FEI Competition

Apparently, our final round presentation for the Financial Executives International Case Competition is now available online. Unfortunately, I can't embed it into the blog, but I can include the link below:

http://www.feicanada.org/cfo-tv.php?vid=22&page=2

Enjoy!

[Rotman] 5 Great Speakers at Rotman

[Rotman Series: 1, 2, 3, 4, 5]

Jaime is a part-time student in the MBA program at Rotman. He has worked in the sports media industry since 2002 and is currently Manager, Digital Media for the Canadian Football League. He and I went to the Latin America study tour in May last year. He was gracious enough to do a write up for me on his favourite guest speakers which follows:

By Jaime Stein

One of the first things you notice when you obtain an e-mail account at the Rotman School of Management is the sheer volume of e-mails from a guy named Steve. At first it can be overwhelming, but if utilized wisely, it can be your ticket to an exclusive roster of speakers. Steve and his team are the masterminds behind the A-list speakers that regularly visit the Rotman School.

The hardest choice I have to make each week is which speakers I will NOT listen to. This is a good problem to have because choice is always welcome when working full time and attending school part time. I simply don’t have the time to listen to every speaker that passes through Rotman. However, in almost three years, I have been privileged to listen to close to 100 guest speakers.

Most of the speakers that I have seen have delivered outstanding talks, but for the purpose of this blog I present five of the best speakers I have listened to during my time at the Rotman School:

1. Paul Martin – Former Prime Minister of Canada

Imagine you are in your second semester of a three-year MBA degree and you are studying Macroeconomics. A large focus of the course stems around Canada’s macroeconomic policies during the 1980s and 1990s; specifically the country’s battle with debt and inflation. One day you find out that the man behind the plan to battle inflation will be speaking at your school. That would be like a young basketball player having the opportunity to shoot hoops with Michael Jordan and ask him for tips.

Fortunately for our macro class, Mr. Martin came to speak at the Rotman School one morning and for about an hour took us through his plan that brought Canada back from the brink in the mid-‘90s. Following his talk he took time to speak to each of us and share some more personal insights and war stories from his time as both Finance Minister and Prime Minister. This was one of the great days at school that left me wanting to explore a subject further.

2. Isadore Sharp – Founder, Chairman and CEO of Four Seasons Hotels and Resorts

One of the main selling points of the Rotman School is its focus on Integrative Thinking – the theory coined by the current Dean, Roger Martin. In one of his books on Integrative Thinking (The Opposable Mind), Martin focuses on the story of Isadore Sharp and his path to building the greatest luxury brand of hotels in the world. In many of our classes we study the Four Seasons Model for customer service and other best-in-class management techniques. We were fortunate to have Mr. Sharp visit the Rotman School and explain firsthand how he went from one Four Seasons hotel in 1961 in Toronto to operating a chain of approximately 100 properties worldwide.

For anyone with an ounce of entrepreneurial spirit this was a motivating discussion. You could see the passion, courage and drive that Mr. Sharp possessed to launch his vision and stay true to it along the way. Any successful company will create a competitive advantage – however, these are eventually replicated by the competition over time. When people are your competitive advantage, it becomes truly sustainable as Mr. Sharp has proven. While other hotels provide outstanding service, none of been able to match the formula created by the Four Seasons.

3. Rahaf Harfoush – Digital Strategist and Author

It was November 27, 2008 when Ms. Harfoush spoke (for the first time, I believe) at the Rotman School. There was lots of hype surrounding her talk that day because Barak Obama had recently been elected President of the United States and Ms. Harfoush was a part of his wildly successful digital media campaign. I also remember this talk vividly, because it was one day later on November 28, 2008 that I joined Twitter. A lot in my personal and professional life has changed since that defining moment – all for the better.

The topic of conversation at Rotman that day was, “Applying Barack Obama’s Social Media Strategy to Your Brand’s Communications Needs” and it was Ms. Harfoush’s talk that became the inspiration for a lot of what we have done at the Canadian Football League over the past two seasons in the social media realm. To me, this is what an MBA program is about – an exchange of ideas to help stoke peoples’ imagination and potential. I’m glad I made time to attend her talk that day.

4. Michael Lee-Chin – Founder and Chairman of Portland Holdings Inc.

In October, 2009 I attended the Rotman School MBA Leadership Conference in downtown Toronto. It was a star-studded event with speakers like George Butterfield, Co-President of Butterfield & Robinson, Beth Comstock the CMO for GE, Don Morrison, COO of Research in Motion, Robert Deluce the CEO of Porter Airlines and Michael Lee-Chin, the Founder and Chairman of Portland Holdings.

Mr. Lee-Chin is one of the most engaging speakers I have had the pleasure to listen to in person. Mr. Lee-Chin spoke for about an hour on a variety of subjects including how to create wealth. He focused on a small number of blue chip businesses with long-term growth potential. But he was adamant that you know and understand where you are investing your money. One quote from Mr. Lee-Chin that sticks with me is, “If you don’t understand what you own, are you investing or speculating?” This is important advice that too many people continue to ignore this day and age.

