SOPHISTICATED FINANCE

Facebook Stock Price Slides

Facebook is now trading at 24% below the IPO price. This is a significant price adjustment for a new stock (or any stock) and suggests that the bankers overpriced the stock at the IPO. Aswath Damodaran, the legendary NYU finance professor, explains where the bankers went wrong in this excerpt from Business Insider:

"I think the investment bankers priced the offering based on how shares of Facebook were trading in the private market and their assessments of institutional demand. I don't think that revenue growth, margins, risk or any other fundamentals played much of a role in the pricing. I don't fault them for playing the momentum game, but they played it badly."

Most stocks do not have a large active private market prior to their IPO. Facebook established their private market partly as a means to provide liquidity to the founders and perhaps to provide some support for an aggressive valuation at the IPO. 

As crowd funding grows as a means to fund startups and other private markets in pre-IPO stock emerge, perhaps one should be cautious about these markets as a basis to price IPOs. 

 

Information Curation

I am always intrigued by companies trying to curate information. I continue to believe it is huge business opportunity. Last post on this theme is here.

From the Live to Close website comes Industry Dive, described here. Industry Dive provides original content as well as a collection of articles, posts and tweets by industry.

I have been following Live to Close for about ten days and they consistently post on interesting startups.

Financial Modeling Workshop Miami May 11

I will be doing a workshop for the FIU Pino Entrepreneurship Center on May 11. The workshop focuses on how to build financial models, including an introduction to some advanced Excel commands that make building models easier. This workshop begins where my workshop on business concept development and growth drivers ends. There is an exercise that develops the logic of model building, a digital handout of a linked income statement, balance sheet and cash flow model and a handout of the advanced excel commands.

More details on the workshop are here. Proceeds go to the Pino Center at FIU. If you would like to see a previous presentation, look here. Very practical, little theory, informal style.

Disclosure: I am a member of the Board of Directors of the Pino Entrepreneurship Center.

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I Need to Rent an Alligator

I had to wait until after April Fools Day to make this post. Otherwise everybody would have thought it was a joke, but I am serious about this. I need to rent an alligator. This is not a variation on "time sharing dogs"--I promise. Here is the story.

A young woman approached me for advice on starting a new business. She wants to be a mammal trainer--dogs, cats, etc. She tells me that she has experience training whales, dolphins, lizards and alligators. I politely ask her if she has a video showing her training alligators. She says no and now you know why I need to rent an alligator. What better way to promote a new business than a video of a ferocious alligator being trained by a young blond woman.

For those of you have read SF for a long time, you should be asking yourself "where's the large market opportunity" in mammal training. The idea I gave her is that she should work toward developing a reality TV series where she trains a different, preferably ferocious animal each week. With all the tie ins such a series could grow into a significant media company.

If anybody wants to see the trainer, her picture is below with a killer whale. If anybody has an alligator to rent, please contact me.

 

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A Simple Rule for Entrepreneurs

My good friend @Yaquesita, also known as @OLPC_Mexico in another life we share, sent me this article "A Good Mentor Will Tell It Like It Is". The required features in a mentor really highlighted the typical weaknesses in entrepreneurs that need to be addressed:

• "Most entrepreneurs have lots of ideas. Some can be put into practice easily, but others will be off-the-wall and need refinement to implement"
• "Entrepreneurs tend to be driven by the crisis of the moment. As such, it is easy to neglect the real priorities of growing the business"
• Entrepreneurs have a constant stream of ideas, but the resources available set the agenda
• Entrepreneurs need to expand their networks in order to efficiently access the best resources to address an issue
• Entrepreneurs tend to become so immersed in their business that they tend not to take the time to reflect and plan

Constant crisis and no time to reflect on the customer, business and revenue growth are two sides of the same problem. Good entrepreneurs always find time to think and plan. If you are unable to tell the difference between a real crisis and the problem of the moment, you should consider this simple rule:

If it does not affect the customer or cash flow, ignore it. 

Leaders who focus on the correct issues and set proper priorities have many fewer employee issues, which is why I have omitted employees from the rule. However, employee morale and development should be the third priority.

