is a scam. A venture that doesn’t bring in enough money to keep operating is not going to exist very long. At the core, every business is a collection of five Interdependent processes, each of which flows into the next:

Value Creation — discovering what people need or want, then creating it.
Marketing — attracting attention and building demand for what you’ve created.
Sales — turning prospective customers into paying customers.
Value Delivery — giving your customers what you’ve promised and ensuring that they’re satisfied.
Finance — bringing in enough money to keep going and make your effort worthwhile.

If these five things sound simple, it’s because they are. Business is not (and has never been) rocket science — it’s a process of identifying a problem and finding a way to solve it that benefits both parties. Anyone who tries to make business sound more complicated than this is either trying to impress you or trying to sell you something you don’t need.

Every business relies on two additional factors: people and systems.

Critical Assumptions are facts or characteristics that must be true in the real world for your business or offering to be successful. Every business or offering has a set of Critical Assumptions that will make or break its continued existence: if any of these Critical Assumptions turns out to be false, the business idea will be less promising that it appears.

Core Human Drives

If you’re going to build a successful business, it’s useful to have a basic understanding of what people want. The most well-known general theory of what people want is Maslow’s hierarchy of needs. Maslow’s theory was that people progress through five general stages in the pursuit of what they need: physiology, safety, belonging/love, esteem, and self-actualization. Physiology represents the “lowest” level of human need, while self-actualization (the exploration of a person’s innate potential) is the “highest.” In practice, I prefer Clayton Alderfer’s version of Maslow’s hierarchy, which he called “ERG theory”: people seek existence, relatedness, and growth, in that order.

According to “Driven: How Human Nature Shapes Our Choices” by Paul Lawrence and Nitin Nohria, all human beings have four Core Human Drives that have a profound influence on our decisions and actions:

The Drive to Acquire — the desire to obtain or collect physical objects, as well as immaterial qualities like status, power, and influence. Businesses built on the drive to acquire include retailers, investment brokerages, and political consulting companies. Companies that promise to make us wealthy, famous, influential, or powerful connect to this drive.
The Drive to Bond — the desire to feel valued and loved by forming relationships with others, either platonic or romantic. Businesses built on the drive to bond include restaurants, conferences, and dating services. Companies that promise to make us attractive, well-liked, or highly regarded connect to this drive.
The Drive to Learn — the desire to satisfy our curiosity. Businesses built on the drive to learn include academic programs, book publishers, and training workshops. Companies that promise to make us more knowledgeable or competent connect to this drive.
The Drive to Defend — the desire to protect ourselves, our loved ones, and our property. Businesses built on the drive to defend include home alarm system manufacturers, insurers, martial arts training programs, and legal services. Companies that promise to keep us safe, eliminate a problem, or prevent bad things from happening connect to this drive.
The Drive to Feel — the desire for new sensory stimuli, intense emotional experiences, pleasure, excitement, entertainment, and anticipation. Businesses built on the drive to feel include movie theaters, arcades, concert promoters, and sports teams. Companies that promise to give us pleasure, thrill us, or give us something to look forward to connect with this drive.

At the core, all successful businesses sell the promise of some combination of money, status, power, love, knowledge, protection, pleasure, and excitement. The better you articulate how your offer satisfies one or more of these drives, the more attractive your offer will become.

Ten Ways to Evaluate a Market

The Ten Ways to Evaluate a Market provide a back-of-the-napkin method you can use to identify the attractiveness of any potential market. Rate each of the ten factors below on a scale of 0 to 10, where 0 is terrible and 10 fantastic. When in doubt, be conservative in your estimate:

Urgency. How badly do people want or need this right now? (Renting an old movie is low urgency; seeing the first showing of a new movie on opening night is high urgency, since it only happens once.)
Market Size. How many people are purchasing things like this? (The market for underwater basket-weaving courses is very small; the market for cancer cures is massive.)
Pricing Potential. What is the highest price a typical purchaser would be willing to spend for a solution? (Lollipops sell for $0.05; aircraft carriers sell for billions.)
Cost of Customer Acquisition. How easy is it to acquire a new customer? On average, how much will it cost to generate a sale, in both money and effort? (Restaurants built on high-traffic interstate highways spend little to bring in new customers. Government contractors can spend millions landing major procurement deals.)
Cost of Value Delivery. How much will it cost to create and deliver the value offered, in both money and effort? (Delivering files via the internet is almost free; inventing a product and building a factory costs millions.)
Uniqueness of Offer. How unique is your offer versus competing offerings in the market, and how easy is it for potential competitors to copy you? (There are many hair salons but very few companies that offer private space travel.)
Speed to Market. How soon can you create something to sell? (You can offer to mow a neighbor’s lawn in minutes; opening a bank can take years.)
Up-front Investment. How much will you have to invest before you’re ready to sell? (To be a housekeeper, all you need is a set of inexpensive cleaning products. To mine for gold, you need millions to purchase land and excavating equipment.)
Upsell Potential. Are there related secondary offers that you could also present to purchasing customers? (Customers who purchase razors need shaving cream and extra blades as well; buy a Frisbee and you won’t need another unless you lose it.)
Evergreen Potential. Once the initial offer has been created, how much additional work will you have to put in in order to continue selling? (Business consulting requires ongoing work to get paid; a book can be produced once and then sold over and over as is.)

When you’re done with your assessment, add up the score. If the score is 50 or below, move on to another idea—there are better places to invest your energy and resources. If the score is 75 or above, you have a very promising idea—full speed ahead. Anything between 50 and 75 has the potential to pay the bills but won’t be a home run without a huge investment of energy and resources.

One of the Hidden Benefits of Competition is that when any two markets are equally attractive in other respects, you’re better off choosing to enter the one with competition. Here’s why: it means you know from the start there’s a market of paying customers for this idea, eliminating your biggest risk. The existence of a market means you’re already on the right side of the Iron Law of the Market, so you can spend more time developing your offer instead of proving a market exists.

The best way to observe what your potential competitors are doing is to become a customer. Buy as much as you can of what they offer. Observing your competition from the customer’s perspective can teach you an enormous amount about the market: what value the competitor provides, how they attract attention, what they charge, how they close sales, how they make customers happy, how they deal with issues, and what needs they aren’t yet serving. As a paying customer, you get to observe what works in your market and what doesn’t before you commit to a particular strategy. Learn everything you can from your competition and then create something even more valuable.

Twelve Standard Forms of Value

Economic Value usually takes on one of 12 standard forms:

Product. Create a single tangible item or entity, then sell and deliver it for more than what it cost to make.
Service. Provide help or assistance, then charge a fee for the benefits rendered.
Shared Resource. Create a durable asset that can be used by many people, then charge for access.
Subscription. Offer a benefit on an ongoing basis and charge a recurring fee.
Resale. Acquire an asset from a wholesaler, then sell that asset to a retail buyer at a higher price.
Lease. Acquire an asset, then allow another person to use that asset for a predefined amount of time in exchange for a fee.
Agency. Market and sell an asset or service you don’t own on behalf of a third party, then collect a percentage of the transaction price as a fee.
Audience Aggregation. Get the attention of a group of people with certain characteristics, then sell access to that group, in the form of advertising, to another business looking to reach that audience.
Loan. Lend a certain amount of money, then collect payments over a predefined period of time equal to the amount of the original loan plus interest at a predefined rate.
Option. Offer the ability to take a predefined action for a fixed period of time in exchange for a fee.
Insurance. Take on the risk of some specific bad thing happening to the policyholder in exchange for a predefined series of payments, then pay out claims only if the bad thing happens.
Capital. Purchase an ownership stake in a business, then collect a corresponding portion of the profit as a one-time payout or ongoing dividend.

These forms of value are not mutually exclusive but can be combined whenever needed. With Bundling we can for example combine multiple small offers in a single large offer (repurposing the value we have already created).

Product

A Product is a tangible form of value. To run a Product-oriented business, you must:

Create some sort of tangible item that people want.
Produce that item as inexpensively as possible while maintaining an acceptable level of quality.
Sell as many units as possible for as high a price as the market will bear.
Keep enough inventory of finished product available to fulfill orders as they come in.

Products can be durable (e.g. car) or consumable (e.g. medications) and they don’t have to be necessarily physical (e.g. software, saas). Products can be duplicated and/or multiplied, making it easy for them to scale.

Service

In order to create a successful Service, your business must:

Have employees capable of a skill or ability other people require but can’t, won’t, or don’t want to use themselves.
Ensure that the Service is provided at high quality.
Attract and retain paying customers.

Services can be lucrative, particularly if the skills required to provide them are rare and difficult to develop, but the trade-off is that they’re difficult to duplicate. Services depend on the Service provider’s investment of time and energy, both of which are finite.

