Patent Application
20050055303
This invention relates generally to a method for incentivizing a customer to confirm an advance purchase order from a manufacturer.
There are industries and markets where the product development is extended and uncertain, with future success depending on critical cost-performance breakthroughs in technological advances. The fuel cell and Hydrogen economy is such an industry, where the economic equation for replacing existing power supplies requires a future development in lowering the cost-performance of the fuel cell stack and significant investment to commercialize to provide products to a large multi-billion dollar market opportunity. A challenge in these industries arises in how to create and retain market traction and commitment without being able to provide the product until a later date after product development and commercialization. This problem may be stated as how to create adequate incentive for customers to pre-order and commit and remain with one supplier for a product that will not be in commercial mass production until a future date. There are significant challenges including opportunity cost, product development risk, volume purchasing from suppliers risk and financial risk not adequately overcome by existing methods.
It is an object of the invention to provide a rapid commercialization strategy for a manufacturer. In particular, it is an object of the invention to provide an incentive to buyers of the manufacturer's products or services to irrevocably confirm their purchase orders in advance of delivery of the products or services.
Therefore, according to one aspect of the invention, there is provided a method of obtaining an advance irrevocable purchase order from a buyer for a product or service of a manufacturer, comprising:
The revocable purchase order can be placed before the manufacturer's initial public offering date. The vesting period can begin at the date the buyer places the revocable purchase order, and can end around the time of the planned delivery date of the product or service. The method can further comprise publicly disclosing the revocable and irrevocable purchase orders after the initial public offering date in order to promote the manufacturer and increase the manufacturer's share price, thereby motivating the buyer to irrevocably confirm its remaining unconfirmed purchase order before the end of the vesting period, as an increase in share price results in an increase in the capital gain resulting from exercising the warrants. The increase in capital gain offsets or eliminate the opportunity cost perceived by the buyer in placing an advance purchase order.
The number of obtainable warrants can be reduced to zero at the end of the vesting period. Also, the number of obtainable warrants can be reduced in stages over the vesting period. This motivates the buyer to irrevocably confirm the buyer's purchase order earlier rather than later. However, the revocable purchase orders can be revoked without penalty or cost to the buyer.
It is an object of the invention to avoid pricing pressure from competitors at a later date. Therefore, the number of obtainable warrants can be reduced when the buyer enters into a commercial relationship with a competitor to the manufacturer. This dissuades the buyer from revoking the buyer's purchase order with the manufacturer.
The warrant strike price can be the share price of the manufacturer at the warrant strike date.
An initial purchase order agreement can be executed with the buyer at the time the buyer places the revocable purchase order. The agreement defines the warrant strike price, a planned product delivery date, the vesting period, and the rate of reduction in obtainable warrants during the vesting period.
A deposit can be received from the buyer at the date the buyer irrevocably confirms at least part of its purchase order. This provides capital to fund the manufacturer's commercialization efforts. Furthermore, the selected number of warrants can be issued to the buyer only when the buyer places a revocable purchase order above a minimum value.
According to one embodiment of the invention, a business process is provided which is applicable to companies whose stock is privately held and whose intention is to go public, and in a special case, companies already having publicly traded stock. Customers of such companies may enter into a purchase order agreement and be incentivized to confirm full or partial portions of an order for future delivery of a product or service, in order to generate revenue for the company and increase the underlying value of the company. Such an incentive may be a growth incentive, such as a warrant issued at the inception of the purchase order agreement, with nth order of reverse vesting periods typically following IPO or liquidity of the company's stock.
The participants in the business process include a buyer and a manufacturer. For the purposes of this description, a buyer means a potential customer or an existing customer, who has or expects a business demand for the manufacturer's product. A manufacturer is defined in this description as the company who produces the product being sold or a provider corporation in the case of services. The manufacturer entity is also referred to also as the issuer or issuing company in this description.
To reduce risk to the buyer, the buyer is invited by the manufacturer to place a purchase order for the manufacturer's product or service in advance of the product or service's planned delivery date, wherein the purchase order is fully revocable without penalty or cost to the buyer before the planned delivery date.
To provide incentive to the buyer to irrevocably confirm the buyer's purchase order, the manufacturer provides an incentive in the form of a right to obtain a selected number of warrants (“obtainable warrants”) of the manufacturer at a set strike price, and that can be exercised for shares in the manufacturer after the manufacturer goes public, provided that the buyer irrevocably confirms its purchase order within a predefined vesting period. The vesting period typically starts at the date the revocable order is placed, and typically ends in the planned product delivery date range.
