Today’s Topic: Company Organizations and Functions

1. Today’s Topic:Company Organizationsand Functions How Businesses are Structured to Deliver and Support Products; and Peoples’ Roles and Compensation (after we finish “financial measurements”)

2. The Course’s First Four Weeks • Companies’ objectives: shareowner wealth, earnings/growth, product success --- previously • Financial statements: earnings and financial performance, opportunities/challenges --- finish today • Roles and responsibilities: how companies bring new products to market--- newtoday • Business/product plans: creating a plan for superior revenue and profit/growth --- next week

3. Today’s Agenda • Learnings to date • Balance sheet and cash flow statements • Analysis of Medtronic (financial and business perspective) • How businesses are organized • Organization roles and responsibilities • Product teams: Getting products to market • Employee incentives and rewards (comp) • Readings and Assignment for next week

4. Today’s Learning Objectives confirm our understanding of how to analyze an income statement begin to look at the business of a company (customers, products, competitors, ... ) learn about the process companies use to bring new products to market understand how companies use compensation to align personal and corporate objectives

5. What we’ve learned so far…… • Companies try to maximize the wealth of their owners --- market cap (stock price) plus dividends • Stock price and the ability to pay dividends are driven by earnings, and beliefs about future earnings growth • Individual products and services are expected to contributetargeted amounts to earnings/growth • Earnings growth (ultimately) requires revenue growth • Firms use financial statements to develop plans, and measure/analyze/report on their performance

6. …..and, in terms of business objectives….. • A company’s basic financial objective is to grow its earnings quickly and sustainably, in order to raise its stock price and have the ability to pay its owners dividends • Products are successful if and only if they attain their targeted contribution to corporate earnings

7. The Income Statement Revenues - Cost of Goods Sold (COGS) = Gross Margin (gross profit) - M&S expense - R&D expense - G&A expense = Operating income (EBIT) - Interest - Taxes = Net income (earnings)

8. Key Financial Concepts • Operations vs. total (e.g., OI vs. NI) • Normalizing results: return measures (e.g., OI as % of revenue; operating return on assets) • Knowing what “good” results are: general or competitive (industry) analogs/benchmarks • Recognizing cash vs. non-cash --- today - Measures (e.g., OI vs. NOCF) - Capital goods: depreciation/amortization - Working capital: inventory, accounts rec’bl.

9. Method: How to analyze anIncome Statement • (First, compute “the percentages”) • Operating income vs. net income • In-period operating performance: costs and expenses as a % of revenue; compare to benchmarks • Cross-period performance (trends): relative change in rev, costs, expenses, earnings… improvements vs. deteriorations, and why • Going-forward opportunities and challenges/ risks for each line item

10. “Good” Operating Returnsin the Business Market Higher GM % Higher R&D % Lower GM % Lower M&S %

11. “Good” Operating Returnsin the Consumer Market Higher GM % Higher R&D % Lower GM % Lower M&S %

12. Income statement (for a time period) Balance sheet (at a point in time) Cash Flow statement (for a time period) revenues, costs, expenses, & earnings assets, liabilities and net capital cash ($$) in and out , and uses of cash Financial Statement Objectives

13. The Balance Sheet Equation Net worth = what you own - what you owe Net Capital = Assets - Liabilities or Assets = Liabilities + Net Capital

14. The Balance Sheet Assets Current Assets: Cash +Accts Rec. +Inventory +Prepaid expenses + Net PP&E: PP&E at cost - Depreciation Total Assets Liabilities & Capital Current Liabilities: Accounts Payable +Accrued taxes +Accrued expenses + Short term debt + Long term debt Total liabilities + Retained earnings/loss + Owners’ equity Total liabilities&capital

15. Cash Flow Statement Net operating cash flow (cash from operations) + Net cash from investing activities: capital expenditures +short term investments +securities (long term) + Net cash from financing activities: debt financing +stock financing Net change in cash

16. Net Operating Cash Flow Net operating cash inflows: revenues - change in accts rec - Net operating cash outflows: COGS- depreciation + operating expenses + change in prepaid exp - change in accrued exp + change in inventory - change in accts payable Net operating cash flow (NOCF)

17. Today’s Learning Objectives confirm our understanding of how to analyze an income statement begin to look at the business of a company (customers, products, competitors, ... ) learn about the process companies use to bring new products to market understand how companies use compensation to align personal and corporate objectives

18. Assignment for Next Week:Analyzing a Company Medtronic Medical technology Founded in 1949 $16.2 B annual revenue and OI%=28.7% (last 12 months) $36.4 B market cap, current P/E = 11.9 Market share leader in several product categories

19. Getting Info on Medtronic • Company website: www.medtronic.com - especially “Investor Relations” section • Yahoo: finance.yahoo.com - enter “MDT” (Medtronic’s stock ticker symbol) • Securities Exchange Commission: ww.sec.gov - select “search for company filings,” enter MDT, see esp. the 10K annual report filed 6/28/11

20. Medtronic Stock Price: last two years

21. Assignment Questions -- 1 • What business is Medtronic in? • What product categories does it compete in? • Who are its customers? • How does it sell its products? • Who are its competitors? • Is its financial performance good? (use the annual income statement for YE Apr11; suggestion: use the version in the SEC 10K report) • Is it improving or deteriorating? In absolute terms? In relative (% revenue) terms? Why? • What were the major determinants of the change in relative operating income from FY10 to FY11?

22. Medtronic Income Statement

23. MDT vs. Nasdaq, last 12 months

24. MDT Opportunities & Challenges • Revenue? (product categories?) • Costs? • Expenses? • Operating Income? • Markets? (product/customer/geog?) • Competitors? • Regulatory/governmental?

