When I owned the shipping company S. Ugelstad, we were almost constantly strapped for free cash, even though the company was running well and was very valuable. The key challenge was that the ships were very expensive to buy (i.e., shipping is a rather asset-intensive business). Reinvestment took more or less all the free cash generated by the company. These investments went to purchasing the new ships that the company required to continue to grow and to stay on top of the rapidly evolving technological developments in the industry.
This example from the shipping industry is not unique. Many family-business owners experience the same thing in different asset-intensive sectors. However, today, a new type of company is rapidly gaining popularity. What we see today is the emergence of many asset-light companies; these asset-light firms are becoming the new winners, as opposed to the asset-heavy industries. Consider the list of the ten most valuable U.S.-based companies today. They are all asset-light firms, typically built around proprietary web-based technology. Examples include Facebook, Google, Netflix, Amazon and even companies such as Uber. If we contrast this with the list of most-valuable companies ten years ago, we find that asset-intensive and/or manufacturing firms from the automotive sector, oil and manufacturing are heavily represented. Today, they have vanished from the top-ten lists. And the new winners, asset-light companies, are growing their top lines fast, even though these companies may not always be very profitable. (On the contrary, Netflix is projected to have a negative free cash flow of about 1 billion USD per quarter in 2018. Yes, you read the number correctly!)
Given the above, what shall a family business owner do, particularly if they are involved in rather asset-intensive sectors? This article shall explore some of the possibilities. First, we shall better understand what it is meant to be “asset-light”. Secondly, we will explore how asset-intensive firms perhaps can be made “lighter”.
In their seminal book, The Network Imperative: How to Survive and Grow in the Age of Digital Business Models, the authors Libert, Beck and Wind argue that investors today tend to prefer companies with fewer physical assets than before, as having physical assets does not seem to be as advantageous as it used to be. These three researchers also discussed this tendency in a Harvard Business Review article (Sep. 29th, 2016). They examined a large number of firms according to their percentage of physical assets owned compared to total assets owned and cross-tabulated this comparison with the average multiple that investors would pay for every one dollar of revenue. They found that firms in the health technology, finance and technology services outperformed others by far, and they labeled these CREATORS (i.e., with a combination of low physical asset intensity and high valuation multiples). At the other extreme, firms in the categories of minerals, utilities or transportation were found to be underperformers (i.e., with high asset intensity and low valuation multiples). They labeled these firms BUILDERS. Between these were the so-called SERVERS (i.e., firms with low asset intensity and low multiples). In the final category, high asset intensity and high multiples, there were no firms! Fittingly, this empty category was labeled DREAMERS. So, the bottom line seems to be the following: Increasingly, less is more!
All of these relatively new, asset-light firms are, of course, pursuing network strategies. This can be seen as linking up with a number of others to supply a fast-moving service to a set of customers, who now might easily be served in more and better ways as well, now that a network has been established around them.
As I see it, there are at least four positive dimensions at work in these new asset-light strategies, but there are also at least two negative dimensions. In the following, I will be drawing on the work of Haskel and Westlake in their excellent book, Capitalism without Capital: The Rise of the Intangible Economy. Here are the positives they discuss:
Scalable: The new business models are scalable, thus allowing for rapid growth. And they often allow for scale often without the associated rise in costs, in other words, avoiding dis-economies of scale.
Synergies: Asset-light firms are open to synergy with their customers, allowing for various services to be offered and bundled. And, through long-term synergies with customers and suppliers, the volatility in profits is reduced.
Harness technology: The new firms build on modern technology (IT, the web, communication, etc.), allowing for networked solutions and greater flexibility.
Innovation: The new firms allow for an innovative culture, are non-bureaucratic and attract young talents.
But, there are also negatives:
These firms’ strategies are relatively easy to copy. Protection would come mainly through having a better product, and this typically requires evolving fast.
These firms may be asset light, but their strategies may involve relatively high service costs!
