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READING 30
1. Financial forecasts are normally part of a more detailed business plan. A business model
should convey how the business makes money, so unit economics (i.e., per-unit revenue
and costs) are a key element of a business model. Based on the product and market, the
target market (who the business serves), the channel strategy (where they purchase), and
the total cost of ownership, including maintenance after purchase, would also be key
business model elements.
2. A business model that assumes premium pricing must address why customers will be
willing to pay a premium, normally because of some type of differentiation. It is less
likely (although not impossible) that a price premium could be sustained in a category
where pricing is set in the market (A), where a small change in price causes a large
change in demand (another way to describe the price taker scenario; D), or when a firm is
trying to scale up to a competitive size (B).
3. All these statements are true, in most cases, for a platform business. A platform business
is defined as a business based on network effects—that is, where the value of its service
or product is enhanced by the addition of customers or users. While many think of
platform businesses as being web-based or software-based, there are many older business
models that qualify, such as brokerage and exchange businesses and transportation and
communication networks. The value creation for a platform business is external to the
company that created the product or service. When the business is launched, it has no
customers, which can make the launch challenging—one reason why many platform
startups employ a "freemium" pricing strategy to attract users quickly.
4. The resume preparation service benefits from the network effects on various online job
sites, but the service is not the source of those network effects. Each of the other
businesses (A, B, C, and D) becomes more valuable to its customers as it attracts users. A
stock exchange is valuable and worth joining because many securities trade on it. The
telephone network is very useful because most people are on it. A classified advertising
website becomes more useful as it attracts more listings. An airfare price comparison
website is valuable to airlines because it has many shoppers and valuable to shoppers
because it features prices for multiple airlines and routes.
5. Unit costs normally include direct labor costs. A unit cost analysis should be considered
in most business models, although in some cases, they will be close to zero (for example,
digital media). If unit costs are non-zero, they must be taken into account when
calculating the break-even point. In D, there are no direct labor costs, so the unit cost
calculation is reasonable. (The lemonade stand is staffed, and no extra labor is required to
pour the lemonade.)
6. Unit costs normally include direct labor costs. A unit cost analysis should be considered
in most business models, although in some cases, they will be close to zero (for example,
digital media). If unit costs are non-zero, they must be taken into account when
calculating the break-even point. In D, there are no direct labor costs, so the unit cost
calculation is reasonable. (The lemonade stand is staffed, and no extra labor is required to
pour the lemonade.)
7. Macro risk is likely to be highest with a Swedish mining equipment manufacturer since
product demand is very sensitive to the global economy. With the coffee plantation in
Brazil, the call center outsourcing business based in India, and the Swedish mining
equipment manufacturer, there is also exchange rate risk that could impact profitability
and competitiveness.
8. A company with consistent operating margins and a stable market share in a highly
specialized business embarks on a significant and ambitious strategic change. Its success
will depend entirely on how well management succeeds in delivering on its objective by
improving margins (either by increasing prices or reducing costs) and taking market share
from its competitors. Considering the relatively small size of the business, it may be
difficult. Considering that many manufacturing businesses in the same industry typically
operate around similar margins, any margin improvement may be difficult. That a
manufacturer replaces aging factory machinery with similar but more efficient equipment
is not an example of execution risk; it is part of regular improvement and capital
investment. That a marketer of high-fashion pet accessories tests the market to see if there
is demand for glamourous dog harnesses made with faux fur is a standard and common
expansion of an existing product line with limited risk.
9. Reducing prices decreases the business's margin, and as such, it increases its sensitivity to
changes in demand, revenue, and costs and its operating leverage. The choice between
debt and equity financing has no bearing on operating leverage, although it should be
noted that interest expenses on debt are contractually determined payments, while
dividends are discretionary payments. Using casual labor rather than a salaried work
force reduces the fixed employee expenses, which reduces operating leverage.
10. Entering a sale–leaseback transaction for the company's head office building increases
financial leverage. The company sells assets with the obligation to repurchase the assets
in the future as well as make lease payments. These transactions increase its financial
leverage. Additionally, sale and leaseback transactions reduce the business's overall asset
base, which, in turn, reduces its ability to add more debt should the company need to
raise debt. Cutting prices reduces the profit margin for the business, thereby increasing
operating leverage. Replacing short-term debt with long-term debt does not change
financial leverage: Debt, irrespective of maturity, is simply debt.

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