Masters in Engineering and Management of Technology Masters in engineering Design Introduction to Entrepreneurship and New Venture Creation

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1 Masters in Engineering and Management of Technology Masters in engineering Design Introduction to Entrepreneurship and New Venture Creation Rui Baptista

2 Analyzing New Ventures: Opportunity Screening

3 Entrepreneurship is an Opportunity Driven Process What is an opportunity? An opportunity is attractive, durable, timely, and is anchored in a product or service, which creates or adds value for its buyer or end user. Jeffrey Timmons

4 Anchors of Superior Businesses They create or add significant value to a customer or end user They solve a significant problem, or meet a significant want or need, for which someone is willing to pay a premium They are a good fit with the founder and management team at the time, as well as with the marketplace and the risk-reward balance They have robust market, margin, and moneymaking characteristics

5 Timmons Opportunity Criteria Industry and Market Issues Economics and harvest issues Competitive advantage issues Management team fit Fatal flaws/overall assessment Strategic Differentiation

6 Venture Criteria: Questions to be Answered (I) Product/service creates or adds significant value to customer or end-user solves a significant problem / need for which the customer is willing to pay a premium Customers are reachable and receptive Product life is durable Robust market in terms of potential revenues and margins

7 Venture Criteria: Questions to be Answered (II) Competitive advantages exist: First mover advantages Control over prices or costs Patents or trade secrets Special know-how Special relationships with customers or suppliers Contractual advantages Attractive value creation and realization: Offers attractive returns for investors (ROI) Has low to moderate capitalization needs that are fundable Has a viable exit strategy Risk/reward balance

8 Screening Criteria: Customer/Market Need/Problem Customer Description/Identifiable and Reachable User Benefit Demand Durability Market Structure Market Size Market Growth Market Trends Market Capacity Market Share Attainable

9 Case Securities OnLine: Customer/Market Product: rapid, easily accessible informaton on emerging East European capital markets (higher risk/return greater demand for information) Customers: financial/business/legal/data services sophisticated, diverse, geographically dispersed financial operators + advertisers Opportunity: customers frustration with current lack of resources/information Large market with high potential for growth Customers are multiple users and have low switching costs Demand subject to international fluctuations in economic growth and financial markets

10 Screening Criteria: Competitors/Competitive Advantage Competitor Assessment Barriers to Entry Competitive Lead Time Competitive Advantage Cost/Price Channels Proprietary Technology Lead Time Service Contracts/Contacts Key People

11 Case Securities OnLine: Industry (I) Competition: inexistent/weak in the market presently; increasing in the near future (reduced lead time) Low barriers to entry Sources of competitive advantage: First mover advantage Technology: low entry costs, low operation costs (but possibly growing as scope of services widens) Product differentiation: quality content and presentation, fast distribution, segmentation per type of customer and type of information Entrepreneurial team dominates both product content and distribution technology

12 Case Securities OnLine: Industry (II) Risks: Low barriers to entry increased competition eroding firstmover advantage Low switching costs limits to product differentiation Large information providers (Reuters, Bloomberg) may enter the market soon with the advantage of established customer base Technology risk: quality and quantitiy of content vs. quick internet access; security and integrity of data Political instability and economic fluctuations

13 Screening Criteria: Economics and Financial Issues Gross/Profit Margins EBIT Sustainability Time to Positive Cash Flow ROI Capital Requirements/Resource Needs Gradual Resource Usage Scalability of Investment

14 Case Securities OnLine: Economics and Financial Issues Low investment requirements: $0.514M in the conservative scenario (C); $1,022M in the agressive scenario (A) Gradual resource usage; high scale economies Quick to positive cash-flow: 14 months (C); 13 months (A) EBIT: $0.7M (C); $1.3M (A) by year 3 Expected ROI by year 3: 36% (C); -31,5% (A) Expected Sales Margin by year 3: 24% (C); 26% (A) Sustainability: strongly conditioned by risk low barriers to entry; low switching costs; increasing competition; political and economic instability Discounted Expected Cash-Flow (DCF): $2.5M (C); $5.5M

15 Screening Criteria: Harvest/Exit Strategic Value Valuation of Assets and Capital Costs Exit Possibilities Capital Market Timing

16 Case Securities OnLine: Harvest/Exit Issues Exit possibilities: Merger vs. IPO vs. Venture Capital Potential investors: Large financial information providers Large multimedia companies (financial cable chanells) Associated customers: financial services (First Boston, ING); information providers (FT) Local (East European) investors

17 Screening Criteria: Management Entrepreneurial Skills Industry and Technical Integrity and Intellectual Honesty Ability to Work Together Balanced in Team Roles and Styles Goal Alignment Team Skills Management Holes/Gaps

18 Screening Criteria: Personal Fit Risk/Reward Goals Timing/Opportunity Costs Stress and Life Style Issues

19 Case Securities OnLine: Management Team/Personal Fit Strong technical skills Low entrepreneurial experience, partially compensated by the advisory board Ability to commit, giving up highly paid corporate jobs Question: ability to extend human resources and management team with the same level of skills

20 Screening Criteria: Overall Assessment Fit between Opportunity-Team-Resources Upside-Downside Risk Fatal Flaws Go/No Go

21 Case Securities OnLine: Overall Assessment Good fit between opportunity, team and resources as regards market and technology Strong/average upside first mover advantage, good established connections, but average/low initial revenues as customer base grows Strong downside: exit through acquisition of strategic assets: customer base and human resources Possible flaws: co-ordination of geographically dispersed team and customer base Risk of internet capital market bubble bursting

22 Bhidé s Opportunity Criteria: Questions to be Answered What competitive barriers must be overcome? What is the competitive edge? What actions will provide the edge? Will the edge in commitment, creativity and competence be enough?

23 Bhidé s Criteria Size and growth of the market Industry concentration Capital requirements Technology and operational complexity Sustainable competitive edge Payback period Fixed costs Sustainable growth rate

24 Bhidé s Types of Ventures Revolutionary Solo Contracting Networking/Syndication Trading/Speculation Institutionalized Hustle Speed Niche Marketing

25 Archetypal Venture Characteristics L O W Revolutionary Enterprise Magnitude of Risk and Return M E D I U M H I G H Speculation Solo Contracting Speed Institutionalized Hustle Networking/ Syndication Niche Marketing LOW MEDIUM HIGH Sustainability of Competitive Advantage/Returns

26 Revolutionary Ventures Costs and benefits to the customer for switching Technological and operational problems to be overcome First mover advantages and the ability to sustain growth Amount and timing of cash required and ability to raise it Requires high levels of competence, creativity and commitment; does not require external change

27 Solo Contracting Perceived superiority of contractor s skills and abilities Reputational capital Personal fit Requires external change and high levels of competence; does not require significant commitment or creativity

28 Networking/Syndication Depends upon the extent and complexity of the network Small/low complexity Need for the product Minimum number of members to be successful Selling ability Reputational capital Large/complex similar to revolutionary venture Requires external change and high levels of creativity; requires medium levels of competence and commitment

29 Trading/Speculation Market dynamics (why are prices low? Is this a temporary or permanent drop?) Time to sale Ability to hold/carry the asset until sale Requires external change and high levels of commitment; requires medium levels of competence and creativity

30 Institutionalized Hustle: Consulting Companies Self assessment Organizational design Partnership agreements, equity terms, performance measurement and reward systems Short term cash forecasts Requires external change and high levels of creativity; requires medium levels of competence and commitment

31 Speed Ability of the entrepreneur to acquire and manage talent and money Number of competitors the market can support Rewards for winning Personal goals/satisfaction Requires external change and high levels of competence; requires medium levels of creativity and commitment

32 Niche Marketing Incremental costs for serving a niche market Size of the market Competitive advantages and sustainability Sustained profitability potential or quick returns Financial and human capital investment Requires external change and high levels of creativity; requires medium levels of competence and commitment

33 Case Securities Online Bhide s criteria suggests that Securities Online is somewhere between network/syndication and revolutionary venture, where speed is also important Requires high levels of competence, commitment and creativity Does not require external change Key success factors: Building reputation and client base High quality and low complexity of product First mover advantage Customer swtching costs Technological and operational problems to be overcome

34 Securities Online in Bhide s Venture Typology L O W Revolutionary Enterprise Magnitude of Risk and Return M E D I U M H I G H Speculation Solo Contracting Speed Institutionalized Hustle Securities OnLine Networking/ Syndication Niche Marketing LOW MEDIUM HIGH Sustainability of Competitive Advantage/Returns

35 First-Mover Advantage in the Assessment of New Venture Opportunities Lead Times: new ventures introducing new products/technologies benefit from high barriers to entry being more likely to survive because high barriers provide long lead times for ventures to get established Entry Timing: pioneers have a disadvantage because they face greater uncertainty (lower financing) and greater customer reluctance to buy, and therefore experience greater costs to enter

36 First Mover Advantage: Myth or Reality First mover advantages are based on the ability to: Lock in customers Build relationships with customers, suppliers and partnerships to build brand and increase market share Learn to operate and achieve advantages over competitors Influence business practices Garner industry attention

37 Sustainability of First Mover Advantage (I) Such advantages may not hold if: Customers don t perceive switching costs Pioneers face significant resistance from customers or there are high training or market education costs Pioneer products are poor and produce customer dissatisfaction Newer technologies replace pioneering technologies

38 Sustainability of First Mover Advantage (II) Such advantages may not hold if: Single strong competitor reduces margins for pioneering companies Existing larger competitors can easily develop competing capabilities no protected intellectual property Competitors can withstand financial losses better than pioneer

39 Sustainability of First Mover Advantage (III) Such advantages may not hold if: Pioneer products don t have significant cost or differentiation advantages Pioneers aren t able to develop organizational and corporate capabilities to exploit technologies Unsustainable first mover advantage benefits fast seconds

40 Fast Second: Technological Knowledge as a Public Good Non-rivalry: the cost of replicating new technology is usually trivial when compared with the cost of creating it in the first place Incomplete Excludability: property rights can be assigned by law to the creators of new ideas; however, technology determines how easy it is to prevent unauthorized use This means that a fast second firm may reach the market with a new product reaping some of the benefits of innovation without facing its costs

41 The Timing of Innovation and the Fast Second Advantage The larger the expected profit from introduction, the greater the probability of innovating first The smaller the profit from the present product/technology, the greater the probability of innovating first The larger the difference between present and expected profits (after introduction), the greater the loss from being beaten to the market

42 Timing of Innovation Revenues Costs V - Total Net Revenue V 2 D - Total R&D Costs V 1 T 1 * T* T