Business Case for 2.009: Introductory...
Transcript of Business Case for 2.009: Introductory...
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Business Case for 2.009:Introductory Pro-Forma
Victor Tang
Massachusetts Institute of Technology
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Business Case 2.009 vtang 2
Why You Need a Business Case
Goal Convince investors that you have a credible business proposal
Proof Points Product is not “me-too” Clear target market Know why customers will buy Know why customers will not buy – product, competition Will make money Confidence and enthusiasm
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Business Case 2.009 vtang 3
Key Points of an Executive Summary
Market Opportunity Exists [market size $, and 3-year CGR %]
Product is Competitive [what makes the product different]
[what are its unique benefits]
Financials are Attractive IRR xx% with initial investment of $ xx M Break-even at units in xx months Reach steady state in yy months
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Business Case 2.009 vtang 4
Describe the Market Opportunity
Target Market[25 words or less what is your product and who will buy]
Market Characteristics[where and how they are going to buy: store, sales rep, etc? why is
your price attractive? how will they find out about your product, its features, and benefits? what other choices do customers have?]
$xx
$yy
$zz
m%
n%
Year 1
abc
def$xxrpq
$xx
$xx
$xx
The Market Top 3competitors
Year 2 Year 3
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Business Case 2.009 vtang 5
Differentiate Against the Competition
abc def lmn 009
attribute k-1attribute k
…
attribute 4attribute 3attribute 2attribute 1
Killer attributes [attribute k] [attribute r] [attribute q] [attribute m]
• Competition can be another product ... or simply old way of doing things.
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Business Case 2.009 vtang 6
What is a P&L? (simplified profit & loss statement)
manufacturing costmaterials cost
gross profit
sales expense
gen admin exp
NEBTinterest exptaxesNEAT
sales revenues
T1 $ T2 $ … Tk $
R&D
Should bemonotoneincreasing
better bemonotoneincreasing
… price*quantity$ paid for parts$ paid for laborsales rev.-material cost- manuf. cost $ paid for engineers andequipment & stuff $ paid for salespeople,cust. lunches, travel ... $ paid for office, copier ...gross profit - Σexpenses
use 4-year time horizon
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Business Case 2.009 vtang 7
Volumes Forecasting Example: Easy Way
Y1
160K
180K
140K120K
100K
80K
60K
40K
20K
Assume volumes(units quantity), Qmax009=180K
4 years to reach asymptote .... and
Y3Y2 Y4
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Business Case 2.009 vtang 8
Volumes Forecasting Example: step 2
Y1
160K
180K
140K120K
100K
80K
60K
40K
20K
Assume volumes(units quantity), Qmax009=180K
4 years to reach asymptote, adjust intermediate points
Y3Y2 Y4
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Business Case 2.009 vtang 9
Develop a Pricing Strategy
5X
3X
$
Time
cost
price
Show price/cost relationship as a function of time Ideally, cost and price both decline, and margin increases ... hard to do well and consistently
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Business Case 2.009 vtang 10
Working Definitions and an Example of Costs
Income Structure[normalized to 100% of revenue]Cost
materials, labor, overhead
SG&A (expenses)salesgeneral and administrative
ExpensesR&D, interest, taxes
ProfitNEBT: net profit before taxesNEAT: net profit after taxes
Fabricated MetalSIC 3499 009
cost
exp.
SG&A
profit
69.7%
24.3%
2.4%3.6%
profit=earnings
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Business Case 2.009 vtang 11
Find Cost Drivers to Develop a Cost Advantage
Build cost structure table. What are the parts? Identify cost drivers Determine cost curve and Δcost/Δvolume trend line
cost elements
cost element q
TOTAL
% cost decline
cost element q-1
cost element 1
….….
….
$ $ $ $
Q=1K Q=100KQ=10K Q=1M
% % % %
100% 100% 100% 100%
costdriver
20% 20% 30%
cost %
decline
r %
0%
s %
t %
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Business Case 2.009 vtang 12
Estimate Profit and Loss (P&L)
units sold
manuf. costmaterials cost
gross profit
returns, etc
sales expensegen admin expNEBTinterest exptaxesNEAT
100%sales revenues<2%
≈20%≈ 5%
≈10%≈ 5%
xxxT1 $T0 %
≈60%
≈20%
≈ 5%
depreciation ≈ 5%
… … Tk-1 $ Tk $
R&D ≈10%
≈17%≈17%
References slide tells you where to get these ratios
f
a
e
cb
d
ghijklm
f=a-(b+c+d+e)
j=f-(g+h+i)
m=j-(k+l)
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Business Case 2.009 vtang 13
IBM’s Profit and Loss (P&L) Statement*
manuf. costmaterials cost
gross profit
returns, etc
SG&A
NEBT
f
NEAT
100%sales revenues<2%
≈20%
≈ 3%
19981998 %
≈38%
≈11%
≈ 7%
depreciation ≈1.5%
… … Tk-1 $ Tk $
R&D ≈ 6%
≈29%≈29%
Slide #13.1
81.7$ B
30.85.0
16.7
1.2
1.6*24.1*24.0*
9.0other 0.1*
6.32.7*
*imputed from financial statements
a
e
cb
d
ghijkl
taxes
f=a-(b+c+d+e)
j=f-(g+h+i)
l=j-k
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Business Case 2.009 vtang 14
Cost Profile Example
revenues
total costs
investments
hardware
software
financing
cost
services
1996 1999$B
43.6
22.9
16.3
2.9
1.5
1.8
$81.7
gross profit
% cost
100
4.0
3.4
6.7
37.4
52.5
% rev
2.2
1.8
3.6
19.9
28.3
55.6
27.1
23.3
2.2
1.5
1.6
$87.6
% cost
100
2.9
2.8
4.1
43.1
50.1
% rev
1.8
1.7
2.5
26.6
30.9
32.038.1
96-99
ã
ã
ã
ä
53.4 61.8
ä
source: IBM Annual Reports
%cost %rev
ã
ã
ã
ã ãã ä
46.6 38.4
“earnings” 41.8 51.2 52.3 59.7
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Business Case 2.009 vtang 15
Concept 1: Time Value of Money
• A dollar now is worth more than in the future.• Why? Because you can invest it. Say at r=10%. (Up arrows denote a positive cash flow)
t0 21 n
. . . . $1. $1.1 $1.21
$(1+r)n
• Future value of $1. in n years at r% p.a. = (1+r)n
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Business Case 2.009 vtang 16
Concept 2: Internal Rate of Return (IRR)
• If you invest $10.00 now and your cash flow is $1. p.a., in 5 years at what interest rate do you break even?