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Problem Solving and Business Model Development

I learned early in my teaching career that students need dramatic images and sayings to help retain concepts. From this methodology came the idea that students should tattoo on their arm "don't run out of cash". Later I started using the question "why can't I timeshare a dog?" to reinforce the idea of relaxing an assumption to develop a new business concept. Recently in social venture workshops I have compared non-profit foundations to stockbrokers, which usually quiets the room and grabs everyone's attention.

The latest idea that I have introduced into my repetoire of teaching tricks is "functional fixedness". This concept basically shows that we have an inherent inability to deconstruct physical things in order to re-assemble them for new purposes. The famous example is you find a box with two rings, a candle and matches. How can you connect the two rings. Most people cannot come up with the solution because of functional fixedness.

Yesterday I heard about a great example of functional fixedness that has spawned a new business model. Most restaurants rent their space but have limited operating hours that match the meals they offer. The rest of the day the space is dormant. In a new business model for restaurants, restauranteurs are renting the unused time (and space) to launch totally different restaurants. For example, during the day the restaurant offers American cuisine for breakfast and lunch and closes at 4 pm. Now at 7 pm a new restaurant uses the space to offer nouvelle French cuisne dinner meals. Both restaurants have lower operating costs and the physical space (functional fixedness) is better utilized. Very clever.

Answer: melt the candle and use the candle wick to tie the two rings together.

More Big Data-Clear Story

My friend @John_Menezes sent me this link to Clear Story after yesterday's post on "Data-based New Business Ideas". Clear Story is working on tools to manipualte big data sets, analyze the data and draw meaningful insights. What is particularly noteworthy are the blue chip investors-Google Ventures, Andreessen Horowitz and Khosla Ventures. These three firms are all top tier VCs, which suggests that the opportunity in big data analytics is very large.

Killer Apps May be Confusing US

IP Carrier is an excellent blog that focuses on new business models in telecom and related areas such as data. A recent story, "Is there a Tablet Killer App?", raised an interesting point not just about tablets but all computing devices.

From the early days of computing, a new device succeeded if there was a "killer app". A killer app was a software application that had such high utility that people bought the device to get the app. The classic killer app was the spreadsheet running on the PC. The conventional wisdom is that VisiCalc, Lotus 1,2,3 and Quattro Pro, the early spreadsheet apps, made the PC market. However, we all know that Microsoft Office, which integrated several useful apps, is the most profitable Microsoft product. What Microsoft realized is that the suite of productivity apps, and not a single product (app) was the way to satisfy the customer need. Effectively, Microsoft looked beyond the product and looked at what was the customer need. (Perhaps Microsoft's last great insight until they became a game company.)

This issue of looking at product and not the real customer need may explain the decline of BlackBerry. The "killer app" for Blackberry is generally considered to be email. However, email was available on PCs and the real benefit to the customer was reliable, remote access... to email. Reliable, remote access explains the popularity of BB Messenger in many developing countries where network quality is not good. Many people in such countries buy their Blackberry just for BB Messenger as a chat device. If Blackberry had realized that the way the device was used and not the app was important they might have dominated chat worldwide and not have their current problems.

If we now turn to the tablet, we should not be considering killer apps but rather why do people use the device. Fortunately there is no "killer app" on the tablet to confuse the analysis. In talking to hundreds of people about their tablet, nobody singles out a particular app consistently to explain their tablet purchase. The manufacturers all highlight their app stores but nobody ever says they bought an iPad because they can easily add new apps. Maybe early adopters mention such "geek nonsense" but typical users never mention it. What people typically cite is the interface and how everybody in the family can use the device--even two year olds. Maybe tablets are "family" entertainment devices or maybe they will become "childrens' connectivity devices". 

When the tablet first emerged, Frog Design, the world renown design firm, said that the tablet was a new interface and not a new product (SF story, Frog Design article, both from March 2010). Frog focused on the customer and why they would use the device and not the device or its apps. This is the same point IP Carrier made in their story. It is a point that cannot be over emphasized. Understand the use case of the customer and not the product.

