Strategic Management

of Technological
Innovation
Melissa Schilling

Chapter 7
CHOOSING INNOVATION
PROJECTS

Boeings Sonic Cruiser

Boeing was developing a new midsized jet, the Sonic
Cruiser, which would travel 15-20% faster than existing
commercial jets. It was expected to cost $10 billion to
develop.
However, in 2002 air ticket sales were down, several
airlines faced bankruptcy, and aircraft were put into
storage to reduce capacity.
Despite this, Boeing forecasted that the worldwide aircraft fleet
would double by 2021.

Boeing also noted that the company needs to create a

new aircraft every 12 to 15 years or else the people with
the skills and experience will be either leave the
company or retire and the next generation of employees
will not have that knowledge passed on to them.
2

Boeings Sonic Cruiser

The Sonic Cruiser was scrapped but
development of the 787 Dreamliner began
and is scheduled to fly in 2009
50 percent of the primary structure, including the
fuselage and wing, will be made of composite
materials. This eliminates 1,500 aluminum sheets
and 40,000 - 50,000 fasteners.
health-monitoring systems will be incorporated
that will allow the airplane to self-monitor and
report maintenance requirements to ground-based
computer systems.

The Development Budget

Most firms face serious constraints in capital
and other resources they can invest in
projects.
Firms thus often use capital rationing: they
set a fixed R&D budget and rank order
projects to support.
R&D budget is often a percentage of previous
years sales.
Percentage is typically determined through
industry benchmarking, or historical
benchmarking of firms performance.

The Development Budget

R&D Intensity (R&D as a percent of sales) varies
considerably across and within industries.
Industry
Software & Internet
Health

R&D as a Percent of Sales

12.7%
11.2

Computing & Electronics

7.6

Technology

4.3

Aerospace & Defense

4.1

Automotive

4.1

Industrials

2.3

Consumer Products

2.1

Telecom

1.9

Chemicals & Energy

1.5
5

The Development Budget

Top 20 Global R&D Spenders, 2004
Microsofts 21% is higher than the 12.7% of the
Software 7 Internet industry
GMs 3% is below the auto industrys 4.1%
Company

R&D
Expenditur
es
($billions)

R&D as
percent
of sales

Microsoft

$7.8

21%

Pfizer

7.7

15%

Ford

7.4

DaimlerChrysler

Company

R&D
Expenditur
es
($billions)

R&D as
percent
of sales

GlaxoSmithKline

5.2

14%

Intel

4.8

14%

4%

Volkswagen

4.7

4%

7.0

4%

Sony

4.7

7%

Toyota

7.0

4%

Nokia

4.6

13%

General Motors

6.5

3%

Honda

4.4

5%

Siemens

6.2

7%

Samsung
Electronics

4.3

6%

Matsushita
Electric

5.7

7%

Novartis

4.2

15%

IBM

5.7

6%

Roche Holding

4.1

17%

Johnson &

5.2

11%

Merck

4.0

18%

Theory In Action
Financing New Technology Ventures
Large firms can fund innovation internally; new start-ups
must often obtain external financing.
In first stages of start-up and growth, entrepreneurs may
have to rely on family, friends, and credit cards.
Start-ups might be able to obtain some funding from
government grants and loans (SBA, DOE, NASA, etc)
If idea and management are especially promising,
entrepreneur may secure funds from angel investors
(typically seed stage and <$1 million) or venture
capitalists (multiple early stages, >$1 million).
In 2005, angel investors funded approximately 50,000
ventures valued at $23.1 billion

Venture vs Traditional Capital

Traditional

More fluid
Bears lower return
Invested based on immediate future
Concerned with past performance
Loaning bank is creditor and requires collateral

Venture capital

Less fluid
Requires high return rate
Invested based on longer-run future
Concerned with product and market potential
Venture capitalist and partner are co-owners
Venture capitalist brings credibility to the company and
mentoring

Angel Funding
The angel investor market in the first half of 2007 has
shown signs of a small retreat from the growth of the
past several years, with total investments of $11.9
billion, a decrease of 6% over the first half of 2006,
(Center for Venture Research at the University of
New Hampshire http://wsbe.unh.edu/cvr)
A total of 24,000 entrepreneurial ventures received
angel funding in the first half of 2007, a 2% decline
from the first half of 2006.
The number of active investors in the first half of 2007
was 140,000 individuals (8% above Q1Q2 2006) though
the total dollar size of the market and the number of
investments exhibited a slight decline from Q1Q2 2006
Reflecting this trend is the decrease in the average deal
size by 4% over the first half of 2006 and an increase
(10%) in the number of investors per deal.

