October 23, 2019
PUBLISHED BY Geoffrey Moore
Let’s be clear–capitalism is not going to end any time soon.
It is, however, entering a new phase, and the secular changes under way are creating unexpected outcomes in both the financial markets and the job markets, ones that can roil society as a whole. We all need to step back for a moment to weigh the impact of these trends on our collective future. Here’s one perspective on the emerging landscape.
Historically, capitalism came to the fore as the critical enabler of industrialization. Industrial economies are asset heavy, not only in terms of manufacturing infrastructure, but also in terms of carried inventory and brick-and-mortar distribution. If you are going to industrialize, you need enormous infusions of capital. It should not be surprising, therefore, that the primary focus of the capitalist system is to generate more capital. Out of that imperative grew a set of management values that make delivering investor returns the preeminent responsibility of the executive team, with board governance to ensure that it is fulfilled.
In free markets today, this system is virtually universal, and wherever economies are still industrializing, it continues to serve its primary purpose well. But many sectors of the global economy, including all of the fastest growing ones, have already transitioned into a post-industrial phase.
The World Economic Forum calls this phase the Fourth Industrial Revolution, but that is a misnomer. It should instead be called the First Digital Revolution. Prior eras of digital disruption were focused on making the industrial economy more efficient. That accounts for the First, Second, and Third Industrial Revolution in the WEF model. But this latest development is actually anti-industrial. It prefers bits over atoms, bots over jobs, and free shipping over retail locations.
Compared to industrial economies, digital enterprises are markedly more asset light. They still need capital, but, with the exception of the mega-utilities that enable the core of the digital economy, it takes much less to generate an equivalent cash flow. Capital, in other words, is no longer the scarcest ingredient in their economic success formula. Nonetheless, we continue to manage them as if it were.
As a result, more and more capital is accumulating on the sidelines. The owners of this capital quite naturally want to put it to work. They would prefer to do so in fast growing businesses in nation states governed by the kind of rule of law that protects private investors. There are plenty of enterprises that fill this bill, but the supply of capital to meet their needs far exceeds the demand.
This has resulted in some increasingly dysfunctional trends in financial markets, including the following:
- An increasing disconnect between private and public company valuations, driven in part by mega-funds putting huge amounts of money into ventures that are still highly speculative. We might call this movie “Desperately Seeking Alpha.”
- A reckless management style that accepts way too much capital, using it to fund increasingly improbable forays into barely emerging categories and radically unproven business models, all without the infrastructure or culture to support operations at scale.
- A ludicrously corrupted interpretation of the venture capital model that includes raising multi-billion-dollar funds to support $30 million “seeds.”
- An IPO market that has no interest in adopting the deformed offspring of this movement, resulting in extraordinary write-downs, be they pre- or post-IPO.
These disconnects, no doubt, will sort themselves out over time, but they raise fundamental questions for which we need better answers. These include:
- If capital is not the scarce ingredient in the digital economy, then what is? Two promising candidates are customer engagement to support the as-a-service business model and unique nexus data to support differentiated digital actions. The first of these is exemplified by Facebook, the second by Google, and the two combined by Amazon. But every digital enterprise must find some way to create a sustainable competitive advantage based on factors like these.
- If investor interests are no longer the highest priority for enterprise management, then whose are? Here we are already seeing a consensus emerge around a more balanced approach to stakeholder interests, focusing first on customers, then on employees, and extending out to the communities that host and house them. Investor interests are still in the mix, but this rebalancing shines a brighter spotlight on mission, vision, and values, as a counter-balance to a laser focus on delivering growth, profits, and return on invested capital.
- If risk-adjusted returns on investment capital are undergoing a secular decline, then how should large-scale investors adapt to this change? I have no good answer to this question. My biggest concern is that neither do they, and thus they will continue to follow the same playbook until it takes them off a cliff. Among other casualties, this would put pension systems and other safety net programs around the world deeply at risk—indeed, I would argue it already has.
Read Geoff’s original post on LinkedIn here.