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Web Trends Map on

Great visualization of the current landscape of web properties, including people. The creator of the map, Franklinss, has demonstrated in a fantastic way how powerful zooming technology can be when it comes to displaying information in a broader context. Must see!  The company behind the technology: Zoomorama

What if you died today?

The Technology Review uncovers an somewhat morbid but yet useful business niche: Passing on your online accounts to your loved ones if you should pass away. Ask yourself – what will happen to your digital identities and digital content? Companies like Legacy Locker offer solutions

Signs of weakness: Massive Due Diligence to become more common

The Deal Professor explains why more than 100 attourneys were involved for IBM in the legal due diligence of the recent merger attempt between IBM and Sun. The I.B.M. mega-diligence may be the beginning of a trend in takeovers, as buyers look to minimize risk and maximize their information, and targets, in weak positions to begin with, are unable to complain.

Data visualization in 3D

Broader Perspective makes a pledge for “an open source data visualization tool suite for virtual worlds is needed, something to be the Many Eyes or Swivel of Second Life and other platforms,” and gives an overview over interesting ongoing projects. The Data Visualization Wiki combines insights & gathers people that explore this area.

A VC Fred Wilson has posted a great piece on what fascinates me about online businesses: incredible margins and thus real value. The point that Fred makes is essential; many Internet businesses are cash flow negative and thus are not creating any real value yet. Other companies are highly profitable and show margins of which traditional industries can only dream of.

So what is more valuable? What is value after all? And in particular, where is the value created by Internet businesses? I take this opportunity to summarize the major aspects of value creation. So back to some basics:

In a simple valuation model value is modeled as the Free cash Flow a company can generate discounted at it’s average cost of capital less intrinsic growth (i.e. growth without making new investments, often assumed to be near the long-term inflation rate)

 
Simple value formula
 

If we split up this formula, we get picture that sheds some more light on what actually drives value.  I take the McKinsey valuation model as an example here. NOPLAT is basically the margin a business can create – income after major costs of goods sold, costs for administrative expenses, etc. Again, as I am trying to keep things simple we will leave out the details (e.g. depreciation, operating lease interest, adjusted taxes, capitalized R&D amortization etc.). What you are trying to do is to count only the net of operating items, i.e. you exclude anything that is not part of the core business.

So we are talking about the revenue minus costs as the basis for value while the growth rate as well as the return on invested capital (ROIC) and the weighted average cost of capital (WACC) influence the value of the company.

Value driver formula

Note that this second equation is derived from the simple value formula and just adds some additional information. The resulting value is the same. If we extend this a little and claim that first a business needs to be healthy in terms of short, medium and long-term measurements as well as from an organizational perspective, we can create the following frame (also from the McKinsey way of looking at value):

Value driver model

So what a company can do to increase value is to adjust ROIC upwards (ROIC is NOPLAT/Invested Capital – so we have revenue minus cost inside the equation), it can focus on growth and on the cost of capital. In a nutshell, this is the essence of value creation.

A good objection to make here is when actually valuing a company, the key value driver formula is usually not applied – instead you would o for a discounted cash flow method (DCF). The reason for this is that DCF is more versatile. Look at the next chart in which I have tried to sketch the typical path of value creation.

Value creation path

The above graph shows how investments typically destroy value before creating value over a period of time. As a consequence, ROIC does not stay constant but rather changes over time. The same is true for growth – it will typically accelerate, reach a peak and then decline to a normal (sustainable) level. DCF allows us to take these effects into account more accurately. However, most DCF valuation assumes a period of constant ROIC and growth after a forecasted horizon. The resulting continuing value is then calculated using the simple value formula.

Let’s get back to the vale driver model and extend the previous model with a bit more detail

Extended value driver model

The resulting extended value driver model is simplified of course but nevertheless allows to connect Fred’s statements to the basics of value creation. Fred says that value is a result of optimizing cost. In other words, maximizing revenues is not primarily the key driver of value, but instead it is the margin (revenue - cost). This simple equation seems to be forgotten often, in particular by Internet startups and businesses. 

