1. Business, Law, and Innovation Business 101 Lecture 3 Spring 2014 Professor Adam Dell The University of Texas School of Law

2. 2 - Business Models / Economics - Finance / Accounting - Strength of Business Models - Market Niches - Changing Markets 2 Big Themes:

3. Class Exercise: Is it a Good Business? Explore various business models and understand the fundamentals that determine a good one from a bad one. Goal

4. 4 Business Models / Finance How much can you sell your WIDGET for? (Sales) How much does it cost you to make the WIDGET? (COGS) How much margin is left over? (Gross Margin) What expenses (rent, employees, etc.) do you have? (SG&A) What is left after that? (EBITDA) What percentage of sales is that? (Operating Margin) How much do you need to invest in the plant? (Cap Ex) What is left after that? (Net Operating Cash Flow) If this doesn’t work…..nothing will. You can quote me on this: “Finance is often a lot of fancy B.S. designed to hide the ball.” 4

5. 5 Business Model / Finance – Income Statement 5

6. What kinds of business models exit? - Service (cost + margin) - Retail (50% gross margin typically) - Manufacturing (low tech vs. high tech) - Software (70% GM, client/server vs..com) - Logistics (trucks and routes) - What else?

7. 7 Strength of a Business Model We’ve got something no one else has (intellectual property) and it’s really valuable to customers (they’ll pay a lot for it) (they come to us looking for it). We’ve got a position that has entrenched us in a market and it’s hard for anyone to compete against us (MS Windows). We have a big “MOAT” (Warren Buffett). The number of people who want what we’ve got is huge and we are growing fast. This thing we sell, its really cheap for us to make additional copies of it and sell it millions of them (software). Strength of the business model translates into a high valuation multiple in the public markets. - Businesses that are growing fast - Have a great big MOAT - Have great Operating Margin (Operating Income / Sales) 7

8. So What Are You Looking For? - Market Size - Gross Margin - Operating Margin - Alternatives / Competition / Moat - Scalability - Adjacent opportunities

9. Let’s Look at Some Business Models Service - Uber Retail - Warby Parker Manufacturing -Tesla Motors Software - Microsoft / Civitas Learning Logistics -AmazonFresh

10. Exercise: Microsoft…Let’s Go Back to our List - Market Size - Gross Margin - Operating Margin - Alternatives / Competition / Moat - Scalability - Adjacent opportunities

11. Microsoft - Market Size: How big you think? - Gross Margin: 72% - Operating Margin: 34% - Alternatives / Competition / Moat: What do you think? - Scalability: - Adjacent opportunities: xBox, Office365, Advertising, Expedia, What else?

12. Civitas Learning - Market Size: 3,400 colleges - Gross Margin: 60-80% - Operating Margin: ? - Alternatives / Competition / Moat: What do you think? Database of student records / behavioral data - Scalability: ? - Adjacent opportunities: What else?

13. 13 Market Niches 13 Think of every company competing in a given market (for $s) as a single plant competing for space in their niche of the canopy of the forest (market). Many never get to see the light. The strength of the business model will define how large and strong the enterprise becomes. But remember: Trees don’t grow to the moon.

14. 14 Markets are Not Static 14 You can be certain of one thing: THINGS ARE GOING TO CHANGE….remember CREATIVE DESTRUCTION. This constant roaring machine gives rise to new opportunities every day.

15. 15 Lawyers and Business 15 Business people make deals. Lawyers “paper” them. A big knock against lawyers is their lack of a fundamental understanding of business. It would serve you well to try to understand the underlying business models of your future clients. It’s important to strip away the “noise” in transactions, contracts, partnerships and businesses. Focus on the key drivers of success. The rest will take care of itself.

16. 16 Lawyers, Business & Negotiation 16 Virtually every interaction in business is a negotiation. It would serve you well to read and understand: “The Art and Science of Negotiation” by Howard Raiffa

17. 17 Lawyers, Business & Negotiation 17 1) You must be willing to walk away 2) Know in your mind what you want / need; don’t be so clear to the other side. 3) Remember that everyone wants to “feel” like they got a good deal. 4) Do not give up something without getting something of equal value. Always work in the context of the entire transaction. 5) If you think you got an extraordinary deal, you probably didn’t. 6) If there are not realistic & fair incentives on both sides, things will likely go bad. 7) Working with great people is more important than working with a great contract. 8) Put yourself in the shoes of the opposite site before you sit down. - Try to understand their alternatives - Try to understand what is important to them - Do not empathize; focus on objective facts - Try to anticipate their arguments - Look at the prism from all sides