MAKING TECHNOLOGY EY Seagal sol lo ake anaes nes ae Peel eng ey MANAGING IT Increased functionality strategy stralegy FUNCTIONALITY Da cule ume CRO)A TECHNOLOGY HANDBOOK FOR :- ~ entrepreneurs ~ investors — scientists ~ economic development officers — public servants Tools and techniques for :- — finding technology — exploiting it — managing it D.J. Doyle Doyletech Corporation Kanata, OntarioCopyright © 1990 by Doyletech Corporation First edition published 1988 Second edition pablished 1990 ‘Third edition published 1982 ‘All rights reserved. No part of ths publication may be reproduced. stored ina retrieval system or transmitted in any form or by any means, electto- ie, mechanical. photocopying, recording or otherwise without the prior writen permission of Doyletech Corporation, Kanata, Ontario, Canada, 2K 267 Published and distributed by Doyletech Corporation. Printed and bound in Canada by Westboro Printers LadAuthor’s Preface The debate over Canada’s position in the world technology race seems to be end- less. It usually centres on the amount of money the country should be spending on scientific research and development (R&D) as a percentage of its gross national product. That is a highly visible parameter and Canada’s percentage is very low relative to that of most of its major trading partners. Those who argue for more R&D do so on the premise that it is the only way we will remain com- petitive with those trading partners and thus maintain our standard of living. They usually place the onus on government for funding the additional R&D. I believe that much of the energy going into that debate is misdirected. The fact of the matter is that the government's contribution to the total R&D effort in Canada is in line with that of most of our trading partners. What is not in line is the contribution by the private sector. We will not change that situation overnight, because it is the product of many years of history. Canada has had an industrial infrastructure that did not require much R&D, because the country has always relied very heavily on the exploitation of its abundant natural resources for wealth creation. It has also had an investment community that was more comfortable with investments in assets which were related to such activities, not only because that community understood such activities better, but because the assets were tangible (e.g. mines, sawmills, etc.) and represented more security. The assets related to the exploitation of technology are often intangible because they consist mostly of knowledge and expertise which reside in entrepreneurs’ heads. and because the activities of technology-intensive companies are often difficult for the average investor to understand, Canadians will direct more of their investments into technology-intensive ven- tures (and therefore into the R&D needed to sustain them) when they come to realize that they can make as much money out of such investments as they can out of mines and sawmills. The best opportunities for such money making is in the funding of new companies because that is the best way of addressing the unique market niches that are available for exploitation from a Canadian base of operations. This requires some knowledge about identifying and assessing exploitable technol- ogy: It also requires some knowledge about the planning and the ongoing manage- ‘ment of such new business ventures. Members of the scientific community have a iirole to play in imparting that knowledge. I believe that the first step is to get the (wo communities communicating effectively with each other. Scientists will have to understand that investors are not interested in technical papers but in business plans which show them how to exploit the technology described in those papers. Investors will have to understand the need for ongoing R&D investments and they must be prepared to deal with the rapid changes that are inevitable in the technolo- gy and the markets they will be developing. There are many things that both scien- tists and investors will have to lear about each other and the communities in which they operate, but a common language is the first thing. ‘This handbook uses language that should be understandable by both communi- ties, It talks about “technology exploitation” as opposed to “technology transfer” or “technology diffusion,” two terms that are the buzzwords of the industry today. It also places more emphasis on products and services than on knowledge and technology because it is products and services that generate sales revenues and therefore profits for investors. It describes a number of very important roles that scientists can play in the exploitation process, such as the identification and assessment of competitive products and services and the forecasting of key developments in the technology. It also shows the investors how to implement simple measuring systems that both they and the entrepreneurs can understand. If some of the energy going into the debate on Canada’s R&D expenditures can be directed toward ways and means of better exploiting what is already in place, 1 believe that the private sector shortfall will diminish on its own over time. But we must show people how to make money on investments in technology. The first step is to show them how to communicate with each other.Table of Contents 1, Introduction y, Products, Services, Markets and Wealth... Technolo; ‘The Business Plan — the entrepreneur’s most basic tool 4. Doing the Market Research 37 5. Finding Exploitable Technology ... 49 5.1 Itis not always where you think it is 49 ‘The innovation chain 49 5.3. Some questions to ask 34 5.4 Pure vs applied research 37 5.5 Business opportunity documents ... 60 5.6 Choosing the appropriate exploitation vehicle ... 61 6. Exploiting Technology 69 6.1 Start with a business plan .. oe 70 6.2 Estimating the investment requirements .. 70 6.3 Estimating the payback ... n 6.4 Negotiating a deal with investors .... 74 6.5 Negotiating a licensing arrangement 76 7. Managing a Technology-Intensive Company. 81 7.1 The role of a board of directors ..... 81 7.2. Some do’s and don’ts-for directors 83 7.3 Some do's and don'ts for presidents 89 7.4. The role of the long range plan, the budget and the forecast 7 7.5 Establishing a management rhythm 108 7.6 Choosing the appropriate corporate structure... 1127.7 The human resources factor 7.8 Maintaining an innovation culture 120 7.9 Employee stock option and purchase plans . 121 7.10 An early warning system for the board of directors 125 7.11 A tool kit for the chief executive officer 126 7.12. A tool kit for the director 127 Conclusion 129 Appendices 130 1 Position Description - Board of Directors ... cnn 130 2— Weekly Reporting System ..... 133 3 An Employee Goal Sheet... 135 viFigure 2 Figure 3 Figure 4 Figure 5 Figure 6 Figure 7 Figure 8 Figure 9 Figure 10 Figure 1 Figure 12 Figure 13 Figure 14 Figure 15 Figure 16 Figure 17 Figure 18 Figure 19 Figure 20 List of Figures The Relationship Between Technology, Products and Markets A Product Migration Strategy Financial Projections for a New Venture Business Plan “The Difference between Selling and Marketing Market Potential, Penetration and Share Five Year Projections of Market Potential, Penetration and Share By Product ‘The Innovation Chain Cumulative Sales Curves Technology and Market Maturity Matrix ‘A Typical Inventory of Technology Exploitation Opportunities Estimating Incremental Revenues and Profits from the Introduction of New Technology A Fiscal Calendar ‘The Relationship Between the Long Range Plan, the Budget and the Forecast Technology/Product/Market Pyramids ‘A Bookings Forecast in Graphical Form A Forecast Analysis Sheet ‘A President's Forecast to the Board A Functional Organization Chart ‘A Business Group Organization Chart ‘A Technology Wheel ~ Technology/Product/Market Pyramids in a Shared Resources Organization vii1. Introduction This handbook is directed at a number of different audiences, but it is primarily directed at the entrepreneur — the person with an idea that he or she thinks can be tumed into a successful business. It covers the entire spectrum of activities which make up the so-called “innovation chain’, all the way from the generation of an idea to the delivery of a product or service based on that idea. It assumes the cre- ation of a new corporation to exploit the opportunity, but the processes involved fare similar to those required in an existing corporation that exploits it through the creation of a new product line or profit centre. ‘The subject matter is broken into three distinct segments, one dealing with the search for exploitable technology, one dealing with the planning of a new busi- ness venture, and one dealing with the management of the new venture. How these three functions are carried out differs with each of the two exploitation paths mentioned above. Obviously the management process will be diferent if the idea is being pursued inside an existing corporation as opposed to a newly created one. Nevertheless, the same basic principles will apply because every new technol- ogy-imensive venture requires special attention to such things as technology and ‘market forecasting and product migration strategies. It also requires careful budget- ing and monitoring by its investors. In this handbook, the investors are assumed 10 be private individuals or venture capital companies and their interests are assumed to be represented by a board of directors. But if the opportunity is being pursued inside an existing corporation, the investment funds will come from the corporate treasury and the new venture will likely be monitored by the senior management committee of the company or by some other committee that it appoints. Such a committee will require the same planning, budgeting and forecasting systems that 2 board of directors will require. ‘The same subtle differences apply to the first two activities, namely the search for technology and the planning of the new business venture. Most corporations, regardless of their size, have systematic ways of searching for exploitable tech~ nology because they are already in the business of developing it. They also have planning procedures in place because they typically update their long range plans for their boards of directors every year and they typically use formal product plans to launch new products. When investors go looking for technology they usually start with publicly funded laboratories or they simply react to opportuni ties that individuals bring to them. Nevertheless, the dialogue that goes onbetween them and the scientists and entrepreneurs is essentially the same as that which goes on inside a corporation. The same business plan format can also be used for either type of exploitation vehicle, because a business plan is nothing more than a description of the business opportunity and an assessment of the payback that it will return to the investor. The product identification and market research that must go into such plans are merely means to those ends and not ends in themselves. Because the handbook covers the entire spectrum of the innovation process, it will be of interest to anyone who is likely to become involved in any way in that process. It will be of interest to commercial development officers in universities and publicly funded laboratories, because it includes guidelines for discussions with the research staff. It will be of interest to investors in technology-intensive ventures because it will help them assess the risks and opportunities. It will be of interest to the managers of such ventures because it will familiatize them with some of the techniques required to establish sound management practices and to communicate effectively with theit investors through a board of directors. People who serve on such boards will also find it of interest. Finally, it will be of interest to the large body of people in our society who have a desire to “make technology happen”. Such people include politicians at every level of government, public servants involved in economic development and trade, economic development officers at the municipal level, the managers of innovation centres and incubation malls, etc Before getting into a detailed discussion of the techniques that are required for the efficient identification, planning and management of technology, it is nec- essary to describe a tool that is basic to all of these processes, namely @ new ven- ture business plan. And before getting into that discussion, it is necessary to discuss the relationship between technology, products* and markets, because it is important to understand their respective roles in the wealth generation process. “In all of the discussion which follows, the term “products” will also refer to “services” because wealth can be created by the delivery of either.2. Technology, Products, Services, Markets and Wealth The first thing that must be learned about technology exploitation is that tech- nology by itself does not create wealth. Only the products and services that are created by technology can be sold. While it is true that technology can also jead to processes which can create wealth by improving the efficiency of exist- ing operations, the delivery of these processes js frequently carried out by an outside firm, This means that there is often a close association between a new process and a new product or service. While there have been situations where firms have developed processes for their own exclusive use, such processes have usually resulted in the creation of new firms that have adopted them in some ther form. In some cases they have resulted in the ereation of new profit centres in existing firms to sell a product or a service (0 ‘outside customers who can ben- efit from the same (or a similar) process. Even though processes will not be dis- cussed to any great extent in this handbook, their contribution to the wealth cre- ation process is acknowledged. The emphasis is on products and services for simplicity only Unfortunately, many people assume that more and more R&D wil automatically create wealth. The fact is. that the only output from R&D is knowledge, and venless that knowledge leads to some form of innovation it will not lead to prod- vets and services. So an emphasis on products and services is an essential ele ment of successful technology exploitation. Technology is an ingredient in the wealth creation process which fits in between the R&D and product development phases. The products and services which are created by technology must be finely tuned to a market need before they can cre~ ate wealth. What is normally referred to as the “innovation chain” (to be dis- ‘qussed later) has @ number of phases