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The myth of the small balance sheet

There is a popular idea out there that internet platforms are different from all other companies because they don't have to own any assets to control their market. Unfortunately, that's wrong. New markets are about networks, ecosystems and routes to customers, not balance sheets.

The misconception stems from a piece by Tom Goodwin in TechCrunch that starts: "Uber, the world's largest taxi company, owns no vehicles. Facebook, the world's most popular media owner, creates no content..." This quote has become the de-facto metaphor for disruption in the internet age – so much so that it was cited by more than 80 per cent of the speakers at a conference we attended in London last November.

What started as an interesting observation – that the internet had shaken up the supply chain and allowed for the emergence of asset-light distribution platforms - has morphed into orthodoxy. In the information age, the theory goes, one set of companies does the hard work of producing goods and services, while another set – internet platforms – distributes them, earning super-normal profits on account of having few assets and negligible costs.

We don't deny that as technology fundamentally changes commerce, it alters consumption patterns, opens up industries to new competition and challenges existing business models. We see very different types of organisation springing up (Snapchat and the Marriott Group have roughly the same market capitalisation, but one employs 330 people and the other 127,500). And internet and mobile technologies have allowed for the separation of distribution from manufacturing, meaning that companies such as Alibaba can distribute physical goods without holding any physical inventory.

But technology is constantly changing. In the same way as the advent of the internet has shaken up value chains across a range of industries from taxis to banking, so additive manufacturing and distributed ledgers will do the same, producing new business models and speeding up disruption. The average lifespan of an S&P company has dropped from 67 years in the 1920s to 15 years today – and will likely continue to fall.

Companies are constantly evolving, too. Platforms that start out asset-light rarely stay that way. High profits attract strong competition, forcing incumbents to strengthen their value proposition to stay ahead. And firms' desire to maximise profits means that they tend to broaden and deepen their offering as they become established.

Take Netflix, for instance. Its assets have grown by a compound annual growth rate (CAGR) of 49 per cent since 2008. It is investing more than $5bn this year on original content, more than cable TV companies such as HBO and FX as it attempts to differentiate its streaming service from those of rivals such as Hulu and Amazon Prime and gain exclusivity over the content – ratcheting up the stakes in the battle to retain and grow subscriber numbers.
It might be tempting to see Netflix as an exception, but examples abound. Alibaba, whose total assets increased by 127 per cent between 2014 and 2015, is investing in original video content through Alibaba Pictures, a movie content firm, and by acquiring media companies such as Wasu Media and ChinaVision. LinkedIn, which has seen assets grow by a CAGR of 78 per cent since 2008, last year acquired online learning website Lynda.com as part of a move into content production. Spotify, BitTorrent, Vimeo and Reddit have all recently announced that they are producing video content in response to rising competition. We believe Facebook, too, will soon have to start doing the same – in its case to support a push into artificial intelligence, which cannot rely on user-generated content alone.
As these platforms build out their assets, their return on capital necessarily falls. In the numerous examples we have looked at, we see a clear trend over the medium term where profitability, initially super-normal, reverts to levels in line with historical norms.

But the biggest issue with the low-balance-sheet theory is that it looks at digitisation through the wrong lens. The fact is that the internet era isn't producing an overall trend to smaller balance sheets – just different routes to customers (with varying delivery models).

Tesla is a company that is taking advantage of technological advances to bring electric cars to consumers. But it's not a low-balance-sheet proposition; quite the opposite. Unlike Apple, Tesla doesn't just design its cars in California, it builds them there. This increases its balance sheet. Unlike almost every other US car manufacturer, it sells directly to customers rather than wholesale through dealers. This increases its balance sheet still more. But Tesla goes even further than this by having to build its own global network of supercharging stations to fuel the vehicles it sells. This would be analogous to Ford owning its own gas stations not just throughout the US but in every global market it entered. This constitutes the mother of all large-balance-sheet businesses – over $8bn at the end of 2015 compared with revenues of $3.7bn

In the media sector, new companies such as BuzzFeed and Vox have taken advantage of changes in the way content is distributed to launch innovative business models. But, again, these are not asset-light. BuzzFeed's model, built for the social-media age, uses a team of staff reporters to create content designed to go viral - breaking news, celebrity-focused stories, lists, quizzes. It also makes very intelligent use of data (for which it has built its own CMS, algorithms and advertising platform) to turn extremely high traffic volume into advertising revenue as well as to investigate why some content works and other content doesn't.

When we look at the fintech sector, which has very different dynamics from cars and media, we nonetheless observe that while new routes to market are opening up, there is no clear trend to lower balance sheets. In fact, we predict that, just like other digital-age companies, successful fintech firms will add products and services as they seek to deliver additional customer value and grow wallet share, necessarily meaning that they will become asset-heavier and in many cases more vertically integrated.

The fact is that the situation is more complex than the balance-sheet-light theory allows. Successful models will vary in asset intensity. Digitisation moves the primacy away from hierarchical models towards ecosystems. But within an ecosystem, some things are controlled while others are not; some assets are owned, others are not.

What matters in the end is not the size of the balance sheet, but the customer.

David Galbraith is a Partner at Anthemis and Ben Robinson is Chief Strategy & Marketing Officer at Temenos

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