網際網路新創公司的價值評估與脫手策略

國

立

交

通

大

學

科技管理研究所

碩

士

論

文

網際網路新創公司的價值評估與脫手策略

Valuation & Exit Strategies for Internet Start-ups

研究生:龐德士

指導教授：虞孝成 教授

Valuation & Exit Strategies for Internet Start-ups

研 究 生：龐德士 Student：Pontus Claesson

指導教授：虞孝成 Advisor：Dr. Hsiao-Cheng Yu

國 立 交 通 大 學

科技管理研究所

碩 士 論 文

Submitted to the Institute of Management of Technology College of Management

National Chiao Tung University in partial fulfillment of the requirements

for the Degree of

Master of Business Administration

Sep 2007

Hsinchu, Taiwan, Republic of China

Valuation & Exit Strategies for Internet Start-ups

Student：Pontus Claesson

Advisors： Dr. Hsiao-Cheng Yu

Dr. Magnus Holmén

Institute of Management of Technology

National Chiao Tung University

ABSTRACT

This thesis work examines possible exit strategies for new technology and Internet firms in its start-up phase, and how new technology and firms in the Internet industry will be valued at the prospect of an exit. The outline of the report is to analyze value potential and exit strategies linked to the value relevance of firm’s with no earnings, no history, and no

comparables. Six exit strategies are identified, all will different significance for start-ups, and two main paradigms in valuing Internet start-ups are identified and discussed. The report is made together with the Department of the Management of Technology at National Chiao Tung University, Taiwan, and the Department of Management and Economics of Innovation

(MEI), and Chalmers School of Entrepreneurship (CSE), both at Chalmers University of

Technology, Sweden.

The work is aimed to give answer to three main questions:

1. “What can a start-up firm do in order to become valuable, in terms of attractive investment object?” and “What operations are value related from the approach of an investing or purchasing firm?”

2. In which way, and how, will MindValue, the specific new technology firm, be valued

3. Which companies are potential buyers for MindValue, the specific new technology firm (who are the players)?

The work has been accomplished through literature studies, market data analysis, and specialist interviews. The study found two paradigms in valuing Internet firms that differentiates from each other, a traditional view in valuing firms, and a view based on

non-financial data. The study identified a number of value drivers for Internet firms that are

used for both valuation paradigms, and finally the report identified the most likely exit for an Internet start-up.

Acknowledgements

I would like to thank you my advisors, Prof. Yu and Prof. Holmén whose academic insight and critical thinking has guided me through the whole thesis process. The writing has been a positive struggle, and with my advisors help I have learned a lot.

I also would like to thank you both my thesis reviewer, Prof. Lin and Prof. Chang who have given me very good critique and recommendation to improve my thesis.

Finally, I would like to thank my family and my friends who have been giving me support during my time study in Taiwan.

Contents

Abstract ...i

Acknowledgements ...ii

List of Tables...v

List of Figures ...vi

1. Introduction...1

1.1.BACKGROUND...1

1.2.AIM...2

1.3.PURPOSE...2

1.3.1 Why a report of exit strategies for start-up companies? ...2

1.4.DELIMITATIONS...3

2. Problem analysis ...5

3. Theory and models ...10

3.1.EXIT STRATEGIES...10

3.2.STRUCTURE ANALYSIS...13

3.2.1. Strategic groups ...13

3.3.DISCOUNTED CASH FLOW VALUATION...14

3.3.1. Discounted Cash Flow ...14

3.3.2. Discounted Cash Flow Value...14

3.4.NON-FINANACIAL VALUATION MEASURES...15

3.4.1. Classification of sectors at Internet – different groups of operations...15

3.4.2. Web Metrics ...20

3.5.MARKET BASED VIEW...21

3.6.RESOURCE BASED VIEW...24

3.7.SCENARIO ANALYSIS...27

3.8.THE INDUSTRY LIFE CYCLE...29

3.8.2. Entrepreneurial approach of industry life cycle ...32

4. Method ...34

4.1.REQUIREMENT OF SCIENTIFIC CONDITIONS...34

4.1.1. Objective conditions...34

4.1.2. Unprejudiced conditions ...34

4.1.3. Balanced conditions...34

4.1.4. Guarantee of Objective, Unprejudiced, and Balanced conditions...35

4.2.THE IMPLEMENTATION OF THE STUDY...36

4.2.1. Literature search...36

4.2.2. Interviews...37

5. Valuing dot.coms...39

5.1.VALUING FROM DERIVATIVES...40

5.2.TWO APPROACHES OF VALUING NEW TECH FIRMS...42

5.2.1. Paradigm 1. A financial statement approach – Cash is King!...42

5.2.2. Paradigm 2. A non-financial approach – The value of an eyeball ...43

5.3.RENAMING OLD PRINCIPLES OR EMBRACING NEW PARADIGMS...44

6. The New Economy ...44

6.1.DEFINITION OF THE NEW ECONOMY...44

6.2.DEFINITION OF A TECHNOLOGY FIRM...46

6.2.1. Two aspects of a technology firm...46

6.2.2. Old tech to new tech...47

6.3.1. E-business ...48

6.3.2. E-commerce ...51

7. Traditional Valuation Models ...52

7.2.PROBABILITY WEIGHTING SCENARIOS...53

7.2.1. Case study of Amazon.com...53

8. Non-Financial Measures ...58

8.1.THE VALUE-RELEVANCE OF NON-FINANCIAL INFORMATION...58

8.1.1. Specialist Discussion ...58

8.1.2. Valuing with Market Expectations and Comparables...59

9. MindValue – an Internet Start-up firm...61

9.1.HISTORY BRIEF...61

9.2.BUSINESS PLAN BRIEF...61

9.2.1. The Problem...61

9.2.2. The Solution ...61

9.3.STRATEGIC GROUP AFFILIATION OF MINDVALUE...63

9.3.1. Mindvalue – Portal, Community or E-tailor?...63

10. Synergies from main activities...64

10.1.SYNERGIES ASSOCIATED WITH AN EXIT...65

10.2.DISTRIBUTION AND MARKETING CHANNELS...66

10.2.1. Relevance to MindValue ...66 10.3.STRATEGIC ALLIANCES...67 10.3.1. Relevance to MindValue ...67 10.4.NEW TECHNOLOGY...68 10.4.1. Relevance to MindValue ...68 10.5.NEW COMPETENCE...68 10.5.1. Relevance to MindValue ...68

11. Structure analysis ...70

11.1.4. Direct Competitors – Pure Internet firms ...80

12. Analysis of a potential exit situation of MindValue ...83

13. Conclusions...87

13.1RECOMMENDATIONS...88

References...90

Appendix A...94

INTERNET...94

Short history brief ...94

Appendix B ...95

List of Tables

Table 6.1. Some value indicators by economies. ...45 Table 9.1. Identified customer utility of three segments ... 62

