Watch the video of Andrew Stotz presenting 7 Fatal Mistakes MBA Students Make in Business Case Presentations or read it below.
I have had the unique pleasure of serving as judge, juror, and, occasionally, as executioner for many case competitions. During my tenure in these roles, I’ve noticed over the years a couple of mistakes that MBA students consistently make. I wanted to highlight the top 7 here and provide some methods for avoiding them.
Oh, for Some Product Validation
The first mistake always relates to product validation. I see students all the time that have not validated their product. There are two parts to this error:
- First, in not validating that a market exists for the product
- Second, not validating that the product supplies the market with the correct solution
Many students fail to verify either of these things, and then they show up to a competition expecting the judges just to believe their word when they say that people want what they’re offering.
To solve this problem, a team should be testing their product continuously and be able to provide the results of those tests as part of their business case presentations.
The first tests can be internal, where the students test the usability of the product themselves. But take note that such testing will not be enough to convince a skeptical judge. The next level of testing is to test with a third party, such as an external laboratory or other professional body qualified to provide an opinion. The third, and best, option would be to demonstrate findings from a test performed together with a potential client or, if possible, many potential clients. The best form of validation is a customer paying you for your product. You should do everything you possibly can to achieve this ahead of the competition, or at least provide substantial evidence of where you are in the process of validation.
But What About Your Distribution Costs?
The second biggest error I see relates to distribution. MBA students often get so excited about their product idea that they forget about the mechanics of actually delivering it to customers. To avoid this mistake, you should think of a business as a flow diagram with raw materials coming in one side and finished goods going out the other. For example, I have seen students present a business case where the raw material is the waste left over after rice harvests. The same students failed to consider how the distribution of this raw material into a central factory is nearly impossible, as it would be coming from a wide network of small-scale suppliers. In such a case, students should then have a compelling story about how suppliers are incentivized to continue to provide raw materials.
In the past, I have seen that students rarely provide the necessary information to demonstrate the various channels they would use to bring their products to market. They also fail to identify the separate marketing strategies each would need. To avoid this error, make sure you provide a thorough exploration of each distribution channel, including how you are going to: find it; incentivize it; secure it; and optimize it. Delivery is an essential part of any business, and you must demonstrate to the judges that you have thought about this enough.
Don’t Ignore Competitor Response
The third biggest mistake I see MBA students making concerns competitor response. In business case presentations, students have a shiny new product that they are excited to share with the world. The reality is that if your idea is good enough, there will be at least a couple of existing products that are similar or there will be a large pool of potential competitors waiting to jump in and imitate—or improve on—your product. Students often think their product is so great—or that it will get to market so fast—that any competitors will be caught off-guard. This is highly unlikely. It is much more likely that if the students can get their product to the market and it is in some way better, faster or cheaper, then competitors will respond quickly. They will swiftly try to match the benefits offered by the student’s new company. If these competitors have the ability, they will also consider reducing the price of their version of the product—to drive down the profits of the student’s business until they can’t survive any longer.
To solve this problem, you should brainstorm various reactions that could come from competitors and lay out a plan for how to mitigate those risks. This involves a high degree of proactive and strategic thinking. Successful student teams are the ones that develop actionable plans that anticipate potential competitor responses.
There’s Only One Type of Excess Cash — Not Enough:
As Featured in The Story of Unrealistic Profit Margins…
The fourth mistake is to overestimate the amount of cash the proposed business will have. Almost every case I judge miraculously predicts that the company will end up with tons of cash sitting in the bank. A good way to test for realistic excess cash is to calculate the amount of cash relative to total assets in year five. Anything over 20% is just nuts. This mistake is usually caused by students overestimating the company’s profit margins.
To avoid the unrealistic profit margin mistake, students should compare net profit against companies operating in similar spaces. The reality is that most companies do not differ greatly from the net average of companies operating in the same sector. In some of my recent research, I calculated the typical net profit margin of nearly 20,000 companies over the past 15 years. The results: the average company across the world generates a 5.5% net profit margin. Of course, this will vary across different industries. Take into account that consumer discretionary companies generate about 4% net profit, while information technology companies generate roughly 8%—on average.
When you look at your awesome company’s expected profit margin, consider these examples of super successful companies: Facebook 39%, Apple 21%, and Alphabet 11%. It is highly unlikely you will beat those. The way to avoid this mistake is to find a few comparable companies and justify your net profit margin in comparison to them.
…And the Tale of Excess Cash from Under Investment
The second reason why students pile up tons of cash is that they don’t account for the high amount of investment that will be needed. There are two main types of investment in a business: long-term investment (mainly fixed assets for traditional businesses) and working capital. Let’s start with the first.
My recent study of companies across the globe shows that 35% of a company’s assets are fixed assets, by far the most important of all asset classes. Usually in business case presentations, students start by forecasting a reasonable amount of fixed assets, but where they go wrong is they don’t expect those fixed assets to grow by much. This would imply fast revenue growth without much asset growth, an unlikely outcome.
The second issue which is almost always overlooked is working capital. The two main asset items here are accounts receivable and inventory, which together account for 22% of assets. Don’t forget that your company will likely have to give your customers good credit terms; and that you are also likely to receive bad credit terms from your suppliers. In addition, you will end up holding more inventory than you thought because you may face minimum order quantities for buying said inventory. When my business partner and I started CoffeeWORKS years ago, we had to buy large lots of coffee and got nearly no credit terms from our supplying coffee brokers. Naively, we did not expect green coffee would tie up so much cash. To avoid this same mistake yourselves, focus on your working capital needs and benchmark against comparable companies if possible.
The fifth mistake deals with Shareholding. There are two extreme example cases I have seen in business case presentations. The first is where the students are giving away a too small a share in the business, and the other occurs when they give away an overly large share. Anything lower than 10% and it will not be worth potential investor’s time to complete due diligence. Anything higher than 49% and you are effectively giving away control of your business. You need to strike a careful balance. To avoid this error, the best practice for bringing in new shareholders is to give all new investors between 10% and 49%. If you have a great idea and strong bargaining power, keep it close to 10%.
Stranger Things: Unrealistic Internal Rate of Returns (IRR)
The final mistake I see quite often is that MBA students forecast strange IRRs. I recently listened to a business idea that was expected to generate an IRR of 23%; this is just too low for a startup and would be unlikely to attract an investor. If your startup business does not generate an IRR between 30% to 40%, then find another business.
The problem is that it’s nearly impossible to properly calculate an IRR before the proposed business even exists. The other error that matters is if you overestimate the IRR. So, you should expect that your potential investors will knock down your IRR to adjust for what they think is your optimism bias. Hence, you probably don’t want to present an IRR that’s below 50%. Take into account though that presenting an IRR of 90% or higher will also be hard to justify. Of course, if your business turns out to be the next big thing in the world, it’s very possible that you do generate such a high IRR. But, to make it realistic, I would target between 50% and 90% IRR. If you have to stretch your financial projections like a rubber band to get in this range, then you may not have a financially attractive business.
That about sums it up for the most common—and fatal—mistakes MBA students make when competing in business case presentations. To summarize,
- Make sure you validate your product/market fit
- Carefully consider how you are going to distribute your product
- Predict your potential competitor’s response
- If your cash is greater than 50% of your proposed assets, something’s wrong
- Don’t underestimate your fixed assets or working capital
- Distribute equity to new shareholders reasonably
- And have a realistic IRR assumption – at least 40%
Article by Dr. Andrew Stotz, Become A Better Investor