Can Modeling a Business Work?
A friend on LinkedIn asks, “Can modeling a business work?” I respond:
Business modeling is a tool similar to accounting in that it aids our thinking in a world whose complexity seems often to exceed the grasp of our comprehension. I look at the value of modeling a business as a means to stress test both the business plan logic and the working assumptions that drive the business plan. In regard to the business plan logic, we're asking if the business has the potential ability to produce the value we think it can; and in regard to the working assumptions, we're testing how sensitively important metrics (i.e., payback time, break-even, required resources, shareholder value) of the business plan respond to conditions in the environment and controllable settings to which our business plan will be subjected.
- Think of such models as "what-ifs" more so than precise forecasts. Use the "what if" mindset to make a business plan more robust against the things outside your direct control versus using it to justify a belief in guaranteed success. The latter is almost a sure fire approach to failure.
- Always compare more than one plan with a model to minimize opportunity costs. Often times, the best business plans derive from hybrids of two models that show how value can be created and retained for at least two different reasons.
- Avoid overly complex models as much as, maybe more so than, overly simplistic models. Building a requisite model from an influence diagram first is usually the best way to achieve this happy medium before writing the first formula in a spreadsheet or simulation tool. Richer, more complex models that correspond to the real world with the highest degree of precision are usually not useful for a number of reasons:
- they can be costly to build
- the value frontier of the insights derived decline relative to the cost to achieve them as the degree of complexity increases
- they are difficult to maintain and refactor for other purposes
- they are often used to justify delaying commitment to a decision
- few people will achieve a shared understanding that is useful for collaborating and execution