How does the Amazon innovation formula keep replicating?

How does the Amazon innovation formula keep replicating?

Feb 7, 2018 | Change, Governance, Innovation, Strategy

Amazon is an astonishing company for a whole lot of reasons, but there is one that is not front and centre in most conversations I have seen and in which I have been involved. This is the means by which Amazon just keeps on innovating, genuine, disruptive innovations, time after time, at astonishingly small intervals.

Note: This link is to an expanded version of this infographic from Visualcapitalist.com

 

Amazon must have the internal processes that enable it to punch out new businesses, and business models that way a factory stamping machine pumps out widgets.

The biggest impediment to efficiency on a widget machine is the changeover times between widget sizes and internal specifications.

Quick changeover is a hallmark capability sought by manufacturing companies employing Lean thinking, and is a challenging proposition, even in a small, tightly run factory. So how does Amazon achieve it at scale in businesses as complex as it routinely disrupts.

Amazon started by flogging books, or as CEO Jeff Bezos  (apparently) liked to say in the early days, ‘we do not sell books, we make books easy to buy’

The hallmark of a successful lean implementation in a factory is that there are processes that take a prospective order through the whole ‘sales funnel’ to production, delivery, and ongoing relationship building. Lean practitioners call it the ‘Value Stream,’ the set of activities required to deliver value to the customer. These are all done the same way, every time.

The paradox is that this process stability is the foundation of innovation, you need a stable base in order to trial ideas at speed, then scale the ones that work. This is an idea sometimes hard to communicate but as fundamental as it gets to successful innovation and continuous improvement.

Amazon appears to have achieved this at scale, in a service business, typically harder than a manufacturing business to get traction.

How?

Amazon is organised just like a whole collection of independent business units, all cross fertilising, and cross pollinating each other, using (I suspect) what Ray Dalio would term ‘Radical Transparency‘.

The secret seems twofold:

  • The internal technology that Amazon uses across all its activities, is modular and scaleable.  It is in effect the machine enabling the manufacturing of Amazon widgets. This enables new businesses to be added the way you would add another coloured widget to the sales inventory of a manufacturing business. I suspect the scalability will be the source of the next round of disruptions coming to the fast moving goods retailers.
  • Each part of the business multiplies the customer impact of the ones next door, a ‘flywheel’ effect. Digital technology enables the network or ‘Flywheel’ effect to build momentum. The more eyeballs you have on one side of the network equation, the greater the value to the other side. This effect builds scale very efficiently once you have reached a tipping point, reflecting Metcalf’s law which states that the value of a network increases with the number of nodes in the network.  Amazon has created their own version of Metcalfe’s law amongst their own offerings, one product or service leading to the one next door.

Bezos has achieved something that I think will be studied for decades, and it is clear he is not stopping any time soon. The only thing that appears likely to slow the momentum is regulatory intervention. Amazon has 44% of  on line retail sales in the US, 35% of global cloud services, a market growing at 40% a year,  where AWS is bigger than the next 5 biggest combined. The list goes on. The point is, Amazon is chewing up competition everywhere, yet pays very little tax, $1.4 billion since 2008, while Wal-Mart has paid $64 billion over the same period, so in effect, Wal-mart is subsidising its greatest threat to eat its lunch. Outcomes and numbers like that will have to prod regulators into some sort of action, before Amazon (and to be fair, Facebook and Google are very similar, even more dominating in their markets)  is in a position of power so dominant that regulators cannot stop them.

Amazon, a product of the 21st century is simply outrunning the capacity of the institutions and public mind set of the 20th century by reshaping our world around us, and with our consent by unthinking compliance. They are being joined in this exercise by Google, Facebook,  Alibaba Tencent, and a few other aspirants like Netfliks, to dominate the way we think, behave and work.

Header photo Jeff Bezos circa 1998

 

Update June 2018.