Data-based New Business Ideas

Last week I met with a young engineer to discuss his early stage company. The company has about $1.5 million in revenue and provides a sophisticated telecom service using proprietary software to manage real time data. The company has one large customer and the entrepreneur wanted to discuss how to find the next customer(s).

In the course of the discussion, I realized that the company, as a by-product of providing its service, was capturing information about company operations that the client did not have. Making the engineer realize this point was a challenge because he thought he was in the telecom services business. Any company that is capturing a large amount of real time data should step back and see if there is a more valuable use of the data.

 For example, a company that does processing of insurance claim collections for doctors has a huge data base on the different procedures and costs for a standard medical procedure--a broken leg. Every legitimate doctor bills the same services and procedures. Any doctor that consistently bills insurance companies differently is probably a crook. We could use this database to identify Medicare fraud by doctors. Yes, the company does medicall billing to insurance companies but using the data to prevent Medicare fraud may be a more valuable business for the company.

This story last week in the NYT about GT Nexus also illustrates my point. The company has a cloud-based service that integrates the supply chain logistics data of large international companies and their thousnds of suppliers. Effectively the status of a shipment can be traced from point of origin to the ultimate customer. Taking this data in its entirety and you have a detailed view into the world economy, a data base that few, if any, other organizations have. GT Nexus has the ability to forecast economic performance based on leading trade indicators, calculate the balance of payments for countries and identify new sources of products by country (e.g. formally China and shifting to Indonesia). The by-product data of supplying logistics tracking is perhaps more valuable than the underlying service.

I frequently write about the need to understand the customer and not get trapped in constantly focusing on product development (especially for engineers). In companies that capture large amounts of real time data, perhaps one should consider if there is a more valuable use of the data for a new customer.

 

The Importance of Distribution

One part of the business model that I stress more than most commentators is distribution strategy. This is probably because I came from the retail industry and partly because distribution and logistics are not taught much in business schools. Apple's iPhone experience in China illustrates the importance of distribution.

Apple is the worldwide leader in smartphones in every major market except China. There they are way behind the market leader--Samsung. Samsung has a 16.8 percentage point lead in market share and their lead is increasing, according to this story in Bloomberg. Part of Apple's problem is that they have not secured a distribution agreement with the largest Chinese cell carrier--China Mobile. The fact that the iPhone does not support the protocol for China Mobile's network is part of the reason, but one could ask who designs a product that does not work in the largest distribution network, 633 million subscribers, in the world. 

Image credit: Wikipedia

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Chomsky on Creativity and Innovation

Noam Chomsky is one of the legendary thinkers of the 20th century. Now an emeritus professor at MIT, he established his reputation in the fields of linguistics and philosophy. He is also well known as an activist for social causes.

A recent speech (with video) on the "Purpose of Education" is in this article from Fast Company. What caught my attention was this quote on creativity and innovation:

"It’s the way cultural progress takes place generally. Classical artists, for example, came out of a tradition of craftsmanship that was developed over long periods, with master artisans and others, and sometimes, you can rise on their shoulders and create new marvelous things. But it doesn’t come from nowhere. If there isn’t a lively cultural and educational system, which is geared towards encouraging creative exploration, independence of thought, willingness to cross frontiers, to challenge accepted beliefs… if you don’t have that, you’re not going to get the technology that could lead to economic gains.”

Great thinkers always explain complex ideas simply. Culture and education foster creativity and innovation.

 

Educating Young Entrepreneurs

I have written frequently about the need to start entrepreneurship education at a much earlier age, perhaps as early as middle school. (Previous posts are here and here.) Two stories support this trend:

1. A prep school in Miami recently received an anonymous grant of $7 million to establish an entrepreneurship program
2. The Academy for Software Engineering, a new NYC public high school, is recruiting its first class. More detail in this post from AVC.

The related articles below talk about programs supported by the Kauffman Foundation and the University of Chicago. The quality of the people experimenting in this space and the exceptionally insightful early stage programs suggest that this trend should quickly become mainstream. 

