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The Value of Digital Transformation: How Investors Evaluate “Tech”

What’s the value of your digital transformation?

This is a question that most large companies struggle with, beyond just the challenge of building a financial model or P&L projection around your changing business.

At a more fundamental level, how will the market value your changing business, given the competitive environment and your new more “digital” self.

When approaching these questions, there’s a tendency to look at tech companies as comparables, particularly fast-growing startups in your industry. In doing so, a lot of vastly different business models often get lumped together, especially if they’re all backed by Silicon Valley.

But public markets tend to see through these superficial comparisons.

The Curious Case of Two IPOs

Two recent IPOs tell an interesting story.

One of the two companies is Blue Apron. Blue Apron was considered a tech company while private, raising money as a startup from Silicon Valley VC’s at valuations that were typical for other tech companies and receiving lots of hype and praise from the traditional tech press.

But when Blue Apron IPO’d last June, public markets told a very different tale. The company is currently trading at a revenue multiple of about 1, with a market cap just under $1 billion dollars. Rather than being valued like a tech company, it turns out that public markets value Blue Apron much the same way they would a typical chain of grocery stores.

And if you think about it, that’s really what Blue Apron is: a grocery store with a different user interface and delivery mechanism. Nothing about Blue Apron’s business model really shifts the fundamental economics of the grocery business, which are typically very low.

Now, let’s look at company number two. That company is CarGurus.

This little-known company went public in early October. Cargurus’ revenue was about $143 million for the first half of 2017, compared to Blue Apron’s nearly $500 million.

Yet Cargurus was valued at a revenue multiple greater than ten. What’s the difference? Cargurus is a platform – a product marketplace to be more precise. Blue Apron is just a digital interface slapped on top of a traditional linear business.

Despite all the hype around Blue Apron ($199m raised before IPO) and the lack of it around Cargurus – which had previously raised only one small round of funding – public markets instantly saw the value of Cargurus’ platform business model.

Platform Innovation Creates the Most Value

This comparison is only one example. In our research for Modern Monopolies, we found a similar disparity between linear businesses and platforms when looking at both public companies and startups. But it’s becoming even more clear that simply adding digital or tech to your business will not automatically mean a higher valuation.

For large companies looking at digital transformation, the lesson should be clear. Simply slapping digital on top of your core business is not enough to significantly increase the value of your business. Software alone doesn’t build a defensible moat, and investors know it.

The real value is in creating and growing an external network and building a platform business. Platform innovation is by far the most valuable type of digital transformation.

However, it’s also likely the most difficult. It requires looking at your industry with fresh eyes and understanding how a network can help you build a better and more defensible business than your traditional supply chain.

This is a hard lesson for many big companies to learn. It involves going against much of what has made them successful in the past.

Yet for those who are able to take the leap – as Walmart has done in the last year – platform innovation can pay big dividends.

Originally appeared in Inc Magazine

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