5. Jay Hennick – Founder and CEO of FirstService

Mr. Hennick spoke to our class recently at the Rotman School. He runs FirstService, a company that provides services in commercial real estate, residential property management and property services and generates about US $2 billion in annualized revenue. Mr. Hennick told us his amazing story of how he achieved his current standing atop a multi-national company. He got his start with a company he ran as a tenth grader that brought in an income of $200,000. Yes, you read that correctly – he was in grade 10.

His key message was focused on people management; what he believed was the differentiating factor for the success of his current company. His “Partnership Philosophy” states that impact players must have more than a salary and bonus invested in the business; they must have an equity stake. His company focuses on aligning employees’ interest with shareholders in building long-term value. This was both fascinating and eye opening for most students who believe this is hard to do in a company of 18,000+. Yet FirstService continues to succeed. Listening to Mr. Hennick and his passion for success was rewarding.

As you can see, there are some overarching themes from these speakers such as focusing on people and establishing long-term strategies. But ultimately, each of these speakers is among the leaders in their field and that is why I feel fortunate to have spent the past three years at the Rotman School. The access to these great minds alone was worth the price of admission – well almost!

What Makes Rotman Different? A foray into the world of Business Design

In anticipation of our trip to LBS, Geoff and I have been asking ourselves: “What makes Rotman different?” In discussing this idea, one of the key points at the top of the list was business design. This week, I’ve had the pleasure of attending various events over at Design works where members of a university in Singapore are undergoing certification for Business Design.

On Tuesday, Geoff and I attended a working session with Anita McGahan discussing the evolution of demographics across different geographies and the implications for the future of the health care industry around the globe. With our guests present, we learned a great deal about the specific differences in the Singaporean culture and life style and were impressed by the innovation produced by their ambitious programs.


This exercise was particularly enlightening for me, not only because of my previous work as a Wireless Consultant for RIM in the healthcare communication and process optimization space, but also to learn more about the business design process.

Today, I also attended a talk given by my class mate and president of the Business Design club, Jason Huang, at Design Works for our Singaporean guests. He gave a very inspiring speech about the current state of business design at Rotman as well as a road map to the initiatives he and his team are putting into place to further develop the program at Rotman at the academic and extra-curricular levels. I am particularly impressed by his attitude, aiming to be the top club at Rotman. I think he also has demonstrated that he has the will and ability to execute on these new initiatives, launching business design more prominently into the spotlight.

He also had a great point about case competitions where “the idea isn’t just to try to do well, but more importantly to learn” a sentiment which I would like to echo and I think reflects my personal motivation for participating in various case competitions, including those not necessarily related to my chosen profession.

What is Business Design @ Rotman? Find out for yourself by watching the YouTube video below:

Financial Executives International – 5th Best in Class Competition

On Saturday, a Rotman team composed of myself, Shree, Fei and Matt Literovich competed in the Financial Executives International 5th annual Best in Class Competition. The case company was HudBay Minerals. Unfortunately, we placed second, behind Alberta School of Business.

The competition was intense, as many of the teams worked late into the night on Friday to put together our decks and get a few rehearsals in before scrambling to get a few hours of shut eye. The next morning, our names were drawn for presentation order and we found ourselves in the seventh spot.

Matt Literovich was phenomenal understanding potential legal issues related to mining and commanded the attention of the room when he spoke of precedent case law.

Fei gave a detailed account of all the organizational issues we could expect as HudBay Minerals grew and followed our acquisition strategy.

And Shree’s knowledge of mining and dissection of potential target companies gave us an exceptionally high level of credibility.

All three were exceptionally strong in both the presentation and the question and answer period and this short description does not do justice to the quality of our presentation.

While we were very disappointed that we didn’t take the top spot, the event itself was challenging and very entertaining. Judges from the competition included top executives from HudBay Minerals, USGold, OTPP, Mercator, a justice and many other top professionals. Definitely a great experience, I would recommend any MBA student to attend this competition.

Competitions Week – RMA Case Comp

Last week was very heavy for case competitions and presentations (hence the lack of posts).

On Wednesday, we had the Rotman Marketing Case competition. The case was based on the Pan America (Pan Am) games, where we were asked to create a strategy for how to engage university students to participate in the Toronto 2015 games.

One key insight from our team was that the university students of 2015 are currently high school students, so we took a two pronged approach:

1. Engage high school students now and use their 40 hours of volunteering to instill a culture associated with sport based mentorship.
2. Create the university infrastructure that would allow these students to be received into such post-secondary institutions.

We proposed that as the system developed, this program could follow PanAm games host cities and was modeled similar to "Right to Play" and eventually leverage the Olympics brand to become international and increase the sense of legacy of the games beyond just physical infrastructure.

While we didn’t place in the competition, it was interesting to see what other teams pitched as it was a fairly open ended question and there were plenty of unique solutions proposed by the other groups.