Early takeaways from these programs:

• Focus on individual empowerment and student-centric learning approaches
• Make entrepreneurship an integral part of the curriculum or its own track
• Make real world mentors an important part of the program (VC and PE folks are probably better than small business owners or corporate types)
• Provide access to startup capital

If anyone needs an advisor on such a program or an easy to read book on developing a new business concept, you might look here.

Image credit: business.wsu.edu

Related articles on high school entrepreneurship programs

• The Ice House Entrepreneurship Program Facilitator Training (kauffman.org)
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Change the Physical Location of the Technology

A friend (@john_menezes) wrote and asked me to talk about the important takeaway from last night's lecture to my entrepreneurship class. The lecture was on Clayton Christensen and his theory of disruptive innovation. Christensen is a professor at HBS and his most recent book on disruptive innovation is "The Innovator's Solution: Creating and Sustaining Successful Growth". This video is a presentation by Christensen on his work and an excellent summary for those who like videos.

Christensen's theory of disruptive innovation states that the size of a market is measured not by those who use a product but rather by those who are unserved. One disrupts the existing market leader by lowering the performance standards through a more limited feature set at a lower price. These changes make the product available to new customers who could not previously afford the technology. The computer industry demonstrates this logic, as shown below.

1. Mainframe computers
2. Mini-computers
3. Desktop computers
4. Laptop computers
5. Smart phones

In each case above the next technology disrupted the dominant technology by offering more limited features, lower performance and a lower price. This change in price-performance enabled a new group of users to adopt the product and this new group is usually larger than the previous user group.

When we observe the five cases above there is an interesting observation, which was the important takeaway from the class. In each case the new technology changed the physical location of the technology. Mainframes were rare, one to an organization. Mini-computers were available in many closer locations in an organization and smart phones are in our pocket. If you do not understand this point and its power as a new business idea, think about hard discs, USB flash sticks and cloud computing. Physical location of memory storage changed in each case and large markets were established. Convenience improved as a result of changing the performance standards and the location.

In my classes and workshops on entrepreneurship one of the goals is to provide a set of tools to build a large business. I am not very interested in self-employment or small businesses. Changing the physical location of a technology is one of those tools that creates the possibility to create a large business.

One of the students made the connection between Christensen's unserved market and Prahalad's concept of serving the "bottom of the pyramid". Very pleased that a student could make the connection between Prahalad and Christensen based on my lectures. This concept is discussed in my upcoming book on social entrepreneurship. 

Happy Valentines Day to all the lady readers.

Image credit: claytonchristensen.com

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Miami-Pino Spring Entrepreneurship Workshop Series

The Pino Entrepreneurship Center at FIU has released its schedule of workshops for March through May. These workshops are open to the south Florida business community as well as students. I will be giving two workshops:

1. "Developing a Killer Business Plan" which focuses on how to develop a business concept and a business model and also provides a checklist for how to write a business plan. March 2.
2. "Financial Modeling" which deals with the logic, design and construction of an Excel model for a business or business plan. More on my philosophy of business models is here. This is the first time in about two years that I have offered this workshop so you may want to save the date May 11.

John Fleming (LinkedIn profile) will present a workshop, "Marketing Strategy and Social Media for Entrepreneurs" on April 13. John does a great job on some complex but important subjects for every entrepreneur.

Registration, location and pricing for my workshop March 2 is here. Proceeds go to the Pino Center.

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Design Insights from Charles Eames

Image via Wikipedia

I have written many times about design as a model for entrepreneurship. The last post on a designer (architect) was on Frank Gehry and the last post on design was here. 

Much of the discussion of design revolves around the notion that great ideas do not come from understanding the customer. Steve Jobs and Henry Ford are frequently quoted to support this view. I prefer this quote about Charles Eames, the famous furniture designer:

“He never worried much (as many designers do) about ‘what the public wants,’ or ‘what the public will accept,’ because he had a profound belief in the public, and the conviction that if they didn’t want or wouldn’t accept the furniture which he was designing for their use, the fault lay in his designs, not in the public."

I think this more humble statement strikes the right balance between design and the customer.

Jeff Bussgang, a well known VC in Boston, has some thoughts from his blog "Seeing Both Sides" on the same theme here.

