Finance: The Secret Key to Becoming a Tech Company
European Straits #66
Dear all,
My partners and I at The Family are constantly rooting for old incumbents to become more of tech companies. The reason is simple and very much in line with our mission of supporting entrepreneurs: startups cannot succeed in Europe until everyone in the business world is convinced that tech companies will win in the end—in every industry.
Some executives may not be willing to act on that conviction, perhaps thinking that it’s not the right time or conditions to undertake a radical transformation of their company. Others are simply afraid, seeking to buy a bit more time, pocket their yearly bonus, and hand things over to a successor that will deal with the more difficult challenges. Too many executives, however, are simply in denial. They’re aware that something called the digital transition is going on. But for some (flawed) reason they think that their particular company or industry is immune to the transition’s transformative impact.
The Family has long tried to cure that denial. When we were in our first year back in 2013-2014, my partner Oussama Ammar and I delivered a whole season (24 issues!) of a conference series called Les Barbares attaquent! in which we would discuss the impact of the digital transition on various industries, from banking to luxury to publishing to agriculture. Then we launched Pathfinder, our advisory practice, to try and follow up on those conferences with the most motivated clients.
Behind the scenes, however, another string of reflection has yet to lead to concrete action on our part. The core idea is that the necessity of becoming a tech company would be self-evident if only we were able to use financial incentives. There are two reasons for this line of thinking:
Corporate executives are constantly accused of responding to short-term financial stimuli only. They’re obsessed with their yearly bonus and stock options. And they react quickly to any signal sent by financial markets. So why not base those people’s rewards on the progress made towards becoming a tech company? And why wouldn’t financial markets punish those who don’t get serious on that front?
The other reason is that becoming a tech company actually pays off! Competitiveness in the Entrepreneurial Age is linked to the capacity to generate increasing returns to scale. This is dependent on regular and systematic monitoring of user activity, which in turn requires that a company provide its customers with an exceptional experience. Those incumbents who successfully tackle the challenge of higher quality at scale will eventually emerge as winners and deliver that precious alpha to their shareholders. As for those who don’t take it seriously, they will go down in flames in the manner of Kodak, Blockbuster, and Toys “R” Us.
How can we make progress on harnessing the power of financial markets to hasten the transformation of incumbent companies? Let me share four ideas with you:
We’re exiting the world where it was ok to just play around with the idea of becoming a tech company. Large corporations have wasted way too much capital in corporate incubators, hackathons, proofs of concept, glittery social media marketing, and corporate venture arms. We’re seeing that corporate CEOs are waking up to this and are now prepared to demand more value for the money. It means that the strategic repositioning of incumbent companies will not be sloughed off onto chief digital officers anymore. Instead it will be elevated to a higher level of C-level attention and it will have an impact on the company’s core business.
In time, this will lead to a radical reinvention of corporate finance. I have long claimed that the CFO was the key person when it comes to becoming a tech company. Since then, R. Martin Chavez, the man credited for turning Goldman Sachs into the “Google of risk”, has moved up to become the CFO of the mighty investment bank. I see this as a sign that a new generation of CFOs is rising—one that is more aware of the challenges of providing customers with higher quality at scale, undertaking constant reinvention, and ultimately becoming a tech company.
Yet we can’t have those new CFOs if we don’t also have their indispensable counterparty: pressure from shareholders and investors in favor of a more tech-driven strategy. And this is where the whole system is lagging behind. I still don’t see shareholder activism with the goal of avoiding irrelevance in the Entrepreneurial Age. The digital transition is not yet identified as a macro-risk, comparable to climate change in its magnitude. As for research analysts, they seem uninterested, and theirs is a profession in crisis anyway.
Fortunately, there are signs that things are changing. Progress is accelerating on the M&A front. GE was recently punished for having duped the public on the extent and soundness of their effort at becoming a tech company. And there are now long/short investment strategies: betting on disruptive new entrants while being short on the incumbents they are trying to disrupt. An example is the short bet performed by the startup Beyond against Dignity, a leader on the market for funeral services (whose share price has consequently plummeted by more than half).
Overall, my view is rather simple. I think that financial markets are like wild animals: tough on the weak, but respectful of the strong. Since his legendary 1997 letter to Amazon’s shareholders, Jeff Bezos has been teaching us a convincing lesson in what it takes to tame those wild animals.
Now all corporate CEOs and CFOs should adopt Bezos’s playbook. If they don’t want to wake up one morning leading the next GE or Toys “R” Us, they need to take the initiative, focus on the transition as a financial challenge, and redouble their efforts at actually tackling that challenge. No more hackathons, open innovation bullshit, or learning expeditions in Palo Alto, Shenzhen, and Tel Aviv. It’s time to finally open the playbook of corporate strategy in the Entrepreneurial Age and translate it into straightforward and convincing financial terms.
I’ll share more on that in the coming weeks and months. In the meantime, I highly suggest reading the following articles:
Innovation Killers: How Financial Tools Destroy Your Capacity to Do New Things (Clayton M. Christensen, Stephen P. Kaufman, and Willy C. Shih, 2008)
How Amazon Trained Its Investors to Behave (Justin Fox, 2013)
Why Amazon Has No Profits (And Why It Works) (Benedict Evans, 2014)
The End of Accounting (Baruch Lev and Feng Gu, 2016)
How to build an alliance against corporate short-termism (Rebecca Darr and Tim Koller, 2017)
Time to Change Your Investment Model (Feng Gu and Baruch Lev, 2017)
Strategy in the Age of Superabundant Capital (Michael Mankins, Karen Harris and David Harding, 2017)
Stop Focusing on Profitability and Go for Growth (Michael Mankins, 2017)
Why Financial Statements Don’t Work for Digital Companies (Vijay Govindarajan, Shivaram Rajgopal and Anup Srivastava, 2018)
Warm regards (from London, UK),
Nicolas