business case for 2.009: introductory...
TRANSCRIPT
Business Case for 2.009:Introductory Pro-Forma
Victor Tang
Massachusetts Institute of Technology
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
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
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
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.
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
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
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
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
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
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 %
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)
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
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
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
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
$10.00 = Σi=1
5 1
(1+r)ir is your IRR
Business Case 2.009 vtang 17
Establish a base-line for required investments
SG&A COGS
expenses
Cost+Expenses
T1$
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
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%
…
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%
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]
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
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
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
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