Revenue minus cost, a simple equation only holds if you actually make revenue, or at least revenue that is larger than costs produced. This, however, is not the case for many startups – and Fred names just a few of them, Facebook and Digg, but there are numerous more. A natural response to not being profitable is to grow in potential future revenue. In the case of consumer services like Facebook and Digg, each user of the service ads another bit of future revenue potential. But this does not change the fact that the companies are still actually destroying value (see value creation path above).

The consumer Internet market is poised by the free factor. Services are commonly available to the end-user for free. The major reason behind that are network effects that are typical for the web2.0 era. In essence, a service becomes more valuable to the user as more people use it. Take Facebook for example – the more people you know are on the network, the more you can connect to them and share your stories, pictures and activities. Digg is another example, the more people that display their favorite posts or websites the larger is the inventory from which you as a user can identify pieces of content that you like.

A consequence of network effects is the emergence of small windows of opportunities in which a leader can establish a dominant first mover advantage. The timeframe in which a first mover advantage is established in the Internet industry is scarily small when compared to traditional industries – mainly through the low cost of service adoption.  In a game where network effects are present, the winner takes it all – at least that is the notion.

Once a clear market leader has emerged it will be very hard for other services to enter the same market with a similar offering, since consumers face rather high switching barriers. In the case of Facebook: If all your friends are on Facebook but not on NewSite.com, you will not derive the same value on the new site. It will be hard to get all your friends to switch to NewSite.com and as long as all your friends are on Facebook and only few of your friends are on NewSite.com, you will derive relatively less value from being on NewSite. The critical reader will object that this may not be entirely true – and here we are talking value again.

I will pick up from here in my next post and will focus on strategies for value creation for Internet businesses. Maybe in another post I will try to take another perspective on value in general, i.e. value creation in the economy and the role of entrepreneurship and multi-project valuation (=valuation of a diversified company). 

I like to work in frameworks - they help me reduce things an compare new ideas with proven ones. So here in this post I'll take a first step at displaying how I understand the internet business.

What is it that constitutes an online business? It basicall comes down to users, data and alorithms which should translate nto usage which in turn generates revenue.

• Information, data: Data, in its most basic form as bits and bytes builds the source of information. Data and information serves as input for people and/or algorithms.
• People: People operate computers and interact with data/information. Every online business model will need to address persons as users.
• Algorithms: Algorithms create meaning by automating tasks and solving particular problems on the basis of data

In order to generate revenues, a business needs to

• Generate usage of the services
• Monetize usage

In order to get some first insights about how major internet businesses generate revenue, I have put together a short table of some of the largest Internet pure-plays below:
 

The preliminary insights for now are as follows:

• Almost all companies are B2C companies, they focus on end-users
• Almost all companies rely on an enter, edit, list & view mechanisms of some kind
• There are three enablers: Google, Yahoo! and Mozilla which are "commodities" for internet users
• Successful models solve a problem as simply as possible – such as: creating a marketplace by making supply and demand visible, matching supply and demand, finding information via search, pooling supply and making inventory searchable, enabling digital identities and leveraging communication tools 

Today is video day :). I just watched another TED video during lunch and was amazed at the clarity of the video "What consumers really want".

Joseph Pine talks about the emergence of the services economy on the basis of a commodity and goods economy. As a consequence of the customization of services, Pine states that experience is the next major evolution of value in the economy. Experience is mostly highly personal and requires a service to be absolutely authentic.

Pine illustrates this with a good example: take coffe beans - as a commodity, they are worth not more than a few cents. Coffee as a good as it can be bought in supermarkets is worth maybe 20 cents a cup. Coffee as a service means brewing the beans and handing out cups of coffe in a restaurant or gas station. For this service, you can charge a dollar or more. Starbucks, however, provides the full experience of coffee in it's stores and can demand four to five dollars a cup.

Great speech!

Here some of the slides: 

The progression of economic value:

The "real real":

Business imperative and customer sensitivity of the types of economic output: