Feature Article: What is the Difference Between Creating and Capturing Value?

Article first published in Venture CFO on January 22, 2015.

What is the Difference Between Creating and Capturing Value?

I recently heard an entrepreneur speak about the founding and growth of his company. It was a fascinating and instructive story overall, but he mentioned one concept that I’ve been mulling over since. He talked about the difference between creating value and capturing value. 

This topic came up when asked how he decided when to take outside capital and how much. He described how he, as a founder, is focused on building value in his company. As he was looking for capital, he found that most potential investors, including venture capitalists, were more focused on capturing value. He found this to be a problem because he believed that capturing value too early would inhibit their ability to create value.

I’ve been thinking about how VC’s and other investors can help entrepreneurs both create and capture value.

First, what does it mean to create value?

The activities that make up the economy are not a zero-sum game. Gains in one area do not have to come at the expense of losses in other areas. The economy grows, and value is created, when entrepreneurs create outputs more valuable than the sum of the inputs.

The process of creating value can include focus on the following:

Creating a network effect. Some products become exponentially more valuable with more users. The classic example is the telephone. One telephone in the world is worthless, but that one phone becomes more valuable as more phones are placed into service. More recent examples include Facebook, Twitter, and other social media sites. Some of these companies created billions of dollars of value even before turning a profit because of the number of users they have been able to attract.

Building brand strength. The stronger the brand, the more a customer is willing to pay for a product. A brand is built over time through marketing and a reputation for high quality and good service. Apple is a good example of value created through brand strength. Consumers are willing to pay more for Apple products than comparable products because they trust the brand.

Developing efficient operations. Manufacturers create value by selling a product for more than the cost of the materials, labor, and equipment needed to produce the product. The more efficient the operations, the lower the cost of production. The lower the cost of production, the more value is created. Value can be considered both the profit to the manufacturer and utility for the customer relative to price.

Second, what does it mean to capture value?

Agriculture easily illustrate the difference between creating value and capturing value. Farmers create value by planting and growing crops. However, creating a valuable crop doesn’t do any good unless the crop is harvested and sold.

Value-capturing activities include:

Monetizing users. Social media companies often struggle with capturing value. Twitter created enormous value by rapidly building a large user base, but they have struggled to capture the value through monetization. Facebook’s stock has been surging because they have found effective ways to monetize through advertising.

Pricing effectively. The value of a strong brand and efficient operations can’t be captured if the product isn’t priced appropriately. Again, Apple is a great example. They earn high margins because of their brand strength and quality product, and they protect these margins by controlling their high pricing carefully across all distribution channels. It is difficult to find lower than usual price on Apple products.

Providing liquidity to shareholders. A company can capture value by monetizing users and pricing appropriately, and then they can pass on that value to shareholders by providing the ability to sell the more valuable shares. This can be done in many ways. Profits can be distributed through dividends. Private companies often raise money at higher valuations and allow new investors to buy out existing investors. The goal of public companies is to allow investors to capture value by increasing their stock price.

Real Value Must Be Created Before Being Captured

Both creating and capturing value are necessary, but it’s important to recognize where to place your focus at a given stage in your company’s growth.

In general more focus should be placed in the early stages on creating value, and as sustainable value is created, some attention can be turned to capturing that value. Even while capturing value, management should stay continually focused on creating value, or the ability to capture value will be short-lived.

Beware of artificial value, such as that created by financial engineering. Failure to recognize this distinction is one of the causes of the housing bubble and subsequent economic collapse. Low interest rates and creative financial products led to a flood of capital into the housing market. This caused housing prices to artificially inflate, creating the illusion of value creation.

Banks allowed homeowners to capture that “value” by borrowing against the inflated value of their homes. The illusion was eventually exposed, leaving behind severely underwater mortgages and general economic disaster.

Entrepreneurs and investors should work together to recognize the distinction between activities that create and capture value and prioritize their resources effectively. As they do so, they will be able to maximize both the value created and the value captured.