Amazon bought on line pharmacist ‘Pillpack’  last week for almost a billion dollars, saw its own share price jump double what they paid at the same time industry incumbents collectively lost 10% market valuation. Jeff Bezos has signalled his interest in pharmacy in various ways for years, so this should not come as a surprise, but it seems to have done so, as the threat of Amazon had clearly not been priced into the market valuations of the incumbents.

The Pharmacy guild in Australia, one of the most powerful lobby groups in the country, should be asking themselves if they are next for the chopper.

Update August 2022.Amazon last month paid $A5.6 billion for subscription health service One-Health, which gives them a network of doctors surgeries around the US. If ever there was a huge industry mired in its own importance, removed from the needs of those it is supposed to service, and ripe for disruption, it is the US health care industry. It will be a tough nut to crack, others have tried and failed, but Amazon has the street-cred to make it happen. The ‘flywheel’ at work again.

9 reasons why SME’s should invest in a governing board

9 reasons why SME’s should invest in a governing board

Jan 31, 2018 | Governance, Leadership, Small business

 

Very few of the small and medium sized businesses I interact with have a governing board of any real quality. Many have a ‘board’ required under the various regulatory regimes they must meet, but very few have a board that acts in the manner of a public company, as an independent oversight of strategy, financial and operational performance, culture, and of the senior management effectiveness.

This is something that should be remedied.

The short term costs are in my experience  heavily outweighed by the benefits over the medium to long term.

Some of the benefits I have seen can be summarised as:

  • Introduction of industry knowledge and networks.
  • Introduction of business management expertise and experience from a wide range of backgrounds.
  • Provides time and the catalyst for management to consider wider issues than the normal ‘urgent’ things that dominate the daily routines.
  • Provides diversity of views, values and ideas
  • Keeps management and particularly the CEO focussed on the issues that will impact long term commercial sustainability, as well as the short term financial outcomes.
  • Adds depth to the management functional capability by enabling mentoring and coaching
  • Thought starter and sounding board for management
  • Acts as a catalyst and guidance for longer term capability development of employees, and the manner in which the business captures and leverages those capabilities.
  • Oversight if not development of strategy, and oversight of strategy implementation, feedback and renewal.

 

There is an old saying that most of the smartest people in your industry work somewhere else. Therefore it makes sense to try and tap into that expertise in some way, and a well considered ‘board’ is a great method.

These bodies do not necessarily operate under the rules of  the Corporations Act, where there are enforceable fiduciary responsibilities. They are usually more of an advisory body, often meeting  formally only 4 times a year, but with significant interaction with management on an as needed basis.

 

What governments can learn from small business.

What governments can learn from small business.

Jan 29, 2018 | Governance, Leadership, rant

Apart from the obvious, of doing sufficient due diligence on the important detail, such as knowing your nationality, there are many other lessons to be learnt.

Amongst the key ones is the depth of consideration small business owners need to give to the deployment of their very limited financial and operational resources. In most cases, some level of financial and strategic consideration is applied, and trade-offs are always necessary and usually painful. Governments on the other hand are not similarly constrained, spending is welcome, and rewarded, whereas constraint and tough choices are avoided, and there is no bank to refuse an increase in the overdraft.

Those I work with are encouraged to consider their commitments from three buckets:

  • What is required to keep the business going, which includes operational and necessary capital expenditure.
  • What is required to build the resilience and agility of the current business, enabling it to grow and prosper at the rate, and in the manner necessary to be commercially sustainable.
  • What is required to move the business to the ‘next level,’ whatever that may be in the context of their competitive and strategic environment.

Those that give this sort of framework deep consideration generally come out on top.

By contrast, Governments seem to consider their expenditures only in two buckets.

  • Sustain operations and get elected. In other words, never take anything away, but find creative ways to rebadge it so that it seem you are always giving.
  • Who is entitled to what from the bottomless purse of money to be spent. Joe Hockey when delivering the 2014 budget referred to ‘The end of the age of entitlement’ and look where it got him, and the Abbot government. A bad dose of adversarial short term politics by the opposition, and marketing incompetence by the government ensured that the age of entitlement continues, to this day.

