Pay or play - licensing mistakes and how they cost you big time

Okay you've sold your idea to a big company for $1 a unit they fit it to..... and they make millions each year. Just before you start driving away in your Ferrari though, you realise they aren't building any units with your baby incorporated. What's worse, you can't get the idea back from them. You've been caught in the pay or play trap.

It's actually very easy to kid yourself that this won't happen to you. Our unit saves 10% of this, reduces that by 30%, makes it all much nicer, faster, stronger or whatever but think again. Say you are working with the leading manufacturer in a market, they have invested in making their product in a particular way. Changing all that will cost money. If one of their competitors had your idea then the leading company might be forced to change to follow suit, but now they have your idea effectively out of the game and can carry on as they are.

So simple rules for this simple game.

Get an agreed sales forecast that the company licensing/buying your idea must achieve. If they miss a quarterly target then allow them some time to come up with a remedial plan (that you can accept or reject at your discretion) - remember you don't want to kill the relationship unless you have to. However if they are not hitting the targets then you should have a clause that the idea reverts to your ownership. This should also be the case if they go out of business, have a change in ownership etc.

If you can get an upfront payment for a license then remember this can be very valuable. You get money into the company without giving away any equity - gotta be good right? Well sometimes - you should be able to figure out if it is good for you in your current situation.

Exclusivity is a subtlety that is worth considering. If you give it away to a small player you may find that you have lost time in the market when they don't meet targets. However, again, exclusivity can be treated as something a partner retains if they hit sales targets. If they drop below these you should be able to withdraw it (at your discretion).

It can be a bit tedious to work through but getting it wrong will kill your business stone dead so stay awake - there may even be a quiz at the end.

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Maximising the return for your startup

One of the most interesting problems in a technology startup can be figuring out where to enter the value chain. This real example shows the thinking needed to maximise the return for your company.

An electronics company had a revolutionary component for mobile networks. Thinking traditionally - they would be sold to form part of an assembly made by another company that would be sold to a systems integrator who would deliver the network for a mobile operator.

The overall savings in a network rollout by using this product would be in the order of 100’s of millions of dollars – by allowing the removal or down-speccing of other systems.

Okay you know enough to analyse the potential deals – but put your sales and psychology heads on please.

Where should they try to sell this product and for how much?

Sell to the company making the current components.

The individidual component that would be replaced costs around $100 each.

First, are the manufacturers of this component going to want to change to this new device? They might but they will have investments in existing devices, documentation etc..

If they do go for it, are they going to suddenly be able to charge $1000 each? I doubt it personally. They might try for a small premium but the massive savings this component allows will be lost to the startup. It’s a similar argument for the company making the assemblies. They might be able to charge a small premium but again, the massive savings are being left on the desk of the mobile operators.

Sell to the system integrators

Okay so these guys are in constant war over prices and winning new contracts. They try to shave the costs down as low as possible to win the next deal. So if they buy the components, they will use the overall system savings to reduce their contract prices. So they might win more work but they don’t make better margins because of the product. Again, the money is left on the desk of the mobile operators.

There’s a pattern here right? The mobile operators are the right place to start in the value chain. If you can’t initially work with them then the next step is the systems integrators etc..

Look for an early strategic purchase of the startup

When I see a technology that provides a knockout blow, I try to look at the tier one companies (the usual suspects) for an obvious buyer – someone who might want to really hurt the competition. However, it is also worth looking at the tier two companies to see if there is a company that is desperate to make the step up. Would an exclusive deal enable them to make that leap? If so, are they capable of paying a premium for the company either now or early on in it’s life?

Copyright Richard A D Jones 2005

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What the heck are investors looking for?

You may have the best idea in the world but if you can't sell it, you're not going to get very far. To sell it, you have to understand your target audience - investors. Now without going into huge reams of psychological detail, if I suggested they want to make huge amounts of money off your hard work then could we agree on that?

Investors see plenty of opportunities and are trying to find the perfect company with no risk and big cheques at the end. The perfect company is very tricky to find, and different investors will have different views on risk....but you need to consider what they are looking for.

