the great (country) race · shifting existing business models or adding new business models to...

THE STRATEGIC NEWS SERVICE ©

GLOBAL REPORT ONTECHNOLOGY AND

THE ECONOMY ™

SNS SubScriber editioN • Volume 23, iSSue 29 • Week of September 3, 2018

SPECIAL LETTER

THE GREAT (COuNTRY) RACE: COMPANY BuSINESS

MODELS AND COuNTRY GDP –OPPORTuNITY OR THREAT?

by Bill Ribaudo

SNS SPECIAL LETTER: THE GREAT (COUNTRY) RACE: COMPANY BUSINESS MODELS

AND COUNTRY GDP – OPPORTUNITY OR THREAT?

BY BILL RIBAUDO

Publisher’s Note: From presidents and policy makers to entrepreneurs and venture capitalists, many leaders today assume the old rules of business and its valuation rewards are instinctive, ineffable, and remain as valid today as they were a generation or two ago in “innovation time.” Bill Ribaudo, through his ongoing research into how the markets have valued different business models, has proven this to be far from true. More important, he has provided detailed guidance to all of these interested parties, from traditional F50 CEOs to startup entrepreneurs, on how to move their valuation models upstream by factors approaching 8x over classical models. While everyone may still assume that customer demand and satisfaction remain primary drivers of business success, Bill and his team have moved the theory into the 21st century, showing the impacts of technology created, IP value and protection, and network effects, on how the markets see companies, and how we all should see country GDPs. In this Special Letter, Bill and his team move further forward in explaining the benefits of paying close attention to the effect of these tech-related operators on valuation. Whether you are an investor, a CEO, or an inventor, you will want to read this week’s issue in order to understand where to put your money, how to manage your company, or which type of product to build next. – mra. [Ed. Note: We’re delighted that Bill Ribaudo will be speaking at FiRe 2018 in October. To be there for his talk and Q&A, and insights by other experts from varied industries on what to expect in the next 3–5 years, sign up now at www.futureinreview.com.]

In This Issue Week of 09/03/2018 Vol. 23 Issue 29

Special Letter: The Great

(Country) Race

o The Revenue Multiplier

Framework

o Investigating the Relationship

Between Revenue Multiplier and

GDP

o What It Will Take to Win The

Great (Country) Race

o About Bill Ribaudo

o Contributors

Inside SNS

Upcoming SNS Events

o FiRe 2018

o Where’s Mark?

http://www.futureinreview.com/

Strategic News Service™ LLC www.stratnews.com Copyright © 2018

SNS: Special Letter Week of September 3, 2018 1

SPECIAL LETTER:

THE GREAT (COUNTRY) RACE: COMPANY BUSINESS MODELS AND COUNTRY GDP – OPPORTUNITY OR THREAT? by Bill Ribaudo In business, the customary wellsprings of value creation have been clear for decades: Create products and services that the market requests and sell it for a profit. Investors have rewarded this mindset and valued organizations in view of their capacity to make a profit, given a specific set of physical resources. In the present economy, however, we're seeing a new breed of business valuation, one that values companies differently. Organizations that have yet to turn a profit command market capitalizations into the billions. Today, investors are measuring, and rewarding, value very differently than they have in the past – and we believe that such valuation is neither a bubble nor a fad. This paper reviews the Revenue Multiplier business model framework1 and explores the implications of our research beyond business strategies and capital market valuation, discusses how gross domestic product (GDP) correlates to business model, and – more important – how insights gained could be used by leaders to incentivize businesses. These findings are about understanding how to recognize and take advantage of trends to create opportunities for economic growth. For corporate leaders, we share insights for consideration about geographical and geopolitical investment strategy. The Revenue Multiplier framework Before we explore the application of our Revenue Multiplier (RMx) framework to countries and its correlation to GDP, let’s review the framework from which our work is based. Across the economy, industries are converging, driven by now-ubiquitous technology that is redrawing – and in some cases erasing – conventional market boundaries. This shifting landscape has set up a Great (Corporate) Race between traditional (typically physical) businesses and new technology companies to see which can create the most value by successfully supporting both physical and virtual assets. Are online hospitality-service businesses hospitality companies or

