Welcome toWelcome to“Entrepreneurship and Business “Entrepreneurship and Business

for for Engineers and Scientists” !!Engineers and Scientists” !!

TG 401, Section ATG 401, Section ACourse website:Course website:

stevens.edu/sse/tgcoursestevens.edu/sse/tgcourse

Dr. Carl PavariniDr. Carl Pavarini

Distinguished Service ProfessorDistinguished Service Professor

School of Systems & EnterprisesSchool of Systems & Enterprises

Today’s AgendaToday’s Agenda

Course objective and target audienceCourse objective and target audience Course administration/requirementsCourse administration/requirements Course outline and learning outcomesCourse outline and learning outcomes

The goal of a commercial businessThe goal of a commercial business Defining product successDefining product success Introduction to financial measurementsIntroduction to financial measurements Readings and assignment for next weekReadings and assignment for next week

Course ObjectiveCourse Objective Investigate the Investigate the business-related issuesbusiness-related issues

critical for critical for successful commercializationsuccessful commercialization of new technology,of new technology,

in in start-ups and existing businessesstart-ups and existing businesses

- - understanding the business side understanding the business side of a company (goals and roles)of a company (goals and roles)

- identifying the key business issues - identifying the key business issues in making products successfulin making products successful

- learning how to address - learning how to address these issuesthese issues

- - understanding the impact of understanding the impact of business issues on products, business issues on products,

and on technical workand on technical work

Course ObjectiveCourse Objective Investigate the Investigate the business-related issuesbusiness-related issues

critical for critical for successful successful commercializationcommercialization of new technology,of new technology,

in in start-ups and existing businessesstart-ups and existing businesses

- - understanding the business side understanding the business side of a company (goals and roles)of a company (goals and roles)

- identifying the key business issues - identifying the key business issues in making products successfulin making products successful

- learning how to address - learning how to address these issuesthese issues

- - understanding the impact of understanding the impact of business issues on products, business issues on products,

and on technical workand on technical work

Critical Critical Business IssuesBusiness Issues…..…..the five key business issuesthe five key business issues

in technology commercializationin technology commercialization

Market and customer analysisMarket and customer analysis Beating the competitionBeating the competition High-tech marketing and salesHigh-tech marketing and sales Planning and managing for Planning and managing for

profitabilityprofitability Partnering with other companiesPartnering with other companies

Dimensions ofDimensions of CommercializationCommercialization

Opportunity selectionOpportunity selection:: deciding on deciding on the market and the specific the market and the specific product/serviceproduct/service

Business planningBusiness planning: : creating a creating a “winning” plan for the business“winning” plan for the business

FinancingFinancing: : getting the money and getting the money and resources (people, assets, connections…)resources (people, assets, connections…)

ManagingManaging: : executing the plan, with executing the plan, with ongoing modifications, to market-entry ongoing modifications, to market-entry and eventual successand eventual success

This Course is NOT….This Course is NOT….

A management courseA management course

(it’s taught from the perspective of(it’s taught from the perspective of

someone with a technical job)someone with a technical job)

A course on how to launch a start-upA course on how to launch a start-up

(the start-ups we’ll study are(the start-ups we’ll study are

already in existence)already in existence)

TechnicalTechnical andand BusinessBusiness jobs……..jobs……..

Design and development of technology-based products Design and development of technology-based products (R&D); engineer or engineering manager(R&D); engineer or engineering manager

Manufacturing engineeringManufacturing engineering Corporate information technology (infrastructure and/or Corporate information technology (infrastructure and/or

applications)applications) Sales engineering (aka technical sales)Sales engineering (aka technical sales) Customer technical support (aka post-sales support)Customer technical support (aka post-sales support) Technical consultingTechnical consulting

Marketing and/or product management of technology-Marketing and/or product management of technology-based productsbased products

SalesSales Manufacturing/operations (supply chain management)Manufacturing/operations (supply chain management) Financial analysisFinancial analysis Business consulting (strategy, operations, …)Business consulting (strategy, operations, …) Leading technology-based companies/divisionsLeading technology-based companies/divisions Founding high technology businessesFounding high technology businesses

Business Business and and Technical Technical JobsJobs

ProductPlanning

(New) Product

Management

Marketing&

Sales

Manufacturing&

Logistics

CustomerSupport

ExploratoryR&D

ProductDesign &

Development

TechnicalSales

OperationsEngineering

Post-saleTechnicalsupport

Information Technology/Infrastructure/Applications

Why you need to know about Why you need to know about “business” in a technical job….“business” in a technical job….

Business issues Business issues will will directly impact directly impact the the technical technical workwork you will do each day you will do each day

Technical employees who Technical employees who contribute to resolution of contribute to resolution of business issuesbusiness issues are considered are considered more valuablemore valuable

Many people Many people transition from technical to business transition from technical to business jobs jobs as their career develops (including starting a as their career develops (including starting a business)business)

……this course will make you a better engineer or scientist this course will make you a better engineer or scientist (or help position you for an eventual “business” job)(or help position you for an eventual “business” job)

Are these Are these “technical” questions?“technical” questions?

