ENVS 1500 Chapter Notes - Chapter 19: Microsoft Scandisk

Sam Ellis is worried. As president and CEO of Forward Software,Inc., Sam

introduced a new spreadsheet product, Cinco, to market lastyear. Forward Software has

been developing and marketing high-quality software packages formore than five years,

but those products were mostly computer software languageinterpreters, similar to

Pascal, FORTRAN, and C. These products received excellentcritical reviews, and

because of Forward’s aggressive pricing and marketing, thecompany quickly captured a

major share of the software market. Buoyed by its wideacceptance, last year Forward

Software decides to enter the applications area for the IBM andcompatible audience,

leading off with Cinco and following up with a word processingapplication, Fast.

The spreadsheet market is dominated by Focus Software, whoseproduct – Focus

A-B-C has an 80% market share. Focus A-B-C was released in 1981,shortly after IBM

personal computer (PC) was introduced, and the two products hadan immediate

symbolic effect. The spreadsheet was a major advance over whatwas available at the

time, but required the extra 16-bit processing power that theIBM PC offered. IBM, on

the other hand, needed an application that would make its PC a“must buy.” Sales of

Focus A-B-C and the IBM PC took off as a result of theirnear-simultaneous release.

At the time of its release, Focus A-B-C was a superb product,but it did have

flaws. For example, because the software was copy-protected, itcould be installed on a

hard disk, but the original floppy disk has to be inserted eachtime before the software

could run. Many users found this step an annoyance. Anotherproblem with A-B-C was

printing graphs. In order to print a graph, users had to exitthe software and load a new

program, called Printgraf, which would then print the graph.Finally, the product had a

list price of $495, and the best discount price available wasapproximately $300.

However, Focus A-B-C had a unique menu system that was intuitiveand easy to

use. Pressing the slash key (/) displayed the menu system at thetop of the spreadsheet.

The menu allowed the user to make choices and provides aone-line explanation of each

menu option. Compared to the cryptic commands or keystrokesusers had to enter in

other products, the Focus A-B-C menu system was a model ofsimplicity and clarity.

Millions of users became accustomed to the menu system andhailed its use.

Another advantage of Focus A-B-C was its ability to let userswrite their own

macros. Literally a program, a macro allowed a user to automatespreadsheet tasks and

then run them with a keystroke or two.

In 1985, a small company named Discount Software introduced itsown

spreadsheet to the market. Called VIP Scheduler, the productlooked and worked exactly

the same as Focus A-B-C. Pressing the slash key displayed theidentical menu as found in

Focus A-B-C. VIP Scheduler was designed to look and work exactlyas Focus A-B-C so

that users would not have to learn a new system and could startproductive work

immediately. VIP Scheduler also offered two advantages overFocus A-B-C: its list price

was $99, and the software was not copy-protected. Sales for VIPScheduler were strong,

but many consumers, perhaps feeling safer with the Focus name,did not buy the product,

even though critical reviews were positive. VIP Scheduler didfind a receptive market in

academia.

When Forward released its first spreadsheet product, Cinco, itwas hailed by

critics as a better all-around product than Focus A-B-C. It hadbetter graphics, allowed

users to print graphs from within Cinco, and was 100% compatiblewith Focus A-B-C,

but the menu and options were arranged more intuitively. Forusers who did not to invest

time to learn a new menu system, Cinco could emulate the FocusA-B-C menu system.

Both menus were activated by pressing the slash key, and theusers could specify easily

which menu system they wanted. All macros written for FocusA-B-C ran perfectly on

Cinco, provided that the Focus A-B-C menu system was being used.Because of

favorable reviews and aggressive marketing by Forward, Cincoquickly gained market

share. In a move that surprised the industry, Focus recentlysued Discount Software,

publisher of VIP Scheduler, for copyright infringement. Focusclaimed that its menu

system was an original work, and that VIP Scheduler, byincorporating that menu system

in its product, had violated copyright laws. Focus claimed thatthe look and feel of its

menu system could not be used in another product withoutpermission. Sam is certain

that Focus initiated this lawsuit because Cinco has made suchdramatic progress in

gaining a share of the spreadsheet market. Sam is also sure thatFocus’s target is not

really VIP Scheduler, because it has such a small market share,but Cinco.