Shared Resource

A Shared Resource is a durable asset that can be used by many people. Shared Resources allow you to create the asset once, then charge your customers for its use. In order to create a successful Shared Resource, you must:

Create an asset people want to have access to.
Serve as many users as you can without affecting the quality of each user’s experience.
Charge enough to maintain and improve the Shared Resource over time.

Gyms and fitness clubs are a classic example of a Shared Resource (most gyms combine access to their Shared Resource with Services and Subscriptions, a common example of Bundling).

The tricky part about offering a Shared Resource is carefully monitoring usage levels. If you don’t have enough users, you won’t be able to spread out the cost of the asset enough to cover up-front costs and ongoing maintenance. If you have too many users, overcrowding will diminish the experience so much that they’ll become frustrated, stop using the resource, and advise others not to patronize your business, diminishing your Reputation.

Subscription

A Subscription program provides predefined benefits on an ongoing basis in exchange for a recurring fee. The actual benefits provided can be tangible or intangible—the key differences from other forms of value are (a) the expectation of additional value to be provided in the future and (b) the understanding that fees will be collected until the Subscription is canceled. In order to create a successful Subscription, you must:

Provide significant value to each subscriber on a regular basis.
Build a subscriber base and continually attract new subscribers to compensate for attrition.
Bill customers on a recurring basis.
Retain each subscriber as long as possible.

Resale

Resale is the acquisition of an asset from a wholesale seller followed by the sale of that asset to a retail buyer at a higher price. Resale is how most of the retailers you’re familiar with work: they purchase what they sell from other businesses, then resell each purchase for more than it cost. In order to provide value as a reseller, you must:

Purchase a product as inexpensively as possible, usually in bulk.
Keep the product in good condition until sale—damaged goods can’t be sold.
Find potential purchasers of the product as soon as possible to keep inventory costs low.
Sell the product for as high a markup as possible, preferably a multiple of the purchase price.

Resellers are valuable because they help wholesalers sell products without having to find individual purchasers.

Lease

A Lease involves acquiring an asset, then allowing another person to use that asset for a predefined amount of time in exchange for a fee. The asset can be pretty much anything: a car, boat, house, bike, or power tool. As long as an asset is durable enough to survive rental to another person and be returned ready for reuse, you can Lease it. In order to provide value via a Lease, you must:

Acquire an asset people want to use.
Lease the asset to a paying customer on favorable terms.
Protect yourself from unexpected or adverse events, including the loss or damage of the leased asset.

Agency

Agency involves the marketing and sale of an asset you don’t own. Instead of producing value by yourself, you team up with someone else who has value to offer, then work to find a purchaser. In exchange for establishing a new relationship between your source and a buyer, you earn a commission or fee. In order to provide value via Agency, you must:

Find a seller who has a valuable asset.
Establish contact and trust with potential buyers of that asset.
Negotiate until an agreement is reached on the terms of sale.
Collect the agreed-upon fee or commission from the seller.

Sellers benefit from an Agency relationship because it generates sales that might not otherwise happen.

Audience Aggregation

Audience Aggregation revolves around collecting the attention of a group of people with similar characteristics, then selling access to that audience to a third party. Since attention is limited and valuable, gathering a group of people in a certain demographic is quite valuable to businesses or groups that are interested in getting the attention of those people. In order to provide value via Audience Aggregation, you must:

Identify a group of people with common characteristics or interests.
Create and maintain some way of attracting that group’s attention.
Find third parties who are interested in buying the attention of that audience.
Sell access to that audience without alienating the audience itself.

Loan

A Loan involves an agreement to let the borrower use a certain amount of resources for a certain period of time. In exchange, the borrower must pay the lender a series of payments over a predefined period of time, which is equal to the amount of the original loan plus interest at a predefined rate. In order to provide value via Loans, you must:

Have some amount of money to lend.
Find people who want to borrow that money.
Set an interest rate that compensates you adequately for the Loan.
Estimate the probability that the Loan won’t be repaid, and avoid preventable losses.

Used responsibly, Loans allow people to benefit from immediate access to products or services that would otherwise be too expensive to purchase outright. Loans are beneficial to the lender because they provide a way to benefit from excess capital. The addition of compound interest on top of the original loan (the “principal”) means that the lender will collect much more than the value of the original loan.

The process of identifying how risky a particular Loan is—a process called underwriting—is an essential skill for lenders, who often require some sort of asset as collateral to protect against the risks of a Loan gone sour. If the Loan is not repaid, ownership of the collateral is transferred to the lender, then sold to recoup any funds lost in the transaction.

Option

An Option is the ability to take a predefined action for a fixed period of time in exchange for a fee. Most people think of Options as financial securities, but they’re all around us: movie or concert tickets, coupons, retainers, and licensing rights are all examples of Options. In exchange for a fee, the purchaser has the right to take some specific action—attend the show, purchase an asset, produce a licensed Product, or buy a financial security at a particular price—before the deadline. In order to provide value via Options, you must:

Identify some action people might want to take in the future.
Offer potential buyers the right to take that action before a specified deadline.
Convince potential buyers that the Option is worth the asking price.
Enforce the specified deadline on taking action. Options are valuable because they allow the purchaser the ability to take a specific action without requiring them to take that action. For example, if you purchase a movie ticket, you have the ability to occupy a seat in the theater, but you don’t have to if a better opportunity presents itself. When you purchase the ticket, all you’re purchasing is the right to exercise the Option to see the movie at the time specified—nothing more.

Insurance

Insurance involves the transfer of risk from the purchaser to the seller. In exchange for taking on the risk of some specific bad thing happening to the policyholder, the policyholder agrees to give the insurer a predefined series of payments. If the bad thing happens, the insurer is responsible for footing the bill. If it doesn’t, the insurer gets to keep the money. In order to provide value via Insurance, you must:

Create a binding legal agreement that transfers the risk of a specific bad thing (a “loss”) happening from the policyholder to you.
Estimate the risk of that bad thing happening, using available data.
Collect the agreed-upon series of payments (called premiums) over time.
Pay out legitimate claims on the policy.

Insurance provides value to the purchaser by protecting them from downside risk. Insurance works because it spreads risk over a large number of individuals.

The more premiums an insurer collects and the fewer claims the insurer pays, the more money it makes. Insurers have a vested interest in avoiding “bad risks,” maximizing premiums, and minimizing payments on claims. Insurers must be vigilant to avoid fraudulent activity, both preventing fraudulent claims and refraining from defrauding purchasers by collecting premium payments without paying legitimate claims. If an insurer fails to pay legitimate claims, they’re likely to find themselves in court as policyholders use the legal system to uphold their Insurance contract.

Capital

Capital is the purchase of an ownership stake in a business. For parties that have resources to allocate, providing Capital is a way to help owners of new or existing businesses expand or enter new markets. Angel investing, venture capital, and purchasing stock in publicly traded companies are all examples of providing value via Capital, which we’ll discuss in detail later, in the Hierarchy of Funding. In order to provide value via Capital, you must:

Have a pool of resources available to invest.
Find a promising business in which you’d be willing to invest.
Estimate how much that business is currently worth, how much it may be worth in the future, and the probability that the business will go under, which would result in the loss of your Capital.
Negotiate the amount of ownership you’d receive in exchange for the amount of Capital you’re investing.

Hassle Premium

Where there’s a hassle, there’s a business opportunity. Hassles come in many forms. The project or task in question may:

Take too much time to complete.
Require too much effort to ensure a good result.
Distract from other, more important priorities.
Involve too much confusion, uncertainty, or complexity.
Require costly or intimidating prior experience.
Require specialized resources or equipment that’s difficult to obtain. The more hassle a project or task involves, the more people are willing to pay for an easy solution or for someone to complete the job on their behalf.

Perceived Value

Value is in the eye of the beholder. Perceived Value determines how much your customers will be willing to pay for what you’re offering. The more valuable a prospect believes your offer is, the more likely they’ll be to buy it and the more they’ll be willing to pay. The most valuable offers do one or more of the following:

Satisfy one or more of the prospect’s Core Human Drives.
Offer an attractive and easy-to-visualize End Result.
Command the highest Hassle Premium by reducing end-user involvement as much as possible.
Satisfy the prospect’s desire for Social Status by providing Status Signals that help them look good in the eyes of other people.

Iteration Cycle

The Iteration Cycle is a process you can use to make anything better over time. Iteration relies on the scientific method, which has five general steps:

Observe what’s happening and identify something that you’d like to improve.
Design an experiment and identify indicators that will tell you whether or not the prospective change is an improvement.
Conduct the experiment and collect data.
Evaluate the results of the experiment.
Accept or reject the change as an improvement.