Customers have a natural reluctance to make an advance irrevocable purchase commitment. The driver for this reluctance is the real or perceived opportunity cost associated with such advance commitment. Technology advances and price decreases from mass production mean that a given expenditure on technology-based products will likely deliver more value in the future than it will today. The loss in value associated with committing to purchase products (that can't be delivered for several years) today, rather than waiting to purchase those same products on the open market in several years, defines the opportunity cost unique to each customer. Under such circumstances, the only way to extract substantial early purchase commitments from customers is to provide them with some tangible value, which offsets the opportunity cost. A purchase commitment can occur when the customer perceives the net cost of making a purchase commitment today as being lower than the net cost of making that purchase commitment in the future. For this to happen, the value of the offsetting tangible asset must exceed the perceived opportunity cost.
Since it is difficult to quantify opportunity costs, and the perception of such costs can vary significantly between customers and over time, it is not clear what the value of the offsetting tangible asset must be. However, if the offsetting tangible asset is something which steadily and rapidly grows in value over time, it will eventually overtake the perceived opportunity cost by an amount which effectively reduces the net purchase price of the products to a point where the customer perceives an early purchase commitment as having a higher probability of a lower net price than a later purchase commitment.
In this business process, the offsetting tangible assets take the form of warrants, which are allotted to the customer upon receipt of an initial revocable purchase order(s). Since the initial purchase order is revocable without monetary cost or penalty to the customer, it creates an opportunity for the customer, without obligation or risk. Opportunity without risk provides an appealing value proposition to the customer, and hence, should be saleable. The manufacturer determines the strike price of the obtainable warrants, at the time of issuing the purchase agreement. For the case of issuing a revocable P.O. prior to the Initial Public Offering (IPO) the strike price may correlate to share value at the time of issuing the purchase order, or alternatively share value at or just prior to the IPO.
For the alternate process of issuing a revocable P.O. after the IPO, the strike price would be the current share price of the manufacturer. The method is optimized when the strike price is maintained to maximize realizable gain for the customer, hence issuing the revocable P.O. prior to IPO is preferred.
To motivate the buyer to confirm the buyers purchase order sooner rather than later, the value of the incentive decays with time: the number of obtainable warrants decreases over a reverse vesting period typically defined as the period between the manufacturer's initial public offering date and the end of the vesting period.
Warrants vest with the buyer when the buyer irrevocably confirms at least part of its order during the vesting period; the number of warrants vesting is related to the size of the purchase order that is confirmed. When the buyer confirms all of its purchase order before the start of the reverse vesting period, all of the obtainable warrants vest with the buyer. However, should the buyer confirm the buyers purchase order during the reverse vesting period, the maximum number of vesting warrants cannot exceed the number of remaining obtainable warrants. Therefore, the buyer is motivated to confirm the buyers order as soon as possible, and preferably before the start of the reverse vesting period.
The customer has ownership only of those warrants that have vested. Vested warrants have an expiry date, which is at some specified date subsequent to the end of the vesting period. Vested warrants offer capital gains potential because they offer both intrinsic value and time value. The intrinsic value equals the difference between the share price and the strike price, since warrants grant the holder the right to purchase the manufacturer's shares at a specified strike price which is fixed and independent of the manufacturer's current share price. The time value is established through applying such standard calculations as Black-Scholes. Warrants are a preferred security as they can be issued from shares allocated in the issuing companies treasury, and typically have extended expiry dates. The Black-Scholes model, developed by Fischer Black and Myron Scholes in the early 1970s, calculates the present value of a stock option as of its grant date, based on specific information about the terms of the option and assumptions about future stock price performance. The value calculated by Black-Scholes is an estimate of the price someone would pay for the option in the market today. The method assumes that the underlying stock behaves in a way that future prices can be modeled by a probability distribution.
A purchase order agreement between the buyer and manufacturer is executed when the revocable purchase order is placed. The purchase order agreement is an offering for a pre-defined product to be delivered at a future date and meeting specifications set out in the agreement. The revocable purchase order agreements may be executed before the IPO of the manufacturer, or in a special case, for a period immediately after the IPO under disclosure restrictions, with appropriate allocation and vesting. This embodiment describes a pre-IPO execution of revocable purchase orders. At and following IPO of the manufacturer, public disclosure of material change of the manufacturer is publicly reported, including the value of revocable and irrevocably purchase orders, which may not be on the balance sheet but will contribute to underlying business value. As an example of a specific application of this method, a market for forklift power supplies is discussed, specifically fuel cell power packs for forklift vehicles to replace existing battery powered packs for which the capital and operating costs are well characterized.