1 For further detail (beyond what is explained in this paper) regarding the Revenue Multiplier (RMx)

framework, please see the SNS Special Letter “Technology is changing how we view industry, value

companies, and develop strategy”, Dated May 2015

https://www2.deloitte.com/us/en/pages/risk/articles/changing-technology-business-model-valuation.html

https://www2.deloitte.com/us/en/pages/risk/articles/changing-technology-business-model-valuation.html



technology platforms? Are e-hailing businesses technology companies or transportation businesses? Are electric-car manufacturers automotive companies or technology companies that create energy, software, and hardware … and put them on four wheels? Rapid innovation is creating space for new business models to emerge in almost every industry. New technology norms – the internet, social media, mobile, and cloud computing – are removing many barriers to entry, allowing companies to open new markets faster than ever before. As companies become digitally enabled, they often trade more on revenue performance than on earnings performance. Therefore, we looked at price-to-revenue (P/R) ratios as a key metric, and hereafter refer to the metric as the Revenue Multiplier. Revenue is also a more stable, more predictable measure, and is less susceptible to high variations as is the price-to-earnings (P/E) ratio. Our market research looked at how company valuations have changed over time. We reviewed 40 years of financial reports for the companies in the S&P 500 index, analyzing which received the highest P/R ratios, and found a strong correlation between valuation and business model. What we learned after evaluating each company’s business model was remarkably simple – and helps one understand and simplify the complexity of industry sector convergence. Our research has uncovered a new way to view, analyze, and value companies – through the lens of business models. We identified four foundational business models: Asset Builders, Service Providers, Technology Creators, and Network Orchestrators.

Each of these four business models yields a significantly different Revenue Multiplier result. In particular, Technology Creators and Network Orchestrators are valued more than Asset Builders and Service Providers. On average, the market pays approximately $8 of valuation for every $1 in revenue generated by a Network Orchestrator. Asset Builders and Service Providers, meanwhile, receive only $1 or $2 in valuation for every $1 in revenue.

The presence and importance of technology within business models has created a “digital divide” – technology-based models above the divide grow faster, scale faster, and have higher margins and Revenue Multipliers. In today’s paradigm, investors are rewarding these models, and show how value has shifted from hard to soft assets, physical to intellectual, tangible to intangible. Armed with this new _______________________

* The 1X, 2X, 4X, and 8X Revenue Multipliers were the result of our original research using data through 2015. Later we validated the research through 2017; while the absolute Revenue Multipliers numbers increased, the relationship among them stayed the same.



perspective, management can begin to look at ways to identify business models that monetize intangible assets to grow a business’s overall value. Financial markets shift to intangible assets Another way to view how value has shifted and valuations have changed is to understand the series of economic revolutions. Starting with the Industrial Revolution in the mid-1800s through about 2010, with the start of the Network Revolution (Figure 1), the major component of the market value of the S&P 500 shifted dramatically from physical assets to intangible assets.* Figure 1. US economic revolutions

Copyright © 2018 Deloitte Development LLC. All rights reserved. In 1975, for a subset of 300 of the S&P 500 companies, 83% of market value was related to physical assets such as factories, equipment, and inventory – all recorded on companies’ balance sheets as net book value. Market capitalization was close to book value, because fixed or tangible assets made up the majority of a company’s value. But by 2015, only 16% of market value in the analyzed group was related to net book value or tangible assets. An overwhelming 84% of value was represented by intangible assets such as intellectual property (IP) and customer capital, as shown in Figure 2.



Figure 2. Tangible vs. intangible assets as components of market value2

Implications In today’s paradigm, companies need to adjust their views of assets to encompass intangible assets – including those for which the market values are not recorded on the balance sheet. With this new perspective, management can begin to look toward shifting existing business models or adding new business models to monetize these (now more visible) intangible assets and grow a business’s overall value. Although the composition of the S&P 500 has changed significantly over the years, there are still plenty of companies that have an opportunity to increase their value (and corresponding Revenue Multiplier) by moving toward information- or network-based business models (see Figure 3).