Angel Funding Sector Analysis Q1Q2

2007
Healthcare services/medical devices/equipment and
software remained the sectors of choice, with 22%
and 14%, respectively, of total angel investments in
the first half of 2007.
This was followed closely by biotech at 10%.
Electronics/computer hardware, IT services, retail and
industrial/energy garnered close to 10% each.
The remaining investments were approximately
equally weighted across high tech sectors, with each
having 3-5% of the total deals.
Sector

Healt
h

Software

Biotec
h

Electronic
s

IT
Services

Retail

Industrial/Energ
y

Deals

22%

14%

10%

8%

7%

6%

6%

Angel Funding Analysis

Angels continue to be the largest source of seed and start-up capital
in the United States, with 42% of the first half of 2007 angel
investments in the seed and start-up stage.
This preference for seed and start-up investing is followed closely
by post-seed/start-up investments of 48%.
While angels are not abandoning seed and start-up investing, it
appears that market conditions, the preferences of large formal angel
alliances, and a possible slight restructuring of the angel market are
resulting in angels engaging in more later-stage investments.
This restructuring of the angel market has in turn resulted in fewer
dollars available for seed investments, thus exacerbating the capital
gap for seed and start-up capital in the US.
In the first half of 2007 angels exited their investments primarily
through sale of the business (acquisitions by another firm), with 61%
of the first half 2007 exits through trade sales.
Exits by initial public offerings represented 6% of exits and
bankruptcy occurred in 33% of the exits.
For all these exits the average rate of return was 30-40% and roughly
half (52%) were at a profit.

Venture Capital Funding Analysis

Venture capitalists invested $29.4 billion in 3,813 deals in
2007marking the highest yearly investment total since
2001.
The total invested in 2007 represents a 10.8 percent increase in
dollars and a five percent increase in deal volume over 2006.
Much of the increase in investments over the prior year can be
attributed to record investment levels in the Clean Technology and
Life Sciences sectors as well as strong investment levels in Internetspecific companies.

Investments in the fourth quarter of 2007 totaled $7.0

billion in 963 deals, marking the fourth straight quarter
with investments totaling more than $7 billiona
phenomenon not seen since 2001.

Source http://www.nvca.org/pdf/07Q4MTRelEmbargoFINAL.pdf

VC Sector and Industry Analysis

The Life Sciences sector (Biotechnology and Medical Device
industries together) set an all-time record for venture capital
investing in 2007 with $9.1 billion in 862 deals, compared to
$7.6 billion going into 786 deals in 2006.
The most significant growth was seen in the Medical Device
industry, which rose 40% in 2007 to $3.9 billion going into 385
deals. For the year, Life Sciences accounted for 31% of all venture
capital invested, which also represents an all-time high.
Life Sciences also retained its position as the number one
investment sector for 2007.

Software investing remained relatively flat in 2007, consistent

with levels over the last five years with $5.3 billion going into
905 deals, compared to $5.1 billion going into 920 deals in 2006.
Despite the lack of growth, it still remained the largest single
industry category for the year both in terms of deals and dollars,
edging out Biotechnology for the top position.

13

VC Sector and Industry Analysis

The Clean Technology sector (alternative energy, pollution
and recycling, power supplies and conservation) which
represented two of the five biggest deals of the year,
experienced significant growth in 2007 with $2.2 billion
invested in 201 deals.
This investment level represents a 46% growth in dollars and a 57%
growth in deal volume over 2006 when $1.5 billion was

invested in 128 companies.

