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Stop Searching for the Next Facebook, and Start Looking Behind the Scenes

When assessing companies, investors need to be aware of oversimplifications.
Martin Hoffmann is a private equity professional, turned author, publisher and entrepreneur. With dedicates his work to help knowledge workers & decision makers navigate an era of change by outlining patterns of change that happen across industries.
Martin Hoffmann is a private equity professional, turned author, publisher and entrepreneur. With dedicates his work to help knowledge workers & decision makers navigate an era of change by outlining patterns of change that happen across industries.

Image via Niall Kennedy/Flickr CC

Around the world, tough socio-economic conditions have provoked a number of knee-jerk reactions from the public. Voters are making extreme decisions based on media hype rather than hard facts. We are seeing the rising popularity of far right parties in Europe, there is negative sentiment towards immigrants in the U.S., and, of course, we have Brexit. People are turning to simple solutions for complex problems that run far deeper than meets the eye.

Interestingly, the same pattern continues in business. The lifespans of Fortune 500 companies have fallen drastically from 61 years in the late ’50s to only 18 years today, on the other side of the coin previously unheard of tech startups are regularly being valued at upwards of a billion dollars. As rapid change replaces predictability, the world is becoming more complex both in politics and business, and easy solutions appear more tempting.

At the same time, startups are heralded as the next Facebook (FB), Uber or Apple (AAPL) – regardless of revenues or business models. This fanfare is purely based on appearances and, though it may be more easily digestible for the public, the reality is far more complex.

If we don’t take the bigger picture into account, and look deep into the operations of each company, we miss out on essential information and the potential it has to truly succeed.

Look Under the Hood

In The Black Swan, Nassim Taleb argues that as a society we far too often create narratives that do not exist, especially when those narratives support our argument or opinions. In the same way, when assessing companies, we need to be aware of oversimplifications.

Veteran investors and entrepreneurs find themselves in an ecosystem where spotting the next big hit is based on a whole new set of value drivers. For ease of understanding, emerging tech companies are often compared to Silicon Valley giants. On the surface this might seem like a straightforward solution, but once you look under the hood, the similarities end.

Many will have raised eyebrows when Dollar Shave Club — a subscription razor service — was valued at more than $600M and then acquired for $1B. Because it is not a tech company, doesn’t spend millions on R&D, and doesn’t follow the patterns of other unicorns people may have assumed it would not be powerful. However, if you delve a bit deeper, the term ‘razorblade business model’ exists for a reason.

Dollar Shave Club excelled because when you look under the surface it has its ducks in a row. The founders might not be shiny Silicon Valley Tech visionaries, but they have a solid business model that is likely to stand the test of time. While the unit economics for razor-blades might be low, people will always need them, providing recurring revenues, and Dollar Shave Club offers a user-focused, easy to access, affordable service. The consumers don’t care whether Dollar Shave Club has a patent or innovative products. But they like the convenience, the brand, and prices and that’s why they stick with it.

When we hear a tempting narrative or comparison to a massive success story, we should question which key element of the company’s story is being focused on, and whether this is the element which really drives success.

While two companies may be superficially similar, they may well have entirely different success factors and different unit economics altogether. Facebook, which is often confused as a social media platform, is another great example of this. Investors and consumers are constantly on the lookout for the next Facebook, without really understanding the true strength of the company itself.

Facebook is a leader in all things social. This is because Facebook is good at mastering the algorithms, analyzing user data and understanding what users want to see. Even more, it is eminently successful when it comes to helping marketers reach their users.

In reality, the platform has developed into an effective marketing lab, with a social media veneer.

The company’s biggest asset, of course, is its massive customer base. Changes within this base — such as younger users swaying towards chat apps like Snapchat and Whatsapp — have forced it to evolve away from its core business into the ‘next hot space’. Facebook’s acquisition of Whatsapp was a defensive move, which added new customers to its core business and turned it into a conglomerate.

This lesson extends beyond assessing a company’s skill set. There are lots of advice to copy Warren Buffett’s investment style or Steve Job’s product development skill set. Yet, there are few investors who match Buffett’s performance or Steve Jobs determination and work ethic.

Focusing on the Business Model

We need to determine what makes a particular business model tick. The only way to do this is by going back to the start and beginning from scratch. Instead of thinking in terms of companies, industries or sectors, we need to think in terms of business models and their success factors.

To determine what is the core skill and activity of the company we need to work out what they are focusing on behind the scenes. A great way to do this is by looking at the type of people they are looking to hire on their website, or sites such as AngelList.

For example, if we look at Dollar Shave Club, they are not looking for razorblade experts, their key activity is building a loyal customer base in an efficient way through excellent marketing and branding. Dollar Shave Club spends a lot of time away from the desk interacting with customers, finding out exactly what they need and want, and work out why they make purchases. The product itself is fairly unimportant.

In the modern business landscape, there is no point trying to compare businesses on face value with previous unicorns and tech giants. While human instincts push us to create narratives and make comparisons, examples like Dollar Shave Club show us that it is the internal workings and business model of a company that defines its chances of success, not its flash, flair and hype in the media.

Just as Warren Buffett and Steve Jobs were formed by unique experiences, skill sets and personal characteristics, which fitted perfectly into the wider picture of what was going on in their industry at that time, it is important to take a step back and assess the real strengths of companies. In politics and business alike, we need to stop hunting for the simple solution and look past the first page, and read the whole story.

Martin Hoffmann is the CEO and Founder of Business & Investor Labs that helps decision makers and forward thinkers understand and analyze the businesses of the Post Industrial Age.