List of Figures

Figure 2.1. Organization and disposal of the work...9

Figure 3.1. Intermediary Business Models for e-business ... 17

Figure 3.2 Five-Force Model... 23

Figure 3.3. A Resource Based Approach to Strategy Analysis... 25

Figure 3.4 U.S. Companies’ intangible assets as a percentage of total assets... 26

Figure 3.5. Resources for the Basis for Profitability. ... 27

Figure 3.6. S-curve and consumer attitudes in the normal distribution curve... 30

Fig 3.7.. The Industry Life Cycle – S-curve... 31

Figure 5.1. P/E Ratio Comparison across sectors... 42

Figure 5.2. P/S Ratios by Sector... 42

Figure 6.1. Price-to-Book-Value Ratios by Sector... 48

Figure6.2. E-commerce primarily involves transactions that cross firm boundaries. E-business primarily concerns digital technologies to business processes within the firm... 51

Figure 7.1 Amazon.com: Potential outcomes – Scenario Analysis... 54

Figure 7.2. Expected Value of the potential scenarios ... 55

Figure 7.3. Volatility of expected values of the potential scenarios... 56

Figure 11.1. Strategic Groups of the Internet Industry... 71

1. Introduction

1.1. Background

In the 1990ies the term New Economy was stated to describe a whole set of forces that started to appear that called for new marketing and business practice. Globalization and Technology are two of several strong forces that play a major role in the reshaping of world economy, and information technology in particular (Friedman, 2005; Mann, 2006). Since Internet’s entry on the world arena, it become possible to combine text, data, sound, and images into bits and transmit from appliance to appliance, and Internet became the “information highway”

conveying the digital information (Friedman, 2005). Much of today’s business is carried over networks connecting people and companies, and the progresses are developing fast.

It has become considerable easy to transfer digital information between people, which also had led to many new business opportunities all over the world. It is comparatively easier to start new technology companies than prior traditional firms, due to very low initial costs, which also have been the case during the last decade (Copeland et al, 2000; ITPS, 2006). Some of the Internet start-ups or new technology firms have demonstrated extremely good business models and have become really successful (DI, 2007; FT, 2006). However, most of the new ventures never succeed, but many of them survive and make progress (Damodaran, 2001).

Being successful in new technology business, in the sense of getting the company profitable requires, as for all continuous industries sustainable business ideas and very often, profound business plans (Kubr et al, 2005). Many of the Internet ventures witnessed a fatal ending by the Internet shakeout in year 2000, and one of the main reasons was naïve business ideas that did not fulfilled basic requirements for sustainable revenues (Lindstedt, 2001). Another main reason to the Internet hardship in early year 2000 was the irrational investments all over the world (Damodaran, 2001).

A business plan or investment plan comprises several chapters and one of them discusses the

exit strategy. The exit strategy describes the long-term plans for the business and presents a

realistic plan of how entrepreneurs successfully can exit a project. In the investor perspective

exit strategies describes how investors are getting back their investments with substantial

return. Ultimately, the most effective exit plans will take into account business, personal, and investor goals.

There are several potential opportunities for successful exits for new technology or Internet

1.2. Aim

The aim with this thesis is to serve as an advisory document for a new start-up company in Sweden – an Internet start-up project of Chalmers School of Entrepreneurship (CSE) at Chalmers University of Technology, and serve as a basis for strategic exit discussions within the firm.

The outline of the thesis is to analyze value potential and exit strategies linked to the value relevance of firm’s with no earnings, no history, and no comparables.

The thesis also contains a comparison analysis of two main paradigm approaches in valuing dot.com and Internet industries.

The thesis will finally conclude a strategic exit analysis of the start-up company, with consideration to the valuation approaches.

The outcome, presented in the chapter of “conclusion & recommendations” will result in a strategic operation plan considering exits1 _{for the new start-up company MindValue. The} thesis will contribute to the start-up’s development program.

1.3. Purpose

The purpose with this thesis is to analyze strategies to successful exits for potential start-up companies within the Internet industry. This thesis is made together with MindValue, an Internet start-up project of Chalmers School of Entrepreneurship (CSE), and the thesis’s outline is focused on the prospects of this specific company.

1.3.1 Why a report of exit strategies for start-up companies?

Thinking of exits during the start-up phase might seam paradoxical, but is at the same time highly relevant. Many start-ups in the new technology industry have shown high growth potential all ready in its cradle, but only some of the companies actually succeed (Koller et al, 2000). Being successful in business is influenced by many factors, all from throughout preparations to proficient talent and in some times, pure luck. Preparing the exit strategy already from the infant stage of the company life cycle will reduce unexpected situations in the future, and the actions towards a specific exit can be taken already in an early stage. The

problem of valuing a new technology company in its early stage is a continuation of its hurdles of strategic planning, why this link is interesting to analyze. This specific topic seams also rare in financial and strategic literature, why an initial study like this s motivated.

1.4. Delimitations

The thesis will focus primarily on exit strategies for newly start-up companies in the new technology industry, that is Internet firms or e-business firms in its start-up stage. Definitions of the terminology are given in coming chapters. The thesis will not take other industries into consideration for exit strategies, than new technology industries.

I will emphasize two significant mechanisms, Globalization and New Technology, as the main drivers of the New Economy development. This view is shared of several monitors of the world’s political and economical development (McKinsey Global Institute, 2002). There are other factors with impact on the development of the New Economy, but in relation to the

Globalization and the New Technology development, they are of less significance for this

report (McKinsey Global Institute, 2002). Since the term of New Economy concerns a major part of the world, there are many small factors of the concept to take into consideration, in order to cover a whole picture. Trying to map all causes in this context is too pretentious and will fell too far out from the core issue of this report.

The definitions of business concepts like e-business and e-commerce are taken from three sources (Laudon & Traver, 2003; Kotler et al, 2003; Weill & Vitale, 2001). There is no over-all consensus concerning the definitions of e-business and e-commerce, since the concepts still are in its cradle (Laudon & Traver, 2003). I find the three sources’ definitions presented in this report well suited for the analysis’ purpose, and will not explore these definitions any further.

The definitions if the strategic groups and the web metrics presented are commonly reported in the business press and are frequently mentioned as valuation parameters in analysts’ reports (Trueman et al, 2000). I find these definitions well suited for the report and will not examine other potential web metrics.

The concept of Discounted Cash Flow (DCF) is a common technique of valuing future cash flows (Copeland et al, 2000). I find this technique most adequate for this report, representing the traditional approach of valuation, and will not elaborate other “traditional” techniques. Other “traditional” valuation models might be more sophisticated than DCF, but also requires

more financial information, which in this case not is available.2 I will only describe the main concept of DCF, and will not elaborate it further for this report, e.g., I will not give examples of different uncertainty scenarios, measuring default risk and estimating default-risk adjusted rates, etc… Also, I will not elaborate the valuing of assets with equity risk or involve

dividends into this report. These concepts are connected to the DCF approach, but will not spread any further light over this report.