For this description, a revocable purchase order is defined as an agreement that can be deemed revoked without penalty, cost or obligation to the customer, in the event the customer has not voluntarily removed subject conditions associated with risks and reliability of the product and standard business conditions of performance and solvency of the manufacturer. The revocable purchase order becomes irrevocably binding when, prior to the end of the vesting period, the customer agrees in writing it is completely satisfied with certain subject conditions described in the revocable purchase order. Subject conditions may include but are not restricted to acceptable warranty underwriters, customer site testing, and validation of proposed value proposition of the product or service.
Referring to
Referring to
The capital gains potential granted to the customer through the warrants is dependent on the quantum or portion of the revocable P.O. whose total value of portion=Ni×Pn, the strike price and share price, and varies with time as shown in
This is a purchase order maximizing process, such that the number of obtainable warrants allotted to the customer is established by the value of a warrant allocation process and the number of warrants allocated to a customer increases as the magnitude of the initial revocable purchase order(s) increases.
Additional restrictions may be applied to the revocable purchase order to maintain quality of customers, such as the manufacturer requiring the customer to pay a deposit, for example, 10%, when the purchase order is irrevocably confirmed, with the balance due on delivery of the product. The incentive rights may be further restricted to purchase orders greater than a threshold set by the manufacturer, as further incentive to place large orders. The order threshold is desired to be significant, to enable cumulative large contributions aimed at target volumes required by the manufacturer to produce lower cost systems, an example is a $25 million order threshold to receive the incentive rights.
The function described in
The warrants available to an individual customer, (considered to be iteration j for this example), are determined by a warrant vesting and reverse vesting process. The warrant vesting process causes warrants to vest to the customer when some fraction of the Customer's Revocable P.O.(s) is confirmed. The larger the fraction of the P.O. irrevocably confirmed on any given date within the term of the vesting period, the greater the number of warrants that vest. Over the reverse vesting period (e.g. between the IPO date and the end of the vesting period), there may be a plurality of segmented periods, such as quarter years, and the number of obtainable warrants are reduced per segmented period to provide the time-sensitive incentive, with a corresponding “rate of reduction” as shown in table 1. The Reverse Vesting Process Warrants reverse vests, or returns to the manufacturer's treasury, some fraction of warrants that have not yet vested. As more time elapses, more warrants reverse vest. All remaining warrants reverse vest at the end of the term of the P.O., and the process terminates.
Purchase agreement example terms are 15,000 warrants for every $1M in purchase agreements for confirmations before IPO and post-IPO with a schedule of reverse vesting as shown in the table, the warrants expire in 5 years (creating time value).
The process in
The feedback mechanism between realizable gain to the customer and stock value requires various calculations and inputs to the participants as shown in
As the manufacturer's stock price fluctuates in a public market, so will the price of its warrants. At some point, a rising intrinsic value of obtainable warrants will, for some customers, create the perception that an early purchase commitment has a higher probability of a lower net price than a future purchase commitment. Under such circumstances, some of these customers will make an irrevocable purchase commitment for some selected fraction of their total purchase order. The time dependent reverse vesting of the warrants means that the net purchase price is lower; the earlier the commitment is made. This provides customers an incentive to act sooner rather than later.
Irrevocable confirmation of significant customer orders ensures future revenue for the manufacturer, and helps to establish market leadership and improves economies of scale—all of which implies future growth in revenue and profitability. Implied future growth in revenue and profitability increases the manufacturer's underlying business value. The increase in the underlying business value has the effect of increasing the value of the manufacturer's stock price (since stock price correlates to underlying business value). An increase in the manufacturer's stock price increases the intrinsic value of the manufacturer's warrants allowing a positive feedback process.
Referring to
The share price is input to step 70, a market for the manufacturer's warrants. Again, other market data 72 may be an input to the warrant market. The warrant market 70 determines a current warrant price in step 74. The warrant price includes an intrinsic value and a time value. For example, a warrant with strike price $10 could have current net present value NPV ($54) and a time value ($30) both of which can be calculated from standard formulas such as (Black-Scholes) and providing appreciable gain to the customer. In this embodiment, the expiry date of the warrant is substantially after the end of the vesting period, which avoids negative feedback by eliminating time pressure to exercise the vested warrant.
A series of steps (92, 94, 96, 98) represent determination of the number of warrants vesting for customer j for a mth order portion, for current and remaining reverse vesting segmented periods, as a necessary input to customer j warrant valuation. Data required for the manufacturer company's vesting process in step 94, may include but is not restricted to the following of step 92;
Typically, only value of the mth fraction of the PO (V), warrants allotted (VI), and the current date (I—to determine reverse vesting segmented period) affects the determination of number of warrants vesting. The value of the PO must also be above a minimum threshold to receive any warrants.