After discussions with Forward’s attorneys, Sam thinks that ifhe makes a quiet

overture to Focus to settle out of court, Focus would beamenable to such proposal. This

overture, if settled, would stave off potential negativepublicity when Focus wins its suit

against Discount Software and then follows up with a lawsuitagainst Forward. Based on

projections of Cinco’s sales, Forward’s attorneys think thatFocus could ask for $5, $8, or

as much as $12 million in damages. Sam believes that theprobabilities of Focus agreeing

to $5, $8, and $12 million are 0.5, 0.3, and 0.2, respectively.Also the settling process

would cost Forward $1 million of the attorneys’ fee.

Sam knows that settling now means an immediate loss of income,in the amount

of one of the three estimates given, plus an admission of defeatand guilt for Forward.

On the other hand, Sam could wait for the outcome of the Focusversus Discount

Software suit. Forward’s attorneys believe that Focus has a 40%chance of winning its

lawsuit against Discount Software. With a win, Focus would haveits legal precedent to

sue Forward. It is by no means certain that Focus wouldinstitute a lawsuit against

Forward because Forward is a much larger company than DiscountSoftware and could

afford a vigorous legal defense. Also the case against Forwardis not a clear-cut because

Cinco has its own menu system as the primary mode of operationand offers the Focus A-

B-C menu system for those who want to use it. VIP Schedulerprovides only the Focus

A-B-C menu system. However, Forward’ attorneys believe there isa 90% chance that

Focus would initiate a lawsuit against Forward if Focus wins itssuit against Discount

Software. They also believe that Focus would not initiate anylawsuit if Focus loses its

suit against Discount.

Sam believes that even if Focus sues Forward, he would still tryto settle the case

out of court at that time or decide to go to trial. An attemptto settle out of court at that

time would be more expensive for Forward because Focus wouldfeel secure that it would

win its case against Forward, having already won its lawsuitagainst Discount Software.

Thus Forward’s attorneys think that Focus would settle for noless than $8 million,

possibly asking for $11 million or even $15 million. Therespective probabilities that

Focus would settle for these amounts ($8, $11, and $15 million)are estimated to be 0.3,

0.4, and 0.3. Also, Forward would have to pay its attorneysroughly $1.2 million to go

through the settling process.

However, if Focus sues Forward and Forward decides to go totrial instead of

initiating settlement proceedings, Forward could lose the case.Forward’s attorneys

estimate there is an 80% chance that Forward would lose thetrial, resulting in a judgment

of $8 million, $16 million, or $18 million against Forward, withprobabilities of 0.1, 0.3,

and 0.6, respectively. The attorneys also estimate that theirfees for a trial could run

around $2.5 million.

What is Sam’s optimal decision strategy and what is the expectedcost of that

strategy. What considerations would you like to bring to Sam’sattention?

An outside law firm has recently offered Forward Software for$0.7 million

dollars to conduct a detailed research on the likelihood thatDiscount Software will win

the lawsuit filed by Focus.

This law firm has a reputation in correctly predicting

outcomes of many copyright lawsuits similar to the one Sam mayrun into. In fact, the

prediction accuracy of this law firm in the past is about90%

2

2

The outcomes of 90% of the lawsuits were correctly predicted bythe law firm; i.e., P(Law firm predicts

Focus wins | Focus actually wins) = .90 and P(Law firm predictsFocus loses | Focus actually loses) = .90.

. Do you think Sam should

hire this law firm to do a similar study for Forward Software?In other words, is $0.7

million a good price for such a study, and if not, what shouldbe Forward’s counter offer?

Explain.

