Hardly anything is as exciting as business. One of the most attractive aspects is certainly investing in young start-ups or established companies that are heading for new, digital horizons. It is not only an opportunity to invest money wisely, but also a valuable contribution to the further development of economy and, at the same time, to gain first-hand insight into exciting new developments.
It is precisely the rapid digitalization of recent decades that has created entirely new business areas. Understanding technologies and approaches down to the tiniest detail cannot and need not be the task of investors. It is the duty of start-up founders and CEOs to keep investors at a level of knowledge that is necessary to gain and maintain confidence in the business model.
Since the mid-1990s, I have had the opportunity to gain a wide range of experience with digital transformation: as a three-time digital founder, as an investor and as a strategy consultant for established companies, start-ups, private investors and venture capital firms. I have noticed repeatedly that the rapid development on the technological side as well as in the field of business models makes it incredibly difficult to keep track of things. Investors often prefer to let the management of companies bring them up to date. But what if CEOs themselves lose sight of parallel developments by focusing on their own business, overlooking trends and technological breakthroughs or even new, destructive business models in their own field of business?
Investors can trigger the debate on market-changing developments and ensure that management and investors develop the same understanding of the business by leading the management into a constructive dialogue with targeted questions. The following eight questions are particularly crucial in the current state of the digital transformation. How CEOs respond to these questions gives investors a good impression of the extent to which management is prepared for change or is actively shaping it.
Question 1: How will you increase efficiency through digital solutions?
Managers of traditional companies are usually focused on increasing efficiency. Automation, robotics and AI applications aim to streamline processes and improve efficiency. When investors ask the management about raising efficiency, they can expect a list of solutions and already started projects on digital manufacturing automation, robotics and process improvements as an answer. Furthermore, managers of established companies should be able to present the financial forecasts of planned efficiency gains and ROI.
The situation is somewhat different for start-ups. Their primary goal is not to achieve efficiency in existing processes, but to create new markets. Only when they succeed in doing so does efficiency become a criterion for business development. However, one aspect plays a role at a very early stage, namely scalability (see also question 5). Especially purely digital business models can reach large markets very quickly. In this case, it is necessary to scale up the performance at least to the same extent in order not to fail due to performance bottlenecks despite a perfect product-market fit. Scalability must be prepared, and founders should be able to provide investors with answers as to how the efficiency of their own service supply can be maintained in exponential growth processes.
Question 2: Which new markets, customers and business models will you develop?
Start-ups have usually answered this question early on before they even get an investment. For shareholders and investors of established companies, the situation is often different. The company has already written a success story. Nevertheless, many of these successful business models are under pressure and lead managers into a dilemma. On the one hand, it is important to maintain the well-running core business. On the other hand, it is essential to radically adapt business models to new realities, to conquer new markets and customers or to build up completely new areas of business.
Investors not only have a right to information here, but also have an important steering function. CEOs often run into internal distribution conflicts. Constructive discussions with investors can help to develop the general direction. Clear demands from the investor side can facilitate prioritization and support internal argumentation.
There are a number of success stories in which established companies have not limited the digital transformation to production but have creatively taken completely new paths. Leaders in the US, such as Uber and Airbnb, have ensured that a broad awareness has developed for the potential of business models that create new markets and appeal to customers in a completely different way. Platforms such as Kloeckner.i and Bosch-SI show that this is not only possible in the USA and not only in consumer markets. CEOs of other companies must therefore also be able to provide answers to corresponding questions. Despite existing success stories, investors must be aware that such far-reaching transformations are a challenging process that goes through ups and downs. Success at the first attempt is unlikely.
Question 3: Does the business model correspond to the actual market dynamics and technical potential?
The first digital company I founded was a B2B platform. In 1996 we were among the first. At that time, nobody knew exactly whether and how such a business model could work. Since then, various standards have developed. In recent years, the platform business model has even become a hype. Numerous founders and also established companies are trying to become successful with platform models. There is nothing wrong with this, but it must be remembered that successful platforms such as Amazon or Alibaba have meanwhile set completely different standards than could have been foreseen ten years ago. Anyone who now starts a classic platform model is lagging behind. The same applies to business models in e-commerce, banking and many other fields. Checking whether a company is up to date is anything but easy for investors. As a rule, intensive involvement in strategy and technical implementation is inevitable and external experts may have to be consulted.
Question 4: What additional business value will you create through digitalization?