In no particular order - here are the top four.

Management team. Investors want to see a complete management team (all critical roles filled) with people they judge can get the job done. In larger companies this may be a CEO that has done a flotation before but industry experience and contacts always seem to figure large in the concerns of investors.

High growth market. Developing the greatest steam tram is going to impress no-one. Investors like high growth markets because the penetration of the start up is also helped by the general rising of the market. High growth markets need more working capital than flat ones but that's for another time.

An unfair advantage. This is a great phrase and it's great when it's true. Does the company have some market access, proprietary technology or whatever that will make it much harder for people to compete with them. I see a lot of software companies where people are working like dogs but can't get funded because their idea can be copied by a larger company in months and they cannot achieve a significant market position before being swallowed up by the larger competition.

Intellectual property. If the company has some patent protection for their technology then it helps reduce the perceived risk for an investor. The 'threat of entry' by competitors is reduced
and patents can be worth their weight in gold in terms of attracting investment. However, again software companies can struggle here. In the UK, and Europe to some extent, it is very hard to get a significant patent for software.

Now the simple final thing you should be able to explain - because I'll ask when we meet. What is the selfish benefit to a user/purchaser of your product/technology? In other words, are you solving a real problem that people have and want solved or just hallucinating that they will love your new gizmo because it's cool. I used to work for Philips and I can assure you that technology-push is not a sustainable strategy for a startup.

Copyright Richard A D Jones 2005

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Monitoring the effectiveness of innovation

Innovation is like a sales funnel, you get prospects in one end and hopefully ‘sales’ out of the other end. The costs associated with generating concepts, clustering, evaluating etc. can be very significant and the business should really understand how these costs are spent throughout the process.

For example, if 90% of your innovation budget is spent on projects that do not become products/features then you probably need to re-evaluate how you are making decisions.

There are two sides to this argument though. If you don’t measure something, you can’t really tell how it is performing. However, the unintended and undesirable consequences of setting metrics can be extraordinary. The easiest way to reduce cancellation of projects late in the process is to cancel everything but absolutely dead certain successes. That is not in the best interests of the company but the metrics can drive you in that direction.

You can only get this right by understanding the requirements of the organisation at the strategic level and then cascade these down as criteria into the decision making process.

This should include understanding the man day and resource costs committed to each point in the innovation pipeline.

Then you can start to assess different projects both against one another and in relation to the existing portfolio.

If you have 20 projects relating to one part of a production process then accepting a 21st is probably a mistake. If all your projects have very high technology and market risk, then you probably need to start some 'safer' ones.

© Copyright Richard A D Jones 2005

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How do you make better decisions? Get senior management out of the process!

When your project has reached a decision point, do you really want to wait until the management team can assemble? Are you sure they will have time to get to your part of the agenda? You've probably been in a project that gets bounced from at least one meeting and has to wait.

HP did some great research on the cost of delaying projects and their return map shows how time really is more important than money (more of that another time).

The key here is to remove senior management physically from the decision making process. I'm not talking about burying them under the patio (tempting though it might be). What I mean is that you need to create criteria that can be used in deciding whether a project can continue. These criteria essentially 'represent' the company's strategy and senior management approach without them having to be present.

A simple example might be that projects should only enter the development portfolio if they have an Internal Rate of Return over 20%. It might also be that a project must have sign off from an internal client, a complete business plan etc.

Putting these criteria in place will achieve two things.

Firstly you can progress projects without the delays associated with requiring senior management attendance and agreement at every stage.

Second - decision making is far more consistent as you avoid the vagaries and inconsistencies of decision making you get from some managers.

It's not perfect, but it works for many decision making points that projects need to pass.

Note - individual project milestones are not the same as these decision making points. Projects (and hence milestones) are unique whereas a process is something that is repeated over and over.


© Copyright Richard A D Jones 2005

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Physical interfacing of teams

This is really simple but works. Think about the processes involved in going from innovation to product/feature delivery. If they are supposed to work closely together then put them close together. Is that it? Okay not quite.

To maximise the interactions between different groups, try to increase the size of the physical interface between them. I'd say that in English if I could.

Maybe an example will help - doubt it but worth a try.

If you have a development team and an industrialisation team say - then don't design the office so they are separated. See if you can set it up so that as many people as possible are next to someone from the other department. I don't mean mixing them up completely as you want each group to still function well on their own. I just mean think about how you can create long borders between groups where colleagues from the different groups can talk.

© Copyright Richard A D Jones 2005

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Customer related costs and how to manage them (1 of many)

There is some simple wisdom about having customers. It costs 10 times as much to acquire a new customer as it does to sell to an existing one. Then, with a strange lack of gratitude, a happy customer will tell between 0 and 3 people whereas an unhappy one will tell more than 10 people of their negative experiences. These figures were created before the advent of email, Internet forums, blogs etc. so I can only assume the picture now is even more extreme.

Customer Support

As part of the cost of having customers, support can make a big difference to the profitability of companies like ISP’s, ASP’s, software companies – in fact most companies that are driving towards low revenues per customer. These companies need to focus on operational excellence and hence low cost customer support.

A helpdesk costs around $40 per hour in the UK (substantially less in India of course) and so a five minute call costs $3.50. If I said that a good ISP might 1 in 64 customers ringing up each month then the costs start to mount.

The main area that people often find tricky is billing. Startups have to rely on third parties to do this for them (e.g. WorldPay) and hence need to talk to them about queries from customers. Ventures spinning out of corporates often have to ‘inherit’ the corporate billing system – with its over-complexity and again, lack of real ‘ownership’.

The approach to addressing the costs (and negative view of customers) is to start to measure the interventions against particular causes. This should capture the product type, source (email, telephone, letter), duration of first line response etc.

In addition, further actions will have been carried out and these should also be noted.

The result should ultimately be a breakdown of time by:


- product
- customer issue
- impact on
front line support
second line
engineering
etc.

You’ve heard time is money right – well it is worth quantifying the cost of the interventions by using a standardised hourly rate for each type of person involved in the company. This may not seem important but one hour of the CEO is slightly more expensive than one hour of an outsourced call centre person.

Beyond that – what are the costs associated to the customer

- replacement product
- delivery

…and most of all – what of the business lost directly? If the customers can’t login for example, then clearly there is a direct impact in lost revenues – not to mention all the nasty things they say afterwards to their friends.

It is obvious to then simply start attacking the major issues but………..hang on do you go for the costs to the company or the impact on the client? This is where you need to use common sense. You can get very fancy assessing the customer impact factored against the cost to the company. My advice is grab a cup of coffee and the pragmatic approach will soon become obvious to you.

© Copyright Richard A D Jones 2005

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Strong spin-outs and weak parents don't mix!

Creating spin-outs from a weak parent can be fatal – no matter how good the new venture. I suggest you sit comfortably and don’t read on if you are of a nervous disposition.

A company I know went through a great public offering and reached near a half-billion dollar valuation based on a series of spin-outs and a pipeline of IP. I know them pretty well so this was a pretty thin story but the market bought it (literally).

In the middle of all this excitement was an attractive little spin out with a novel approach to optical transmission. I would explain but that’s as much as I can remember or dare to try to explain at the moment.

So anyway – they had gone through some early rounds when over a few months, the parent hit trouble with the markets. The shares fell faster than a pigeon with a rocket plummeting to its doom. In the end, the company was valued at around $10 million – even though they had near $50 million of ‘value’ in spun out subsidiaries and investments and $30 million in the bank. I’m no Gordon Gekko but even I saw a possibility here but sadly the situation meant you would not have been able to convince enough shareholders to sell.

Back to our heroic start-up which is now trying to raise a $7 million round. Look at the maths. People could pay several million for a small part of the spin out or seemingly a large chunk of the parent (and hence a bigger stake in the start up). Things did not go well and the start up is no more I am afraid. The logic of investing was clouded by its ownership structure and it died.

The identity of these companies has been disguised to protect the guilty. The value of your investment can go down as well as up. No animals were hurt in the making of this story.

© Copyright Richard A D Jones 2005

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