2 Ocean Tomo Investment Group, “Annual Study of Intangible Asset Market Value from Ocean Tomo,

LLC”, Dated March 4, 2015

http://www.oceantomo.com/2015/03/04/2015-intangible-asset-market-value-study/

http://www.oceantomo.com/2015/03/04/2015-intangible-asset-market-value-study/



Figure 3. Composition of the S&P 500 by business model

Note: Based on analysis of the S&P 500 Source: Capital IQ data pulled June 2018 Manufacturers and other traditional Asset Builders have the opportunity to embrace new digital technologies, leverage information and customer data, or even move to orchestrate networks to propel themselves across the digital divide – driving higher Revenue Multipliers and shareholder value. Know that while traditional businesses eye a shift to leverage their nascent intangible assets, Technology Creators and Network Orchestrators are continuing to eye investments in the physical space, setting up what we believe is The Great (Corporate) Race. There is no single solution for winning The Great (Corporate) Race. In the end, it’s about using today’s technology to build businesses that meet customers’ needs (better than one’s competitors). Businesses that dominate tomorrow’s landscape will likely be those that move rapidly to seize opportunities, reallocate capital, and find the balance of tangible and intangible assets to win The Great (Corporate) Race – those that remain one-dimensional will likely lag behind. Investigating the relationship between Revenue Multiplier and GDP After establishing the correlation between the business model of a company and its market value, we extended our research to look at potential correlation between a country’s GDP and the business models the country supports. Do countries fare relatively better if the company business models it supports are primarily making and selling physical products and services, or if they’re also building technology-based businesses? And how, if at all, does a country’s support of particular business models correlate with its GDP growth or decline? In short, are there insights to be gained that connect business models with GDP? We believe there are … and this sets up The Great (Country) Race.



Research Our research was based on nominal GDP – the value of final goods and services that an economy produces during a given year. We identified seven countries with the highest nominal GDP – the US, China, Japan, Germany, the UK, France, and India – and added Switzerland and Israel due to their reputation for high innovation. Together, these nine nations comprise 67% of global GDP. This was our starting point, and we’ve since added (and continue to add) numerous other countries to our study. For the identified set of nine countries, we classified economic activities and industries for these countries based on how each fit into the Revenue Multiplier framework (the four business models: Asset Builders, Service Providers, Technology Creators, and Network Orchestrators). We considered the business models of the most influential companies in each industry / sub-industry segment. For example, we classified pharmaceutical manufacturing as an Asset Builder, and pharmaceutical research / licensing as a Technology Creator. Similarly, transportation was classified as an Asset Builder, while taxi e-hailing was categorized as a Network Orchestrator. Once the industries within each business model were identified, we assigned each industry a weightage within its relevant business model. Higher weightages were given to industries with a higher impact on GDP value in economies. Figure 4 shows a sampling of our classification of industries / sub-industries into the Revenue Multiplier business model framework. Figure 4. Classification of industries by Revenue Multiplier business model framework

Further, we focused on key characteristics and infrastructure enablers for each business model:

• Asset Builders. The availability of government support, grants, and subsidies; prime lending rate; and the amount of foreign direct investment were indicators of a healthy environment for Asset Builders. In addition, infrastructure enablers required to move



products, such as port, rail, road, and distribution facilities were critical.

• Service Providers. Government initiatives, such as nationalized healthcare, tourism, and open banking all help support a positive environment for Service Providers. Infrastructure enablers include well-established healthcare and educational ecosystems of hospitals, clinics, schools, colleges, and universities.

• Technology Creators. Government and private partnerships, as well as a streamlined drug approval process and healthy research and development (R&D) spend in drug development, support growth of the Technology Creators business model. Infrastructure enablers include IP protection and enough universities to encourage advanced studies and PhDs in science and engineering, providing the basis for innovation and new product development.

• Network Orchestrators. We compared data privacy policies, the number of data breaches, and the security of financial transactions for Network Orchestrators. Infrastructure enablers for the adoption of Network Orchestrator business models include mobile internet user penetration, social-media network usage, digital buyer penetration, and e-business readiness.

