Critical assumption planning

Critical assumption planning is a service mark of D. Dunham & Co and was described in Journal of Business Venturing by Sykes in 1995. Critical Assumption Planning (CAP) helps managers and entrepreneurs maximize business development learning at least cost. The continuous process consists of six steps: Knowledge Base Assessment, Critical Assumption Planning, Test Program Design, Funding Request, Test Implementation and Venture Reassessment.

Overview

CAP is built on the foundation of the work of Block (1989) who showed that assumptions can stand in the way of perceiving current business realities. The identification and assessment of assumptions solves this problem and forms the foundation for managing new business ventures.

CAP involves six steps, combined in a "Learning Loop". Once all six steps are completed, a milestone is reached and the loop starts over again. The loop is constantly repeated as the business is developing.

The Critical Assumption Planning Process

Knowledge-base assessment

This step takes "a comprehensive analysis of what is known and unknown about the competition, market and technology" (Sykes 1995). In this step the entrepreneur oversees his plans and the first assumptions are exposed. Important parts of the business plan to check are the definition of the business concept and an assessment of the competition.

Critical assumption identification

During this step the assumptions are identified and there is a determination of criticality. The hardest part of CAP is to identify the assumptions that are not written down.

In order to determine the criticality of the assumptions, they need to be quantified; it is then possible to put the financial results in a spreadsheet and link them together. These financial impacts will change for the various assumptions.

CAP measures the criticality of an assumption as a change in the net present value of a venture (NPV). To determine criticality each assumption is assigned a range of uncertainty: base case, best and worst case. Then, assumption for assumption, while keeping the other assumptions at base case, the NPV changes for each assumption in the worst and best case scenarios are checked.

The NPV analysis proves the company with information about the criticality of an assumption. Two signals strongly indicate a critical assumption: a big difference in NPV between the best and worst-case scenarios, or a huge loss of NPV in the worst-case scenario

Test program design

The assumptions need to be tested. Sometimes good market research is enough, other times a working prototype needs to be developed. The order in which the assumptions are tested is critical in terms of the money spent on testing. One of the major focuses of the CAP method is to maximize the learning per unit expenditure on testing.

In order to determine the best testing option the test Effectiveness ratio (e) is calculated for one or more assumptions based on the estimated Costs (C), Time spend on testing (T) and the estimated reduction (R) between the NPV values of the assumptions (P as a percentage of the NPV range). Using these parameters, the effectiveness ratio (e) is calculated:

$e = \frac{\sum (PR)}{CT}$

Once the best testing option is chosen from the different test effectiveness values, the organisation can finish the planning of the test.

Funding request

When the test program design is ready and the costs are clear, resources have to be allocated to the test program. In most companies or start-ups clearance from senior managers or venture capitalists is needed to conduct the tests.

Test implementation

In this step the actual testing of the assumptions takes place.

Venture Reassessment

When the results of one or more tests are known, it might be that resources need to be re-allocated and business plans have to be updated.

References

• Sykes, H. B. and D. Dunham (1995). "Critical assumption planning: A practical tool for managing business development risk." Journal of Business Venturing 10(6): 413-424.

See also

• Assumption-based planning

Australian CAP Case Study