The goal is then to go through each iteration cycle as fast as possible.

When asking for feedback its important to:

Get Feedback from real potential customers instead of friends and family
Ask open-ended questions
Steady yourself and keep calm
Take what you hear with a grain of salt. Even the most discouraging Feedback contains crucial pieces of information that can help you make your offering better. The worst response you can get when asking for Feedback isn’t emphatic dislike: it’s total apathy. If no one seems to care about what you’ve created, you don’t have a viable business idea.
Give potential customers the opportunity to preorder.

Economic Values

Assuming the promised benefits of the offering are appealing, there are nine common Economic Values that people consider when evaluating a potential purchase. They are:

Efficacy — how well does it work?
Speed — how soon does it work?
Reliability — can I depend on it to do what I want?
Ease of use — how much effort does it require?
Flexibility — how many things does it do?
Status — how does this affect the way others perceive me?
Aesthetic appeal — how attractive or otherwise aesthetically pleasing is it?
Emotion — how does it make me feel?
Cost — how much do I have to give up to get it?

Shadow Testing

Shadow Testing is the process of selling an offering before it exists. As long as you’re up front with your potential customers that the offering is still in development, Shadow Testing is a very useful strategy you can use to test your Critical Assumptions with real customers. Shadow Testing can then be coupled with a Minimum Viable Offer. A Minimum Viable Offer is an offer that promises and/or provides the smallest number of benefits necessary to produce an actual sale. A Minimum Viable Offer is a Prototype that’s been developed to the point that someone will pull out their wallet and commit to making a purchase.

Marketing

Marketing is the art and science of finding “prospects”—people who are interested in what you have to offer. Marketing is not the same thing as selling. While direct-marketing strategies often try to minimize the time between attracting attention and asking for the sale, marketing and selling are two different things.

Rule #1 of marketing is that your potential customer’s available attention is limited. However, some kinds of attention aren’t worth having. You want the attention of prospects who will purchase from you — otherwise, you’re wasting your time. Believe it or not, it’s often wise to turn away paying customers. Not every customer is a good customer: customers who require more time, energy, attention, or risk than they’re worth to your bottom line aren’t worth attracting in the first place. Qualification is the process of determining whether or not a prospect is a good customer before they purchase from you.

In fact, the fastest way to be ignored by anyone is to start talking about something they don’t care about. Receptivity is a measure of how open a person is to your message. Receptivity has two primary components: what and when. People tend to be receptive only to certain categories of things at certain times.

Prospects experience five distinct Levels of Awareness during the marketing and sales process:

Unaware — the prospect is not aware of any need or desire for what you have to offer.
Problem Awareness — the prospect knows they have a need or desire, but they aren’t aware of any suitable solutions.
Solution Awareness — the prospect knows that potential solutions exist, but they aren’t aware of your specific offer.
Offer Awareness — the prospect is aware of your offer, but they’re not sure it’s right for them.
Full Awareness — the prospect is convinced your offer is a good solution to their need or desire, they just need to know the price and terms so they can decide whether or not to purchase.

If you want to attract Attention, give something valuable away for Free. Marketers often try to explain the benefits of their offers, but it’s more effective to show the product in action. Demonstration increases a prospect’s belief in the benefits of your offer by showing them how well it works.

Framing is the act of emphasizing the details that are important while de-emphasizing things that aren’t by either minimizing certain facts or leaving them out entirely. Proper use of Framing can help you present your offer persuasively while honoring your customer’s time and attention.

The most effective way to get people to want something is to encourage them to use Visualization — to picture what their life would be like if they accepted your offer.

A Hook is a single phrase or sentence that describes an offer’s primary benefit. Sometimes the Hook is a title and sometimes it’s a short tag line. Regardless, it conveys the reason someone would want what you’re selling.

A Call to Action directs your prospects to take a single, simple, obvious action. The best Calls to Action ask either for the sale or for Permission to follow up. Making direct sales is optimal, since it makes it easy to figure out whether or not your marketing activities are cost-effective. Asking for Permission is the next best thing, since it allows you to follow up with your prospects over time, decreasing your marketing costs and increasing the probability of an eventual sale.

Controversy means publicly taking a position that not everyone will agree with, approve of, or support. Used constructively, Controversy can be an effective way to attract Attention: people start talking, engaging, and paying Attention to your position, which is a very good thing.

The Hero’s Journey

Most compelling Narratives around the world follow a common format. The world-renowned mythologist Joseph Campbell called this prototypical storyline the “Hero’s Journey” or the “monomyth.” People all over the world respond very strongly to this story motif, and you can use this basic format to craft and tell your own stories. The Hero’s Journey begins by introducing the Hero: a normal person who is experiencing the trials and tribulations of everyday life. The Hero then receives a “call to adventure”: a challenge, quest, or responsibility that requires them to rise above their normal existence and hone their skills and abilities in order to prevail. When the Hero accepts the call, they depart their normal experience and enter into a world of uncertainty and adventure. A series of remarkable experiences initiates them into this new world, and the Hero undergoes many trials and learns many secrets in the pursuit of ultimate success. After persevering in the face of adversity and vanquishing the foe, the Hero receives a mighty gift or power, then returns to the normal world to share this knowledge, wisdom, or treasure with the people. In return, the Hero receives the respect and admiration of all. Your customers want to be Heroes.

Testimonials, case studies, and other stories are effective in encouraging your prospects to accept your “call to adventure.”

Sales

Without a certain amount of Trust between parties, a Transaction will not take place. No matter what promises are made or how good the deal sounds, no customer is going to be willing to part with their hard-earned money unless they believe you’re capable of delivering what you promise. Building a trustworthy Reputation over time by dealing fairly and honestly is the best way to build Trust. Making Damaging Admission and Reciprocation can also be two other selling aspects to keep in mind to build trust.

One of the most fascinating parts of sales is what I call the Pricing Uncertainty Principle: all prices are arbitrary and malleable. Pricing is always an executive decision. If you want to try to sell a small rock for $350 million, you can. If you want to quadruple that price or reduce it to $0.10 an hour later, there’s nothing stopping you. Any price can be set to any level at any time, without limitation. The Pricing Uncertainty Principle has an important corollary: you must be able to support your asking price before a customer will accept it. In general, people prefer to pay as little as possible to acquire the things they want (unless Social Status is at stake). If you expect people to pay you good money to buy what you’re offering, you must be able to provide a Reason Why the offered price is worth paying. Auctions are an example of the Pricing Uncertainty Principle at work—prices change, rising in proportion to how many people are interested and how much they’re each willing to spend.

There are four ways to support a price on something of value:

Replacement cost (“How much would it cost to replace?”)
Market comparison (find a similar offer and set your price relatively close to what they’re asking)
Discounted cash flow/net present value (“How much is it worth if it can bring in money over time?”)
Value comparison (“Who is this particularly valuable to?”) These Four Pricing Methods will help you estimate just how much something is potentially worth to your customers.

Most people who are new to business assume that the best way to increase sales is to reduce prices. That’s not necessarily true. Often, raising your prices is an effective way to attract more customers. Discounts attract customers when the offer is a commodity. In introductory economics courses, this idea is called “price elasticity.” Offers with high price elasticity experience major changes in demand when prices go up or down. Offers with low price elasticity experience little fluctuation in demand when prices change. The trouble with the traditional pricing curve is that it can be misleading when the offer isn’t a commodity. In practice, raising your prices can increase demand by appealing to a more attractive type of customer. As you test different pricing strategies, you’ll notice thresholds where you stop appealing to certain types of customers and start appealing to customers with very different characteristics. This Price Transition Shock can change the experience of operating your business, and you shouldn’t take it lightly. There are two major considerations when setting your prices with Price Transition Shock in mind: (1) potential profitability and (2) ideal customer characteristics. The best strategy is to set your prices to appeal to the prospects that will ensure you work with your most desirable customers in a way that results in the highest profits.

Value-Based Selling is the process of understanding and reinforcing the reasons your offer is valuable to the purchaser.

Understanding the other party’s Next Best Alternative gives you a major sales advantage: you can structure your agreement so it’s more attractive than their next best option. The more you know about the other party’s alternatives, the better you can fine-tune your offer by Bundling or Unbundling various options.

In most sales situations, it’s in your best interest to maintain Exclusivity: creating a unique offer or benefit that other firms can’t match. If you’re the only person or company that offers what your prospect wants, you’re in a very strong position to negotiate on favorable terms.