Internet-specific companies received $4.6 billion in 748 deals
in 2007, an increase of 12% and 8%, respectively, over 2006
when these companies received $4.1 billion in 691 deals.
Internet-specific refers to a company whose business model is
fundamentally dependent on the Internet, regardless of the
companys primary industry category. These companies accounted for
16 percent of all venture capital dollars in 2007, approximately the
same percentage as in 2006.
14

VC Sector and Industry Analysis

The Media and Entertainment industry saw more venture
capital dollars in 2007, with $1.9 billion going into 340
deals compared to 2006 when $1.7 billion went into 318
deals.
Other industries that saw increases in deals and dollars
during the year include Business Products and Services,
Financial Services, IT Services, and Retailing/Distribution.
Telecom companies saw a decrease in investment in
2007 with 290 deals receiving $2.1 billion dollars, a drop
from the $2.6 billion in 301 deals they captured in 2006.
Other industries that experienced declines in deals and
dollars in 2007 include Healthcare Services,
Semiconductors, and Electronics/Instrumentation.
15

Total equity investments into

venture-backed companies Q1 2001Q4
2007

16

Most active venture investors 2007

The most active venture firms in the US closed 20 or
more deals each in 2007.
For the third year in a row, Draper Fisher Jurvetson
topped the list of most active venture firms for the
full-year, completing 100 deals in 2007, up from the
82 deals they participated in during 2006.
Like last year, New Enterprise Associates and Intel
Capital rounded out the top three firms.
Making a big move up the list was Canaan Partners;
whose 50 deals completed in 2007 was 28 percent
higher than the 39 deals completed in 2006. For the
year, the top 10 firms invested in eight percent of all
the deals done in 2007.
17

Most active venture investors 2007

http://www.pwcmoneytree.com/MTPublic/ns/moneytree/filesource/exhibits/National_MoneyTree_full_year_Q4_2007_Fi
nal.pdf
18

Quantitative Methods for Choosing

Projects
The difference between the present value of cash inflows and the
present value of cash outflows. NPV is used in capital budgeting to
analyze the profitability of an investment or project.
NPV compares the value of a dollar today to the value of that same
dollar in the future, taking inflation and returns into account. If the
NPV of a prospective project is positive, it should be accepted.
However, if NPV is negative, the project should probably be rejected
because cash flows will also be negative.
For example, if a retail clothing businesswants to purchase an
existing store, it would first estimate the future cash flows that
store would generate, and then discount those cash flows into one
lump-sum present value amount, say $565,000.
If the owner of the store was willing to sell his business for less than $565,000,
the purchasing company would likely accept the offer as it presents a positive
NPV investment.
Conversely, if the owner would not sell for less than $565,000, the purchaser
would not buy the store, as the investment wouldpresent a negative NPV at that
time and would, therefore, reduce the overall value of the clothing company.
19

Quantitative Methods for Choosing

Projects
NPV = Net Present value = Present value of net cash
flows
Each cash inflow/outflow is discounted back to its PV
and then they are summed.

or shortened
t - the time of the cash flow
N - the total time of the project
r - the discount rate (the rate of return that could be earned on an
investment in the financial markets with similar risk.)
Ct - the net cash flow (the amount of cash) at time t
(for educational purposes, C0 is commonly placed to the left of the
sum to
emphasize its role as the initial investment.).
20

Quantitative Methods for Choosing

Projects
Commonly used quantitative methods include discounted cash
flow methods and real options.
Discounted Cash Flow (DCF)
Net Present Value (NPV): Expected cash inflows are discounted
and compared to outlays.
In Excel use the formula NPV(interest rate, cell range of
cashflows)

$943.3
9

21

Quantitative Methods for Choosing

Projects
Internal Rate of Return (IRR): The discount rate
that makes the net present value of investment zero.
It is an indicator of the efficiency of an investment, as
opposed to NPV, which indicates value or magnitude.
The IRR is the annualized effective compounded return
rate which can be earned on the invested capital, i.e.,
the yield on the investment.
A project is a good investment proposition if its IRR is
greater than the rate of return that could be earned by
alternate investments (investing in other projects,
buying bonds, even putting the money in a bank
account).
Thus, the IRR should be compared to any alternate costs
of capital including an appropriate risk premium.
22

Quantitative Methods for Choosing

Projects
Mathematically the IRR is defined as any discount
rate that results in an NPV of zero of a series of
cash flows.
In general, if the IRR is greater than the project's
cost of capital, or hurdle rate (minimum rate of
return that must be met for a company to
undertake a particular project), the project will add
value for the company.