 

Let’s hope that in this new year we see some common sense and vision emanating from Canberra. A big ask, but after a year of utter and complete chaos, irresponsibility, and self-congratulatory bullshit in 2017, I think we all deserve more.

 

How do you measure the scalability of your business?

How do you measure the scalability of your business?

Jan 23, 2018 | Change, Governance, Management, Strategy

Almost every business I know  seeks to grow, as there is a recognition that growth brings benefits beyond simply the size of revenues and profits. It  brings credibility, attracts good employees, enables negotiation from a stronger position, and much more.

It seems to me that there are four macro measures that can be applied, each with a few key sub measures that can be used as appropriate.

‘Stickiness’.

This is a term I use to describe a combination of factors vital to the health of every business.

  • Customer retention rates. How much customer ‘churn’ do you get, how long is the average ‘ ‘lifetime’ of a customer, and what is the subsequent lifetime value of a customer. Associated with customer retention is the cost of customer acquisition. At some point, investment in further customer retention will start to deliver diminished returns. It is therefore sensible to have a parallel process in place that delivers a steady flow of new customers coming in to replace those that do move on, and build the spread of customers and the penetration of your preferred markets.
  • Share of Wallet. Regular readers will be aware of my attraction to this measure. In effect, how much of a customers purchases that you could service, do you actually attract. Calculation becomes an important strategic exercise as it forces you to consider which types of business you can and want to service, which markets you are able to compete in effectively, and the relative power of your value proposition in any market segment.

 

Referrals.

How likely are your customers to refer you to others? When an existing customer values the services you provide sufficiently to recommend you to their own networks, that is marketing gold. One of the formal measures that has gained a lot of traction is the Net Promoter Score. This is a very binary system, which has its merits, but I like to see some qualitative evidence as well, gained by customer stories, feedback, and various answers to the question ‘where did you hear about us’?

How likely are those in your value chain to recommend you, these referrals are as useful and relevant as those from your customers, as they have a commercial relationship with you, and are in a great position to judge.

Margins.

The simple word ‘Margin’ can have different meanings to different people, particularly accountants, but in its simplest form, is the profitability divided by revenue. However, you do not bank percentages, just dollars, so you also need to consider the absolute amounts of money that can be made from a market. Generally the higher the margin, the better, but generally, higher margins attract competition, so over time margins become eroded. The key is  to make the margins sustainable, which requires appropriate strategic investments to be made.  Measurement  of margin can take many forms:

  • Customer margins can be measured both individually and by group, depending on the nature of the business.
  • Product margins similarly can be measured by product and product group.
  • Both the customer and product margins can then be further measured by geography, market segment, and any other sensible parameter. The absence of margin management is a sign of poor or at least lacking management, and the mixing of marginal costs, particularly in the case of a manufacturing business, with overheads is a significant drain on management ability to make informed price and cost management decisions.

Investments.

Effective financial management captures all investments of cash irrespective of the nature of that investment. It makes no distinction between operational and regulatory investments necessary to keep a business functioning, and those that have some risk associated with shoring up future revenues and margins. Investment in marketing, innovation, staff capability, process optimisation and others do not routinely turn up in financial statements, but without them any business is doomed, so seek them out in any due diligence exercise.

Good businesses make the investments in line with their strategic priorities, and track the outcomes of those investments over time.

Need help thinking about these issues, give me a call.

 

11 trends that will influence success in 2018

11 trends that will influence success in 2018

Jan 15, 2018 | Governance, Leadership, Strategy

This is not really a set of predictions, those are around at this time of the year aplenty. Rather it is a mix of the things I am thinking about, the trends I see underlaying the performance of both the public and private sectors, and the performance of marketing and strategy in these changing contexts.

It is pretty easy to make predictions, get a few right, and you become seen as a ‘guru’ but few remember the many you got wrong, so I am not going to try this year.

