3 wheels of technology in creating wealth
The January 2015 Fortune article by Erin Griffith and Dan Primack, The Age of the Unicorns, created quite a stir in the technology venture community.
“Unicorns” are start-ups that have achieved billion-dollar valuations. These companies have a robust business model, are capable of achieving stellar growth, are led by a strong team, and have been able to secure funding at lofty valuations.
Xiaomi, the Beijing-based smartphone company, is currently valued at USD45 bil. Uber, the current poster child, is valued at USD50 bil. In total, 80 companies are listed, including Airbnb, Snapchat, Pinterest, and Malaysian-founded Grab.
It’s worth remembering that Travis Kalanick’s early attempt at fundraising – that is, before Uber – was at quite a pedestrian valuation. His first technology start-up, formed just before his graduation from University of California, Los Angeles (UCLA), was called Scour, the first peer-to-peer software company, predating Napster by about 18 months.
That was in 1998, when Kalanick raised USD4 mil for his company, giving away 51% ownership of common stock!
Kalanick has spoken of this experience several times, including at a video presentation at FailCon 2011, where he said they were “kids out of UCLA” and not familiar with Silicon Valley terms.
Kalanick and other founders are now major investors and finding successes with a host of new technology companies. It’s no wonder that the lure of entrepreneurship is so strong, and that so much emphasis is placed on innovation and entrepreneurship as engines of growth.
This might interest you: Who’s Grooming Today’s Unicorn Founders For Success?
What have been the drivers for the phenomenal success of technology companies in the United States (US), backed by Silicon Valley venture capital (VC) funds?
There are reasons for their success. Some are obvious, like outstanding entrepreneurs, access to leading technologies, ability to find early adopters, and the very large homogenous US market.
Other reasons are less obvious and relate to the operating environment that seems to favour companies operating in the US.
What is the “US Technology Wealth Creation” model, and can it be adopted by countries outside of the US?
The US advantage
Before we address that issue, we need to understand the US environment. By the end of the Second World War, the US had developed the world’s largest industrial capacity. Supporting this industrial might was a very significant investment in research and development (R&D).
Outside of this national effort, private equity funds, in particular VC funds, were turning their attention to technology companies.
By the late 1980s, information and communications technology (ICT) companies, possibly spurred by the success of Silicon Graphics Inc which was founded in 1982 and listed in 1986, were actively seeking funding from VCs.
There was a significant growth in private equity funds starting in 1990. And not coincidentally, from 1990, there was also a rise in initial public offerings (IPOs) that attracted VC funding.
So, the new money was finding a good return through IPO exits, and was being actively recycled.
The US, arguably the wealthiest and most powerful nation in the world, has a population of 319 million, a GDP (gross domestic product) per capita of USD54,625 and a population that has a literacy rate of over 97%, based on World Bank data for 2014.
The Malaysian challenge, and Asean
In contrast, Malaysia has a population of 29.9 million and a per capita GDP of USD10,933. Does this huge difference in market size have an impact on business potential?
Definitely! Ask any of our entrepreneurs. The larger the market, the more opportunity to find a customer who will value (and pay for) the service or product you have.
Naturally, therefore, the larger the market opportunity, the larger the profit potential – which translates to a much higher valuation!
Small countries are at a disadvantage, hence the importance of open regional groupings like the European Union.
It is important, therefore, that Malaysians are able to target and serve the regional market. Efforts are being made by government agencies to change the market paradigm. Access to the large Asean market of 625 million, across 10 countries, covering 4.4 mil sq km, is important, even though it is not a homogenous market.
In Malaysia, national ICT custodian Multimedia Development Corporation (MDeC) is actively supporting a regional push of its MSC Malaysia status companies, as well as promoting a broader adoption of technology in companies to improve efficiency and productivity.
The R&D issue
The availability (and harnessing) of technology, of talented individuals, the interest in the market for new solutions and access to funding, did drive the growth of US technology companies.
Clearly, these were strong drivers that favoured US companies, but there were others. A strong R&D base was critical. There is a huge commitment to R&D from corporations as a means of creating new products.
These are other factors that came into play with what we call the Technology Wealth Creation model.
Let’s look at a major driver of R&D and innovation – funding.
The Malaysian Gross Expenditure on R&D (GERD) is actually quite high, yet there seems to be a paucity of successful technology companies.
