Business Case for 2.009:Introductory Pro-FormaVictor Tang Massachusetts Institute of [email protected] Case 2.009 vtang2Why You Need a Business CaseGoal Convince investors that you have a credible business proposalProof 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 enthusiasmBusiness Case 2.009 vtang3Key Points of an Executive SummaryMarket 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 monthsBusiness Case 2.009 vtang4Describe the Market OpportunityTarget 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$zzm%n%Year 1abcdef$xxrpq$xx$xx$xxThe MarketTop 3competitorsYear 2 Year 3Business Case 2.009 vtang5Differentiate Against the Competitionabc def lmn009attribute k-1attribute k…attribute 4attribute 3attribute 2attribute 1Killer attributes [attribute k] [attribute r] [attribute q] [attribute m]• Competition can be another product ... or simply old way of doing things.Business Case 2.009 vtang6What is a P&L? (simplified profit & loss statement)manufacturing costmaterials costgross profitsales expensegen admin expNEBTinterest exptaxesNEATsales revenuesT1 $ T2 $ …Tk $R&DShould bemonotoneincreasingbetter bemonotoneincreasing…price*quantity$ 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 - Σexpensesuse 4-year time horizonBusiness Case 2.009 vtang7Volumes Forecasting Example: Easy WayY1160K180K140K120K100K80K60K40K20K Assume volumes(units quantity), Qmax009=180K 4 years to reach asymptote .... andY3Y2 Y4Business Case 2.009 vtang8Volumes Forecasting Example: step 2Y1160K180K140K120K100K80K60K40K20K Assume volumes(units quantity), Qmax009=180K 4 years to reach asymptote, adjust intermediate pointsY3Y2 Y4Business Case 2.009 vtang9Develop a Pricing Strategy5X3X$Timecostprice  Show price/cost relationship as a function of time  Ideally, cost and price both decline, and margin increases ... hard to do well and consistentlyBusiness Case 2.009 vtang10Working Definitions and an Example of CostsIncome Structure[normalized to 100% of revenue]Costmaterials, labor, overheadSG&A (expenses)salesgeneral and administrativeExpensesR&D, interest, taxesProfitNEBT: net profit before taxesNEAT: net profit after taxesFabricated MetalSIC 3499009costexp.SG&Aprofit69.7%24.3%2.4%3.6%profit=earningsBusiness Case 2.009 vtang11Find Cost Drivers to Develop a Cost Advantage Build cost structure table. What are the parts? Identify cost drivers Determine cost curve and Δcost/Δvolume trend linecost elementscost element qTOTAL % cost declinecost element q-1 cost element 1….….….$ $ $ $Q=1K Q=100KQ=10K Q=1M% % % %100% 100% 100% 100%costdriver20% 20% 30%cost %decline r %0% s % t %Business Case 2.009 vtang12Estimate Profit and Loss (P&L)units soldmanuf. costmaterials costgross profitreturns, etcsales expensegen admin expNEBTinterest exptaxesNEAT100%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 ratiosfaecbdghijklmf=a-(b+c+d+e)j=f-(g+h+i)m=j-(k+l)Business Case 2.009 vtang13IBM’s Profit and Loss (P&L) Statement*manuf. costmaterials costgross profitreturns, etcSG&ANEBTfNEAT100%sales revenues<2%≈20%≈ 3%19981998 %≈38%≈11%≈ 7%depreciation≈1.5%… … Tk-1 $ Tk $R&D≈ 6%≈29%≈29%Slide #13.181.7$ B30.85.016.71.21.6*24.1*24.0*9.0other0.1*6.32.7**imputed from financial statementsaecbdghijkltaxesf=a-(b+c+d+e)j=f-(g+h+i)l=j-kBusiness Case 2.009 vtang14Cost Profile Examplerevenuestotal costs investments hardware software financingcost services1996 1999$B43.622.916.32.91.51.8$81.7gross profit% cost1004.03.46.737.452.5% rev2.21.83.619.928.355.627.123.32.21.51.6$87.6% cost1002.92.84.143.150.1% rev1.81.72.526.630.932.038.196-99ãããä53.4 61.8äsource: IBM Annual Reports%cost %revããããããä46.6 38.4“earnings”41.8 51.252.3 59.7Business Case 2.009 vtang15Concept 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)nBusiness Case 2.009 vtang16Concept 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$10.00 = Σi=151(1+r)ir is your IRRBusiness Case 2.009 vtang17Establish a base-line for required investments SG&A COGS expensesCost+ExpensesT1$Tk-1TbT2$ $ $ $TkTotal…………$CE0…$CE1$CEb Target an initial break-even time, Tb Let I0= [$CE1]+[$CE2]+…+[$Ceb] Use I0 as initial estimate of required investmentCOGS: cost of goods sold, i.e., the cost of parts+labor+warrantyBusiness Case 2.009 vtang18Iterate to determine Internal Rate of ReturnSG&ACostsexpensesRevenuesT0 $ 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$CFk-1$CFkassume tax rate=50%…Business Case 2.009 vtang19HeuristicsIRR 30+% for risky new ventures 20 % for new products 15 % for extensions/improvements to existing product line 10 % for cost improvement to existing product lineRisk-Free Rate-of-Return ~ 6% for Short Term Government BondsMaterials cost = manufacturing costTax Rate = 50%Business Case 2.009 vtang20Anticipate Questions about RisksIdentify and