October 19, 2012
Startup White Board

Enterprise 101:  A Simple Powerful Model for How Enterprises Work

If you want to lead an enterprise or company you will do a better job if you understand how they work. Most people think that you need a business degree of some sort to understand how a company works, but most successful Entrepreneurial Leaders (ELs) never went to business school.

Studying accounting or marketing or sales can help you know how to run important parts of your enterprise, but they do not give you the big picture of how everything must work together. Entrepreneurial Leaders need to understand how enterprises of any sort actually produce value.

There are only 4 things that can create value in an enterprise: Projects, Processes, Tools, and Culture.

A Process is an organized and repeated set of actions by people, using Tools, which transform or modify materials and/or data into something more valuable. Processes are the basic ‘division of labor’ that Adam Smith described using a pin factory in his The Wealth of Nations. How value was created using processes has been instinctively understood since our ancient ancestors sat around fires using rocks to sharpen their wooden spears in advance of going on a hunt. Today a common process might look like people sitting in a big air-conditioned office organizing and disseminating information by entering data into computer systems. Modern enterprises with even modest scale operate many processes (for example, paying salaries, replenishing office supplies, taking orders).

All the processes and tools in use today did not just materialize; people working together on a Project created or procured them. Projects generate value by creating something new, or making something better. They have a finite existence, unlike processes that can operate indefinitely. Projects start with a specific goal and a team of people that work together to accomplish the goal. Projects end when the objective has been achieved, or when the team has been disbanded for failure, or disbanded because the project’s objectives are no longer considered important. At any point in time the enterprise may have multiple projects underway to develop new organizational capabilities.

The word Tool applies to either the sharp rock that makes the hunter’s spear deadlier, or to the computer form that once filled-in will disseminate information rapidly and accurately among office workers. “Tool” could also apply to the ovens that a baker uses to cook bread, or to the forklift truck a warehouse worker uses to store raw materials. In the most general sense the entire warehouse is also a tool, as is rented office space. In my very basic depiction of an enterprise, all the value producing or value protecting assets of an enterprise fall into the Tool category. For example, if an enterprise has a patent on a technology it invented, the actual patent is a tool that can be used to defend against other enterprises copying or using the protected technology.

People populate the enterprise for the purpose of making processes work and projects succeed, although people feel more comfortable with the relationship pointing in the other direction, with processes and projects existing to make people more ‘productive’.

All enterprises need a minimum set of rules and understandings by which they are governed and these rules and understandings can be either formal or informal. How people react to the total sum of all the formal and informal rules is called the Culture. Powerful Cultures create an alignment of action among all employees towards achieving the objectives of the enterprise. Entrepreneurial Leaders understand how to create powerful cultures where all their stakeholders know what to do to best help the enterprise without having to be told!

Creating Value and the Concept of Leverage

In all cases, enterprises are formed to create leverage – doing more than a person or an unorganized group of people could do on their own. Without leverage an enterprise would not be worth the efforts required to form it and to keep it going. Leverage is how much more output can be created compared to what the same people could produce on their own. Leverage is the same thing as the ‘productivity’ of the enterprise.

Enterprise leverage is created solely by utilizing processes and by successfully completing projects. Enterprises create their leverage by intelligently organizing people to repetitively perform processes that create output more effectively than the same number of people could do themselves. Factories and offices are all filled with people performing processes to create products and deliver services that the world values.

All enterprises use projects to create the processes they need to operate and the tools they use to make their employees more productive. Some enterprises create most of their value using projects. For example, many contractors and architectural firms derive most of their competitive advantage from their ability to manage projects rather than their ability to create innovative processes. Similarly, volunteer organizations are often focused on delivering their value through charitable projects, like holding an annual flower show to raise money for a children’s hospital.

Since the value created by an enterprise[1] is directly proportional to both the amount of leverage the enterprise generates and to the number of people working for the enterprise, Entrepreneurial Leaders need to understand both how an enterprise operates and how to lead significant numbers of highly motivated people to staff their projects and processes. This is what ELs need to know about how enterprises create value.

Some people instinctually understand how enterprises work but most people don’t. There is major confusion over projects and processes that causes even MBAs to fail. Many entrepreneurs don’t understand the critical role of culture in creating value and mistakenly think that culture means creating an office environment that feels good but which doesn’t align anyone to make any extra effort to help the enterprise achieve its goals.

You now know more about how enterprises work than most MBAs.

[1] The value created by an enterprise can be measured using different metrics but the most common are profit, EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization), and cash flow. Social enterprises like charities or churches may measure their value creation using other metrics that ultimately directly relate to contributions or volunteers.

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