Retail Experts Speaker Series - Jurgen Schreiber, President and CEO, Shoppers Drug Mart

Rotman hosted another speaker series session today from the Retail Experts Speaker Series @ Rotman and the guest was Jurgen Schreiber, President and CEO, Shoppers Drug Mart Corporation. And he spoke on "How and Why Shoppers Drug Mart is Transforming its Stores to One-Stop Shopping”.



After noting that this talk was organized before the change in pharma regulations, he began with a quick history of Shoppers and the development of its stores, noting that the first Shoppers store originally had a variety of products.

He offered a breakdown of Shoppers value proposition on five key elements:

1. Dominate on Convenience


2. Differentiate on Service


3. Differentiate on Products


4. Differentiate on Experiences


5. Compete on Price

Why? Simple answer: Because the customer is ready for it. Real answer: “Our gut told us to do so – to create something really unique and different” & “We have the capital resources and financial strength.”

Mr. Schreiber went on to discuss mega-trends that he perceived as being crucial to the long term success of Shopper’s including: Health, Convenience, Age Complexity, Gender Complexity, Individualism, Sensory, Comfort, Connectivity and how it was necessary to understand and embraces these factors, use them in combination to differentiate and innovate in a scalable way. He also reflected on the changes in demographics in the Canadian market place such as more singles, no or less children, smaller households, aging population and multiple income couples.

Jurgen defined a modern one-stop shopping experience as needed to focus on location and opening hours, store experience, clear assortment, in-store convenience, service, product, loyalty programs and loyalty specific products, to create a “Have it all drug store”. He emphasized how it was also necessary to avoid small and mega store formats, traditional assortments, all services, and all profit pricing. He spoke about how there is a concept of “My store”: my SDM (Shoppers Drug Mart), My SDM Associate and Team, My Optimum, as part of My Neighbourhood.

There was one odd little insight in Shoppers product mix. They don’t sell fresh food, but they make an exception for fresh bread, a noteworthy exception pointed out by Jurgen. He mentioned that, in testing, customers perceive this product has being an exception as to what types of products are expected at Shoppers.

He closed by speaking about the Optimum program. A classmate I was watching the presentation with on the third floor commented that Optimum was a program that was the first of its kind. Unlike popular third party programs, or other loyalty programs, Optimum induces customers to return to the shop to pick up additional items. As an example, this is in contrast to a gas station loyalty program which just causes you to return to the same gas station to purchase something in which you have a relatively inelastic demand – gasoline and convenience goods during travel – selecting between vendors versus marginal purchases though increasing basket size and return visits – two of the key value drivers of Dilip Soman’s customer value framework.

Financial Executives International Competition

On Wednesday we had Rotman’s internal competition for the Financial Executives International competition. I was part of a team of four, including Irina, Shree and Matt Literovich. The case was on Tiffany’s expansion into Japan and how they wanted to protect themselves from exchange risk. All the teams did a comprehensive analysis on the potential hedging options and the exposure. It was very humbling to see the caliber of work produced by our classmates in such a short period of time.

It was great to work with my team mates and our discussion on the financial strategy was highly enlightening. In the end, we looked at a variety of strategies including forward contracts, put options and collars.

Yesterday, we found out that we were selected to represent Rotman at the national competition which will be hosted by Ryerson on November 12th. Unfortunately, Irina will be unable to attend, but Fei has gratiously joined our team.

We are all excited at the opportunity to represent our classmates and showcase Rotman talent as well as meet MBAs from all across Canada at the "Best-in-class" competition.

Free Cash Flow to Firm and Net Change in [OPERATING] Working Capital

A few of my classmates have been asking me a very common question so I thought I would post the answer. Particularly because I think it is a fantastic question and is something I’ve wrestled with for sometime.

In Corporate Finance, Financial Management and Mergers & Acquisitions, one of the most important metrics of a company’s performance is it’s free cash flow. Or more specifically, it’s free cash flow to firm (aka. Unlevered free cash flow). This is the cash flow metric that is used to value the entire enterprise. It’s defined as:

FCFF = EBIT (1 – tax) + DA – NWC – Capex

Where:
EBIT is Earnings Before Interest and Tax (otherwise known as operating income)
DA is Depreciation and Amortization (which is actually a place holder for all non-cash expenses, but DA is the largest and most common one)
NWC – Change in net working capital (*NOTE* This is the tricky part that people are asking about)
Capex – Capital Expenditures

So while this formula is not new to most, what I want to focus on is NWC. If you have read my post on the difference between OPERATING working capital and working capital will know what I’m getting at.

First, before we even get to that, I want to emphasize a lesson taught in Anita McGahan’s first year strategy course relating to Dupont analysis (one of my favourite frameworks). Dupont analysis looks at Return on Equity and Anita made a fantastic point about how to look at the formula:

ROE = NI / Equity

ROE = (NI / A) * (A / E)

ROE = ROA * FLA

Where:
ROA is return on assets (Operational Strategy)
FLA is financial leverage (Financial Strategy)

In a discounted cash flow, a company’s value is calculated as it’s enterprise cash flows discounted at the appropriate enterprise cost of capital (it’s weighted average cost of capital).