The presentation of the specific start-up company, MindValue, will contain a short history brief, a presentation of a problem with solution that MindValue have based its business plan upon. Due to the secrecy of the detailed business plan I will not elaborate and present business models and revenue models any further.

Both before and after the Internet shakeout in 2001, several valuation models and techniques have been presented (Damodaran, 2001). Many of the techniques presented focus on how to avoid as much risk as possible, that is, rational investor behavior (Grinblatt & Titman, 2004). Focusing on risk management and portfolio investment gives the analysis a statistical

approach, which is not the purpose. The risk eliminating techniques are not needed for this report, since the approach of this analysis is focusing on corporate strategy for new start-up companies with the ambition of a successful exit.

I use an online historical exchange converter, valid for the specific year and month of interest, when converting foreign exchange rates (www.oanda.com). The foreign exchanges are

foremost discussed in chapter 11, where examples of acquisitions of other Internet firms are made. Some of the sources of the transactions are presenting the currencies differently, why I am converting domestic currencies into US dollars ($ US).

2 _{The outline of the report is to analyze value potential and exit strategies linked to the value relevance of firm’s} with no earnings, no history, and no comparables.

2. Problem analysis

In order to fulfill the purpose of the master thesis, an analysis that covers practically all prerequisites and conditions concerning exit strategies of Internet start-up companies, is required. It has been necessary to divide the report in several chapters, as well as different blocks, that describes different areas, which all have impact of the final conclusion. The areas describes and elaborated in the report are supported by theoretical models and theories from prior studies and researches.

The organization and the disposal of the work is an assemblage of three blocks, which content are related to different stages in the analysis. First a block of general information, needed to be familiar with definitions and the main outline of the economical and technological

development, is presented. Second, an analysis and discussion of the content from the first block, related to the specific firm of interest, MindValue, an Internet start-up project in Sweden, will be conducted, and finally, the third block will generate a conclusion together with recommendations.

The first block will contain background information and the foundation to the new technology industry. I will give a brief of the term of new economy and how this concept is related to the industry of today. Since the report is discussing strategies and outcomes from Internet firms, possessing knowledge of the forces that are present in the global economy today will facilitate the analysis. The outline of this thesis, analyzing valuation and exit strategies for start-up

firms in the new technology industry, is a proactive reaction in a highly competitive

environment like the new technology industry, already in a planning stage. The new technology industry differs from traditional industries, because of its fast pace, fast

development and volatile nature (Brown & Eisenhardt, 1998). Proactive analysis of a firm’s resources and capabilities is based on the theory of the Resource Based View, which will be further elaborated in chapter 3.

The concept of new economy is very close to the emerging new technology industries (Kotler, 2003). The first block therefore also contains facts of the Internet industry and why it differs from traditional industries, concerning corporate strategy. After describing the new

economy’s and new technology’s impact on the traditional corporate culture in broad outline, I will describe the specific new technology firm of the report, MindValue. The details of the specific firm of the report, belongs to the block of general information that will give the report a body to relate analyzed information to. The theories presented in block 2 and 3 of this report will be applied onto MindValues strategy plan, concerning exit strategies.

The second block contains chapters of valuing new technology firms, and a brief of the new

economy concept. High price valued firms are always targets for acquisitions, due to

opportunities of high ROIC, Rate on Invested Capital (Damodaran, 2001). Acquisition is also a desirable exit opportunity for many start-up firms, since the operation is often connected with large amounts of economical benefits for the entrepreneurs of the start-up. One of the purposes of the thesis is to identify value drivers of a new technology firm, in order to put the specific firm, MindValue, in a more advantageous position than other industry competitors. Identifying the value drivers, the report will try to give answer to the first question of issue:

1. “What can a start-up firm do in order to become valuable, in terms of attractive investment object?” and “What operations are value related from the approach of an investing or purchasing firm?”

When analyzing new technology firms, which operate in a fast growing and volatile industry, there are several feasible alternatives for an exit (interviews, 2006). The exit alternatives are valued differently depending on the firm’s activities (interviews, 2006). The analysis will try to clarify the most important alternative in a valuable exit perspective, both for investors and for entrepreneurs.

A new start-up firm with ambition of a future acquisition has to clarify the exit strategy already in an early stage, that is, the start-up stage, in order to effectively manage adequate operations (Kubr et al, 2005). The approach to design a corporate strategy based on the firm’s external environment, is linked to the Market Based View of corporate strategy. The Market

Based View is based on the outlook of the external environment as a factor that influences a

specific company’s proceedings (Porter, 1980). The concept will be further elaborated in chapter 3. The Market Based Approach is a theory basically used to design marketing

strategies (Porter, 1980). The concept of the Market Based Approach has some significance of the design of a competitive strategy for the specific firm, MindValue, but the focus of

designing a corporate strategy will incline a greater part of the Resource Based View, since that approach is taken fast pace and a volatile nature to consideration, in contrast to the

Market Based View.

Opposite to traditional industries, the new technology industry typically faces the different stages of its life cycle much earlier and faster, which requires planning of its whole life cycle already at an early stage (Damodaran, 2001; Kubr et al, 2005).

Since the life cycle of a new technology start-up might be very short, the initial operations of the firm will reflect the outcome significantly.

The statement is an attempt to a “hypothesis” or statement that I will “test” in the report. It is not a real hypothesis test, since the authentic dittos are tested under more controlled

circumstances.

The great complexity and uncertainty of the industry, due to fast pace, fast development and its volatile nature, have given birth to divided opinions of what really drives value of the Internet firms (Damodaran, 2001). I will elaborate two main paradigms that are distinguished in the valuation of firms, as an extension of the first question of issue – identifying the value drivers. The extension will give rise to the analysis’ second question for this report, that is:

2. In which way, and how, will MindValue, the specific new technology firm, be valued

The two paradigms has been questioned and discussed frequently after the Internet shakeout in 2001, which will substantiate the second question of issue (Damodaran, 2001; DI, 2007; Cooke, 2006; FT, 2006; Interviews, 2006). The operations of the Internet users are valued differently, depending on companies’ profiles and business approaches, and the models and praxis used to determine a firm’s value (Damodaran, 2001). The second question aims to identify the main paradigms of Internet firm valuation and elaborate its attitude, as well as investigate and distinguish the differences in valuation of advertising, e-commerce, e-services, etc…

Business models like online gaming as poker and casino related sites, which are typical examples of activities on Internet that are strictly transactional – the site users strictly visits these sites to bet and transact money, which might raise the turnaround of the Internet company more than an Internet companies with different business models. This statement is interesting to elaborate for this report why an examination of the following statement will be made:

Specific transactional activities will be higher valued, than activities that only count visits and unique users.

