Lecture 1 – “Navigating the Business Environment”

1. Lecture 1 – “Navigating the Business Environment” Steve Montgomery

2. Introduction To The Business Environment • What to do when someone’s not telling you what to do • High level topics covered: • Course introduction, Overview of corporate structure (1 session) • Business strategy (2 sessions) • Introduction to Marketing (2 sessions) • Basics of Accounting and Finance (2 sessions) • Project Valuation and ROI (2 sessions) • Putting it all together (A Review) (1 session)

3. Steve Montgomery - Bio • Education: • BS, Mechanical Engineering, U. of Illinois, 1994 • MS, ME, Purdue, 1996 Vacuum Drying • Ph.D., ME, Purdue, 2000 – Nanoscale Surface Particulate Adhesion • M.BA (Technology Management), U. Washington, 2008 • Accepted a position @ Intel 9/2000 in R&D • Individual contributor roles: Heat sink fouling, Heat pipes, thermosyphons, data center cooling, liquid cooling of CPUs, thermal interface materials, Nanotechnology • 20+ patents awarded or pending • Refereed journal publications + invited reviewer of prospective articles • Member and Invited speaker, ASME International Congress and Exposition • Business and Management path • Started off as a team lead, mentoring 2 ME’s. Added lab management responsibilities + contractors, interns • Promoted to co-department head, 2005 • Program manager/silicon design manager, Integrated Silicon Voltage Regulation technology

4. Course Module Overview

5. Lecture 1: Course Intro • Course introduction & syllabus • Introduction to business: • Goals of corporation • The mindset change, with an example • Corporate structure • Overview of profitability • Intro to SWOT, Strength, Weaknesses, Opportunities, Threats (Time permitting)

6. Strategy • Overview of competitive strategy: What are the high level goals of any company? • Differentiation and pricing power • Survival and profitability • Porter’s Five Forces Model • How to assess the landscape of your market • “Blue Ocean” Strategy* • A toolkit to identify areas to explore – creating a competition-free zone to reach the above objectives • End goal: • Understanding your business allows you to pick smart projects *Kim, W.C. and Mauborgne, R., 2005, Blue Ocean Strategy – How To Create Uncontested Market Space and Make the Competition Irrelevant, HBS Press. (We’ll also be using their HBR articles for brevity)

7. Lecture 2: SWOT & Porter’s Five Forces Model • Business strategy overview: • Strengths, weaknesses, opportunities & threats (SWOT) • Porter’s five forces model • Class discussion: Microsoft’s market position and future options/opportunities (freeform SWOT analysis + application of Porter’s)

8. Lecture 3: Blue Ocean Strategy • The Blue Ocean Strategy model & framework: • Overview • Competitive mapping tools and frameworks • Application examples: Southwest Airlines, Toyota RAV4

9. Marketing • Purpose of Marketing: • “Create, communicate and deliver unique value to customers so that the organization can capture a portion back” – D.J. Turner, UW Assoc. Dean • Why you should care: • Good marketing = people buy what you have to sell • Bad marketing = people don’t buy what you have to sell • An effective market strategy is synergistic with your company’s global strategy - and a way to create a lasting mental link • Marketing is the design of a psychological construct • You are creating positive associations in buyer’s minds. How do you do that? • End goal: • Understanding your business and how you reach customers allows you to pick smart projects and sell them to management

10. Lecture 4: Marketing 1 • Marketing 101: • The purpose: Marketing as a design exercise • How do you identify the unique niche your product/project occupies? • The 5 C’s: Context, customers, collaborators, competitors, company • The 4 P’s: Product, price, place, promotion

11. Lecture 5: Marketing II • Heath and Heath, Made to Stick: Why Some Ideas Die and Why Others Survive • What gets a person’s attention? Why do people respond to certain stimuli in a certain way? • And how can this be used to your advantage? • The SUCCES approach to communicating with an audience: • Simple, Unexpected, Concrete, Credible, Emotional, Stories

12. Accounting/Finance • Accounting: Two types • Bookkeeping and managerial • Bookkeeping: Your company’s overall financial health • Balance sheets income statements and how to read them • Managerial: Measurable metrics that drive decision making • What incentives are you creating, and can you measure the right things? • Finance: The art and science of cash management • Cash is King • Treat it like it’s yours • Time = money • End goal: • Understanding your business, how you reach customers, and your firm’s business condition allow you to pick smart projects and sell them to management

13. Lecture 6: Accounting Basics • Balance Sheets • Income Statements • Analysis formulae • Examples: • Healthy companies • Intangible asset driven (Microsoft) • Tangible asset driven (Boeing) • Unhealthy company (GM, pre-bailout) • How can we infer management’s thinking by looking at the financials?

