Up until recently, we can all agree the past couple of decades has had no shortage of capital. And this has become the operating norm for corporate priorities. With low-interest rates, debt has been inexpensive, and with a focus on growth, it wasn’t as important if profits were forthcoming right away.
In fact, according to a recent HBR article, the $3.4 trillion of uninvested capital of PE (private equity) funds is a record high. “With such massive liquidity chasing few opportunities, valuations for innovative investments have been high.”
However, in the past few months, we’re seeing interest rates increase and liquidity reduced. This has shifted the focus from growth to returns. Our attention is turning back to earnings and valuation. This is an inflection point for companies that have started in the last two decades and have operated in a growth market.
Getting back to basics may be viewed as a good thing. The valuations of technology companies led most companies to invest in digital transformation. According to the article, “The challenge is that big tech companies had some unusual advantages, and their ability to be a gatekeeper, which commands extraordinary power, cannot be easily replicated. So alongside many courageous business transformations that have added value, we have also seen a blind belief that emulating some aspect of major tech companies’ approach by acquiring a firm that would help firms credibly argue that they could become a platform owner or ecosystem orchestrator. Firms the world over rushed to showcase AI credentials, signal their commitment to the metaverse, and declare themselves the next platform.”
This approach won’t work in a tight market and with limited liquidity. The key is not to overreact and become overly cautious. An example used is the fall of cryptocurrency recently. It does not signal the technologies that support cryptocurrency pose any less of a threat to financial institutions. The article calls out conditions to consider:
This is no easy request. “…the cost benefit calculus should not compare the investment case to the status quo. It should compare the investment case with what inaction will entail — and this often means declining margins and volumes, and changing customer needs.”
Engage with Innovation
Demonstrating how innovation affects growth and margins requires, “…going beyond the buzzwords to see what digital transformation and disruption really bring to the table, understanding the merits of engaging in platforms and ecosystems, the benefits of using AI, the potential upsides of getting involved in the metaverse early on, and the merit of employing gamification to better connect to their customers.”
Instead of taking the approach to dominate the category or industry, and investing in this way, consider a dialed-back approach of being a complementary player. “…they will need a portfolio of thought-through propositions. Their criteria should not be the upside alone, but also the risk and magnitude of the investment they will undertake.”
Our business environment has changed more in the past two years than we’ve ever seen. And this needs a constant evaluation of business strategy. With the recent changes in financial markets, we are now facing a time for prudence and as the article ends, time to roll up our sleeves.
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