t21 5
. . . .
$10.
(1+r)(1+r)2 (1+r)5
$10.00 = Σi=1
5 1
(1+r)ir is your IRR
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Business Case 2.009 vtang 17
Establish a base-line for required investments
SG&A COGS
expenses
Cost+Expenses
T1$
Tk-1TbT2$ $ $ $
Tk
Total
……
……
$CE0
…$CE1
$CEb
Target an initial break-even time, Tb
Let I0= [$CE1]+[$CE2]+…+[$Ceb]
Use I0 as initial estimate of required investment
COGS: cost of goods sold, i.e., the cost of parts+labor+warranty
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Business Case 2.009 vtang 18
Iterate to determine Internal Rate of Return
SG&ACosts
expenses
RevenuesT0 $ Tk-1 $Tb $T1 $ Tk$
Depreciation*(0.5)Cash Flow
… …
$CF0 …$CF1 $CFb
Solve for R;
R=internal rate of return (IRR) Is IRR acceptable? Yes, you are done. Too high, decrease I0 and repeat process. Too low, adjust time horizon, cost, or expense structure & repeat process.
$CF1
(1+R)1 (1+R)2 (1+R)k
$CF2 $CFk+++ … I0 = 0
$CFk-1 $CFk
assume tax rate=50%
…
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Business Case 2.009 vtang 19
Heuristics
IRR 30+% for risky new ventures 20 % for new products 15 % for extensions/improvements to existing product line 10 % for cost improvement to existing product line
Risk-Free Rate-of-Return ~ 6% for Short Term Government Bonds
Materials cost = manufacturing cost
Tax Rate = 50%
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Business Case 2.009 vtang 20
Anticipate Questions about Risks
Identify and Address Key Risks, 3<n<7 What are they and what is your strategy to handle
Market Risks [risk 1]
[risk 2]
[risk 3]
Technical Risks [risk 4]
[risk 5]
[risk 6]
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Business Case 2.009 vtang 21
Take Away Points for your investors
We have an attractive market [market size $, and 3-year CGR %] [profitability and other killer descriptors]
We have a competitive product [what makes the product different]
[what are its unique benefits]
We have a viable business IRR xx% with initial investment of $ xx M Break-even at units in xx months Reach steady state in yy months
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Business Case 2.009 vtang 22
References
http://www.ibm.com/investor/financial guide/ Tutorial on how to read financial statements.
Industry Norms & Key Business Ratios, D & B 2000. Excellent source of information, down to the four digit SIC code. In Dewey Reference Library. HF 5681, .R25, .I53 1999/2000.
Troy, L., Almanac of Business and Financial Ratios, Prentice Hall, 2000. Alternative to D&B above, also very useful. In Dewey Reference Library. HF 5681, .R25, .T8644.
Annual Statement Studies, 2000-2001. rma publishing. More business ratios by 4 digit Sic code. In Dewey Reference Library. HF 5681, .B2, .R642 2000/2001.
Kahrs, K. (Editor), Business Plans Handbook. Thomson Publishing Co. 1994. Seven volumes of business plans of all types. In Dewey Reference Library. HD 62.7, .B865, 1994
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Business Case 2.009 vtang 23
Anticipate Questions about the Value Chain
suppliers
Generic elements of Value Chain, a.k.a. “Food Chain”
customerdistributorretailerwholesalermanufacturer
profit
quantityi
priceiquantityo
priceo
cost & expense
Key considerations
Know which elements you will outsource and why
Slide #17
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Business Case 2.009 vtang 24
Caveats & Important Note
This pro-forma is abbreviated; nevertheless, it covers the keytopics and principles needed to defend your business case
A pro-forma is not a series of forms or formulae to fill-in mindlessly
Apply your judgment and compare your results against yourcompetitors and benchmarks
Slide #2