In other words: In the summation formula, the numerator is operating (FCFF) and the denominator is financial (WACC).

This is another good way to think about the difference between OPERATING working capital (OWC) and working capital (WC) as I explained previously.

While the commonly accepted formula for FCFF is as explained above, anyone who has done a proper financial model is quick to learn that it isn’t change in net working capital which is important, but rather change in OPERATING net working capital (excluding financing items such as cash and short term debt).

FCFF = EBIT (1 – tax) + DA – NOWC - Capex

But the next logical question is what is the difference between something like short term debt (a quantifiable liability) and accounts payable (also a quantifiable liability which is equally a debt of sorts – a debt to a supplier). The answer? Interest.

The reason why something would be considered OPERATING working capital (or particularly an operating current liability) versus a normal working capital (or current liability) is that a financial current liability *bears interest* whereas an operating liability does not.

This raises the next interesting question: How do you treat pension liabilities? As you may recall, I mentioned previously how the CFA treat’s pensions as if they are interest bearing liabilities (or specifically, debts of the company owed to it’s workers which is expected to grow at the company’s cost of debt). This is a perfect example of a judgment call. Some of the top equity research analysts will consider pensions to be part of operating a business (not included in enterprise value as a financial consideration) whereas others will consider pensions to be a type of financing (don’t take my word for it, check out the research reports of companies with sizable pensions and see how different analysts treat different companies). Some will consider current pension obligations as debt (as it has to be financed to be paid out) whereas others will treat the entire long and short term obligation as debt.

2nd Year Case Comp - My Turn

Last year, I went to the 2nd Year Management Consulting Association (MCA) Case Comp as an observer to see the upper year students duke it out. Just like last year, there were a few first year students who came to observe. This year, I put together a team to give it a try. While we didn't place, the experience was well worthwhile. It certainly served as a good primer to get back into "the right frame of mind" for school.

I'm incredibly impressed with the quality of the presentations. One of my buddies came out with a truly unique solution to the problem presented and had an equally incredibly pitch to sell the idea.

One interesting lesson was why companies focus on top line revenue at the expense of bottom line income. While a short term focused company will need to produce results in the form of profits, a firm with a more long term outlook will often focus on top line revenue as a metric reflecting product and volume growth (with operational margins improving over time and producing future profits).

The first place team was a group of part time students, and I'm starting to notice a trend when it comes to part time students and their performance in case comps.

Negotiations

Classes have started a bit early for me as I've started taking negotiations this week (I had repeatedly missed this class for study tours). I've been taking this class since Sunday with the incoming Morning MBA class (apparently this is their first class that they take with FIT).

It's a fantastic class, showing you the mechanics of negotiation with the opportunity to practice your skills with your fellow classmates. A large component is experiential so I don't that it is easy to transpose the nuances onto a blog post. However, I have been told (and can understand why) this class is popular with students.

Most people would probably initially think that a negotiations course will help people "get a bigger slice", but that is too narrow a perspective. It focuses on tactics and strategies for how to enlarge the pie, how to ensure that the counter party feels like they have been dealt with fairly (even deals in which you concede a great deal of value is no guarantee that your counterparty will be entirely happy with the deal and can affect your relationship and future ability to negotiate).

Flight of Fancy: What If...? A Market for Bid Points

One common theme I've heard is that MBA's are often upset when they don't get all the elective courses that they want. While I certainly can't complain, it brings up an interesting question: "What if someone like me was able to sell their bid points? What would I get for them? And how would you value them?"

For example, my course choices weren’t very restrictive, I got 500 points to bid on four courses, most of which I could have gotten with a zero bid. Whereas, Mr(s). Ambitious was trying to take TMP and Value Investing while going on Exchange (physically impossible, Value Investing is a year long course and Exchange means you are physically gone). If there existed a mechanism (and therefore a market) for me to transfer my points for a price, what would I get for them? What should they be worth? Clearly, there is currently some "market inefficiency" as we are both unsatisfied: Mr(s). Ambitious because they didn't get all the courses they wanted [net deficiency] and me because I didn't realize the full value of my bid points because I had more than I could use - [net surplus].

Well let’s make some assumptions:

• Rotman tuition is C$35k per year (let’s not include first year as it’s common, or you can adjust the value of points accordingly if you feel second year courses are more / less important)
• You take 10 elective courses in your second year
• You are given 1000 points with which to bid

A “book value” of the points would simply be C$35k / 1000 points or about $35 per point.

But keep in mind that when something is inherently useful, especially in a scenario where a few points margin can mean the difference between getting the course you really want versus having to settle for a less popular course, there can potentially be bidding wars from “oversubscription” (points trade at a multiple above their book value) especially if they were in limited supply.

