Welcome to the course Developing The Opportunity. In this introductory session, I'd like to define entrepreneurship, give you some examples, and then turn to the question of financial sustainability. How do you create an enterprise that can live on and endure? I would then want to turn to the important question of, what is your probability of success? What kind of risks are you taking as an entrepreneur? I'd also like to address the audience here. Some of you are going to be entrepreneurs and some of you are just interested in entrepreneurship. And I want to argue that this material is valuable for you as well. And then lastly, I'd like to give you a road map to the rest of the course and also to the broader specialization in entrepreneurship. So let's start with the definition. We define entrepreneurship as the creation and management of a new enterprise to accomplish some objective. Entrepreneurship can be quite small in scale in some cases. For instance, this is a photo of an entrepreneur I encountered on a recent trip to Istanbul. This is a guy who sells fish bread by the side of the road. His entire business is comprised of a little grill and some inventory of raw materials. This guy is an entrepreneur. He started this business, and his objective was to make a living, was basic livelihood. For most of you and for most entrepreneurs in the developed world, entrepreneurship typically has an objective beyond just making money. Let me give you three examples, Laura Overdeck created a company called Bedtime Math. Bedtime Math delivers math problems to kids that allows them and their parents to learn math just before bed. Sort of like a bedtime story, but Bedtime Math. Laura started this business because she wanted to do a better job of math education. That was her primary objective. Nate Hodge and Ryan Cheney started Raaka Chocolate. They've just been always interested in chocolate, so they started Raaka Chocolate to pursue their own personal passion in a particular kind of food. Carl Dietrich is the founder and CEO of Terrafugia. Carl, since he was a teenager has wanted to create flying cars and so in fact, his primary objective with this new venture is to bring flying cars to consumers. Now in all these cases the entrepreneurs had an objective other than making money. But the unfortunate reality, is that in order for them to stay in business,they need to be financially sustainable. They have to create a venture that can have positive cash flow in the long run. Otherwise, they go out of business. So in order to realize their objective, they actually have to achieve financial sustainability. So while not usually the primary objective, financial sustainability is still an important objective for virtually any entrepreneur. So let's talk about what's required to achieve financial sustainability. I'm going to give you two basic ways to think about financial sustainability. Two conditions that define financial sustainability. The first is for companies that make and sell products, physical goods typically. And the second for companies that provide services or software to consumers. So let's start with the first. First a disclaimer, throughout this course, I'm going to use examples from my own experience as an entrepreneur, and as an investor in other entrepreneurs. I want to be clear, the reason I'm doing that is because I know a lot of details about these examples, so I can share rich and interesting content about these entrepreneurs and about their products and services. But I'm not trying to sell you on this products. Well, I do have a financial interest in these companies, I hope that the trade off of me been able to provide rich detail out ways any perception of commercialism which I really don't intend. So, I want to first start with the category of ventures that are selling a product to a consumer. This is the Belle-V Bottle Opener which is made by a company that I helped to found, Belle-V Kitchen. The Belle-V bottle opener is a luxury item sold in museum stores mostly in the United States. And it sells for $50 US. Now what are the conditions under which Belle-V could be sustainable financially selling the Belle-V bottle opener? I've put on the screen an expression that defines the conditions for financial sustainability when you're making and selling something. And the expression is Q (p-c), must exceed f. If that condition is true, then the company can be financially sustainable. Well, what do those terms mean? Q is simply the quantity sold per unit time. So in the case of the opener, it would be, how many openers per year were sold? That's Q, P is the price that the company receives when it sells one unit. So, in this case, it might be $50 US per opener. Cost is the cost per unit that the company pays to make the good. In this case, it might be $20 USD. So p- c in this case is 50- 20, or $30. That by the way is called the gross margin. And F is the fixed cost, those are the costs that are required to operate the business whether or not you sell any product. And so for instance, that might be rent, advertising, salaries, marketing and so forth. And in this case, let's imagine that's $400,000. So in order for Belle-V to be financially sustainable, Q (p-c) has to be greater than F. Now let's look at how the math might work out. Let's imagine that Belle-V sells 20,000 units per year. It gets $50 per unit. It has to pay $20 per unit in cost, and so it's able to get $600,000 in gross margin, or 20,000 x 30. And in fact, in this case, if we assume that F is $400,000. Then it's taking in more than it requires to sustain the business. 