Risk, Return, Product Design

1. Risk, Return, Product Design

2. Risk & Uncertainty • “Failure is the opportunity to begin again, more intelligently.” Henry Ford • Regret – the amount of loss a person can tolerate A Game of Chance :

3. Regret Function • V = U – l R U = upside U > l R R = downside or regret l = risk-adjusted const. • Entrepreneur can forgo one year income ($50,000) and willingly invest savings ($60,000), then regret is $110,000 • For l = 1, we are neutral. For l = 2, we are risk averse. • If, l = 2, required upside is U > 2(110,000) > $220,000

4. Risk • Value of potential losses • Uncertainty of those losses (Lottery Variations) • SBA – ½ of all small businesses are acquired by another firm or leave the market within four years

5. Question • What might be the sources of uncertainty for a new venture ?

6. Sources of uncertainty • Market uncertainties • ??? • Organization / Management uncertainties • Product / Process uncertainties • Regulation / Legal uncertainties • Financial uncertainties

7. Sources of uncertainty • Market uncertainties • Customer • Market size / growth potential • Competitors • Organization / Management uncertainties • Product / Process uncertainties • Regulation / Legal uncertainties • Financial uncertainties

8. Sources of uncertainty • Market uncertainties • Organization / Management uncertainties • Capabilities • Talent • Strategies • Product / Process uncertainties • Regulation / Legal uncertainties • Financial uncertainties

9. Sources of uncertainty • Market uncertainties • Organization / Management uncertainties • Product / Process uncertainties • Cost • Technology • Design • Regulation / Legal uncertainties • Financial uncertainties

10. Estimating Risk / Reward • Describe most likely scenario, expected reward and estimated probability • Describe worst case scenario, expected loss and estimated probability • Describe best-case scenario, expected reward and estimated probability • Determine how much the entrepreneurial team (investors) can afford to lose.

11. Estimating Risk / Reward • A leading aircraft manufacturer, you wish to bid on a new jet trainer for the dept. of defense. Specs call for front-back seating, mach 2.0 at 400 ft. To even hope to bid, you will have to develop a new avionics package with forward looking radar and hire 100 new engineers. Estimate the risk / reward.

12. Return Versus Risk

13. Cost per Unit Economies of Scale Diseconomies of Scale qm Scale and Scope • Scale – the extent of the activity of a firm as described by its size • Scalability – how big a firm can grow in various dimensions to provide more service.

14. Scale and Scope • Scope – the range of products offered or distribution channels utilized • Economies of Scope • Google – economies of scale • Amazon – economies of scope • Wal-Mart – economies of scale and scope

15. Network Effects • Network economies – arise in industries where a network of complementary products is determinant of demand • PC software PC • eBay: buyers sellers buyers • Others ??

16. So how do we incentivize risk? • Should we ?

17. No FEAR • Tom Peters & FEAR • YouTube - Famous Failures

18. Product Design / Development • IDEA: locate and describe new ideas without binding users too closely to the old ways of doing things. Entrepreneurs must find the balance between novelty and familiarity, between impact and acceptance (Palm Pilot docking cradle – PDA extension of PC)

19. Research & Development (Concept Develop) Product Design Build Prototype Test Prototype / Market Satisfactory Finalize Design Yes No

20. R&D Establish Product Goals and Attributes Identify components & parameters available Identify set of physical and social constraints Write Performance Specifications Write Performance Specifications Write Performance Specifications Write Performance Specifications

21. Product Development • Usability – measure of the quality of user’s experience when interacting with product • Ease of learning • Efficiency of use • Memorability • Error frequency • Satisfaction (VCR, DVD – poor usability)

22. Product Development • Dominant Design – single architecture that establishes dominance in a particular class IBM _PC compatible VHS

23. Disruptive Applications • Disruptive Application – a new product that establishes an entirely new category and dominates that category Email Sony Walkman

24. Question • Why did the digital video recorder (DVR) take so long to become popular? What key features finally made use of the DVR acceptable to the customer base?

25. Question • Why did the digital video recorder (DVR) take so long to become popular? What key features finally made use of the DVR acceptable to the customer base? Users browse a listings grid on the TV and press a record button to select each show they want to record. How would you design a DVR to sell widely and reach a mass market?

26. Question • Using the product design method, complete an outline of the steps necessary to design a small electric car that can compete favorably with the GEM.