Option Fatigue is often a major barrier to buying decisions: if a prospect is overwhelmed by Decisions, they often choose to resolve their discomfort by abandoning the purchase instead of completing it.

Reactivation is the process of convincing past customers to buy from you again. If you’ve been in business for a while, you’ll have some “lapsed” customers—people who have already purchased from you but haven’t purchased for quite some time. You know they’re interested in what you have to offer, and you probably already have their contact information.

The four phases of successful selling

Understanding the situation
Defining the problem
Clarifying the short-term and long-term implications of that problem
Quantifying the need-payoff, or the financial and emotional benefits the customer would experience after the resolution of their problem.

By encouraging your prospects to tell you more about what they need, you reap two major benefits. First, you increase the prospect’s confidence in your understanding of the situation, increasing their confidence in your ability to deliver a solution. Second, you’ll discover information that will help you emphasize just how valuable your offer is, which helps you in Framing the price of your offer versus the value it will provide.

Education-Based Selling

Education-Based Selling is the process of making your prospects better, more informed customers. It requires an up-front investment in your prospects, but it’s worth it. By investing energy in making your prospects smarter, you simultaneously build Trust in your expertise and make them better customers. Be forewarned, however, that effective education requires your offer to be superior in some way to your competitors’—otherwise, you’ll be sending customers away. All the more reason to ensure that you have an offer worth selling.

Negotiating

When negotiating, there are Three Universal Currencies: resources, time, and flexibility. Any one of these currencies can be traded for more or less of the others. In every negotiation, the power lies with the party that is able and willing to walk away from a bad deal. In almost every case, the more acceptable alternatives you have, the better your position. The more attractive your alternatives, the more willing you’ll be to walk away from a deal that doesn’t serve you, resulting in better deals.

The first phase of every negotiation is the setup: setting the stage for a satisfying outcome to the negotiation. The more you can stack the odds in your favor before you start negotiating, the better the deal you’ll be able to strike.

Who is involved in the negotiation, and are they open to dealing with you?
Who are you negotiating with, and do they know who you are and how you can help them?
What are you proposing, and how does it benefit the other party?
What’s the setting—will you present your offer in person, by phone, or by some other means?
What are all of the environmental factors around the deal—do recent events make this deal more or less important to the other party?

Setup is the negotiation equivalent of Guiding Structure — the Environment surrounding the deal plays a huge role in the eventual outcome, so it pays to ensure that the Environment is conducive to getting a good deal before you ever reach the table.

By thinking about the setup, you can make sure you’re negotiating with the right person — the person who has the Power to give you what you want. Research is what gives this dimension of negotiation its power — the more knowledge you gain about your negotiating partner during this phase, the more power you have in the entire negotiation, so do your homework before presenting an offer. The second dimension of negotiation is structure: the terms of the proposal. In this phase, you put together your draft proposal in a way the other party is likely to appreciate and accept:

What will you propose, and how are you Framing your proposal to the other party?
What are the primary benefits of your proposal to the other party?
What is the other party’s Next Best Alternative, and how is your proposal better?
How will you overcome the other party’s objections and Barriers to Purchase?
Are there Trade-offs or concessions you’re willing to make to reach an agreement?

Remember, your goal in creating the proposal is to find Common Ground: an agreement that both parties will be happy to accept. By thinking through the structure of your proposal in advance, you can prepare a few different options that you believe the other party will want, on terms you’re willing to accept.

The third dimension of negotiation is the discussion: presenting the offer to the other party. The discussion is when you talk through your proposal with the other party. Sometimes the discussion happens the way you see it in the movies: in a mahogany - walled boardroom, across the table, toe to toe with the CEO. Sometimes it happens over the phone. Sometimes it happens over email. Whatever the setting, this is the point where you present your offer, discuss or clarify any issues the other party doesn’t understand, answer objections and remove Barriers to Purchase, and ask for the sale. Regardless of what happens during the discussion phase, the end result of every round of discussion is either (1) “Yes, we have a deal on these terms,” (2) “We don’t have a deal quite yet—here’s a counteroffer or another option to consider,” or (3) “No, we don’t have a deal—there’s no Common Ground, so we’ll suspend negotiations and reserve the right to talk to somebody else.” Discussion continues until a final agreement is reached or the parties decide to quit negotiating, whichever happens first.

Buffers

A Buffer is a third party empowered to negotiate on your behalf. Agents, attorneys, mediators, brokers, accountants, and other similar subject-matter experts are all examples of Buffers. Buffers who have expertise in specific types of negotiations can be valuable in helping you get the best deal possible. Be very mindful of Incentive-Caused Bias when working with a Buffer. Depending on the arrangement, your Buffer’s priorities may be very different from your own. Agents are usually compensated on a commission basis, so it pays to be wary if you’re using them on the buy side of a deal. The Agent is compensated if (and only if) a Transaction occurs. Their first priority is to complete a deal—any deal—regardless of whether or not it’s the best possible deal for the buyer. If at all possible, work with a Buffer who is willing to accept a flat fee in exchange for services rendered, whether or not the deal happens.

Persuasion Resistance

One of the things that makes prospects uncomfortable around salespeople is the feeling that they’re going to get the “hard sell” or be tricked into agreeing to something that’s not in their best interest. This experience is called Persuasion Resistance, and it’s a major barrier to making sales.

The more effective strategy, is to present yourself to the prospect as an “assistant buyer.” Your job is not to sell the prospect a bill of goods: it’s to help them make an informed decision about what’s best for them. You’re not pressuring them to give you their money; you’re helping to ensure they invest their resources wisely.

Salespeople need to be aware of two additional signals that can trigger Persuasion Resistance: desperation and chasing.

Objections during sale

There are five standard objections that appear in sales of all kinds:

It costs too much (best addressed via Framing and Value-Based Selling).
It won’t work (best addressed via Social Proof—showing the prospect how customers just like them are already benefiting from your offer).
It won’t work for me (best addressed via Social Proof—showing the prospect how customers just like them are already benefiting from your offer).
I can wait (best addressed via Education-Based Selling).
It’s too difficult (best addressed via Education-Based Selling).

Risk Reversal

Risk Reversal is a strategy that transfers some (or all) of the risk of a Transaction from the buyer to the seller. Instead of making the purchaser shoulder the risk of a bad Transaction, the seller agrees in advance to make things right if—for whatever reason—things don’t turn out as the purchaser expected.

Value Delivery

Value delivery involves everything necessary to ensure that every paying customer is a happy customer: order processing, inventory management, delivery/fulfillment, troubleshooting, customer support, etc. Without value delivery, you don’t have a business.

A Distribution Channel describes how your form of value is delivered to the end user. There are two basic types of Distribution Channels: direct-to-user and intermediary. Direct-to-user distribution works across a single channel: from the business to the end user. Services are a classic example: when you get a haircut, the value is provided by the business itself to you, with no intermediary. Direct-to-user distribution is simple and effective, but it has limitations—you have full control of the entire process, but you can only serve as many customers as your time and energy allow. Once demand for your offer outpaces your ability to deliver it, you’re risking disappointing your customers and diminishing your Reputation. Intermediary distribution works across multiple channels. When you purchase a Product from a store, that store is engaging in Resale. The store (in most cases) doesn’t manufacture the Products—it purchases them from another business. The business that created the Product can sell it to as many stores as it wants, a process called “securing distribution.” The more distribution a Product has, the more sales the business is likely to make—the more stores selling the Product, the more opportunities for sales. Intermediary distribution can increase sales, but it requires giving up a certain amount of control over your value-delivery process. Trusting another business to deliver your offer to your customers frees up your limited time and energy, but it also increases Counterparty Risk—the risk that your partner will screw up and diminish your Reputation.

A customer’s perception of quality relies on two subjective criteria: expectations and performance. You can characterize this relationship in the form of a quasi-equation, which I call the Expectation Effect:

\[\text{Quality} = \text{Performance} - \text{Expectations}\]

The best way to surpass expectations is to give your customers an unexpected bonus in addition to the value they expect.

Dollar throughput is a measure of how fast your overall business system creates a dollar of profit. Assume a standard time unit, like an hour/day/week/month—how many dollars does your business system produce on average during that time? The faster your business produces dollars of profit, the better. Satisfaction throughput is a measure of how much time it takes to create a happy, satisfied customer.

Multiplication is Duplication for an entire process or system.

If your goal is to create a business that doesn’t require your direct daily involvement, scalability should be a major consideration. Products are often the easiest to Duplicate, while Shared Resources (like gyms, etc.) are easiest to Multiply. Humans don’t Scale. Individual people only have so much time and energy each day, which is a Constraint that doesn’t change with the volume of work to be done. On the contrary, a person’s effectiveness usually goes down as the demands on them increase. As a result, Services are often difficult to Scale, since they tend to rely heavily on the direct involvement of people to deliver value. As a general rule, the less human involvement required to create and deliver value, the more scalable the business.