While people are paying C$70+k to go to school, for a marginal $35 x 100 points (a rough approximation of the average points allocated per student / course) or $3500 you can get any course you want (including the highly coveted TMP and Value Investing – which includes a trip to visit Warren Buffet – one of the reasons why this course is so wildly popular).

If you could some how do it, you could see how much additional probability you have of getting into the classes you wanted and put a dollar value on how badly you wanted to be in that class (regression analysis), you can determine a price you’d be willing to pay to attend that class. For example: Would there be a correlation between the number of points you consumed to get into classes of your choice against your overall earning power once out of university (thinking along the lines of DCF to value bid points like common shares).

And also imagine if this market had a “market maker”. For example, the PSO will (create and) sell you points for a certain value (either regulated and pre-determined or floating with the market). Students could liquidate their points at market value and get money back or buy points of the market to be more competitive for course selection and the school could potentially get revenue from selling points.

And since you have a market with underlying assets, imagine if you created financial instruments for those assets (shorts, puts, and calls for bid points, futures).

And imagine if other schools had market systems (I’m told that bidding systems are not uncommon at other MBA schools), you could trade between these. Or even other programs!

Of course, these points would inherently have an “expiry” as to their value (you wouldn’t want to be holding (take delivery of) 5000 MIT Engineering points if you were going to Stanford Law School).

There are some interesting implications. For instance, a new ranking system for schools where the relative value of a course is determined by the market value (determined by students taking courses there) in real time with comparisons to year over year values. Example: Would an engineering calculus class go for more at Waterloo or Toronto? Could you couple this with flexibility between schools (accreditation programs) which allow students to take equivalent courses at other schools and what do you get?

It would be a more sophisticated and real-time version of tuition regulated by the market. Taken to the extreme, here is another idea: drop the original tuition completely and have students buy bid points for classes. And then what if you were able to connect this market to actual financial markets? An S&P Index of Undergraduate studies to benchmark the valuation of your individual class’ performance.

Another thought: If the value of courses in a particular faculty started to "overheat" would that be a leading indicator of oversupply of labour in a particular industry in 4 years time?

Bidding Strategy - The Mechanics

So I've been lucky enough to receive all the classes I want in all the sections I want and it turns out that LBS doesn't use a "bidding" system per say (classes awarded based on listed "preference" - an ordinal system).

A few people were asking about how my bidding formula works and while it's hardly perfect, I figured I'd put up some of the details just for laughs (or a least as building blocks for someone who plans on taking this model to the next level). It uses only public information available to all students at the time of bidding.

In this model, each course bid is determined by three factors. The first is the inital base and most people will choose one of two initial bases: Last year's minimum bid or last year's median bid (depending on how competitive the class is).

After determining the appropriate bases for your five courses, the remaining points (“the Remainder”) can be divided amongst your courses to make your bids more competitive. But like all dilemmas in bidding, you want to assign just enough points so that you get the courses you want, but not so much that you jeopardize your chances of getting the other courses. So how do you do it?

I propose that the two major factors you should look at are what I call:

1. The Ballot factor (anticipated) (x% of the Remainder, or “X-Factor”)
2. The Historic factor (backward-looking) ([100% - x%] of the Remainder, or the “Y-Factor”)

Where x% is the weight of value of your Ballot factor versus your Historical factor (In other words: how much you believe your Ballot Factor represents real bidding behaviour versus historical).

Ballot Factor:

This factor accounts for the number of people who say they will take the course. A few notes:

• People don’t always bid for the courses they ballot for
• Use the numbers as guidance to see if the course is oversubscribed
• Calculate the expected utilization capacity = total number of students balloting for any course in that section / total class capacity
• Square the utilization capacity to create an “intensity factor”
• Total all the factors and express each factor as a percentage of the total
• Multiply the percentages by the X-Factor
• The result is each individual courses’ Ballot Factor offset

Example:

• 2 classes have a capacity of 40 people each
• You have 200 points allocated to Ballot Factor
• 20 people bid on Class A (fairly certain everyone who bids will get in… There is even a chance that a 0 point bid could win) has utilization 50% and Ballot “intensity factor” of .25
• Class B has 60 bidders has utilization 150% (red flag: guarantee that not everyone will get in) and it’s “intensity factor” is 2.25.
• Class A’s weight is .25/(.25+2.25) = 10%
• Class B’s weight is 2.25 /(.25+2.25) = 90%
• Class A’s Ballot factor offset is 10% * 200 points = 20 points (a non-zero bid with decent margin, you'll probably get in)
• Class B’s Ballot factor offset is 90% * 200 points = 180 points (a strong bid, considering an average of 100)

This model tries to account for the fact that only very high bids will win the competative class, but you also don't want to low ball Class A incase a few stray bids appear from people who take the class last minute (obviously, the less people who originally bid on the class, the less you have to worry about dark horse bidders).