600,000 exceeds 400,000 and therefore, Belle-V is sustainable and it can pursue it's objective of creating heirloom quality products for the kitchen. As a caveat, I want to note that this analysis is an expression for long term sustainability. It doesn't account for any investment that might be required up front before the business even opens its door. So, for example, it doesn't include the product development expense. The manufacturing expense associated with making molds and tools in order to create the product, that is the investments are not captured here. But in the long run, if Q (p-c) exceeds f then this business can be sustainable. Now for some kinds of businesses, for many kinds of businesses typically services and software related businesses. You weren't selling a widget, you weren't selling a product on a one time transaction to a customer. Instead, what you're doing is entering into a relationship with a customer who often pays you a subscription or a monthly or an annual fee in order to enjoy your service. For those kinds of businesses, we use a different analysis, and I want to talk about that analysis. Let me use an example, and the example is another company that I'm involved with started by a former student of mine. The company is called Gridium. And what Gridium does is sell software that helps building owners operate their buildings. It does things like help them with energy efficient seed decisions and also helps them with building maintenance operations. Gridium is a so-called software as service, or SAS business, and it's sold on a monthly subscription basis. In fact, Gridium has two main pricing levels, a $79 a month option and a $150 per month option. And so, we really need to think about the Gridium customer as paying us every month, hopefully for a very long time. Now there's some standard terms that we use to describe these kinds of businesses. In particular, the condition that has to be satisfied for financial sustainability is that LTV has to be greater than CAC. Now I know those are two idiosyncratic acronyms, so let me explain what they mean. LTV refers to customer lifetime value and CAC refers to customer acquisition cost. If lifetime value exceeds acquisition cost, then we have a sustainable business. So what goes into lifetime value? Well, a few different variables determine lifetime valuable. Well what goes into LTV? Well a few different variables determine lifetime value. For instance, what's the churn rate? That is, what fraction of customers do you lose every month? Obviously, the fewer customers you lose, the longer their lifetime value is. What are the service fees per unit time? That's the $79 per month or the $150 per month. What's the duration of engagement on average? How long does the average customer stay with the company? And lastly, most of these customers don't just buy one service, they might buy several services. So you want to think about their value in terms of total value of services the customer uses. So for instance, with Gridium, we might imagine that the lifetime value is $5,000. And that could correspond to the average customer buying an average of $250 per month of services and staying with the company for an average of 20 months. 20 months times $250 per month would give me a lifetime value of $5,000. Okay, now let's turn to CAC, or customer acquisition cost. Customer acquisition cost is just what the term implies. What does it cost me to get a customer to adopt my service? And this is typically mostly selling and marketing expense. So for instance, if the CAC is $3,000, that could arise because I paid my sales people $90,000 per year and on average they acquire 30 new customers per year. That would give me a CAC of $3,000. But in this case, if $5,000, the lifetime value, exceeds $3,000, the customer acquisition cost, then I have a sustainable business. As with the previous model, this model ignores any investments I have to make in building the product initially and in getting the company started, but it describes the condition that has to be satisfied for my business to eventually be sustainable. So, while you as an entrepreneur will typically have some greater objective, improving math education, pursuing your passion for chocolate or bringing flying cars to the masses. While that might be your primary objective, an important secondary objective is that you achieve financial sustainability. And if you're creating a widget, that is, a product which we often call a widget, then quantity times price minus cost has to exceed your fixed costs. That's the condition you have to achieve. And if you're in more of a service business, more of a software business or a service related business, then lifetime value has to exceed customer acquisition cost. As you contemplate pursuing an entrepreneurial career, I think it's important to understand the probability of success and conversely, the probability of failure. Now the first thing I want to say is that your probability of success depends, of course, on you. Who you are. And depends, of course, on the opportunity you pursue. But, some opportunities are riskier than others. For instance, if what you're doing is starting a franchise of an existing proven business in a new geographic area, your chances of success might be 80, 90%. On the other hand, if you think you've invented a new medical device and it's brand new addressing a new unmet medical need, then your chances of success might be only 5 or 10%. So different kinds of opportunities have different chances of success. So for now, I'm just going to speak in averages, in average terms. To help inform that question, we can look at some survival data provided by the US government, by the Small Business Administration. This graph shows the fraction of businesses that are still in existence as a function of the time since they were started for all businesses started in the United States from 1994 to 2013. Now the way to read this graph is that one year after formation, 78.5 business that were started are still in existence, or in other words, 21.5% of all businesses that were started fail within the first