How would you go about How would you go about answering them?answering them?

What would you do…?What would you do…?

You need to decide whether to add a You need to decide whether to add a particular feature to a product you are particular feature to a product you are

designing. designing.

The product requirements document The product requirements document doesn’t mention it. doesn’t mention it.

You ask someone in Marketing, but she You ask someone in Marketing, but she really can’t recommend with confidence really can’t recommend with confidence

whether to add it or not.whether to add it or not.

What would you do…?What would you do…?Your product team is meeting to make some Your product team is meeting to make some

important decisions on: important decisions on: (1) new product directions, (1) new product directions,

(2) which customers/markets to focus on, and (2) which customers/markets to focus on, and (3) how to improve customer service. (3) how to improve customer service.

You are asked to represent the Engineering You are asked to represent the Engineering or IT department at the meeting.or IT department at the meeting.

What contributions will you make to these What contributions will you make to these

deliberations?deliberations?

What would you do…?What would you do…?You have an idea for an exciting new You have an idea for an exciting new intrusion detection product, based on a intrusion detection product, based on a

new signal processing algorithm you new signal processing algorithm you invented.invented.

You’d like to convince “management” to You’d like to convince “management” to fund the development of this product.fund the development of this product.

What arguments/analyses will be What arguments/analyses will be persuasive, and how will you create them?persuasive, and how will you create them?

What would you do…?What would you do…?

You are behind schedule in implementing You are behind schedule in implementing an important new process technology for an important new process technology for

the Manufacturing line. the Manufacturing line.

A Sales person asks you to join him in A Sales person asks you to join him in visiting an important potential customer.visiting an important potential customer.

The customer location is in China and the The customer location is in China and the visit will take 3-4 days.visit will take 3-4 days.

What would you do…?What would you do…?You need a new piece of test equipment You need a new piece of test equipment

for your design lab. for your design lab.

A Manufacturing engineer on your product A Manufacturing engineer on your product team also needs a (different) piece of test team also needs a (different) piece of test equipment; there’s not enough money for equipment; there’s not enough money for

both. both.

Your product team leader (a non-technical Your product team leader (a non-technical person from Marketing) asks the two of person from Marketing) asks the two of you to decide which one to buy, and to you to decide which one to buy, and to explain the reason for your decision.explain the reason for your decision.

These are decisions that These are decisions that typically must be made by typically must be made by

“engineering” or “technical” “engineering” or “technical” people…people…

……how will you make them?how will you make them?

……what objective(s) and criteria what objective(s) and criteria will you use in will you use in

making these decisions?making these decisions?

We’ll learn by analyzing We’ll learn by analyzing “Business Cases”“Business Cases”

WiFi networks (FHP Wireless)WiFi networks (FHP Wireless) Online brokerage services (DLJdirect/eTrade)Online brokerage services (DLJdirect/eTrade) Package delivery (Airborne Express/DHL)Package delivery (Airborne Express/DHL) Electric Cars (THINK)Electric Cars (THINK) Engineering analysis software (Mathsoft)Engineering analysis software (Mathsoft) Personal computers (Lenovo)Personal computers (Lenovo) Golf equipment (GolfLogix)Golf equipment (GolfLogix) Web marketing software (Hub Spot)Web marketing software (Hub Spot) Pacemakers/defibrillators (Guidant)Pacemakers/defibrillators (Guidant) Shoes (Crocs)Shoes (Crocs) Videogame accessories (Emotiv)Videogame accessories (Emotiv) Orthodontics (Invisalign)Orthodontics (Invisalign)

Instructor IntroductionInstructor Introduction

Carl PavariniCarl Pavarini- PhD, systems engineering, Rensselaer Polytechnic InstitutePhD, systems engineering, Rensselaer Polytechnic Institute

- 10 yrs applied research and product development (Bell Labs)10 yrs applied research and product development (Bell Labs)- 15 yrs product & division management (AT&T/Lucent)15 yrs product & division management (AT&T/Lucent)

- 10 yrs venture investing and board participation10 yrs venture investing and board participation- Adjunct professor at RPI and Stevens Inst of Tech Adjunct professor at RPI and Stevens Inst of Tech

(previously taught in Columbia & Rutgers MBA programs)(previously taught in Columbia & Rutgers MBA programs)

Why am I teaching this course……Why am I teaching this course……

and what makes me qualified to do so?and what makes me qualified to do so?