Are monopolies OK?

Facebook and Google between them control 75% of the global digital ad spend, not a monopoly, but certainly a global duopoly.  Currently around 40% of advertising spending is digital,(depending on whose numbers you use)  and the lack of transparency and accountability is huge. The rock was kicked over by Procter & Gambles  Mark Pritchard in a presentation to the IAB in January 2017, and the roaches are still scuttling from the light. There has been movement for the better as Colgate, and several other major advertisers followed the lead of P&G and slashed their digital ad budgets until their suppliers could/would supply data that supported their claims. However, advertising is only a slice of the cake.

Facebook as a ‘community’ holds unprecedented power, with the attendant opportunity for morally challenging situations to arise, something Mark Zuckerberg  acknowledged in his 2018 letter, and  needs to be addressed.

Amazon continues its march to world retail dominance, (so long as you ignore Ali Baba which is more an exchange platform rather than a retailer) and the retailers we are all familiar with are racing to the wall. Amazon bought Whole Foods for $13.7billion, cash, on August 28  and the next day, the Amazon share price jumped $15.6 billion. In other words, Amazon got paid $1.9 billion to buy Whole Foods and got a distribution base into the bargain as well as a whole swag of quality relationships with produce suppliers, and a great brand. At the same time, the share prices of Walmart, Target and other major retailers took a bath in the wake of the purchase.  On top of Amazon as a retailer, we have Amazon providing an unprecedented breadth of services from Amazon Web Services, to a vast array of web tools, to space exploration, to demonstrating newspapers can still work with the turnaround of the Washington Post. 

Google copped a €2.4 Billion fine in June 2017 for anti-competitive behaviour as it used its dominant position in search to give itself the edge in price comparisons, from which it may take a cut when the product has been advertised  using AdWords. While Google is disputing the ruling, the evidence seems pretty clear, and in any event, the fine is only a few weeks profit, so is easily afforded.

As a new year resolution, Mark Zuckerberg has pledged to clean up Facebook. This guy is really smart, he has built the biggest communication platform in history, and in the process made billions for himself and a relatively few others, but I cannot help wondering if the juggernaut can be turned around by anything other than regulatory intervention, without which there is  no incentive to turn the tap off. History would suggest differently, and perhaps the impending IPO of Snapchat will put a dent in the flow of Facebooks  ‘automatic’ ad revenue. By automatic I mean hands off, they give you the tools to micro focus on segments, a great capability easily manipulated as demonstrated by both the Trump campaign and the Russians.

The apparent lack of ‘moral governance’, of the new digital behemoths that are now 5 of the 10 biggest companies in the world, Google, Facebook, Amazon, Tencent (still unknown to many) and Alibaba, all of which were just start-ups in 2000, will encourage regulators to try and throw a rope around their activities. However, if history repeats itself, they will be replaced at the top of the pile by companies we have not yet heard of inside 25 years. The corporate life of a major enterprise seems to be reversing Moore’s law, and increasingly diminishing every couple of years. This reality creates great challenges, as well as opportunities.

 

We will figure out how to use data

We are awash with data, the vast majority of it currently unused. Consider the opportunities to use the data currently around, in all sorts of applications from SME’s collecting and leveraging data on their customers to Governments digitising medical records, activity, and diagnoses to improve the productivity of the investments they are making by reducing waste, and improving the  delivery of health outcomes for patients. On top of that we have the emergence of ‘Blockchain’ technologies, with the attendant hype and bubble. However, it seems to me that the applications of this technology are both wide and deep, but require a wholesale change in the manner in which our private and public institutions work, and that will not happen in a hurry. Or will it?

There are some pretty scary implications in all this, as well as the benefits to be gained.

 

The final frontier: Attention.

The greatest challenge in marketing is the fight for attention, and it is becoming a more challenging, expensive, and bitter fight by the day.

