for shareholder value in the age of the internet
on the fault line
Moore is perhaps the best known and most respected thought-leader on the subject
of the New Economy. At this Morino Institute
Netpreneur.org event held October 26, 2000, he explained how managing for
shareholder value is all about increasing your company’s future unrealized
potential and how startups, dot.coms and going concerns can do that more
effectively. If you understand the technology adoption lifecycle and focus on
those things which enhance competitive advantage, Moore says we can maximize the
Internet, this “most investable opportunity we’ve ever seen,” and create a
New Economy where a network of interlocking companies all focus on the core
functions they do best.
made at Netpreneur events and recorded here reflect solely the views
of the speakers and have not been reviewed or researched for accuracy
or truthfulness. These statements in no way reflect the opinions or
beliefs of the Morino Institute, Netpreneur.org or any of their
affiliates, agents, officers or directors. The transcript is provided
"as is" and your use is at your own risk.
2000 Morino Institute. All rights reserved. Edited for length and
one: mary macpherson: welcome
Good evening and
welcome to Living on the Fault Line. It's great to see you. I'm Mary MacPherson, Executive Director of
the Morino Institute's Netpreneur.org. On behalf of the Institute, the Netpreneur.org team and this
evening's sponsors, I'd like to thank you for coming. We invite you to sit back and enjoy what's going to be a terrific
Joining us live via the Internet are
folks from all over the planet. Here in
Washington are over 1,200 of our closest friends. This definitely qualifies as the biggest party we've hosted
since starting our learning community for Internet startups in 1997. The fault line isn't just in California;
it's everywhere. It's the
Internet. And speaking of parties and
the Internet, this morning The Washington Post reported on a
UCLA study that concluded that the Internet
has become a new source of social contact.
We can safely say that the Internet
has been bringing us together here in Greater Washington for some time, both
online and off line. How we all came to
be here tonight is a story in itself.
In the best tradition of viral networking, you helped us get the word
out. How many people in the audience
got more than one email about this event?
How many got more than three? We
heard again and again that people were getting multiple emails about it, but
they were interested in seeing the thread and seeing who they were coming
from. We truly have an organic network
of hundreds of groups and thousands of individuals involved in Greater
Washington's entrepreneurial community, so thanks to all of you who helped get
the word out--corporations,
associations, user groups, schools, individuals and organizations. Please give yourself a hand, and I'd like to
give a special recognition to Mitch Arnowitz, the Netpreneur team's viral
marketing maestro, who orchestrated our connecting effort tonight.
Let me tell you about tonight's
Moore will lead off. He will then
be joined by two entrepreneurs to expand the conversation, followed by open
microphone Q&A. Those of you
watching via Webcast can email your questions.
Finally, Mario Morino will bring it together as he does so well to wrap
up the evening. The conversations can
continue afterward, over coffee and dessert served in the foyer outside.
That dessert and this entire evening
are made possible by our sponsors. They
have stepped up in a major way to support you, and we encourage you to learn more
about their services and how partnering with them can benefit your
businesses. Thanks to our community
partners, Imperial Bank, Heidrick & Struggles, Deutsche Banc Alex. Brown, The Staubach Company and The ProMarc Agency; and to our premier
partners, Brobeck and Washtech.com. We hope that you have noticed the big changes in the print
edition of The Washington Post and in the new Washtech.com site. Business and technology coverage has come a
long way since the days of being in the back of the Post’s sports section. Finally, a special thanks to our marquee
event partners, UUNET's Head Start program and NaviSite.
NaviSite, as part of the CMGI family, has grown guided by the vision of
David Wetherell. Like many of you, he
is a true entrepreneur who started a small company called College Marketing
Group (CMGI). With his vision, CMGI
went from selling direct marketing services 30 years ago to a Nasdaq 100
company, now, managing, developing and investing in the most diverse network of
Internet companies in the world.
NaviSite is the leading provider of managed application hosting
services, and they provide what companies need to launch and sustain their Web
businesses. A little later in the
program, Andy Sherman, NaviSite's Vice President of Sales, will lead our
audience Q&A session. Andy is
building a national sales team focused on responsiveness, a solutions
orientation, flexibility and professionalism.