Further detail is shown in Figure 5. Figure 5: Summary of key characteristics and infrastructure enablers for business model adoption



Offering more detail into our research approach, we identified parameters, regulations, and key performance indicators (KPIs) that play a critical role in each industry (see Figure 6). Figure 6. Factors impacting each industry

As examples: Healthcare services (one of the industries within the Service Providers business model) parameters (level 1) were market demand and number of hospital beds (per million population). Regulations (level 2) were the presence of a policy roadmap and changes in the regulatory landscape. Taxi e-hailing (one of the industries within the Network Orchestrators business model), parameters (level 1), and KPI (level 3) were taxi market size, mobile internet user penetration, and level of government regulation. Within our research, each factor (parameters, regulations, and KPI) was assigned a relative score and given a weight based on its impact on each industry. A total weighted average score was calculated for each industry in each country based on the sum total of the three factors. Each industry was given a weight based on its impact on the overall business model, and a weighted average score was calculated for each country for an entire business model classification. The business model score of each country was compared with its GDP (growth or decline) for the three multi-year periods of 2010–2013, 2014–2015, and 2016–2017 to see if results correlated. Findings There is correlation: The GDP of the US, China, the UK, India, and Israel increased in each of the three multi-year analyses3, as did the adoption of Technology Creator and Network Orchestrator business models in these countries. The GDP of Japan declined in two of the time periods, while the GDP of Germany, France, and Switzerland declined over 2013–2015. In the same years, the relative adoption of Technology Creator and Network Orchestrator business models declined in these countries. Figure 7 shows the strong correlation of business model adoption with GDP growth or decline.

3 With the exception of the UK’s GDP declining in 2015–2017 due to depreciation of the pound, resulting

inflation, and decrease in consumer spending on the heels of Brexit. (The Guardian, “The Brexit

economy: falling pound and rising inflation fuel fears of slowdown”, Dated October 24, 2016

https://www.theguardian.com/business/2016/oct/24/brexit-economy-falling-pound-rising-inflation-fuel-fears-brexit-watch

https://www.theguardian.com/business/2016/oct/24/brexit-economy-falling-pound-rising-inflation-fuel-fears-brexit-watch



Figure 7: GDP correlates to supported business models

We observed that countries that support technology-based business models (above the digital divide) without ignoring the models below the digital divide have positive GDP growth, and those countries that don’t appear to support technology-based business models have declining GDP. In countries where this correlation isn’t consistent, we saw extenuating circumstances, such as government stimulus programs (Japan) and Brexit (the UK), that influenced GDP growth independent of business model support. As newer technology-based business models emerge, traditional industries that once controlled information and access are being challenged by new entrants. The democratization of information is placing power in the hands of the consumers – and leaders should understand these market forces and consider how they might balance support of new and old business models. Examples Taxi e-hailing The governments of the US, Japan, and the UK have each approached the emerging taxi e-hailing industry differently. Generally, in the US the regulations seem more relaxed, while in Japan and the UK the regulations seem more stringent. In many states in the US, there is a two-tier framework for transportation companies (taxi e-hailing) and traditional taxis, even though they provide the same service. More than 30 US states have legalized e-hailing apps by creating a new



regulatory category, under which the e-hailing regulation is lighter than for traditional taxis. In 2013, the California Public Utilities Commission established a new category called “Transportation Network Company,” under its statutory authority over “charter-party carriers,” to regulate e-hailing services. In contrast, Japan’s e-hailing regulations seem tougher. When an e-hailing company launched a pilot program in the city of Fukuoka in 2015, the Japanese transport ministry stopped it, identifying it as an unlicensed taxi business. Meanwhile, in the UK, the e-hailing phenomenon has set traditional taxis against e-hailing companies. In London, the taxi drivers’ union has fought to prohibit e-hailing businesses, while 850,000 customers / riders have signed petitions seeking to allow the e-hailing companies to do business in the country. Like many other traditional industries, the incumbents often rely on legal arguments based on existing (old-economy) laws, while the new entrants tend to rely on market-based / consumer-driven demand. As expected, the US scored higher than Japan and the UK when it came to regulatory favorability for the taxi e-hailing industry.

