The Hybrid Trap: Why Most Efforts to Bridge Old and New Technology Miss the Mark Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for The Hybrid Trap: Why Most Efforts to Bridge Old and New Technology Miss the Mark case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Hybrid Trap: Why Most Efforts to Bridge Old and New Technology Miss the Mark case study is a Harvard Business School (HBR) case study written by Fernando F. Suarez, James M. Utterback, Paul von Gruben, Hye Young Kang. The The Hybrid Trap: Why Most Efforts to Bridge Old and New Technology Miss the Mark (referred as “Technology Ev” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, .

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of The Hybrid Trap: Why Most Efforts to Bridge Old and New Technology Miss the Mark Case Study

Technological transitions are challenging, particularly for companies in mature industries. Incumbents are frequently blindsided by new technologies, thereby missing opportunities to enter emerging markets early. While some established companies become early adopters of new technologies, the authors argue that they typically lack the vision and the commitment to become leaders. Too often, they cling to the familiar, developing "hybrid"products that combine elements of the old and the new.This puts even the best incumbent companies in a weak position when the market finally embraces the new technology, something the authors call the "hybrid trap." This article takes a close look at the auto industry's transition from internal combustion engines to electric vehicles (EVs) and compares it to precedents in other industries. Several incumbent automakers, such as General Motors Co. and Honda Motor Co. Ltd., entered the EV market early, but they backed away from these projects in favor of continued emphasis on established engine technology. Gradually, most of them focused on hybrid cars that combined old and new technologies. This opened the door to new competitors, notably Tesla Inc., which focused solely on the EV technology. By mid-2017, nearly every old-line engine producer was playing catch-up on EV technology, working to release new electric models in the next two to five years. Although it is too early to know if Tesla will be successful in the long run, the Tesla example, in the authors'view, points to a fundamental weakness in how incumbents respond to industry transformations. In the 1960s, U.S. electronics companies responded to the introduction of Japanese transistor radios by developing products that blended transistor technology with traditional vacuum tubes. In the early 1990s, Kodak Ltd. tried to sell a "film-based digital imaging"product, which merged film photography and digital technology. And a decade ago, BlackBerry Ltd. tried to respond to the challenge of the iPhone by releasing a phone that had both a touchscreen display (like the iPhone) and a traditional keyboard (like earlier BlackBerry phones). The answer for incumbents, the authors write, isn't to walk away from products based on the old technology and jump headlong into the new. But they need to take precautions so that the company's legacy operations don't hamper their ability to pursue new technology. New technologies can open opportunities that extend well beyond the scope of legacy products. But such opportunities can be accessed only by companies that are willing to view the world through the lens of the new technology.

Case Authors : Fernando F. Suarez, James M. Utterback, Paul von Gruben, Hye Young Kang

Topic : Technology & Operations

Related Areas :

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Calculating Net Present Value (NPV) at 6% for The Hybrid Trap: Why Most Efforts to Bridge Old and New Technology Miss the Mark Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10010546)	-10010546	-	-
Year 1	3455933	-6554613	3455933	0.9434	3260314
Year 2	3967630	-2586983	7423563	0.89	3531177
Year 3	3942438	1355455	11366001	0.8396	3310147
Year 4	3250606	4606061	14616607	0.7921	2574784
TOTAL			14616607		12676422

The Net Present Value at 6% discount rate is 2665876

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Profitability Index
2. Internal Rate of Return
3. Net Present Value
4. Payback Period

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Timing of the expected cash flows – stockholders of Technology Ev have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Technology Ev shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of The Hybrid Trap: Why Most Efforts to Bridge Old and New Technology Miss the Mark

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Technology & Operations Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Technology Ev often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Technology Ev needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10010546)	-10010546	-	-
Year 1	3455933	-6554613	3455933	0.8696	3005159
Year 2	3967630	-2586983	7423563	0.7561	3000098
Year 3	3942438	1355455	11366001	0.6575	2592217
Year 4	3250606	4606061	14616607	0.5718	1858545
TOTAL					10456019

The Net NPV after 4 years is 445473

(10456019 - 10010546 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10010546)	-10010546	-	-
Year 1	3455933	-6554613	3455933	0.8333	2879944
Year 2	3967630	-2586983	7423563	0.6944	2755299
Year 3	3942438	1355455	11366001	0.5787	2281503
Year 4	3250606	4606061	14616607	0.4823	1567615
TOTAL					9484361

The Net NPV after 4 years is -526185

At 20% discount rate the NPV is negative (9484361 - 10010546 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Technology Ev to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Technology Ev has a NPV value higher than Zero then finance managers at Technology Ev can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Technology Ev, then the stock price of the Technology Ev should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Technology Ev should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

What can impact the cash flow of the project.

What will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of The Hybrid Trap: Why Most Efforts to Bridge Old and New Technology Miss the Mark

References & Further Readings

Fernando F. Suarez, James M. Utterback, Paul von Gruben, Hye Young Kang (2018), "The Hybrid Trap: Why Most Efforts to Bridge Old and New Technology Miss the Mark Harvard Business Review Case Study. Published by HBR Publications.