Cs207 5

CS207 #5, 28 Oct. 2011

Gio Wiederhold

Gates B12

10/28/2011 Gio: CS207 1

Syllabus: 1. Why should software be valued? 2. Open source software. Scope. Theory and reality 3. Principles of valuation. Cost versus value. 4. Market value of software companies. 5. Alternate business models. Making money from free SW 6. Intellectual capital and property (IP). 7. Life and lag of software innovation. Marketing. Allocation. 8. Sales expectations and discounting. 9. The role of patents, copyrights, and trade secrets. 10. Licensing. 11. Separation of use rights from the property itself. 12. Risks when outsourcing and offshoring development. 13. Effects of using taxhavens to house IP.

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Example of Free

• Adobe produced software to generate and read markup text (pdf) for sale to companies.

minor business for internal publishing

• Arrangement with the IRS that if Adobe would separate the reader and provide for free, it would publish tax forms using pdf

huge business – now everyone needed a reader and companies bought pdf generators to publish in pdf

• When patents ran out, others companies made pdf generators available

Adobe still provides many pdf related services

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Intangibles

Book

value

Let’s ignore the intangibles, we cannot measure

them reliably.

Intangibles

capitalization of cost allowed under GAAP

Distribution

to Sales

Costs

→ Centroid of

revenue

time →

Sales lag . ←−−−−−−−−−−−−−→

Sales

Manufacturing & distribution delay

←→

←→ marketing lag

Marketing

← C

osts

development lag ←─→ Centroid of total

development cost .. ~60%→

Research,

Design, Implementation

Testing

Centroid of pre- sales marketing costs part of investment: IGE

Development done →

Revenues →

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Timing of expense

and income

Release to Production

Post-sales marketing, part of sales cost: CoGS

Centroid of revenue

sales lag . ←−−−−−−−→

Development done →

Revenues →

Costs

→

Research,

Implementation

&Test

ing

Sales

development lag ← → includes testing

← C

osts

Centroid of pre-sales

marketing costs time →

Marketing

β

↔

↔ marketing lag

← General

availability

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SW Lags

7 Gestation period →

Eff

ort

→

start 75% 50% 25% done

Development

Testing

35%→

@27.4% →

Lag delays benefits

of R&D investments

Estimate effective lag .

~37% →

~14% →

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Research growth limit

growth limit

Start-up development

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A startup is unlikely to ramp up linearly Use exponentional growth, exp 0.025

Assume

1. 12.5% research

Given that idea is clear, only towards for implementation

2. 25.0% testing

Minimal and risky

3. 67.5% left for implementation

• Overlap research and implementation until testing starts

• Overlap implemtation and testing until RPS

Results Overall centroid @0.27 before RPS -- later

Research from 1.00 to 0.33, centroid @ 0.65 before RPS

Implementation from 0.67 to 0.00, centroid @ 0.29 before RPS

Testing from 0.17 to 0.00, centroid @ 0.08 before

Hiring rate at RPS 21%, at the limit for effectiveness Ignore different staff salaries

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21% effort

growth

62.5% Implementation

@0.29→

Research ends when

33% time remains → 12.5% Research

@0.65→

0.75 0.50 0.25 done start

0

40%

20%

80%

100%

60%

25% Testing

Implementation starts when

67% time remains →

Testing starts when

17% time remains →

33% time remains

Res., Imp, &

Test @0.27 →

Graph of start-up development

Development in mature

company with

12.5% research and

25% testing effort,

62.5% implementation

@0.46→

Testing starts when

←−−− 40% time remains

Res., Imp, & Test @0.42 →

Research ends when

← 65% time remains

Available

resources

Values based on finite integration, exp= 0.05

@0.85→

0.75 0.50 0.25 done

50%

25%

0

75%

100%

1.00

Rela

tive

Effort

→

38% effort growth at start

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I R

T

←Implementation starts when

85% time remains

5% company staff growth

done R&I

Testing

start

Effective lag =

Development period × Centroid fraction

Lag differs less than

development period

start

Testing

R&I done

start

R&I

Testing

done

done

done

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Ongoing development

New considerations 1. Have staff already

a. Early versions rapid growth, but observe ~20% limit b. Later, best grow slower

2. Can overlap version development a. Don’t let valuable staff be idle b. Missing features should already be understood c. Rapid analysis of problems to allow next version fixes d. Any research should be done before major staff effort