The quote came from Curiosity Counts.

How Entrepreneurship Flourishes

Image via Wikipedia

Recently I heard a lecture by a professor at the Harvard Graduate School of Education. The lecturer was discussing worldwide trends in education. Fostering creativity was a major theme, which was not being fulfilled. However, the country-by-country analysis failed to consider that certain failing countries were centrally controlled governments. Such governments typically prefer for the government to provide the "creativity" through a form of central planning. This approach is particularly prevalent in economic development.

This article from the NYT, "Entrepreneurial Spirit Awaits its Moment in the Middle East”, cites Joi Ito, the new Director of the MIT Media Lab, on entrepreneurship in the Middle East:

 “In five to ten years, I think this will be a very vibrant entrepreneurial hub [Middle East and North Africa], but when it is going to happen will depend a lot on how much the governments and big companies are willing to allow those small companies to grow here.”

I would point out that the Middle East and North Africa has a long history of centrally controlled governments.

When one considers the countries where entrepreneurship flourishes, the U.S., Israel, Brazil and Singapore immediately come to mind. Two of these countries have long histories as democracies, the third has been a successful democracy in recent years and the fourth is probably the most progressive centrally controlled government in history. However, I do not draw the conclusion that we should foster democracy in order to encourage entrepreneurship. Rather I think we should foster entrepreneurship recognizing that it is much more challenging in centrally controlled governments.

Entrepreneurship requires certain support in order to flourish:

1. Great universities (MIT, University of Singapore, etc.)
2. Access to capital (independently managed firms for seed, venture capital, private equity)
3. A class of "business" people (barter does not support entrepreneurship)

The good news is that the people exist everywhere. Access to capital can be arranged, with perhaps Israel offering the best example. To encourage entrepreneurship, the Israeli government allocated a significant amount of money to be run by foreign private sector venture capital firms. The Brazilian government tried the same approach but elected to manage the money itself and failed.

The challenge is in fostering great universities, especially in the areas of science, technology and maybe business. Perhaps Joi Ito plans to use the considerable expertise and resources of MIT to address this issue in northern Africa and the Middle East.

 

How to Survive the End of the Industrial Age

Many have recently written on the end of the industrial age of mass production and the new economy that is emerging. Seth Godin's article is particularly good and another post from Business Insider is equally thoughtful. My first post on the subject, "A Future of Individuals", is here.

Most commentators agree that jobs in big business (and perhaps government) will be greatly reduced and that individuals will need to manage their economic survival much more aggressively. Few have offered plans for how to do this, so I share a few thoughts:

• Ideas will be the product of the 21st century. Executable ideas will be the most valuable because they produce economic and social benefits. Pure theory in general will be less valuable because there is so much data and information available to quickly test theories.
• Successful people will demonstrate great skill in using digital media to disseminate there ideas, whether it be e-books, blogs, webinars or old fashion conferences. Success may be more dependent on digital media skills than on the quality of ideas. Remember several people typically have a new idea at the same time. As the world becomes more connected greater access to information will spawn more ideas....and more entrepreneurship.
• Qualifications will no longer be the exclusive domain of universities. The various approaches of online learning and app stores will create a much more "informal" system of recognition and certification that may become the norm. The lower cost of these offerings may accelerate the trend.
• Entrepreneurship and self-employment are the strategies most likely to succeed if you are not inclined to do manual labor (which will always be required). Such approaches put the responsibility for your economic and social well being squarely in your own hands. Israel Kirzner explained entrepreneurship as "the asymetry of information" or in the vernacular as "a unique insight". As information proliferates and is more widely available the opportunities for an "asymetry" should increase greatly. This is perhaps the good news, but remember there will be a lot more people looking for these asymetries.
• Solutions to social problems will increasingly be the "big market opportunity". The social problems are scaling much faster than the resources governments can bring to bear. While "do good" is popular today, in the future the slogan may be "it's a market, not a mission". C.K. Prahalad introduced this idea perhaps as early as 2002 in his book "The Fortune at the Bottom of the Pyramid". Prahalad argued that market driven solutions could alleviate poverty and its related problems.
• Capital organization has traditionally been viewed as silos: government, non-profits, Wall Street type capital markets. For many of the opportunities of the 21st century, I think this silo system will breakdown and different sources of capital will come together. Social entrepreneurship and certain investment theses at Deutsche Bank may be examples of this trend. Organizing capital in this multi-dimensional environment is a new and valuable skill which should spawn a new branch of the finacial industry. Doing this capital organizing at different requirement levels will generate a lot of new jobs in much the same way that investment banks of all sizes have proliferated in the last ten years.

