Thinking carefully about economics and business strategy can mean the difference between having great technology and having a great company. This lecture focuses on clearly defining your business model, including how you’re going to make money with your product or service. Case studies are used to test concepts against a specific business. For more information including video, visit: http://www.marsdd.com/events/details.html?uuid=00529d2c-acfd-4248-bad9-efe866917fe9

2. N O V E M B E R 1 7 , 2 0 1 0
E N T R E P R E N E U R S H I P 1 0 1 @ M A R S
P R O F E S S O R A J A Y A G R A W A L
U N I V E R S I T Y O F T O R O N T O
©2010 Ajay Agrawal
Business Models

3. Three Key Features
©2010 Ajay Agrawal
 Power
 Market structure (5 forces)
 Market for ideas (complementary assets, appropriability)
 Incentives
 Ecosystem is often complex
 Capture
 Primary versus complementary products/services
 Direct versus indirect customers

4. Professor and Graduate Student
©2010 Ajay Agrawal

5. The Team

6. Motion Metrics: Broken Tooth Detection System
©2010 Ajay Agrawal

7. Power
 Market structure
 Professor Michael Porter’s Five Forces
 Suppliers – how competitive are the markets for key inputs?
 Buyers – OEMS? Distributors? Mines?
 Substitutes/Complements – do nothing
 Rivals – innovative product, no direct competitors?
 New entrants – trade secret or patent?
 (Government) – regulation? customer?

8. Power – and The Market for Ideas
©2010 Ajay Agrawal
• Most common options
– License technology
– Sell product
– Sell service
• Key issues
– Who owns key complementary assets? (market power?)
– Appropriability of value? Enforcement of patent protection?
• Suggested reading:
– David Teece (1986) “Profiting from Technological Innovation,” Research
Policy
– Gans, J. and Stern, S. (2003) "The Product Market and the Market for
‘Ideas’: Commercialization Strategies for Technology Entrepreneurs,"
Research Policy, 32(2), pp 333-50.

9. Cooperate or Compete?
©2010 Ajay Agrawal
 Gans and Stern evaluate the commercialization strategy for start-ups:
 Cooperate (sell license)
 commercialize by engaging in an intermediate market to sell their intellectual
property to an incumbent
 Compete (sell product)
 commercialize by developing the good in-house and competing directly in the
product market
 The decision of whether to license is based primarily on two factors
1. the excludability environment
2. the specialized complementary asset environment

10. Two Elements of the Commercialization Environment
©2010 Ajay Agrawal
 The excludability environment
 To what extent can successful technological innovation by the start-
up preclude effective development by an incumbent with knowledge
of the innovation?
 The specialized complementary asset environment
 To what extent does the incumbent’s complementary assets
contribute to the value proposition of the new technology?

11. Benefits from Selling Idea Rather than Selling Product
©2010 Ajay Agrawal
 Savings
 If the incumbent firm has already invested in developing the
specialized complementary assets, the entrant can save the costs of
duplicating this effort and the savings may be shared between the
incumbent and entrant
 Less competition
 If the entrant engages the intermediate market with its invention,
that will preclude it from entering the product market. As such,
there will be less competition in the product market and so producers
will collect a greater surplus

12. Costs of Engaging the Intermediate Market for R&D
©2010 Ajay Agrawal
 The main cost is the potential expropriation of
intellectual property secrets and know-how by trading
partners arising from the paradox of disclosure

13. Compete
(stealth strategy,
Christensen, disk drives; disrupts
existing industry leadership)
Cooperate?
(strategy: invest in reputation for
trading in ideas; e.g., Cisco; formal
organizations, e.g., ASCAP in
music, TLOs in universities, VCs;
reinforces existing industry
leadership)
Either Strategy
(strategy: entrepreneur’s choice,
relative returns from competition v.
cooperation?; e.g., Xerox developed
complete vertical chain versus
Nintendo’s widespread licensing of
software development tools)
Cooperate
(strategy: demonstrate value, attract
multiple bidders; biotech/pharma;
reinforces existing industry
leadership)
Importance of Complementary AssetsExcludability
LowLow HighHigh
©2010 Ajay Agrawal

14. Incentives
©2010 Ajay Agrawal
• Despite value creation
• need to align incentives with all parties involved
• at the firm level and at the individual level
• Costs and benefits
• Which division gains from reduced broken teeth?
• Which division in the company bears the cost of broken tooth
detection system malfunctions?
• Which division pays for purchasing a broken tooth detection system?
• Which division pays for servicing a broken tooth detection system?
• what if they are different divisions in the same firm?

15. Capture
©2010 Ajay Agrawal
• Complementary products (integration)
– Razors and blades
– Consoles and games
– System (CPU, accelerometers, cameras) and parts/service/
upgrades
• Multiple customer-types
– Cable television
– Magazines
– Mobile phones
– Discount travel
– TIFF