Note that it is 9x because at least 20 people are guaranteed to not get in the class. Classes that are oversubscribed will have intensity factors much higher than 1 with much heavier weights and undersubscribed much lower than 1 with much lower weights. This accounts for the premium on variation and intensity due to the number of bids in a competitive environment. Note that in this pure form, this is a best effort bidding mechanism with the scaling of points to consume all remaining points.

Historical Factor:

Another way to try to guess what the bidding will look like is to use the historical bidding as guidance for the variation of bids (were the bids tight or across a broad range?) One indicator of that is the minimum and median bid. If you make some HUGE assumptions, you can use these two points to create a normal curve with standard deviations. Since the mechanics of this are taught in stats in first quarter, I won’t bore my readers with a poor facsimile of Prof. Krass’ lecture.

Even if you don’t technically know the actual distribution of the curve, you can also use Chebyshev's inequality to position yourself within a certain percentile (also looking at the expected capacity utilization of the class based on your previous calculations). How? Here’s a hint (shown above): the bidding percentiles (% of students bidding that are not successful being admitted into the class) should be the same as the bid oversubscription capacity (again, huge assumptions) to provide the number of standard deviations. Combine this fact with the distance from the median to the minimum should provide a clue as to size of a standard deviation. Note that using this method, you may not (probably won't) have enough points to guarantee getting into the courses you want (unless like me, you probably have a surplus of points or are taking unpopular courses), but it is probably one of the best mechanical methods for balancing aggresive bidding with conserving points as well as building a view for what the bidding landscape looks like. In practical terms, at this point you can use a best effort model similar to the one shown above using the Y-Factor.

Also, I’ve deliberately left out methodology for mechanically scaling up courses based on your individual preferences (ie rating courses from 1 to 10 and incorporating that into your bidding strategy). Also, there are huge economic implications for bidding strategy considering that the involved parties do communicate with each other and affect the bidding levels of courses (ie Friends talk to each other about how they plan to bid). Signalling, game theory and strategy all come into play.

While not perfect, this model will give you some perspective into what a reasonable, very mechanically inclined bid would be. Admittedly, while I built this model, I did do some “emotional” adjustments to my bids (there was one course where I wanted to work with my friends on their team, so I wanted to be CERTAIN that I got the course). Like anything done on a computer, it’s just a tool.

Disclaimer: Like anything on this blog, this model does not guarantee any degree of success. This post is intended as a conversation / pensive reflection piece only. It is possible for you to use this model and not get ANY courses you want. For instance, it is physically impossible to get both Top Management Perspective AND Value Investing because both courses usually require exceptionally high bids. Note that by definition, there will be some people who don't get the courses they want. The more you want to be certain that you are in one course, the less certain that you will be in another (almost like the Heisenberg uncertainty principle). For better or worse, it is a zero-sum game.

Also, more importantly, I've been told that it's all a wash and at the end of the day, after the drop and add periods are over, most people get the courses they want anyways.

Another Look at Synergies

In thinking about OWC and also M&A recently, I was thinking about other possible forms of synergies rather than the two most obvious ones: revenue growth and cost reduction.

While not exactly the same as cost reduction, there are potentially certain economies of scale which can be achieved through reducing OWC requirements. Firstly, when looking at PV of CFs related to synergies, recall that FCFF (UFCF) is defined as:

FCFF = NI + Dep - Δ WC - Capex + Int (1 - t)

Increasing sales and decreasing costs will certainly affect NI, but I also thought that there was the possibility of also being more operationally efficient (reducing size of distribution networks, inventory holding requirements and demand / capacity mismatches due to manufacturing variations resulting in either lost sales etc). Most of these topics are the same topics ones we discuss in our Strategy and Operations Management courses and would affect all the activity ratios.

While probably not the most significant category of possible synergies, when dealing in deals worth millions or billions, I'm sure such attention to detail would probably result in noteworthy potential value creation opportunities. Also, this could be another potential reason why Stragetic buyers will probably command a higher premium than Financial buyers.

Another potential example I was thinking about was the idea of writing up intangible assets (which was the cause of my deal being dilutive). The value creation in this case, however, would be more for the target companies current share holders rather than the acquirers (and also be reflected in the division of synergies between the two groups through the premium).

The idea is that the target companies share holders gain value throught the premium which is the excess over fair market value. This excess is divided into write up of intangible assets and good will. While the acquirer "loses" some of the value through good will, it can reclaim some of the value of the write up of intangible assets through the tax shield provided by amortizing this value.

Again, while not as large an effect as the original two primary methods, I'm sure the attention to this detail will yield some additional value creation (and at least value retention for the acquirer) associated with an M&A deal. At the very least, the target shareholders can gain and the acquirers can give up less of their synergies.

Integrative Thinking Practium - Agent Based Modeling

At the beginning of the course I was a bit confused. At first I thought I didn't really understand what was happening. And then our class today started by describing a model of sand falling on a table. I was further confused as to how this was in any way related to business.