23

Quantitative Methods for Choosing

Projects

24

Quantitative Methods for Choosing

Projects
Strengths and Weaknesses of DCF Methods:
Strengths
Provide concrete financial estimates
Explicitly consider timing of investment and time value of money

Weaknesses
May be deceptive; only as accurate as original estimates of cash
flows.
May fail to capture strategic importance of project
Technology development plays a crucial role in building and
leveraging firm capabilities and creating options for the future
Intels investment in DRAM technology must have been
considered a total loss by NPV methods, however it laid the
foundation for Intels ability to develop microprocessors which
proved enormously profitable
Thus, some managers and scholars have promoted the idea of
treating new product development decisions as real options
25

Quantitative Methods for Choosing

Projects
Real Options: Applies stock option model to
nonfinancial resource investments. e.g., with
respect to R&D:
The cost of the R&D program can be considered
the price of a call option.
The cost of future investment required to
capitalize on the R&D program (such as the cost
of commercializing a new technology that is
developed) can be considered the exercise price.
The returns to the R&D investment are
analogous to the value of a stock purchased with
a call option.
26

Quantitative Methods for Choosing

Projects
Real options are based on stock options
A call option on a stock enables an investor to purchase the
stock at a specified price (the exercise price) in the future
If, in the future, the stock is worth more than the exercise
price, the holder of the option will typically exercise the option
by buying the stock
If the stock is worth more than the exercise price plus the
price paid for the original option, the option holder makes
a profit
If it is worth less, the option holder will typically choose not
to exercise the option, allowing it to expire. The amount
paid for the initial option is a loss.
If the stock is worth more than the exercise price but not more
than the exercise price plus the amount paid for the original
option, the stockholder will typically exercise the option. The
amount lost is less than if the option were to expire.
27

Quantitative Methods for Choosing

Projects
Examples of real call options

28

Value of a call option at expiration

The value of a call
option is zero as long
as the price of the
stock remains less than
the exercise price
If the value of the stock
rises
above
the
exercise
price,
the
value of the call rises
with the value of the
stock, dollar for dollar
(thus the 45-degree
angle)
29

Quantitative Methods for Choosing

Projects
Options are valuable when there is uncertainty (as in
innovation)
Some research shows that an option approach results in better
technology investment decisions than a cash flow analysis
approach

However, real options models have some limitations:

Many innovation projects do not conform to the same
capital market assumptions underlying option models.
May not be able to acquire option at small price: may require full
investment before its known whether technology will be successful.
Value of stock option is independent of call holders behavior, but the
future returns of the of R&D investment can be significantly
influenced by the firms capabilities, complementary assets, and
strategies.
Rather than being an observer (as in the option scenario), the
investor can be an active driver of the value of the investment
30

Qualitative Methods of Choosing

Projects
Many factors in the choice of development projects are extremely difficult
(or misleading) to quantify.
Almost all firms thus use some qualitative methods.
Screening Questions may be used to assess different dimensions of
the project decision including:
Role of customer (market, use, compatibility and ease of use, distribution
and pricing)
Role of capabilities (existing capabilities, competitors capabilities, future
capabilities)
Project timing and cost (time to complete, first to market, readiness of
market, project cost, other costs)

Can create a scoring mechanism that can weight the questions

according to importance
Even if Boeings Sonic Cruiser project would not be profitable based on
quantitative analysis, it may be necessary just to pass on the skills and
experience of building an airplane to the next generation of
employees. That value is difficult to asses quantitatively but is
revealed by qualitative analysis
31

Qualitative Methods of Choosing

Projects
The Aggregate Project Planning Framework
Managers map their R&D projects according to levels of risk, resource
commitment and timing of cash flows

32

Qualitative Methods of Choosing

Projects
Advanced R&D Projects: develop cutting-edge technologies;
often no immediate commercial application.
Breakthrough Projects: incorporate revolutionary new
technologies into a commercial application.
Platform Projects: not revolutionary, but offer fundamental
improvements in cost, quality and performance of a technology
over preceding generations of products.
Derivative Projects: incremental improvements in products
and/or processes to provide a variety in design features.
Toyotas Camry platform offers LE, SE and XLE models to
appeal to different market segments
Derivative projects pay off the quickest, and help service the
firms short-term cash flow needs. Advanced R&D projects take
a long time to pay off (or may not pay off at all), but can position
the firm to be a technological leader.