Close connected to the valuation models and paradigms of Internet firms are the arising

synergies connected to new technology industry. The synergies of this analysis are defined as

those external benefits that arise from the main operations. The synergies explain some of the rhetoric from the valuation models that have great implication on the answers to the main questions of issue to this report.

The gained resources derived from synergies have shown to be an important reason to an acquisition (DI, 2007). This means that specific benefits of acquiring a specific company, like

distribution channels, new technology, or new competence, carries great weights towards

other main activities of the acquired firm (DI, 2007). After identifying the value drivers of a new technology firm, and elaborate how a specific firm can be valued, I will give an example of actors that might be interested in an acquisition of a new technology firm. This will give birth to the third question of this report:

3. Which companies are potential buyers for MindValue, the specific new technology firm (who are the players)?

The question will generate a market structure in order to analyze potential purchasers, by following a pattern of acquisitions from the acquiring firms. The question will generate an example of potential companies of different markets that might be interested in purchasing activities. The structure aims to illustrate a diversity of parties attracted to acquire new technology ventures, which derives from contemporary financial press and media (DI, 2007; FT, 2006). From the third question of this report the relevance of following statement will be further examined: The market structure of the potential buyers of a new technology firm is

divided, that is, it is not only direct competitors or firms in the same market sector that are interested in acquisitions of new technology firms.

The third block of the report is a presentation of groups of interest, which will gather the players at the market into different groups, in order to examine possible exit opportunities. Finally in the third block, I will conclude the analysis and present possible exit strategies to MindValue. The report will present a structured picture in an area of strategy that is complex and have highly divided opinions.

The outline of the report, figure 2.1, is designed to represent the steps of the analysis. The first part covers the theory and models the report is based on together with general information, the second part is the analysis and discussion block and the third part is the concluding part of the report.

No. Chapters 4 3 2 1 Problem Analysis Method Theory Introduction Block 1 6 7 8 5 Traditional valuation Possible exits of MV Conclusion Structure Analysis Synergies MindValue - MV Non-Financial Valuation The New Economy

Valuing dot.coms Block 2 12 10 11 9 Block 3 13

3. Theory and models

This chapter motivates and explains the theories and models this report is based upon.

Research within Strategy has to a large extent concentrated on the understanding of why some companies and organizations, from a marketing point of view, succeed better than others. The aim of the research is to identify the underlying factors that constitute the difference between those companies that are more successful and those companies that are less successful in their business.

The debate of the underlying factors of what constitutes the difference in success has mostly and traditionally been based on two concepts: Market Based View and Resource Based View. The concepts will be further elaborated in this chapter.

One of the leading theoretical frameworks in this report is the concept of exit strategies, which describes the last stages of a business in a specific phase (in this report: the start-up phase), and the prerequisite of a successful exit. The exit strategy contains both an investor strategy and a settle strategy, and a successful strategy enriching both sides.

Other analysis components that use theoretical frameworks are Structure Analysis, and

Scenario Analysis together with Mixed Strategy.

3.1. Exit Strategies

Kubr et al (2005) emphasizes in order to attract investors to a start-up project, a solid exit

strategy, which describes how the investors will get their investments back with a substantial

return and exit the project, will facilitate a company’s progresses. Naturally investors are interested in growth and profit of the business, but the lack of a solid and realistic exit strategy demonstrating how investors can accomplish this goal can immediately turn off many sources of capital (www.bizplanit.com, 2006).

The exit strategy also describes the long-term plans for the business. Ultimately, the most effective exit plans will take into account business, personal, and investor goals. Much of entrepreneurial literature describes the importance of a solid exit strategy chiefly from the investors’ perspective; how to demonstrate a realistic plan for investors to successfully leave the project and when to expect to reach liquidity.

A thorough exit strategy serves as a profound operation plan for the business, clarifying the projects future destination (www.bizplanit.com, 2006). To maximize the value of a new start-up it is essential to think, from an entrepreneur’s perspective about how to leave it further down the line. A carefully planed exit from the business helps the entrepreneur to

successfully design the business into the ideal shape for the chosen exit option, and maximizing the value from it. It also helps to exit at a time of own choosing, when the business is doing well and the market conditions are advantageous (www.bizplanit.com, 2006). To be able to design the business to fit the plan, it is important to look backward, that is to discount back the ideal scenario five years from now and identify actions needed today until the strike date (www.bizplanit.com, 2006).

The exit strategy is important for both for the entrepreneur and in the eyes of the potential investor. When elaborating different exit strategies, there are several definitions of exits, some of them similar to each other.

BizPlanIt, a consultancy firm, have identified the most common exits strategies, which are

IPO (initial Public Offering), Acquisition, Sale of Company, Merger, Buy-Out, and Franchise

(www.bizplanit.com, 2006). The difference of the six strategies concerns different types of companies, which are at different stages of its Company Life Cycle. For mature companies and organizations, the concept of IPO might be a successful strategic move, but may be difficult for a new start-up firm to accomplish, because of its complexity, uncertainty and costly process (www.bizplanit.com, 2006). In this report I will mostly analyze the

opportunities for acquisitions, since it the most common and used exit strategy of new start-up firms (www.bizplanit.com, 2006).

Looking at the buyers’ side of an acquisition and asking the question why someone is interested in buying another company, there are several reasons for that. Most of the worlds companies have competitors in some extent, no matter if the business is big or small.

Competing in a specific sector requires specific strategies to beat the industry average or close competitors. Among many strategies of how to gain market shares and succeed in the struggle of customers, growth is in many cases a successful strategy (Porter, 1980). As the company grows, the market share follows, and the revenues will probably follow as well. Large corporations are traditionally stronger competitors than small firms. A company can grow either by organic growth or by acquisitions. Organic growth means that the firm acquires its own customers and market share. An acquisition is a purchase of an existing corporation, and with the purchase comes the acquired firm’s market share as well.

In order to be familiar with the other concepts of exits, I will outline the other strategies and its’ characteristics stated by BizPlanIt (www.bizplanit.com, 2006):

Initial Public Offering, IPO

Initial Public Offering or IPO implies selling the shares of the company to the public to be traded on a stock exchange. The advantages of an IPO is the conversion to cash for investors, major shareholders usually maintain control, and high potential return. The company must have tremendous growth potential to receive IPO, it is a costly process, and the outcome is uncertain, which all are seen as disadvantages of the IPO concept. Major shareholders may be limited as to how much, when, and how they can sell stock. This event is very rare for most start-ups (Benjamin, 1996).

Acquisition

Acquisition means a business bought outright by another existing company. The advantages of acquisition are the receiving of cash or stock, it is often purchased by a strategic partner, and the management contract can be negotiated.

