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?
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Feature Article: When the walls falls.

The relentless, unstoppable force that spooked Murdoch and Lowy


  • By John McDuling

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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.

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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

#23 What playing Monopoly as a child taught me.

I have a confession to make.

I am a sucker for playing monopoly and I don’t mean the type of game that lasts a few hours. No. I am talking about the game that lasts days!

That is probably why I haven’t played it now that I am a bit older, because none of my friends have the time or patience to continue a game for days and days with the same enthusiasm and drive to win.

But as a child, I remember endless pursuits of trying to be the last one standing. Often times, when my cousins came to visit for a weekend, I’d challenge them to a game of Monopoly. My house ,my rule right? To me, those endless hours seemed to whizz by unnoticed as my money and properties built up, then, through some silly role of the dice, leave me dry, forcing me to foreclose on properties and start afresh.

What would happen when mum came to tell me it was time for bed? Well after having a hissy fit, I’d make sure to write down everyones position on the board and record everyones amount, and as if saving or pausing the game, we’d leave it as it was to return at a later time.

I remember being such a sore loser, I hated being broke, but I hated losing and quitting even more. In fact I never accepted I was bankrupt till I had nothing left. I had strategies to make sure that I was always one step ahead of the game, or so I thought. At each pass of the Go, I’d put $100 aside. Each time I raised money,  I’d put a portion of the earnings aside as retained capital. I made sure all my properties were partially developed (never get to hotel status), I tried to negotiate with the banks for leeway and I was adamant about lending finance to players to keep them in the game when they were broke or wanted to quit. The last point is perhaps the reason why our games lasted so long. I realised that in order for me to accumulate more wealth, there had to be players in the game. For me, the goal was to have the bank go broke before me. That was the thrill!

But what did all that adolescent-money- gaming do to my cognitive development. As a child, we become a product of all the experiences we are exposed to, so what lasting scars did the game of monopoly have on me. Well these are a list of things I believe I have gained from it:

  1. Unnerving ability to believe that there is always a way out

    Despite being claustrophobic, I am a pretty calm person. I know that there is always a way out even if that entails facing up to the issue. I remember games where I would lose everything and then scheme my way back into the game by borrowing from the bank or other players.

  2. Deep belief in my own ability to control the board (destiny)

    It was only when I watched Invictus that the words resonated with me “I am the master of my fate, the captain of my soul”. One of my truest of truths is that I can change my circumstances whenever I want. We all suffer from something or rather mentally, I am no different but I just can usually pull myself off the scruff of the neck and get on with life. For some reason, Monopoly taught me that the board doesn’t play the same hand twice and a bad role once won’t always lead to a bad role twice. There is always a way out.

  3. Dealing with having, and not having power

    I love power. I like having it, being around it and messing with it. But Monopoly taught me an important lesson in  respecting power – be humble in victory and gracious in defeat. Learning how to deal with the bankers as money lenders earlier on and showing mercy to those who couldn’t afford to pay you for landing on your highest earning properties was all about courting power. Allowing people to pay me slowly allowed them to be in the game longer, appearing merciful assured me allies and power.

  4. Highly developed Emotional Intelligence 

    If I have earned anything, it is the power to be deeply reflective and empathetic. I call it the God Perspective and this was honed with a few other games too but being able to read people and predict what their reaction was going to be was incredibly important to my own survival on the board. Understanding when to take a break when I could sense a tough phase was occurring ensured that I had a game to play that wasn’t wearing everyone out.

  5. Taking risk and being ok with loss

    Children need to learn how to deal take massive financial risks and experience the glories of winning and lossing. Too many people are risk averse, resulting in not much happening. They sit back and take on a life of average because they are afraid of taking big risks and losing. For them,  loss is equal to death. For me death is the only loss. I loved Monopoly, I didn’t always win and those were tough. When I was really addicted to it, I remember being furious that I’d lose, but it made me want to play it even more. The thrill of taking risks, knowing I could lose it all at the next round of the board was strangely appealing to my adolescent mind. The thrill of uncertainty still remains with me today. Certainty and comfort makes me bored.

Obviously, there must be a more ways that Monopoly defined me that I have not figured out yet. I highly recommend getting your children, or your friends children, inducted into the world of Monopoly. If anything, they may just learn a bit about themselves.

Kind regards,

Hans Lee