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The Business Production Function: A Framework for Growing Early Stage Ventures

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What is the optimal business strategy for your company? What is the next project you should work on?

The answer, of course, is “it depends.” Your business strategy is dependent upon the stage of the business, it’s industry, and macroeconomic factors outside your control. But, I think that there are frameworks that can help you figure out the next step.

The framework I’ve found most helpful was conceived in Israel in the 1980s. Creative Output, an Israeli company, developed the first software package that sped up scheduling for production environments.

In the process of setting up and installing the software, one of Creative Output’s founders, Eli Goldratt, found that frequently the software failed to live up to its potential because of existing habits of employees and managers.

Despite the software offering them obvious solutions to improving production speed, the pre-existing paradigms of the managers kept them from implementing the software successfully.

Goldratt, frustrated by the inefficiency, holed up for 13 months to write The Goal which laid out his Theory of Constraints.

The Theory of Constraints states: any system with a goal has one limit and worrying about anything other than that limit is a waste of resources.

If a factory has an assembly line with three machines and those machines can produce 50, 100 and 150 units per hour, then the total output of the system will be 50 units.

Increasing the capacity of the second two machines seems “productive” and like a “good business strategy,” but is, in fact, a total waste. More resources have been spent to improve the product line, but the first machine is still the limit.

Goldratt’s work revolutionized the manufacturing industry, but it’s applicable far beyond that. Nearly any system can be improved using the two core questions of the Theory of Constraints:

  1. What’s the current limit?
  2. What’s the obvious way to improve the limit?

Take a non-business example: trying to lose weight. You join the gym, put together a workout plan, and order all the right supplements. You got protein powder, creatine and everything else we read about on the internet (because the internet always knows!)

You start waking up at 5am every day to go to the gym. Because you’re going at 5 am, many days you only sleep five or six hours if you were up late the night before. You also treat yourself to a scone from Starbucks after every workout.

An hour running on the treadmill will burn 400 calories. A scone from Starbucks has 400 calories which, per the second law of thermodynamics, means you’re probably not going to lose any weight. The hormonal benefits of exercise are being counteracted by the lack of sleep. You are spending more and more time exercising without making progress. Why? You’re addressing the wrong limit.

  1. What’s the limit?
  2. What’s the obvious way to improve it?

If you fix your sleep and diet then you’ll get better results, even with less exercise. It’s not that you need to spend more time getting healthy, but that you need to spend that time and energy on the appropriate limit. By cleaning up your diet and getting an extra couple hours of sleep every other night, even with no or a very modest amount of exercise, you start to see the pounds drop off.

Instead of spending two hours in the gym every day, an hour in the gym every other day suddenly yields better results because you’ve addressed the appropriate limits.

Limits and Business Strategies

Any type of system, be it your health, a manufacturing line or a business, can be analyzed and optimized by understanding the key components and which of them is the bottleneck.

For any specific type of system, the bottlenecks and constraints tend to be fairly similar. For almost everyone, the right combination of diet, sleep and exercise will get you in better shape. Ditto with manufacturing production lines.

For almost a decade, I’ve been working with early-stage companies, startups, small businesses and founders and I’ve discovered there is a pretty clear series of bottlenecks which companies go through.

When these businesses struggle or don’t grow as quickly as founders or managers expect, the situation is similar to that of losing weight: it isn’t a lack of effort, but one of two other things.

  1. Effort directed at the wrong limit – You are stuck in a recurring story of “what got you here, won’t get you there.” When one limit is removed, doing more of it simply won’t help. What gets a business off the ground is not what keeps it in the air.
  2. A lack of systems to maintain throughput – The other common issue is that the business is directing resources at the appropriate limit, but previously solved limits collapse. Imagine a factory floor where instead of documenting how the work at each station is done and hiring someone to consistently do the work, everyone on the floor rushed to whatever seemed most urgent. For an early stage company, this typically looks like alternating between generating new business and servicing existing business without being able to balance the two.

