Hello, welcome to Cracking the Creativity Code Part Two: Delivering Ideas. My co-author Arie Ruttenberg and I, Shlomo Maital, have prepared a journey for you through ten startup tools. We hope these tools will help you take your wonderful idea and transform it from an idea into a sustainable, growing, profitable business that will make hundreds, thousands, millions of people happy. Let's begin with tool number 1. I should begin by saying that I love all of these ten tools. They're all proven, they're all visual, they're all pictures. I love all ten tools like I love all my children. But, I love tool number 1 perhaps more equally than I love than others because I think it can help you avoid what I call type two error in Part One of this Cracking the Creativity Code course. Type two error is avoiding implementing bad ideas. How do you know if an idea is bad? A lot of ideas turn out to be not good. In music there are hit songs and flop songs. In startups there are great ideas and there are bad ideas. And the fact is that most startups are a flop. So the risks are high. The question is can you improve the odds? Can we improve the odds for you? And the answer is yes, we can. According to a Harvard Business Review article, April 2011, less than 3% of consumer packaged goods launches, new consumer packaged good products, less than 3% reach $50 million in the first year. That's regarded as a big success. So we know that American families, for example, buy the same 150 items again and again and again. To create a successful idea and build a business around it, you need something really well. So here is tool number one price, cost, value. How can you tell if your idea can become a viable sustained growing business? And then think about this in advance rather than learn from bitter experience. This tool is really simple. One of the tools I considered including in the ten tools is the tool of simplicity. But I chose not to, the reason is simple. Simplicity is a tool you need to apply in all of the ten tools and in everything you do. Simplify as much as possible, as Einstein counseled us. So, to determine whether your idea has business and economic viability, you only need 3 numbers. The numbers you need are first value, second cost, and third price. With these three numbers if these numbers make sense in advance, they suggest that your idea may turn out to be a success, a hit. If the numbers don't look good, then your idea my be headed for a flop. Value is the highest price clients would pay for your idea. Cost is the unit cost to deliver your idea to a client. And price is the amount of money your client will pay for the idea. If you can create a sustained value at low cost, you have a viable idea. Here on the slide is the tool. And it looks a little complicated, it's really quite simple. I'd like to explain it. We begin with value. Take your idea, do a prototype, an example, a sample webpage. Always good to have something tangible to show to people. And then present it to a client and ask the client whether they'd like it, whether they'd buy it, whether they'd use it and what they'd be willing to pay for your product. Put a number on the value, that number will be different from client to client. Talk to a few people, very important at an early stage to get people's reactions. This is not rocket science. This is an art, the art of creating value. And it depends solely on your clients and your customers, not on what you think. There's a difference very often between what your client thinks and what you believe. Step two is to try to estimate the cost of the resources it will take in order to deliver the value to your client or your customer. Variable costs, meaning production costs, operating costs, and fixed costs, meaning the overhead not related to the actual units that you produce. So the second number is the cost number, also difficult to put together for a really new product. You can look at similar products, but we need to get some hard numbers here on cost. Finally the price, you look at the difference between value and cost. And I call that the social margin. And this is the reason we're doing startup entrepreneurship. To take resources, to do something magical and wonderful with them, and to create far more value in terms of dollars or euros, than we are spending in the cost of those resources. And the gap between value and cost is called social margin, the value we're creating for society. The last number we need is the price. And when you set the price, essentially, you share this social margin that you're creating, between yourself and your company's shareholders, and between the client, the customer. So the difference between value and price is the client margin, the benefit the client gets where the value they receive exceeds the price and the value of the dollars, or the money they give up to get it. Company margin is the gap between price and cost. It's the value the shareholders, probably yourself as well, you get in return for your hard work and your creativity. And a rule of thumb, which some disagree with, a rule of thumb is that you share the social margin, roughly equally. So your clients are happy, your shareholders are happy. You have profit so you can build your business and create new and better ideas. And you create customers who are happy so that they return again and again, creating a client, a permanent customer rather than just a one time customer. That's the price value cost tool, and it's simple to explain, relatively, difficult to put numbers on. But if the numbers don't add up into a beautiful picture of value creation, probably you don't really have a great idea. So how do you calculate value. You interview potential clients, talk to them, find out whether they like your idea or they think it's a good idea, whether they want to use it, want to try it. This is a crucial step. Remember you need one great customer in order to launch a business. How do you calculate cost? You look at existing alternatives and substitutes. You adjust your cost. Take into account that initially your costs are high, but they come down as you gain experience. One of our tools later will be called the learning organization and learning curves. And remember, be creative in managing your costs, not just in creating value. So cost reduction is part of your creativity. You calculate price in order to share the social margin fairly between your shareholders and your clients in a way that's sustainable and creates loyalty. We have frequent flier cards and loyalty cards. The best way to create loyalty is to create great value for your clients and your customers. I'm an economist, and we economists teach profit maximization. But I'm preaching to you long run value maximization and sharing the profit, the social margin, with your client rather than squeezing blood out