John Mullins and Randy Komisar explore how one company’s experience provides lessons for good management practice in difficult economic times

Yvon Chouinard never set out to become a businessman. He simply wanted to make the world a better place. Even today, outdoor equipment company Patagonia – the company Chouinard leads – is not as much a business as a vehicle for doing the things Chouinard finds important.

As he recently put it: “Patagonia is a private company, and the sole stockholders are me and my wife, so we can do anything we want.” One thing Chouinard and his wife wanted was to sustain a company that lived up to a strong moral code, which contributed to society and put environmental protection and conservation at the top of its list of priorities.

Chouinard founded Chouinard Equipment (the predecessor to Patagonia) in the late 1950s. He and his rock climbing buddies all loved the outdoors; hanging on to a steep rock face with the help of steel pitons was their way of being close to nature. He eventually learned that the pitons his company produced were damaging the rocks.

Although pitons accounted for 70% of Chouinard’s revenue, he decided to phase them out and introduce in their place aluminium chocks that were far less damaging to the rock face – a Plan B success for his company and for the rock faces he was so passionate about. This was the first example of Chouinard’s commitment to the environment and the beginning of a professional life marked by putting profits at risk for his environmental values.

Chouinard’s pro-environmental philosophy – his Plan A – served him and his business well. In 1977, Chouinard introduced the famed fleece jacket, made of polyester, a fabric ideal for the outdoors, which kept moisture out and heat in. To be more environmentally conscious, Chouinard soon changed the manufacturing of the fleece, using recycled plastic soda bottles to construct the fabric.

Patagonia’s products were very popular with hardcore outdoor enthusiasts and fashionable city-dwellers, but its ensuing growth soon became unmanaged and out of control.

Big fall

In 1991, when the US economy fell into recession, Patagonia hit a wall. Sales slowed considerably, and its bank called in its revolving loan. The company was forced to file for bankruptcy. Patagonia’s near-death experience taught Chouinard two big lessons about his business model. First, to stay in business he would have to manage the company’s growth rather than let it get out of hand. Second, he firmly rejected the growth-for-growth’s-sake pattern that had got his company into trouble.

Post-bankruptcy, Chouinard decided his company’s environmental values were paramount. “The reason we hadn’t sold out and retired was that we were pessimistic about the fate of the world and felt a responsibility to use our resources to do something about it,” he says. Business-wise it was time for Plan C. His leap of faith was that Patagonia customers would pay higher prices, giving Chouinard the gross margins he needed to support his high internal cost structure and his company’s pro-environmental creed.

He has since been able to grow Patagonia into a powerhouse marketer of premier outdoor products, while also improving the environment that is so important to Chouinard and his wife. By creating a robust business model with its high gross margins, Patagonia has been able to provide grants to organisations protecting habitat, wilderness and biodiversity. Between 1985 and 2006, Chouinard and his company donated $26m to environmental organisations. They have also created “1% for the Planet”, an initiative encouraging Patagonia’s partner organisations to donate 1% of their own revenue to environmental efforts.

By catering to environmentally conscious customers who appreciate and can afford top-quality outdoor clothing and gear, Patagonia provides lessons about business models and more: that an entrepreneur’s values don’t have to take a back seat to the company’s bottom line.

The road to Plan B

How can you break through to a business model that will work for your business, even in the face of adversity as severe as that engulfing Patagonia in 1991?

First, you will need an idea to pursue. The best ideas resolve somebody’s pain, some customer problem you’ve identified for which you have a solution that might work. Alternatively, some good ideas take something in customers’ lives that is pretty boring and create something so superior it provides true customer delight, as was the case for Patagonia’s fleece jackets.

Next, you will need to identify some analogues (companies that have gone before you worth copying in some way) that can to help you understand the economics and various other facets of your proposed business and its business model. And you’ll need antilogues (companies whose experience you decide explicitly not to copy), too. Analogues and antilogues don’t have to only be from your own industry; sometimes the most valuable insights come from rather unusual sources.

Having identified both analogues and antilogues, you can quickly reach conclusions about some things that are, with at least a modicum of certainty, known about your venture. But it is not what you know that will likely scupper your Plan A, of course. It’s what you don’t know. The questions you cannot answer from historical precedent lead to your leaps of faith – beliefs you hold about the answers to your questions despite having no real evidence that these beliefs are actually true. For Chouinard, an early and important leap of faith was that he could convert safety-conscious rock climbers from using steel pitons to using his new aluminium chocks.

Taking a leap

To address your leaps of faith, you’ll have to leap! Identify your key leaps of faith and then test your hypothesis. That may mean opening a smaller shop than you aspire to operate, or a small-scale experiment, just to see how customers respond. By identifying your leaps of faith early and devising ways to test hypotheses that will prove or refute them, you are in a position to learn whether or not your Plan A will work before you waste too much time, and money.