Disadvantages are: Fit must be appropriate, potential management changes, and corporate identity may disappear. Acquisition or buyout is the predominant method of achieving liquidity for small company shareholders (Benjamin, 1996).

Sale of Company

Sale of Company means business bought by other individuals or entities. The advantage is that cash is received immediately. The disadvantages are that the company must find a willing buyer, and that a sale of company normally results in new management.

Merger

Merger means join with and existing company. The advantages are that stock and some cash may be received, resources are combined, and current management may stay. The

disadvantages can be new partners or bosses, less control, little or no cash are received.

Buy-Out

Means that one or more stockholders buy out the others. The advantages are that seller receives cash, and other owners remain in control of the company. The disadvantages are that the seller must be willing to sell and the buyers must have sufficient cash to buy others.

Franchise

Franchise mean selling business concept to others to replicate. The advantages are that cash is receive, the current management is retained, and the opportunity for large scale growth. The disadvantages are that the concept must be appropriate for franchising, and the concept is legally complex.

In the context of a new technology start-up firm, the most likely exit strategy may be an acquisition, that is: the company of interest is purchased by a strategic partner (i.g. another company) (Benjamin, 1996). The other exit strategies are not suitable enough, because of the requirement of healthy liquidity, which start-ups mostly do not benefit of (www.bizplanit.com, 2006).

3.2. Structure analysis

The structure analysis is divided into two frameworks, both stems from strategic groups in different levels, which helps to gather the players at the market in an adequate way. I will use

Strategic Groups to separate new technology players’ different operations at Internet, and

structure the strategic groups further into brand and company name.

3.2.1. Strategic groups

The concept of strategic groups was first introduced into industrial organizational theory in the beginning of the 1970-ies, by M. S. Hunt (1972), to account for differences in profitability in firms competing in the same industry. The concept was further developed by Michael Porter (1980) in the 1980ies, and adopted by the fields of strategy and business policy. Porter’s (1980) definition of a strategic group is “the group of firms in an Industry following

the same or similar strategy along the strategic dimensions.” Strategic groups are defined as

sets of firms in an industry who compete with each other on the basis of similar combinations of scope and resource commitments (Cool & Schendel, 1988). Porter and Caves (1977) advocated the presence of mobility barriers that prevent the free movement of firms from one group to another, because decisions made by firms within a group may not be imitable by firms outside the group without incurring substantial cost. The presence of these mobility barriers makes the strategic group structure of most industries relatively stable and

distinguishable. Strategic group analysis provides insights into competitors’ approaches to the market and the conclusion of the organizational and industrial performance (Harrigan 1985). Porter (1980) advocates that the profit margin in general differ between strategic groups

because of Porter’s five forces have different importance for different strategies. Firm’s real profit will theoretically be equal in the long run, assumed that firms do not differ in the ability to conduct the strategy. These kinds of differences will always appear though.

3.3. Discounted Cash Flow Valuation

3.3.1. Discounted Cash Flow

The value of any asset is determined by its expected cash flows in the future, e.g. the present value of the expected cash flow from the asset (Damodaran, 2001).

Discounted Cash Flow (DCF) is a method of evaluating an investment by estimating future cash flows and taking into consideration the time value of money. This sub chapter will give a brief of the DCF-model and how it is linked to value an asset. The DCF-model covers the groundwork for how to value a firm and estimate the inputs that go into the valuation.

3.3.2. Discounted Cash Flow Value

The value of any asset should intuitively be a function of three variables: • How much the asset generates in cash flows • When these cash flows are expected to occur

• What uncertainty is associated with these cash flows

By computing the value of any asset to be the present value of its expected future cash flow, DCF valuation brings all three of these variables above together (Damodaran, 2001).

Value

=

CF

(1

+ r)

∑

n = Life of the asset

CFt = Cash Flow in period t

r = Discounted rate reflecting the riskiness of the estimated cash flow

The cash flows vary from asset to asset – dividends for stocks, coupons (interest) and face value for bonds, and real projects’ after-tax cash flows3 (Damodaran, 2001). The discount r is a function of the riskiness of the estimated cash flows, e.g. riskier assets carry higher rates, and safer projects carry lower rates.

ate

4

3.4. Non-Finanacial Valuation Measures

This sub chapter comprises a Structure Analysis, explaining and evaluating the present groups of operations on Internet, which have economic and financial functions. After the strategic groups, I will present the non-financial web metrics that have robust value-relevance.

3.4.1. Classification of sectors at Internet – different groups of operations

The Internet industry can be divided into the following sectors: Portals, Content/Communities, and E-tail. These sectors are considered to have business models for which web traffic plays an important economic role. Chiefly, these sectors are B2C companies that are expected to earn revenues either directly or indirectly by attracting web traffic to their sites.

3 _{Dividends, coupons, and after-tax cash flows will not be further elaborated in this report. Readers interested} are recommended to acquaint oneself with the references of this report.

4 _{The risk and uncertainty are two of the ground stones in Finance. I will not elaborate the concept of} uncertainty further, since it is too wide for this report. Interested readers who are not familiar with the concept are recommended to adequate Finance literature

3.4.1.1. Portals

Portals are providers of gateways to the Internet. Some of the most popular sites on the Internet, both for consumers and business users, are intermediaries, where portals count in. The intermediaries are sites that stand between the buyer and the seller. The number and variety of intermediaries are growing fast, and the business models become more and more sophisticated. Internet is home to a variety of intermediaries, each of which provides a different value proposition.

Figure 3.1 presents a framework for comparing intermediaries on the basis of the

completeness of service offered and the number of buyers and sellers participating (Weill & Vitale, 2001). Completeness of service is the proportion offered of the full set of services that could potentially be proved by an intermediary. According to Weill & Vitale, 2001, the services include:

• Search: To locate providers of products and services.

• Specification: To identify important product attribute. Specifications reduce

communication costs for both buyers and sellers.

• Price: To establish the price, including optional extras such as warranties.

Options for setting the price include fixed prices, auctions, reverse auctions, and dynamic pricing based on demand or relationship.

• Sale: To complete the sales transaction, including payment and settlement. • Fulfillment: To fulfill the purchase by delivering the products or service. • Surveillance: To conduct surveillance of the activities of buyers and sellers

in order to report aggregate activity and prices and to inform and regulate the market. This activity can include reporting on the results of completed transactions (e.g., stock market summaries or auction results) and on the depth of the market (e.g., the number of active buyers and sellers and the prices at which they are willing to transact).

• Enforcement: To enforce proper conduct by buyers and sellers, including

resolving disputes and sanctioning improper behavior. Some intermediaries, such as stock exchanges, have guarantee funds to compensate for any loss.

Special Auctions Electronic Auctions Electronic Markets Portals Electronic Mall Shopping Agents Components of Service Search Specification Price Sale Fulfillment Surveillance Enforcement Increasing Comple teness of Services

Number of Buyer and Seller

Figure 3.1. Intermediary Business Models for e-business, Weill & Vitale, 2001.