According to the Malaysian Science & Technology Information Centre, GERD in 2012 was RM10.612 bil, which represented 1.13% of GDP. The GERD to GDP ratios taken from Organisation for Economic Cooperation and Development data for other countries are: Japan (3.47%), US (2.73%), and United Kingdom (UK) (1.63%).
Malaysia’s expenditure as a percentage of GDP is close to that of the UK, but in real terms, its expenditure on R&D (2013) at £28.9 bil is equivalent to RM183 bil – 17 times that of Malaysia!
Besides expenditure on R&D, the critical ingredient is the quality of the researchers, and it is in this area that the US has a big advantage – the best brains from around the world compete to work at the world’s best universities.
International students in the US account for 70% of the full-time graduate students (Master’s and PhDs) in electrical engineering, 63% in computer science, and 60% in industrial engineering.
We only have to look at two chief executive officers’ appointments, where both candidates went to the US for their Master’s and stayed on to work there: Satya Nadella of Microsoft, a graduate of the Manipal Institute of Technology; and Sundar Pichai of Google, a graduate of the Indian Institute of Technology Kharagpur.
Total expenditure on R&D is driven by the pressure on companies to stay competitive through innovation and that drives technology generation, the first of the Three Wheels of Wealth Creation (3WWC) illustrated.
The three interlocking wheels show the interplay between Technology Generation, Business Creation, and Wealth Creation.
Working in harmony, the 3WWC promotes the development of appropriate technologies, encourages and supports the development of early stage companies, and finally, rewards the participants with financial wealth from IPOs and acquisitions – which in turn frees up funding and support to keep the three interlocking wheels in motion.
Underlying all the wheels are a number of positive driving factors.
The willingness to take risks is a critically important factor across all the wheels. At the creation stage, founders take risks, mostly with money from others but they are comforted by the fact that should they fail, there is no stigma attached to failure. They can go back to the job market, or start a new venture!
This is a unique feature of the US landscape, particularly in Silicon Valley.
Passion vs professionalism
What is equally interesting is the willingness of early customers who take on unproven products and solutions.
Why are they willing to take this risk? The answer is pretty simple: The companies are constantly looking for a competitive advantage, and generally the companies are privately owned and managed by professionals, who are measured by their performance.
Much is spoken about the need for passion in business creation, or actually, in most endeavours. It is therefore portent to remember that competence is far more important than passion.
Ben Horowitz of Netscape fame once gave the commencement speech at Columbia University, which he titled Don’t Follow Your Passion.
He said, in reference to the quality of the contestants in the show American Idol, “just because you love singing does not mean you should be a professional singer,” and “what you are passionate about at 21 is not necessarily what you’re going to be passionate about at 40.”
One needs to have a sense of reality and self-awareness.
Finally, with wealth creation, the market (intuitions and individuals) is willing to buy shares in new companies at huge forward valuations.
Some companies show earnings performance, but many don’t. A few companies survive, others get acquired, fortunes are made, and money is recycled – not just in new companies, but in huge research grants and endowments to the leading universities.
Harvard, Stanford, Berkeley and others have become the centres of research because of the quality of their labs and access to huge funds from benefactors.
Harvard University has the largest endowment fund in the US at USD36.4 bil and for the year 2013, paid out USD1.5 bil to support its programmes, some of which are dictated by the donors.
Yale, Stanford and Princeton all have endowment funds in excess of USD20 bil.
Outside of the US and China, which share some commonalities with the US (population, technology generation, propensity to take risks, etc), following this strategy would not be a viable path.
Honestly, any attempt to unearth a Malaysian “unicorn” is not likely to end well.
But we do have large corporations and industries that are faced with an increasingly volatile world, and they need to find a formula for success. Added to their problems is the fact that we live in a world that is getting increasingly competitive.
Leadership skills will be severely tested – fair weather captains need not apply! To quote Professor Jay Rao of Babson College, speaking on leadership today: “Several different kinds of leadership – heroic, transformational, charismatic – worked prior to the 21st century. However, as VUCAH (volatility, uncertainty, complexity, ambiguity and hyper-connectivity) increases around us, those types of leadership are quite inadequate. Entrepreneurial leadership is what works better in today’s world.”
This new world requires all companies to put in place new management practices which need to take in the “attributes” of entrepreneurs who are experts at dealing with change and finding opportunities.
Otherwise, the future for large companies is bleak.
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Reposted with permission on Leaderonomics.com.