Founders' motivations and entry into educational software business

Spinnaker

Tell us how each of you came to the point of wanting to start your own company and what was it in your background that made you think you would be any good at it?

What did each of you do to prepare yourself for entry into this field?

David -- I wasn't sure I would be good at it actually but I did desire to be a line manager instead of a consultant. My education, my experience at BCG, and my expertise in marketing all prepared me for my role as an entrepreneur.

Bill - My work experience in personal computer allowed me many insights into the industry. I had been a programmer and then an IT manager. Later I also acquired a lot of experience in my role at BCG.

How did you come to identify this specific opportunity? From top to bottom, give us a step down analysis of the business we're in…be as specific as possible because we need to understand how we got here in the first place in order to help determine a future course of action.

Bill -- At the time, I was constantly scanning for business ideas because I was interested in starting a business. Out of all the different options that I ran into, the software industry seemed the most promising with the greatest amount of potential growth. That coupled with the ease of entry into the industry, as well as Bill's technical expertise, we were able to craft a model that added value to consumers.

David -- The original business plan developed somewhat out of chance. I was researching another company in the minicomputer software business when I asked David's opinion of the industry. I was shocked to learn how easy it was to get into the industry and, with David's input; we decided to put something together.

#3.

What was it about this opportunity that you liked? What gave you second thoughts? Is this what you BCG guys would characterize as a "structurally attractive industry"? If so, why? If not, what are we doing here?

Bill -- the opportunity to target educational software presented itself pretty early in the planning stage and we quickly realized that we had the potential to dominate this industry. It was definitely an attractive industry because it was early in the life cycle development and we could be the forerunners.

David -- It was definitely an attractive industry in the early development stages. Any potential competition didn't have the capacity to be a real threat since they couldn't manage the comprehensive set of business functions that it would take to be the market leader. I did have some second thoughts however. I wasn't sure I was ready to give up my cushy position and embrace uncertainty; yet I finally gathered enough courage to do it.

# 4. (4 parts)

Take us back through your thought process. I remember meeting after meeting, listening to the two of you harp on your Strategic Financial Planning Process. Again, what does that really mean…define it? Also, please comment on the Strategic Financial Planning Process as it relates to Spinnaker at the beginning of the business, during its growth phase, and where we are today.

David - The Strategic Financial Planning Process definitely went through different stages in its evolution. In the beginning we were mainly focused on getting our feet wet and keeping expenses at the bare minimum. However, as the company's rapid growth became evident, we had to plan on becoming the industry leader and begin constructing barriers to ensure our future success.

Bill -- From an operations perspective, the company made leaps and bounds within a short period of time. Going from an organization with only a handful of people, to a much larger organization approximating one hundred people adds several layers of complexity and a whole range of new dynamics. Planning for strategic financial decisions quickly took on a whole new meaning from the growth phase to where we are today.

# 5 (8 elements)

You gentlemen created this business out of a blank sheet of paper. Articulate and evaluate, if you will, the elements of Spinnaker's strategy (manufacturing, marketing, financial, sales, etc.). It will be easier for us to understand if you could come back to us with an exhibit like the one below, detailing each element of strategy, what strategic choice you made, why you made that choice, and the risk(s) associated with making that choice. Be sure to cover all the bases now, we don't have time to do this more than once…the clock is ticking

Element of Strategy Strategic Choice Rationale Risk

Manufacturing Internal Easy to Produce Minimal

Marketing Pull Strategy Identified Need Minimal

Financial Outside Investment Needed Capital High

Sales Retail Distribution Channels Profitable Medium

#6

All of these strategic choices, and their attendant risks, converged to constitute a bet. What was the specific bet and why did you make it?

Bill -- The bet was that were could construct a model that would fit the identified niche as well as be able to successfully meet that niche's requirements in terms of quality and consumer appeal.

David -- The bet was that there was a demand for the product in the market. Although, consultations with various retailers led us to believe that there was a demand for this type of product, there was certainly no guarantee that consumers would be receptive.

#7

Everyone talks about their business model. If I were to meet you in an elevator for the first time and you had the opportunity to describe your business, as it was when you started out, in 5 sentences (no more than two lines each) what would say?

Bill -- Our organization is an innovator in the software industry. We target new consumer demand and meet that demand faster than any of our competitors. Our entire organization is built upon a rapid growth model and we are responsive and adaptable to the dynamic marketplace. We will provide the world with the most effective and entertaining educational software in the world.

David -- Our organization is entirely market driven and fully capable of meeting consumer expectations. Our model began by first identifying a need in the market place and working quickly to become the industry leader in fulfilling that need. Our niche identification, distribution channels, and general marketing practices are world-class. Having a competitive advantage in regards to marketing will ensure our company's growth path and it sustainability well into the future.

