One of the biggest challenges C-suite executives face today is around the disparity that exists in how revenue is valued by Wall Street. Depending on a company’s business model, one company can generate a dollar and Wall Street measures it as a dollar. Another company, such as Zoom, can make a dollar and that same dollar is valued at $90. Clearly, a dollar is not a dollar anymore.
Companies everywhere are trying to figure out how to generate a dollar that is valued at 90 times that amount. The answer to this common board room problem lies in a company’s business model and, specifically, how it embraces digital models. Traditional companies are being crushed by digital businesses that can generate durable recurring revenue streams, and, as a result, digital companies are valued higher.
Chipotle and big box retailers are examples. Even before the COVID-19 pandemic, they began their journey to create very robust digital models where customers can buy online and pick up curbside or have purchases delivered. It’s these companies willing to embrace new ways of doing business that tend to grow faster because they are more resilient. Other major retailers have struggled with the COVID-19 crisis because they didn’t start evolving their business models to embrace digital sooner.
The below highlights the characteristics of traditional business models and digital business models:
|Physical supply chains||More resilient adding digital supply chains|
|Lumpy revenue creates surprises||Greater predictability with recurring revenue streams|
|Hard to create additional cash flows||Rethinking business models to increase free cash flows|
|Business is fragile and unpredictable at times||Consistent and forecastable|
Digital Supply Chains
Many product companies today are dependent on physical supply chains, but because they have been optimized for cost, they don’t offer the resiliency needed during challenging times. A digital supply chain is much more flexible, redundant, and can scale up or down as quickly as needed.
It’s also more durable. During the COVID-19 crisis, a lot of companies had severe problems because their physical supply chains were disrupted because they had single points of failure, were overly complex, and experienced significant interruptions. Companies such as Zoom didn’t have this type of problem and when their business demand went up significantly, their platform and supply chain was able to handle that.
While companies like Zoom are full-on digital, it’s important to note that companies can’t just flip completely from physical to digital. They just need to balance their revenue streams so that if their physical supply chain is disrupted, they still have a way to make money through their digital side of the business.
Free Cash Flow is King
Cash flow is a view of how efficient a business is. Often times, companies on a digital transformation journey will also try to free up cash flows, which is very important during economic downturns. In the past, a company looking to transform into an As-a-Service model needed to think more about zero-sum budgeting.
For example, if they were going to spend $15 million, they needed to find $15 million cost savings to do that. The ability to become more digital and create free cash flow is even more important. A company needs to fund the development of these new capabilities, but when growth may be slowing, they need to make controlling costs a real priority so they can continue to make money.
Wall Street used to value digital companies solely on growth and how they could scale, and it seemed like it didn’t matter how much money they lost. Today, the market has changed and it’s all about a balance of growth and profit and digital models allow companies to switch from a “growth at all costs” approach to a more reasonable growth with profitability strategy.
Another reason Wall Street likes digital models is because they don’t like surprises and want visibility into the future. Most C-suite executives remember the days of waiting for the last day of the quarter to get that last license agreement needed, which determined if they hit or missed their quarterly target. This type of lumpy revenue is in contrast to a subscription businesses where over 80 percent of its revenue is already booked at the beginning of the year because its recurring.
Moving to Digital Business Models
In these challenging times, more resiliency and durability must be built into all businesses. It is imperative that CEOs and CFOs understand this need to digitally innovate to create real value. In fact, digital models can often act as an insurance policy for the business when it enters uncertain and/or challenging periods.
C-Suite executives looking to add more digital capabilities should start by asking themselves the following questions:
- Is my business set up to take advantage of the digital economy? Two good metrics to evaluate your business include your Z Altman Score, which measures a company’s financial stability and the Rule of 40, which looks at a company’s tradeoff between growth and profitability.
- How easily can we create recurring revenue streams or new digital models?
- Do we have the expertise in-house to pursue new digital growth opportunities or do I need to partner/outsource?
- Are there key functions we can outsource to free up internal teams to focus on building differentiated digital products and services.
- Do we have an agile culture that will embrace a digital business model?
After asking the above questions, executives can then start developing their plan. This involves the following key initial steps:
- Identify new business opportunities
- Carefully re-evaluate investments in core businesses
- Get the expertise needed to tackle new growth businesses
- Develop short term and mid-term roadmap and action plan
- Control costs and identify actions to create new revenue streams
- Rethink offers, pricing and monetization models
- Simplify processes to go faster
The Winning Business Model
As companies begin their journey to add or increase digital capabilities, they will discover that the winning business model is all about creating customer value. Digital models are resilient, generate recurring revenue, and are built on a platform that can provide leverage for the company in the future as market dynamics change. They are also customer focused and deliver great experiences, which makes it easier to upsell and cross-sell products and services.
Developing these durable, resilient revenue streams can also enable high growth over time, which is the name of the game.
Kevin Dobbs is managing director, As-a-Service Business leader for Accenture.