14. Lecture 7: Managerial Accounting • Perfect decisions result from having perfect information, but in reality: • Assumptions are made, clouding the picture • How do we create the right incentives? • How do we measure the right things in a company?

15. Project Valuation and ROI • The project decision: Is this project a good use of company resources? • How can we tell? What should we measure? • What are we not doing by starting this project? • Techniques for estimating Return on Investment • End goal: • Understanding your business, how you reach customers, your firm’s business condition and the potential impact your of your work allow you to pick smart projects and sell them to management

16. Lecture 8: Project Valuation and ROI I • Introduction to discounted cash flow (DCF) analysis • Weighted average cost of capital (burden rate) • Opportunity cost: What is lost by taking one action over another

17. Lecture 9: Project Valuation and ROI II • Application of DCF analysis • What kind of project do I have? • Cost reduction? • Market segment share increase? • Premium offering? TBD

18. Lecture 10 • Course wrap-up and summary • How to identify whom to influence: • Who is liable to support your project? • Who is liable to oppose your project? • How to identify stakeholders, and how does my idea affect other teams?

19. Point of this course? • As future technical leaders, you will need: • An ability to evangelize your ideas and rally support/resources • An understanding/grasp of business topics and strategy • An ability to communicate your ideas to senior management • The ability to pick projects that maximize your business, promote your career, and promote the careers of those on your team • All the tools here are applicable on a number of levels: • Your firm • Your business group • Your own career • By way of necessity, we’ll stay at the firm level (since the details of everyone’s particular company is often confidential)

20. Homework And Grading • Homework after each module • Mix of problems and cases • Cases = read the case and answer some questions. No right or wrong answers • Problems = Out of textbooks • Thinking process, not final answer, is the important thing • No exams: • Your final will be more along the lines of a project (TBD) • Will integrate all aspects of the class • Rough breakdown of grading: • Class participation = 10% • Homework = 40% (some are weighted more than others) • Final = 50%

21. Textbook • There is a course pack/textbook for this course, ~$130 at the bookstore • Contains excerpts from texts, journal articles, and cases.

22. Making The Transition • As students, you’re making 2 transitions: • From not in school to back in school • From engineering education to business, e.g. from hard sciences to softer subjects • Keep disciplined, and don’t get frustrated: • There are few F = m*a formulas in business • Softer topics require you to think differently! • An example: Firm-wide financial calculations

23. ROIC: Rate of Return On Invested Capital • ROIC = Metric of how well a firm uses its invested capital • Usually calculated before taxes (Because firms pay taxes at different rates. Removing the tax variable allows for apples/apples comparison across firms) • Where do we find this information? • Note: Careful! There are several different philosophies on calculating the above!! • First and foremost: tax treatment • Also: If you were a CEO and you wanted to increase this number…

24. ROIC, cont.

25. ROIC, cont. Revenue and cost of revenue R&D, SG&A and total operating expenses (We’ll use the total number)

26. ROIC, cont. Long term debt: Loans provided to the company (Ebay has zero long term debt) Shareholders’ equity: What the invested capital is worth as of the date of the Bal sheet Under ‘key statistics’, you can find # of outstanding shares and dividends/share.

27. A Discussion Point • Consider these companies: • EBAY (EBay) • MSFT (Microsoft) • INTC (Intel) • CAT (Caterpillar) • Which of these companies would you expect to do well on ROIC? • Software/.com based company? • Or heavy industry/manufacturing?

28. ROIC, cont. • Mindset change #1: What does this tell you about blanket comparisons between industries? • What happens if INTC cancelled their dividend? Or if MSFT increased theirs to match CAT and BA?

29. INTC, No Dividend, MSFT to $1.68 • Now the picture looks somewhat different! • What if stock analysts graded firms on ROIC alone? • Mindset change #1: Variables are subject to human behavior and decision making • People respond to incentives! • How come Boeing’s ROIC is so high?

30. Negative Shareholder Equity? • A negative number for shareholder equity?? • Looking at YOY changes, BA has been active in asset management – look at the “Other Liabilities” line!

31. What If We Had Gone to AOL Finance? • Remember: Many formulas are calculated differently! • Always use as many metrics as makes sense to measure performance, and be wary of incentive creation!

32. Strategic Thinking • As future leaders, you need to keep the following ideas in mind: • What incentives do the programs that I observe create? • What behaviors do these incentives drive? • Are these behaviors good or bad? Why? • What metrics best reflect value creation? • And how do you use them to your benefit? • Everybody else plays checkers. You should play chess.