to it and it is sometimes difficult to know which phase to look at in order to identify exploitable technology. Even though R&D does not lead directly to products and services, R&D is where the technol- ogy exploitation process should usually begin. The process 16 practiced in its vost efficient form when a researcher at the front end of the chain can visualize the products and markets which are likely to appear at the other end. But such people are very rare. For example, it would be unusual for a researcher ‘who has discovered a new way to encode or sample an analog signal to visualize wil of the possible applications for the new technique, And it would be unusual for a user who might benefit from that technique to know enough about electron-ies to understand that it could dramatically reduce the amount of memory and processing power required to monitor and control a manual operation, and thus reduce the cost of an add-on instrument to a cost-efficient level. If every poten- tial user of a technology-intensive product or service could dialogue directly with the experts who develop the technology, the introduction of products and ser- vices would come about very quickly. But they are at opposite ends of the inno- vation chain and they have few opportunities for such dialogue. Even the dialogue that takes place between salespeople and end users is often ineffective because unless the salespeople understand the underlying technology they will be unable to visualize the new products. To put it another way, they are ‘both at the same end of the innovation chain; they understand the application but not the technology on which it is based. When I joined Digital Equipment Corporation in 1963, I had been using their digital modules for three years and I knew almost as much about them as the engineers who had designed them. The company was still small (less than $6 Myr) and it was easy to communicate with. T often collaborated with the engi- neers while they were designing the products. I found that my new sales col- Teagues nearly all had the same product knowledge. What had happened is that we all became so enamoured with the product that we gave up our careers as design engineers and research scientists to get closer to the action by actually joining the firm. None of us knew anything about selling but we learned very quickly, because as users, we had been familiar with the back end (or distribution end) of the innovation chain and by collaborating with the design engineers, we had become familiar with the front end (the idea end) as well. The result was that Digital grew very quickly, thanks largely to the finely tuned market information we were able to bring back to the plant. The difference between selling and mar- Keting will be discussed later, but what we lacked in sales capability, we more than made up for in marketing capability. There is no simple solution to the “dialogue problem.” If the two parties are at opposite ends of the innovation chain, they are not likely to communicate with each other. If they are at the same end, they will not know enough about what is going on at the other end to direct the exploitation process. A third party, who is familiar with all of the steps in the innovation chain, can be of great help in achieving effective communications between the various parties who will be involved in the exploitation process. Such a person will be referred to as a “tech- nology exploiter” or “technology broker” in this handbook.‘Technology Push ——+ — Technology Marke Rthece Moses ‘Tenoiogy os crestor Aderess | ¥ Markets v Market Pull Figure 1 The Relationship Between Technology, Products and Markets ‘The relationship between technology, products and markets is illustrated in fig- ure 1, It illustrates the various points made above about the mechanics of wealth creation, It is also a useful diagram for describing the difference between “tech- nology push” and “market pull” — two terms that investors and entrepreneurs should be familiar with. “Technology push” occurs when scientists (or other developers of the technolo- gy) are so enthusiastic about their technology that they become convinced that it can create wealth even though they cannot identify the products that it might spawn or the markets that it might address. “Market pull” is what happens when 5someone who is thoroughly familiar with a given market identifies the need for a product in that market and sets out to develop both the technology and the prod- ‘ucts to address it. While it may seem obvious that “market pull” is better than “technology push,” such is not always the case. It depends on how well the product need is addressed. “Market pullers” are sometimes just as cavalier about the product as “technology pushers” are. They often take the attitude that if plenty of money is spent on promotion and market development it will automatically create wealth even if the product is substandard, or non-existent. The sins committed by too much “market pull” are every bit as mortal as those committed by too much “technology push”. Unfortunately, the investor ~ the person who has to identify and assess those sins ~ is not usually well equipped to do so. He or she can be as easily swayed by a fast talking salesperson as by an over enthusiastic scientist. Some tips on how to deal with both situations are given in chapter 5. At the risk of duplicating some of the information provided in that section, the following advice is offered to the Prospective investor in a technology-intensive venture. Keep asking the question: ‘What is the product and how much of it can I sell?” If a simple answer to that question cannot be obtained within a very short period of time, the investor should not continue the dialogue. While a complete assessment of the sales Potential can only be obtained after a detailed business plan is written, the investor should be wary of anyone who considers the product or the service as incidental to the whole enterprise. Although it may seem inconceivable that such ‘thing can happen, the fact of the matter is that it happens in all too many cases when a would-be entrepreneur approaches an investor with a new business opportunity. To summarize what has been said in this chapter, technology by itself is of no use 10 any investor, because it does not create wealth on its own. It is important for the investor to understand the difference between technology, products and markets. If the product is not strikingly apparent and well defined, there is no technology exploitation opportunity. In fact, if the product does not lead to other products, the opportunity will be limited. More will be said about product migra- tion strategies in the next chapter, but it is worth pointing out here that any new venture which starts out with only one product in its portfolio is probably doomed to failure. Follow-on products should be clearly visible at the outset.3. The Business Plan — The Entrepreneur’s Most Basic Tool ‘A business plan is a recognized management tool used by corporations and insti- tutions of all sizes to document objectives and to propose how they will be attained. It typically covers a period of several years — usually five. It is not a budget, but is intended as a background document to the budget. Both must be updated annually if they are to serve their intended purposes, In an ongoing company, the board of directors relies on the long range plan as its “toad map” in approving the annual budget. Such a plan must therefore pro- vide a look ahead at major anticipated problems and opportunities as well as major financing requirements. It must also identify changes in the technology and shifts in market conditions well before they are likely to impact on financial performance. What will be discussed in this chapter is not that type of plan but the type that must be written to start the firm in the first place. It will be referred to as a new venture business plan. What is a New Venture Business Plan? A major difference between a new venture business plan and one for an ongoing company is in the marketing data wh..h is available to the planner. In a new ven- ture, revenue projections must be based mostly on judgments as opposed to his- torical data — judgments about the quality of the technology and the acceptance of the new products in the market place. In an ongoing business, the planner can rely on historical data to estimate the impact of key variables such as price, fune- tionality, competition, distribution channels and marketing strategies. Despite the difficulties and uncertainties associated with the planning of new business ventures, it is a necessary first step in the venture itself. While the emphasis in this handbook will be on technology-intensive ventures, the same concepts and format can be used for any type of new venture. Even the establish- ment of a new hardware store or a boutique should not be undertaken without a thorough analysis of the opportunity, an overview of the products or services to be offered, the market to be served, and a forecast of revenue projections and cash flow. These things should not only be thought through, they should be written down and the final decision to proceed should be based on that written document.Why is it Necessary? The new venture business plan is, in effect, a “memorandum of understanding” between the entrepreneur and the investor. Indeed, the format to be described here bears a great deal of similarity to what is generally referred to in the invest- ment community as an “offering memorandum”. It is a necessary first step in the dialogue between the two parties. ‘The starting point in any business is when someone puts a business plan down on paper and someone puts some money on top of it. The two “someones” may in fact be the same person, but even in that case there should be a clear separation of the two processes — the planning process and the investment process. There is no harm in an entrepreneur writing a memorandum of understanding to him- self; in fact, itis essential that he do so. ‘The important thing to understand is that when money has been put on top of the plan, it becomes the contract between the two parties. Once the company is up and running, the plan should be updated every year so that it can serve as a road map for the preparation of the yearly budget. It then becomes a conventional long range plan. Such a plan will follow a slightly different format and will be ith the budgeting process. described in chapter 7 along Who Should Write It? Since the new venture business plan is intended to become the contract between the entrepreneur and the investor, and since it usually starts out as a solicitation for funds from the investor, it should ideally be written by the entrepreneur. It should not be written by the potential investor. Only as a last resort should it be written by a third party. In the case of technology-intensive ventures, significant help in the preparation of the plan should be obtained from the person who is most familiar with the technology and the products. This is usually a scientist or researcher. Such peo- ple can play an invaluable role in the transfer of technology out of publicly fund- ed laboratories and universities. However, they may initially object to what appears to be a diversion from what they are good at. While they will argue that it should be done by a professional writer or “business planner,” they will fre- quently enjoy the exercise, particularly the market research portion of it, Above all, they will help keep the entrepreneurs realistic.As will be explained in the marketing section of this handbook, marketing (and specifically market research) is a seience. It follows the same basic principles as other disciplines of science. Target markets can be defined. segmented and quan- tified, market shares can be estimated, market penetration data is available in the literature and price/performance ratios are real entities whose impact on market share and market penetration can be assessed. It is possible to make reasonably accurate revenue projections for any business, provided appropriate attention is paid to the analytical factors. The process will have a familiar ring to it for most scientists Unfortunately, too many scientists (and business people as well) confuse market- ing with selling. The salesperson makes use of the tools (the market data, the brochures, the applications notes, etc.) that the marketer builds. Selling is more of an art than a science. In a new venture, the selling and the marketing are usu- ally done by the same person. One way of distinguishing between the two func- tions is to visualize the selling as what that person does in the daytime and the marketing as what he or she does at night. More will be said about the differ- ences between the two activities in the next chapter, but in the dialogue with the scientist whose help you are trying to obtain in the preparation of the business plan, it is important to emphasize that in order to do good marketing, he or she need not have any significant sales skills. For a technology-intensive product, the technology assessment and the product migration strategy are the two most important ingredients of marketing, and scientists can play key roles in both of them. So in summary, the business plan should ideally be written by the person who will assume responsibility for carrying it out ~ the entrepreneur. The second choice should be the scientist who is best qualified to assess the technology. The third choice should be the investor or a third party who can collect inputs from all of the parties concerned. Who Will Use It? While the new venture business plan is written primarily for the purpose of attract- ing investors, the entrepreneur will find there are many other parties who will have aan interest in it — especially during the first year of operation. It will be used as an operating document by nearly everyone who joins the new enterprise. It will prove useful in accessing government funding and other types of financing (e.g. debt) in addition to the original equity financing, It may even be made available to potentialsuppliers for the purpose of establishing a line of credit. It can be an invaluable recruiting tool for attracting senior management and technical personnel to the new venture. It will also be useful in the establishment of milestones and individual work assignments during the first year. However, since the plan is a contract between the investor and the entrepreneur, the investor's approval must be obtained for each of the above uses. In a technol- ogy-intensive enterprise, confidentiality is a primary consideration, and every attempt should be made not to divulge