With a few changes in our frame of mind, "sand falling on a table" became a metaphor (or analogy?) for customer arrivals at a business. Pile height became analogous to company capacity constraints and pile location became geographic properties of companies.

Suddenly, we actually had a working model for the growth of an industry into equilibrium which encompassed such ideas as customer movement from one business to another. With a few more tweaks, the model was even able to show the decline of an industry (and death of underperforming companies).

I think my favourite part of this class was that it showed us in a very intuitive way how the models of our business work in more practical sense which are based in math, but don't require formulas.

I do apologize for my explanation as I don't feel it truly does justice to the class, but it encorporated topics we had learned in economics, operations management, managerial accounting, strategy I and II (Prof Ryall even made references to Anita McGahan's research).

Gravity as a Analogy to Globalization

Our professor just used one of the most clever analogies for international trade I've ever seen. It's surprising how much the physics of gravity can model relationships involving size and proximity.

The formula for the physics of gravity is:

Force = Gravitational Constant x Mass 1 x Mass 2 / Distance ^ 2

In this analogy:

• Force -> Strength of trade relationship
• Gravitational Constant -> Trade coefficient <-- trade barriers / regulations / tarrifs?
• Mass 1 -> Size (GDP as proxy?) of country 1
• Mass 2 -> Size (GDP as proxy?) of country 2
• Distance -> Distance

Our professor, Blum, took it a step further and did a logarithmic deconstructed the formula to further show how changing different values of each variable (pulling different strings) results in intuitive changes in the relationship. For example: Decreasing distance between countries increases. He even quotes his research (2004). This is his criticism of the idea that the world is truly "flat".

Imagine the game theory implications also. If you could use this relationship to predict how countries would trade and grow, you could build a model with multiple components (countries) to see how they'd develop.

So... It turns out that when Roger Martin tells us that Rotman has a world class research faculty which impacts the material we learn in our classes, he certainly wasn't lying.

Operating Leverage

Anita McGahan once explained to us the nuances in a decomposition of the DuPont formula. Where:

ROE = ROA x FLA

In non-math terms: The profitability of a company is a function of it's operating strategy (ROA) and it's financial strategy (FLA).

We've been looking more at this topic (focusing on Operating Strategy) in Operations Management and were introduced to a very interesting idea: Operating Leverage.

Operating Leverage, put simply, is loading up fixed costs to reduce variable costs. Another way of looking at it is similar to capitalized leases versus operating leases. Like financial leverage, increasing operating leverage also increases risk, but increases potential reward.

While debt provides the lever in the financial leverage analogy (and interest expense provides the potential downside), in operating leverage the lever is fixed cost (and sunk cost is the potential downside).

If the volume of quantity demanded isn't equal to the break even amount, there is a significant loss. If the volume of quantity demanded is higher, there is a relatively amplified effect on the profit base through the cost side of the equation.

Excluding the effect of taxes, a basic formula for profit is:

Profit = Revenue - Costs
Profit = (P x Q) - (FC + VC x Q)
= Q (P - VC) - FC

Break even (BE) is when Profit = 0 so

FC = Q (P - VC), where P - VC is contribution margin, CM (profit per unit sold)

Therefore the break even quantity, Q, is defined as:
Q = FC / CM

Using financial leverage as an analogy, I would suggest that it is only truly increasing "operating margin" if the BEQ increases (risk increases). This would only happen if the percentage change in FC is greater than the percentage change in CM (very similar to elasticity).

I believe this would be analogous to a type of operating accretion? In finance, deals are accretive if the cost of capital of the source is cheaper than the cost of capital of the use (buying high return instruments with low return instruments) and is the foundation of financial leverage.

Also, because CM is defined as P - VC, there is an inherent leverage relationship as well as it relates to cost in the same way a commodities based company has a leveraged exposure to it's underlying commodity price. If CM is anchored on one end (P), a change in VC has an amplified effect.

Business Design Competition - 3rd Place

I spent to better part of yesterday afternoon and this morning participating in the Business Design Competition. Our team was composed of myself, Yan, Mark, Justin and Xinxin. It was an interesting challenge. We were introduced to the business design process and given an open problem and carte blanche to find an appropriate solution.

We had a great team dynamic and every member contributed according to their strengths. At the end, I think we all learned something new, picked up more skills and experience which we can certainly apply to other aspects of our business careers.

The competition was judged by several industry professionals including a strong showing from Monitor Consulting.

After the first round presentation, when we discovered that we had made it to the second round, I think our group took the criticism of the judges very well. Even before our ranking was announced, I had told my team that I was exceptionally happy with the improvement we had made as a group in refining our presentation skills on the fly.

Integrative Thinking: Dutch Auction - Tender Offer

What an interesting concept. We had briefly touched the idea of Dutch Auctions in microeconomics way back in Q1 which is a bidding strategy whose mechanics are based in the math of economics. Today, we applied this strategy towards share buy-backs in finance.

While it might be easy to pick up shares at the current market price, large orders by corporations to buy-back their shares is much more difficult because the market can't immediately absorb the change in liquidity from the huge jump in temporary demand.