Question: What are other value creating and value capturing activities?
6 Likes
Share
Newer Post
4 Ways to Prevent Personal Finance from Hurting Your Business
Older Post
Should Sales or Accounting Handle Collections?
BACK TO TOP
Powered by Squarespace

Feature Article: When the walls falls.

The relentless, unstoppable force that spooked Murdoch and Lowy


  • By John McDuling

http://imasdk.googleapis.com/js/core/bridge3.187.0_en.html#goog_1596283442

Play Video

It is hard to think of a more fitting conclusion to 2017 for corporate Australia than the two seismic deals involving Rupert Murdoch and Frank Lowy that sent shockwaves around the world [in Dec 2017].

Fox-Disney
Fox Entertainment sold to Disney

 

Murdoch has made little secret of the fact he was concerned that his Fox entertainment businesses didn’t have the necessary scale to compete with the likes of Netflix and Amazon, so he sold them to Disney.As you almost certainly know by now, the two iconic, octogenarian billionaires decided to sell assets they had spent decades building up, at least in part due to concerns about threats posed to their businesses by internet led rivals.

Westfield
Westfield is being sold to Unibail-Ramenco

Even Murdoch is buying into it.“I read this week about my Australian friends at Westfield. They can see what Amazon is doing to bricks and mortar retail,” he told the Financial Times over the weekend.

As one of the next generation of globally significant Australian executives, Mike-Cannon Brookes, pointed out last week, every industry is being threatened by some form of digital insurrection at the moment.

The advent of Amazon, which terrified retail executives and investors in the sector; Elon Musk and Cannon-Brookes’ intervention into the national energy debate in South Australia, and the rise of crypto-currencies upending the established order in finance were just a few of the big stories that played into this theme.

wp-image-373527896.
Elon Musk is ready to deliver in South Australia’s energy crisis.

There is a belief the Murdoch and Lowy mega-deals could merely represent a taste of things to come, with the theme of technology motivated mergers and acquisitions set to continue next year.

Senior investment bankers this column has spoken to say rapid technological change remains a top concern among directors on the boards of our biggest companies.

This is forcing them to invest more in innovation and technology. Selling assets (including infrastructure and property, but also non-core businesses) that aren’t central to their business is one way to fund that.

One such example could be Telstra’s decision to take steps to reduce its stake in pay TV company Foxtel.

A recent survey of companies and private equity firms by consulting giant Deloitte found that companies in the US expect to do more acquisitions next year.

They are sitting on more cash than they were a year ago – potential changes to America’s tax regime could provide them with even more firepower – and they expect to use that cash to buy other companies.

The biggest motivating factors for acquisitions, according to the Deloitte survey, were a desire to acquire technology, and the need to build out a digital strategy.

The Deloitte survey dovetails with a forecast by Goldman Sachs, which expects M&A spending in the world’s largest economy to rise 6 per cent to $US355 billion next year.

Almost every company these days is trying to position itself as a tech firm. This includes our big banks, Telstra, and in a global context, century old industrial giant General Electric.

The distinction between business and technology is becoming increasingly blurred, the firms with the best tech over the long run will win.

For people exposed to the technology industry, it can be nauseating to hear old school executives rattle off terms like digital disruption, the blockchain and artificial intelligence.

But in fairness to them, in an era of rapid technological change, fighting progress will be futile, so they have little choice but to embrace it.

Unless, like Lowy and Murdoch, you can find a way out.

 

Originally published in the Sydney Morning Herald (online) on 18 December, 2017

Part2/2: Ptsh. F*#% Off mate. “Parking might not be as important to restaurants.”

In a recent piece, I spelled out that I had grown accustomed to owning a vehicle in Cairns. Not a lot has changed. I still need a car, maybe more so now since I sold my car and live a fair way out of the CBD.

It was with a tad bit of bitterness then when I chanced upon a piece in the The Conversation written by Professor Barbara T. H. Yen reporting on her research with a team of scholars from Griffith University.

