Valuations alone can never be the parameter on which a business should focus. Valuation should lead to value creation. A business creates value when it is able to generate steady revenue, maintain stable profitability, create an impact, and establishes a model that can be financially viable to last for generations.
Sometime back, I came across a report that India now has more than 35 unicorn startups, around 11 of which were added in 2020 alone. Industry experts have predicted that India will have 100 unicorns by 2025. The targeted focus on unicorns made me wonder how it has now become the parameter of success for startups.
There is this tremendous peer pressure among startups that if they are not raking billions in valuation, their venture is a failure. Ironically, these seemingly successful businesses have been consistently reporting losses, a few of them have also shut down. This is a testament to the fact that valuations alone can never be the parameter on which a business should focus.
Valuation vs Value Creation
It does not mean that valuation is without merit. Problem is that valuation is often confused with value creation. Valuation is heavily dependent on market conditions. Even mathematically, the same company can be valued differently by two different evaluators. It could also have a valuation that is four times in an “in” market as compared to what it would have been in other circumstances.
Hence, it is erratic and a highly misleading metric.
Valuation should lead to value creation. A business creates value when it is able to generate steady revenue, maintain stable profitability, create an impact and establishes a model that can be financially viable to last for generations.
Are startups designed to fail as value creators?
When the objective of a startup is just to make a successful exit or just survive in the herd, it fails as value creators. The journey from being a startup to a matured business is an uphill trek. This is the stage where post-stage startups lose their focus. Since they are not designed to think institutionally, their focus is on exits, they were never built in the first place to move forward.
How do we measure value creation – Capturing the value created
Peter Thiel writes – Even very big businesses can be bad businesses. Creating value is not enough – you also need to capture some of the value you create.
“For example, US airline companies serve millions of passengers and create hundreds of billions of dollars of value each year. But in 2012, when the average airfare each way was $178, the airlines made only 37 cents per passenger trip. Compare them to Google, which creates less value but captures far more. Google brought in $50 billion in 2012 (versus $160 billion for the airlines), but it kept 21 percent of those revenues as profits—more than 100 times the airline industry’s profit margin that year,” Thiel exemplifies.
If a startup only creates value and does not capture it, it would not survive in the long run. As we can see from the above example, revenue or the number of users are not always quality metrics to measure value creation. Net profit, on the other hand, is a far more reliable parameter.
Innovate – do not replicate
The running trend among Indian startups is to replicate existing business models. Replicating an already successful model does not result in mirroring their success too. The next Zuckerberg will not create a social network, Neither will Google be recreated. Be a Maverick – create something disruptive and new that has a niche of its own.
Economies of Scale
At the organization level, we are huge propagators of economies of scale. Each customer that comes your way is a gold mine. With them, they bring their network. A scalable market, combined with a bankable network is what creates a disruptive but sustainable model. Any business that has created a legacy – Apple. Arguably, being the aptest example has taken advantage of the Network Effect. Nearly 70 Percent of Value in Tech is Driven by Network Effects.
Can your startup raise prices and retain your customers?
The litmus test for any business is whether they are able to raise prices without losing their customers. It indicates whether you have something to offer that your competitors do not. A good business must have the ability to capture value. The test of value capture is pricing power. If you’re deathly afraid to raise prices, you do not have what Thiel would refer to as a ‘monopoly’ — you don’t control your market. Disney found that it could raise those prices a lot and the attendance started right up.
Unlocking value propositions
1. Align key decision-makers by creating financial and non-financial ambitions that assimilate short- and long-term value creation
2. Develop a dynamic business model that creates value across multiple time horizons
3. Align KPI dashboards to measure and empower progress towards goals
4. Encourage long term design thinking within your organization
The Future will belong to Camels – Not Unicorns
Gradually, the markets are now making way for Camels. “Camel” startups are reminders that an evolved model exists. These still achieve rapid growth, but balance it with other objectives like managing costs and charging a reasonable price for products or services. The founders of Camel startups understand that building a successful business starts with a strong foundation that is built to last.
Growth is easy to measure. Longevity is not. It is pointless to succumb to valuation mania. User acquisition, revenue, projections are all important but obsessing over it is not the trajectory of creating legacy businesses.
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