Case 14-6 Making Connections Social Konnections Inc. (SKI or the “Company”) is a global Internet company that runs Social Konnections, a large social media networking Web site. SKI has experienced steep growth since its launch in 2005, and the Company went public in 2010. SKI currently has over 500 million active users who visit the site to connect with others, express themselves, and play games. Last year, substantially all of SKI’s revenue came from advertisers who market their products and services to SKI’s active users through advertisements placed on the Web site or its various mobile platforms. The Company’s remaining immaterial revenue was received from fees associated with the sale of virtual goods and services by third-party application developers using SKI’s various platforms. In Q1 of the current fiscal year, SKI acquired Corporate Collaborations (CC), an entity that manages private and public social media networks for corporations. CC’s customers are primarily national and global companies whose employees connect over its platform. In addition to hosting private social media networks for corporations, CC provides services to develop the networks it manages. CC’s revenues are earned through the performance of multiyear revenue contracts with its customers. In the current year, CC is expected to produce approximately 20 percent of SKI’s consolidated revenue. SKI’s investors are focused on the growth prospects of the Company’s legacy open social media platform operations and its new corporate revenue unit. The Company’s MD&A disclosures include (1) various user and revenue metrics to help financial statement users assess its traditional operations and (2) backlog information to help users assess CC’s operations. Audit Because of SKI’s continued growth, the audit committee has requested that the Company choose a new audit firm with experience in auditing public technology companies. A new firm was selected and has performed each of the interim reviews in the current year. Kristine Drew, a senior auditor, is the in-charge accountant on the SKI audit. In addition to her supervisory and administrative responsibilities, Ms. Drew is responsible for auditing revenue. Ms. Drew has read the Company’s disclosed accounting policies and is interviewing the revenue controller, Bill Cook, and various sales personnel to develop in- depth process flow documentation that will serve as the basis for the team’s risk assessment. SKI creates advertising space on its Web site and mobile applications and sells the space to advertisers either directly or through advertising agencies. According to Mr. Cook, the amount an advertiser pays is dependent on the number of views the ad receives or on the number of user clicks (depending on the type of advertisement defined in the underlying contract) and the revenue is recorded in the period in which the views or clicks are made. Ms. Drew has learned that simple advertising can be purchased directly from SKI through SKI’s advertising Web site at standard rates, with the advertisements and terms input directly into the Company’s ad delivery platform. However, most advertising revenue is generated directly through the advertising sales team, which has the ability to help advertisers develop more sophisticated advertising campaigns. Management has established minimum pricing and volume thresholds for these advertisements; however, the sales staff is given significant latitude in securing contracts with customers. Extra commissions are paid to sales individuals who sign longer-term contracts that meet minimum revenue targets. Once a contract is signed, the ad development department creates the ad content and obtains the customer’s approval. The approved ad and the contract are electronically sent to the ad scheduling department, and the advertisement is uploaded into the Company’s ad delivery platform. The ad delivery platform is a robust system and is designed to capture all the nuances associated with the contract. For example, an advertiser may wish to have its ads displayed only to users whose IP addresses are from a specific geographic location, or the contract may be structured to provide the advertiser with variable pricing or incentives (such as a set of free advertisements) once a certain level has been paid for. In summary, the delivery platform captures all the relevant pricing information associated with the contract to allow for real-time revenue recognition according to the terms of the contract. After the contract is entered into the system, a summary of the contract setup is provided to the sales manager that worked with the customer. The sales manager then reviews the contract setup for accuracy. The Company’s ad delivery platform automatically tracks the advertising activity each day and reports the activity to its customers, who are then billed weekly for the aggregate ad activity. As part of its new corporate services program from the acquisition of CC, the Company earns revenues by providing corporate social network development and hosting services. For new customers, a contract will typically require an up-front fee to SKI for the development of the customer’s specific social media network; the contract will also include a separate multiyear hosting agreement. The customized social media networks only operate on the Company’s hosting platform, and customers do not have the option to take possession of the software used to run the networks. Revenues for the up-front fee associated with the development are recognized as the development is completed and the system is available to the customer. Hosting revenues are automatically recognized by the system based on the invoicing cycle outlined within the customer’s contract. According to Mr. Cook, this invoicing cycle is fairly uniform throughout the hosting period; therefore, from a materiality perspective, the Company will disclose that hosting fees are recognized ratably throughout the hosting contract period. , Ms. Drew was told that the corporate sales director had established a goal of increasing the length of the average hosting contract. Before SKI acquired CC, most of the multiyear hosting agreements were for three-year terms. In Q4, the corporate sales director implemented a strategy shift that would increase the contracted hosting period to five years. To accomplish this goal, the sales team was able to offer its customers three months of free service, to be added at the end of any new five-year agreement signed. In addition, the sales director offered an additional commission for converting existing contracts to five-year agreements. To accelerate the implementation of this plan, the sales commission is doubled if the contract modification occurs before the end of the fiscal year. Ms. Drew’s Concern Ms. Drew is concerned about several things she has learned regarding the appropriateness of management’s revenue recognition policies. Question: 1) Identify the potential revenue recognition issues related to each of the Company’s sources of revenue. 2)On the basis of the information Ms. Drew has learned, what fraud risk factors should she consider discussing with her team at the next fraud brainstorming meeting? 3)What potential audit procedures could the team consider to evaluate management’s revenue recognition policies and determine whether those policies are appropriately applied?

