Coup- B 8

HAR V ARD| BUSINESS scHo oL

9-801-419
REV: APRIL 7. 2005

AVES sE5ENts

Betonn Corporation
Confidential Negotiation Information
Betonn Corp. supplies specialized components to telecom, network, and internet architecture
tirm lt has $940 million in net sales and an
urgent need to boost its $100 million in earnings. Given
brutal equitv markets, Betonn currently has a nmarket
capitalization of S1.1
billion, which is down
by
two-thiris irom a vear ago. You head the high-pertorming B-Division, which has sales of about $200
million and contributes roughly S30 million to Betonn's earnings. Your deputy has just returned
trom prumising. but inconcdusive. joint venture
("N) talks with a division of
oroducing and marketing the "B-a gate." While emphasizing a very different Alphexo
Corp. over
technical approach,
Alpheno has about S1.4 billion in sales, S150 million in earnings, and a sharply reduced market
capitalization of about $2.25 billion; vet relative to Betonn, Alpheio has a weaker balance sheet and
higher bornOwing osts. You must step in to bring these negotiations to a rapid and maximally
rotitable conclusion if possible; if not. vou should terminate the process and move to other
priorities
The Opportunity. Among its other products, your division invented, patented, and sells the
sucassful "B-gate," while your counterparts at Alphexo sell the related "a-gate," though mainly to a
ditterent ustomer segment. With management support, technical people from both firms
conceptualized and developed the "6-agate," which would combine aspects of each side's
technology to overoome some key phvsical limits of each product for certain classes of applications
t no sevai by either firm. Neither firm could exploit this opportunity by itself but a combined
etort i t h Alphexo would yield substantial sales over two years before technical developrments make
he - a gate obsoete, along with gates based on a- and B-technology.
Key provisions of the N term sheet are summarized below with comments. While nothing is final
nal ail issues are agreed, the negotiators have made considerable progress, provisionally settling
most of the issues with two major erceptions: protit-sharing percentages and possible sales
rsincions.
ideal) while theirs
Names of Product and Joint Venture. Your people insisted on "ß-a" (your
You rather like the sound of
demanded "a-ß" (OK to you but distinctly inferior to the alternative).
to it. There is no resolution of this issue.
- a but wouldn't trade ofi any economic provisions get
Gorernance, Control, Dispute Resolution, Duration, and Exit Provisions. These terms were agreed
to they similar to those
or the two-vear projected life of the venture and are fully acceptable you; are

of several other joint successful ventures in which you've participated.

a - and
Contributions. Each side will, on a non-excdusive, limited basis, contribute elements of its
B-technology. Each side has designated a comparabie group of sales engineers and necessary
to contribute half of the
support to market the joint product. Each side has provisionally agreed
required up-front investment cost, totaling S50 milion, much of which will go to pay an agreed, very
reliable contract manufacturer on a fixed-price basis. Betonn will charge your division for your share
of these capital costs plus a 10% "annual corporate capital charge" for any capital employed. This
charge is mainly based on Betonn's borrowing costs but it also includes a somewhat arbitrarv

s eerde ras drelopei yProtassor Janas Sebenius HBS cass are developad soleir as the basis for cdass discussion. Cases are not
n i e d to e r e s endoemas s u s d prmarr da'a or ilusraaons of effactive or inetfactive management.

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ocoo rer ing

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Betonn Corporation
801-419

overhead assessment. (Worthwhile investments under $50 million can be made and debt-financed by
Betonn without raising broader financial issues for the company.)
Venture Location and Facilities Charge. The ]V must be located either at Alphexo or Betonn, but,
without displacing valuable existing activities, there would simply be no place at Betonn's site for the
V's operations. Given Alpheo's incredibly ight space constraints, their people pushed very hard
for, and obtained fom Reton, provisional agroement that the venture's final fabrication
customization, and administrative operations will be located at Betonn, at a total "facilities charge to
the venture of $10 million, to be paid (to Betonn) from the V's sales proceeds. Therear
management, marketing, or strategic advantages to having the venture located at Betonn. Indeed,
locating
Vour peOple
peTations
prVately estimated that, apart from quite minor costs of physically
at Betonn, this choice would cause the elimination of a total of $8.7 million (net present
aluc) ot otherwise profitable Belonn activities. While your negotiators did not share this pre
fac1itjes
fngure ith Alphexo, the $10 million more than covers the real costs to you of locating the JV
at Betonn.
Possible Sales Restrictions. Now it gets tricky. If the joint venture's sales efforts were directed at
almost certainly
i-gatesales well as n e w target customers, it would
cannibalize your and
users as
eAIsting-gate division's of the f3-gate to your current customers. Alphexo has a similar
concern. Without restrictions on JV sales to Betonn's current customers, or even with a 6-month
restriction, jour sales cngineers have estinmated that you would rapidly lose 100%o of projected sales
to CXIsting customers. By kecping JV sales cfforts away from your current customers for 12 months,

you would at least preseive -gale sales with a prescnt value to you of $2 million; restrictions ot or
values to of
24months would prescrve B-gate sales to your cxisting customers with total present you
$10 million and $14 million, respectivcly. These figures have been treated as highly confidential.

Naturally, your negotiators fought hard for 24 months of restrictions to protect projected sales to
our curTent customers. Alphexo made the same argument, but your people stressed that the sales
cost to the joint venture of two years of Alphexo protection was simply "too high," whereas two
vears of protection for Betonn exacted a smaller toll on the JV and was, therefore, appropriate. Given
the impasse,
negotiators from each side collaborated in good faith to reach a consensus estimate
(Table 1) of the present value of net sales JV
under different lengths of
restrictions. These figures are net Alphexo and Betonn sales
of all
(e.g. costs
materials, labor, etc.) except the investment and the
facilities charge. For example, if the JV had total freedom to maximize its sales to any
potential customers, its sales would be $80 million; if JV sales efforts had to avoid existing
and all
and Betonn customers for 24
months, its sales total would drop to $42 million. Alphexo
effects of other combinations of restrictions. You Table 1 details the
are sure that these figures are accurate.
Table One

JV Sales With Various Restrictions (Smillions)

Length of Restrictions on JV Sales
to Betonn Customers
None 6 mos. 12 mos. 18 mos. 24 mos.
Length of None 80 80 79 77 65
Restrictions on JV 5 mos. 76 76 75 73 61
Sales to Alphexop 12 mos. 71 1 70 68 56
Customers 18 mos. 65 65 64 62 50
24 mos. 57 57 56 54 42
Profit-Sharing. No consensus at all was reached on this ditficult
question, though 50-50
recurred as the possible "defaulr" chojce,
a
split
e»pecially given equal investment by each sicde.

These net sales igures are all

pirbent valurs, dibi vuntrl at dn gired romnon rate that inancial
determined to be appropriate to t JV iisks and (rprale vputuity costs people on both sides

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 Betonn Corporation 801-419

Venture Leadership. Fxperience has taught both sides that strong leadership, vested in a single
person who is acceptable to everyone, is essential. Each side produced a very good candidate from
its own ranks and argued hard for their person. Given Alphexo's larger size, the Betonn side
conceded that the Alphexo candidate, Ralph, could lead the venture. Their peop finally
seemed proud to
have "won" this issue but you think this is a triumph of ego over economics. Ralph would do a fine
job, but your candidate, Beth, would be extremely effective as the head of this venture,
leading to an extra $5 million in net sales (relative to the levels shown in Table 1, for very likely
any set of
restrictions). Your negotiators argued this point, but
were ultimately yielded to the Alphexo people who
vociferously behind Ralph, dismissing your economic claims as exaggerated and
best. speculative at
Residual Intellectual Property ("I.P.") Rights.
While you agree that and B-gate
be obsolete after two
years, you approximately
see technologies will
a-
$5 million in (net present) value
obtains exclusive residual to Betonn if it
rights to B-a technology; shared control involves too
and coordination costs and hence is
worth nothing to you. many compromises
well to exclusive control of Clearly
B-a technology. Your people argued so Alphexo sees
potential value as
rights that, in the end, the other side's negotiators vigorously for these residual
provisionally conceded on this point.
Evaluating Potential Deals (using the Practice
options have been raised by your people-such asEvaluation Worksheet). While a variety of creative
full acquisition of a
purchase of Alphexo's
a-gate business or even a
You want to make a JVAlphexo-these are distractions from the issues and deal structure outlined
above.
the end of this case) if itagreement along
the lines of the term sheet in the
can be Report Form (attached at
profitable relative to your no-deal alternatives. Your objective is
crystal clear: to maximize the pre-tax economic value to Betonn of the deal. You do not
consider tax need to
implications to your division since
Report Form is to be completed and turned in whenthey will be assessed at the
corporate level. (The
you finish negotiations.)
Here's how you evaluate the
overall value of the venture to
negotiation; a detailed sample calculation follows below. Start you, Betonn, which is your goal for the
venture, which equals its net sales with the profitability of the
(given any sales restrictions) minus any facilities joint
overall profitability (your objective) is equal to Betonn's share
of JV profits plus
charge. Betonn's
benefits to Betonn (such as any additional
B-gate sales due to JV sales restrictions or residual I.P. rights) less Betonn's
investment
deal.
cost
(including the annual charge
of and 10%) any other economic costs to Betonn of the

Sample Calculation of Betonn Valuation of

Terms
Hypothetical Deal
of Hypothetical Example (not agreed
Technologies selling the ß-a gate, led by Ralph,by with facilities
both sides): Consider a venture
named ß-a
located at Betonn at a $10 million
charge to the venture (paid to Betonn), with 50-50 profit and investment
of restrictions on JV sales to both
Alphexo and Betonn customers, and with cost-sharing, with two years
to Betonn. residual I.P. rights going

Step One: Calculate Joint Venture Profitability (of the

JV sales (given agreed restrictions): $42 mm (from Table hypothetical example)
Less any facilities
1)
charge: $10mm
Effect of any other economic
provisions on JV profits: none
Total: $32 mm

(Step Two follows on the next page.)