Course Requirements/AdminCourse Requirements/Admin

Required textRequired text (custom casebook, e-access via HBSP)(custom casebook, e-access via HBSP)

Required readingsRequired readings each week; articles on business each week; articles on business concepts, business “cases,” internet searchesconcepts, business “cases,” internet searches

““One-page, two-sides” One-page, two-sides” written homeworkwritten homework each weekeach week

Class discussion/dialogueClass discussion/dialogue on readings and assigned on readings and assigned homework questionshomework questions

Syllabus, weekly class presentation slides Syllabus, weekly class presentation slides andand supplementary materials supplementary materials are available on the course are available on the course website: website: stevens.edu/sse/tgcoursestevens.edu/sse/tgcourse

Class attendance and participationClass attendance and participation: we start on time; : we start on time; email pre-notification of missing classemail pre-notification of missing class

Accessing the CasebookAccessing the Casebook

Link:Link:

cb.hbsp.harvard.edu/cb/access/12058376cb.hbsp.harvard.edu/cb/access/12058376

Complete the registration process to get a Complete the registration process to get a login and passwordlogin and password

Pay for the casebook via credit or debit cardPay for the casebook via credit or debit card

Course GradingCourse Grading

25% case-based midterm exam25% case-based midterm exam

25% weekly homework25% weekly homework

25% case-based final exam25% case-based final exam

25% in-class participation (really!)25% in-class participation (really!)

Weekly HomeworkWeekly Homework

Questions related to the reading assignment will be Questions related to the reading assignment will be assigned assigned each weekeach week (12 weeks) (12 weeks)

Each student submits written answers via email or Each student submits written answers via email or on paper; on paper; no late submissionsno late submissions

maximum length of maximum length of “one page (both sides)”“one page (both sides)” Homework questions are “in advance” of covering Homework questions are “in advance” of covering

the material in class, so…the material in class, so… ObjectiveObjective is to demonstrate that you’ve thought is to demonstrate that you’ve thought

about the questionsabout the questions (not that you necessarily have (not that you necessarily have the correct answers -- yet)the correct answers -- yet)

Graded Graded “acceptable” or “not acceptable”“acceptable” or “not acceptable” Individual submissions required, but Individual submissions required, but group group

discussion encourageddiscussion encouraged!! Returned with comments only at request of Returned with comments only at request of

studentstudent

Course Homework GradesCourse Homework Grades # of acceptable course hw grade# of acceptable course hw grade submissionssubmissions

12 A12 A

11 A-11 A-

10 B10 B

9 C9 C

8 D8 D

7 or fewer F7 or fewer F

Email notification of unacceptable or missing assignments;

Homework will be not be returned UNLESS you ask for comments

Class Participation GradingClass Participation Grading

D,FD,F: poor attendance and participation; inattention: poor attendance and participation; inattention (web surfing, texting, talking, sleeping, etc)(web surfing, texting, talking, sleeping, etc)

CC: good attendance and attention, but little/no active: good attendance and attention, but little/no active class participationclass participation

BB: 2-4 active contributions per class (answers,: 2-4 active contributions per class (answers, comments, questions, stories, disagreements, comments, questions, stories, disagreements, challenges, …)challenges, …)

AA: particularly insightful or useful contributions : particularly insightful or useful contributions (not necessarily more frequent!)(not necessarily more frequent!)

You will receive an interim cp grade at mid-term;You will receive an interim cp grade at mid-term; If you want to know how you’re doing……ASK MEIf you want to know how you’re doing……ASK ME

Typical Grade DistributionTypical Grade Distributionindividual semesters vary individual semesters vary considerablyconsiderably

D/F C B A

homework 0+ 10% 10% 80+%

class participation 0+ 30% 45% 25%

mid-term exam 5% 35% 40% 20%

final exam 0+ 25% 50% 25%

course final grade 0+ 15% 60% 25%

out of 18 students 0 3 11 5

Carl Pavarini Carl Pavarini Contact InformationContact Information

Office hoursOffice hours: before and after class: before and after class

andand by appointment by appointment (in-person, phone, e-mail, IM)(in-person, phone, e-mail, IM)

EmailEmail: : carlpavarini@aol.comcarlpavarini@aol.com

cpavarin@stevens.educpavarin@stevens.edu

TelephoneTelephone: : 973-543-9496 (home) 973-543-9496 (home)

973-809-8336 (cell) 973-809-8336 (cell)

What you get in return…...What you get in return…...

Useful concepts, information and insights Useful concepts, information and insights about the business world…..about the business world…..willwill make you make you a better engineer/scientista better engineer/scientist

The benefit of my practical experience as The benefit of my practical experience as an engineer and business person…..what’s an engineer and business person…..what’s important, and what worksimportant, and what works

A productive, stimulating, interactive and A productive, stimulating, interactive and fun environment…..if you do your partfun environment…..if you do your part

Course Outline Course Outline – modules 1 & 2– modules 1 & 2

Objectives of Commercial Businesses Objectives of Commercial Businesses Financial MeasuresFinancial Measures Structure and roles within a companyStructure and roles within a company Creating winning Business PlansCreating winning Business Plans

Market and customer analysisMarket and customer analysis Beating the competition: competitive Beating the competition: competitive

advantage and differentiationadvantage and differentiation Making decisions about productsMaking decisions about products Case-based midterm exam – on product Case-based midterm exam – on product

decisions (Mathsoft – engineering decisions (Mathsoft – engineering analysis software)analysis software)

Course Outline Course Outline – modules 3 & 4– modules 3 & 4

Marketing, and its interfaces with R&DMarketing, and its interfaces with R&D Sales and sales channelsSales and sales channels Market-focused product development Market-focused product development Operations (manuf, logistics, service)Operations (manuf, logistics, service)

Launching a product (esp. marketing & Launching a product (esp. marketing & sales decisions)sales decisions)

Case-based final exam – on product Case-based final exam – on product launch (Invisalign – orthodontics)launch (Invisalign – orthodontics)

Course OutcomesCourse Outcomes  You are able to analyze a company’s You are able to analyze a company’s income statementincome statement, , and can identify the company’s critical and can identify the company’s critical opportunities and opportunities and

challengeschallenges in growing its business profitably. in growing its business profitably.