The result for many founders and managers is that they often times get stuck in a cycle of products or projects taking off then falling back to the ground whenever the next “shiny object” comes along.

What I’ve seen, having worked deeply with dozens of early stage companies and talked with hundreds (if not thousands) of early-stage founders is that there is a pretty formula for the bottlenecks which early-stage companies go through.

The Business Production Function

Imagine an early stage business where it is just the founder and maybe a couple of contractors. The founder is strong operationally but not so much at marketing and sales. There are still no employees so hiring and management isn’t an issue. The throughput of their business would look something like this:

Even though getting more efficient at delivering the service might seem productive, it is mostly a waste unless that efficiency generates more sales.

When I first start working with someone, I will take them through a diagnostic assessment (more on that below) to identify what the bottleneck is. Like a manufacturing production line, the bottleneck is always changing. If the same business improved their marketing and sales and were able to hire a full-time person, then the production function would shift to look something like this:

Now, the bottleneck is hiring and management and the business needs to focus its attention there. Let’s say they do and there is a small team which works well together so operations and management improves. This is great, total output goes up.

But now the founder’s personal operations may have fallen behind as their schedule fills up with meetings and responding to emails that are coming in way faster then they were used to. The bottleneck shifts to personal operations.

The business production function looks at every business and asks the same two questions:

  1. What is the bottleneck?
  2. What systems need to be put in place to eliminate it?

What you’re going to be very excited to learn is that this framework is (wait for it….) fractal. That is, there are constraints within constraints. So while marketing and sales may be the overall bottleneck, within the marketing and selling systems of that business, there is an even more specific bottleneck (either traffic, conversion or economics)

I’m going to briefly walk through the different sub-categories I think through with clients and how you can apply it. Generally, I find businesses run into the bottlenecks in the order I listed them (Personal operations –> marketing and sales –> business operations –> HR)

For each area, I’ll list a set of questions or things you may be thinking if that area is your bottleneck and some resources for addressing that bottleneck.

Personal Operations

The first bottleneck for many founders is what I call personal operations. I break personal operations down into three sub-categories: task management, priority management and knowledge management.

If this is your bottleneck, you’re thinking things like:

  • How do I keep from letting things fall through the cracks?
  • Why do I keep missing meetings?
  • I feel overwhelmed by reactive work like emails and meetings
  • My priorities are rapidly changing and I can’t seem to complete any of the projects I’m working on before something else comes up
  • Didn’t I do something like this a couple of years ago? Where is that file?
  • Should I be using Evernote or some other note taking app? If so, how should I organize it?

Task management – At the most basic level, this means an ability to do what you are going to do, when you say you are going to do it. 90% of people struggle to do this and by just clearing this hurdle, you are probably top 10% in your field.

Task management includes things like:

Priority management – If task management is the ability to take incoming data and request and transform them into tasks that get done, then priority management is the ability to not just complete tasks, but to prioritize them based on bigger business objectives.

While most jobs require people to be reasonably good at task management, many do not require priority management. Priorities are dictated from above with relatively little latitude for autonomy. I’ve found that people who move from a less entrepreneurial environment (usually school or a large company) to a more entrepreneurial environment (freelancing, starting a business, working for a small business or startup, working at the fringes of a large organization, etc.) fall prey to shiny object syndrome – chasing whatever the latest idea is – and end up not completing projects. 

Priority Management Includes things like:

Personal Knowledge Management

If priority management is the ability to prioritize tasks into projects based on bigger business objectives, then personal knowledge management is the ability to take the learnings and outcomes of those projects and convert them into  re-usable intellectual property.

Personal Knowledge Management focuses on processing new information in a way that allows it to be translated to usable knowledge and eventually into career-advancing outputs. I learned about personal knowledge management from taking my friend Tiago Forte’s course Building a Second Brain.