It is now my pleasure to introduce
Brad Wise, Vice President of Channel Sales & Development for UUNET. Having quickly grown to be the largest ISP,
UUNET has not forgotten about its entrepreneurial roots. Through its Head Start program, the company
now offers full-service support and access to startups while they are still
young and have the potential to become the next generation of large UUNET customers.
Brad Wise has been there since the beginning and is one of the people at UUNET
who has kept the entrepreneurial fires burning with the Head Start program and
other initiatives. Please help me
welcome Brad Wise, who will introduce tonight's speaker.
two: brad wise: introduction
ladies and gentlemen. It is my pleasure
to be here. I'm Brad Wise, Vice
President of Channel Sales & Development at UUNET,
and I'm excited to be a part of Living On
The Fault Line tonight. Our Head
Start program was also a sponsor of the Cluetrain
event back in March. At the time, I did
not think the excitement and enthusiasm could be exceeded, but I believe
tonight we're going to prove that wrong.
It is my pleasure to introduce our
featured speaker this evening. He is a
guy with many dimensions--venture capitalist, author, business and market
strategist and tech visionary--and none of this happened until he was 32 when he
wrapped up his career as an English professor and took the plunge into
business. Since then, he has written
books about a chasm, a tornado, and, now, a fault line. And let us not forget Geoffrey's gorillas,
which were the inspiration for Netpreneur.org's Garage2Gorilla event
last year. Amid these geologic and
anthropologic things, there is some extraordinary wisdom for people in the
audience tonight, whether it’s two of you in a garage, a startup that recently
received a first round of funding or a brick-and-mortar company looking at what
you need to do with your business model.
Geoffrey Moore's latest book is Living on the Fault Line,
subtitled Managing for Shareholder Value
in the Age of the Internet. In his
remarks tonight, Geoff will talk about new metrics, navigational tools and new
strategies for achieving and sustaining the competitive advantage. Please help me welcome Mr. Geoffrey Moore.
three: geoffrey moore: gaps,
caps, & pragmatists in pain
Brad. Thank you all. This is amazing. It’s exciting from the point of view that when networks start to
come together, there is something called increasing returns--you
folks are right in the middle of increasing returns. It's a huge tribute to yourselves, to Mario and Netprenur.org,
and I'm just delighted to be a circumstance in this process.
Building a network is crucial to
economic development, particularly around disruptive technologies, so, to kick
this off, I’d like to add two nodes to your network by introducing two
individuals. I’m affiliated with both
the Chasm Group and Mohr Davidow Ventures, both of which now have
offices in this area. Brian Nejmeh of InStep is providing Chasm Group consulting
services for the DC area as an affiliate of the Chasm Group, and we are
absolutely delighted. Michael Sheridan
is our newest General Partner in Mohr Davidow Ventures, and he is opening up
the office for the Greater Washington corridor. I hope you get a chance to introduce yourselves to both of them
sometime tonight. Thanks, guys.
For this first part of the evening, I
want to put four ideas in front of you, then engage with the panel and Q&A
around how applicable they might be to your current economic challenges. It's pretty well known, however, that can
you only retain three ideas in any one speech, so I'd like you to look
carefully at this list, and pick the one you are going to zone out on:
for shareholder value . . .
2. . . . in a
3. . . . in a
4. . . . in a
Just pick the
three you want and we'll make it go. It's a little bit of a long run, but I
really want to share all four ideas with you.
The first one, Managing for
shareholder value is a framework for understanding stock price and
shareholder value. The others are
applications of that framework to startups, to dot.coms and to existing, going
concerns. In each context the framework
changes in interesting ways, so let me start with stock price.
what is managing for shareholder value?
If you spend some time with a Wall
Street analyst, as I did when I was writing The Gorilla Game, you
learn that the actual price of a stock is set by whatever people will pay for
it. The theoretical value of a company,
however, is the present value of all your future returns forever, discounted
for risk. Those three ideas--present
value, all future returns and discount for risk--are all wrapped up in how
people are trying to calibrate whether valuations are too high or too low.