The so called panacea, ‘Inbound marketing’ can and does work, but needs to be built on a solid foundation of marketing strategies directed at specific customers who will value what you have to offer above all else. Otherwise, the leads you to spend money to generate via inbound campaigns are going to be largely useless, as the conversion rate will be low. The name of the game is to get to those whose attention is valuable to you, and generally, these people at the top of the corporate food chain are very selective about to whom and when they give their attention. I think we are almost at a tipping point  where the personal contacts of yesteryear are becoming as important as any inbound activity, with the caveat that the digital stuff out there offers fantastic resources to do research to select out those who may be of value to you and then find them in a highly personalised way, if not in person.

Account based blather.

So called ‘Account Based Marketing’ became a buzzword over the last year or two, with all sorts of automated solutions vendors breathlessly declaring it the saviour. This will become recognised as the bullshit that it is, a tactic to flog software, not a solution to the basic challenge of marketing, to find, engage, service and retain customers.  It is not new, it is as old as selling, but those with a ‘shiny new tool’ to sell act as if they had discovered the holy grail. Define your target customer as closely as possible, ensure the exact alignment with your value proposition, research their company as well as the individuals as much as possible, and turn the on-paper prospect into a warm lead. It has always been so, and slowly marketers will come to realise that software is no substitute for creative and informed thinking and strategy development.

Brand building will again be seen as the key to sustainable success.

In a commoditised and connected world where information is freely available, brands are struggling to maintain their role as an assurance of value, just as consumers need it the most.

Building a brand has always been challenging, time consuming, risky, and expensive, but the return was there when  successful. In a world of sameness, the return is still there when successful, but the task of building a brand has become geometrically harder. This will not go away, but  there is light in the tunnel. The tools available enable very tight marketing, customer and value source definition to be done, enabling brands to be built that are relevant to a very specific group of people, and  therefore able to deliver value to them that is sufficiently unique to act as insulation from the general competitive milieu. Niche brands will become the go. In truth they always were, even the biggest brands occupied some sort of segment rather than the whole breadth of any market.  Even Microsoft, as the US Department of Justice was seeking to break it up to destroy the ‘Monopoly’ position it was seen to hold, was not the only option at the time.

The brand building skills of the ‘old guard’ will come back into fashion, simply because they are more relevant and effective than ever when armed with the digital tools. The generations of so called marketers who can use only the tools without understanding the principals behind their use, will struggle.

Given brands can be targeted, the message must necessarily be unambiguous and specifically relevant to the receiver. It makes it necessary for marketers to make very clear choices about who they will target, and with what, as generic offers have no weight. The greater the degree of personalisation and specification the more likely it will be received favourably, by the few who really want it.

Marketing in the boardroom

Increasingly marketing will be seen as a profession, requiring not just the creative and collaborative skills of the past, but also deep  technical and management skills.

Investment in marketing technology is accelerating at a huge rate, driven by the competitive pressures that come from the increasing productivity coming from marketing automation. Therefore the marketing personnel will increasingly be responsible for huge IT investments that determine the effectiveness of the strategic choices that are made. Marketers need to be qualified to make those choices, and more importantly, need to have the credibility in the boardroom necessary to gain the support for the allocation of the limited resources available, and to prepare the business case underpinning the choices. Those businesses without marketing in the boardroom will fall progressively behind their competitors.

The time for marketers to step into the top jobs has never been better, the ability to focus an enterprise on customer outcomes which are then reflected in the financial results will become the mark of successful leaders who shape enterprises for commercial sustainability.

Time frames will continue to compress.

Time frames for everything from long term R&D as in the pharma industry to the local start-up and political actions are being radically compressed, and this will not change, just get faster. If you are unable to keep up by changing at least as quickly as a those around you, the abyss is just down the road.

20th Century institutions are not able to cope.