Personal Knowledge Management includes:

Everything listed here is by no means exclusive to people working in early stage companies, but are generally useful work skills. Lots of founders seem to get by without many of these skills for quite a while, but my experience has been it eventually catches up with them so having them in place lays a strong foundation.

Helpful Books at this stage:

Marketing/Sales

The next bottleneck is typically marketing and sales and is all about making sales (and getting to Product/Market Fit along the way). The most common mistake among first time entrepreneurs is an insistence on getting all their “ducks in a row” before going out to (aggressively) market and sell their product or service.

The truth is that selling your product or service is the best way to not just generate revenue but also get your ducks in a row. For one, nothing is more motivating than knowing you have to give back money if you don’t deliver. But more importantly, the act of marketing and selling forces you to constantly be thinking about and talking to potential customers. That shortens the feedback loops, allowing you to iterate and improve on your product faster. It also generates the revenue and momentum you need to hire others to manage the day-to-day operations of the company.

If this is your bottleneck, you are thinking things like:

  • How do I get to product/market fit?
  • How do I reach my customers?
  • Does my Unique Value Proposition resonate with my target market?
  • How can I generate more revenue from existing customers?
  • Why aren’t my leads converting into customers?
  • How do I establish a consistent pipeline of qualified leads?

The three elements I typically look at are the Economics, Conversion, and Traffic, what marketing guru Perry Marshall calls the Tactical Triangle.

source

The idea of the Tactical Triangle is that in order to sell something, you have to get Traffic, then Convert that traffic into sales. You need to make a profit on what you sell, which is the Economics. When you make that profit, you reinvest in getting more traffic, which converts into sales in a virtuous cycle.

This is marketing and sales 101:

  • Traffic: Who would buy this?
  • Economics: Can you reach them at a profit?
  • Conversion: Can you convince them you can solve their problem?

The way to improve your marketing and sales system is to ask: What’s the biggest bottleneck – Traffic, Conversion or Economics? That’s where you should focus your attention.

Traffic – Traffic means getting people through the door (literally or metaphorically). The main components of traffic are determining who you are targeting (who would buy this?) and how you are going to reach (how are you going to reach them?).

This includes things like:

Economics – When I ask people what they think the bottleneck in their marketing and selling systems is, the most common answer (almost always in fact) is “traffic.” However, the correct answer (if you’ve never asked it before) is almost always “economics.”

Think about it. If your customer lifetime value (CLTV) is $10, then you have very few distribution channels open to you. You’re definitely not going to buy a billboard and you probably can’t acquire traffic profitable through any channel other than word of mouth and referrals.

If your CLTV is $10,000, then you can use almost any distribution channel. The importance of economics is self-evident for bootstrapped businesses because they need the profit to keep operations running, but it’s equally important for venture-backed companies to have good unit economics, even if they are burning money.

Improving the economics of your business consists of things like:

Conversions – If the economics of the business are good, the next step is typically to work on better converting leads into buyers. Similar to economics, many businesses neglect working on their conversions to focus on traffic, but by optimizing conversions and economics first, the value of each additional visitor increases.

This includes things like:

See also Case Study: Growing a B2B eCommerce Business 527% in 18 Months

Helpful Books for this Stage:

Business Operations

The next bottleneck is business operations. At this point, a business typically has product/market fit but is having trouble scaling. I find this to be a particularly common problem with fast-moving founders.

I use an assessment with clients I work with called the Kolbe A Index which measures their natural work style. The dominant pattern I find is that most founders and managers at high growth companies are high on what Kolbe calls “quick start” and “fact finder” but low on “follow through.” Here’s a pretty typical example:

Kolbe A Index Profile. There is a Fourth category called “Implementor” which I have left off because I don’t find it very useful.

This leads to the business looking something like the manufacturing line where instead of documenting how the work at each station is done and hiring someone to consistently do the work, everyone on the floor rushed to whatever seemed most urgent. Projects get off the ground quickly and gain traction, but frequently end up back where they started – on the ground.