3. Adequate testing to keep reputation

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1.50 1.25 0.75 0.50 0.25 done Release

version n-1

[email protected]→

Effort

→

100%

25%

75%

50%

2nd Version substantial testing

56%

[email protected]→

43% Testing during version n

interval

→ R&I @1.00

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Marketing

• Business model must allocate spending optimally

Technology, as needed, long life and lag & Marketing, necessary, less lag, slower growth

Life of advertising 50% of technology, mix product & brand

• Interdependence viral

Consistent

Relevant

Linked by a common name and label

Honest name for file software misled: FLASH for flexible, but it wasn’t fast

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CS207

in your brain

forever

Planning: Consistency in plans

When comparing business alternatives • Give each choice the same chance 1. Temporal consistency Computing versus communication

Local versus Cloud in 2012 o Skate to where the puck is going [Gretsky]

2. Discount rate 3. Resource prices Green alternatives

Benefits may depend on future price of oil – o if you assume future price = 3 x now, why not invest in oil instead

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Example Enterprise SW versus cloud

[Benioff:2009]

• SIEBEL enterprise sales force management $

1. Price $1,500 per seat, at 200 users = 300,000

2. $54,000 for support (18%) /year, x 5 = 270,000

3. $1,200,000 consulting for installation =1,200,000

4. $100,000 admin.personnel/year, x 6 = 600,000

5. $ 30,000 training / year, x 6 = 180,000

6 years’ usage Total = 2,550,000

Note that the customer’s total is >> than the price

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Cloud delivery by salesforce.com

• Benioff Saleforce.com new entry: $150.-month & user only -- monthly billing Make interface look like Amazon – no training needed Low risk for individual adopters

Still a high risk for a changeover in large businesses, where changes are controlled by a risk-adverse IT manager or CIO.

Start focusing on small businesses Hard to reach a broad market with little cash Must make a lot of noise

Later sales force had to change its initial model Deal with large companies Deal with the Dot-com bust, when many companies failed

Business must remain flexible 10/28/2011 CS207 17

Advertising 1. Audience

Focused

Salesforce In front of competitors

annual sale meetings 3x

1. Fake demonstrators in SF. 2. Give coffee, mugs, rides,

literature to attendees in NY 3. Hire all taxis in Nice, give

free rides to site in Cannes.

3. Logo & name Essential for branding

Metaphor

Negative?

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Vs. Superbowl? • Much buzz

• Huge audience • Your audience?

4. Timing Have Product ready

• Few bugs

• Clear operation

• Useful

2. Address

a. Buyers in corporations b. Users and employees

• Understand motivations for change

c. Both

Review Allocation

• When is allocation needed?

1. Tech. , Pharma company:

income due to R&D versus advertising

2. Financial Company:

income due to software versus investment experts

3. Internal ▬ product mix

• For the Pareto-optimality allocation of income we use cost.

But recall: Do NOT use cost as a surrogate for value, value of intangibles come from derived income.

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Expense Rollover A valuation based on cost

1. Collect the expenses ei over the total lag period p

2. Adjust the expenses by a discount rate d, ai= (1+d)p-i

3. For year i = 1 → p estimate the R&D retained ri =1- 1/p

4. Aggregate retained to the end date, R = Σ ri x ei x ai

5. From experience, publications obtain an expected expense to income margin m; m can range from 1 to 20 ...

6. Expected value of IP V = m x R

But the estimation of m is verrrrrrrrrrry iffy Technological advances are rarely stable But could be used for a) advertising -- much untrustworthy data

b) stable maintenance component only 28-Oct-11 tCS207 20

m≈2 in the first model we used

Setting License fees

Say you want to delegate sales in Europe to some company EUsales that can do it easier over there

• How do you set the fees or royalties?

1. You have computed a value of your SW of $1M But without discounting, it is actually $1.6M = Σ(due old, slide 5)

You will also maintain the SW 1.36M = Σ(maintenance cost, slide 12)

The total due is $3M

2. You expect the European sales will be 40% of total, 20 000 The reason for not discounting is that funds arrive at the same times.

• To earn the same you should charge 1./2.= $150/unit It does not matter how EUsales sells it and what it charges

Complexities are required language, interface improvements

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Discussion

• A long-lived product is hard to displace if

It is well maintained,

but that becomes costly

Keeps up with all standards

• Internal replacement

Should be easier

But has not been in practice

Next week IP, IP protection, and IP licensing

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