The past one year has been a roller-coaster for new-age internet-based companies that listed amid much fanfare—from attracting massive interest during their IPOs (initial public offerings) to their stock prices plunging sharply from their peaks. Key factors that could perhaps explain this fall are the global tech meltdown, blue-sky valuations, Indian markets being unfamiliar with such hyper growth ‘loss reporting’ businesses, and company specific and technical issues.
We focus on three key dimensions. First, was the stock move in new age internet stocks a bubble? Second, we try to understand the new-age entrepreneurs’ mindset. Third, we look at ways to identify winning stocks.
Is it a new-age tech stocks bubble: The level of fear that new-age companies are witnessing currently seems overwhelming. Nonetheless, being in a platformed/ networked age also allows successful companies to reap incredible rewards far more rapidly than earlier times. Despite the tech sell-off globally, five of the top 10 most valuable global companies are technology firms. Even in India, while some of these companies may fall by the wayside, it is likely that a few could emerge big winners.
Asymmetrical investment opportunities present themselves in the midst of panic with few takers. As such, for long-term contrarian investors, this panic in new age stocks can present an opportunity. Peter Thiel’s book Zero to One emphasizes that “Being contrarian does not mean that dumb people disagree with you; it means that smart people disagree with you.” Most smart investors would agree that investing in proven ideas is better than investing in unproven ones. However, business model innovation involves trying something that is new, and is thus unproven. This paradox is often true for all investment opportunities which are at inflection points.
Understanding the new-age entrepreneur’s mindset: When a startup matures to the point where it has a killer product, sizeable market, and robust distribution channel, it may become a ‘scale-up’. Often, the fastest and direct path from startup to scale-up is the hyper-growth produced by ‘Blitzscaling’, which is the term popularized by Reid Hoffman in his book Blitzscaling. When a market is up for grabs, the risk often is not inefficiency – the real risk is playing too safe. Now, Blitzscaling involves doing things that don’t make sense according to traditional business thinking, such as prioritizing speed over efficiency despite an uncertain environment.
Amazon was criticized for consuming capital without delivering consistent profits. But the global e-retailer’s ‘inefficiency’ helped it dominate online retail, ebooks, and cloud computing. The power of ‘Blitzscaling’ lies in the ‘first scaler advantage.’ Once a scale-up occupies a high ground in its ecosystem, both talent and capital flow in. This explains why venture capitalists want entrepreneurs to pursue exponential growth, even if doing so costs more and increases the chances of failure. The greater risk is moving too slowly and allowing competitors to win market leadership.
How to identify possible winners: Growth alone does not create value, unless paired with an innovative business model. For example, a firm can achieve high customer satisfaction and revenue growth if it sells a ₹100 bill for ₹10. But no amount of scaling this model will build any sustainable value. Reid Hoffman gives a set of tools, principles and patterns to evaluate innovative business models and winners.
How to know if a business model can deliver exponential growth: The first is the ability to predict the total addressable market and how it would grow. Next, the new-age firm must evaluate if it could leverage existing networks to create a viral distribution pattern—where users bring in more users. The third factor is the ability to generate large gross margins. Finally, the firm must be able to create network advantage.
Then there are a few patterns to look for. Models based on electronic bits are more scalable than material atoms, as with digital goods. Then, a platform with scale and network effect is a great combination to have. Three, free services have great power, Google and Facebook being great examples. Four, marketplaces have created many global winners, made more powerful when paired with two-sided network effect. Five, subscription model has a substantial delivery advantage. Finally, businesses based on feeds, like twitter or Instagram can have considerable advantage.
We believe, long-term investors could leverage these tools, principles and patterns to identify possible winners of tomorrow.
Siddharth Bothra is fund manager at Motilal Oswal AMC.
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