How Much Research and Examination Should You Do?

Given our work — engaging in investment examination and in execution after the investment has been made — I have always asked, "how much time and cost should be spent on examination and research?" In this article, I would like to do a simple quantitative simulation against this question and offer a hint for thinking about a reasonable volume of research and examination.

Premises

• No examination at all is fine — just start, and figure out everything as you go
• Before execution, you must mobilize every available resource and examine everything

Both of these polar claims are clearly wrong. That being so, we need to quantitatively derive a reasonable volume of examination and find the right balance.

Also, since I have consistently been in a position of driving investment forward, please be aware that I may be somewhat biased.

Research and examination cost relative to investment amount

For example, suppose we are examining a high-risk investment of 100 million yen. Here, let us assume the investment target is a new business inside the company. How much money is it reasonable to spend on examination (the decision on whether to invest)?

For now, let us assume 5%. In other words, 5 million yen can be spent on research and examination. If, at the other extreme, we set this at 50% and spent 50 million yen on research and examination, the difficulty of recovering the 100 million yen investment would become significantly higher, so you can see that this would be wrong.

If the company examining this investment is a large enterprise, what can be done within 5 million yen? In fact, this becomes quite limited. The cost figures shown here are approximations based on enableX's past experience.

For example, market sizing, customer interviews (3), incumbent interviews (3), and desktop research — information-gathering activities — would come to 2.1 million yen.

Deriving competitive strategy, sales plans, and revenue plans from the gathered information and aligning internally within the execution team — 3 million yen.

Preparing a 50-page material for the executive presentation, plus the Q&A for additional questions from executives (assuming 20 questions) — 3.5 million yen.

The total comes to 8.6 million yen — exceeding the initially assumed 5% and reaching 8.6%.

At this point, the side making the investment decision must choose from the following options

• Raise the proportion that can be spent on research and examination
• Raise the amount per investment
• Narrow down the items to be examined

These are the options.

Incidentally, the above is not an extreme case — it is not unusual at all for 10 million yen of research and examination cost to be incurred for a 30 million yen investment decision.

There is also a view such as: if the above is examination of a proof of concept (PoC), then it is not an investment decision of 100 million yen but encompasses the 500 million yen of subsequent investment to follow, and so 8.6 million yen is justified.

However, in reality, once you actually try entering a business, the volume of information you have access to is incomparably greater than during the examination phase — so the information gathered during examination ends up being nearly useless. In other words, even an investment decision for a proof of concept should be treated as a standalone investment decision.

In practice, I recommend **"narrowing down the items to be examined."**

Even if you choose "raising the proportion that can be spent on research and examination," pre-entry information itself lacks reliability. For reasons described below, even doubling the examination budget is unlikely to contribute to raising the probability of investment success.

What about "raising the amount per investment"? That is, if you raise the amount spent on a single proof of concept, the 5% benchmark is mathematically preserved — but this also defeats the original purpose of the "experiment" as a small-scale activity aimed at limiting risk.

If the side making the investment decision cannot make the judgment **"what is truly important in this matter, and what, conversely, can be considered later,"** the examination budget will balloon without limit. No work is easier than picking holes in a deliberation document for a new initiative.

However, you should recognize the risk that every single question you raise can cause an excessive increase in the research and examination budget. If you are in a situation where 15 million yen of research budget is being spent on a 30 million yen investment, the side making the investment decision also bears significant responsibility.

Furthermore, there is no work more demoralizing for someone with genuine passion for the business than producing materials answering the vague questions of someone who has never run a business. You should recognize not only the risk that excessive research and examination budget is being demanded, but also the risk that an extremely scarce resource — "people with passion for the business" — is being ground down.

The logarithmic relationship between volume of research and effect

For example, the effect per interview when 3 interviews are conducted versus when 50 are conducted is significantly different. You can imagine this — in the latter half, you tend to get roughly the same information.

Research and examination have a peak of high cost-effectiveness. The more you do, the better your investment decisions do not get.

After a certain amount of research and examination, the only way to answer the question "will this investment succeed?" is to produce a real track record through the business. The meaning of research and examination fades relative to execution.

On the other hand, research and examination has the wonderful value of being able to explore information across a broad range. Launching multiple businesses in different domains in parallel is difficult, but research and examination makes this possible.

In other words, when the situation calls for seeing things broadly and shallowly, research and examination is superior; once a specific theme has been narrowed down, execution is superior.

Running a small-scale execution can also be a highly accurate and cost-effective means of gathering information — once the theme to pursue has been narrowed down.

To put it simply: suppose I am thinking about doing a certain business. To judge whether it will succeed, I keep conducting interview research. Don't do that — it is far better to take that idea directly to a customer and say, "please buy."

A consideration on the cost of time

Up to now, I have mainly looked at this from the perspective of the amount of money spent on research and examination (or thinking of time converted into money).

On the other hand, how can we quantitatively consider time itself? How should we evaluate the value of the time lost by sending a proposal back for rework?

Let us take a very simplified view: that a CEO's job is to discover investment opportunities within their term and produce returns (in reality it is not this simple, but for the sake of argument).

In Case A, the investment opportunity is discovered early and 100 million yen is invested in Year 1. The opportunity succeeds and goes on to generate 100 million yen per year thereafter.

In Case B, the discovery is delayed and the same investment is made in Year 3. The result is the same — it goes on to generate free cash flow (FCF) of 100 million yen per year.

Case A's IRR is 93%; Case B's is 62%. Ignoring present value and comparing only the FCF generated during the CEO's term, Case A is 3 against Case B's 1.

Furthermore, from the earlier point on "the logarithmic relationship between volume of research and effect," even if you stretch out the investment decision, the probability of making a better one is low.

In practice, in Case A, the probability of discovering further investment opportunities is high. The opportunities discovered while engaged in actual work are often high-quality ones.

For time, it is hard to say bluntly "the cost of stretching out examination right now is XX," but in many cases, stretching out examination loses both the opportunity to generate returns and the opportunity to discover additional opportunities — while its effect on raising the certainty of the investment decision is limited.

Summary

I apologize that the writing has been hard to follow, but the conclusion is simple:

• Do not unconsciously spend an excessive examination and research budget relative to the investment amount
• The examination and research budget — including the time of employees — should be calculated simply to understand how much is being used
• If you bear the responsibility for making the investment decision, you must be able to judge "what is truly important in this matter, and what, conversely, can be considered later"
• Excessive examination and research grinds down the scarce resource of "people with passion for the business"
• The moment at which small-scale execution becomes more advantageous than examination and research — even as a means of information gathering — comes early
• The effect gained by stretching out the investment decision is low (a decision to stop examination is fine)