Anyone can now start a business with a laptop and a few dollars, and physical location is becoming increasingly irrelevant. This is leading to a whole new structure of internationalised competition and governance,  self and part time employment, multiple jobs and career paths. Our institutions were simply not designed to accommodate the pace and breadth of change, no matter how much we may not like that reality.

The future of creativity in an increasingly automated world

What is the future of creativity, which takes time, energy, imagination, and does cost, in an increasingly automated and short term world?  Does the volume of ordinary ideas required to keep the ‘content machines’  turning outweigh the few big ideas? This is not just marketing, our lives are increasingly programmed, often without us realising, e.g. the Facebook algorithms that deliver to our feeds the ads, and stuff that the algorithms ‘think’ we might respond to, this is just telling us more of what we already think, removing the need and urge to think, to make leaps of logic, and see a different perspective.

It seems to me that we are pretty good at seeing what is coming from within our narrow domain, but very poor at seeing what is coming from outside, which is where most change comes from, and where creativity has the opportunity to deliver real leverage. Most of the great blunders thrown around reflect this reality, while the companies concerned continued to be successful within their own boundaries. Edison’s failure to recognise the benefits of AC over his baby of DC, Thomas Watsons declaration that there is a market for only 5 computers, Bill Gates initially missing the internet (then, remarkably turning Microsoft on a dime) Steve Ballmer dismissing the first iPhone, IBM missing the shift to personal computers, Xerox not commercialising any of the stuff they invented in PARC, (except laser printers which were right in their playground of document reproduction), that now underpin much of the tech we use every day, and many others. These are obvious with hindsight, but when you think about the context of the missed opportunities, each came from outside the essential expertise that had delivered initial success. The lesson is that creativity is more essential than ever, it is the source of innovation and change but usually only obvious with the benefit of hindsight.

The public vs private world

We are demanding more of our public sector, schools, hospitals, teachers, and all the services we take for granted, but we are also demanding we pay less. Partly this is a response to the waste we all see in the public sector, but there is a longer term trend at play that will focus attention on the really challenging problems associated with the revenue side of public budgets, rather than just the expenditure. Large corporations with an international footprint can select their tax domicile to minimise tax, and the releases of the ‘Panama Papers‘ and the more recent Paradise Papers have at least lifted the rock a bit so we can see a few of the roaches running for cover, but it is the tip of the iceberg.  With the US corporate tax rate dropping to 21%, we (in Australia) will have to adjust to changed flows of US capital, one of the underpinnings of the Australian economy, potentially drying up while politicians argue about our corporate tax rates, and how reducing them is giving back to the rich at the expense of the poor. The reality is that the pie is getting smaller. Then we have the movement in the economy from  PAYE employees to contractors and small businesses with the attendant tax benefits. The  impacts of all this will be an increase in the heat of the political debate, with a geometric increase in the bullshit that  gets served up, when what we really need is some genuine leadership that is prepared and able  to articulate the core issues driving these trends, and execute sensible strategies to start the process of addressing them.

Are we at the tipping point?

To end with, this is a question that will continue to bother me, as the implications to the management of both private and public institutions, and the rules to which they are supposedly accountable, are profound:

Are we reaching a tipping point in a range of tech enabled areas? Artificial intelligence, Augmented Reality, Virtual Reality, Autonomous everything,  new generations of quantum and neuromorphic computing, and most particularly renewable energy.  All are being rapidly developed, or already being incorporated into our daily lives without us really seeing it, after 100 years of science fiction. It seems to me that the revolution that took place 100 years ago as electricity revolutionised our lives, is about to be repeated, but from a different direction. we will be confronted by the change from disruption to collaboration,  and I do not think most of us are ready for it.

Ray Kurzweils observation (I think it was Ray) that ‘The future comes very slowly, then all at once‘, seems to be coming true.

What do you think?

 

 

Einstein’s formula to calculate business value

Einstein’s formula to calculate business value

Jan 11, 2018 | Change, Governance, Strategy

Our world is being broken into bits, powered by algorithms, few things appear to be immune to the pervasive intrusion. One that has been largely immune is strategy development, a subjective hold-out in a world of programmatic automation.