year. And as we go out in time, of course, the fraction of companies that survive declines. But eventually, ten years out, about one-third, 33.5%, of new ventures across all new businesses in the United States are still in existence. I don't know whether you perceive that as a big number or a little number, but I just want you to understand the base rate, the basic chances that you face as an entrepreneur. Another perspective you can take is as an investor. For many of the kinds of opportunities that you'll pursue, you're going to require some kind of outside investment. The financial resources that you will need will exceed what you can pull together yourself. And so I want to take the perspective of the investor which I think will be, will help illuminate for you what your chances of success are for ventures that require outside investment. What I've done here is to analyze some data provided by the Kauffman Foundation for 499 new ventures backed by angels. Now angel simply refers to an affluent individual who invests in a company. We're going to talk some more about that in a later session. So what the Kauffman Foundation has in their data set is for these 499 ventures, what was the cash return and the cash put in in terms of investment? Now what I did to analyze these ventures was to look at the ratio of cash out to cash in. And then to take the log of that ratio. And the reason I take the log of that ratio is that the ratio varies over several orders of magnitude. Let me make that very specific for you. Let's imagine that my business returned $1 million in cash. That's the cash out. On a $100,000 investment, that's the cash in. So the ratio of cash out to cash in would be 1 million over 100,000, which would be 10. Now I take the log of that, the base 10 log of that. And of course, the base 10 log of 10 is 1. 10 to the 1st power is 10. And so you can see on the horizontal axis the value of 1, there in the middle, corresponds to a 10x return for the investors. And of course, a value of 3, which would be all the way out to the right. That corresponds to a 1,000x return. Meaning someone who invested $100,000 would get a $100 million in return, 1000x return. The value of 0 on this graph corresponds to 0 term, meaning you lost everything. Now, there's two notable features of this graph. The first notable feature is that most of these ventures returned nothing. In particular, more than 350 of the 499 ventures are in that first bucket of 0 return. Most of the ventures return nothing. And yet, the average return is 0.34 or if we delog it, the average return is 2.2 x, 2.2 times the amount of capital that was put in. So how can both facts be true? That most ventures fail and yet the average venture returns 2.2x. The reason that can be true is that there are few ventures in this sample that returned hundreds of times the original investment. So that pulls up the average to a very reasonable 2.2x return. So the key insight from this analysis is that on average, entrepreneurship provides pretty good returns to investors, about 2.2x their money. And yet, the modal outcome is 0, meaning the most frequent outcome is that the investor loses everything. So there's good news and bad news in this analysis. But I just want you to make sure to understand it, that you as an entrepreneur are taking on something quite risky. And so you need to understand those risks as you pursue entrepreneurship. Having said that, our entire goal in this course and in this specialization, is to help you manage that risk. To help you take your chance of success up from 20, 30, 40%, up to hopefully 40, 50, 60, even higher percent, depending on what kinds of opportunities you're pursuing. Many of you are either entrepreneurs or hope to be entrepreneurs. But some of you have no real intention, given the risks of ever being an entrepreneur. This course is still very valuable for you, because you can be an entrepreneurial manager within an established enterprise. Let me give you an example. Scott Mills studied entrepreneurial management here at Wharton. But he works for an established enterprise Viacom, a big company. Scott is an entrepreneurial manager. Meaning, he applies entrepreneurial thinking. How to minimize risk. How to maximize your chances of success. How to be smart about exploring opportunities. But he does that in the context of a large, established enterprise. This course is for those of you who find yourself in this situation, as much as it is for those of you who are yourselves, entrepreneurs. Or who intend to start a new venture. This course is about developing the opportunity, but it's part of a portfolio of courses. The next course is about launching your business. The third course is about growth strategies. The fourth course is about financing and profitability. And then as part of the entrepreneurship specialization, we have a Capstone Project. This course can stand alone on its own, but we hope you'll enjoy all five of these experiences. Looking at the opportunity, how to launch your business, how to grow your business, how to finance your business and manage profitability, and apply all of that to the Capstone Project. The key questions we hope to address in this course, the first course, developing the opportunity are, is entrepreneurship for me? What are the different approaches to entrepreneurship and the different types of new enterprises that exist in society? How do I identify promising opportunities? How do I select the most promising opportunity? How do I develop a solution concept to address a need I've identified? How do I test my concept? How do I resolve risk and uncertainty surrounding the opportunity? And lastly, how do I persuade others about the promise of the opportunity? I hope you'll stay with us and enjoy this experience to help you be a better entrepreneur or a better entrepreneurial manager.