The larger the mth fraction of the P.O. irrevocably confirmed on any given date within the reverse vesting segmented period, the greater the number of warrants that vest. For confirmed orders after the IPO, the later the current date, the larger the amount of reverse vesting penalty per segmented period. The vesting and reverse vesting conditions described, are provided to the customer at issuance of the purchase agreement, to allow the customer to make financial calculations independently. In one embodiment, the earlier that P.O. issue date is, the greater the allocation of obtainable warrants value, either by increased percentage K of allotment number or in a reduction of reverse vesting.
The next step 96 indicates the warrants available to customer j. Typically this can be calculated by customer j using the conditions in the purchase agreement, or provided by the issuer to the customer j upon request. The customer j planning to make a mth fraction of a P.O. confirmation in each of the remaining periods, can calculate in step 98 the number of warrants vesting due to the confirmations. The inputs from steps 74 and 98 are provided to step 76, which multiplies the current warrant value 74 to each current and remaining warrant and in step 78, sums the total to produce a realizable gain from each segmented period based on irrevocably confirming the mth fraction of the P.O. in each of the remaining N segmented periods. The net realizable gain is the sum of each realizable gain in the reverse vesting segmented periods for the planned confirmations and is input to step 82 for net cost analysis.
As described earlier, the loss in value associated with committing to purchase products (that can't be delivered for several years) today, rather than waiting to purchase those same products on the open market in several years, defines the opportunity cost. The opportunity cost is derived by each customer, based on their perception of future cost savings from delaying commitment. Step 80 shows customer j's perception of the opportunity cost as input to the customer's net cost analysis in step 82.
Cost Savings S=G(realizable gain for the current period)−Opportunity cost.
Typically, S is positive when the realizable gain offsets the opportunity cost. Since realizable gain decreases with each reverse vesting segmented period. If the stock price stayed constant, S would decrease and become negative in future reverse vesting segmented periods. However, due to the invention methodology, the stock price is coupled to the underlying value represented in the total customer orders and will typically increase as more and larger mth order portions are confirmed through the reverse vesting segmented periods, so S will vary accordingly and not decrease as with time. Step 84 represents the output S of calculation 82 which inputs to a customer decision process 88, along with other external factors 86 such as available cash, trial validation etc.
The customer may decide to either confirm the mth portion of the P.O. or take no action in which case the available warrants for the current segmented period reverse vest to the issuer. When the customer confirms the order, the corresponding available warrants vest and can be exercised or redeemed on a date after the company's IPO date for shares, and issued from the manufacturer corporate treasury. Typically, this will result in no change to fully diluted market capitalization as the allocation of customer warrants was preferably made by the manufacturer pre-IPO, but results in a material change to the trading shares outstanding. The outcome 90 is input back into the public company reporting, updating shares outstanding, reverted warrants and additions to customer order book. Customer j returns to the warrant utilization process in
The process has described how an increase in share price results in an increased customer cost savings when the corresponding order is confirmed in the current reverse vesting segmented period, which incentivizes customers to confirm orders in this period, which is reported back to increase the underlying business value of the manufacturer, creating a feedback process.
The net present value (NPV) of the manufacturer value is proportional to the value of confirmed orders, and should correlate to public stock value after the IPO. This allows for a correlation and feedback between the incentive and early commitment on the part of the customer. The more value the customers order, the more the value of the stock rises.
The process provides low risk and flexibility in that the customer can confirm portions of a purchase order dollar value while waiting for perceived risk or opportunity cost to be reduced, or confirm the entire amount at any time, or confirm no orders with no financial obligation. The use of multiple reverse vesting segmented periods (example 7 quarterly periods) allows for iterative valuation decisions and flexibility by the customer, while iterating through small changes in share value, which are acceptable for public markets and major shareholders. In one embodiment, the segmented periods overlap with prototype product validation, for example, for fuel cell power packs used to power forklift vehicles, where the validation risk and opportunity cost decrease as performance and cost data is verified. Such prototype product validation may be conducted on individual customer sites to prove specific value targets. Following validation, product delivery commences after a period of time set in the revocable purchase order and may also extend over a set completion of delivery period similarly agreed in the purchase agreement. The planned product delivery date as provided in the revocable purchase order, may occur before, at or after the end of the vesting period and is not restricted, although a date range may be agreed with the customer to set unit pricing. Upon delivery and satisfactory performance per the purchase agreement, the customer pays the agreed price per delivery, to the manufacturer.
