We typically think of the capital value of our businesses in terms of share price or what we think someone will pay for it. But these constructs will misdirect your efforts in building the real drivers of capital value in your business. You need an alternate view of capital value to really focus on growing value.

 

Active Knowledge Question:

What are the drivers of capital value in your business and how are you investing in them?

 

What Is Capital Value Anyway?

We have a view of capital value that I do not believe supports leadership in keeping their eye on – or even correctly identifying – the real drivers of it in their businesses.

We tend to view capital value in a number of ways:

Independent Valuation: The sum attributed to the value of a business based on a capitalisation of profits or discounted cash flow model. A figure established by a professional valuer (usually an accountant) who examines the financial history of the business and forms a view as to what risk should be attributed to the likelihood that those profits will be earnt in the future. Often these valuations are benchmarked around industry norms, recent sales and the gut feel of the valuer.

Listed Company Share Price: The market value that shares are trading at on a listed exchange. Since the dot-com boom – remember the early-1990s? – ‘multiples’ applied to earnings have increased substantially for businesses associated with the internet, digital technologies and social media. In many instances, pricing seems to include ‘a lot of blue sky’, as there are no profits, just expectations. There is also a risk the listed share price of a business will be impacted by actions or events totally out of management’s control (short selling, world events etc).

Market Price: The actual cheque someone is willing to write, and have you bank, which will turn heavily upon what the buyer believes they can do with the business, the urgency of the sale by the vendor and the negotiation skills of both parties. In one sense, it is the real test of the value of the business, that is, what the market is willing to pay, today.

In each of these views of value, the judgement is premised around profits that have been earned and some expectation as to where those profits may move to in the future. Although in each instance there is likely some attempt to take account of the underlying drivers that will influence those profits, they are still views looking at profits, either backwards into the business or forward into how markets may move. I do not believe this view actually lifts the real drivers of capital value to the forefront.

What Produces Value?

Go back 50 years and value was about tangible assets. It was about hard assets such as machinery, factories, equipment, freehold – assets you could put your hands on – and the profits those clearly identifiable assets could produce.

Move forward to more recent times and value has shifted and is now reflected far more in ‘intangible assets’. In some instances, these are still assets that you may be able to touch in one way or another, but not like the old tangible assets. Here is a more traditional list of intangible assets:

• Agency, licence, franchise and supply agreements.
• Brands and trademarks.
• Copyright and content.
• Customers – supply agreements, their loyalty and their visits – online and offline.
• Data and information.
• Designs, blueprints, software, apps etc.
• Know-how, patents and other IP.
• Leaseholds and domain names.
• Lists, relationships, networks, community forums, platforms – online and offline.
• A trained workforce and the programs to create them.

I actually prefer the following list of intangible assets as a way of jogging my mind as to where value may lie:

• Artistic and design expressions.
• Brands.
• Code.
• Communities.
• Contractual rights.
• Data – habits and preferences.
• Human capability.
• Locations – offline and online.

Essential Traits

Of course, once you think you have identified what you believe are intangible assets in your business, you need to make sure they pass the following tests, otherwise they may hold no or little value:

• It can be identified and recognised.
• It has a legal existence and can be protected by law.
• You hold the right of ownership and can transfer that ownership.
• It came into existence at some point of time and can be destroyed or terminated.

I vary these tests slightly and express them as follows:

• Ownership: I legally own it.
• Transferability: I can legally transfer that ownership.
• Durability: It’s going to be around for a while
• Competitive Value: It actually adds material value to my competitiveness.

The bottom line, however, in value, is that ‘value lies in certainty’. The more certain we can be about future profits, the higher the value will be. This statement is true under any of the approaches of thinking about capital value.

From a strategist’s viewpoint, I find the ‘finance’ approaches to capital value lacking. They are premised in calculation – what is the value? Whereas, to a strategist, the question is absolutely – what creates value and how do I influence it?

Accordingly, I think of capital value as the ‘ability of a business to earn an enduring income’. And therefore, my focus is drawn to ‘ability’ and identifying the drivers of this ability (capital value).

Catalysts Not Outputs

In thinking about capital value, I believe it is important that we draw a clear distinction between catalysts and outputs. If ‘value lies in certainty’ then I clearly need to be looking at the catalysts, not the outputs.

What’s an output?

• Sales.
• Visits to my store or online presence.
• Supply chain efficiency.
• Cash flow.
• Profit.

And a catalyst, well, that is what has allowed me to generate those outputs. And in seeking to identify these catalysts, you must continue to ‘peel the onion’ back until you get to its core. The question then becomes: what allowed this output to be delivered? And the further you peel back, the more ‘intangible’ and real that catalyst will become.

What Has Made My Business Successful?

Changing tack on the question of capital value. What do you think has made your business successful?

In order of importance, create a list of the things that have allowed your business to be competitive and, therefore, successful.

Here is a list, top 15 only, that arose a few years ago from a survey of Australian business people as part of my doctoral research, again in order of importance:

1. Strong leadership providing direction and focus for the company.
2. Focusing on the customer.
3. Vision in setting the future course of the business.
4. Creating the correct culture within a company.
5. Being proactive, not reactive.
6. Recognising the importance of employees.
7. Identifying core competencies and building the business upon these capabilities.
8. Flexibility so as to pursue new opportunities as recognised.
9. Accurate intelligence on competitors, customers and industry.
10. Creating minimum bureaucracy.
11. Having a clear understanding of what business you are in and sticking to it.
12. Sustaining overall cost leadership, or differentiation, or focus.
13. Establishing learning capabilities as a competitive advantage.
14. A reward system that encourages innovation at all levels of a company.
15. Creating drive and motivation to achieve to a level of almost obsession.

The key point that struck me when l looked at this list is that there are no tangible or intangible assets to be found anywhere on this list. Not one of the 500 or more people who responded to the question of ‘what made your business competitive?’ listed an asset. What they all listed were ‘actions’. What they listed actually were the catalysts.

It also informed my view that while capital value may be calculated on profit expectation, that value is generated through tangible and intangible assets. But it is the elements of the competitive engine that allow those assets to be brought into existence and worked to generate profits.

The focus in driving capital value commences with the elements of the competitive engine and moves forward from that point.

Strategy and Capital Value

There must be a direct connection between your business strategy and the capital value drivers of your business. In developing your business strategy, you must identify and lift to the surface this connection.

It serves no purpose executing a business strategy through which you are not assured that you are investing in and building your capital value drivers.

Therefore, your strategic plan must reflect an investment in the catalysts and the assets that they create. Without this connection, you are not investing in your capital value drivers and just hoping it will all hang together.

 

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All the best in the success of your business,

Richard Shrapnel