Amplification: making a small change to a scalable system produces a huge result.

Always choose the best tools that you can obtain and afford. Quality tools give you maximum output with a minimum of input. By investing in Force Multipliers, you free up your time, energy, and attention to focus on building your business instead of operating it. As a general rule, the only good use of debt or outside capital in setting up a system is to give you access to Force Multipliers you would not be able to access any other way.

Triage is the process of identifying and handling the most important matters first, allowing less urgent matters to wait.

Finance

Finance is the art and science of watching the money flowing into and out of a business, then deciding how to allocate it and determining whether or not what you’re doing is producing the results you want. Accounting is the process of ensuring the data you use to make financial decisions is as complete and accurate as possible.

Profit is the difference between revenue and expense and it is important because it allows businesses to stay in operation and to weather unexpected events. If a business is barely generating enough revenue to cover its expenses, and those expenses suddenly rise, the business is in a great deal of trouble. The more profitable the business, the better it will be able to handle Uncertainty and Change, and the more options it has to respond to the unforeseeable.

\[\text{Profit} = \text{Revenue} - \text{Expense}\]

Profit Margin (often abbreviated to “margin”) is the difference between how much revenue you capture and how much you spend to capture it, expressed in percentage terms.

\[\%\text{ Profit Margin} = \dfrac{(\text{Revenue}-\text{Cost})}{Revenue} \times 100\]

Profit Margin is not the same as “markup,” which represents how the price of an offer compares to its total cost.

\[\%\text{ Markup} = \dfrac{(\text{Price}-\text{Cost})}{Cost} \times 100\]

Margins can never be more than 100 percent, but markups can be 200 percent or even 500 percent.

Value Capture is the process of retaining some percentage of the value provided in every Transaction. If you’re able to offer another business something that will allow it to bring in $1 million of additional revenue, and you charge $100,000, you’re capturing 10 percent of the value created by the Transaction. Value Capture is tricky. In order to be successful, you need to capture enough value to make your investment of time and energy worthwhile, but not so much that there’s no reason for your customers to do business with you. People buy because they believe they’re getting more value in the Transaction than they’re spending. The more value you capture, the less attractive your offer becomes.

There are only four ways to increase your business’s revenue: 1. Increase the number of customers you serve. 2. Increase the average size of each Transaction by selling more. 3. Increase the frequency of Transactions per customer. 4. Raise your prices.

Lifetime Value is the total value of a customer’s business over the lifetime of their relationship with your company. The more a customer purchases from you and the longer they stay with you, the more valuable that customer is to your business. One of the reasons Subscriptions are so profitable is that they maximize Lifetime Value. Instead of making a single sale to a customer, Subscription businesses focus on providing value—and collecting revenue—for as long as possible. Once you understand the Lifetime Value of a prospect, you can calculate the maximum amount of time and resources you’re willing to spend to acquire a new prospect. Allowable Acquisition Cost (AAC) is the marketing component of Lifetime Value. The higher the average customer’s Lifetime Value, the more you can spend to attract a new customer, making it possible to spread the word about your offer in new ways.

Overhead represents the minimum ongoing resources required for a business to continue operation. This includes all of the things you need to run your business every month, regardless of whether you sell anything: salaries, rent, utilities, equipment repairs, and so on. Overhead is a critical metric to track if you are building your company on a fixed amount of Capital. Venture capitalists and other forms of investment can provide “seed capital” — a fixed amount of money you can use to start the business. The more money you raise in Capital and the more slowly you spend it, the more time you have to make the business work. The faster you “burn” through your Capital, the more money you need to raise and the faster you need to start bringing in revenue. If you burn through all of your start-up Capital and can’t raise more, game over.

Fixed Costs are incurred no matter how much value you create. Your Overhead is a Fixed Cost. Variable Costs are related to how much value you create (e.g. material used to produce goods). Reductions in Fixed Costs Accumulate; reductions in Variable Costs are Amplified by volume.

Cutting costs can help you increase your Profit Margin, but it often comes at a steep price: the Incremental Degradation of your offer.

Breakeven is the point where your business’s total revenue to date is equal to its total expenses to date—it’s the point where your business starts creating wealth instead of consuming it.

Purchasing Power is the sum total of all liquid assets a business has at its disposal. That includes your cash, credit, and any outside financing that’s available.

Opportunity Cost is the value you’re giving up by making a Decision. The value that would have been created by your Next Best Alternative is the Opportunity Cost of that decision. A dollar today is worth more than a dollar tomorrow. How much more depends on what you choose to do with that dollar. The more profitable options you have to invest that dollar, the more valuable it is. Calculating the Time Value of Money is a way of making Decisions in the face of Opportunity Costs.

Compounding is the Accumulation of gains over time. Whenever you’re able to reinvest gains, your investment will build upon itself exponentially—a positive Feedback Loop.

Leverage is the practice of using borrowed money to magnify potential gains. Leverage is a form of financial Amplification—it magnifies the potential for both gains and losses. When your investment pays off, Leverage helps it pay off more. When your investment tanks, you lose more money than you would otherwise.

Return on Investment (ROI) is the value created from an investment of time or resources. Every future ROI estimate is a semieducated guess. You can only know your ROI for certain after the investment is made and the returns collected.

Sunk Costs are investments of time, energy, and money that can’t be recovered once they’ve been made. No matter what you do, you can’t get those resources back. Continuing to invest in a project to recover lost resources doesn’t make sense—all that matters is how much more investment is required versus the reward you expect to obtain.

Valuation

Valuation is an estimate of the total worth of a company. The higher a business’s revenues, the stronger the company’s Profit Margins, the higher its bank balance, and the more promising its future, the higher its Valuation. Many companies base their financial decisions on what will increase the business’s Valuation. Higher estimates of value are beneficial for many reasons. If a company is private, having a high Valuation makes it easier to borrow money. If the company is public, a high Valuation leads to a high share price and a profit opportunity for the shareholders. If another business seeks to acquire the company, a high Valuation leads to a big payday for the business’s owners or shareholders. Valuation is also important if you intend to take on investors. The amount of Capital you raise, as well as the total amount of ownership you give to your investors in exchange, depends on the business’s Valuation at the time of investment. The higher the business’s Valuation, the more money you’ll be able to command for every share you sell to the investor. It’s important to note that Perceived Value applies just as much to businesses as it does to individual offers. When people believe a company has bright future prospects, the company’s Valuation increases. If people believe the company is in trouble, the Valuation decreases.

Cash Flow Statement

It’s an examination of a company’s bank account over a certain period of time. Think of it like a checking-account ledger: deposits of cash flow in, and withdrawals of cash flow out. Ideally, more money flows in than flows out and the total never goes below zero. Every Cash Flow Statement covers a specific period of time: a day, a week, a month, a year. The time period of the report depends on the purpose. Shorter periods, like days and weeks, are most useful for making sure the company doesn’t run out of cash. Longer periods, like months and years, are more useful for tracking performance over time. Cash tends to move in three primary areas: operations (selling offers and buying inputs), investing (collecting dividends and paying for capital expenses), and financing (borrowing money and paying it back). Cash Flow Statements usually track these sources separately to make it easy to see where the cash flows come from. The nice thing about cash is that it doesn’t lie. Barring outright fraud, cash either is in the bank account or it’s not. If the company spends a lot of money, but less is coming in, the business’s cash position will decrease over time. There’s little room for “creative interpretation.”

Many investors use a metric called “free cash flow” when evaluating companies. This metric comes from the Cash Flow Statement: it’s the amount of cash a business collects from operations minus cash spent for capital equipment and assets, which are necessary to keep the company operating. The higher a company’s free cash flow, the better: it means the business doesn’t have to keep investing huge amounts of Capital in order to continue bringing in money.