3
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ON,
801-419
Betonn Corporation

Step Two: Calculate Total Value of Deal to Betonn

Betonn share (50%) of JV profits: $16 mm
Plus Betonn net sales due to 24 mo8. of restrictions: $14 mm
Plus other Betonn benefits: $10mm (facil. chg.) $5mm + (IP rights)-$15mm
Less Betonn investment costs: $15mm times corporate charge factor (10% annually, implying a
factor of1.21 (=1.1 x 1.1) for the two years; thus $15 mm x 1.21) =$18.15 mm
Less any other Betonn costs: $8.7mm eliminated activities
Total Value to Betonn: (16+14+15)-18.15-8.7-$18.15 million
This total exceeds the $14 million possible by simply selling to existing customers-with none of
the hassles of the JV--making thhe sample deal economically worthwhile (and you should accept it if
it were the only available possibility). Given the urgent corporate priority of boosting earnings,
however, you would be disappointed if you couldn't do much better than this for Betonn. You are
thinking hard about your negotiating strategy; for which you have complete authority and
accountability. Bottom-line impact is everything here.
For your convenience, the blank Practice Evaluation Worksheet (next page) summarizes the
elements of this calculation and is intended to help you to evaluate possible deals during negotiation.
The Report Form, including the term sheet, shows the issues and provisional settlements achieved
thus far. When you are fihished with the negotiations-deal or no-deal-complete and turn in the
TO HAND IN" copy of the Report Form (which follows the Practice Evaluation Worksheet). BE
SURE TO CALCULATE THE OVERALL VALUE OF THE DEAL (IN SMM) TO BETONN AND
PUT THIS VALUE IN THE BOx ON THE LOWER RIGHT SIDE OF THE REPORT FORM. (An
extra copy of the Report Form, labeled "TO KEEP", is provided for your later reference)

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 r o r the excIusN V. VEDIOA
NDATION
OUNDAIION
801-419
Betonn Corporation

Report Form Copy: Term Sheet and

Betonn Evaluation
(Note: Actual Report Form to turn in is on the next page.)
TO KEEP
Your namels): Group no./letter
(if appropriate):

Alphexo team name(s):

If yes,
Did you reach
agreement? please complete/modify provisional
terms as briefly summarized below in italics.
JV name:
open
Governance, Control, Dispute
Duration, and Exit Provisions: Resolution, as agreed
Contributions: 1) a-and
B-technology on
nonexclusive basis
2) Designated sales
engineers and
support
3) Each side to contribute $15 million
in investinent costs
Venture Location and Facilities
Charge: at Betonn, $10 million (to Betonn)
Restrictions on Venture Sales (in months):
unresolved
To Alphexo customers (circle one): 110ne 12 18 24
To Betonn customers
(circle one): 1101ne 6 12 18 24
Profit-Sharing: unresolved
Venture Leadership:
Ralph (fronm Alphexo)
Residual Intellectual Property (LP.")
Rights: to Betonn
Other Provisions:
open

Betonn Valuation: (in $mm from worksheet

box in Practice Evaluation
Worksheet-BE
SURE TO FILL IN):

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 For the exclusive use of V. VEDICA FOUNDATION, 202

H(O1-419
Betonn Corporation

Report Form: Term Sheet and TO HAND IN

Betonn Evaluation
Group no./letter

(if appropriate):
Your name(s):

Alphexo team name(s) provisional

complete/modify
lyes, please summarized
below in italics.
terms as bricfly
Did you reach agreement?

ope
JV name
Resolution, As agreed
Governance, Control, Dispute
Exit Provisions:
Duration, and
1) a-and B-technology on
nonexclusive basis
Contributions:
and
2) Designated sales engineers
Support
million
3) Each side to contribute $15
in investnent costs

at Betonn, $10 million (o Betonn)

Venture Location and Facilities Charge:

Restrictions on Venture Sales (in months): unresolved

To Alphexo customers (circle one): none 12 18 24

To Betonn customers (circle one): 1onc 6 12 18 24

Unresolved
Profit-Sharing:
Venture Leadership: Ralph from Alphexo)
Residual Intellectual Property ("I.P.") Rights: to Betonn

Other Provisions: opein

Betonn Valuation: (in Smm from worksheet

box in Practice Evaluation Worksheet-BE
SURE TO FILL IN!):

801419 rev-050329.doc

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