Einstein told us that ‘defining the problem is the greatest challenge, the rest is just maths’. This applies as much to strategy as it does to any sort of problem, and it seems even possible to adapt Einstein’s simple beauty of E=MC2 to the creation of business value, albeit there may be some ‘stretching’ involved.

Back in 1937 as a graduate student at MIT, Claude Shannon demonstrated that complex problems could be broken into a series of minute, sequential steps with a binary answer that delivered an outcome. This break-through created the foundation of all modern computers. Shannon then went on to demonstrate in 1948 that digital systems could not only perform logic, but also enabled transmission of information. Another technical challenge addressed that can be reasonably translated to most strategic challenges.

The problem with strategy development is not the creation of strategies,  as much as the definition of the problems to be solved, as Einstein so aptly observed.

When you have the problem defined, it is suddenly easier to break it into its constituent parts, to see the granular detail, and at least partially quantify the cause and effect chains that exist to enable informed  testing, followed by adjustments based on the outcomes.

This is starting to look like Game theory: ‘if this, then that‘ mixed in with a dose of options theory, ‘do not commit to an option amongst all those available, until you absolutely have to‘.

I think it is only right to finish where this thought started, with Albert.

His theories of relativity that famous formula we all know, but have no idea what it means, explains the workings of the universe. Perhaps it can also give us an insight into the value we can add to an enterprise, which is after all, what we are setting out to do by strategic planning.

The internet has changed everything about the business models that will be successful in the future, because of the transparency and connectivity it delivers. Therefore we need to find a way to recognise the power of digital access and the compounding that is possible by leveraging networks in our planning processes.

I like E=MC2 as a strategic metaphor, because it can explicitly compound the value of our digital networks, something not done in any model I have seen.

Here is how it works.

E is the enterprise value.   This is not the stock market valuation, which is only a financial calculation based on expected future earnings, but the total value that is created by the enterprise, which has many forms. Value can be time, services, transparency, design, everyone sees value as being different, and is subject to the context in  which it is seen. The obvious challenge is to put a number on these usually subjective items, which evolves from the other side of  the equation.

M is the mass of the enterprise.  This is the sum of the physical assets and processes of the business, the stuff that enables the work to be done.

C is Capital of the enterprise.  It includes financial capital, but the greater part is the capital contributed  by  the people who populate the place, those who are in the value chains, including existing and potential customers, and the context in which the business competes.  This comes in many forms:

  • Intellectual capital, what is between peoples ears, what they know, and how they extract and leverage that knowledge
  • Relational capital of the individuals in the enterprise, as well as those assets, both tangible and intangible, the enterprise owns such as brands, patents, and defensible market assets such as franchises.
  • Cultural capital, the way in which there is collaboration and alignment of activity towards the creation of value by the enterprise throughout the value chain, and the manner in which the enterprise, which is just a collection of people, conducts itself, both internally and externally.
  • The competitive, strategic and regulatory environment in which the enterprise competes.

This number is squared, simply because of the geometric nature of relationships, and the network effect, the more you have the greater the sum of the value that can be created.

As noted earlier, there may be some ‘stretching’ involved to apply Einstein’s formula, but on the other hand, the logic is there. This thought process came about as a result of an acquaintance seeking to sell his business.  The business brokers and accountants he spoke to all had variations of a similar formula which focussed on multiples of profitability that would be applicable, with only passing attention given to many of the intangible assets he had built up over a 30 year period. Knowing his business quite well, it was my view that the profitability multiples method substantially undervalued the business, so we set about putting numbers to some of the intangibles as a means to increase the sale price, by demonstrating that the profitability was not just robust in a challenging environment, but would be increasing over time.

The eventual sale price convinced me that Albert may have been onto something, and it just cemented my view that he was in reality, the most under-valued strategic guru in history, as well as being a pretty smart physicist.