Income Statement

Cash is important, but it’s not the whole picture. Cash is not Profit, and Profit is what we’re after. It’s possible to have a nice, comfortable cash position for a while but lose money with every sale. In order to determine whether or not your sales are profitable, you need to be able to track which sales and expenses are related. By matching each sale with the expenses incurred in the process of making that sale, it’s possible to see if you’re making a Profit immediately, eliminating unpleasant surprises. First, the company must change the way it accounts for expenses. Instead of recording revenue when cash flows in and an expense when cash flows out, the company must begin tracking revenue and expenses on what’s called an “accrual” basis. In accrual accounting, revenue is recognized when a sale is made (i.e., a product is purchased, a service is rendered, etc.), and the expenses associated with that sale are incurred in the same time period. Accountants call this the “matching principle,” and one of the primary jobs of an accountant is to match revenue and expense records. The result of this effort is an Income Statement, which is sometimes called a “profit and loss statement,” “operating statement,” or “earnings statement.” Regardless of the label, the Income Statement contains an estimate of the business’s Profit over a certain period of time, once revenue is matched with the related expenses. The general format for an Income Statement looks like this:

\[\text{Net Profit} = \text{Revenue} - \text{Cost of Goods Sold} - \text{Taxes} - \text{Expenses}\]

That said, it’s important to recognize that Income Statements, by nature, include many estimates and assumptions. By changing when revenue is recognized and how expenses are matched to that revenue, accountants and finance professionals can make the “profit” line skyrocket or plummet by changing a few assumptions or formulas. For example, large expenses like equipment purchases may involve a huge cash outlay, but the Income Statement might attribute only a small piece of the expense to each sales period, a practice called Amortization (the process of spreading the cost of a resource investment over the estimated useful life of that investment).

Balance Sheet

A Balance Sheet is a snapshot of what a business owns and what it owes at a particular moment in time. You can think of it as an estimate of the company’s net worth at the time the Balance Sheet was created. Balance Sheets always cite a specific day and use this calculation:

\[\text{Owner’s Equity} = \text{Assets} - \text{Liabilities}\]

Financial Ratios

A Financial Ratio is a comparison of two important elements of your business.

Profitability ratios indicate a business’s ability to generate Profit. The higher your revenue and the lower your costs, the higher your profitability ratios (e.g. profit margin).
Leverage ratios indicate how your company uses debt. “Debt-to-equity ratios,” which are calculated by dividing total liabilities by shareholders’ equity, tell you how many dollars a company has borrowed for every $1 in owner’s equity. If the Ratio is high, it’s a signal the company is highly Leveraged, which could be a bad sign. Other Ratios, like “interest coverage,” calculate how much of the business’s profit goes to pay off interest on debt.
Liquidity ratios indicate the ability of a business to pay its bills. Running out of cash is a serious issue, so ratios like the “current ratio” (current assets divided by current liabilities) and the “quick ratio” (current assets, minus inventory, divided by current liabilities) make it easy to determine how close a company is to bankruptcy, or if the business is sitting on cash instead of investing money in growth or improvement.
Efficiency ratios indicate how well a business is managing assets and liabilities. The most common use is inventory management: having too little inventory is a bad thing, but having too much is also bad.

Segregation of Duties

Accountants and finance professionals rely on a system called Segregation of Duties to prevent all sorts of shady activities. The system, which is intended to reduce cases of fraud and theft, limits a single person’s ability to complete the following business processes:

Authorization: reviewing, approving, or overseeing a Transaction.
Custody: receiving, accessing, or controlling any assets related to that Transaction.
Record keeping: creating and storing accounting records related to each Transaction.
Reconciliation: verifying that two sets of records, like internal company Transaction records and external bank statements, match with respect to timing and amount.

The core principle behind Segregation of Duties is multiparty verification: no individual in the organization is able to complete all four of these processes concerning a single Transaction.

Another possible approach to prevent potential misconduct is Limited Authorization. Limited Authorization is a straightforward principle: it’s best to limit each individual’s ability to act in areas that are outside the scope of their responsibilities. If access to an asset or authorization isn’t required or necessary, it should be withheld by default. If access or authorization is needed in special cases, it should be granted on a temporary basis and in a way that preserves Segregation of Duties by requiring more than one person to authorize the action.

Hierarchy of Funding

I think it’s useful to imagine a Hierarchy of Funding: a ladder of available options. Every businessperson starts on the bottom and climbs as far up the ladder as necessary. The higher you climb, the more funding you get and the more control you give up in exchange. Let’s examine the Hierarchy of Funding, starting at the bottom:

Personal cash is by far the best form of financing. Investing cash you already own is quick and easy and requires no approval or paperwork. Most entrepreneurs begin by financing themselves out of cash as much as possible.
Personal credit is another low-cost method of financing. As long as your needs don’t exceed a few thousand dollars, it’s easy to finance expenses via personal credit. Approval is quick if you have good credit, and payment over time helps increase your cash flow. You risk ruining your personal credit rating (a form of Reputation) if you can’t make your payments, but for many entrepreneurs, that’s a risk worth taking.
Personal loans are often made by friends and family. If you need more money than you can cover via personal cash and personal credit, Loans from friends and family are not uncommon. Just be wary: the risk that you won’t be able to pay them back is very real and can have a devastating effect on important personal relationships.
Unsecured loans are usually made by banks and credit unions. You fill out an application and ask for a certain amount of money, and the bank will evaluate your ability to pay the loan back with interest over a certain time period. The loan can be either a lump sum or a line of credit that can be used at any time. The bank doesn’t ask for collateral for smaller amounts (a few thousand dollars), so the interest rate will probably be a bit higher than on a credit card or secured loan.
Secured loans require collateral. Mortgages and automotive loans are good examples of secured loans: if you don’t make the payments, the lender can legally seize the property promised as collateral. Because the lender can then sell that property to recoup their funds, secured loans are much larger than unsecured loans—tens or hundreds of thousands of dollars.
Bonds are debt sold to individual lenders. Instead of asking a bank for a loan, the business asks individuals or other companies to loan them money. Bond purchasers give money to the business, which is paid back at an agreed-upon rate for a certain amount of time. When the time expires (i.e., the bond “matures”), the company must give back the original loan amount in addition to the payments already made. The legal and regulatory process that surrounds the bond market can be complicated, so bond issues are usually conducted through an investment bank.
Receivables financing is a special type of secured lending unique to businesses. Receivables financing can make millions of dollars in credit available, but at a cost: the collateral for the loan is control over the business’s receivables. Since the bank controls the receivables, they can ensure their loan is paid before anything else, including employee salaries and vendor commitments. Large amounts of funding are available, but you’re giving up a great deal of control to the lender.
Angel capital is where we shift from Loans to Capital. An “angel” is an individual private investor—someone who has excess wealth they’d like to invest in a private business, usually $10,000 to $1 million. In exchange, they’ll own 1 to 10 percent of the business. Taking on an angel investor is a bit like taking on a silent partner—they give you Capital, and in exchange you give them partial legal ownership of the business. Some angels offer advice and are available for consulting, but they don’t have the power to make business decisions.
Venture capital takes over where angels leave off. Venture capitalists (VCs) are wealthy investors (or groups of investors who pool their funds) with very large sums of Capital available: tens (or hundreds) of millions of dollars in a single investment. Funding via venture capital happens in “rounds” that start small, then grow as more Capital is needed. Later rounds can dilute the ownership percentage of current shareholders, so there’s often a great deal of negotiation involved. VCs also require large amounts of control in exchange for large amounts of Capital, which usually means seats on the company’s board of directors.
Public stock offerings involve selling partial ownership of the company to investors on the open market. This is usually done via investment banks: companies that will provide a business with enormous amounts of Capital in exchange for the shares of that company to sell on the public stock market. The investment banks make money by selling the shares they’ve purchased at a premium to individual investors on the open market. An “initial public offering” (IPO) is the first public stock offering a company offers on the open market. Any investor who purchases shares is a partial owner of the company, which includes the right to participate in management decisions via electing the board of directors. Whoever owns the most shares in the company controls it, so “going public” creates the risk of a hostile takeover: the mass purchasing of shares in an effort to control the company. Public stock offerings are usually used by angel and venture capital investors to exchange ownership for money. Investors can collect their returns in one of two ways: reaping dividends that distribute the Profits of the company or selling their shares to another investor. Public stock offerings enable investors to sell their shares in exchange for money, so it’s common for angels and VCs to push successful companies to “go public” or be acquired by another company in order to “cash out” of the investment.

The more control you must give up for each dollar of funding obtained, the less attractive the source of funding. The more people you’re required to consult with before making decisions, the slower your company will operate. Investors increase Communication Overhead, which can adversely affect your ability to get things done. It’s also not uncommon for investors to remove executives of a company that’s not performing well, even if those executives are the founders of the company.

Bootstrapping

Bootstrapping is the art of building and operating a business without funding. Don’t assume that the only way to create a successful business is by raising millions of dollars of venture capital—it’s not true. By limiting yourself to the use of personal cash, personal credit, the business’s revenue, and a little ingenuity, you can build successful businesses without seeking funding at all. Bootstrapping allows you to grow your business while maintaining 100 percent control over the business’s operations. You don’t have to get anyone else’s approval to make the decisions you think are best. The drawback is that growing the business can take much longer. Prudently used, funding can help make things happen faster than they’d happen otherwise. If you accept funding, make sure that you use it to do things that you couldn’t do any other way. Force Multipliers are useful but expensive—taking on funding in order to get access to critical capabilities can be smart. Otherwise, try to operate from cash and operating revenue as much as possible. For best results, Bootstrap as far as you can go, then move up the Hierarchy of Funding only as needed. Having 100 percent ownership and control of a profitable, self-sustaining business is a wonderful thing.