33

Qualitative Methods of Choosing

Projects

Managers then compare actual balance of projects with

desired balance of projects.
A typical firm experiencing moderate growth might
allocate 10% of its R&D budget to breakthrough
innovation, 30% to platform projects and 60% to
derivative projects
A firm pursuing a more significant growth might allocate
higher percentages to breakthrough and platform projects
A firm that needs to generate more short-term profit
might allocate a higher percentage to derivative projects

34

Qualitative Methods of Choosing

Projects
Mapping the companys R&D portfolio encourages the firm to
consider both short-term cash flow needs and long-term
strategic momentum in its budgeting and planning
A firm that invests heavily in in derivative products that may be
immediately commercialized with little risk may appear to have
good returns on its R&D investment in the short run, but then be
unable to compete when the market shifts to new newer technology
A firm that invests heavily in advanced R&D or breakthrough
projects may be on the leading edge of technology but run into
cash flow problems from a lack of revenues generated from recently
commercialized platform or derivative projects
Jack Welch, former CEO of GE You cant grow long term if you
cant eat short term. Anyone can manage short. Anyone can
manage long. Balancing those two things is what management is
Because the development of a new drug takes 10-15 years at a cost of
$800 million and drug companies have become reliant on a few
blockbuster drugs for a significant share of their revenues, drugs firms
could experience extreme volatility in their sales revenue
35

Drug Firms Reliance on a Few

Blockbuster Products, 2000

36

Qualitative Methods of Choosing

Projects
Q-Sort is a simple method for ranking ideas on different
dimensions.
Used for many diverse purposes from identifying personality
disorders to establishing scales of customer preferences
Individuals in a group are each given a stack of cards with an
object or idea on each card (e.g., a potential project).
A series of project selection criteria are presented (technical
feasibility, market impact, fit with strategic intent) and, for
each criterion, the individuals sort their cards in rank order
(e.g., best fit with strategic intent) or in categories
(technically feasible vs infeasible) according to that criterion
Individuals compare their ran ordering and use these
comparions to structure a debate about the projects
After several rounds of sorting and debating, the group is
expected to arrive at a consensus about the best projects.

37

Combining Quantitative and

Qualitative Information
Managers may use multiple methods in combination.
Use quantitative methods to estimate the cash flows
anticipated from a project when balancing their R&D portfolio
on a project map

May also use methods that convert qualitative

information into quantitative form (though this has
similar risks as discussed with quantitative methods)
Conjoint Analysis estimates the relative value
individuals place on attributes of a choice which can
then be used in development and pricing decisions.
Individuals given a card with products (or projects) with
different features and prices.
Individuals rate each in terms of desirability or rank them.
Multiple regression then used to assess the degree to which
an attribute influences rating. These weights quantify the
trade-offs involved in providing different features.
38

Conjoint Analysis
Conjoint analysis is a popular marketing research technique that
marketers use to determine what features a new product should
have and how it should be priced.
Conjoint analysis became popular because it was a far less
expensive and more flexible way to address these issues than
concept (market) testing.
Suppose we want to market a new golf ball. We know from
experience and from talking with
golfers that there are three important product features:
Average Driving Distance
Average Ball Life
Price

There is actually a range of feasible alternatives for each of these

Average
Average
Price
features:
Driving
Ball Life
Distance

275 yards

54 holes

$1.25

250 yards

36 holes

$1.50

225 yards

18 holes

$1.75

39

Conjoint Analysis
Obviously, the markets ideal ball would be:
Average
Driving
Distance

Averag
e Ball
Life

Price

275 yards

54 holes

$1.25

and the ideal ball from a cost of manufacturing perspective would

be:
Averag
Averag
Price
e
Driving
Distanc
e

e Ball
Life

225
yards

18 holes

$1.75

assuming that it costs less to produce a ball that travels a shorter distance and
has a shorter life.

The basic marketing issue: Wed lose our shirts selling the first ball
and the market wouldnt buy the second. The most viable product
is somewhere in between, but where? Conjoint analysis lets us find
out where.
40

Conjoint Analysis
A traditional research project might start by
considering the rankings for distance and ball life as
follows:
Rank

Avg
Driving
Distance

Rank

Avg Ball
Life

275 yards

54 holes

250 yards

36 holes

225 yards

18 holes

This type of information doesnt tell us anything that

we didnt already know about which ball to produce.

41

Conjoint Analysis
Now consider the same two features taken conjointly.
The next two figures show the rankings of the 9
possible products for two buyers assuming price is
the same for all combinations.

42

Conjoint Analysis
Both buyers agree on the most and least preferred
ball. But as we can see from their other choices,
Buyer 1 tends to trade-off ball life for distance,
whereas Buyer 2 makes the opposite trade-off.
The knowledge we gain in this analysis is the
essence of conjoint analysis.