In another embodiment of the invention, the available incentive value is reduced or eliminated if the customer starts a commercial relationship with a competitor to the manufacturer's product offering. The purchase agreement includes a term detailing elimination or reduction in the customer's rights to obtain warrants upon occurrence of such competitor business. A commercial relationship may include requests for quote, product testing and validation, joint ventures, or disclosure of pricing targets provided by the manufacturer.
Due to the necessity for releasing customer order status following IPO of the manufacturer to provide suitable information, an embodiment of the invention includes clauses in the purchase agreement authorizing permission from the customer for the issuer to disclose order information as a condition to receiving the incentive rights.
The following is an example of application of the business method for sale of a fuel cell power pack for electric forklifts. The example is derived using standard financial valuation formulas such as discounted cash flow, and shows a significant market capitalization of the manufacturer, at relatively low market penetration of confirmed orders.
Financial model Assumptions:
d) Valuation of the manufacturer is based on 15×EBITDA (earnings before interest, taxes, depreciation etc) and 15% discount rate, and a 50% ownership of the joint venture.
Therefore as observed in Table 2, the result of the embodiment method is that the future value of the manufacturer results in a significant market capitalization due to the underlying business value of the confirmed orders, and the customer value of the warrants demonstrates a larger “in the money” gain for the earlier Q2 2005 confirmation, than for the Q4 2006 confirmation.
Referring to
In step 200, rights to obtain warrants are allocated to a customer in exchange for a revocable purchase order for a future product delivery, with time-dependent subject conditions upon irrevocably confirming a portion of the order. The subject conditions include vesting and reverse vesting processes, including anumber of reverse vesting segmented periods, vesting and reverse vesting amounts in each segmented period and expiry date. A strike price for the warrants is set before the start of the vesting period.
The customer warrants available for vesting are determined in step 210, as previously described as a percentage of the fractional PO value. The vested warrants are then granted when the customer confirms the fractional PO value. A key step is described in 220, of notifying participants and public investors of the total customer order status, such that the status information can be included in market assessment of the underlying business value. The manufacturer has control over these 3 steps, which represent the core methodology of the business process in its simplified embodiment described by
The operation of the business process is illustrated in
The bars represent the net cost to the customer for an mth portion of the P.O., and include a cost at expiry (or “end of vesting period”) component 340 and an opportunity cost 310 as previously described. For the purpose of this illustration, the opportunity cost 310 is constant in each segmented period, however it may be variable and decreasing over time.
The cost at expiry 340 represents an upper net cost limit for confirming an order. As can be observed, before the first segmented period (“pre-IPO” in this example) the net cost is greater than the cost at expiry due primarily to the opportunity cost 310. In the current reverse vesting segmented period, the net cost is now offset by a realizable gain g, which reduces the net cost to below the cost at expiry 340, creating a cost savings S1 (320) as per the formula described earlier. With each consecutive segmented period the cost savings S1 decreases and becomes negative as the realizable gain decreases as shown.
As opportunity cost is a perceived value determined by the customer only, it is desirable to find an upper limit on the cost for showing feasibility of the process. The opportunity cost is shown in the equation below, to never exceed the current product purchase price, provided the product technology is useable and not obsolete at the time of delivery, obsolete being defined for this purpose as unable to meet operable customer performance requirements.
The opportunity cost function is given by;
The asymptotic opportunity cost function has a value that can never exceed today's purchase price. Therefore when the value of the capital gain offsets the purchase price entirely, the incentive value and limited maximum risk should be suitable to incentivize the customer to confirm all orders, or remainder of purchase order.
An illustrative example;
In this example the customer is passing up $9,000 in value at a delivery date of 5 years in the future, requiring a significant incentive to confirm orders with today's purchase price.
In an alternate embodiment of the invention, options are used in place of warrants and the issuer determines in advance of IPO, to create a pool of available shares for the customer conversion process.
In an alternate embodiment of the invention, a third party acts as the agent of the issuer to provide the issuer functions described herein in exchange for a percentage or fee.
In an alternate embodiment, warrants may be transferred to other customer participants within the same conditions, to create an exchange market, while meeting all SEC regulations concerning such transfer.
As such, a method for incentivizing customers to confirm advance purchase orders is described. In view of the above detailed description and associated drawings, other modifications and variations will now become apparent to those skilled in the art. It should also be apparent that such other modifications and variations might be effected without departing from the spirit and scope of the present invention as set forth in the claims that follow.
