Companies that add value to their ecosystems are more sustainable

image I recently met with a company that got me thinking about the link between the value a company adds to its ecosystem and its long term share price potential.  This may sound trite but in a nutshell it seems to me that the best startups either create value by making something possible for the first time or by radically changing the price/quality dynamic in an existing market.

One example of each from our portfolio:

  • graze (in which we invested earlier this year) created a new fresh food delivery service through some patented packaging innovations, creation of a sophisticated production line and a novel business model
  • Buy.at (which took investment from us in 2006 and was acquired by AOL last year) drove a cart and horses through the affiliate network market by increasing product quality (zero tolerance for spyware and adware, and high good customer service) and driving price down

Looking more widely it becomes clear that all the best web companies fall into these categories – Google makes the web more searchable, ebay makes it possible to sell things that otherwise remained unused in our lofts, Skype made phone calls free, etc. etc.

I guess the most important part of this post is to list a some types of company and business model that don’t add value in this sense and therefore may not make sense as venture capital investments.  (Which isn’t to say that there is anything wrong with them and they won’t make profits and money for their owners.  In fact some of the types of businesses listed below can be very fast growing and require little cash to get started.)

  • Companies relying on price arbitrage generally evoke the concern that over time the value of that arbitrage will trend downwards, usually to near £0
  • Business models based on customers not fully understanding how the company makes profits or what they are getting for their money – one has to assume that over time transparency will arrive, and these days that it will arrive sooner rather than later
  • Simple re-sellers of third party products

If you can think of any more examples please let me know.

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  • chrispadfield

    What do you mean by re-sellers? Most re-sellers package another product/service with what they are selling (is this not what Graze is doing?) or are retailers – which is clearly value creating. Even resellers which just brand a product (for example Sony for some products) are lending their brand to a product which consumers value.

    I would tend to agree on confusing business models, although still a long way to go in lots of industries such as finance and travel. I don't think the confusing nature of some of these industries will prevent VC investment though partly because I don't expect them to become transparent in the near future.

    I guess the argument is really about the difference between short term revenue/profit generation and the long term. Arguably I think a lot of VCs have actually invested into the former and aimed for a quick exit – but I expect we will see a re-focus on long term value building. I always think the most important question to ask a company is “What will be your long term, unfair, competitive advantage” and I think it is the lack of that for some companies that is really the issue you are addressing. If they have that competitive advantage, they will be building value.

  • Hi Chris – the difference between short term revenues and longer term value creation that I am talking about, and you are right that VC money has sometimes chased the former. I guess what I'm signalling here more than anything is that I'm interested in the latter – and as you say they will be businesses that have some form of long term competitive advantage.

    By simple re-sellers I mean low-margin pile-it-high sell-it-cheap companies. There are lots of IT hardware companies in this category and some etailers where long term profitability can be elusive. Companies (like Graze) that change the product on the way through or add value via their brand fall outside of this.

  • chrispadfield

    What do you mean by re-sellers? Most re-sellers package another product/service with what they are selling (is this not what Graze is doing?) or are retailers – which is clearly value creating. Even resellers which just brand a product (for example Sony for some products) are lending their brand to a product which consumers value.

    I would tend to agree on confusing business models, although still a long way to go in lots of industries such as finance and travel. I don't think the confusing nature of some of these industries will prevent VC investment though partly because I don't expect them to become transparent in the near future.

    I guess the argument is really about the difference between short term revenue/profit generation and the long term. Arguably I think a lot of VCs have actually invested into the former and aimed for a quick exit – but I expect we will see a re-focus on long term value building. I always think the most important question to ask a company is “What will be your long term, unfair, competitive advantage” and I think it is the lack of that for some companies that is really the issue you are addressing. If they have that competitive advantage, they will be building value.

  • Hi Chris – the difference between short term revenues and longer term value creation that I am talking about, and you are right that VC money has sometimes chased the former. I guess what I'm signalling here more than anything is that I'm interested in the latter – and as you say they will be businesses that have some form of long term competitive advantage.

    By simple re-sellers I mean low-margin pile-it-high sell-it-cheap companies. There are lots of IT hardware companies in this category and some etailers where long term profitability can be elusive. Companies (like Graze) that change the product on the way through or add value via their brand fall outside of this.

  • Cawky

    hello all you nerds

  • Cromwell

    hello all you nerds out there…