One argument you could make is that we
were insensitive to risk in 1999, and that today we are hypersensitive to
risk. We experienced both in the press,
right? In 1999, no matter what
happened, somebody found a good news story out of it and we went up. Now, no matter what happens, somebody finds
a bad news story in it and we go down, so the discount for risk has got to
recalibrate around technology.
Let me show you a picture of that same
idea, then tie it back to the thing that you can control as a manager in your
own company. If you think about this issue
of future returns discounted for risk, the first thing we can talk about is
that your company has some current returns.
Copyright 2000, Chasm
They are a benchmark. The investor uses
it as a frame of reference for understanding your future. When I buy a share of your stock, I'm only
buying a part of your future. I'm not
entitled to the current returns, so, fairly quickly, I will ask, “How are you
going to do in the future?” Now, you
entrepreneurs are remarkably
consistent in how you answer that question, so investors have to say,
“Okay. Looks good. Yep.”
Then the investor asks, “How am I
going to respond to your promise in terms of valuing it in the present?” They apply the notion of discounting for
risk. They break it up into two
chunks. One has to do with the present
value of money. Basically, that it's a
function of interest rates--how could that money be put to work today in a bond,
which is essentially a risk-free investment.
The haircut I just got, that's the money that I could have earned from a
bond’s compound interest going forward in time. I'm not going to give you any credit for that because I can get
that "risk free." The second
and more powerful discounting phenomenon is discounting for risk, based on
looking at your future going forward.
Copyright 2000, Chasm
The further out in the future you promise returns, the greater the discount for
risk I apply to them. It's just an
issue of future uncertainty--competitors could enter the market, conditions could
change, oil prices could go up, we could go back to an inflationary economy, on
and on and on. The further out in time
we go, the higher the risk discount until eventually it becomes 100%. That simply means, once you get to the end
of that green curve, I will assign no additional value to any promise you make
outside that point in time.
Now, the area under the green curve is
a visualization of your market capitalization, whether you are a public company
or a private company.
Copyright 2000, Chasm
It is the value
of your company from a fundamentalist investor's point of view. This isn't a speculator's idea; this is a
person who says, “I really do want to value you on the present value of your
future returns, discounted for risk.” From this investor's point of view, you have one job--make
the green area bigger. This is actually
pretty easy to do in PowerPoint, but harder in the real world.
When you deconstruct the challenge,
the key thing is that you want to start with the notion of making the green
area bigger. You either have to make it
taller or wider. It turns out that the
actionable equivalent of taller is to take management actions which will
increase the gap between your company's offers and those of your closest
competitors. The greater the Competitive Advantage Gap (GAP), the
greater the differentiation in terms of a vector that the customer values in
making buying decisions. If you can
create greater differentiation, there’s a higher probability that you will win
the sale and a higher probability that you will be able to win it at a premium
price. The higher your GAP, the greater
the suggestion that you will have very privileged earnings going forward.
Most management teams understand this
in spades. In fact, this is what most
managers spend most of their days talking about, starting with their sales force
explaining why the GAP is too small, engineering explaining why the GAP can't
shift for three months and marketing explaining how you never did the GAP that
they asked for. We are always talking
GAP, GAP, GAP all the time, so I don't think there is a lot you need in terms
of getting educated on that vector. It's the other vector that gets lost in the
The other vector the investor is
interested in is how long you can keep your GAP. We call it the Competitive
Advantage Period, or CAP. The more
sustainable that competitive advantage, the more I can give credence to your
future projected earnings statements.
Conversely, if I think you have a GAP right now but your competitor is
going to ship the same product in three months, then I have to assign a much
lower valuation to that advantage because it's not going to last very
That issue of sustainability of
competitive advantage is what gets lost in the shuffle of day-to-day
management. When we look at the two
ideas, we put a lot of attention on GAP, such as new product introductions
which get the entire company mobilized.
