Resources and company value

Ultimately, the goal of starting a business is about demonstrating value that is legally bound to a legal entity you own. That may sound cynical, simplistic and diabolical, but it is essentially the truth. So the question of business becomes quite straightforward:

How do I show value in my company?

Companies are like engines. That take in some input of raw materials, do some work and output a finished good with some waste. The best companies minimize the waste (high efficiency/gross margin), minimize the cost of raw materials (low COGS) and maximize the value of the finished good (high profit margin). Along this chain lives competition and as a company you strive for differentiation. So in differentiation you have three options:

Type 1 - Your waste is different (same coffee, same machine, but at a better price because we reuse old beans)

Type 2 - Your work is different (same coffee but a one of a kind espresso machine/world famous barista)

Type 3 - Your raw materials are different (we are the only one who use Kopi Luwak coffee beans)

Type 1 companies

Type 1 is a stressful and largely unviable long term business model, as it breeds perfect competition and subsequently self erosion of profits. This is usually driven by businesses that thought their work was different (2) but actually wasn’t. Or worse, work that was different but that didn’t translate into value for the customer in the finished good. This is the worst kind of business in my opinion because the only asset you can ever differentiate with is brand - which ultimately is not a characteristic of you business (like IP), but a characteristic of the market. Intangible assets or goodwill are the remainder between the market value and the value of the balance sheet. Without IP, your intangible assets are just a market imbalance. And you can’t sustainably grow a market imbalance.

Type 2 companies

When the work you do is truly different, you have real, defensible Intellectual Property (IP) and can either protect it via design/patents (front-end value) or disguise it from competitors in a non trivial manner (back-end value). You might call this the secret sauce or magic of a product. My grandmother first used Google because of the clean user experience and front-end (compared to other search engine homepages) and I used it for the clever back-end algorithms that gave quality results. This kind of business is valuable due to its uniqueness and if managed well can be a new source of raw materials, which brings us to the ultimate business model.

Type 3 companies

Creation or access control to raw materials or resources has been the fundamental business model of man since the dawn of time. Countries that control significant amounts of natural resources (oil, gas, copper, corn, diamonds) can dramatically influence markets. While this is desirable, it is virtually impossible (without breaking some laws) to acquire significant ownership of a finite natural resource. The good news is that if you can uniquely generate a new and valuable unnatural resource, you can control access and hence the market for those resources. Central banks can control the entire economy of a nation by simply turning the printing press on and off.

Again, it is virtually impossible to uniquely create a new and valuable resource overnight and hence why most all businesses start out as type 2 and those that have real IP end up as type 3 and those that didn’t end up as type 1.

In our communication era new and valuable assets nearly always take the form of information (data) or distribution channels (users) for information. The most successful companies have both.