Chiefly, portals earn revenues from advertising on its own pages and from click through referrals to the sites listed. The basic requirement for survival as a portal is sufficient volume of usage to cover the fixed costs of establishing the business and the required infrastructure. Attracting and retaining a critical mass of customers/viewers/users of the portal is therefore the primary critical success factor (Weill & Vitale, 2001). Two other success factors Weill & Vitale (2001) advocates is the capability of building up infrastructure quickly enough to meet demand as it increase. The third critical success factor is to the customer relationship and producing a portal with a high degree of stickiness5_{, which is the need or desire to return to} the site.

3.4.1.2. Content/ Communities

Content and Communities provides catering to certain segments of the population or to groups of people with specific interests. In this text, a content provider is a firm that creates and provides content (information, products or services) in digital form to customers via third parties (intermediaries). The primary source of revenue for a content provider is fees from its third parties, based on fixed price per month or on the number of times a user uses the content. The business models of content providers are constantly progressing. Chiefly, there are three critical success factors connected to content providers:

• Branding – The content must be recognized by a label in order to maintain

a long-term presence at the market.

• Recognized as best in class – content providers must deliver state of the art

content. This recognition is close connected to a brand, which announces a sense of quality and reliability.

• Network – The establishing and maintaining of a network of third parties is

crucial for the distribution of the content.

Communities, or virtual community business models offers members the opportunity to interact electronically with like-minded individuals and to both create and consume content relevant to a topic of personal or professional interest (Weill & Vitale, 2001). Many

commercial web sites, both new technology firms and traditional firms with web-sites, uses communities to sell goods and services or to provide information. The communities are important marketing tools as well, gathering special niche groups of customers that are willing to discuss and interact with the products the firm is providing. An example is Procter & Gamble (P&G), an American fast moving consumers goods firm, and SCA, a Swedish global consumer goods and paper company. Both firms are providing baby diapers, branded

Pampers (P&G) and Libero (SCA), and have created communities on in the Internet focusing

on the segment of new parents. Both these parent’ communities have remarkable impact on the segment, who discuss everything concerning baby issues to pure product development. The customers are really involved with the brand and are important “marketers” of the word

of mouth (Kotler et al, 2003).

The firm can gain revenues of the community from:

• Membership fees

• Direct sales of goods and services

• Advertising

• Click-through

• Sales commission.

3.4.1.3. E-tailers

E-tailers sell goods and services on the Internet. The e-tailers benefits form the

direct-to-customer business model and fall into four categories. In each category the products or services are sold directly to the customer. The products or services could be physical and delivered by regular mail or parcel services, or digital and delivered instantly over the Internet. The four categories are:

• Space-based firms,6 or pure Internet firms selling their own branded products, such as RealNetworks.

• Place-based firms7 also operating over the Internet, selling their own branded products. Compare with traditional mail order versus online ordering.

• Place-based firms selling third-party products both in physical outlets and on the Internet.

• Dot.coms selling third party products, such as Amazon.com.

The benefits of the direct-to-customer business model are significant for both the customer (low prices, faster response time, self-service, etc.) and the seller (lower selling costs, online customer data collection, larger geographical reach, etc.) (Weill & Vitale, 2001). The business model of direct-to-customer and the concepts of e-commerce and e-business that e-tailers benefits of enables the online retailers to provide huge ranges of carefully specified and described products on their web sites, take orders, receive payment, and arrange delivery the items. The direct-to-customer business model offers the prospect of higher margins, expanded markets, and greater information about customers to the firm of interest. To the customer, the business model of direct-to-customer offers greater choice, increased convenience, and lower costs.

The main source of revenue is usually direct sales to customers. Higher margins than traditional bricks-and-mortar8

firms may be attained either by reducing the cost to serve the

customer directly or by cutting steps out of the distribution chain (Weill & Vitale, 2001). The e-tailers operate in a highly competitive space, and according to a study of 221 e-tailers in year 2000, Boston Consulting Group (BCG) found that only 40 percent were profitable, mostly due to extremely huge marketing costs (Weill & Vitale, 2001).

6 _{Space-based firms, refers to Weill & Vitale’s definition of Internet firms that exclusively operates on the} Internet, or in the cyber-space.

7 _{Place-based firms, refers to Weill & Vitale’s definition of traditional firms who not have migrated their} business to space, but are running the operations on place. Many of the assets (e.g., brand, cash, relationships, market share) of successful place-based businesses will serve equally well in space (Weill & Vitale, 2001). 8 _{Bricks-and-mortar is a description of a company with a physical presence, as opposed to one that only exists} on the Internet (www.investorwords.com, 2006).

3.4.2. Web Metrics

Web metrics are commonly used performance benchmark for Internet firms and have now became standard. The web metrics are commonly reported in the business press and are frequently mentioned as valuation parameters in analysts’ reports. Prior reports (Trueman et

al, 2000) have proved evidence on the value-relevance of raw web metrics for Internet stocks.

Interviews with two specialists in 2006 at a global Accounting and Financial Advisory firm in Sweden, showed on a contradiction of the interpretation on using the non-financial data, and other literature on the topic advocates more traditional valuation techniques (Copeland et al, 2004). Web metrics are applied on analysis in both popular press and in business reports, and even if studies have showed evidence for value-relevance, the use of web metrics has not reached consensus (Demers & Lev, 2001; Trueman et al, 2001).

Demers & Lev (2001) use factor analysis and presents three web traffic metrics in their report. The study investigates the separate valuation role of these three different dimensions of web traffic performance. The results of the study are examined both before and after the Internet shakeout in year 2000. This examination before and after the shakeout is pertinent because some analysts and practitioners have suggested that web traffic metrics are no longer

important (Briginshaw & Higson, 2000). A viewpoint, shared with the specialists interviewed for this report.

Three key dimensions of traffic generating performance are: the attraction of new visitors to a website, the retention of visitors at the website, and the ability to generate repeat visits from surfers who have been attracted to the website in the past (Demers & Lev, 2001). These three dimensions of web traffic performance are commonly referred to as: reach, stickiness, and

customer loyalty.

3.4.2.1. Reach

Reach is generally defined as the number of unique individuals who visit a site (Demers & Lev, 2001). The measure is stated both in percent of the active web population or in real numbers, indicating how many unique visits a website has the ability to attract. Reach is the most frequently cited web metric in the business press and has been studied in prior

researches (Trueman et al, 2000; Hand, 2000; Rajgopal et al, 2000). In Demers & Lev’s (2001) report, the performance measure reach is positively associated with the value of the B2C Internet companies, due to the importance of scale in the B2C sector.