This question again affects established companies more than start-ups. For companies seeking an exit, valuation is of paramount importance. It used to be easy decades ago. It was assets and discounted cash flow that counted. With new, digital business models, such as platforms, the low asset value no longer has any relation to the billions of dollars in revenues that are generated in some cases. Even a DCF is only meaningful to a limited extent if a business relies on network effects. The size and quality of the network are better predictors of future success than historical cash flows. In these cases, new and more suitable metrics must be developed.
Investors should insist that management clearly demonstrates which market dynamics and technological developments create value in which form through the business model and the technological basis. At no other point is it so important to pay attention to the precisely fitting interaction between business model, market dynamics and technology. Companies that are well positioned here can tell a story of value creation that inspires shareholders and investors with its stringency and persuasiveness. If gaps are found, rework is urgently required.
Question 5: Is your digital business model scalable?
Scalability is what investors expect today in order to pursue an attractive exit. Digital solutions and business models of established companies are now also expected to be scalable. In the best case, this means that the company’s reach and revenues can be significantly increased with only minimal additional effort. This corresponds to a zero marginal cost approach. For the investment goods industry, this is an unusual way of thinking, since higher unit numbers always result in higher costs. Although the latter can tend to fall with mass production, a zero-marginal cost model will never result. The situation is different for platforms and digital services. In discussions with CEOs, investors should always insist that new products, services and business models are tested for scalability. They should also demand information about the means and measures with which scaling can be achieved. Here, too, several sides must be considered: technical scalability, increasing market reach and developing internal resources.
Question 6: How do you increase the speed of innovations and their implementation?
From my personal experience, this is one of the most critical points that investors should look at. Nowadays, it is no longer the earth-shattering idea alone that makes a company successful, but the speed and perfection with which new ideas are converted into successful market innovations. Most companies are still too slow.
Today, having a good product idea that is transformed into a specification within three months and then developed to market maturity over the course of three years leads in digital businesses to launching a product that is three years and three months out of date. It will lose out to providers that launch a product that is only three months out of date, and which is then continuously further developed. Agile management methods, business experiments and rapid prototyping are the basis for companies to develop an innovation engine that continuously generates and tests new and customer-centric solutions. Speed is a success factor. And when investors ask for speed in product development and digital transformation, they should not be satisfied with the answer “10% speed up”, but rather demand “speed boost by a factor of 10”. Fortunately, the methods required for this are not difficult to learn. The problem is rather to find an understanding and a place for them in the corporate culture. Investors have a right to know which innovation processes are used, how long the cycles are, and which methods are applied to make the company more agile.
Question 7: With which risk management do you ensure security?
Extensive investments in IIoT systems cause high costs. As a first step, they only make sense if the company has clear and optimized processes and it is precisely known that further digitalization will have a positive financial effect. Investors should be particularly attentive to how capital is used and have the risk management behind the investments explained. If doubts arise whether the company’s processes are so efficient and standardised that they are already mature enough to be transferred to IIoT systems, investors should be cautious. It is very likely that an iterative-experimental approach will be more successful than a pure software implementation, as it provides important data about what works and what does not. It allows for controllability throughout the process. This minimizes investment risks. But the process of software implementation is not the only risks in digital companies. The safety and security of systems and the protection of sensitive data (privacy) are essential for the survival of the company. Investors should therefore always urge top management to join forces with security experts and develop ways for the company to make safety, security and privacy in systems, processes, products and services a standard – not as an “add-on” but “by design and default”.
Question 8: How high is the probability that you will achieve your goals?
Many companies still approach projects in a ballistic and linear way: Idea – release – investment – a long period of project work – evaluation of success. The only things that can be used to measure the probability of success of a product idea or a process change are a gut feeling and more or less plausible model calculations that were created before the project was released. This type of project management is risky and outdated.
A significantly higher probability of success is obtained when innovation projects and digital transformation are iteratively structured as agile processes, so that after each sub-step – in the best case by business experiments – increasingly precise data is available for improvement. Success is then not the more or less incalculable result of a preceding development process, but a criterion and control variable already during the development itself.
It is true that, from an investor’s point of view, iterative procedures are difficult to bear. Either it requires a permanent and intensive interaction with the management in order to be able to follow the development continuously, or there must be a very strong relationship of trust between management and investors. Especially if the latter is the case, an iterative approach, which is evidence-based, significantly increases the probability of achieving goals.
Digital business models will continue to offer attractive investment opportunities over the next years. However, they are not self-runners, but require a constructive and critical discussion between investors and management on a regular basis.