Social media networks In general, internet regulations are stricter in the EU than in the US. In the US, all electronic communication is regulated by the Federal Communications Commission (FCC). In line with freedom of speech, protected by the First Amendment to the US Constitution, the US has minimal content regulations. In contrast, EU laws, which generally have a greater focus on individual privacy, have led to stricter social-media regulations. Germany, for example, has stricter security-breach notification requirements than other EU jurisdictions4 (e.g., before sending unsolicited marketing by email, one must first obtain consent from the recipients). In China, media and internet censorship is generally understood to be prevalent, and content and access can be routinely restricted. For example, the government has shut out access to a number of non-Chinese social media companies and is cracking down on video-streaming websites, virtual private networks (VPNs), online forums,

4 EU GDPR Academy, “EU GDPR Knowledge Base”, Dated August 2017

https://advisera.com/eugdpracademy/knowledgebase/eu-gdpr-vs-german-bundesdatenschutzgesetz-similarities-and-differences/



and chat rooms.5 China-based websites cannot link to overseas news websites or distribute news from overseas media without separate approval. As expected, the fact that it is much easier for internet-driven businesses to operate, and without as many obstacles in certain countries compared to others, the following relative degree of regulatory favorability resulted.

Retail e-commerce France, Japan, and Germany scored higher than many of the countries we studied for e-commerce retail, due to regulations and policies that have a favorable impact on both e-commerce operators and consumers. The US Federal Trade Commission (FTC) and the Organisation for Economic Co-operation and Development (OECD) have privacy and protection guidelines promoting data transparency that benefit both e-retailers and consumers alike. In China, policies that call for foreign products to be registered and labeled according to Chinese laws and regulations can limit the availability of foreign products online, restricting inventories for e-retailers and choice for consumers. Marketplace differences also impact retail e-commerce environments. Digital buyer penetration, or the percentage of internet users who purchase products online, is close to 54% in the US and about 44% in France. E-commerce retail sales as a percentage of GDP were 1.9% in the US and 1.7% in France.6 Financial transaction security varies by country. In 2014–2015, the US had approximately 1,600 secure internet servers per million people, and France had about 800 per one million7 and accordingly, the following relative degree of regulatory favorability resulted.

5 The CNBC, “China has launched another crackdown on the internet – but it's different this time”,

Dated October 26, 2017 6 The eMarketer, “eMarketer Roundup: Media usage around the world”, Dated March 01, 2016 7 The World Bank Database, “Secure Internet Servers”, Data refreshed January 2018

https://www.cnbc.com/2017/10/26/china-internet-censorship-new-crackdowns-and-rules-are-here-to-stay.html

https://www.emarketer.com/search1/?query=media%20usage&hitsPerPage=10

https://data.worldbank.org/indicator/IT.NET.SECR.P6?view=chart



Intellectual property protection A country’s patents, copyrights, and trademarks are very valuable, and countries have a strong reason to enforce policies that safeguard IP and protect against counterfeiting. In terms of IP protection, the US, Germany, and the UK scored higher than other countries. Across the board, the US continues to rank high in IP protection. Major indicators include the related rights and limitations placed on patent, copyrights, and trademarks; enforcement; and membership in and ratification of international treaties. The International Property Rights Index (IPRI) tracks and reports on the property rights of countries worldwide. It found that IP rights show robust correlation with civic activism and the number of researchers in R&D. Results indicate that a robust property-rights system plays a positive role in alleviating poverty, fighting corruption, and creating the social norms that allow citizens to participate responsibly in the process of setting public policy8; and accordingly, the following relative degree of regulatory favorability resulted.

Implications for leaders

For an economy to thrive, leaders should consider support for all four business models – those not only below, but, equally important, those above the digital divide. This support should include social, digital, and mobile technologies and offer strong IP protection. We also believe that leaders should focus on economic (over political) issues. For example, the need to invest in physical infrastructure (roads, bridges, and tunnels) is evidence to support Asset Builder and Service Provider business models, yet a balancing message to also invest and support technology-based IP business models is (as our analysis suggests) correlated to promoting GDP growth. What it will take to win The Great (Country) Race In 2013, when we completed our original business model research and began articulating its results, many of the concepts were not yet widely understood, and many leaders continued to operate with an Industrial Revolution economic mindset. In the last few years, the pace of change has accelerated, and as these trends have become more evident, leaders have begun to take notice and change.