So what to do? What mechanism will work where the company can get the best (a "fair") price for buying back its shares and shareholders can get the best (a "fair") price. The mechanism to use is a Dutch Auction.

Everyone announces their lowest acceptable price and number of shares for sale. The buyer (the company in the case of a buy-back) slowly adds up all the numbers of shares from lowest price to highest price until it accumulates all the stock it wants. It pays out all the share holders at the highest price of the group. This ensures that sellers get AT LEAST their minimum required amount and the buyer (the company) gets all the shares they need at the LOWEST possible price.

This actually happened in practice with Morgan Stanley's Dutch Auction system used for Google's IPO. They used a similar Dutch auction system which neutralized the effect of large companies purchasing stock and allowed smaller investors to also pick up shares.

Also, another lesson from class (something I was wondering about previously) Dividend policies don't really matter. Perhaps, like our capital structure lecture, this only occurs in "perfect" capital markets, but it is something to think about.

In summary: If a company gives out cash, it's beta goes up (because it's mix of "risky" assets has gone up, and it has given out cash which is a "safe" asset). However, on a net position your total holdings is the same. The risk gained / lost by giving out cash doesn't change your total net position.

Commitment - Restrictions for Improved Reward

Wow. What an oxymoron. We had briefly heard about this in game theory in Economics way back in Q1 and now it's coming up again in Q3 in finance.

First in game theory and dominant strategies. Look at the following example of the prisoner's dilemma:

So in the typical fashion, the dominant strategies for both players show that they will end up in the lower right corner with a return of 3 each. This is unfortunate, as there is a potential to get 5 each if they could only credibly commit to Strategy A each. But because of the conditions of the prisoner's dilemma, it's impossible.

To change the parameters of the game, what if it was possible for Player 1 and 2 to commit to impairing their own return matrix? For instance, what if Players 1 and 2 could reduce their returns in the cells AB and BA to 4 instead of 7 (as shown below)? Suddenly, the dominant strategy changes and the end game to a return of 5 each rather than 3.
We achieve a counter intuitive result. By placing restrictions on their own returns, both players can achieve a higher return.

In our finance class today, we talked about a different scenario with similar characteristics. First, an overly simplified example. Because equity holders are only liable for capital at risk (what money they put in), with the effects of leverage, they can increase their upside with a bottom of bankruptcy. This will encourage them to take on projects even if they have a stand-alone negative NPV (but a positive NPV with regards to the equity holder's return and relationship in bankruptcy - equity holders don't lose more money then they put in).

However, the debt holders will require a larger return on their debt to compensate them (make them whole) and offset the risk. This in turn can make projects unattractive and become prohibitive.
However, shareholders can introduce debt covenants in order to restrict the their own flexibility (preventing them from taking on too much risk and inflating their upside) to secure financing and ensure debt holders that they won't have to bear the dead weight loss of projects which fail.
Again, a counter intuitive result: You can do better by restricting your choices.

Looking at BCG's (In)Famous 2x2 Matrix with HHI

Today, we were talking about BCG's 2x2 Matrix (shown above) in our marketing class and our professor proposed to specifically define market share using a benchmark of the industry leader (or if the company was the market leader, the second place leader) as the line between High and Low Market Share. He acknowledged the primary shortcoming that using this definition, there can only be (by definition) one cash cow in the industry. He then introduced the idea of Coke and Pepsi with 52% and 48% relative marketshare (a slight exaggeration to prove a point) where they are both cash cows generating regular cash flows, but failing the definition: Pepsi would then be "dropped" as a project because of poor systematic definition. Or even if you use a given number (say x%) it doesn't account for the number of firms or size of firms.

In thinking about this, I also started to think about how we might be able to use the Herfindahl-Hirschman Index (HHI)to help correct for this problem. The current problem in the above standard proposed model is the definition of "market share" doesn't include competitiveness of the market (or lack thereof) when defining a cash cow. However, by definition the HHI looks at both the market share of the leaders as well as the effect on competitiveness from their relative size to each other.

Having said that, I would change "Market Share" in the horizontal axis to "Competitive Market Share" or mathematically:

Competitive Market Share = Competitive Market Capture / HHI

Where,

Competitive Market Capture = [% Market Share * 100]^2

Using this formula, we can tell that in the extremes, it works. For instance in a monopoly, Competitive Market Capture = HHI, so Competitive Market Share = 1.0 or 100%

In "perfect" competition (infinite number of firms with infinitesimal or marginal / trivial /zero market share), Competitive Market Capture = 0, Competitive Market Share = 0.0 or 0%.(Actually, to try to use "layman's" calculus terms, the Competitive Market Capture would be by definition a "smaller" zero than the HHI).

Also, because of the effect of squaring the market share (as is the case in HHI) we account for the effect of size in terms of competitiveness.

Having said that, the finance perspective is different then the marketing perspective. The only thing that really matters: Positive NPV.