the company’s intentions to existing or potential competitors. Finally, the new venture business plan will be used to create a conventional long range plan at the end of the first year. The Proposed Format ‘A major misconception held by most scientists or would-be entrepreneurs about business plans is that they must be lengthy documents. In fact, the people who are likely to invest in such ventures are very busy people, whether they be ven- ture capitalists or private investors. They do not have time to read and analyze lengthy documents. They typically only want enough data to allow them to ask the right questions. Above all, they do not want to see “boiler plate” material whose only purpose is to make the document look impressive. The following pages will describe how to write a business plan for a new tech- nology-based venture. It may seem a little carly in the book to launch into it, because some of the topics that should be covered before preparing such a plan (e.g, market research and the difference between selling and marketing) have not been covered yet. However, because nearly all of the material in the book is related so closely to a new venture business plan, it is best to cover it now. The plan being proposed will be less than twenty pages long. It will have the fol- lowing format: ‘The Opportunity (Suggested length ~ 1/2 page). This is a simple statement of why an investor ‘would consider this new venture as opposed to something else. The follow- ing is an example: “The research into seismic sensor technology which has been carried out in the Department of Geology at Canuck University has 10resulted in the identification of a new type of blast monitoring device that could be marketed in large quantities to the construction, mining, and quarry industries.” It should be expanded upon to the point where the reader can visualize the extent of the opportunity and the risks involved — at least from a technology standpoint. The investor should know from the first sentence if he or she is being asked to invest in an anti-gravity device or a device whose technology is defined and achievable. In fact, that first sentence should make reference to the technology, the products and the markets involved - as the above example does. ‘The Products and/or Services (Suggested length — one to two pages). Using non-technical language, explain the purpose of each product or service and the reason why it is being developed. Describe the features, functions, and benefits of each and com- pare them to competitors’ products on the market. Some of the questions that should be answered are: ‘+ What is the purpose of the product or service? + How does it achieve this purpose? + What are its unique features? (Cost, design, simplicity, etc.) + What is its technological life? (How soon will it become obsolete?) + What is its stage of development? (Idea, engineering model, engineering prototype, production prototype?) + How will the product be produced? (Is it capital intensive, labour inten- sive, material intensive? Will some or all production be subcontracted?) + Can the product be protected by patent, copyright or trademark? Finally, a product migration strategy should also be discussed, because as exciting as the initial product offerings might be to both the scientists and the entrepreneur, investors will want to be assured that the company will be able to compete with new entrants to the marketplace. Figure 2 is an exam- ple of a product migration chart which can aid in this thought process. It shows price on one axis and functionality on another. In planning the new venture, the first product or service should be followed up very quickly with two others — one with a lower price and lower functionality and the other with a higher price and a higher functionality. This family of products should all be possible with today’s technology, and they should offer the cus- tomer clear buying choices. 1Current generation of products Initial product Early follow-on products PRICE — Increased functionality strategy Next generation of products Price reduction strategy FUNCTIONALITY Figure 2 Product Migration Strategy However, some thought should also be given to the next generation of prod- ucts. An ideal product migration strategy will call for each product to evolve along both axes simultaneously, thereby giving rise to two new products, or even a family of products. In one case, the new product will have increased functionality at the same price and in the other, it will have the same func- tionality at a lower price. There are many ways of achieving this, but for technology-intensive products, the new family will likely be based on a new generation of technology. It is therefore necessary to do some technology forecasting and of course scientists, engineers and technologists are the best people to do this ~ another reason why the opportunity can often be identified more precisely by such people than by the investor or a third party “business planner. Although the above product migration discussion focussed on product fune- tionality as the key variable, there will be situations where it might be useful 12to consider product features and/or benefits as well. As will be pointed out later, customers buy products because of the benefits they hope to derive from them. Functionality is stressed in this discussion because that is usually the most closely related to benefits for a technology-intensive product. Also, it is usually the easiest to assess However, it should be understood that itis only possible to rate functionality in qualitative terms, whereas price can be stated precisely in quantitative terms. In order to do this qualitative rating, the product must be viewed from the perspective of a potential user. Unfortunately, many entrepreneurs become so enamored with their product that they are unable to do so. Such people usually suffer from the “technology push” syndrome described in the last chapter. Investors should be very wary of them. The development of cumulative sales curves for all of the products during the first few years of the new venture will be discussed in chapter 5. While it is impossible to predict precisely how long a product will last and how it will be received in the market place, an attempt to develop such curves will assist the entrepreneur in understanding the market dynamics of each prod- uct. For example, the original product (the one in the middle of the diagram) will usually be the “workhorse” product in that it will sell in larger numbers than the two on either side of it. The “price reduced” product will typically have a shorter lifetime but may have a higher peak sales volume. The “increased functionality” product will appeal to a more selective clientele who may take longer to understand its true functionality. Therefore its sales curve will likely be flatter and will reach maturity at a later stage than either of the other two. A product migration chart is also a useful competitive analysis tool. For example, if all (or most) of the existing products on the market fall above the line, the new venture has a fighting chance, but if they fall below the line, itis likely doomed to failure. One difficulty will be in determining what constitutes the true functionality (and in some cases the true price) of the competitive products. For example, if the new product is an instrument that produces a direct readout as opposed to an existing product that requires off-line processing of the data, it certain- ly has more functionality and this will be more important to some customers than to others. This means that in using the product migration chart, the tar- get market should be taken into account. In fact, a chart should be drawn for each target market.The development of such a chart should be part of the technology/ prod- uct/market analysis process that goes into the planning of the new venture. The discussion on market research which follows in the next chapter will help in this process, but the important thing to understand at this point is that if no product migration path is visible, the planning process should be termi- nated immediately. A single product company is not viable, at least not in the world of high technology. ‘The Market (Suggested length — 5 to 6 pages) This section is the most important part of the business plan; it should address the following questions: + Who are your customers? + How will you distribute your product? (Direct sales or dealer network, transportation, export implications, tariffs and duties, barriers, foreign exchange.) + What are your market share objectives? (Rationale and costs of achieving different levels.) + What is the total market potential over the next five (or ten) years? + What are other important factors? (Seasonality, regulatory requirements, assistance programs available, market trends, etc.) + Competition — what are the alternative solutions, how do they compare in cost, and what is your competition likely to do when this product or ser- vice is introduced? The techniques for doing this market analysis will be explained in the next chapter, but the purpose of the market analysis is to give credibility to the revenue projections for the new venture. It is simply not good enough to make statements such as: “The total North American market for this family of products over the next ten years is forecast to be $2 billion and our firm plans to capture 5% of that market. Therefore, total accumulated sales will be $100 million in the first ten years of operation. Our annual sales will reach $6 million in the fifth year and $25 million in the tenth year.” The rationale for capturing any share of any market must be clearly spelled out in the marketing section of the business plan. 4More will be said about what should go into the marketing section of the plan in the next chapter. Financial Projections (Suggested length — 2 pages). Even though the product is not yet fully defined and even though the market research is not as complete as both the entrepreneur and the investor would like it to be, there comes a point in the planning process where revenue projections must be made. The first year’s projections should be done on @ monthly basis, the second and third on a quarterly basis and the next two on a yearly basis. Most business plans cover a period of five years, but there is no harm in extending it to ten years if there is enough visibility of the company’s prospects for that period. While the first year’s figures will be based on specific target markets, and maybe even specific customers, obviously anything beyond the second or third year must be based on estimated market size, market trends and anticipated mar- ket share. The same is true of expense projections. There should be good visibility of engineering, manufacturing, marketing and other costs for the first year at least, but for the final years, they will likely be based on a pricing model in which such costs are taken as a percentage of revenue. The following is a typical pricing model for a technology-intensive goods-producing company (Le. hardware) in which significant ongoing investments in R&D and mar- keting are required. - 100% 45% Sales revenue Cost of Sales (Mfg. costs) . Gross Profit Operating Expenses Marketing & Selling Costs... Engineering Costs ‘Warranty General & Administration Costs... Total Operating Costs Operating Profit It is extremely important that there be a pricing model for each business that the new venture will be engaged in. This is not to suggest that each of the 15products shown on the product migration chart requires a separate model, but each business does. For example, if in addition to supplying hardware products, the company plans to provide post-sale support on a profit-making basis and perhaps a family of software packages, a separate profit model should be provided for each of these activities because they are all very dif- ferent from a cost perspective. ‘The chart below shows how these three specific activities would compare. In all cases, the revenues are net of distributors’ discounts. The operating costs (and in fact, the cost of goods) would likely all be incurred by centralized groups and would be allocated to each of the businesses according to 2 for- mula agreed to in advance. All figures are in percentages. Hardware Service __ Software Sales Revenues 100 100 100 Cost of Sales (Labour, materials & overhead) 45 60 20 Gross Profit 55 40 80 Operating Expenses Selling (In house sales force) 5 2 10 Marketing. 