Hypothesis Testing

NEWS FLASH: Every business plan is wrong. Not to worry. As Dwight Eisenhower once said, “plans are useless but planning is essential.” This is certainly true for business plans. The actual documents aren’t worth the paper they are written on but the process of creating them … priceless.

The value of a company is inversely proportional to the uncertainty surrounding the assumptions that make up its business plan. We must therefore systematically and iteratively drive out the uncertainty in our business plans. Here’s the shocker: the place do this is not the boardroom, but rather the marketplace.

It is all too easy to treat assumptions as knowns. The danger is that we lose sight of the uncertainty of the assumptions as we build a complicated spreadsheet business model around those assumptions. Never forget that no matter how fancy your model, it is worthless if the underlying assumptions are not true. That is why I no longer use assumptions in my planning. They are just too dangerous. They tend to lie hidden in the details and then blow up at the most inopportune times. Instead of assumptions, I insist our business models are built around a set of hypotheses. It is a subtle but important difference because it emphasizes the ‘unknowns’ in the business model. The business priority therefore becomes validation (or testing) of the hypothesis rather than building upon it as you would do with an assumption. If the hypothesis is validated, the uncertainty is reduced and it is far easier justify investing into the next stage. If the hypothesis turns out to be wrong (something that happens quite a bit), we’ve hopefully learned early enough in the process to try a different approach.