3.4.2.2. Stickiness

arrived there. The web metric stickiness is a desirable performance measure because a sticky site may be able to generate higher advertising rates since the visitors are spending more time at one place. The higher advertising rates are motivated of believes that surfers might be more influenced of specific advertising due to longer exposure (Demers & Lev, 2001).

3.4.2.3. Customer Loyalty

The loyalty measure generally refers to the site visitors willingness to revisit a website that the already has been visited before. The measure is relevant because a website’s ability to

re-attract current visitors is expected to be an important determinant of its ability to sustain and/or ultimately grow to the critical mass of traffic that is necessary to attain profitability. A visitor who returns several times is important for e-commerce firms, because of a high probability of steady income.

Both stickiness and customer loyalty reflect important dimensions of an Internet firm’s brand value.

3.5. Market based view

The way of designing an exit strategy already in the start-up stage of a company’s life cycle is a conscious act in order to design a competitive strategy. If the aim of the exit strategy is a company sale, an IPO, or an acquisition, a company in its early stage has to identify its external surroundings, in order to successfully design a strategy that will meet the requirements from a potential buyer (Porter, 1980; BizPlanIt, 2006). The approach of identifying an industry’s external environment and adapting the corporate strategy to it is close connected to the Market Based View (Porter, 1980). Later studies have accused the approach of having some limitations, because the presumptions in this theory proceed from a stabile industry structure (Brown & Eisenhardt, 1998; Grant, 1991). The disagreement will be discussed in this chapter.

The Market Based View has only significance in some part of the exit strategy outline of this report, mostly because of its idea of adapting to external environment, in this case - the potential buyer’s requirements. The design of a corporate strategy for a new technology start-up firm has more inspiration to gain from the Resource Based View, because of its volatile and unstable nature, also describes in this chapter (Brown & Eisenhardt, 1998; Grant, 1991).

Market based view is based on the outlook of the external environment as a factor that

influences a specific company’s proceedings. Market based strategy manages the company’s reactions to the external environment that are required to maximize the internal resources

efficiency. The market based approach uses the external environment as basis to design a successful corporate strategy. Supporters of this approach (Porter (1980)) advocates that differences between different markets and companies concerning profitable success, depends on external factors. Competitive advantage depends on a company’s ability to adapt to its external environment (see figure 3.1) (Porter, 1980).

The competitive advantage that lead to profitable success is in the market based approached derived from thee factors:

• Establishing hurdles

• Monopoly and competition

• Power of negotiation

Porter (1980) developed the concept further and introduced the Five-Force Model (figure 3.1) as a strategic tool for competitive advantage. The model describes five forces, which have impact on every specific company. The five forces are defined as follow:

• Threat of New Entrants

• Bargaining Power of Buyers

• Threat of Substitute Products or Services

• Bargaining Power of Suppliers

The Five-Force Model is illustrated in the figure below:

Figure 3.2 Five-Force Model, Porter (1980)

Porter’s Five-Force model is basically a framework for analysis of markets and competitors and views the profitability of an industry as determined by five sources of competitive

pressure (Grant, 2005). The model is a tool objected to clarify the relation between a company and its external environment. The forces of the model, illustrated in figure 3.1, are according to Porter, the main factors that affect the competitive situation in an industry. The joint impact of these forces, on a company determines the potential profitability in the industry. Because every competitor is exposed of the force’s impacts, it is crucial to be aware, and analyze the source of every force, to be able to develop a successful specific corporate strategy. The collective affection of the model’s five forces has various impacts on companies depending on specific industry. In order to develop a successful competitive strategy, the specific industries have to be defined. Porter (1980) defines an industry as a group of companies, which produce products and services that are close substitutes to each other, as an example. Added to the specification of the industries there is a question of time as well. The five force’s impact on the company is depending on what stage the company is, in the industry lifecycle.9 A lucrative and prosperous business with little competition, can during time realize tougher competition and less space and market share for small actors, as more competitors enters the market and the industry matures. This scenario is typical for the majority of industries. The consequence of Porter’s Five Force’s is that the analysis works best in matured and stabile

industries, because the presumptions in this theory proceed from a stabile industry structure (Brown & Eisenhardt, 1998).

Even if the market based approach puts the company’s external environment in focus, Porter (1980) emphasizes the importance of industry structure analysis. The external environment shall limit to the environment of a specific industry structure. The forces of the environment outside the industry structure are only relative, because every competitor in the industry faces these forces. Porter (1980) also describes the importance of the internal structure and

organization of a company, and introduced the Value Chain, which is an analysis model aimed to map the functions that add value within a company (Grant, 2005). Conducting a value chain analysis of a company, the framework of Porter can expand to encompass more factors that a company can take into consideration. This will present an even more

comprehensive analysis as basis for decisions.

When elaborating the market base view, there are those who consider the approach to narrow and emphasize other approaches to a strategic foundation of a corporation. One of the views is the Resource Based Approach.

3.6. Resource based view

The key to a resource based approach of a sustainable corporate strategy formulation is an understanding of the relationships between resources, capabilities, competitive advantage and profitability (Grant, 1991).

Porter’s strategic development process starts by looking at the relative position of a firm within a specific industry. This can be formulated as, starting by considering the firm’s environment and then try to assess what strategy is the one that may maximize the firm’s performance. In the specific context of this report – designing an exit strategy of a new technology firm, after assessing what actions and operations that may maximize the firm’s performance is on par with the Market Based View.

The Resource Based view, by contrast, can be seen as an “inside-out” process of strategy formulation. Brown & Eisenhardt, 1998, advocates that the Resource Based approach is more suitable for business in volatile and typical uncertain industries, like new technology industry, which is why the Resource Based view has significance for this report. Starting by looking at what resources the firm possesses. Then assess their potential for value generation and end up by defining a strategy that will give allowance to capture the maximum of value in a

sustainable way. The resource based strategy is sustainable successful if the resources which build the strategy foundation, is rare, not can be imitated, or be replaced (Grant, 1991; Barney,

1991). Figure 3.2 outlines the framework of a resource based approach:

Figure 3.3. A Resource Based Approach to Strategy Analysis. (Grant 1991).

Formulating a strategy, the starting point must be some statement of the firm’s identity and purpose. Form a market based approach this takes the form of the mission statement, which answers the question: “What is our business?” Traditionally the definition of the business is in terms of the served market of the firm, e.g. focusing on customers demand (Grant, 1991). In a world where customers preferences are highly volatile, customers’ identity are changing, and the technology for serving customer requirements is constantly evolving, the externally focused strategy does not provide a adequate foundation for formulating a long-term strategy (Grant, 1991). Grant (1991) further advocates that the firm’s resources and capabilities may be a much more stable basis on which to define its identity, when the external environment is in a state of flux.