Viewed through the framework of Goldratt’s Theory of Constraints, there is a pretty clear bottleneck: Follow Through, which tends to translate into a lack of systems in the business.

If this is your bottleneck, you are thinking things like:

  • How do I get out of day-to-day operations?
  • Why can’t we get a consistent quality of service to our customers?
  • If we got a huge influx of sales, we would be stressed to the max.
  • The business is growing, but this doesn’t feel sustainable.
  • I’d like to be able to sell my business at some point but I’m too essential right now.
  • I feel like I’m spending a lot of time keeping things together rather than moving them forward.

Automate – The first and best way to improve systems is through automation. Software works 24/7, predictably and cheaply. Any systems in the business which can be (profitably) automated should be.

Automation includes things like:

Document – For those tasks where automation isn’t feasible, the next step is to clearly document the processes in a way that passes the “off the street test.” That is, could someone who has the basic qualifications for their role, be that an electrical engineer or social media manager, read your documentation and complete the task successfully.

Document includes things like:

Outsource –  Once you have the basic documentation structure for the business or business unit set up, the next bottleneck is to outsource those tasks which can be done more efficiently by a specialized contractor.

Outsourcing includes

  • Use sites like Fancy Hands and Fiverr which provide general outsourcing help for administrative tasks.
  • Hire specialized outsourcers using marketplaces like Upwork and Freelancer which have a huge category of specialists.

Helpful books for this stage:

Hiring and Management

When a business has a good marketing and sales system in place and established processes in their operation, the bottleneck typically shifts to hiring and management. Getting your business operations in place is about maximizing the leverage of a single team member. Once that leverage is achieved through automation and outsourcing, the next stage is to bring in additional team members to take advantage of it. 

Hiring – The first step for going from a good to great company is getting the right people on the bus. That means developing systems for attracting, vetting, onboarding, and training new team members.

Hiring includes things like:

Culture – After AirBnB closed their Series C round with Peter Thiel in 2012, they invited him to their office and asked him what was the single most important piece of advice he had for them. He replied, “Don’t fuck up the culture.”

This isn’t what you would expect from someone who just gave you $150 million, but in Thiel’s experience, it’s the biggest factor in success.

One of the common mistakes that happens at this stage is that the founder or managers try to micromanage too much. Having specific documentation and checklists for some things is great, but at this stage, founders and managers need to rely more on communicating a mission and values then letting the team have greater latitude to operate.

Culture includes things like:

Managing – Many people who haven’t studied management or don’t have a lot of experience think that management means assigning tasks to people in Trello or holding team meetings. If you read someone like Peter Drucker (who pioneered the field), you will see that management is something much more broad, an understanding of how to use the resources of the business, in the most efficient way possible.

This includes things like:

  • Establishing Key Performance Indicators (KPIs) for each team member
  • Creating a KPI Dashboard to be able to monitor the business as you step out of day-to-day operations
  • Establishing Communication Working Rules – who meets with who, how often and what is discussed? What is the balance between 1-on-1 and team meetings? Do you do regular(e.g. every 6 months) employee reviews?
  • Finances – Do you have clean, up-to-date books? Do you do forecasting and budgeting? Do you have a business emergency fund in case something happens?
  • Improving your Decision Making – Now that you are in charge of a substantial amount of resources, do you have the heuristics, processes and systems to consistently make good decisions?

Helpful books for this stage:

Conclusion

This framework is not perfect and the list is not exhaustive by any means. Whole books have been written about each bullet point in this list and there are entire fields of study about each of the sub-categories.

Yet, it’s proven helpful for me as a starting point for analyzing pretty much any business.  All models are wrong, but some are useful as they say. I’ve found this is a great complement to the quarterly planning system. Every quarter, I can look at a business and analyze the bottleneck again, allowing me to consistently focus on the highest leverage task.

 

Last Updated on October 17, 2023 by Taylor Pearson

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