February 15, 2013 Leave a comment
In these times of heavy crisis, one of the most important issues for companies (especially SMEs and small entrepreneurs) is the lack of financing resources. As any economist or business person knows, external financing is fundamental to improve the company operation and make it grow. Financing paves the way for having the means to produce goods whose sales will generate an income that will allow returning the received funding and generating profits.
The improvement in the functioning of the company provided by external funding is so great that the metaphor of the lever has been used to illustrate it, in line with what Archimedes said: Give me a place to stand and I will move the Earth. And so, in the language of business and accounting, this boosting effect of financing is commonly referred to as financial leverage.
In normal circumstances (it is clear that this is not the case now , but we hope it will some day!), Banks give financial leverage for companies to enhance their performance, and this is one of the Banks day-to-day activities. They do that through loans and other different financial instruments.
Small businesses and other commercial activities use this kind of leverage from Banks since they exist, and financing businesses is a natural part of the Banks’ classical business model.
Therefore, SMEs and small entrepreneurs generally get leveraged by a loan from a Bank. Traditionally, SMEs and entrepreneurs have undertaken activities within a local or geographically limited region, at least initially. In these cases, it is relatively easy for Banks to analyze the viability of the business for which the loan is sought, since it is enough to analyze a very local and well known market. But with the advent of the Internet, everything changes. Now, most entrepreneurs and start-ups try to make a relatively low local investment. But they try to drive a global business. Thus, their market expands dramatically, and knowing it and accessing it is much more complex. Thus, Internet entrepreneurs and start-ups may have a great business idea and a very competitive product. But they have two problems: on the one hand, they do not usually have global market knowledge nor ability to get access to it on their own and, on the other, when applying for the loan it is very difficult for the bank to assess the potential response of the market, given its size and features.
This is why I would like to introduce the concept of market leverage. Up to now, I have not found traces of this term nor its associated concept whith the traditional searching engines (Google, …). But of course, I do not feel as being its father. Not only because nowadays everything has already been invented, but also because the concept is so overwhelming logical that it must have been already used. In fact, this concept is partly the basis of our business innovation strategy in AGBAR/Aqualogy, including among others the CDTI’s INNVIERTE project, which has a similar goal. So, the most probable thing maybe is that it has not been put in words as a specific term (or at least I could not find it!). And, if this is the case, we should remember that even in the Bible (In the beginning man gave names to all the creatures…) it is stated that progress requires nominal definition from the beginning.
This is then the issue: just like banks offer financial leverage to businesses so they can grow, new SMEs and Internet entrepreneurs need other companies to give them market leverage, in the sense of facilitating their entry to the market, giving them market knowledge and commercial networks, and perhaps giving them also some operating leverage, not in the accounting sense of the term, which also exists, but in the sense of making available structural and/or intangible assets that can help (leverage) the operative development of the start-up.
When this market leverage is effective, it is also easier for the bank to analyze the project and to grant its funding, since the existence of the leveraging company is an additional warranty.
In this regard, the utilities case is particularly interesting . Indeed, these companies often run in a very large market, frequently international. And thus they have deep market knowledge. In addition, many of them are rooted in former state-owned companies and are subject to regulated prices, and therefore they usually have a corporate culture which is a galaxy away from the digital and the entrepreneurial culture, which is much more collaborative, more agile, more fiercely competitive, more unstable, but with a huge development potential in the future business environment. So when utilities market-leverage digital start-ups, the benefit flows in both senses:
- On the one hand, the start-up gets market and operational leverage (sometimes financially complemented from the same utility company) to access global, difficult or unfamiliar markets. And even in the case that the utility does not give funding, its real presence in the business facilitates also financial leverage by Banks.
On the other hand, if the utility chooses the start-up properly , it will also get business results, either because the start-up provides new technology for their traditional processes, or because it provides a new product to its traditional or new customers or because it brings prestige (and thus more sales) or other intangible assets. In addition, the utility can keep a very close relationship with the start-up culture during the leveraging stage. This will certainly help evolving the utility’s own culture into another potentially more successful within a world with a permanent digital economy growth. Care should be taken to avoid standardizing the start-up, ie introducing there the utility tipically bureaucratic rules, because if this is done, the beneficial effects of the mix will probably die before birth.
This market and operational leverage can be materialized formally through a strategic alliance agreement between the two entities, or by any other form of association, optionally including shareholding in the start-up. Each case should receive special attention to choose the rightest model, which in any case must respect the win-win approach, ie ensuring that both parties win with the transaction.
Startups are rapidly expanding in the present times . In fact, they are very closely related to the digital economy impressive growth and success. Moreover, the current economic crisis is also undermining the foundations of the more traditional labor contracts within consolidated companies. As a result, the entrepreneurial culture will expand in a twofold way. In the context of the utilities traditional business model decline, mixing each other’s culture will probably lead to a new business culture. A new and stronger culture to face our liquid times, which if they evolve in their turn, they will certainly do towards the gaseous state…
With all the above, I do not know if you have already noticed that I am a strong believer on the market and operational leverage. I really see many opportunities in it, and I try to apply it everyday wherever I go. However, it is a very innovative approach and therefore it generates a strong change resistance, the greater the older and stronger the preexisting culture. The only way to carry it out is by identifying increasingly attractive projects , more productive and more profitable projects, which can show more clearly the model advantages.
I therefore invite all who pass by here and somehow agree with me in this vision, to share ideas and projects that we can develop under this concept.