Capital allocation: portfolio or platform?

One of the most important jobs of any leadership team is to allocate capital effectively. It’s a huge value creator, or destroyer, and it can make or break the future of a business. One important aspect of capital allocation is portfolio management. Leadership teams have an obligation to invest in assets that create value and divest those that don’t (or that might have higher value elsewhere). The best leaders act as a principal would, and a key role for Boards is to ensure this obligation is being met.

At the same time, the digital economy has seen the rise of powerful platform ecosystems. These businesses facilitate the exchange of value between independent parties. Well-developed platforms have ecosystems of mutually supportive products and services. Many of these have built defensible moats and grabbed share, and the market has rewarded them with outsize returns. Companies in this category, such as Amazon (Prime, Video, Whole Foods), Google (Gmail, YouTube, Android), Bloomberg (news, data, television), Facebook (Facebook, Instagram, Messenger, WhatsApp) and many other smaller, lower-profile businesses (Stripe, Axel Springer, etc.) now have unique advantages.

Where the platform ecosystem model isn’t relevant, portfolio analysis is relatively straightforward. A subsidiary business has its own revenue and earnings (which may require an allocation), and it can be valued. If the multiple is likely to be significantly higher, or lower, than the parent company, a financial arbitrage opportunity may present itself. And, if the subsidiary is diverging on strategy, a divestiture by the parent may allow its management team to focus on the core business and achieve better results.

In the case of a platform business, fully capturing the role and value an asset plays is critical.

But, in the case of a platform business, where the asset is part of an ecosystem of interdependence, fully capturing the role and value that the asset plays is critical. If it is not understood, there is a risk that even if a favorable headline value is achieved for the separated asset, the remaining business will suffer. Short-term investors may applaud the immediate value capture, but long-term investors will find they’re left with a deteriorating business. Only when the entire strategy and value are tied together do correct portfolio decisions get made.

So, how do you determine if an asset is actually part of a platform ecosystem? When does that asset actually achieve its highest value? And, most importantly, what is the implication on strategy and value for purposes of effective portfolio management?

Viewing a portfolio asset as independent simply because it has a separate brand, or because its results are reported independently under GAAP rules, or even because it might sit on a distinct technical architecture, is inadequate. In a platform business, there are more important data signals to look for when determining if an asset is part of a strategic ecosystem:

• Customer Overlap. Commonality of customer base between an asset and other parts of a platform ecosystem indicates a need to look further at customer acquisition cost and lifetime value. It also is an indication of strategic coherence. If there is little or no customer overlap, there is usually little ecosystem synergy. Prime, Prime Video and Whole Foods have high customer overlap, for example, while Amazon Web Services has relatively low customer overlap with other parts of the Amazon platform.  
• Cost of Customer Acquisition. The cost of customer acquisition is a critical driver for all digital businesses and, in particular, consumer businesses. In a platform ecosystem, each asset contributes to the whole by lowering the overall cost of customer acquisition. That may mean the product or service provides an easy entry point for customers, or it may mean that it adds value to the overall customer proposition and, in turn, brings down acquisition cost. Bloomberg news and television are available outside the financial terminal and introduce financial professionals globally to the Bloomberg service at little to no cost, while making it cheaper and easier to sell a subscription bundle.
• Customer Lifetime Value. Perhaps the most important driver of platform benefits is the ability to increase the customer lifetime value. This may be through direct cross monetization, or it may be because it is part of a bundle that makes it more likely for a customer to renew a subscription, or accept a price increase. Prime Video is an excellent example of a “business” that is actually part of a bundle, and it creates value by selling Prime, significantly improving the lifetime value for the customer. Google uses the surface area of all of its properties, from Gmail to Android to YouTube to Search, to increase its share of advertising and improve its ad rates.
• Product and Data. In a digital ecosystem, separate products can support each other and become powerful drivers of customer satisfaction, while lowering development costs. Facebook uses product resources to benefit its entire platform ecosystem, whether it is a common login between Facebook, Instagram and Messenger, or data-sharing across its properties, to better target customers for vertical propositions like Facebook Marketplace.

If an asset has some or all of the characteristics above, it doesn’t in itself mean that the asset must be retained at all costs; but it raises the bar on divestiture or monetization considerations. In addition to the independent revenue that the asset generates, all of the platform benefits must be captured. Could synergies be captured by contract in the event of a divestiture? Possibly, but history shows that in the case of platforms, contracts are weak proxies once the assets are separated and under different management or ownership. Benefits, (such as co-product development, and pricing and service level trade-offs between assets to increase overall customer value) are exceptionally difficult once an asset is separated.

Portfolio management as a component of capital allocation is a critical part of effective corporate stewardship. Divesting assets can create value and provide focus. But in the case of platform businesses, there is a risk of winning the battle and losing the war. If a “good price” is achieved for an asset but the sale precludes the synergies possible on the full platform, the remaining business could deteriorate and destroy value. The best management teams and investors understand this dynamic and fully capture it in their decision making process.