10 10 20 Engineering 10 5 15 Warranty 5 2 10* General & Administration 8 8 6 Total Operating Expenses 38 a 61 Operating Profit 17 13 19 —cost of supplying a “call-in” software support service Included in all of the above costs are depreciation and amortization as well as a portion of occupancy and other shared costs. ‘Most accounting firms resist this type of accounting and allocation of costs, particularly for a startup firm. They may agree to track the cost of sales in this way, but they will almost certainly insist on lumping all operating expenses under such categories as salaries, rent, telephone, etc. They will argue that it is not worth breaking them out by activity such as selling, mar- keting and engineering because it means tracking all costs by department, and that this is not worth doing for a startup firm. They will even try to con- 16vice the entrepreneurs that the allocation of costs in this way can lead to administrative nightmares and a breakdown of team work. Nothing is farther from the truth. This topic is addressed further in chapter 7. Investors will want fo see the numbers expressed this way because they will want to know that the right mix of activities (and their resultant costs) is built into the busi- ness plan. While it is true that each of the departmental costs must be backed up by such itemizations, it is seldom necessary (or advisable) to put them into the material. They business plan because investors might regard them as “fille must, of course, be available on request. Obviously, a given pricing model can only be applied after the product meets some level of maturity, because in the early stages of any business, costs such as engineering and marketing cannot be contained to ten or fifteen per- cent of sales. Investment Requirements (Suggested length ~ 4 to 5 pages). The final step in the business planning process is a complete set of financial statements, the most important of which is a cash flow analysis. Before an investor will put money into a new venture, he or she will want to know how much total money it is going t0 take to turn it into a viable ongoing business that can attract funds from con- ventional sources (e.g. the banks, government programs, the stock market, etc.). Almost every new business loses money in its first year or two and those losses must be financed by the founding investors. Those same investors must put up most of the funds for the capital equipment that is needed to start the new business and they must finance most of the inventory and the accounts receivable until the business is able to generate cash on its own, ‘Those investment needs must be estimated and presented in a five-year cash flow analysis. Such an analysis must identify all these outflows of capital as well as the inflows from earnings, new equity financings, bank loans, gov- ernment grants, etc. It is not an onerous exercise once the operational vari- ables have been projected. Since those variables depend so much on accurate the importance of the marketing section of the plan can- revenue projections not be overemphasized. Ww‘The entrepreneur may wish to add additional sections such as one on the industry (or industries) pertaining to the technology and the market, one to explain the tech- nology itself, and one on the backgrounds of the key people. However, the above constitute the minimum that should go into any new venture business plan. A section on the potential payback to investors presents a dilemma. While it is tempting to say something like “a total of $400,000 of risk capital is required, for which the founders are willing to sell 35% of the equity in the company, thereby providing investors with a 30% compounded annual rate of return on their investment,” most investors would consider the entrepreneurs to be naive in stat- ing their opening bargaining position in this way. It is best to emphasize the qual- ity of the product and the market opportunity and allow the investors to start the bidding process Another alternative to the payback discussion is one on risk analysis. Chapter 6 describes how a deal will finally be struck between the entrepreneur and the investor and it will show that the percentage of ownership that an entrepreneur will have to give to an investor is more directly related to risk than to anything else. While the concept of the innovation chain to be described in chapter 5 will be helpful in quantifying the risk, there are many excellent texts on the subject which describe tools and techniques that are accepted in both business and aca- demic circles. For example, a book by Dr. Gerald G. Udell and Dr. Kenneth G. Baker entitled “How to Assess Before You Invest” describes a “Preliminary Innovation (Self) Evaluation System” or PIES-IV which uses 33 factors to evalu- ate a new venture. They are grouped as follows: a) Legality ~ are new regulations required, or could the new venture attract new regulations? Is the product safe? etc. b) Business risk factors — functionality, feasibility, payback period, etc ©) Demand analysis factors — demand trends, stability of demand, product migration potential, etc. 4d) Market acceptance factors ~ compatibility with existing attitudes and meth- ods of use, ease of use, dependence on other technologies, products and mar- kets, promotion costs, ete. ise of market ©) Competitive factors ~ appearance, durability, price sensitivity, entry, etc, 18In the PIES-IV methodology, each question has five possible answers ranging from negative to positive in terms of impact on the business. It therefore pro- vides an objective way of assessing the probability of the new venture’s success and it is extremely easy to apply. An entrepreneur should have some familiarity with techniques such as this for the assessment of risk. While the innovation chain will help in assessing the technical risks, a system such as the above will help in covering the broader spectrum of business risks. The process of analyzing risks will automatically help in their reduction and this will allow the entrepreneurs to keep more of the ownership for themselves. A Model Business Plan ‘There is no such thing as a perfect business plan. While a business plan is a nec~ essary step in raising risk capital, it provides no guarantee of success, no matter how well it is written, In fact, the Association of Canadian Venture Capital Companies (ACVCC) used to offer a prize for the best written business plan that ‘was presented at its annual “show-and-tell” meetings, but stopped the practice after two years when neither of the two winning business plans were able to attract any financing from ACVCC member firms, ‘This section will not include @ pro-forma business plan because there are plenty available from venture capital companies, government agencies and financial institutions. They will not likely follow the format proposed here, but they will address the same issues. Their financial sections will almost certainly violate the ules laid down above. Also, some of them, if followed too precisely, will result in unnecessarily long business plans because they tend to present the writer with an endless array of questions to be answered and the answers have to be tied together with a significant amount of narrative if they are to make any sense to the reader. What will be discussed in this section is how to tie the marketing data into the financial data, because it has been my experience that this is an area of weakness in nearly every business plan I have read over the years. What tends to happen is that the financial section of the plan is written by someone who is good at spreadsheet analysis, understanding the rules on depreciation, taxation, govern- ment incentives, etc., but is not as good at understanding the marketing informa- tion on which the financial data is based. Also, the person who is familiar with 19the market and the technology is unable to visualize the financial impacts of vari- ous alternatives. In fact, in all too many cases there is a complete lack of coordi- nation between the person who generates the financial data and the one who gen- erates the marketing data. For example, I have never seen a business plan (other than those I have helped prepare myself) include a bookings (orders received) line on the operating state- ment. This is probably the most important line of all because unless an order is received, there will be no revenue generated. But it is not done because “book- ings” is not @ common term in the accountant’s vocabulary. In some cases, orders will be easy to obtain and may even come before a proto- type is available for demonstration. In other cases, there will be a long sales cycle and the first orders will not come in any significant numbers until a presti- gious user gives the product (and maybe the market and the technology) credibil- ity. Obviously, the difficulty in getting orders will have a profound effect on the cash requirements of the new venture. It is for this reason that the entrepreneur should forecast the order stream as well as the revenue stream. In fact, in manag- ing the company after it is up and running, the bookings line should be the responsibility of the sales/marketing manager and the revenue line should be the responsibility of the operations manager (i.e. the person who fills the orders). The other marketing-related shortcoming of most financial statements is their failure to reflect fully the product migration concepts discussed earlier. In fact, if the financial analysis is done properly, it can help shape the product migration strategy. For example, if more emphasis on the price-reduced product will mini- mize the cash flow requirements in the early stages of the company, then the mid-range and high-range products should probably be delayed. On the other hand, if the high-range product is where the company’s future really lies and if it could be brought on stream quickly with a larger injection of capital, that might be a better strategy because venture capital companies are more prepared to con- sider opportunities that requite several millions of dollars than those that require a few hundred thousand because they assume that both types will require the same amount of attention. However, the payback from the larger investment must be identifiable History shows that product and market strategies pursued by most companies are closely related to their financing strategies. Digital Equipment Corporation was founded in 1957 with only $70,000 of risk capital and this was the only risk capi- tal it ever required until it went public in 1966 because it used its low-end prod- 20ucts (digital modules) as cash generators for introducing its high-end products (computers). Its mid-range products were computer testers (e.g. memory testers) that were constructed from the digital modules and actually sold to other com- puter companies. Corel Systems adopted a totally different startup strategy. Dr. Michael Cowpland, its founder, assembled a group of the most capable software and hardware people he could find and funded them until they developed products, that would sell in large volumes. This is how new product lines are created in established companies, but such an approach would not likely attract any outside venture capital. Dr. Cowpland acted as his own venture capitalist and gave his, people the technical and marketing leadership they needed to develop winning products such as Corel Draw. It is unlikely that the Digital or the Corel strategies were even reflected in detailed financial projections, but they were not conventional startups. One was too conservative in its approach and the other was too risky ~ at least for the average investor. Closer attention to the financial implications would probably have resulted in different strategies, but likely the same results. In the discussion which follows, a set of financial projections will be shown for a startup company that will be supplying the following products and services. a) A family of electronic instruments — Three different versions of the same product will always be supplied, with the first family being available five months after starting and the second about twenty-four months later. b) Post-sale service ~The products will carry a six-month warranty and will be repaired on a return-to-factory basis afier the warranty expires. ©) Software product — This will be a software package whose demand will be created by the users of the data produced by the family of instruments. It will be offered in the twelfth month of operation. The financial section of the plan will include the following statements which will show monthly figures for the first year of operation, quarterly figures for the fol- lowing two and yearly for the next two: a) Operating statements (Figures 3.1 through 3.3) b) Cash flow statements (Figures 3.4 through 3.6) c) Balance sheet (Figures 3.7 through 3.9) 21In order to substantiate such statements, the following additional statements will be required but will not be included in the business plan: a) Cost of sales analysis b) Cost centre statements ~ sales , marketing, engineering, etc, ©) Capital equipment purchases The following are notes of explanation on the various statements: .1 through 3.3) 1. Note that the first order for an instrument is received two months before shipment and that selling and marketing costs total $ 16K in the first quarter. 2. Engineering costs are budgeted to be in the vicinity of $ 6K to $ 10K per month during the first year. The president charges some of his time to engi- neering during the first five months. Operating Statement (figs. 3. Warranty costs are extremely high during the first year as a percentage of sales ($ 24K on sales of $ 320K) in order to ensure product reliability and customer satisfaction. 4. Some service revenue is actually generated in the first year because the war- ranty on the instruments is only six months. Some of this revenue is assumed to be generated by consulting activity as a result of customers asking for on- site training and support services. This would not have happened if the deci- sion had not been made in the beginning to operate the service department as a profit centre. The work associated with the $ 24K of warranty service was delivered by this same service department, but it was budgeted and expensed separately so as not to jeopardize the service manager’s chances of making @ profit from the non-warranty service. It is often lumped in with the cost of sales, but this penalizes the operations manager’s performance, because the product's failure during warranty is often more related to design problems than to manufacturing problems. The best way of dealing with it is ‘o have a separate budget for warranty and give it to the operations manager or the service manager for carrying out the activity. Otherwise, the warranty services will not be properly delivered and the company’s reputation will suffer. This is a subtle issue but one with dire consequences if not handled properly. (Note: In a company of this size, the service department would likely be managed by the operations manager until at least the fourth year, but it would always be budgeted separately.) G&A costs include outside legal and accounting services, incorporation fees, most of the president's salary, and overheads that cannot be realistically allo- cated to the various operating departments.6. It should be noted that when the accounting is done in this way, budgets can be more easily assigned to the various operating managers. For example. the sales/marketing manager owns the bookings line and the selling and mar- keting lines, while the manufacturing (or operations) manager owns the rev- enue, cost of sales, and gross profit lines. The engineering manager owns the engineering line, the financial manager and the president own the G&A line and so on 7. As the company matures, each of the businesses begin to reflect the pricing models referred to above, but for the first year, the emphasis is on bringing the products on stream and creating a market for them and this tends to dis- tort the engineering and sales/marketing budgets as a percent of sales. 8. Depreciation costs are built into the various expense budgets. Engineering costs may seem low in later years but they reflect the rather generous R&D incentives that are available in Caneda at this time (1992). (The incentives for selling and marketing are minimal and the costs shown are nearly all borne by the company.) 