Adjust your strategy in a tight market
As the business environment adjusts to higher inflation and less capital, companies must stop prioritizing growth above all else while recognizing that innovation remains essential. They will need better thought out strategies that factor in costs as well as necessary changes to technologies and business models.
Over the past two decades, the scope and priorities of businesses have been shaped by an abundance of capital. Today, uninvested capital in private equity funds stands at an all-time high of $3.4 trillion. With such massive liquidity chasing few opportunities, valuations for innovative investments have been elevated. The prevailing low interest rate environment has only heightened 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, was enough to convince investors of the value of a company.
Now that interest rates are rising and liquidity is being flushed out of the system by central banks around the world, the focus is now on yields. As investors shift from irrational exuberance and fear of missing out (FOMO) to a preoccupation with earnings and valuation, the criteria for what adds value will adjust, creating challenges for companies based on the value of growth. Whereas in the past, skilled sellers like WeWork’s Adam Neumann could oversell a concept even when the finances didn’t add up, burn through cash with little comfort other than buying growth, costs of higher investment and lower liquidity will inevitably lead to closer scrutiny.
Such a review can be a welcome change. Seduced by the promise of new business models, and obsessed with the stratospheric valuations and cash generation of Big Tech, many companies have embarked on a strategy of digital expansion. Look at tech platforms, the folklore has gone: focusing on profits would have drowned the business. Jeff Bezos was right to push back against the pressures to be profitable, because growth and ultimate scale would later lead to untold riches.
The challenge is that big tech companies had unusual advantages, and their ability to be a gatekeeper, who commands extraordinary power, cannot be easily replicated. So alongside many brave business transformations that added value, we also saw a blind belief that emulating certain aspects of the big tech company’s approach to acquiring a company that would help companies credibly claim that ‘they could become a platform owner or an ecosystem orchestrator. Companies around the world 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 this blind belief. That’s not a bad thing, but the risk, of course, is that business leaders will swing from unbridled enthusiasm to overcautiousness as the structural forces transforming our world are stronger than ever. As companies will inevitably have to absorb some of the cost increases and reduce their profit margins, the question of whether they will switch from naïve excitement to blind caution remains.
It would be a mistake. The collapse of cryptocurrency valuations, for example, does not mean that the technologies behind them pose less risk to banks and other financial institutions. Digitization continues to progress rapidly. Customers are ready to be seduced by multi-product ecosystems or encompassing experiences. While WeWork’s original thesis was oversold, smaller competitors like Workland in Estonia are finding that returns can emerge if the model is well thought out.
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. Chinese tech giant Tencent and its all-in-one service WeChat, Japanese retailer Rakuten, Chinese insurer PingAn, Indian conglomerate Reliance Jio and major Western tech companies are in a race to find a single point of contact. for consumers. Companies like Omada in the US, which focus on care for chronic conditions such as diabetes, are using their experience ecosystems as a new way to engage the customer. Loyal Italian coffee supplier Lavazza is experimenting with a role as an orchestrator of a coffee experience ecosystem. In short, sector after sector, value is migrating towards creative multi-firm propositions going from physical to digital and connecting different actors.
As companies adapt to these new conditions, managers will need to:
- Accept change, which is probably the most difficult request. It is important for managers to understand that the cost-benefit calculation should not compare the investment case to the status quo. It must compare the investment case with what inaction will entail – and that often means declining margins and volumes, and changing customer needs.
- To understand the nature of the added value of the commitment to innovation. They must show how innovation is linked to both growth and margins. This means going beyond buzzwords to see what digital transformation and disruption really brings to the table, understanding the merits of engaging with platforms and ecosystems, the benefits of using IA, the potential benefits of getting involved early in the metaverse, and the merit of employing gamification to better connect with their customers.
- Recognize that rather than trying to dominate and risk overinvesting as an orchestrator in these new platforms and ecosystems, they can also engage in a more modest strategy of being a good partner or complement, and that they will need a portfolio of thoughtful proposals. Their criteria should not only be the upside, but also the risk and the scale of the investment they are going to undertake.
The challenge facing businesses is that the world is changing and success will likely come from new ways of adding value. Yet, with no quick solution to inflation in sight, we should expect a reassessment of strategic priorities, with reduced liquidity and increased capital costs leading to greater scrutiny. This will require the ability to develop reasoned arguments about what adds value and why more than casual selling. The time for real strategic work, grounded in reality and connected to a company’s long-term vision has arrived. It’s time to embrace it and roll up our sleeves.