Industrial Finance 101
Like many other rules we’ve invented for ourselves, the rules of business finance are a child of the industrial age. The ideologies which fill economics and accounting text books are based on the findings from what worked in the factory era of doing business. Trial and error for more than 200 years of mass production gave us some handy rules of thumb which could guide financial decision making. But when the physical and commercial world changes around us, it becomes time reassess what we believe.
Today we must ask ourselves if those beliefs on what works are still relevant. For startups, outside of raising capital, for some reason financial management and decision making tends to be an after thought. We have focused so much on new techniques to build things and connect with audiences we forget about the new numbers game. Likewise, very few corporate finance managers have thought about why they are getting disrupted through they eyes of a technologist. Even startup founders rarely take the time to think about the financial implications of a technology driven economy. And so with this in mind here’s my Top 4 Accounting Hacks for the technology age. Whether you’re trying to save an industrial giant, or topple one over, these new rules in finance apply to us all.
Hack No 1: Innovation & Profit Margin
Every large company I worked for had a simple rule: Any new innovation which would cannibalise existing products had to have a higher margin than the product it cannibalised. Seems to make perfect sense. And most large companies still have this ‘rational’ financial rule in place. Only thing is, it doesn’t make sense anymore. In a world of low barriers to entry, a world where people can access assets and don’t have to own them (think Airbnb) then all companies need to release innovations even if margins are lower than what they were previously. They need to do this because if they don’t someone else will. Very often new iterations must tolerate lower margins. In the new tech driven world the choice is more likely to be between a lower margin, or no customers.
Hack No 2: Customer Interactions & Revenue
In a pre-web world, most business models were a fairly simple affair. Build a product at cost X1 and sell product for price X2. And most often the money would change hands at the time of transaction or sign up. It’s all around us from retail to services to finance. But we have now entered a world of what I call the Related Revenue Realm. In this world, we connect first with an audience, and profit from the audience in another area. It’s often one or more layers outside of the initial interaction. That is, we give aware the core value we create for free, and profit from the things that result from the interaction. Google give search away and sell ads to companies who have what people are looking for. Facebook do much the same. So we need to have a wide perspective of potential revenue streams, many of which are indirect, and hard to see in the early stages of innovation. It also means that the revenue may occur much later than in traditional business models. This gives startups a massive advantage over large organisations, but only if the large organisations don’t understand this shift.
Hack No 3: Accelerating Technology & Deflation
Large capital investments once built a wall of protection around companies. It meant that new players had to make large investments in order to compete. It was a the financial moat of goodness, which defined the economics of large businesses for the entire 20th century. But in a world where the new resources are more technological than physical, we must consider the Law of Accelerating Returns. In short, this law states that the cost of most technologies tend to drop (often half) and the power tends to increase (often double) every two years or so. This creates exponential change and disruption potential. What this means is that the large investments of yesterday not only do not protect companies, they have the opposite effect. They become financial millstone. The firm gets caught up in generating an ROI on outdated assets. The new rule in finance is that it is better to access infrastructure than own it. All companies need to realise that in a technology world the barriers to entry are on a constant trajectory of being significantly reduced. Think Alibaba – anyone can get anything made to order with a few keystrokes without owning a factory. Technology forms a rapid deflationary economy and this should shape the all investment decisions in this area.
Hack no 4: It’s not fair anymore
There is a different set of rules for technology and startup firms than those who are established. The owners of the capital in startups are more patient. Heck, the owners of Amazon which is now 21 years old haven’t really been filling their back pockets with dividends. The unfairness is that the market (investors) lets these ‘tomorrow builders’ over invest in creating tomorrow. They don’t have to pay back as frequently, as quickly, or sometimes even at all. The net result is that new startup firms get into a positive spiral where the attitude of those investing gives the new players a better chance of success by allowing them the time to get a return on their business. They have extra time to work out their disruptive technology business models. Established firms are not afforded this luxury as shareholders and mutual funds scream for dividends without margin dilution.
It’s a new reality as the economy gets re-shaped, and if older firms what to be around, they at least need to convince the market that they to have re-shaped their DNA so they get some financial breathing room.