Internal controls

Internal Controls are a set of specific Standard Operating Procedures a business uses to collect accurate data, keep the business running smoothly, and spot trouble. Internal Controls are most useful in three areas:

Budgeting is the act of estimating future costs and taking steps to ensure that these estimates aren’t exceeded without good reason.
Compliance is necessary when a business operates in an industry affected by government regulations.
Theft and fraud prevention is important to protect against the risk of financial loss at the hands of an unscrupulous party.

The Human Mind

Loss Aversion is the idea that people hate to lose things more than they like to gain them.

Scarcity encourages people to make decisions quickly. Scarcity is one of the things that overcomes our tendency to conserve—if you want something that’s scarce, you can’t afford to wait without the risk of losing what you want. Loss Aversion ensures that this possibility feels bad enough to prompt us to take action now. As a result, adding a Scarcity element to your offer is a great way to encourage people to take action.

Here are a few ways you can add an element of Scarcity to your offer:

Limited quantities—inform prospects that you’re offering a limited number of units for sale.
Price increases—inform prospects that the price will go up in the near future.
Price decreases—inform prospects that a current discount will end in the near future.
Deadlines—inform prospects that the offer is only good for a limited period of time.

Working with Yourself

If you’re trying to create something, the worst thing you can do is to try to fit creative tasks in between administrative tasks—context switching will kill your productivity. The “Maker’s Schedule” consists of large blocks of uninterrupted time; the “Manager’s Schedule” is broken up into many small chunks for meetings. Both schedules serve different purposes—don’t try to combine them if your goal is to get useful work done.

There are only four ways to “do” something: completion, deletion, delegation, and deferment.

Completion — doing the task—is the option most people think about.
Deletion — eliminating the task—is effective for anything that’s unimportant or unnecessary.
Delegation — assigning the task to someone else—is effective for anything another person can do 80 percent as well as you can. In order to delegate, you must have someone to delegate to. Employees, contractors, or outsourcers can all help you get more things done by completing tasks on your behalf.
Deferment — putting the task off until later—is effective for tasks that aren’t critical or time dependent. Don’t feel bad about putting some things off; the best way to bog yourself down is to try to handle too many things at the same time.

A Most Important Task (MIT) is a critical task that will create the most important results you’re looking to achieve. Everything on your plate is not equal in importance or value, so don’t treat everything on your task list the same. By taking a few minutes to identify a few tasks as important, you’ll make it easier to focus on doing them first. At the beginning of every day, create a list of two or three MITs, then focus on getting them done as fast as possible.

Well-formed Goals accomplish two things: they help you visualize what you want and make you excited about achieving it. Goals are most useful if they’re Framed in a Positive, Immediate, Concrete, Specific (PICS) format:

Habits are regular actions that support us. Most Habits take on one of four common forms: things you want to start doing, things you want to stop doing, things you want to do more, and things you want to do less. Habits usually require a certain amount of willpower to create. Habits are easier to install if you look for triggers that signal when it’s time to act.

Don’t feel you need to have all of the information before you decide—the world is too complicated to make accurate predictions. Failure to make a Decision is itself a Decision. Abdicating responsibility for your Decisions doesn’t mean you’re not making them—you’re just allowing yourself to be a victim of circumstance.

The Five-Fold Why is a technique to help you discover what you actually want and connect your core desires to physical actions.

A Doomsday Scenario is a Thought Experiment where you assume everything that can go wrong does go wrong. Doomsday Scenarios are pessimistic for a reason—they help you realize that, in most circumstances, you’re going to be okay. If you’re starting a business, you can begin defining the actual risks and make plans to mitigate them. Instead of being a victim of your fears, you can use them constructively.

Confirmation Bias: One of the best ways to figure out whether or not you’re right is to look for information that proves you’re wrong.

New skills create new opportunities, and new opportunities often translate into more income. Your ability to save is limited; your ability to earn is not.

Everyone has Limiting Beliefs in certain areas. Anytime you use the words “I can’t,” “I have to,” or “I’m not good at,” you’ve discovered a potential Limiting Belief.

Dunning-Kruger effect

Incompetent individuals tend to overestimate their own level of skill.
Incompetent individuals fail to recognize genuine skill in others.
Incompetent individuals fail to recognize the extremity of their inadequacy.
If they can be trained to improve their own skill level, these individuals can recognize and acknowledge their own previous lack of skill.

Working with others

Communication Overhead is the proportion of time you spend communicating with members of your team instead of getting productive work done. As the number of people you work with increases, Communication Overhead increases geometrically until the total percentage of time each individual must devote to group communication approaches 100 percent. After a certain threshold, each additional team member diminishes the capacity of the group to do anything other than communicate. Large companies are slow because they suffer from Communication Overhead.

Effective communication can only occur when both parties feel safe. As soon as people start to feel unimportant or threatened in a conversation, they start “stonewalling,” shutting down communication. The threatened party may continue to interact, but mentally and emotionally, they’ve withdrawn from the conversation. The only way to prevent stonewalling is to make the person you’re communicating with feel safe being open and honest with you.

If you want to make others feel Important and Safe around you, always remember to treat people with appreciation, courtesy, and respect. Appreciation means expressing your gratitude for what others are doing for you, even if it’s not quite perfect. Courtesy is politeness, pure and simple. Respect is a matter of honoring the other person’s status.

Over time, you become more and more like those whom you spend time with and less like people in other groups. Convergence is the tendency of group members to become more alike over time. In business, this is sometimes called a company “culture,” in the sense that people who work there tend to have similar characteristics, behaviors, and philosophies.

Commander’s Intent

Whenever you assign a task to someone, tell them why it must be done. The more your agent understands the purpose behind your actions, the better they’ll be able to respond appropriately when the situation changes. Commander’s Intent alleviates Communication Overhead. Additionally, make sure to always assign tasks to a single owner with a clear deadline. Only then will people feel responsible for getting things done.

6 Principles of Effective Real-World Management

Recruit the smallest group of people who can accomplish what must be done fast and with high quality. Comparative Advantage means that some people will be better than others at accomplishing certain tasks, so it pays to invest time and resources in recruiting the best team for the job. Don’t make that team too large, however — Communication Overhead makes each additional team member beyond a core of three to eight people a drag on performance. Small, elite teams are best.
Communicate the desired End Result, who is responsible for what, and the current status. Everyone on the team must know the Commander’s Intent of the project, the Reason Why it’s important, and the specific parts of the project they’re responsible for completing—otherwise, you’re risking Bystander Apathy.
Treat people with respect. Applying the Golden Trifecta — appreciation, courtesy, and respect — is the best way to make the individuals on your team feel Important and is also the best way to ensure that they respect you as a leader and manager. The more your team works together under supportive conditions, the more Clanning will occur and the more cohesive the team will become.
Create an Environment where everyone can be as productive as possible, then let people do their work. The best working Environment takes full advantage of Guiding Structure—provide the best equipment and tools possible and ensure that the Environment reinforces the work the team is doing. To avoid having energy sapped by the Cognitive Switching Penalty, shield your team from as many distractions as possible, which includes nonessential bureaucracy and meetings.
Refrain from having unrealistic expectations regarding certainty and prediction. Create an aggressive plan to complete the project, but be aware in advance that Uncertainty and the Planning Fallacy mean your initial plan will be incomplete or inaccurate in a few important respects. Update your plan as you go along, using what you learn along the way, and continually reapply Parkinson’s Law to find the shortest feasible path to completion that works, given the necessary Trade-offs required by the work.
Measure to see if what you’re doing is working — if not, try another approach. One of the primary fallacies of effective Management is that it makes learning unnecessary. This mind-set assumes your initial plan should be 100 percent perfect and followed to the letter. The exact opposite is true: effective Management means planning for learning, which requires constant adjustments along the way. Measure your performance across a small set of Key Performance Indicators—if what you’re doing doesn’t appear to be working, experiment with another approach.

The best managers don’t act like big-shot executives: they’re more like very skilled assistants, whose primary purpose is to keep the people with Economically Valuable Skills focused on improving the Five Parts of Every Business: that is, doing things that contribute to the company’s results.