You understand the importance of competitive You understand the importance of competitive differentiationdifferentiation, and can utilize the , and can utilize the “whole product”“whole product” concept concept

and identify opportunities for and identify opportunities for competitive advantagecompetitive advantage..

  You can identify and choose You can identify and choose target customerstarget customers and perform and perform a a competitive analysiscompetitive analysis, in order to make decisions on , in order to make decisions on

product definitionproduct definition and other elements of the and other elements of the marketing marketing mixmix..

  You are able to identify: the best-practices utilized in You are able to identify: the best-practices utilized in market-focused market-focused product developmentproduct development processes, the key processes, the key operations operations trade-offs/balances, and the trade-offs/balances, and the impacts technical impacts technical

people have on a company’s business functionspeople have on a company’s business functions (marketing, sales, operations).(marketing, sales, operations).

……because you’ll understand and because you’ll understand and apply these apply these ConceptsConcepts (13) (13)

Definition of Definition of product successproduct success

Whole productWhole product Product plan: key Product plan: key

success factorssuccess factors DifferentiationDifferentiation Market Market

attractivenessattractiveness Target customersTarget customers

Competitive Competitive advantageadvantage

Marketing mix Marketing mix (C+4P)(C+4P)

Product positioningProduct positioning Sales functionsSales functions Channel optionsChannel options Channel value-Channel value-

addedadded Operations balanceOperations balance

… … and you’ll be able to use these and you’ll be able to use these Methods/ToolsMethods/Tools (13) (13)

Income statement Income statement analysisanalysis

Financial Financial benchmarksbenchmarks

Target customer Target customer descriptiondescription

Target customer Target customer selectionselection

5 Forces analysis5 Forces analysis Competitive Competitive

analysis analysis (10 dimensions)(10 dimensions)

Product decisionsProduct decisions Decision criteriaDecision criteria Identifying Identifying

competitive optionscompetitive options Product competitive Product competitive

positioningpositioning Channel economicsChannel economics Process dimensionsProcess dimensions Product Product

development best development best practicespractices

Today’s TopicsToday’s Topics

The “purpose” of a business; The “purpose” of a business; objectives of business leadersobjectives of business leaders

Introduction to financial Introduction to financial measurementsmeasurements

How do you know if a How do you know if a product or service is product or service is

“successful”?“successful”?

Definition of Definition of successsuccess, , andand

its market/competitive/financial its market/competitive/financial driversdrivers

(class discussion and dialogue)(class discussion and dialogue)

The “Purpose” of a The “Purpose” of a BusinessBusiness

Understanding the Objectives Understanding the Objectives of Commercial Businesses of Commercial Businesses

(and Business Managers)(and Business Managers)

A Commercial Business’ A Commercial Business’ Objective is to…?Objective is to…?

Provide quality goods and servicesProvide quality goods and services Provide jobsProvide jobs Beat competitorsBeat competitors Contribute to the overall economyContribute to the overall economy Contribute to economic/national securityContribute to economic/national security Make money (profits)Make money (profits) Increase the wealth of its executivesIncrease the wealth of its executives Increase the wealth of its ownersIncrease the wealth of its owners Some combination of the aboveSome combination of the above

On What Basis Should We Decide on On What Basis Should We Decide on the Answer?the Answer?

How about: How about:

Examine how the business’ Examine how the business’ leader is evaluated and leader is evaluated and

compensated?compensated?

Which raises the question:Which raises the question:

Who does the leaderWho does the leader

““report” to?report” to?

Corporate GovernanceCorporate Governance

Owners

Board of Directors

President/Chief ExecutiveOfficer (CEO)

Who are the owners?Who are the owners? Normally, a company has many ownersNormally, a company has many owners Owners may be individuals, other Owners may be individuals, other

companies, investment firms, …...companies, investment firms, …... The units of ownership are “shares of The units of ownership are “shares of

stock”stock” Each owner owns a percentage of the Each owner owns a percentage of the

company (equal to the percentage of the company (equal to the percentage of the total shares of stock)…….total shares of stock)…….if a company has if a company has 10M shares outstanding, an owner with 500,000 10M shares outstanding, an owner with 500,000 shares owns 5% of the companyshares owns 5% of the company

Shares can (normally) be sold to othersShares can (normally) be sold to others

S&P 500 Stock Price IndexS&P 500 Stock Price Index(log scale)(log scale)