8 IPRI, “The International Property Rights Index 2018”, Dated August 09, 2018

https://www.internationalpropertyrightsindex.org/



While industries converge and traditional industry boundaries blur, manufacturers are mining data and generating insights from devices – at the same time, technology-based companies are investing in storefronts and expanded campuses. Amid such intense change, leaders should strive to understand this digital divide and balance support for all business models. Our analysis shows that balanced support that enables businesses to leverage data assets or orchestrate networks, in addition to manufacturing and service models, can drive higher GDP growth. There is no single solution to winning The Great (Country) Race. In the end, it’s about using thoughtful, balanced support cognizant of today’s technologies. The economies that dominate tomorrow’s landscape will likely be those that balance support of all four business models. Those that remain focused on older business models may risk falling behind.

About Bill Ribaudo

Bill Ribaudo is an author and frequent international speaker on digital business model innovation and its link to market valuation. He has written for the Wall Street Journal, Knowledge@Wharton, Deloitte CFO Insights, and the Strategic News Service Global Report. He’s been featured as a speaker at engagements including the 2018 LinkBridge Global Investors Annual Meeting, CES 2018, the Economy and Technology 4.0 Conference, the Intelligent Enterprise Conference, the 2015–2017 SNS

Future in Review (FiRe) conferences, the 10th Annual Utah Economic Summit, BBC radio, Business Radio on Sirius XM powered by the Wharton School, The McCuistion Program on PBS, and the Dallas Annual Governance Symposium at the University of Texas. As the managing partner of Deloitte Risk and Financial Advisory’s Digital Risk Venture Portfolio at Deloitte & Touche LLP, Bill oversees investments and services designed to help clients drive the digitization and transformation of their businesses. He is also a senior advisory partner to some of Deloitte’s most strategic clients. Prior to his current role, he led Deloitte Advisory’s Technology, Media, and Telecommunications Industry practice for many years. He is a member of Deloitte’s US CFO Program leadership team and serves as managing partner and founding dean of The Next Generation CFO Academy. His more than 35 years of business experience includes executive financial management in public companies and strategic and operational consulting.



Contributors

Seema Bajaj Nicole Harper

Bill is supported by a leading team of professionals, led by Seema Bajaj and Nicole Harper. In addition to directing the Revenue Multiplier research, both Seema and Nicole serve clients, helping executives see these new opportunities and begin their journey to shift business models for higher shareholder value.

Parikshit Sinha Aditya P. Singh They are supported by Parikshit Sinha and Aditya Pratap Singh from Deloitte’s Research team in Hyderabad, India. This document contains general information only and Deloitte is not, by means of this document, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This document is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. In addition, this document contains the results of surveys conducted by Deloitte or its affiliates. The information obtained during the surveys was taken “as is” and was not validated or confirmed by Deloitte or its affiliates. Deloitte shall not be responsible for any loss sustained by any person who relies on this document. As used in this document, “Deloitte” means Deloitte & Touche LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of our legal structure. Certain services may not be available to attest clients under the rules and regulations of public accounting. Copyright © 2018 Strategic News Service and Deloitte Development LLC. All rights reserved.

I would like to thank Bill and his team for not only creating this Special Letter, with all of the time involved across his global teams, but also for continuing this path of research into the deeper causes of the connections between types of technology and how each drives both company, and country, economic successes.



And, last but never least, our gratitude to Editor-in-Chief Sally Anderson, for putting all of these thoughts into perfect shape.

Your comments are always welcome.

Sincerely,

Mark R. Anderson

CEO Strategic News Service LLC Tel.: 360-378-3431 P.O. Box 1969 Fax: 360-378-7041 Friday Harbor, WA 98250 USA Email: [email protected]

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