The Value of a Business

This is something that I was thinking about the other day: What determines the value of a business? Two things immediately came to mind:

1. Existing market position
2. Business knowledge

Existing Market Position

By ‘existing market position’, I mean how well established a company is. Companies that are leaders in their respective industries are generally worth more than their smaller competitors*. A company that is a market leader is one that has established itself in the marketplace and has a recognizeable presence in the market. That presence could be seen as a brand, a trademark, or a general reputation. Sometimes companies are even lucky enough to have their name be associated with all products in that market (e.g.: gelatin desserts – Jell-o. Tissues: Kleenex). Because of their existing market position they have already proven that they are capable of making a profit. Their established presence allows them to introduce new products without having to fight against other more established competitors or fight against customer ignorance (customers that do not know their products exist).

*This isn’t to say that large, estabilished companies are set. If they fail to innovate or continue to improve things, they can easily be knocked down by their competitors. In this sense, the companies who have more to gain can be seen as being more valuable from an investment standpoint because they have more room to grow.

Business Knowledge

The combined understanding of the existing business model and market is what I will refer to as business knowledge. This may also be called intellectual capital. The value here is not in common knowledge, but in the particulars of how things work.

Take for example, building a car. The general process for building a car is probably something like this:

  1. Come up with a concept for the car using artistic sketches.
  2. Have engineers design the car.
  3. Tool a production line to build the car.
  4. Build the car.

This sort of thing would be fairly obvious to someone who isn’t in the automotive industry (such as myself). This knowledge has little value. The real value comes in to the details: What sort of upholstry fabrics wear better than others? How can a switch be properly designed so that it will last for several hundred thousand on/off cycles? What paint and plastic combinations will not break down under sunlight, or peel off? How can a particular part be designed so that it can be produced at a lower cost?

This sort of knowledge generally comes either through study or through experience. This is why someone who has received more post secondary education is generally seen as a more valuable employee than someone who has less education: They already have some non-common knowledge of a particular business or process. Sometimes this knowledge is openly shared between companies and other times it is not. (For a great example of sharing non-common knowledge, look at some of the technical slides released at the Game Developer’s Conference each year. The slides often include shader code and techniques that are used in particular games). Knowledge that is learned can also help avoid future problems. For example, knowing which paint and plastic combinations work for a car can avoid a future class-action lawsuit because suddenly all your cars have peeling paint.

This knowledge is valuable because, when used properly, results in a better product. Better products often sell better. Products that sell better make more money, which makes for a more successful business. Not only does it help the company build a better product, it helps them avoid issues that their competitors may experience, for example how to effectively reach your target market. While their competitors are struggling, a company may have already figured out how to reach their target market, which could potentially save them time and money.

There are a few things that can have a great effect on a business with regards to these two items. I’ve graphed them out, as so:

  • Your average start-up company (at least in the IT world) does not have much business knowledge and little to no market position.
  • A soon-to-be-successful startup may have considerably more business knowledge, but little to no market position. This can be because the individuals starting the business already have previous knowledge in their particular industry. This quite often happens when someone who has been at an established business breaks off to start their own similar business. The new start-up is not well known, but the existing knowledge can be leveraged to increase market presence much faster than a company without such knowledge.
  • A well established business has developed both lots of business knowledge and a significant market position.
  • A rotting business has lots of market position, but lacks business knowledge. This may be because the market has shifted from underneath them and they have failed to keep up, or they have lost all their intellectual capital (all the brains in the company have left, and have taken all their knowledge with them).

So what good is all this? How does knowing this apply?

  • Value your business knowledge. If the majority of the value of your company is in its business knowledge, hang on to that knowledge. Treat the people with that knowledge well so that they won’t walk off with it. Get them to record it in places where it can be easily shared, such as in internal wiki or central document repository. Get dirty with your company, and understand how all the bits and pieces work. There is no excuse for failing to know your business. It’s your business.
  • Increase your business knowledge. If you don’t understand how your business should work, now is the time to find out. Get your hands on any sources of information you can get – websites, trade magazines, sitting down and chatting with industry professionals. Do whatever it takes to understand what you are getting yourself into. For software designers, sit down with the people who are wanting the software. Figure out what they really want and what they really need. Understand how they work, and more importantly, how they think.
  • Leverage your existing market position. If you are already established in your market, leverage your existing position to help you do whatever it is you are doing. A prime example of this is the game company Rovio. You might not be familiar with the company, but you are with the game Angry Birds. They recently launched a new game that sold 10 million copies in three days. They leveraged their exsiting position (a well known franchise) to launch a comparatively new product, and to great success. The larger companies are generally quite good at doing this. Take a look at EA, DICE, BioWare, and any of the other big game companies to see how they leverage their existing position to sell a new game. They act big, they play big, and they are big.
  • Scale up your market position. This is a tricky one, and can take a lot of work to get down. Regardless of how it is done, it is probably going to take a lot of work. This can include building up a community by providing regular, new content, running promotions, advertising, giving away trail products, attending trade shows, sponsoring events, etc. This is really where you have to throw yourself out there. Becoming well known takes time, and generally doesn’t happen overnight unless you are freakishly lucky. Don’t ever count on luck as a business model.
  • Use your existing business knowledge. There might be some great brains where you work, just that they have been too quiet/dormant to say or do anything. There might be documentation hiding away in the recesses of your network shares that has long been forgotten. You might not realize it, but you could very well know your business better than any of your competitors. Use what you know to improve what you have. If you fail to do so, it is your own fault.
  • Don’t let the grass grow under your feet. Once you have established yourself, continue to innovate. If you sit on the nest too long you risk smothering the chicks. Failing to continue working at things is just as bad as slowly getting rid of all your business knowledge. Technology has made the world a much smaller place, and if you fail to innovate someone else will.

There are two other things that can have a massive effect: skills and culture.

Let’s face it – there are some people who are more skilled than others. Some people have business skills, some technical skills and others have people skills. These skills have value because they can be used to quickly acquire business knowledge and market position. The ability to swing a hammer is a skill, but on its own isn’t particularly useful. The ability to swing a hammer to make a wall is much more valuable. Skills, when applied, are valuable.

Culture is what the inner workings of a company are like. Do the employees enjoy spending time working for the company? Do they get along well? Do they all have the same mindset, goals, and desires for the company? The ultimate example of culture, in my mind, is Valve. They have developed a very unique but incredibly successful business. The company culture is that employees can work on projects, and form whatever teams necessary to get things done. This enabling power that all the employees have allows them to come out with some pretty incredible (and successful!) products. All of the employees have the same sort of mindset. There are very few companies that are fashioned in such a way. There are few things that will kill a company quicker than fighting within the company.

A company that is lacking either (or both) skills and culture will not be as successful as one that has both. Both can be grown over time, but that time could also be spent getting a product to market or furthering innovation.

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