10. Selling, marketing and engineering costs show a sharp increase at the end of the second year because of the introduction of the second generation of prod- ucts in the early part of the third year. However, by this time, gross profit exceeds 60% on the first generation of products. It drops slightly in the first quarter of the third year to reflect the new product introductions, Warranty also increases slightly. Cash Flow Statement The main purpose of a cash flow statement is to determine the amount of capital required by the new venture, particularly risk capital. This can best be done by assuming that no capital of any kind is put in at the beginning and then itemizing all the elements of inflow and outflow of capital associated with operating profits (or losses), capital purchases, inventory purchases, credit from suppliers, etc., to determine how negative the cash flow goes. Depending on the collateral value of the assets that are in the company at that time, that maximum negative cash may or may not all have to be covered by risk capital, but such en assumption is usu- ally not far off. Banks and conventional lending institutions do not place much value on such assets because they typically do not know how to turn them into cash in the event of a bankruptcy. A cash flow statement can be very complex, but for purposes of a new venture business plan, it need only contain the following items:a) [es 98) Jon 0 0 oo fo |o 800) leo 98) _[92)_lor food ee @ |e os foe Jor foe sosurdeg| Sunesado reo} ser or for for for foe for fumpy a wp cd 0 Aouease 36 ar for for for Jor for | susomsuy 9 s |e |st |s Jor une re cele lett iumas sosuadg Sueando| ae SHUaADYLIO % FA st ss_[st_loe loc foe 0 kos |s2_hse) ojo jo [o 04g $804] soz Joct_joo los joc |jso se oor los jos |o Jo Jo [o HO oF or for 0 0 0 aaimIjoS oF or joc |oz 0 o 0 somaas ste 8 foe Joc joc fs» foc joc }sc Jor os 0 ore St_jo lor fsa for jor lee fos |sx Ise lo fo Jo fo $ $ 0 0 0 0 or for 0 0 0 Sor 9 Joo Jor fse for Joc |se fos sz {se 0 she oor {os _jso foo jor lor for [sx [sz sx [sc fsx |se lo st or for fs fo 0 0 0 or for 0 0 0 ‘up 08/09 Jo9 foor for Joc for |sz sz |se |se se |se ruxwior [ro few [iw fo] eo [ow [aw | av] [ow [sn nw [10 [ew [aw 24XeEOUY 1g] NBL 0g woIsA0. sie O8T 1 TUAWVLOL co1S Sune gry aundyy 261. Net income (loss) — taken directly from the operating statement. np Add back depreciation — this is required because depreciation is already included in the operating statement costs. 3. (Increase)/Decrease in current assets (excluding cash) ~ the main components of this item are increases in inventory and accounts receivable. (The operating statement does not reflect the delay between the time of invoice and receipt of payment.) 4, Increase/(Decrease) in current liabilities (excluding bank debt) ~ Vendors are a source of financing, which is why they rate so high on a company’s hierar- chy of responsibilities. (To be discussed in chapter 7.) 5. Purchase of fixed assets — plant and machinery, test equipment, etc. (This is what is depreciated and allocated as expenses to the various operating man- agers.) 6. Increase/(Decrease) in shareholders’ equity While there should be backup information available to potential investors on all the above items, particularly the current assets and current liabilities, it is not necessary to include it in the business plan, For example, even items such as share purchases due to the exercise of stock options (to be discussed in chapter 7) will impact the cash flow statement and the balance sheet but their impact is minor compared to the above operational items. The simpler the approach to cash flow analysis the better, but the assumptions should be clearly stated. A cash flow statement for this venture is shown in figs. 3.4 through 3.6. It reflects the following. 1. $500K of risk capital is required and is all injected at the beginning. During the first few months of operation, the main requirements for cash are 10 cover the operating losses and to purchase capital equipment. 3. Inventory is purchased at the time of first bookings (month 3) and accounts receivable show up in month 5 to reflect the first sales. 4. A major capital purchase ($100K) is made in month 7 to support the buildup of ‘manufacturing activity. Prior to this, most of the manufacturing is subcontracted out and the test equipment required for final assembly and testing is assumed to be rented. (The rental costs are included in the cost of sales.) 5. The cash is negative by $175K at the end of the first year. Even though it might be prudent to increase the equity (or risk) capital by this amount at this 2Se pe aunsyy omsaagy/eneiui| Ked foo sz Kon) (sep Supa) sassy asin uy seo. j (12424 s fst js |s Is € pads 904 Pvt (ca) Jaen jes) feo) (271 2p) aooen a9] git Joze jos | viz aw | 2sre aunty x4 a48yS UW (aSPa4D9q)/ase919U stossy panty Jo (aseyoang) Gaeq ue HupAy>X9) tw (asvasn9q) /aseo.0uy (use Suypnyaxa) sassy auazan ut asea.nag 1 (asva.0u) Hpa.dad. eH PPY| (69071 N) / auo09U 199] aounyegt yse Suyuado)| (oo0's) SoMa IV 29row) IS MOL YSeD 9'¢ andy Doureg auIsoT (osea.09q)asea.0uy] IaSy PX aaa 1H 10 (ase yang} xa) (use uppnpara) sassy quan ut aseasoaq_ j (asvaaoup)} uonepasdag eg ppy (88071 92N) / SAA TOL PAA TOLtime, at least some of the capital purchases can be covered by bank debt. ‘There are government programs available for guaranteeing such debt and even for providing it directly. The cash goes much more negative than this in yeai ‘wo, but the company has sufficient assets to cover it. 6. Another major capital equipment purchase is planned for the first quarter of year 3 to accommodate the new generation of products. This is obviously a critical period in the company’s evolution because sales will be relatively flat from quarter four of year two, gross profits will be down and further invest- ments in capital equipment will be required. Potential investors will ask a lot of questions about the cash flow projections for this period but they should be encouraged by the fact that this much thought has gone into a product migra- tion strategy. This is another illustration of the need for close collaboration between the person generating the numbers and the entrepreneur(s) with the product ideas. 7. The company’s cash flow increases sharply positive after the new products begin to produce revenue. Balance Sheet The main purpose of a balance sheet is to provide a picture of the overall finan cial health of the company. There is plenty of information available in financial textbooks on how to prepare and read balance sheets and it is not necessary to repeat it here. However, the following are some key issues that should be addressed in preparing and analyzing the balance sheets of technology ~ inten- sive companies: 1. How good are the accounts receivable? It is very easy for purchasers of sophisticated products and services to haggle over the exact nature of the deliverables and the terms of acceptance. In fact, if a customer decides not to pay for them, the best option for the supplier is usually to take them back (or in the case of services, negotiate a partial payment). Such transactions can have a devastating effect on balance sheets, particularly in the early stages of a company. " How good is the inventory? In the fast moving world of high technology, inventory can become obsolete very quickly and sufficient provision must be made for writedowns at all times. Such writedowns should be charged against the cost of sales and the operations manager should be held accountable for them. 3. How good are fixed assets? The same considerations as above apply to fixed assets, particularly sophisticated test equipment. 314. Beware of capitalized R&D and startup costs. Many high technology compa- nies treat certain product and market development costs as assets that get amortized over the expected life of the product. In fact, the accounting profes- sion and governments encourage such practice and have guidelines for what to capitalize and how to amortize it. The best advice I can give to any entrepreneur is to capitalize none of it. Not only are such assets somewhat dubious when compared with items such as inventory, accounts receivable and test equipment, their very presence in a company’s accounting system causes severe control problems. The reason is because it is difficult to mea- sure the true profitability of a particular product or service when most of the R&D costs it is carrying on its operating statement are related to the amortiza- tion of some R&D that was carried out several months ago. In high technolo- gy companies staff turnover can be high and promotions frequent, which ‘means that the person who was responsible for carrying out the R&D in the first place is often not around (or in the same position) when it is being amor- tized. I consider this topic to be of such importance that in earlier versions of this handbook, I included an item in the list of do’s and dont’s for presidents (chapter 7) entitled “Never capitalize R&D expenses”. I removed it, not because I no longer believe it, but because the issues were too complex to explain fully within the context of that chapter. Hopefully, the above explana- tions will provide a partial answer. 5. How sound are the accounts payable assumptions? The amount of credit available to a high technology company from its suppliers can depend on a wide range of variables and is therefore subject to changes which are unpre- dictable. For example, when the industry is booming and certain components are in short supply, suppliers will give preferential treatment to those compa- nies that pay their bills promptly. This means that a company that wants to be assured of a stable source of supply may have to shorten up its payables peri- od and even pay in advance. On the other hand, when the industry is slack, suppliers are not only willing to give extended payment terms but “just-in- time” delivery as well. Such variables can have a tremendous impact on a company’s inventory management system as well its accounts payable. Both can have a tremendous impact on the overall cash needs of the company, par- ticularly during periods of high growth when inventory buildup is required. Figures, 3.7 through 3.9 show the balance sheets for this venture. The following points are worth noting: 1. There are no capitalized R&D or startup costs. 32yous sourjeg {+ aan sity OLE toe [oct [eee faze | ooe [ioc [coe zoe [sse [sor [eer [cer [ase [aor zt sot [ere [ice lie [wee [ese [eae lume [see [ome [vie [or low [oom loo €) [sow fae) fired ote) (ese) [sve) [arc Koz) cos 0s Joos foos Joos |o0s | oos | oos ws 02, soi [vet {ror ror |es [oe foc foc at oI a {tu fe ye fe fe fe 5 s Sele le lela is s ° o fo Jo Jo Jo Jo Jo Jo Jo ° 8 s je |e je |e Js js fa |e 8 su set Jset |r Joor Jor foe fre for fo ° — og Ste [ore [eve [vee [exe fee occ See [sor [eer [eer [aor [ear wav PL ar wer [oer [oer ist for fear [ist a ay PA are, avz_|eve |eze [oar Jor fost [ort exe Jaze [ose [ose | cae | isp somsy nosing frm ee | tee | ees ee Serre | ceee| eres ceed set eee eee spe cena cama da se |se [se [se [se fsx Joo Joo Jos fos jor Jor Jor Jor Jo Jo sr sr Jor [sc Jse Ise Jee Jor fox foc |rz for Jor Jr Jo fs or Jor fos |ss [sv or Jer Jae Jac fac Is Jo Jo fo Jo |o o Jo Jo Jo Jo fo fo fo Jor jor Jost }rez foce foce | rae | ovr Tua ro [enw om co [ow [aw [iw | 20 [ow [sw [ow EESTSESENUTENECIETN) 33atgeseg soxeg, swoouy auqeeg syunoxy ssouparqnpuy yur, Aunbatstopyoqazeys 9 so sassy TIO, TaN PMAandi siapyoqaaeys » 5 aquseg sox, awoouy aigeceg siunosoy ssauparqapur ued,“Investment tax credits receivables” reflect payables due from Canada’s R&D Investment Tax Credits which in a company’s early years, are not really tax credits but actual cash paybacks for performing R&D. They range up to 35% of the R&D expenses until profits reach $200K and then drop to 20%. When the company becomes taxable, they serve to reduce its taxes payable, In the operating statements, they are treated as reductions in R&D costs in the early years which means that the R&D costs shown are net of all assistance. Summary Comments on Business Planning More will be said about the market research that must go into such business plans in the next chapter, but the following points should be noted from the above discussion: 2) The business opportunity should be described in simple language. b) The technology, the products and the markets should all be clearly definable. If the product discussion is weak, the plan is likely not viable. c) The plan should tell the potential investor what the annual sales Tevenues and profits will be in each of the first five years and how much investment capital (both equity and debt) will be required to launch the business and sustain it through that period of time. d) The plan should be as short and as clear as possible, With this information, any intelligent investor can decide whether to invest in such an opportunity or in a mine or a sawmill or government bonds. Before reaching such a decision however, he or she should give some consideration to how the investment will be managed, because a technology. intensive investment is not the same as the alternative investments because it will invariably require a lot more follow-up for it to be successful. That topic will be discussed in detail in chapter 7. Because of the extreme importance of good market research in the business plan- ning process (and thus in the identification and exploitation of technology) it is useful to address that topic in more detail at this stage in the handbook.4. Doing the Market Research ‘The market research for a new technology-intensive venture can be as difficult, costly and time-consuming as the scientific research and product development that must go into the creation of the product itself. Most entrepreneurs would find this an overstatement, but most seasoned venture capitalists would not. It is easy 10 do poor market research and get away with it, but if the scientific research or the product development does not get done properly, the result is very visible — the product does not materialize or it does not work when it does materialize. However, if the market does not materialize, it is always easy to blame it on such factors as “predatory pricing by competitors” or “poor timing.” In all too many cases, the real reason is that not enough homework was done in analyzing the market and properly positioning the product in that market in the first place. ‘This brings us to the distinction between marketing and selling. It has been my experience that when I tell scientists they are capable of doing marketing, and more specifically market research, they assume that I am trying to make sales- people out of them. I find that the easiest way to make the distinction is to go back to the operating statement that was discussed in the last section and explain how the two activities are budgeted. The activities budgeted in marketing and selling are listed in Figure 4. ‘What is being discussed in this chapter is marketing and more specifically mar- ket research. In order to do good market research the researcher must have a good knowledge of the technology and the products as well as their target mar- kets, It is indeed possible to acquire such knowledge without having any signifi- cant selling skills. ‘The main objective of the market research is to estimate sales revenue. As stated earlier, investors will want to know how much revenue can be generated in each of the first five years. One does not need any formal training in marketing to do reasonably good market research. Technical people should not be afraid to tackle it because their ability to forecast changes in the technology is an asset that many professional market researchers would envy. Also, most technical people have had experience in the evaluation of new products in the course of their work and so they can empathize with potential users of the products to be supplied by the new venture. 