business case for 2.009: introductory...

Business Case for 2.009:Introductory Pro-Forma

Victor Tang

Massachusetts Institute of Technology

[email protected]

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


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


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


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.


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


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


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


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


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


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 %


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)


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


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


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


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


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


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%

…


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%


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]


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


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


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


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

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