In the context of this report, designing a strategy with the ambition of a successful exit, the approach is first inspired by the Market Based View, when examining what acquisition firms and investors are purchasing and paying for. When the start-up firm of interest, here

MindValue, has a clear picture of what environment to compete in, the exit strategy are turn to examine it own resources and capabilities, since those may be a much more stable basis, referring to Grant’s statement (Grant, 1991).

Typically, companies’ management systems lack of identification routines that clearly identifies a firm’s capabilities and resources. Financial statements and balance sheets only provides a fragmented and incomplete picture of a firm’s resource base, and clearly disregard intangible resources and people-based skills. Looking at American companies in 1982, some 62 percent of corporate assets were physical assets, but by 2000, that figure had shrunk to a mere 30 percent (see figure 3.4.). At the beginning of the 1990ies, in Europe, intangible assets accounted for more than a third of total assets (WIPO, 2003).

0 20 40 60 80 100 120 Intangible assets Physical assets % 1982 2000

Figure 3.4 U.S. Companies’ intangible assets as a percentage of total assets, WIPO 2003.

In the new economy, wealth is generated through creating and capturing the value of knowledge, which requires profound strategies to identify and analyze measures of

knowledge based resources and capabilities (WIPO, 2003). The technology boom of the late 1990-ies encouraged a mindset of new thinking about business strategies, which strengthen the significance of the resource based view (Grant, 2005).

and intangible assets: • Financial resources • Physical resources • Human resources • Technological resources • Reputation • Organizational resources

Figure 3.5. summarizes the relationships between resources and profitability:

Figure 3.5. Resources for the Basis for Profitability, Grant (1991).

3.7. Scenario analysis

When assessing volatile industries and companies with no comparables, no earnings, and no history, like many new technology firms, the actual facts to use are limited. In order to produce robust assessments in this environment a usable tool is Scenario Analysis. The

Scenario Analysis will be used due to the lack of real data in the assessment of the specific

firm, MindValue.

Whenever a company is seeking to adapt to external change or to shape industrial evolution, an understanding of the forces driving the industry development is important. It is crucial to forecast the industrial development as close to the truth as possible, in order to carry out proactive actions and react on critical changes in advance. It is not possible to predict the future with a 100 percent probability, but it is possible to think about what might happen. Using information of what is already known about current trends and signals to future development, in a systematic way, gives series of highly probable outputs. This is what scenario analysis is. Scenario Analysis is a process for thinking and communicating about the future development (Grant, 2005).

The scenario analysis was first defined as “hypothetical sequences of events constructed for

the purpose of focusing attention on causal process and decision points” (NcNulty, 1977).

The multiple scenario approach constructs several distinct and internally consistent views of how the future may look like in coming years ahead. Typically the multiple scenario approach constructs three to or four alternatives. The time range to analyze pertains from 5 to 25 years in traditional industries, and shorter time range in fast-moving sectors. Its key value is in combining the interrelated impacts of a wide range of economic, technological, demographic, and political factors into a few distinct alternative stories of how the future might reveal. Scenario analysis can be either qualitative or quantitative, or a combination of them (Grant, 2005). Grant (2005) advocates “quantitative scenario analysis models events and typically runs simulations in order to identify distinct and likely outcomes. Qualitative scenarios typically take the form of narratives and can be particularly useful in engaging the analytical abilities and imagination of decision makers.”

Scenario Analysis is used in companies to explore industry evolution, to examine developments in particular country markets, and to analyze the prospects for specific

investments projects, for the purpose of strategy making. Scenario Analysis has been a useful tool in identifying possible threats and opportunities, generating flexibility of thinking by managers. The Scenario Analysis gives decision makers time to react proactive in advance, developing practical approaches to the management of risk. Grant (2005) advocates that scenarios applied to particular industries, can help clarify and develop alternative views of how changing customer requirements, emerging technologies, and new firm strategies may influence industry structure, and what the implications for competition and competitive advantage will be.

I will use the Scenario Analysis together with other frameworks in this report, with purpose to portray possible outcomes, and to demonstrate what the consequences in a financial

perspective will be. The ordinary scenarios in this report will be three to four outcomes, one

poor, one OK, one good, and one extremely good. The usage range of Scenario Analysis goes

far beyond trivial cases just mentioned, though. The strength with Scenario Analysis in this report is the organized process to determine series of outcomes and predict possible outcomes, and not necessarily bringing together different ideas and insights about business environment and building consensus, that Grant (2005) highly advocates. On par with Grant (2005) though, scenarios can help to evaluate alternative strategic options. By assessing how a strategy might perform under different scenarios, they can help identifying which strategies are most robust and can assist in contingency planning (Grant, 2005).

3.8. The Industry Life Cycle

The Industry Life Cycle is presented due to the terminology of the types of firms the report is discussing. A company faces different stages during the company life cycle (Grant, 2005; Damodaran, 2001). The start-up phase is in the infancy of the company life cycle, and after that follows a row of phases on par with the development of the firm. The concept of

company life cycle is presented in order to highlight the phases and to identify the difference between the stages. The difference of the phases implies more solid financial analysis the further the company matures. At the start-up phase the value of the firm rests entirely on its future growth potential, and valuation poses the biggest challenge, since there is little useful information to go on (Damodaran, 2001). The concept of the industry life cycle indicates phases where the valuation analysis of the firm is more or less solid. The valuation is generally easier in the last stage than in the first, due to historical data and accumulated knowledge of the industry (Damodaran, 2001). The valuation is clearly more of a challenge in the earlier stages in a life cycle, and estimates of value are much more likely to contain errors for start-ups or high growth firms (Damodaran, 2001).

One of the best-known and last-longing marketing concepts is the product life cycle, figure 3.2, (Grant, 2005). Like products, which are born, their sales grow, they reach maturity, they go into decline, and finally they die, industries that produces them follows the same cycle. The industry life cycle is the supply-side counterpart of the product life cycle. The industry produces a range and sequence of products, though, which makes the industry life cycle likely to be of longer duration than a single product. According to Grant (2005) the life cycle

comprises four phases: introduction (or emergence), growth, maturity, and decline (figure 3.2).

rate over time. The characteristic profile is an S-shaped growth curve, and is close connected to the innovator theory of E. M. Rogers from 1962. E.M. Rogers (1962, 1995) classifies consumer attitudes towards purchasing products in a normal distribution curve, and into five categories according to how quick consumers are to purchase new products; innovators (2.5%), opinion leaders or early adapters (13.5%), early majority (34%), late majority (34%), and laggards or late adapters (16%). E. M. Rogers (1962, 1995) compared the normal

distribution curve to the S-shaped curve formed by “cumulative frequency distribution of product diffusion.” The 16% line marks a cut-off point between innovators, opinion leaders, and early majority and roughly coincidence with the point where the S-curve starts to increase dramatically (Rogers, 1962,1995).

Figure 3.6. S-curve and consumer attitudes in the normal distribution curve. E. M. Rogers 1962, 1995.