 "However, what has vexed Mr. Obama as well as economists and policy makers is that Apple — and many of its high-technology peers — are not nearly as avid in creating American jobs as other famous companies were in their heydays." New York Times Not just the manufacturing jobs but all the design, engineering and logistics jobs.

"In any democratic nation with the freedom of speech, information can never be as strongly regulated by the public as our food, water, and air. Yet information is just as vital to our survival as the other three things we consume. That’s why personal responsibility in an age of mostly free information is vital to individual and social health." Clay Johnson The Information Diet: A Case for Conscious Consumption from Brain Pickings

“One of my central mathetic tenets is that the construction that takes place “in the head” often happens especially felicitously when it is supported by construction of a more public son “in the world” – a sand castle or a cake, a LEGO house or a corporation, a computer program, a poem, or a theory of the universe. Part of what I mean by “in the world” is that the product can be shown, discussed, examined, probed, and admired. It is out there.” Seymour Papert The Daily Papert

 

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Update: Coral Gables Entrepreneurship Workshop FEB 8

I will be doing a workshop for the Coral Gables Chamber of Commerce on February 8 from 10 am -12 noon. I expect that more established business owners will attend so the focus will be on how to grow a business. The topics will include understanding the customer, the growth drivers in the business and what prevents scaling a business. Many of the themes are discussed in my book, "Billion Dollar Company: An entrepreneur's guide to business models for high growth companies", which is available on Amazon. Video review of my book by Jeff Stamp is here.

Location:

Mercantil Commercebank, N.A. 
220 Alhambra Circle, 12th Floor 
Coral Gables, FL 33134

 There is a fee of $50 for on-site registration. For more information and applicable discounts follow this link.

 

 

 

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Distribution in the Business Model

As discussed in my first book on business models, I believe that a business model can be defined in 3 concepts:

1. The revenue driver (subscribers, accounts, new locations, distribution and sales people)
2. Pricing (15 alternatives)
3. Sales and distribution strategy

Yesterday I heard a great example to illustrate point 3, distribution. Before Blockbuster a lady operated a large retail store that sold used videos. In a small corner of the store she sold used games. She noticed that on many days the sales of used games exceeded the sales of videos. Ever the alert entrepreneur, she approached K-Mart and offered to merchandise and supply games to the chain. Eventually this wholesale business went public.

A simple change from retail to wholesale distribution. Others would call this a "revenue pivot".  I think it is easier to understand as a change in distribution.

Market Leaders On the Internet

The assertTrue blog has an interesting post on market share leaders in the physical and Internet worlds. The writer points out that in the physical world there are usually two to three companies that control the market as measured by market share. McKinsey made the same point in the 1980s. In the Internet world, to date, there is usually one dominant company and then a bunch of also rans. Examples include Google (search), Facebook (social networking) Amazon and Netflix. 

If this change in market share dominance is correct, the question to ask is why does a sole Internet company in a market dominate? I think there is one principal reasons:

Comparatively low capital requirements to enter the market and to scale rapidly 

Internet businesses are not as capital intensive as physical world companies and therefore can achieve dominant market positions faster. With the notable exception of Apple, Internet companies do not have to invest in stores. Few have warehouses or any significant sales forces. Little investment is required for logistics after the server farm is established. With Amazon Web Services such investment is turned into a marginal cost. In summary, low startup capital and limited capital requirements to scale characterize Internet companies and explain why a single company can dominate a market segment. First to find product/market fit combined with a limited capital constraint allow Internet companies to achieve dominant market positions faster that can not be displaced.