Continue reading “Part2/2: Ptsh. F*#% Off mate. “Parking might not be as important to restaurants.””

#35: How I made the patchwork princess too? ( 2/2)

Part 2/2 – How I made the patchwork princess too?

names-for-drunk
Patchwork Princess

The patchwork princess from primary school days grew up without anyone telling her the right words to use. She could never really stop the boys from embarrassing her.

The primary school boys never learnt that ‘no’ meant ‘no’. That boy does not deserve girls affection after grand gesture. That there was a fine line between romance and harassment.

Continue reading “#35: How I made the patchwork princess too? ( 2/2)”

#34- Making the Patchwork Princess (1/2)

Primary school gossip was scandalous to say the least. Paper notes passed up and down grades, between friends – cautious of peering eyes. These were days before the DMs – I am talking about days before mobile phones and snapchat.

Continue reading “#34- Making the Patchwork Princess (1/2)”

#33 Talking Urbanism- Fixing the Heat in Cairns.

I’m breaking a sweat from J-walking across Grafton Street.

For the first time in a few mild months, I am reminded that this is the tropics. 


The feel of humidity rising in the morning leaves a lot to be desired as I get caught in the mid-Friday-morning sun darting into Rusty’s for the ritual coffee and samosa. 


Friendly nods between the frenzied buzz give way to warm murmurs interjected by the whizz-shhhhh of the coffee machine at Billy’s.


Flippy-floppy thongs slap hard against concrete followed closely by the clip and clop of a heal and a shoe.


Someone mentions in passing that it looks like ‘it’s going to be a hot one’. 


But I can’t tell if they were talking about the coffee or sun.


I notice the first signs of redness beginning to show on our melanin-deficient brothers and sisters who have ventured a bit too long without sunscreen. 


The morning streets will soon be a buzz with tropical professionals zipping into air-conditioned hideaways of the next cafe to avoid unsightly sweat patches. 


But the weather this time of the year is temperamental.


The rains do poke through humid blue skies on the odd occasion, cooling streets and shrinking sidewalks. 


Rains Descend
Wet Weather brings a welcomed reprieve from the heat.

It lingers long enough to make us yearn for more sheltered walkways. But it stays away long enough for us to forget we need them. 


The indecisive weather is part of the lifestyle. A short walk from the Esplanade to Cairns Central would attract an unwarranted public baptism by either precipitation or perspiration. 


I call on a thought to distract myself from the rising hunger as I wait in the samosa line. 


How is it that our city stops short of catering to our tropical lifestyle? 


Why does my daily commute to work have to involve navigating patches of sweat from rising humidity? 


We praise the outdoor tropical lifestyle, yet accept, and think it normal to spend the better part of the week inside air-conditioned cubicles glaring through double-glazed tinted panes.


This is the disjuncture of our existence that evades the public forum, but one that concerns us all. 


This may be about to change. 


I bite into my tamarind sauce topped samosa to settle the hangry morning monster in my belly.


James Cook University, under the vision of Dr Lisa Law and Dr Silvia Tavares, have initiated the Tropical Urbanism and Design Laboratory (TUD Lab) – a space to think about these particular issues. 


Taking advantage of JCU’s agenda on pursuing research with a tropical focus, the JCU TUD Lab will pursue important questions concerning the livability of tropical urban environments. A feat warranted by a State of the Tropics report that claims close to 50% of the worlds people will live in the tropics by the middle of this century.


After having the Cairns Regional Council’s Tropical Urbanism vision applauded at the state level, this TUD Lab would mark an important milestone for thinking about tropical planning and urban design in Cairns, if not the world.


The Lab is set for launch at JCU on the 20th October with registrations essential for catering


Maybe there will be some respite from the heat soon.


By

Hanslee

Image Sources

  1. Foodvixen.com
  2. RamblingsOfAGlobalCitizen (blog)
  3. TropicNow.com.au