37Vice President Sales & Marketing R&D Communication * Competitive Data + Advertising + Networking + Product Migration Data “Trade Shows Prospecting + Industry Date Base + Product Releases Qualifying Prospects + Prospect Data Base + Customer Newsletter + Getting Orders + Customer Data Base + Applications Notes, + Forecasting Orders + Customer Survey's + Brochures + Managing Accounts + Macroeconomic Data + Data Sheets fanaging a Territory *Datz on the 4P's + Promotional Material ‘Managing a Distibution (price, promotion, + Direct Mail Campaigns (Channel place, and product) + Seminars Figure 4 The Difference Between Selling and Marketing The first step in the process is to understand the “jargon” of marketing, Just as an electrical engineer in today’s world would be unable to do effective design work without knowing what an eprom or a gigahertz is, anyone attempting to do mar- ket research must understand what is meant by terms such as potential market, market penetration, target market and market share. As has been stated above, market research is not easy, but it will at least be a manageable process if the person undertaking it takes the time to learn the vocabulary. Therefore, a few definitions are in order: Market ~a group of people with a common need, the ability to pay for the satis- faction of that need as well as the willingness to do so. For example, everyone needs air to breathe, but since it is available for free, it does not represent a mar- ket opportunity. Also, most people want their own houses, but if itis less expen- sive to rent a house than to own one, or if interest rates are unusually high, the willingness to pay for personalized housing goes down and so the market dimin- ishes. The important terms to remember about markets are satisfaction of a need and willingness to pay, because they are the things that determine the size of a 38market more than anything else. Also, it is very important to remember that mar- kets are made up of people because it is their needs that are being satisfied Markets are not institutions or firms but people within those institutions or firms, and it is the behaviour of those people that must be assessed. Target Market — This is defined by the types of users who are likely to have the need and the ability to pay for it. For example, a portable seismograph for mea- suring the after effects of dynamite blasts will have the following target markets: a) quarry operators b) construction companies ©) mines d) regulatory authorities ¢) blasting consultants Market Segments - This can refer to subsets of the target markets of to the target markets themselves. For example, the above target markets could be looked upon as segments of the blast monitoring market, or each of these target markets could be further segmented by geography, the type of quarry, sales volume of the user, the type of construction company (i.e. road building vs. basement excavations), the type and location of mine etc. So the term “market segment” can refer to a target market or to a component of it. There are many reasons for segmenting markets. For example, geographic segmentation of the quarry and construction markets will help in predicting the seasonal variations in the demand for seismo- graphs in those markets, because users in the more northern latitudes tend 10 cease operations during winter months. Segmentation by business volume will identify those that have an ability to purchase the product. Segmentation by proximity to urban areas will also be useful because it gives an indication of the number of quarry and construction operators who are likely to be involved in damage claims. One of the main reasons for monitoring blasts is to produce evi- dence that will be useful in such litigation. Market Potential and Market Penetration ‘These two terms are closely related and so they will be discussed simultaneously. The term “market potential” refers to the total market for a product or service and “market penetration” is the percentage of that total market which has been acquired by all suppliers. For example, microwave ovens have not completely penetrated their potential market, which can be defined as all households in the industrialized world. On the other hand, colour televisions have achieved a large penetration of that same market. While it can be argued that the need for a 39microwave oven in the average household is equal to or greater than the need for a television set, obviously the willingness to satisfy the two needs is different. ‘The implication is that there is a greater growth potential in the market for microwave ovens than for colour televisions, assuming both products last for approximately the same period of time Another way of thinking about market potential is to ask the question: “Who hes a legitimate need for this product if it were available free of charge?” In the case of the quarry market for seismographs, it would be easy to jump to the conclusion that the total market potential in North America is 60,000 since that is the total number of quarries. However, on closer examination, it will be found that those 60,000 quarries are owned by about 6,000 quarry operators and that most of them can get by with one or two seismographs since they do not tend to carry out blast- ing operations simultaneously in all of their quarries. In other words, they can “time-share” a single instrument. Therefore, the real market potential of the quar- ry market for seismographs in North America is more like 6,000 than 60,000. It is not the number of quarries, but the number of quarry operators — ot a slightly high- er figure depending on the amount of “time-sharing” that is possible. The next step in analyzing potential sales into that market would be to ask the question: “How many of those 6,000 operators have seismographs at this time?” ‘That is what the current market penetration will be. It is useful to know this figure because it is an indication of the difficulty of market entry. However, it is not uncommon for entrepreneurs to underestimate the current market penetra- tion, especially when entirely new products are being brought to market. For example, when the first seismographs were introduced to the quarry market, (and to the other target markets identified earlier) it would have been easy to conclude that the penetration was zero and therefore that all of the 6,000 quarries (the potential market) was available to the first supplier of such an instrument. However, many of the quarries had been using tape recorders to record the after effects of blasts for years and even though those tape recorders did not have the same functionality as the new seismographs, they were less expensive and they “got the job done.” Obviously, the assessment of market penetration requires the same kind of reason- ing as the assessment of the market potential. Using the above example, it would have been too simplistic to merely find out how many quarries there were in North America and how many of them already had seismographs. Even the trade statistics ‘on seismographs would have been misleading. They would have shown that a lot of seismographs were being sold, but since they were being used to measure earth- 40‘quakes or to search for oil or whatever, the statistics would not have been relevant to this particular market opportunity. (Remember the first step — identify the target markets.) In fact, a more detailed analysis of the statistics would have probably shown that none were being used by quarry operators. So if the seismograph entrepreneur in this instance had relied on statistics, he might have concluded that the penetration was zero, whereas in fact it was penetrated to whatever extent that the quarry operators were using the tape recorders. If 2,000 of the 6,000 operators were using them, then the market was penetrated by 33% since the tape recorders were in fact competitive products even though they were not called seismographs. In fact, if he had drawn a product migration chart, the tape recorders could have been shown as competitive products on that chart. They would have appeared in the lower left comer because they were lower in both price and functionality than his seismographs. The fact that they belonged on his chart should not have been a cause for concern unless they lay below the line representing his initial family of products. Incremental Market and Replacement Market In analyzing the behavior of a market such as the one discussed above when new technology and products are introduced into it, itis useful to break the sales into two components: a) those that replace the existing units (in this case the tape recorders) b) those that are bought by operators who have never used any type of monitor ing system in the past ‘The first is referred to as the replacement market while the second is referred to as the incremental market. These are two additional pieces of marketing jargon that the entrepreneur should become familiar with, because the marketing and sales strategies will tend to be different for each type of customer. The replacement mar- ket is usually made up of people who find it desirable or necessary to replace their existing units, whereas the incremental market is usually made up of more venture- some people ~ the “technology mavericks” as they are sometimes called. The for- mer are influenced by price whereas the latter are more influenced by functionality. The price / functionality chart shown in figure 2 can assist in predicting the buying patterns of each, In fact, the difference in buying patterns is another reason for pro- viding clear buying choices in terms of price and functionality. Market Share The ultimate objective of any market research activity is to arrive at market share, because that is a number that is vitally important to both investors and 41entrepreneurs, not only during the planning stage, but after the enterprise is up and running. It is widely accepted marketing dogma that a company’s gross prof- it is highly dependent on the share of the total market it is able to capture. Using the above concepts, a given supplier's market share is the sum of the replacement and incremental markets that he is able to capture, and if the total potential and the penetration are known, itis possible to calculate market share rea- sonably accurately. To translate market share into sales revenues for each of the first five years of operation, all of the above variables will have to be estimated. Figure 5 illustrates the above concepts in graphical form. The area of the circle represents the market potential and the sectors of the circle represent market penetration, the replacement and incremental markets. Market share is the sum of the replacement and incremental markets. It is also widely accepted marketing dogma that if all else is equal, the market share enjoyed by any product is related to two main factors + a differential advantage in terms of functionality and benefits to the end user, * the level of marketing and sales effort (advertising, promotion, personal sell- ing, etc.) in terms of dollars expended in support of the product. The people who develop the technology and the products (the scientists) can play a key role in evaluating the first factor, but they may need some professional marketing help with the second one. However, the same common sense thinking that scientists use in their everyday work applies here as well. For example, it would be unreasonable to aim for a 10% share of the market with a marketing budget of only 1% of what a competitor with an established 30% share of the market is now spending. It is also unreasonable to plan for a 10% share of the market if there are already 20 competitors in it with viable products and with healthy marketing budgets, no matter how superior the new product is, or how big the planned marketing budget is. Itis not uncommon for the founders of new ventures to overestimate their market share in the early years of product introduction. This is usually due to an unreal- istic assessment of differential advantages, as well as to a lack of understanding of the marketing challenge. There will also be cases where the market share is grossly underestimated. 42Market Potential “area of circle Incremental Market Original Replacement Market Market Penetration Figure 5 Market Potential, Penetration and Share Both underestimation and overestimation of sales result in financial difficulties for the new venture. The former results in lost sales and/or cash flow problems, while the latter results in inventory problems (which can also lead to cash flow problems). In the final analysis, the revenue projections will be the result of an iterative pro- cess in which tradeoffs are made between the budget allocated to manufacturing, engineering, administration, selling and marketing. As a guideline, a figure of at least 5% of total sales revenue must be allocated to the marketing function, and anywhere from 10% to 20% must be allocated to the selling function (refer to the pricing models which were discussed in the last chapter). In a new venture, sales and marketing are usually managed by the same person, but they should always be budgeted separately. 