of a stone. Let's do an example. So let's take the Apple iPhone 6, which sells for $649 in the United States, at least it did a little while ago. A research firm called IHS did something really cool. They took the iPhone 6, they took it apart. They looked at the components, and they calculated how much it costs Apple to actually make the iPhone 6. So [COUGH] this appeared in an article in Time Magazine. You can see the source on the screen. And we can now apply the price value cost tool to analyzing Apple's iPhone 6, and we see that on your screen. What's the value, what's the most that on average clients would pay for an iPhone 6, especially when it's relatively new, just hitting the market? So I'm going to guess that that's roughly $700 based on my own introspection, maybe too high, maybe too low. You may wanna supply your own numbers if you're an iPhone6 fan. Or if you're a Samsung phone fan or some other fan, let's say $700 as value. The cost according to the IHS research company is $200. Apple is creating a significant social margin, $500 worth of social margin, 700 minus 200. How is Apple sharing that margin? If the price is $649, then Apple's company margin, we call that the profit margin, is $449. And the client margin is $51. So the company margin is eight times larger than the client margin. This explains why Apple is making enormous, enormous profits, $18 billion net profit in the fiscal first quarter in 2015. Here I'd like to express a controversial opinion. I think Apple is overcharging, and may be in some trouble because of that. I think they should share their social margin, brilliantly created, much more fairly with their clients in order to have longtime client loyalty, rather than make such enormous, enormous profits. But I'm sure that many people disagree, including Apple. And if they could they would probably appear with me and explain why I'm totally wrong. I'd like to go through another real world example with you very quickly. Please, this takes some concentration to follow what I'm explaining. This is a case study done by student of mine named Do Hyun Kim, who was my student at MIT 30 years ago, almost 30 years ago. And he was given a reward by his company at the time called, Lucky Gold Star, which is today's LG because he invented the ViewMax. [COUGH] The Viewmax is a combined TV, VCR recorder in one box, one compact box with one tuner. And the beauty of the idea is that it saved the cost of a tuner that you need in separate VCRs, video recorders, and TVs. And that $30 saving created value to be shared between the retailer and the customer and, of course, LG itself. So here are the numbers. Separately, a 19" TV and a VCR cost about $500, $498. And LG was selling products in the 2, 250, $300 range, and they wanted to move up to sell products that were in the $500 range, moving up the value chain. So Do Hyun Kim, my student engineer, came up with the idea of the Viewmax, combining a VCR video recorder and a TV. To do that, you create the Viewmax, and the cost of doing so [COUGH] is $271. And the FOB, free on board price to the retailer in America would be $290. So the net income here, [COUGH] the difference between the free onboard price and the cost is $19. The retailer sells the product for $500, [COUGH] just like the separate items. And so of the $30 saving in the price of the tuner, the difference between $300 cost of the combined products and 271 for the Viewmax, most of the profit is delivered to the retailer. The difference between 308 and $290 is about $19. $18, so it's a bit of rounding here. So of the $30, LG keeps $12 of the cost saving and passes on $18 or $19 to the retailer, giving more of a margin, social margin to the client, the opposite of the Apple example. So, something to think about, client margin, company margin, and social margin. You hear a lot in business school about profit margin, gross margin, operating margin, shareholder profit. But the truth is client margin is much more important. And of course social margin is the most important of all. Very quick story before we run out time. Alibaba is a company found in 1999 found by Jack Ma, a Chinese entrepreneur from the city of Hangzhou. Alibaba is one of the world's biggest websites. It's consumer to consumer sales, business to business sales. Fascinating story, I've written a long case study about Alibaba, and I hope I can make it available to you students taking my course. The point here is that for years, for three years, Jack Ma promised that his service to businesses, many millions of Chinese businesses that could sell their products to the world, on the Alibaba Internet website. When these businesses had no way of reaching the world otherwise, Jack Ma promised them that his service would be free for three years. And many people, many experts, competitors, eBay mocked Jack Ma and said free is not a business model. A zero price is not a business model. But of course it is, it's a very strong business model. And in fact, it may have been the only viable business model to attract small Chinese businesses to learn how to do business and sell to the world on the web. [COUGH] Eventually, the customers of Alibaba told Alibaba how to create revenue. They asked Alibaba to move them up in the listings on the website, so they'd be higher up and more likely to sell product. And they would be willing to pay a lot of money, $5,000 in order to be moved up the list to reach more and more customers. And that became the revenue model for Alibaba, which of course has become very successful. So to conclude to a one, our action learning assignment, you can find this in the assignment section of this course. Action learning, so startup entrepreneurs, create a price cost value diagram for your business idea. Interview potential clients to determine V. Start to figure out and estimate, guesstimate, your unit cost. Determine your price. Share the value, the social margin between your clients and yourself or your shareholders. Do you have a viable business idea based on price value cost? And essentially what this means is are you creating serious social margin? Are you creating high value at relatively low cost? If the answer is yes, perhaps your idea is a really good one. If the answer is, I don't think so, maybe you should think about another idea. Please go to the assignments section and test your understanding how PVC can determine whether your idea's viable, which of the three are most crucial, what you think about Apple's price cost value, despite my opinion. What is social margin? What is client margin? You rarely hear about those concepts. They're crucial in determining whether your idea is viable. This concludes tool number one. I hope you found this interesting, and I hope you find it useful as you apply it. Please join us for tool number two which is strategy and structure.
