ustomers of incumbents are used to a particular pricing and delivery model. The start-ups have taken the role of disrupting the existing business models. Customer adoption and customer acquisition  have taken precedence over burn rate. Growth is encouraged even at the cost of negative unit economics.

The plan is to build market share by subsidizing new customers.

Venture capitalists and private equity funds are willing to fund the growth with their risk  capital. For example today wallet companies are challenging banks with their simplified payment interface. Traditional businesses are being challenged by aggregator and marketplace business model.

Since the unit economics is negative, higher growth rate requires continuous fund raising. The companies are able to raise money at higher valuations to acquire more customers to build their market share. These companies are also moving to adjacent services offerings to build an integrated business model.

The  same disruption can be done by the established conglomerates also. They need to create wholly owned subsidiaries and fund them with adequate capital.

The start-ups are dependent on investors to grow their business. They don’t have the balance sheet to support their growth. The established financial metrics like profit margin, ROE, ROCE have been replaced by burn rates, GMV in the name of apps and disruption. The investors are willing to fund them since it is a growing company.

Venture - Image by Gerd Altmann from Pixabay

The same disruption can be done by a conglomerate with a better and predictable capital structure. The established companies have profit generating divisions which does not need capital to grow. These divisions may have reached a matured and saturation phase. The new division is created with capital from these established profit making business units.

The new division enjoys a patient and recurring capital with better controls and predictable time frames . The conglomerate is willing to sacrifice the short term losses  and fluctuating stock prices to build the new division. The shareholders are willing to support the new venture with their resolutions and approvals. Once the new business achieves profitability,the conglomerate can spin it off into a separate company with a strategic partner.

This kind of support and capital structure cannot be compared with companies supported by investors.

The private equity funds have limited partners who have given money. All the funds have a limited life cycle and timeframe. They always have a basket approach. Redemption and NAV pressure can influence their investment decisions.

The businesses are built over decades with patient capital .More importantly both the investor and entrepreneur are aligned with the interests of business unlike the funds.

For funds it is another company in their portfolio. We have seen how Amazon has built different businesses in various categories with their cash flows from retail and web service businesses. They don’t depend on investors to fund their new businesses.All the new business units are funded by profits of other divisions. This has allowed Amazon to have a real long term approach despite not making profits for many years.

In India we have seen how Reliance industries has incubated retail and telecom business with the cash flows and balance sheet strength of reliance industries.

The management was very clear about the long term potential of telecom and retail.The entire decade was spent on investments by RIL.

To summarize, to build a new business or disrupt any industry conglomerates can do it  with more flexibility and time unlike the funds.They don’t have the constraints of fund if they manage the investment phase.

Lot of businesses  take time. It requires patient and recurring capital to create a “ winner takes all “ market leader.

This does not mean all incumbents build new businesses with their cash flows. We have seen many examples like Nokia, Blackberry, retail giants and Kodak losing their business to start-ups.

With all these changes, customers have turned out to be the real winner. With competitive pricing and better product features, customers are the true boss even if the businesses become a monopoly.


Title Image by Tumisu from Pixabay

Nov 18, 2019

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