Business, Law, and Innovation

Business 101

Lecture 3Spring 2014

Professor Adam Dell

The University of Texas School of Law

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- Business Models / Economics

- Finance / Accounting

- Strength of Business Models

- Market Niches

- Changing Markets

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Big Themes:

Class Exercise:

Is it a Good Business?

Explore various business models and understand the fundamentals that

determine a good one from a bad one.

Goal

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Business Models / Finance

• How much can you sell your WIDGET for? (Sales)

• How much does it cost you to make the WIDGET? (COGS)

• How much margin is left over? (Gross Margin)

• What expenses (rent, employees, etc.) do you have? (SG&A)

• What is left after that? (EBITDA)

• What percentage of sales is that? (Operating Margin)

• How much do you need to invest in the plant? (Cap Ex)

• What is left after that? (Net Operating Cash Flow)

• If this doesn’t work…..nothing will.

• You can quote me on this: “Finance is often a lot of fancy B.S. designed to hide the ball.”

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Business Model / Finance – Income Statement

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Outlook Plan Plan VarianceNewCo. ($Mils) 2007 2008 2008 Fav/(Unf)

Revenue 1,430$ 1,473$ 1,464$ 10$ COS 586 621 619 (2)

Gross Margin 844$ 59.0% 853$ 57.9% 845$ 57.7% 8$

Total SG&A 736 745 742 (3)

EBITDA 108$ 7.6% 108$ 7.3% 103$ 7.0% 5$

CapEx 215 213 197 (17)

Net Op Cash Flow (107)$ (106)$ (94)$ (12)$

Notes: P&L excludes Eliminations

What kinds of business models exit?

- Service (cost + margin)

- Retail (50% gross margin typically)

- Manufacturing (low tech vs. high tech)

- Software (70% GM, client/server vs. .com)

- Logistics (trucks and routes)

- What else?

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Strength of a Business Model

We’ve got something no one else has (intellectual property) and it’s really valuable to customers (they’ll pay a lot for it) (they come to us looking for it).

We’ve got a position that has entrenched us in a market and it’s hard for anyone to compete against us (MS Windows). We have a big “MOAT” (Warren Buffett).

The number of people who want what we’ve got is huge and we are growing fast.

This thing we sell, its really cheap for us to make additional copies of it and sell it millions of them (software).

Strength of the business model translates into a high valuation multiple in the public markets.

- Businesses that are growing fast

- Have a great big MOAT

- Have great Operating Margin (Operating Income / Sales)

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So What Are You Looking For?

- Market Size

- Gross Margin

- Operating Margin

- Alternatives / Competition / Moat

- Scalability

- Adjacent opportunities

Let’s Look at Some Business Models

Service - UberRetail - Warby ParkerManufacturing - Tesla MotorsSoftware - Microsoft / Civitas LearningLogistics - AmazonFresh

Exercise: Microsoft…Let’s Go Back to our List

- Market Size

- Gross Margin

- Operating Margin

- Alternatives / Competition / Moat

- Scalability

- Adjacent opportunities

Microsoft

- Market Size: How big you think?

- Gross Margin: 72%

- Operating Margin: 34%

- Alternatives / Competition / Moat: What do you think?

- Scalability:

- Adjacent opportunities: xBox, Office365, Advertising, Expedia, What else?

Civitas Learning

- Market Size: 3,400 colleges

- Gross Margin: 60-80%

- Operating Margin: ?

- Alternatives / Competition / Moat: What do you think?Database of student records / behavioral data

- Scalability: ?

- Adjacent opportunities: What else?

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Market Niches

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Think of every company competing in a given market (for $s) as a single plant competing for space in their niche of the canopy of the forest (market).

Many never get to see the light. The strength of the business model will define how large and strong the enterprise becomes.

But remember:

Trees don’t grow to the moon.

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Markets are Not Static

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You can be certain of one thing: THINGS ARE GOING TO CHANGE….remember CREATIVE DESTRUCTION.

This constant roaring machine gives rise to new opportunities every day.

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Lawyers and Business

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Business people make deals. Lawyers “paper” them.

A big knock against lawyers is their lack of a fundamental understanding of business.

It would serve you well to try to understand the underlying business models of your future clients.

It’s important to strip away the “noise” in transactions, contracts, partnerships and businesses.

Focus on the key drivers of success.

The rest will take care of itself.

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Lawyers, Business & Negotiation

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Virtually every interaction in business is a negotiation.

It would serve you well to read and understand: “The Art and Science of Negotiation” by Howard Raiffa

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Lawyers, Business & Negotiation

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1) You must be willing to walk away

2) Know in your mind what you want / need; don’t be so clear to the other side.

3) Remember that everyone wants to “feel” like they got a good deal.

4) Do not give up something without getting something of equal value. Always work in the context of the entire transaction.

5) If you think you got an extraordinary deal, you probably didn’t.

6) If there are not realistic & fair incentives on both sides, things will likely go bad.

7) Working with great people is more important than working with a great contract.

8) Put yourself in the shoes of the opposite site before you sit down.- Try to understand their alternatives- Try to understand what is important to them- Do not empathize; focus on objective facts- Try to anticipate their arguments- Look at the prism from all sides