#8 (4 items)

In what ways would you say your strategy for Spinnaker has been successful? In what respect would you say not so successful?

Bill -- Our strategy has been successful because we have found innovative ways to design and build quality products in a relatively short amount of time which has made us the industry leaders. However, despite our success, we have yet to dominate the market to the extent that we can completely avoid the volatility created from the first-party manufactures.

David -- Our Company has been successful because our strategy has remained flexible. The joke in our company is that our long-term planning scenarios cover exactly one month out. We have worked hard; up to 24 hours a day for a month to get products to market. But that what it takes in this industry and that is what we will keep doing. However, we have been unsuccessful in determining how long we could continue operating like this until we hit at least one major glitch.

#9 (7 elements)

In this boardroom we have had many long and hard discussions concerning breakeven. In simplest terms, how do we calculate breakeven in sales dollars? For this fiscal year just ended 1/31/85, what was our breakeven at the start of the new fiscal year in February of 1984? What was the breakdown between fixed and variable costs at the beginning of the year?

Our breakeven point is determined by the level of revenues that will cover all the expenses, interest payments, payroll, taxes, etc. The breakeven point in 1985 had believed to be somewhere around the nineteen million mark. In the beginning of the fiscal year it was around twelve million. The breakdown between fixed and variable costs is heavily skewed toward fixed costs. This is because the company has invested so much in technologies to help develop the software packages.

Based on the expansion plan, revenues were projected going to $50 million…what was the planned breakeven? Again, what was the breakdown between fixed and variable costs based on that plan? By the time we put on the brakes, what was the revised breakeven and the breakdown between fixed and variable costs? How did Spinnaker actually end the year in simplest P & L. terms and how did that relate to their latest breakeven estimates?

The planned breakeven would be roughly twenty five million given the projection of fifty million because expenditures are roughly half of revenues as a general rule of thumb. The company lost nearly three million dollars in cash flow that year with sales only reaching fifteen million. The projected breakeven point was nineteen million and was heavily dominated by fixed costs. The actual loss for the fiscal year was somewhere in the neighborhood of two million.

inventory of $2,028, calculate inventory turns for the FYE 1/31/85. (1,626,000)

d. Accounts payable increased roughly $1 million during the year. Is this good or bad in general? How do you view this in relation to Spinnaker's specific financial condition as of fye 1/31/85? It's a good deal in general. However, with the volatility in the industry it can also be troubling since a large number of firms are going under. However, the line of credit established at the bank which is tied to A/R also helps to mitigate the risk of the high accounts receivable account.

e. The bank line of credit is $6 million, but the amount the company can borrow is based on an 80% advance rate against accounts receivable. How much additional borrowing can the company do on its line of credit using this information and the information provided as of 1/31/85 from Exhibit 2? 3,140,800

f. What is Spinnaker's leverage ratio at 1/31/85? .53

g. How many months before the company runs out of cash? A little over six months unless the company makes drastic changes.

12. (4 issues)

Bill, as you stand before us today, what are the key issues facing the company?

The company is undoubtedly cash poor and it rests square in a very volatile industry. These are by far the biggest two issues that are currently facing the company.

13. (5 options along with the advantages and disadvantages of each)

Given those issues, what are the Company's options? What are the advantages/disadvantages of each of these options?

Drastically reduce expenses -- The Company can make cuts to its labor force which will help to reduce costs however they will lose some of their qualified staff as well as some of their competitive advantage.

Dump Inventories -- They could dump their current inventory at below market value to find some more cash. This would help the company stay afloat longer but would also take a loss and possibly diminish the brand's image.

Liquidate Assets -- The Company could also liquidate some of its assets in order to help it meet its obligations. However, it would not receive anywhere close to market value for most of its assets and this would also be a costly move.

Raise more capital -- Raising capital through whatever mean possible would be a possible alternative to help the company recover. However, the rate of return would be quite high to attract investors.

Make Marginal Cuts in every Department and Assets -- The Company doesn't want to lose any of its competitive advantages during the cost reductions. Therefore if they make a series of small cuts in different areas this could also buy them some more time. However, these cuts may not be timely or deep enough to completely cover the liabilities and would only buy a little more time.

14.

It's lonely at the top time Bill. Which option or combination of options would you recommend? Why? What is the relevant timeline? Be very specific as to the course(s) of action you are recommending, what is entailed, and the timing involved.

The Company needs to grow its way out of the cash flow dilemma and it has all the resources to do so. However, what it doesn't have is the market demand at this point. Yet this demand is only a matter of time. The Company must make a series of marginal cuts in every way it can as well as take advantage of the line of credit and pursue new investment. The company can quickly respond to a spike in demand at any point and thus the company needs to maintain until the markets show some signs of light.