But what do you actually need to consider when developing your business model? Every business model needs to quantitatively address five key elements:

• Your revenue model. Who will buy? How often? How soon? At what cost? How much money will you receive each time a customer buys? How often will they send you another check?
• Your gross margin model. How much of your revenue will be left after you have paid the direct costs of what you have sold?
• Your operating model. Other than the cost of the goods or services you have sold, what else must you spend money on to keep the lights on?
• Your working capital model. How early can you encourage your customers to pay? Do you have to tie up money in lots of inventory waiting for customers to buy? Can you pay your suppliers later, after the customer has paid?
• Your investment model. How much cash must you spend upfront before enough customers give you enough business to cover your costs?

Uncovering the right analogues and antilogues, identifying your most important leaps of faith, and testing a series of hypotheses to inform all five elements of your business model doesn’t happen in a single “eureka” moment. Getting to a viable Plan B, as Yvon Chouinard discovered, is a journey that can take months, even years.

Building a dashboard

Like any journey that wants to go somewhere, this journey needs tools to point the way and track your progress, something we call a dashboard. A dashboard plans, guides, and tracks the results of what you learn from your hypothesis testing. In part, it highlights key indicators of your progress, much as the dashboard in your car tracks key information. But dashboards as entrepreneurs use them are much more than the dashboard in the family car. A dashboard in this sense is also a trip planner to help you determine the best route. It provides a detailed map of the hypothesis-testing journey you will take, as well as determining any necessary alterations as you travel.

Your dashboard serves four key roles:

1. It forces you to think strategically about the most crucial issues that can – quickly and inexpensively – answer the all-important question, “Why won’t this work?”

2. It forces you to think rigorously about how you can examine your leaps of faith by testing hypotheses whose results can be measured quantitatively, wherever possible. Numbers are more persuasive than naïve hopes or dreams.

3. If one or more of your leaps of faith are refuted by the evidence you collect, the results displayed on your dashboard are visible and dramatic indicators of the need to alter your Plan A and move towards Plan B.

4. A dashboard is a powerful tool for convincing others – whether members of your management team, investors or others, even yourself – of the need to move from Plan A to Plan B. If your tenacity or perseverance is questioned, you can show the evidence to support the move towards Plan B. You are not being erratic or flighty; you are systematically testing hypotheses to prove or refute your leaps of faith, and you are listening to what the data tell you.

A dashboard forces you to keep track of the questions you have about your venture, while keeping your assumptions (often guesses, really) in mind. It focuses your attention on the critical issues and more efficiently deploys your precious time and resources to removing the critical risks. And it provides a way to respond to the real-life data you generate. Moving into the dashboarding stage in developing your business model means moving from spectator – observing others as you gathered analogues and antilogues – to doer.

The cold, hard facts

Most business plans assume that nearly everything is already known upfront – not the case, as the Patagonia example has shown. As Douglas MacArthur, the famous American general, is reputed to have once said: “No plan ever survives its first encounter with the enemy.”

There are many elements that need to be artfully combined in order to develop a successful business model. For Patagonia, and many other socially aware companies, a key component of their business models is leveraging the ability of their businesses to do more good for the world than they would be able to do individually. Patagonia was built out of a love of nature, producing innovative products that have been successfully marketed to other outdoor enthusiasts who are willing to pay a premium because they know the products are environmentally responsible and a portion of the revenue is donated directly to environmental causes. Patagonia has been able to do well financially in part because it works to do good for the environment, and it resonates with its target audience.

There are lessons from Patagonia’s inspiring story about more than its robust gross margin model. Chouinard’s laser-like focus on his company’s environmental values prompts us all to consider why we are in business. Chouinard was clear about this question. “The reason we’re in business is to be in politics; it is to change the world, not to make clothes,” he says. “I decided that if I was going to be a businessman, I was going to do it on my own terms. And I wasn’t going to act like a lot of the other businessman. And I wasn’t going to be bottom-line oriented. I believe that if you do everything correctly in business, the profits will happen. But you don’t focus on it. My bottom line at the end of the year is how much good we’ve done, not how much money we’ve made.”

The process articulated here is a healthy alternative to the straitjacket of today’s business planning practices – to enable you to anticipate and move beyond a failing Plan A. It is a process designed for learning and discovering, rather than for pitching and selling. It’s a process that recognises the cold, hard facts – most often, what ultimately works, is not the Plan A that was so persuasively articulated in the original plan. Instead, it’s Plan B.

John Mullins and Randy Komisar are authors of Getting to Plan B: Breaking Through to a Better Business Model, published by Harvard Business Press in 2009. Mullins is an associate professor of management practice at London Business School. Komisar is a partner at Kleiner Perkins Caufield & Byers and a lecturer on entrepreneurship at Stanford University.

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