The Board of Directors The Board of Directors represents the Ownersrepresents the Owners

The (share)owners of a company elect a The (share)owners of a company elect a board of board of directorsdirectors to represent the interests of the owners; to represent the interests of the owners; the board elects a the board elects a chairmanchairman

The The managementmanagement of a company is selected by, of a company is selected by, and reports to, the board of directors; the highest and reports to, the board of directors; the highest member of management is the member of management is the Chief Executive Chief Executive Officer (CEO)Officer (CEO), who is also often the , who is also often the PresidentPresident

One or more members of management may also One or more members of management may also serve as members of the board; at a minimum, serve as members of the board; at a minimum, the the CEO CEO is on the boardis on the board

The Difference BetweenThe Difference BetweenPublic and Private CompaniesPublic and Private Companies

PublicPublic: shares of its stock are sold : shares of its stock are sold through “public” exchanges (NYSE, through “public” exchanges (NYSE, Nasdaq, etc)…. Nasdaq, etc)…. anyone can purchase stock, anyone can purchase stock, and its price is known and public informationand its price is known and public information

PrivatePrivate: all sales of shares of its stock : all sales of shares of its stock are arranged through “private” are arranged through “private” transactions….. transactions….. price is determined through price is determined through private negotiation (at the time of a private negotiation (at the time of a transaction) and is not publicly knowntransaction) and is not publicly known

The Objective of a The Objective of a Commercial Business is to…?Commercial Business is to…?

Provide quality goods and servicesProvide quality goods and services Provide jobsProvide jobs Beat competitorsBeat competitors Contribute to the overall economyContribute to the overall economy Contribute to economic/national securityContribute to economic/national security Make money (profits)Make money (profits) Increase the wealth of its executivesIncrease the wealth of its executives Increase the wealth of its ownersIncrease the wealth of its owners Some combination of the aboveSome combination of the above

Answer: Answer: Increase the Wealth Increase the Wealth

of the Ownersof the Owners

The total value of the owners’ The total value of the owners’ interests in the companyinterests in the company

( “total shareowner value”)( “total shareowner value”)

Shareowner Wealth is Most Shareowner Wealth is Most Directly Measured By……?Directly Measured By……?

Revenues Revenues Profits/earningsProfits/earnings Stock price per shareStock price per share Market capitalization Market capitalization Dividends paid to shareownersDividends paid to shareowners Combination of the aboveCombination of the above

Ans: Ans: Market CapitalizationMarket Capitalizationplus plus dividendsdividends

The “market cap” (for private firms: “valuation”) of the firm =The “market cap” (for private firms: “valuation”) of the firm =

stock price per sharestock price per share

xx

number of shares outstanding (held by shareowners)number of shares outstanding (held by shareowners)

Dividends =Dividends =

Cash payments ($/share) made by the firm to shareownersCash payments ($/share) made by the firm to shareowners

upon the approval of the board of directorsupon the approval of the board of directors

Market Cap (Stock Price) is Market Cap (Stock Price) is Primarily Driven By…….?Primarily Driven By…….?

RevenuesRevenues Revenue growthRevenue growth Earnings (profits)Earnings (profits) Earnings growthEarnings growth Beliefs about the future values of Beliefs about the future values of

revenues and earningsrevenues and earnings Combination of the aboveCombination of the above

Ans: Ans: beliefsbeliefs about future earnings about future earnings (and revenues)(and revenues)

By By definitiondefinition::

Stock price/share = (Stock price/share = (P/E ratioP/E ratio) x ) x earnings/shareearnings/share

EmpiricallyEmpirically, it has been observed that:, it has been observed that:

P/E ratio ~ k x % earnings growthP/E ratio ~ k x % earnings growth (so, k is often called the “(so, k is often called the “PEG ratioPEG ratio”)”)

P/E and PEG, empirically…P/E and PEG, empirically…

For the S&P500 from 1950-2008:For the S&P500 from 1950-2008:Average long-term earnings growth ~ 7%Average long-term earnings growth ~ 7%

Average P/E (trailing=most recent) ~ 16Average P/E (trailing=most recent) ~ 16

Average PEG ~ 2.2Average PEG ~ 2.2

Interesting article on “current” P/E:Interesting article on “current” P/E:http://finance.yahoo.com/banking-budgeting/article/110510/the-decline-of-the-pe-ratio

[note: both “trailing” (last 12 months earnings) and [note: both “trailing” (last 12 months earnings) and

““forward” (expected earnings) P/Es are discussed]forward” (expected earnings) P/Es are discussed]

PEG varies by industry and over timePEG varies by industry and over timeAverage PEG by industry as of July 2002Average PEG by industry as of July 2002

Financials 0.84 Utilities 0.88 Health Care 1.03 Consumer-discr 1.10 Industrials 1.10 Consumer-staples 1.32 Info Tech 1.33 Materials 1.40 Energy 1.47 Telecom 1.93

……as does Earnings Growthas does Earnings GrowthAnnual Earnings Growth by industry--- 2Q08Annual Earnings Growth by industry--- 2Q08

Information Technology 24.3%

Industrials 20.5%

Utilities 17.2%

Telecommunications Services

17.2%

Healthcare 9.6%

Consumer Staples (mostly soft goods)

8.3%

Energy 7.2%

Consumer Discretionary (mostly hard goods)

-53.8%

Financials -96.8%

All S&P 500 – average -22.1%

Median sector 9.6%

The money to pay dividends The money to pay dividends usually comes from…….usually comes from…….