Lower priced offerings, a sales force that's up for it, superior
customer service--those things are all a little bit CAP-ish, but you can still
get GAP stuff going around that. CAP
things like patent positions, market share leadership or brand loyalty--investments
that take time to put in place--they tend to get the short shrift in highly competitive
situations. This is where managing for
shareholder value is the thing that rescues you because, in the short term on
this quarter's P&L, investing in CAP is a losing proposition. It won't pay off in the quarter that you
expense it. Shareholders, however, are
able to look past that to your competitive advantage position as a whole and
value it. If you use your stock price
instead of your P&L as a guiding point, you get that input back into the
corporation. If you compensate the
corporation with stock options, you have the opportunity to get that same
thinking as part of the motivation of the company going forward.
Managing for shareholder value has the
opportunity to keep management accountable to its best self going forward.
There is a dark side to this, as well, and we'll get there, but it has the
opportunity not only to build advantage in the present, but to make the
investments necessary for sustainability going forward. The key is that investors value power. They do not value P&L statements in and
of themselves. Yes, investors like to
see revenue growth, but it turns out that they really want to see good revenue growth.
The notion that there could be such a
thing as good, neutral and bad revenue will not go over well with your sales
force, okay? That's not an idea they
want to entertain, but, from an investor's point of view, it's absolutely
true. Good revenue is any revenue you
get from a customer where the business you do today actually tees you up to do
more and better business in the future.
It means a good customer in your target market making an investment today
that implies future investment with you later.
Neutral revenue is opportunistic revenue that you take from a customer
that you will probably never see again.
God bless them, though, it's a purchase order and the check cashes, so
it’s a good thing.
The danger zone is bad revenue. Bad revenue comes from agreements you make with customers who are
not appropriate for your company. They
require you to make ongoing investments in ways that divert scarce resources
from where you should be investing. Over
time, actually, it will be harder for you to make your numbers in future
quarters when you make this quarter's numbers by taking bad revenue. You will have fewer resources to deploy next
quarter and you will have a harder nut to crack. Managers have asked, “But Geoff, if I'm going to miss the quarter
shouldn't I take bad revenue?”
The correct answer to that question
is: You have already missed the quarter.
The only question is, which
quarter do you want to miss? It turns
out that if you are going to miss a quarter, you want to miss the current
quarter. Every time you defer that
reckoning, it gets worse. There was a
spectacular example of that in the Bay Area about five years ago with a company
called Informix. They had an incredible management team; the
CEO was a very charismatic salesman who made what I would call diving catches
in the end zone at the end of quarter after quarter after quarter to keep up
with or exceed Oracle’s growth. On the
sixth quarter, he missed his numbers.
He only missed it by one digit, but it was the first digit, so it was a
serious miss. Bad revenue is serious,
and you must have this discussion with your management team about what’s good,
bad or indifferent revenue.
This isn't to say that you can blow
off the P&L when you are talking to investors, but understand that your
P&L is always a trailing indicator.
It actually establishes your credibility about past promises you made and
whether or not they came true. The investor is always investing in your future,
not your past, and that's the first lesson of this section. This is the thing that you don't want to
lose sight of: managing for shareholder
value equals managing for competitive advantage. If you are serious about stock price, if you are serious about
managing for shareholder value, then understand that you are managing for
competitive advantage. Understand that
market capitalization¾whether in good markets, bad markets, mature markets or
always a representation of the future unrealized potential of your company.
When shareholders buy your stock, they
need you to increase the future unrealized potential of your company in order
for them to sell at a price higher than they bought. Instead, if you milk that potential to make numbers and end up
with a company that has less future unrealized potential, then, when they sell,
they lose money. That's what we are
managing for when we are managing for shareholder value--future unrealized potential.
It is inherently future-oriented, and it is inherently a build-and-hold
kind of idea.
That's fundamentalist investing, by
the way. There are other forms of
investing, such as momentum investing and speculation, but this is a Warren
Buffet-type of fundamentalist investing.
I think it's the one you should teach your employees, customers and
partners. You should recruit investors
who believe in those ideas.
Now I want to apply these ideas to
three zones, and the first zone is the domain of the startup.
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