Risk tolerance is a highly personalized trait. The commitment of customer managers to invest in a PIP is always a trade-off between their perception of risk and the PIP's potential profits. No matter how many dollars of profits you propose, managers will adjust them downward for risk. This reflects the managers' subjective sense of the unlikelihood of their realization: in other words, their estimate of uncertainty about the future.
All PIPs deal in futures. The faster the future payoff, the more certain the PIP. As the time frame to payback and payout lengthens, customer managers have a more difficult task in forecasting the probability of PIP success. The same characteristics that make the PIP so successful can also make its customers' evaluations more intense:
Each PIP focuses on a single best solution, ruling out contingencies.
Each PIP focuses on a single factor that is critical to the success of a customer operation or sales to a market segment, eliminating options.
The space between a PIP's proposal of realizable future profits and the costs of uncertainty is known as its "trade space." It is the space within which customers contain their indecision, their yes-no trading area where they go back and forth in their decision-making process. Invest in these prospective profits or not? Invest this much, more, or less? Invest now or accept this much opportunity cost? Live with this much technological uncertainty or this much market volatility?
After adjusting a PIP's profits for risk as customer managers perceive it, they place a personalized dollar value on the PIP's stream of cash flows. From this moment on, the PIP's value is contingent on the managers' sense of how much any uncertainty may cost. The resolution of this calculation will become the PIP's negotiable net worth.
Since minimizing risk automatically inflates a PIP's perceived value, you should ask yourself how much you are willing to invest to reduce risk: that is, to shrink the customer's trade space so you can get to close fast. Three investment opportunities are available to you:
Guarantee the PIP's payout. This means that you pay any default between your proposed value and the customer's realized value so that the customer is made whole.
Insure the PIP's payout. This means that a third-party insurer pays any default to the customer, but you pay premiums to the insurer.
Gainshare in the PIP's payout. This means that you share in some or all of the customer's risk by depending for your own compensation on the reward. You can claim a larger share of the gain if you are willing to put up some or all of the up-front costs.
Even without accepting the added burden of taking on the risk of partnering with a supplier, customers are already inundated with risk factors in their own businesses. They include the unpredictability of their operating results, the uncertainty associated with the introduction of new products, the exposure they feel from their dependence on a small number of currently successful products and markets, the potential failure to manage their growth and avoid compliance liabilities or a loss of proprietary rights, and the chance that they may be unable to raise capital if they need it. The following statements of risk by a semiconductor equipment manufacturer are typical of the dangers that all customers deal with even before a supplier knocks on their doors.
Our revenues and operating results may fluctuate significantly from quarter to quarter due to a number of factors, not all of which are in our control. These factors include:
Economic conditions in the semiconductor industry generally, and the equipment industry specifically
Customer capacity requirements
The size and timing of orders from customers
Customer cancellations or delays in our shipments
Our ability in a timely manner to develop, introduce, and market new, enhanced, and competitive products
Legal or technical challenges to our products and technology
Changes in average selling prices and product mix
Exchange rate fluctuations
We base our expense levels in part on our expectations of future revenues. If revenue levels in a particular quarter do not meet our expectations, our operating results are adversely affected.
Further, because of our continuing consolidation of manufacturing operations, natural, physical, logistical or other events or disruptions could adversely impact our financial performance.
We obtain certain components and sub-assemblies included in our products from a single supplier or a limited group of suppliers. Each of our key suppliers has a one-year blanket purchase contract under which we may issue purchase orders. We may renew these contracts periodically. Each of these suppliers sold us products during at least the last four years, and we expect that we will continue to renew these contracts in the future or that we will otherwise replace them with competent alternative source suppliers. We believe that we could obtain alternative sources to supply these products. Nevertheless, a prolonged inability to obtain certain components could adversely affect our operating results and result in damage to our customer relationships.
Rapid technological changes in semiconductor manufacturing processes subject us to increased pressure to maintain technological parity with deep submicron process technology. We believe that our future success depends in part upon our ability to develop, manufacture and introduce successfully new products and product lines with improved capabilities, and to continue to enhance our existing products. Due to the risks inherent in transitioning to new products, we must forecast accurately demand for new products while managing the transition from older products. If new products have reliability or quality problems, reduced orders, higher manufacturing costs, delays in acceptance of and payment for new products and additional service and warranty expenses may result. In the past, product introductions caused some delays and reliability and quality problems. We may be unable to develop and manufacture new products successfully, or new products that we introduce may fail in the marketplace, which would materially and adversely affect our results from operations.
We derive a substantial percentage of our revenues from a limited number of products, and we expect these products to continue to account for a large percentage of our revenues in the near term. Continued market acceptance of our primary products is, therefore, critical to our future success. Our business, operating results, financial condition and cash flows could therefore be adversely affected by:
A decline in demand for our products
A failure to achieve continued market acceptance of our products
An improved version of products being offered by a competitor in the market we participate in
Technological change which we are unable to match in our products
A failure to release new enhanced versions of our products on a timely basis
Our management may face significant challenges in improving financial and business controls, management processes, information systems and procedures on a timely basis, and expanding, training and managing our work force if we experience additional growth. There can be no assurance that we will be able to perform such actions successfully. In the future, we may make additional acquisitions of complementary companies, products or technologies, or we may reduce or dispose of certain product lines or technologies, which no longer complement our long-term strategy. Managing an acquired business or disposing of product technologies entails numerous operational and financial risks, including difficulties in assimilating acquired operations and new personnel or separating existing business or product groups, diversion of management's attention to other business concerns, amortization of acquired intangible assets and potential loss of key employees or customers of acquired or disposed operations. There can be no assurance that we will be able to achieve and manage effectively any such growth, integration of potential acquisitions or disposition of product lines or technologies, or that our management, personnel or systems will be adequate to support continued operations. Any such inabilities or inadequacies would have a material and adverse effect on our business, operating results, financial condition and cash flows.
Other parties may assert infringement, unfair competition or other claims against us. Additionally, from time to time, other parties send us notices alleging that our products infringe their patent or other intellectual property rights. In such cases, it is our policy either to defend the claims or to negotiate licenses on commercially reasonable terms. However, we may be unable in the future to negotiate necessary licenses on commercially reasonable terms, or at all, and any litigation resulting from these claims by other parties may materially adversely affect our business and financial results.
Our success depends in part on our proprietary technology. While we attempt to protect our proprietary technology through patents, copyrights and trade secret protection, we believe that our success depends on increasing our technological expertise, continuing our development of new systems, increasing market penetration and growth of our installed base, and providing comprehensive support and service to our customers. However, we may be unable to protect our technology in all instances, or our competitors may develop similar or more competitive technology independently. Other parties may challenge or attempt to invalidate or circumvent any patents the United States or foreign governments issue to us or these governments may fail to issue pending applications. In addition, the rights granted or anticipated under any of these patents or pending patent applications may be narrower than we expect or in fact provide no competitive advantages.