4BTo forecast total sales revenue for a product that will have several different target markets, the above analysis will have to be done for each of those markets. And if there are many products and many target markets for each, the market research task will expand accordingly. If it is done to the level of detail that most profes- sional investors require, the market research for the new venture can indeed be as difficult and time consuming as the development of the technology and the prod- ucts themselves. For example, in the model business plan discussed in the last chapter, a circle similar to the one shown in figure 5 should be drawn for each of the three businesses (instruments, service and software) for each of the five years. Such a chart is shown in figure 6.1. What it illustrates is that the potential market for the instrument is relatively large at the time of its introduction but it is relatively unpenetrated, That potential only grows by 40% during the five year period, but the company’s share increases dramatically. Figure 6.2 illustrates that the service and the software markets are created by the introduction of the new instrument and that they both grow significantly during the five years. However, the company is not able to retain 100% of those markets because others are capa- ble of supplying competitive services and products. If each of the products and services have distinctly different target markets, the number of circles will multiply accordingly. In actual fact, there is no need to use circles for all of them because a simple notation of market potential and market share for each of the years is sufficient. Whether circles or figures are used, all of them need not (in fact, should not) be included in the business plan, but they should be readily available for discussion with potential investors. This may seem like a lot of work, but you have likely put this much effort into the design of the product at this stage, so why not do it for the market research as well? Every would-be entrepreneur should try to gain as much knowledge as possible about marketing because more new ventures fail because of poor marketing than because of poor engineering or poor financial management. An understanding of the jargon is the first step in that learning process. Sources of Market Information ‘The following is an abbreviated list of sources of marketing information. However, the best source of marketing data for 2 new venture is often the trade associations and publications that serve the targeted markets. This list does not include such sources, because they number in the hundreds just in North America alone. 440 pouiad seaf-aay Sutnp %op Ka roe yore jos yoo ee [006 P0008 [099 for bs0'9% jsot [so0r loot [250 [eos [ss hso'0s borer sores bore bose 2098 WeotT fans jose juorrt boro [20°02 5091 fel ores osz'ss | osoves: | oor'es 09°98 Tae a 4546Canadian Business Index published by Micromedia Limited, 144 Front Street West, Toronto, Ontario [A reference guide to articles published in Canadian periodicals on business, industry, economics, administration, and related fields. Contains 15,000 subject items, along with names of companies, organizations, and individuals mentioned. Canadian Institute for Scientific and Technical Information (CISTI) ‘A unit of the National Research Council of Canada, Ottawa, Ontario, K1A 0S2, 613-993-2013 Scientific reference material — standards, technical publications, research activi- ties, ee ee Findex Cambridge Information Group, Bethesda, Maryland, 20814 ‘A listing of 13,000 marketing reports prepared by 191 marketing firms, (13 in Canada) along with their age, frequency and cost. _ ae Maclean Hunter Maclean Hunter Limited, 777 Bay St., Toronto, Ontario, M5G 2E4 Corporate, marketing and financial data. Forecasts, buying power indices, com- munity profiles, media and industry data based on Statistics Canada data jaca cee Market Research Handbook published by Statistics Canada, Ottawa, Ontario, KIA 0V4 ‘A comprehensive listing of statistical data on economic indicators, government finances, merchandising, population, personal income and spending, metropoli- tan area data and census data. Encyclopedia of Business Information Sources published by Gale Research Company, Book Tower, Detroit, Michigan, 48226 'A detailed listing of subjects of interest to managerial personnel, with a record of ‘source books, periodicals, organizations, directories, handbooks, bibliographies and other sources of information. ee 47Fraser’s Canadian Trade Directory 777 Bay Street, Toronto, Ontario, MSW 1A7 A list of Canadian manufacturers and distributors by product category. (A Maclean Hunter publication) Scott’s Industrial Directory of Manufacturers, published by Scott’s Industrial Directories, 75 Thomas Street, Oakville, Ontario, L6I 3A3 A list of manufacturers by cities, towns and SIC code. Published in 4 editions annually, covering western Canada, Ontario, Quebec and the Maritimes. Arthur D. Little Acom Park, Cambridge, Massachusetts, 02140-2390, Tel. 617-661-5830 Economic studies, industry sector surveys, technology forecasts. Evert Communications Ltd P.O. Box 3158, Ottawa, Ontario, K1Y 44, Tel. 613-728-4621 Various newsletters on electronics and R&D in Canada. Maintains a database of corporate profiles and industry statistics. Infoglobe 444 Front St. West, Toronto, Ontario, MSV 289 Socio-economic data, newspaper articles. Dialog Information Services Inc. 3460 Hillview Ave., Palo Alto, California, 94304 Electronic data base of scientific, economic and marketing data. Frost and Sullivan Inc. 106 Fulton St., New York, 10038 Market, product and economic studies. 485. Finding Exploitable Technology Most entrepreneurs who want to start a new business already have a product in mind. If it is a technology-intensive product, they already have a technology in mind, However, there are many people in the technology venturing business who do not, They are people whose job it is to encourage entrepreneurship ~ to find exploitable technology, identify products or services that might flow from it and then go about finding the management and the money to create a business. They are the technology exploiters and brokers referred to in Chapter 2 as well as commercial development officers, R&D managers, consultants and venture capi- talists. They must start by finding exploitable technology. ‘This chapter will be useful to such people as well as to anyone who is thinking of becoming an entrepreneur and is at the technology assessment stage. 5.1 It Is Not Always Where You Think It Is One of the misconceptions about technology is that it is only found in research laboratories or universities or other establishments which form part of what is commonly referred to as the “knowledge industry.” In fact, tech- nology is everywhere; it is on farms, in retail stores, in small manufacturing shops and in many other places that people do not tend to associate with technology. ‘A farmer who develops an add-on device for a piece of farm machinery is not only creating technology but is advancing it along the innovation chain by turning it into a useful product. If he sells a few to his neighbours and they find it a useful product, he has taken it through the entire length of the innovation chain, from the idea stage to the distribution stage. He has simply not formalized the innovation process by writing a proper business plan, raising some investment capital and starting a business. ‘The people whose job it is to encourage technology venturing would do well to look beyond the traditional R&D laboratory for exploitable technology. ‘An understanding of all of the steps involved in taking an idea and turning it into a product and a commercial enterprise will be helpful. 5.2 The Innovation Chain Nearly everyone involved in the innovation process has his or her own con- cept of an innovation chain, Figure 7 shows the basic components of one 49that applies to the exploitation processes described in this handbook. Obviously, the relative importance (and difficulty) of each phase will vary depending on the technology, the product and the market involved. Also, it will be somewhat different for a service-oriented venture than for a goods- producing venture. Nevertheless, each of these phases will be present in nearly every innovation process. The chain which is illustrated is directly applicable to a technology-intensive hardware product. Obviously, stages such as the “engineering pilot run” would not apply to a software product of a service in the same way that they would to an electronic instrument. On the other hand, some form of cus- tomer evaluation is typically required for such ventures at or near this stage of development, so the concept of an engineering pilot run is still applicable even if it comes under a different name. Also, the definition between phases is not as clearcut as suggested in the fig- ure. Most companies do both technical research and market research throughout the entire product life cycle in the hope of finding variations on the product and developing new markets. It is this activity which delays the eventual decline in the sales and profit curves. In fact, if the product migration strategy which was outlined in Chapter 3 is followed properly, each of the new products represented by the “price reduc- tion” and “increased functionality” strategies will be introduced well before the original product reaches maturity. Figure 8 illustrates how the S-curves represented by the sales revenues from each of the products cascade upon each other to provide a total sales curve that grows continuously. A good product migration strategy will result in timely product introductions to ensure that the new products will begin generating revenues at or very near the time that the old ones ate reaching maturity. It should be pointed out that figure 8 only shows the sales curves associated with the new products and that the introduction of each product will require an investment (or negative profits) in both technical and market R&D as well as inventory buildup and all of the items identified in Chapter 3. The payoff from such investments can be dramatically affected by either premature or late introduction of the product. Premature introduction will sap the old product of any life that might have remained in it and if the new product cannot be deliv- ered in sufficient volume to make up the difference in sales volume (which is often the case), then total sales could fall. Late (or slow) introduction could give the competition an opportunity to gain market share. 50sutsows IDEAS AS ae : BA trots business Pn 5 | __teermieat sto wartet R40 z 15 emit | tnpinering Protouee Tengineering Pot ng ae castor twintion ps pre-protction ot] g Se |_frewet Mefienerse worket Develoment Tnereased anpetition je becrine TPINANCIAL RETURN Figure 7 The Innovation Chain SLNext Generation (Price Reduced Product) a sates 7” NexGereion uta 7 tacts Ere eae re ~~ TIME Figure 8 Cumulative Sales Curves A detailed discussion of every link of the innovation chain is beyond the scope of this handbook, but it is presented here to illustrate the following points: a) Ideas are easy to generate and easy to kill. b) There are many steps between the idea phase and the distribution phase and all of them require financing. ©) The people who use technology and the people who produce it are at opposite ends of the innovation chain and are often motivated very differ- ently. For example, researchers are often more interested in advancing the science on which the product is based, while the user is generally only interested in the features, functions and benefits of the product or service, 52It is worth elaborating on those phases that specifically relate to the intro- duction of the product or service to the marketplace, because they are the phases that create wealth, Also, it will be noted that the mortality rate of ideas shows a slight upward “bump” in the product development part of the chain. This is because it is not uncommon for a product to show great promise during the “idea” and “R&D” phases, and then fail during the “product engineering” phase because it cannot meet its intended specifica tions at a reasonable selling price. Also, it is not uncommon in a fast moving technology for a new competitive product to appear on the scene at this stage. In a large corporation, such a competitive product may come from within the corporation itself, sometimes in the form of a service. The following is a list of the key activities that would be carried out in the stages from “breadboard” to “pre-production”, For purposes of discussion, the product is assumed to be an electronic instrument and the target markets are assumed to be the laboratory and industrial markets. Breadboard and Product Definition define the functionality of the instrament do a block diagram do a proof of concept do a technology assessment test the integrated system Engineering Prototype ' document the design finalize specifications and operating procedures complete list of materials check adherence to quality standards Engineering Pilot Run — doa short run of the engineering prototype — establish quality control and maintenance procedures — document the production processes Customer Evaluation — demonstrate and install the product at customer site — evaluate and maximize “user friendliness” 53Pre-production model finalize final assembly and test procedures draw up product promotion and introduction plan finalize bill of materials It is easy to see how the product could die during any of the above steps. I can recall a product at Digital that got sent back to the drawing board because when it reached the engineering prototype stage it was subjected to the scrutiny of the service department and they discovered that four different tools were required just to take it apart so it could be serviced. It is useful to familiarize the scientist and all the people who will be involved in writing the business plan with the above steps because most peo- ple tend to underestimate the difficulty (and the cost) of bringing a product to market. Some Questions to Ask Even though it was emphasized earlier that R&D laboratories (and the scien- tists who work in them) are not the only sources of exploitable technology, it is useful for investors and other technology exploiters to know how to com- municate with them. In fact, it is useful for them to feel comfortable with the types of people who are likely to become innovators and with every possible source of technology. A person looking for exploitable technology will be overwhelmed by the variety of sources available. There are many commercial organizations in the business of publishing lists of technology transfer opportunities. Nearly all government research organizations and universities have staff dedicated to making known the commercial opportunities that their research might pre- sent to the outside world. The value of such sources will vary widely with the technology, the product and the market. Technology can be licensed to many different people at the same time, and so just because it comes from a catalogue that has been in circulation for several months does not mean that the technology has been “shop wom”. Technology can be thought of as the ultimate renewable resource. While mature technology may not be as excit- ing or interesting as new technology, it is usually easier to transfer, it can be put to use more easily and it can be renewed and upgraded more easily. 