Pivot to the Future: Discovering Value and Creating Growth in a Disrupted World (PublicAffairs, 2019).

Netflix, Starbucks, and the Value of the 'Wise Pivot' -- Barrons.com

By Omar Abbosh, Paul Nunes, and Larry Downes 

Two decades into the digital revolution, investors still struggle to estimate the value -- and risk -- of disruptive innovation for companies. For a public company, that estimate comes in the form of its future growth value, or FGV. Traditionally, FGV is what's left of the company's total or "enterprise value" after subtracting the portion of its value attributable to current earnings. How investors accurately determine that premium, however, largely remains a mystery. 

Investors in companies with high FGV -- think Amazon.com, Netflix, and Salesforce -- care most about tomorrow's businesses. That's even more likely in the case of highflying companies with no earnings, where FGV accounts for the entirety of the company's market value. A recent study by Pitchbook, in fact, found that the stock prices of unprofitable tech companies that recently went public performed better than their profitable peers. 

But to better estimate how much FGV a company will realize, we think that investors ought to look more closely at what that company is doing about current earnings. An Accenture Research analysis of over 1,300 public companies found only a select few that managed to sustain growth both in their current business and in their future business. Examples include Starbucks, genetic analyzer Illumina, and China-based software giant Tencent Holdings. 

Companies like these excel in both improving today's earnings and nurturing an environment of innovation that allows them to quickly build new businesses. When opportunity knocks, they pivot around their core assets rather than lurching away from them. Rather than disposing of legacy businesses at fire-sale prices, or treating them as "cash cows," they invest in them to prolong profitability. They do this even to older products that competitors have begun to abandon. And they are prepared to scale rapidly into new markets -- but only when the right combination of cost- effective technologies, business models, and ecosystems comes together, often suddenly. 

We call this approach "the wise pivot." A wise pivot is continuous. It regularly rebalances a company's assets and resources across its businesses in all three stages of the business life cycle -- the old, the now, and the new. 

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Consider Netflix. It began as a mail-in DVD rental service. But CEO Reed Hastings was already preparing to move to the "new": a subscription-based streaming service. Capturing and analyzing customer data in the streaming business was in turn an essential pivot to get the company to its next new: the creation of original video content informed by a deep, data-driven relationship with its more-than 100 million global subscribers. As this example makes clear, the wise pivot doesn't simply balance unrelated investments across the three life-cycle stages. It discovers valuable synergies among them. 

Companies that pivot wisely are much more likely to realize the FGV the market assigns them. They know that their businesses need a war chest of robust earnings in today's markets to fuel investments in future innovation. They also know that speed matters: Markets created by disruptive innovation are increasingly short-lived. When users recognize that an innovative product is both better and cheaper than current offerings, they often adopt the new en masse. This creates "catastrophic success" -- a level of instant demand that even the best companies struggle to fulfill. 

Those that succeed, however, take the lion's share of the new market's earnings. The winners both time the market correctly and leverage core capabilities to deliver products to everyone, at once. Examples include e-books, smartphones, and social networking, all of which achieved rapid consumer adoption. In all of those cases, the major movers took most of the earnings. The innovation ecosystems of the future will probably see the same kind of accelerated user adoption, whether we're talking about artificial intelligence, the Internet of Things, blockchain, or other emerging categories. 

What, then, should investors do right now to test their assumptions about FGV? 

First, reassess whether the company is reinvesting enough in the core -- the "old" and "now" businesses -- to generate the cash needed to cover new business investment, which is usually woefully inadequate. The total must be sufficient not just to enter a new market, but also to allow the company to rapidly scale the moment opportunity strikes. 

Next, rethink assumptions about how profit-sharing across an industry might look in a future, disrupted industry. Will earnings be roughly split across some number of competing players? Or, instead, are most of the profits more likely to go to one company, in a winner-take-all game? 

Finally, reconsider how much customer value the new business will be expected to create. Our research suggests that digital businesses are expected to create unusually large amounts of consumer surplus -- value the customers receive but don't pay for. Does your FGV calculation take that into account? 

Today's environment of rapid technology change promises new amounts of FGV for many. It's time to reconsider how it's valued. 

Omar Abbosh, Paul Nunes, and Larry Downes are executives at Accenture and co-authors of Pivot to the Future: Discovering Value and Creating Growth in a Disrupted World (PublicAffairs, 2019).