RevenuesRevenues Earnings (profits)Earnings (profits) Company borrowing (loans)Company borrowing (loans) Selling more stockSelling more stock ““Excess” cash on handExcess” cash on hand Combination of the aboveCombination of the above

Answer: EarningsAnswer: Earnings

Earnings Earnings

not spent on business operationsnot spent on business operations (e.g., marketing, new product development, (e.g., marketing, new product development,

manufacturing, sales, etc)manufacturing, sales, etc)

or saved or saved (retained earnings)(retained earnings)

So, if earnings and earnings growth are So, if earnings and earnings growth are the primary drivers of shareowner the primary drivers of shareowner

wealth;wealth;

and, and, businesses businesses are trying to maximize are trying to maximize earnings and earnings growth……..earnings and earnings growth……..

when is awhen is a product or serviceproduct or service “successful”?“successful”?

TheThe Technology Technology Commercialization Mantra !!Commercialization Mantra !!

A product (or service) is A product (or service) is

successful if and only if successful if and only if it generates, over time,it generates, over time,

earnings at or above earnings at or above

the levels targeted for itthe levels targeted for it

by the company itselfby the company itself

Company and/or ProductCompany and/or ProductEarnings are Determined By…?Earnings are Determined By…?

Sales/revenuesSales/revenues Cost of goods soldCost of goods sold Gross marginsGross margins ExpensesExpenses Interest paid/receivedInterest paid/received TaxesTaxes Combination of the aboveCombination of the above

Ans: Ans: A combo of all of theseA combo of all of these

Earnings are calculated via Earnings are calculated via the the

““income statement”income statement”

The Income StatementThe Income Statement(simplified)(simplified)

Revenues (Sales) - Cost of Goods Sold (COGS)= Gross Margin (gross profit)

- Marketing & Sales expense - Research & Development expense

- General & Administrative expense = Operating income (~EBIT)

- Interest paid or received - Taxes paid or credited

= Net income (earnings)

StandardStandard Financial MeasuresFinancial Measures

A firm’s A firm’s income statementincome statement, as well as ……, as well as ……

Cash flowCash flow and and balance sheetbalance sheet statements statements (next week)(next week)

So far……….So far………. Companies try to maximize their Companies try to maximize their market cap (or market cap (or

stock price) plus dividendsstock price) plus dividends

Stock price and the ability to pay dividends are Stock price and the ability to pay dividends are both driven by both driven by earnings, and beliefs about earnings, and beliefs about future earnings growth future earnings growth

Individual Individual products and services are expected products and services are expected to contributeto contribute to earnings/growth; successsful to earnings/growth; successsful products meet or exceed their earnings targetsproducts meet or exceed their earnings targets

Earnings growth (ultimately) requires Earnings growth (ultimately) requires revenue revenue growthgrowth, which is “easier” in fast(er) growing , which is “easier” in fast(er) growing marketsmarkets

Firms use Firms use financial statementsfinancial statements to develop plans, to develop plans, and measure/analyze/report on their performanceand measure/analyze/report on their performance

Let’s try an example……Let’s try an example……

What can we learn about the What can we learn about the performance of performance of

Apple, Inc. (AAPL)Apple, Inc. (AAPL)

by looking at its by looking at its

income statements ? income statements ?

(Sources:(Sources:

finance.yahoo.com,finance.yahoo.com,

google.com/finance,google.com/finance,

reuters.com/finance/stocks,reuters.com/finance/stocks,

www.sec.gov)www.sec.gov)

Apple Apple AnnualAnnual Income Statement Income Statement

Year ending Sep 24 2011 %revenue

Revenue ($M) 108,249 100%

COGS 64,431 59.5

Gross margin 43,818 40.5

R&D expense 2,429 2.2

SG&A expense 7,599 7.0

Operating income 33,790 31.2

interest & other inc 415 0.4

taxes 8,283 7.7

Net income 25,922 23.9

Apple Apple AnnualAnnual Income Statement Income Statement

Year ending Sep 24 2011 %revenue 2010 %revenue

Revenue ($M) 108,249 100% 65,225 100%

COGS 64,431 59.5 39,541 60.6

Gross margin 43,818 40.5 25,684 39.4

R&D expense 2,429 2.2 1,782 2.7

SG&A expense 7,599 7.0 5,517 8.5

Operating income 33,790 31.2 18,385 28.2

interest & other inc 415 0.4 155 0.2

taxes 8,283 7.7 4,527 6.9

Net income 25,922 23.9 14,013 21.5

Apple Apple AnnualAnnual Income Statement Income Statement

Year ending Sep 24 2011 %revenue %growth 2010 %revenue

Revenue ($M) 108,249 100% 66.0 65,225 100%

COGS 64,431 59.5 62.9 39,541 60.6

Gross margin 43,818 40.5 70.6 25,684 39.4

R&D expense 2,429 2.2 36.3 1,782 2.7

SG&A expense 7,599 7.0 37.7 5,517 8.5

Operating income 33,790 31.2 83.8 18,385 28.2

interest & other inc 415 0.4 167.7 155 0.2

taxes 8,283 7.7 83.0 4,527 6.9

Net income 25,922 23.9 85.0 14,013 21.5

Method:Method: How to Analyze an How to Analyze an Income StatementIncome Statement

Operating income vs. net incomeOperating income vs. net income

In-period operating performance: In-period operating performance: costs, costs, expenses and earnings expenses and earnings as a % of revenueas a % of revenue

Cross-period performance (trends): Cross-period performance (trends): relative relative changechange in revenues, costs, expenses, earnings… in revenues, costs, expenses, earnings… improvements vs. deteriorations, and whyimprovements vs. deteriorations, and why

One more item to come… One more item to come… (next week)(next week)

How did 2011 How did 2011 net income net income compare compare to 2011 to 2011 operating incomeoperating income??

How did 2011 How did 2011 net income net income compare compare to 2011 to 2011 operating incomeoperating income??

Net income ($25.9B) was less than operating Net income ($25.9B) was less than operating income ($33.8B) …income ($33.8B) …

Largely because of taxes paid ($8.3B) …Largely because of taxes paid ($8.3B) …

Slightly offset by other income ($415M, mostly Slightly offset by other income ($415M, mostly interest received)interest received)

Since taxes grew faster than revenues (83 vs 66%), Since taxes grew faster than revenues (83 vs 66%), relative net income (23.9%) was less than relative relative net income (23.9%) was less than relative operating income (31.2%)operating income (31.2%)

For the For the year ending Sep ‘11 (FY11)year ending Sep ‘11 (FY11), what were AAPL’s , what were AAPL’s revenues ($), and revenues ($), and relative (%revrelative (%rev) gross margin, operating ) gross margin, operating

income, and net income?income, and net income?

For the For the year ending Sep ‘11 (FY11)year ending Sep ‘11 (FY11), what were AAPL’s , what were AAPL’s revenues ($), and revenues ($), and relative (%revrelative (%rev) gross margin, operating ) gross margin, operating

income, and net income?income, and net income?

Revenues = $108.3 BRevenues = $108.3 B

GM% = 40.5%GM% = 40.5%

OI% = 31.2%OI% = 31.2%

NI% = 23.9%NI% = 23.9%

How did How did operating incomeoperating income change change from FY10 to FY11 from FY10 to FY11 (on (on both a both a total $total $ and and relativerelative basis)? What were the major basis)? What were the major financial determinants of the total $ change (revenues? financial determinants of the total $ change (revenues?

COGS? R&D exp? SG&A exp?)? Of the relative change?COGS? R&D exp? SG&A exp?)? Of the relative change?

How did How did operating incomeoperating income change change from FY10 to FY11 from FY10 to FY11 (on (on both a both a total $total $ and and relativerelative basis)? What were the major basis)? What were the major financial determinants of the total $ change (revenues? financial determinants of the total $ change (revenues?

COGS? R&D exp? SG&A exp?)? Of the relative change?COGS? R&D exp? SG&A exp?)? Of the relative change?

Total$OI: grew from $18.4 B to $33.8 B, up 83.8% !Total$OI: grew from $18.4 B to $33.8 B, up 83.8% !

Relative%OI: increased from 28.2 to 31.2% of revenueRelative%OI: increased from 28.2 to 31.2% of revenue

Total$ change (up 83.8%) mostly driven by 66% revenue growthTotal$ change (up 83.8%) mostly driven by 66% revenue growth

Relative improvement of 3.0% comprised of:Relative improvement of 3.0% comprised of:

1.1% GM% 1.1% GM% improvementimprovement

0.5% R&D exp 0.5% R&D exp improvementimprovement

1.5% SG&A exp 1.5% SG&A exp improvementimprovement

Method:Method: How to Analyze an How to Analyze an Income StatementIncome Statement

Operating income vs. net incomeOperating income vs. net income

In-period operating performance: In-period operating performance: costs, costs, expenses and earnings expenses and earnings as a % of revenueas a % of revenue

Cross-period performance (trends): Cross-period performance (trends): relative relative changechange in revenues, costs, expenses, earnings… in revenues, costs, expenses, earnings… improvements vs. deteriorations, and whyimprovements vs. deteriorations, and why

One more item to come… One more item to come… (next week)(next week)

For more detailed info….For more detailed info….