43

Conjoint Analysis
Next, lets figure out a set of values for driving distance and a
second set for ball life for Buyer 1 so that when we add these
values together for each ball they reproduce Buyer 1's rank
orders.
Heres one possible scheme.
Note that we could have picked many other sets of numbers that
would have worked, so there is some arbitrariness in the
magnitudes of these numbers even though their relationships to
each other are fixed.

44

Conjoint Analysis
Next suppose that the table below represents the trade-offs Buyer 1 is
willing to make between ball life and price.

Starting with the values we just derived for ball life, the next table
shows a set of values for price that when added to those of ball life
reproduce the rankings for Buyer 1 in the table above.

45

Conjoint Analysis
We now have in the table below a complete set of values (referred to as utilities or partworths) that capture Buyer 1's trade-offs.

We can now use this information to determine which ball to produce.

46

Conjoint Analysis
Suppose we were considering one of two golf balls shown in the table below

The values for Buyer 1, when added together, give us an estimate of his preferences.
Applying these to the two golf balls were considering, we get these results

Wed expect buyer 1 to prefer the long-life ball over the distance ball since it has the larger total value

47

Theory In Action: Courtyard by

Marriot
Marriot used conjoint analysis to help it develop a midprice hotel line.
First used focus groups to identify customer segments and attributes
they cared about in a hotel. These included:
external surroundings, room, food, lounge, services, leisure activities and
security

Then created potential hotel profiles that varied on these features and
asked participants to rate the profiles.
For example, under the services factor was reservations
Two levels were devised- Call the hotel directly or call an 800 reservation number

A sample of hotel customers were given 7 cards, each containing one of the
factors above with a dollar value assigned to each level of service within a
factor. A maximum of $35 could be budgeted to creating a profile of features
If the budget was exceeded, features had to be eliminated or a less expensive
level of services had to be chosen
The participants set their own priorities and made their own trade-offs. This help
management understand what was important to different customer segments

48

Theory In Action: Courtyard by

Marriot
Participants werethen asked to rate each of the
profiles created
Regression was then used to assess how different
levels of service within a specific attribute
influenced customer ratings of the hotel overall
Based on the results, Marriott developed
Courtyard concept: relatively small hotels with
limited amenities, small restaurants and meeting
rooms, courtyards, high security, and rates of $40$60 a night.
By the end of 2002, there were 553 Courtyard
hotels and their average occupancy rate of 72%
was well above the industry average
49

Combining Quantitative and

Qualitative Information
Data Envelopment Analysis (DEA) uses linear
programming to combine measures of projects based on
different units (e.g., rank vs. dollars) into an efficiency
frontier.
Projects can be ranked by assessing their distance from
efficiency frontier.
As with other quantitative methods, DEA results only as
good as the data utilized; managers must be careful in their
choice of measures and their accuracy.
DEA has been applied in many situations such as:
health care (hospitals, doctors), education (schools,
universities)
banks, manufacturing
benchmarking, management evaluation
fast food restaurants, retail stores
50

Data Envelopment Analysis

Assume that there are three players (DMUs decision making
units), A, B, and C, with the following batting statistics. Player A is
a good contact hitter, player C is a long ball hitter and player B is
somewhere in between.
Player A: 100 at-bats, 40 singles, 0 home runs
Player B: 100 at-bats, 20 singles, 5 home runs
Player C: 100 at-bats, 10 singles, 20 home runs
Analysis
Player A: No combination of players B and C can produce 40
singles with the constraint of only 100 at-bats. Therefore player
A is efficient at hitting singles and receives an efficiency of 1.0.
Player B: Can be constructed as a combination of players A and
C. (For example, a 50-50 combination would yield 25 singles
and 10 home runs).
Player C: No combination of players A and B can produce his
total of 20 home runs in only 100 at bats so player C is efficient
51

Data Envelopment Analysis

Graphically, we can see that Player B is inside the optimal efficiency frontier created by A and C and is
thus operating at a sub-optimal level
Bs efficiency can be determined by comparing him to a virtual player formed from player A and player
C.
The virtual player, called V, is approximately 64% of player C and 36% of player A. (measure AV/AC and
CV/AC.)
The efficiency of player B is then calculated by finding the fraction of inputs that player V would need to
produce as many outputs as player B. The efficiency of player B is OB/OV which is approximately 68%.

52