During the past two decades, corporate scope and priorities were shaped by an abundance of capital. Today the univested capital of private equity funds stands at an all-time staggering high of $3.4 trillion. With such massive liquidity chasing few opportunities, valuations for innovative investments have been high. The prevailing low interest rate environment has only reinforced the focus on growth: With debt so cheap, capital has felt able to afford patience, and the promise of growth, even in the absence of profitability, has been enough to convince investors of the value of a business.
Now that interest rates are rising and that liquidity is being drained out of the system by central banks the world over, the focus is switching to returns. As investors turn from irrational exuberance and fear of missing out (FOMO) to a concern with earnings and valuation, the criteria of what adds value will adjust, creating challenges for businesses predicated on the value of growth. While in the past skilled salespeople like WeWork’s Adam Neumann could oversell a concept even when the financials wouldn’t add up, burning cash without much by way of reassurance other than buying growth, higher capital costs and lower liquidity will inevitably lead to greater scrutiny.
Such scrutiny may be a welcome change. Infatuated by the promises of new business models, and obsessed with stratospheric valuations and cash generation of Big Tech, many corporations embarked on a strategy of digital expansion. Look at tech platforms, the folklore went: A focus on profits would have drowned the business. Jeff Bezos was right to fend off pressures to be profitable, as growth and ultimate scale would later lead to untold riches.
The challenge is that big tech companies had some unusual advantages, and their ability to be a gatekeeper, which commands extraordinary power, cannot be easily replicated. So alongside many courageous business transformations that have added value, we have also seen a blind belief that that emulating some aspect of major tech companies’ approach by acquiring a firm that would help firms credibly argue that they could become a platform owner or ecosystem orchestrator. Firms the world over rushed to showcase AI credentials, signal their commitment to the metaverse, and declare themselves the next platform.
In a tighter market with less liquidity and higher expected returns managers can no longer afford that blind belief. That’s not a bad thing but the risk, of course, is that corporate leaders may veer from unbridled enthusiasm to excessive caution, when the structural forces transforming our world are stronger than ever. As companies will inevitably have to absorb part of the cost hikes and reduce their profit margins, the question of whether they will turn from naïve excitement to mindless caution remains.
That would be a mistake. The collapse in cryptocurrency valuations, for instance, does not mean that the technologies behind them pose any less of a risk for banks and other financial institutions. Digitalization is continuing to progress apace. Customers are open to being wooed by all-encompassing multi-product or experience ecosystems. While WeWork’s original thesis was oversold, smaller competitors like Estonia’s Workland are finding that returns can emerge if the model is thought through.
From wellness and lifestyle, where big tech giants are making significant strides, to services that financial institutions and retailers want to offer, the face of competition is changing. The likes of Chinese tech giant Tencent and its WeChat all-in-one service, Japanese retailer Rakuten, Chinese insurer PingAn, Indian conglomerate Reliance Jio, and the Western big tech firms are in a race to find a unique point of contact for consumers. Companies like Omada in the U.S., which focuses on in care for chronic conditions such as diabetes, are using their experience ecosystems as a new way to woo the customer. Italian coffee supplier stalwart Lavazza is experimenting with a role as orchestrator of a coffee experience ecosystem. In short, in sector after sector, value is migrating towards creative multi-firm propositions spanning the physical ad the digital and connecting different players.
As firms adjust to these new conditions managers will need to:
The challenge firms face is that the world is changing, and success will probably come from fresh ways of adding value. Yet, with no quick fix to inflation in sight, we should expect a re-evaluation of strategic priorities, with reduced liquidity and increased capital costs leading to more scrutiny. This will require the ability to develop reasoned arguments on what adds value and why more than glib salesmanship. The time for proper strategy work, grounded in reality and connected to the long term vision of a firm has arrived. Time to embrace it and roll up our sleeves.
This content was originally published here.