Access Apple’s 10Q (quarterly) and 10K (annual) Access Apple’s 10Q (quarterly) and 10K (annual) reports at reports at www.sec.gov ( (or through Yahoo Financeor through Yahoo Finance))

Particularly useful 10K/10Q sections:Particularly useful 10K/10Q sections: financial reports (incl. income statement)financial reports (incl. income statement)

management’s discussion of financial …. (incl. net sales,management’s discussion of financial …. (incl. net sales,

gross margin, operating expenses, other income, taxes)gross margin, operating expenses, other income, taxes)

Interesting article on Apple’s financial growth:Interesting article on Apple’s financial growth:

http://tech.fortune.cnn.com/2010/07/12/how-apple-maintains-explosive-earnings-growth/

For For FY11 FY11 what % of revenue came from what % of revenue came from each of AAPL’s product categories? each of AAPL’s product categories?

Revenues; $M 2011 Annual growth

Desktops 6,439 4% Portables 15,344 36%

Total Mac sales 21,783 25%Peripherals and other hardware 2,330 28%Software, service and other sales 2,954 15%

iPod 7,453 (10%)Other music related products and services 6,314 28%iPhone and related products and services 47,057 87%iPad and related products and services 20,358 311%

Total sales 108,249 66%

Apple Stock Price, 2007 - 11Apple Stock Price, 2007 - 11

How has AAPL stock performed compared to the Nasdaq How has AAPL stock performed compared to the Nasdaq index over the last two years? Speculate as to why.index over the last two years? Speculate as to why.

Readings for Next ClassReadings for Next ClassAppendix toAppendix to Writing a Business Plan: The BasicsWriting a Business Plan: The Basics (in casebook)(in casebook)

……and…and…

How to Read a Financial ReportHow to Read a Financial Report(on course website under “Supplementary Materials”) (on course website under “Supplementary Materials”)

read about the income statement,read about the income statement,pages 1-3, 6, 26-36, 42-43; note pages 1-3, 6, 26-36, 42-43; note glossaryglossary at back at back

……and…and…

Google’s (GOOG) financial and stock performanceGoogle’s (GOOG) financial and stock performancehttp://finance.yahoo.com/q?s=GOOG&ql=0http://finance.yahoo.com/q?s=GOOG&ql=0

……and…and…

Google’s SEC 2010 Annual Report (10K) filed 11-Feb-2011Google’s SEC 2010 Annual Report (10K) filed 11-Feb-2011(access via Yahoo Finance or SEC website www.sec.gov)(access via Yahoo Finance or SEC website www.sec.gov)

read “Management’s Discussion” pages 22-29read “Management’s Discussion” pages 22-29

Assignment Question #1Assignment Question #1::understanding that technical people affect understanding that technical people affect

income statement resultsincome statement results

How can technologists impact the How can technologists impact the line items of the line items of the income statementincome statement??

(cite (cite two examples for two examples for eacheach line item line item: : revenues, COGS, M&S expense, R&D revenues, COGS, M&S expense, R&D expense, G&A expense, interest, and expense, G&A expense, interest, and

taxes)taxes)

Assignment Question #2Assignment Question #2analyzing Google’s (GOOG) income statementanalyzing Google’s (GOOG) income statement

For For FY10 (calendar 2010)FY10 (calendar 2010), what were GOOG’s revenues ($), , what were GOOG’s revenues ($), and and relative (%revrelative (%rev) gross margin, operating income, and net ) gross margin, operating income, and net income?income?

Why did relative operating income and relative net income Why did relative operating income and relative net income change differently change differently from FY09 to FY10from FY09 to FY10? Taxes? Interest? ? Taxes? Interest? Other?Other?

How did How did operating incomeoperating income change change from FY09 to FY10 from FY09 to FY10 (on (on both a both a total $total $ and and relativerelative basis)? What were the major basis)? What were the major financial determinants of the total $ change (revenues? financial determinants of the total $ change (revenues? COGS? R&D exp? SG&A exp?)? Of the relative (%rev) COGS? R&D exp? SG&A exp?)? Of the relative (%rev) change?change?

For For FY10 FY10 what % of revenue came from each of GOOG’s what % of revenue came from each of GOOG’s product categories? Which products had the highest and product categories? Which products had the highest and lowest gross margin %? (see 10K for product data)lowest gross margin %? (see 10K for product data)

How has GOOG stock performed compared to the Nasdaq How has GOOG stock performed compared to the Nasdaq index over the last year? Speculate as to why.index over the last year? Speculate as to why.

RemindersReminders “ “How to Read a Financial ReportHow to Read a Financial Report,,”” today’s slides today’s slides and and

slides for next week’s class slides for next week’s class on course websiteon course website

Hand-in your Hand-in your name cardname card at the end of each class at the end of each class

Register on HBSP site to Register on HBSP site to purchase e-casebookpurchase e-casebook::

cb.hbsp.harvard.edu/cb/access/12058376cb.hbsp.harvard.edu/cb/access/12058376

Notify me via emailNotify me via email if you will be if you will be missing a classmissing a class

Discuss readings and homework in Discuss readings and homework in small groupssmall groups

Submit Submit written homeworkwritten homework via email before class via email before class (preferred), or on paper at beginning of class(preferred), or on paper at beginning of class