25. A Business’ Functions and Organizations • Marketing (incl. “product management”) • R&D • Sales • Operations (manufacturing, distribution/logistics, service operations) • Support: IT, Finance, HR, Legal, Investor Relations, Public/ Media Relations (PR), Quality Office, etc

26. Alternative Org StructuresDetermined largely by the level to which the multiple functions report • Corporate (functional structure) • Division (product groups or market groups) • Product (local responsibility)

27. Getting Products to Market:from concept to product launch (various names/labels for this activity)… • R&D/Engineering (a misnomer) • New product development (NPD) • Product realization • Product innovation • Product commercialization • Product development & management • …etc…

28. What’s a “New” Product? New to Company New Product Line Completely New Line Extensions Core Product Revisions Repositionings Product Enhancements New to the World

29. Many new products fail… “35 percent of all new [IT] products now fail to achieve minimum acceptable market share or financial return --and the failure rate is rising.” VAR Business, November 1999

30. New Product Failure Rates For every 4 projects that enter development, only 1 makes it to the market. At launch, at least 1 of 3 products fail despite research and planning. An estimated 46% of all resources allocated to product development and commercialization by U.S. firms is spent on products that are cancelled or fail to yield an adequate financial return.              Source : Winning at New Products, Dr. R.G. Cooper, 2001

31. What are some reasons that a new product might “fail” ?(i.e., fail to meet the market and financial objectives set for it)

32. Some Reasons for Product Failures • Mismatched to market needs • Little/no competitive differentiation • Late to market • Too costly (price and/or COGS) • Poor quality • Inability to deliver to customers • Poor service/support • Ineffective sales/channels • Unrealizable objectives • …

33. Getting Products to Market • Structure: product teams • Process: how the team will work • Plan: the product plan (to be discussed next week)

34. Product Development Process:Overall Structure • Linear (“handoffs”) • Parallel/concurrent (multifunction involvement at all/most stages)

35. Core Product Team and Roles • Marketing - leader, product definition, project management, marketing program, sales training, forecasts, financials • R&D - product development (milestones and dates), tech support for marketing/sales, transfer to manufacturing, support for trials/betas, product fixes/revisions • Operations - manufacturing engineering, manufacturing (ramp), product costs and quality, logistics and service plan

36. Other Team MembersDepends on the Product, Market and Company Practices • Sales? Friendly customers? • Finance? • Information technology/MIS? • Field operations (installation and service)? • Public Relations? • Partner companies (esp. manufacturing and/or sales and service)?

37. Product Development Process:Common Elements • Stages/phases with “gates” • Customer involvement and/or input • Concept-through-lifecycle tenure • Goals/measurements/rewards focused on overall success

38. Example of NPD Stages & Gates

39. Product Development Process:Some Best Practices • design-to-market (customers/needs) • design-to-cost (COGS) • concurrent engineering • requirements “freeze” • time-driven milestones • time-to-market or time-to-volume • fast iteration • cross-team communication • team goal compensation

40. Employee Incentives/Rewards • Assigned work • Working conditions • Promotion (power and perks) • Recognition • (Direct) Compensation ($$) • Benefits ($$: medical, dental, legal, 401-K/savings/ESOP, ESPP, etc)

41. Forms of Direct Compensation • Salary(fixed wages, paid regularly) • Bonus (annual/quarterly/spot payments from a pool, often based on profits) • Stock options (the option to buy stock at a specific strikeprice, upon futurevesting) • Stock grants(grantsof stock upon future vesting, often with restricted rights)

42. So, why should you care about your company’s…. • Revenue growth ? • Efficient use of resources? • Earnings ? • Stock price ?

43. What would you do…? You need to decide whether to add a particular feature to a product you are designing. The product requirements document doesn’t mention it. You ask someone in Marketing, but he really can’t say with confidence whether to add it or not.

44. What would you do…? You are behind schedule in implementing an important new process technology for the Manufacturing line. A sales person asks you to join her in visiting an important potential customer. The customer location is in Japan and the visit will take 3-4 days.

45. What would you do…? You need a new piece of test equipment for your design lab. A manufacturing engineer on your product team also needs a (different) piece of test equipment; there’s not enough money for both. Your product team leader (a non-technical person from Marketing) asks the two of you to decide which one to buy, and to explain the reason for your decision.

46. What would you do…? Your product team is meeting to make some important decisions on: (1) new product directions, (2) which markets to focus on, and (3) how to improve customer service. You are asked to represent the engineering department at the meeting. What contributions will you make to these deliberations?

47. What would you do…? You have an idea for an exciting new intrusion detection product, based on a new signal processing algorithm you invented. You’d like to convince “management” to fund the development of this product. What arguments will be persuasive, and will you be able to make them?

48. Next week……. Creating a winning business plan Key aspects of a successful plan Critical importance of differentiation

49. Readings for Next Week • Writing a Business Plan: The Basics (first article in casebook) • Sources of Information on Starting a Business course website under “Supplementary Materials”; see esp. sample business plans on www.bplans.com • Opportunity Assessment Aperture course website • FHP Wireless (our first case analysis)

50. FHP Wireless case Timeframe is late 2002 FHP has invented a unique (?) technology for building wide-area wireless networks (Wi-Fi) Their first-year sales efforts have been mostly unsuccessful They need to decide which customers to target: current targets, telecommunications companies, or public safety ……and whether they need to change/enhance their product ……and they are just about out of money, and are looking for additional investors