34“ew No market history "Fad" Markets and high technology risks Market oLo eg. Hula hoop eg. Video home shopping Good profit margins but very high risk because ‘the market may not accept the product No market stability Proven Markets Some market history and Technology available eg. Appliances eg. electronic thermostats, portable field instruments Low profit margin Good profit margins OLD Technology NEW Figure 9 Technology and Market Maturity Matrix However, the most exciting and promising technology is usually new tech- nology. The best business opportunities generally occur when new technolo- ‘ew technologies applied to new markets can gy is applied to an old market. be more exciting, but such ventures are extremely risky since no market his- tory exists and because large investments are usually required to develop the market. Figure 9 illustrates the risks and opportunities associated with vari- ous combinations of market and technology maturity ‘The dream of every technology exploiter is to find new technology. The best way to do this is to talk directly to the scientists. But just as the dialogue between a scientist and an end user can be difficult, it can be equally diffi- cult between a scientist and a technology exploiter. The scientist is likely to try and use his or her latest technical publication as the basis of the discus- sion while the exploiter will want to talk about a piece of hardware or soft- ware, or a service, In fact, the exploiter will really want to talk about a busi- ness plan which describes the product, analyzes the market and projects investments, revenue and profits. Some kind of common ground must be found to establish an effective dialogue.The following is a suggested list of questions for the exploiter to pose to the scientist + Can your research lead to commercial products or services? ‘The answer to this is nearly always strongly positive because every scien- tist wants to feel that he or she is making an economic (as well as a social) contribution to society. + In what time frame? It will be difficult to extract a reliable answer to this question from the average scientist because such people are usually unfamiliar with the steps involved in commercialization. This is where a detailed discussion of the innovation chain can be of some help. + Where does your product fit on the innovation chain? ‘The answer to this question will help quantify the risks and the costs involved in bringing the product to market. Most researchers tend to be too optimistic about where they are on the innovation chain. + If an investor were standing in front of you with a million dollars to invest in a new business based on your research, how would you describe that business opportunity to him or her? ‘This is where the dialogue gets even more difficult, because the researcher will think that the best thing to do with the million dollars is to put it into more research. So it will be necessary to familiarize him or her with all of the components that go into the negative cash flow shown in Figure 7 — namely market research, inventory, accounts receivable, plant and equip- ment, etc. If necessary, the scientist should be given a model answer to this. The one that was used as the opportunity statement in the seismograph example in chapter 3 might serve as an example. It might be expanded as follows: “The major technological breakthroughs that have been achieved at Canuck to make this product possible are: a) A new sampling technique which reduces the amount of memory required in the computer that is built into the seismograph (which of course must be portable). 56by A selftriggering system which allows the instrument t0 operate unat- tended. c) Anew method of interfacing the seismic sensor unit to the computer.” ‘The important thing to note about the above answer is that it identifies the technology involved, it gives a thumbnail sketch of the product, and it lists the markets it might address. In short, it gives a potential investor enough information to not only ask more questions, but to do some homework on his own. “Another thing to note about the above answer is that itis in simple, non-tech- nical language. “The answers to such questions will allow the opportunities to be captured on paper so that they can be reviewed by potential investors. A tool for doing this will be described shortly, but itis first useful to discuss the prospecting task from some other perspectives so that the dialogue can be carried out as intelligently and smoothly as possible. 5.4 Pure vs Applied Research One of the most common misconceptions in the technology exploitation business is that only applied research results in products or services. Nothing could be farther from the truth, particularly with today’s pace of technology; the time lag between invention and commescialization is shrinking at an accelerating rate in nearly every field. The following table will illustrate how this time lag has changed over the past century and a half. INVENTION TIME LAG FROM INVENTION ‘TO MASS PRODUCTION Photography 112 years Telephone 56 years Radio 35 years Radar 15 years Television 12 years ‘Transistor 5 years Integrated Circuit 3 years Laser 5 years 37In addition to the shrinking time lag, one should consider the following fac- tors which relate to the potential of pure research for innovation: 1. Pure research often involves the development of test procedures and test instruments which must be “hand-crafted” because they are not commer- cially available. The commercialization of such procedures and instru- ments, both of which would likely be at the breadboard stage in the inno- vation chain shown in Figure 7, often presents unusually exciting busi- ness opportunities. Ideas and scientific knowledge (and in particular software) that get gener- ated as by-products in pure research activity can be packaged and sold on their own. The licensing and transfer options for doing so are extremely varied and will be discussed in the next chapter. A proactive approach to technology exploitation will force both the scien- tist and the exploiter to do at Jeast rudimentary technology forecasting. ‘There are many examples of cases where such activity might have influ- enced the development of products in the past. Scientists at the Atomic Energy of Canada Ltd, (AECL) Chalk River Nuclear Research facility developed a sophisticated pulse height analysis system in the late 1950's using core memories and transistors, both of which were very new devices at the time. Those same scientists could probably have predicted that a complete arithmetic element could be built out of those same tran- sistors a few years later and that it could be made small enough to fit right into the analyzer. (They needed computing capability, but they were doing it off line at the time.) If AECL had initiated an “arithmetic element development project” after they mastered the core memory and transistor technologies, the result would likely have been the development of the world’s first minicomputer. As it turned out, the world’s first minicomput- er was the PDP-5 developed by Digital Equipment Corporation in 1963. It came about by reducing the word length of a larger computer from 18 bits to 12 bits. In fact, it was developed for a reactor control experiment at AECL which was unrelated to the pulse height analysis project. When the nuclear physicists who had been using their own home-built analyzers Ieamed of its ability to do that task as well as computing and controlling, they discarded their own instruments in favour of the computers. Although technology forecasting is usually scorned by most scientists because there have been so many mistakes made in it, the exploiter should urge the scientist to do it, just as he is urged to assist in product and market 58definition, Certainly, some technology forecasting on the part of the AECL scientists could have drastically changed the course of computer develop- ment in Canada. Considerably more could be said about the potential of pure research for new products and services, but the important thing to remember is that there is not a natural progression from pure to applied science, to breadboarding, to engineering prototype and so on. A carefully thought out strategy of exploiting the by-products of pure research can result in @ shortened innova- tion chain. As the AECL story illustrates, some technology forecasting should be part of that strategy. Lessons in exploiting pure research might also be learned from the history of the transistor itself. Even though there was a relatively short interval between its invention and commercialization, that interval might have been shorter if a proactive exploitation program had been in place at the Bell ‘Telephone Laboratories where it was invented. The major problems with the early transistors were related to instability and unpredictable performance characteristics. If such a program had been in place, two complementary projects would likely have been initiated as soon as the transistor was dis- covered — one dealing with circuit design and the other with quality control. “The above examples are provided to illustrate what might have happened if a more conscious effort had been made to turn pure research into viable com- mercial products through technology forecasting. It is difficult to devise « common approach to such efforts, but the following is a list of more specific questions that might be put to scientists working on pure research: + What trends do you see in this technology that might influence the kinds of products that might flow from it? + What trends do you see in related technologies that might influence this technology and/or the products that might flow from it? + What parallels can you draw between your technology and products and others that you have been familiar with in the past? + What type of research do you think you will be doing five years from now if you continue to work in your present field? ‘The main point of the above discussion is that pure research can be just as pro- ductive as applied research in the development of new products if the dialogue 59can focus on the future. However, it may require a somewhat different approach and a different dialogue. In fact, as was pointed out in chapter 2, the pure research may never lead to exploitable technology unless a conscious effort is made to make the connection between the two. A clear dialogue between the researcher and the exploiter is the most efficient way of doing so. If the technology exploiter has the authority to alter the research program or initiate a complementary one, commercialization should come more quickly Business Opportunity Documents ‘A useful tool for packaging technology exploitation opportunities so that they are more visible and understandable by potential exploiters is an abbreviated version of the new venture business plan known as a Business Opportunity Document (BOD). It has been used extensively by Doyletech Corporation in helping Canadian publicly funded laboratories transfer their technology to the outside world. Assistance in its development was provided by Dr. Keith Belinko of CANMET who saw it as a middle ground between “technology fact sheets” which had been used by CANMET for this purpose for some time and full blown business plans which were originally proposed by Doyletech. It is intended to be less than three pages long and has the following format: ‘The Business Opportunity... 4 simple statement of how an investor will make money from a product, service or process generated by the technology. The Technology... 2 brief description of the technology so that potential investors can determine quickly if it fits with their own missions. ‘The Products/Services and Processes... a brief description of each, along with possible migration strategies. ‘The Markets. who will purchase the products, services and processes and in what (approximate) quantities over some period of time (usually five years). ‘The Investment and Payback... an indication of how capital intensive the exploitation process is likely to be, the timing and the magnitude of the payback. 60Technology Transfer Possibilities... how investors might work with the owner of the technology (licensing, sale of technology, consulting arrangements, etc.) In order to dialogue effectively with the outside world, the people who are actively involved in the exploitation of technology will find it useful to maintain an inventory of all current opportunities on which they are work- ing. The best way of doing this is to maintain a list in which the key parame- ters of every opportunity are clearly spelled out. The parameters used in the Business Opportunity Document are suitable for this purpose. Figure 10 shows a format for such an inventory system, In addition to simplifying the dialogue between potential investors and those who want to see the technology commercialized, such an inventory system can be useful to research managers because it allows them to identify opportunities at an earlier stage and to rate one against another for the allocation of resources. In an established manufacturing or service corporation, it can be used to decide which ones should be pursued internally and which ones should be pursued externally through such arrangements as licensing or joint ventures. (The crite ria for making such choices will be discussed in the next section). It can also be used in performance appraisals for people whose job it is to snerate exploitable technology. Commercial development officers in research laboratories and universities. and even economic development officers at the municipal level will find such an inventory system useful in their work because it provides them with ‘a menu of opportunities for presentation to outside investors. Finally, it can be used to safeguard the technology and to control the flow of information relating to it. Choosing the Appropriate Exploitation Vehicle While the main thrust of this handbook is the creation of new business ven- tures, there will be situations in which this is neither practical nor desirable. For example, if the new technology involves a process that can only be used in an office or manufacturing environment as opposed to a preduct or ser- vice, and the developer of the process is strictly a manufacturer, he may grant one or more licenses to others who may wish to use it. He may also use it to improve his own productivity. 61sayqunpoddg won exe, ABopouysay, Jo Kzojuaauy jearddy, Y OT ANSE TpuLs ywony+| — porwsuaduroo asuaory] (9007 1k sieog + omy + Burssa001g aatsnpoxo-uon « |

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