Interactive Session: Management The Mobile Pocket Office

Can you run your company out of your pocket? Perhaps not entirely, but there are many business functions today that can be performed using an iPhone, iPad, or Android mobile handheld device. The smartphone has been called the “Swiss Army knife of the digital age.” A flick of the finger turns it into a web browser, a telephone, a camera, a music or video player, an e-mail and messaging machine, and, increasingly, a gateway into corporate systems. New software applications for document sharing, collaboration, sales, order processing, inventory management, and production monitoring make these devices even more versatile business tools. Mobile pocket offices that fit into a purse or coat pocket are helping to run companies large and small.

Sonic Automotive is one of the largest automotive retailers in the United States with more than 100 dealerships in 14 states. Every year Sonic sells 250,000 new and used cars from approximately 25 different automotive brands, and it also sells auto parts and maintenance, warranty, collision, and vehicle financing services. Sonic Automotive managers and employees do much of their work on the iPhone and iPad.

Sonic developed several custom iPhone and iPad applications to speed up sales and service. Virtual Lot, a dealer inventory app, lets sales associates quickly search for vehicles held in inventory by all Sonic dealerships. They have immediate access to vehicle information, pricing, trade-in values, interest rates, special promotions, financing, and what competitors are charging for identical vehicles. The associates can quickly find the best selection for each customer and often offer far more choices than the competition. Dealers are not limited to selling only their own inventory.

A mobile app called the Sonic Inventory Management System (SIMS) has speeded up and simplified trade-in appraisals and pricing. Sonic staff use their iPhones or iPads to take photos of a car, input the vehicle identification number (VIN) and mileage, and note any issues. The data are transmitted to corporate headquarters, which can quickly appraise the car. A Service Pad app simplifies the steps in repair and warranty work. In the past, customers with cars requiring repairs had to go inside the dealership and sit at a desk with a Sonic staff member who wrote up the repair order by hand. Now the Sonic staff members go outside to the customer's vehicle and enter the repair order on an iPad on the spot.

SKF is a global engineering company headquartered in Gothenburg, Sweden, with 140 manufacturing sites in 32 countries and 48,500 employees worldwide. SKF produces bearings, seals, lubrication systems, and services used in more than 40 industries, including mining, transportation, and manufacturing. SKF has developed more than 30 custom iPhone and iPad applications for streamlining workflows and accessing critical corporate data from anywhere in the world.

For example, a virtual reality app uses the iPhone or iPad camera to identify a factory machine and produce a 3-D overlay of the SKF parts it contains. A sensor-driven app called Shaft Align is used by SKF service teams and customers in the field. Shaft Align connects via wireless Bluetooth sensors to a piece of machinery such as a motor-driven fan to ensure that the drive shaft is running in proper alignment. If not, the app generates step-by-step instructions and a 3-D rendering to show how to manually align the motor. Then it checks the work and produces a report.

A mobile app called MOST enables factory operators to monitor some SKF factory production lines. MOST links to the back-end systems running the machinery and provides operators with key pieces of data. Operators using this mobile app are able to use secure instant messaging to communicate with managers and each other, update maintenance logs, and track products in real time as they move through the factory line.

SKF's Shelf mobile app allows sales engineers and customers to access on demand more than 5,000 pieces of product literature, catalogs, product specifications, and interactive marketing materials. Sales teams can use Shelf to create custom “shelves” to organize, annotate, and share materials with customers right from their iPhones or iPads. The iPhone, iPad, and Shelf app save company sales engineers as much as 25 minutes per day on processes and paperwork, freeing them up to spend more time in the field supporting customers. This increase in productivity is equivalent to putting 200 more sales engineers in the field.

SKF auditors perform about 60 audits per year, and each audit used to take more than a month to complete. With the SKF Data Collect app, auditors are able to use their iPads to collect data and present customers with detailed reports instantly.

SKF Seals offers specifications and information about SKF's machined and injection-molded seals and plastic parts, while the Seal Select app helps users select seals and accessories using several different input parameters to find the right solution for their needs.

Case Study Questions

1. What kinds of applications are described here? What business functions do they support? How do they improve operational efficiency and decision making?