Most of us understand the power of compound returns when it comes to our investment portfolios. You establish a nest egg and watch as interest and cumulative value balloon over time. However, very few leaders and boards appreciate that these same principles apply to strategy too. There are new business models that yield “compound returns” and dramatic competitive advantage. What is their fundamental differentiating characteristic? Strong, active networks, leveraging digital network technology, to bolster the influence, growth, and value.
For decades, the growth rate of organizations has been constrained by their material assets – things and people. If you are a manufacturer and you want to grow, you need to acquire more plants, machinery, distribution channels, and other physical assets characterized by cost and constraints. If you provide services and want to grow, you will need to source, hire, and train a bigger workforce to bring those services to market. Growing an asset base of physical things or skilled people is a time-consuming and uncertain process, and this essentially limits organizations to linear growth.
Now, a new business model, supported by a slew of new technologies, offers higher growth rates at lower costs. These organizations invest in networks – assets that offer compounding returns over time. Consider what the following organizations have achieved in record time:
- In 12 years, Facebook grew to 1.86 billion monthly active users – more than a quarter of the world’s population.
- In eight years, Airbnb achieved a valuation of $30 billion, more than Hilton and Hyatt combined, which is particularly impressive considering Hilton and Hyatt have more than 100 years in operation combined, and perhaps 100,000 more employees than Airbnb.
- In less than six years, Uber has reached a valuation of $68 billion, surpassing Ford and General Motors
These companies are achieving incredible growth rates by tapping into external networks. Rather than having to source, acquire, and manage all the physical and human assets themselves, network companies build relationships with people who are willing, for a share of the rewards, to contribute to company value. Building relationships is easier than building assets, and companies that use network-based business models also enjoy network effects: each additional participant provides added value for everyone else in the network. Network effects, usually complemented by referral programs created by the company, encourage those already in the network to entice other people to join, catalyzing a virtuous cycle of contribution, collaboration, and resource aggregation. Facebook, LinkedIn, Uber, and Pinterest all created rapidly growing value – to investors and customers – as their networks grew.
Networks have always been around, from matchmakers to unions to social clubs. What is different today is that technologies like social, mobile, and cloud enable networks to scale at incredible speed and near-zero cost. The combination of networks and technology, which amplifies them, is what fosters this latest example of the power of compound returns. When another networked participant joins a digital platform, the incremental cost to the company is minute, but the value added to the network is significant and typically multiplicative, fostering further growth.
Although getting the platform, incentives, and critical mass of participants isn’t simple, once companies ”get it,” they tap into a virtuous cycle of value creation. The network of participants joins in to share in the heavy lifting and value compounds for everyone.
Your organization can target digital and business model transformation to create compound growth, profits and value. But, transformation requires new mindsets and strategies. Here are three rules for navigating this ambitious shift:
- Start now – don’t procrastinate. The rapid growth comes after establishment. The sooner you get started experimenting with network engagement, the sooner you can get to the compounding stage where rapid growth and profits occur.
- Build true partnerships with your networks. The reason that some business models achieve compound growth is that the network is engaged and personally invested. Participants have value at stake, so everyone wants to succeed. You must understand your networks, including their goals and motivations, in order to build the right incentive structure to foster these virtuous cycles.
- Invest in digital with discipline. Digital technology is a foundational technology that enables rapid scaling, reduced expense, and community engagement. Investments must be made up front and continued with diligence, discipline, and determination while the fledgling network is developing. Make digital a central pillar of your ongoing budget and investment strategy. An uncertain, tentative, or one-time allocation is unlikely to yield anything other than friction and failure.
Network-based business model transformation is not easy, but it’s essential as new disruptors spring out of Silicon Valley targeting every legacy industry under the sun. Network-based business models offer organizations an unprecedented opportunity to tap into virtuous cycles of value creation. Digital technology is the enabler and amplifier of this positive feedback loop. Market value today is being funneled towards digital platforms and networks like those built by Amazon, Uber, Netflix and Microsoft. And building on their strengths, these companies are entering new markets and swamping old ones on a weekly basis, disrupting the status quo.
Network-based business models promise compound returns for value, growth and profits. You need to act quickly to preserve your terrain and build your own virtuous relationships with your firm’s key communities before someone else does. Returns on these investments will start small, but, with discipline, your results can compound dramatically over time.
This piece was coauthored with Megan Beck, Chief Insights Officer at OpenMatters and Michael Krugman Associate Vice President of Communication and Collaboration Services at Boston University.
This article was written by Barry Libert from Forbes and was legally licensed through the NewsCred publisher network.