33. Corporate Structure, Goals & Profitability

34. Corporate Goals • Any corporation in business today (for profit, obviously) has the following goals: • Survival • Profitability • Survival can mean many things: • Staying in business • Returning value to shareholders • Pushing the state of the art • Pursuing a mission and a set of values

35. Survival • To survive, companies seek to minimize inefficiencies and streamline processes • Organizations are grouped to streamline tasks, allocate resources, and unify functions • Analyzing an org chart can tell you a lot about what a company values • …and is a gateway to understanding the overall strategy and business model

36. Intel Corporation: Operational Model Source: theofficialboard.com

37. Intel Corporation: As of 3 Weeks Ago Source: theofficialboard.com

38. Apple’s Organization

39. General Electric: Conglomerate Model Source: http://www.ge.com/investors/personal_investing/ge_organization_chart-1_2.pdf

40. Sun Hydraulics

41. Organization Types • Several different types of models in use: • Operational Model: Focused mainly on centralizing core functions and distributing businesses • Conglomerate Model: Manages vastly divergent businesses. Company-within-a-company model • Sun Hydraulics model: No structure at all!

42. Mission of Corporations: • “Maximizing shareholder value is the ultimate goal of profit-making companies” • Shareholders provide the risk capital • If company fails, risk capital = gone • Shareholders own the company! • Shareholder value = stock price, dividends, or both • Stock price: Market value of a firm’s common shares • Dividends: Cash payments doled out by the firm on a regular basis as a direct return to shareholders Ref: Hill, Chapter 1.

43. Profitability • There are several metrics that can used to measure the health of a company: • ROA (Return on assets) • WACC (Weighted average cost of capital) • Used in financial calculations • Others (See Hill’s Appendix) • ROIC: Return on Invested Capital (from earlier) • Profitability is the bottom line – make profits and stay alive • We’ll study these metrics in a later lecture

44. Profitability, cont. • Profitability can be had 2 ways: • Top line growth • Bottom line discipline • The best firms do both: • Grow revenues (top line) while holding the line on costs and expenses (bottom line) • What’s the single biggest predictor of profitability? Product differentiation

45. What Is Differentiation? • Differentiation is achieving the ability to deliver a product or service that customers perceive to be unique or distinct in some important way • Differentiation doesn’t need to be tangible - Examples: • Nordstrom’s – known for customer service above all else, even on similar merchandise to rivals • Mercedes, BMW – Perceived status of owning a Bimmer or a Benz vs. an equivalent car • Brand image plays a huge role in determining perceived value • Can be based on cost as well

46. Differentiators: Nordstrom’s Rolex Porsche Prada Broad differentiators: Intel Samsung Sony Ford Toyota GE Differentiation (Higher costs, higher prices) Cost leaders: Wal-Mart Generic drug man’f Southwest Airlines Costco Cost leadership (Low costs, low prices) Differentiation, cont.

47. Differentiation, cont. • Differentiation is often the result of strategic choices: • Make a choice to do something particularly well, then go execute • Does this happen through more R&D? (Innovation) • Achieving better brand image? (Marketing) • Improving your customer service? (Responsiveness to customers) • Or do you cut costs and differentiate on price? (Cost controls) • In any of the above, you’re making choices to invest (often limited) resources – choose well! • Some firms are able to do a number of things well at the same time

48. Differentiation, cont. • Sometimes firms choose to differentiate via market segmentation: • Artificially create a bunch of market niches, which you conveniently have a product for • Allows you to deliver a product with incremental (if that) differences from your other offerings…and your opponents have to responds • Some firms pick 1-2 segments and focus effort there • Often means focusing on one customer type • Example: Porsche only builds sports cars and luxury SUVs • Examples: • Truck market: Compact, crew cab, full size, dual axles, etc. • Microprocessors and system on chips (SOCs) • Television sets • Some firms are able to fill several markets with good products • Examples: Toyota, Intel • Reason is the ability to leverage a flexible manufacturing capability + low costs

49. Differentiation Summary: • Firms make choices on which factors to promote or ignore (we’ll explore this more in Lecture 3) • When you achieve differentiation, either hard (features you have the competition doesn’t) or soft (brand perception), you can charge a higher price • Key is delivering perceived value to customers • Intangibles can be harder to imitate: • Me-too products can be reverse engineered • Intangibles often reflect execution, which is harder to match • BUT, intangibles often are a function of consumer trust. If that’s ever lost, may be difficult to get back (GM?)

50. Implication To Strategy • Choosing the right strategy means your strengths are maximized and your weaknesses minimized. Also means you can exploit some weakness in your competition. • End result: You end up with products your customers want to buy. • What if you make a mistake and focus on the wrong thing? • IBM thought that hardware was the main buying decision for PC’s in the late 80’s (and gave away DOS to MSFT) • BUT, were able to refocus on services and recover • MSFT today is re-orienting towards online services to counter Google (as we’ll see in the case for next time)