Understanding Systems

Gall’s Law: all complex systems that work evolved from simpler systems that worked. Complex systems are full of variables and Interdependencies that must be arranged just right in order to function. Complex systems designed from scratch will never work in the real world, since they haven’t been subject to environmental selection forces while being designed.

The theory of Normal Accidents is a more formal way of expressing a universal proverb: shit happens. In a tightly coupled system, small risks accumulate to the point where errors and accidents are inevitable. The larger and more complex the system, the higher the likelihood that something will eventually go very, very wrong.

Analyzing Systems

Measuring something is the first step to improving it. In the immortal words of Peter Drucker, “What gets measured gets managed.” It’s true.

Some Measurements are more important than others: Key Performance Indicators (KPIs) are Measurements of the critical parts of a system. Measurements that don’t help you make improvements to your system are worse than worthless: they’re a waste of your limited Attention and energy.

Business-related KPIs are often related to either the Five Parts of Every Business or Throughput.

Value Creation: How fast is the system creating value? What is the current level of inflows?
Marketing: How many people are paying Attention to your offer? How many prospects are giving you Permission to provide more information?
Sales: How many prospects are becoming paying customers? What is the average customer’s Lifetime Value?
Value Delivery: How fast can you serve each customer? What is your current rate of returns or complaints?
Finance: What is your Profit Margin? How much Purchasing Power do you have? Are you financially Sufficient?

If you analyze poor-quality data, the resulting analysis will be worthless at best, and misleading or damaging at worst.

A Tolerance is an acceptable level of “normal” error in a system. Within a given range of measurements, the system is performing as intended. As long as the errors don’t exceed a certain threshold, urgent intervention is not required. Tolerances are often referred to as being “tight” or “loose.” A tight Tolerance is one in which there’s little room for error or variability, which is common if the component or subsystem is critical to the performance of the system. A loose Tolerance allows significant room for error or variability and is common when small mistakes produce no major repercussions.

The reliability of a system is often measured in terms of a percentage. Companies use this reliability measurement as a Tolerance, and they write a contract called a “Service Level Agreement” (SLA) that promises to compensate customers if errors exceed a certain threshold.

Sampling is the process of taking at random a small percentage of the total output, then using it as a proxy for the entire system. Random “spot checks” are also a form of Sampling. Many retail stores employ “secret shoppers” to test customer service or the skills of their sales staff. These shoppers are hired to express interest in specific items, ask certain questions, make a return, or act in annoying ways. Since the staff doesn’t know which customers are real and which ones are not, it’s an effective way for the management of a store to test their staff without scrutinizing them every second of every day.

Margin of Error is an estimate of how much you can trust your conclusions from a given set of observed Samples. The more Samples you take, the lower your Margin of Error becomes and the more faith you can have in the conclusions you make from examining the Samples as a whole.

Correlation is not Causation. Even if you notice that one measurement is associated with another, that does not prove that one thing caused the other. Causation is always more difficult to prove than Correlation. When analyzing complex systems with many variables and Interdependencies, it’s often difficult to find true causality. The more changes that happen in a system over a period of time, the higher the likelihood that more than one change had an impact on the result you’re trying to analyze. Adjusting for known variables can help you isolate the potential causes of a change in your system.

A Proxy measures one quantity by measuring something else.

Improving Systems

By definition, if you’re trying to maximize or minimize more than one thing, you’re not Optimizing—you’re making Trade-offs.

Refactoring is the process of changing a system to improve efficiency without changing the output of the system. Refactoring starts by Deconstructing a process or system, followed by a search for patterns.

In any complex system, a minority of the inputs produce the majority of the output. This pattern of persistent nonlinearity is now called the Pareto principle, or the 80-20 rule. Optimization and Refactoring are affected by the Critical Few as well—a few small changes can produce enormous results. After you’ve picked the “low-hanging fruit,” further Optimization can cost more in effort than you’ll reap in returns. That’s a good point to stop. Perfectionism is a trap for the unwary. Optimize and Refactor up to the point you start experiencing Diminishing Returns, then focus on doing something else.

Friction is any force or process that removes energy from a system over time. In the presence of Friction, it’s necessary to continue to add energy to a system to keep it moving at the same rate over time. Unless additional energy is added, Friction will slow the system down until it comes to a stop. Remove the Friction and you’ll increase the system’s efficiency. Every business process has some amount of Friction. The key is to identify areas where Friction currently exists, then experiment with small improvements that will reduce the amount of Friction in the system. Removing small amounts of Friction over time Accumulates into large improvements in both quality and efficiency. Removing even small amounts of Friction from your marketing, sales, and value-delivery processes can generate major improvements in Profit. On the other hand, introducing intentional Friction can sometimes encourage people to behave in a certain way or make a particular decision (e.g. decrease goods returns rate).

Automation refers to a system or process that can operate without human intervention and its best for well-defined, repetitive tasks. Here’s the Paradox of Automation: the more efficient the Automated system, the more crucial the contribution of the human operators of that system. When an error happens, operators need to identify and fix the situation or shut the system down—otherwise, the Automated system will continue to Multiply the error. Additionally, its important to keep in mind that the more reliable the system, the less human operators have to do, so the less they pay Attention to the system while it’s in operation. Reliable systems tend to dull the operator’s senses, making it very difficult for them to notice when things go wrong—the moment when their Attention is required. As a result, the more reliable the system, the lower the likelihood that human operators will notice when something goes wrong—particularly if the error is small. The best approach to avoid major Automation errors is rigorous, ongoing Sampling and Testing.

A Standard Operating Procedure (SOP) is a predefined process used to complete a task or resolve a common issue. Business systems often include repetitive tasks, and having a standard process in place can help you spend less time reinventing the wheel and more time doing productive work. Well-defined Standard Operating Procedures are useful because they reduce Friction. Instead of wasting valuable time and energy solving a problem that has already been solved many times before, a predefined SOP ensures that you spend less time thrashing and more time adding value. Don’t let your Standard Operating Procedures lapse into bureaucracy.

Resilience is never “optimal” if you evaluate a system solely on Throughput. Flexibility always comes at a price. Some characteristics that makes a company resilient are:

Low (preferably zero) outstanding debt
Low overhead, fixed costs, and operating expenses
Substantial cash reserves for unexpected contingencies
Multiple independent products/industries/lines of business
Flexible workers/employees who can handle many responsibilities well
No single points of failure —Fail-safes/backup systems for all core processes

Most large businesses use Scenario Planning as the basis of a practice called “hedging”: purchasing various forms of Insurance to reduce the risk of unfavorable future events. For example, manufacturers care about oil prices because they increase the cost of importing raw materials and shipping finished products to their customers, both of which decrease their Profit Margins. By purchasing financial instruments called “futures,” the businesses can make money if the price of oil goes up, which helps to offset the losses they would incur in their primary line of business if oil prices increase.

Figuring out which changes or investments will give you the best outcomes is a major area of study in probability theory, which is best illustrated through the “multi-armed bandit” problem. Information is valuable, but it comes at a price: experimentation is sometimes a form of Malinvestment but it should never stop.

Quotes

“As time went on, however, I realized three very important things: Large companies move slowly, Climbing the corporate ladder is an obstacle to doing great work, Frustration leads to burnout.”

“Business schools don’t create wealthy and well-connected people. They accept them, then take credit for their success.”

“Iron Law of the Market: If you don’t have a large group of people who want what you have to offer, your chances of building a viable business are very slim.”

“Becoming a Mercenary doesn’t pay—don’t start a business for the money alone. Here’s why: starting and running a business always takes more effort than you first expect.”

“Stealth mode” diminishes your early learning opportunities, putting you at a huge early disadvantage. It’s almost always better to focus on getting feedback from real customers as soon as you can. A Prototype is an early representation of what your offering will look like.

“We don’t see things as they are. We see things as we are.” —ANAÏS NIN, AUTHOR AND DIARIST

“One death is a tragedy. A million deaths is a statistic.” —KURT TUCHOLSKY, SATIRIST

“Work expands so as to fill the time available for its completion.” - Parkinson Law

“You are the average of the five people you spend the most time with.”

Once you eliminate your number one problem, number two gets a promotion. —GERALD WEINBERG, COMPUTER SCIENTIST AND SYSTEMS THEORIST

It is better to have an approximate answer to the right question than an exact answer to the wrong question. —JOHN TUKEY, STATISTICIAN

If you don’t believe in sampling theory, next time you go to the doctor and he wants to take a little blood, tell him to take it all. —GIAN FULGONI, COFOUNDER AND CHAIRMAN OF COMSCORE, INC.

There is nothing so useless as doing efficiently that which should not be done at all.

Book Author: Kaufman, Josh.

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