Yet might there still be hope for more traditional asset-intensive firms? The answer is yes! Let us again illustrate this view in the context of a shipping company. There are perhaps three ways for such firms to improve their value, as I have discussed in my new book, Innovation in Shipping:
Attempt a so-called “asset play”: This involves purchasing an asset, say a ship, when the market is low (getting in), then trying to sell it when the market is high (getting out). It also involves buying and selling (i.e., active trading)! Asset play might also involve securing a long-term freight contract for one’s ship when the market is strong (going long), while running the ship on a short-term contract or, as it is called in the shipping business, “on spot,” when the freight market is low (i.e., anticipating a market strengthening; going short)*. So, asset play can only be done in one or both of these two ways: in/out or long/short! This is also true for other assets of this type: steel mills, paper mills, cement plants, chemical plants, real estate and so on. Proper timing is everything! And it is key to have some—but not too much—financial leveraging (i.e., to be financially strong enough to ride out a cycle)!
In contrast to asset play, one might focus less on the market and more on attempting to secure long-term income contracts for the fleet, say, by entering into a long so-called time-charter or base-boat charter in shipping. One might then take advantage of this stable, relatively long-term income stream to leverage relatively heavily on the asset, which typically would increase the deal’s profitability. To underscore the financial predictability of such a deal, one might have a so-called put/call option at the end of the project so that the investor/owner can estimate what return to expect.
Some shipping companies have attempted to become relatively more asset-light while still remaining active in shipping. Take A.P. Moeller-Maersk as an example. This company is the world’s largest container shipping company, with a global market share of more than 18%. Maersk has chartered in about half of its container ships from other owners, thereby reducing its own need to invest in ships. Furthermore, this company has developed several IT-based approaches to enhance the attractiveness of its basic processes, particularly the container service as experienced by its customers. Technology makes it easier to handle the paperwork associated with freight forwarding, container position tracking, simplifying booking and price quotes, undertaking storage for customers and so on. In this respect, it is worthwhile to note that the new chairman of the company is the former CEO of SAP (the German software specialist), Mr. Kaspar Snape. Other shipping companies are, of course, taking strategic steps analogous to Maersk’s. Indeed, one could envisage a shipping firm that does not own its ships. In a similar way, firms in other types of asset-intensive industries are successfully become lighter, through strategies such as outsourcing, licensing in, franchising and asset-sharing. Examples include companies as diverse as Toyota, Nike, Apple and Hilton.
Conclusion
Although high-tech, asset-light strategies are capturing the most attention from both investors and the media at the moment, these strategies have some negative aspects, namely that they can be copied and disrupted or that they may struggle to deliver the profitability that investors envisage. For this reason, more traditional investors and business owners should not lose their cool. Indeed, asset-intensive businesses may have more positive aspects than what is commonly thought. For business owners, the attractiveness of controlling asset-heavy industries can be increased through a) asset-play strategies, b) long-term income contracts and higher leverage and, paradoxically, c) asset-light strategies. In other words, the picture is nuanced here, as in so many other situations, and asset-light strategies offer possibilities for financial investors as well as for more traditional business owners.
Footnote: The terms “going long/going short” thus mean slightly different things in shipping versus in the finance industry. In finance, going long means buying an asset because you think the asset and the market will rise, while going short means being a seller of an asset because you think it will fall in value and can be bought back later at a lower level. Just a clarification of terms!
Discussion questions from the Lorange Network team
Why are so-called asset light strategies becoming more attractive?
What are some of the potential strategy benefits from so-called asset-light strategies?
What might be some potential shortcomings/weaknesses when pursuing an asset-light strategy?
This note has been inspired by the following three readings:
Haskel, J. and Westlake (2018), Capitalism without Capital: The Rise of the Intangible Economy, Princeton University Press.
Libert, B., Beck, M., Wind, J. (2016), The Network Imperative: How to Survive and Grow in the Age of Digital Business Markets, Harvard Business Review Press.
Lorange, P. (2018), Innovations in Shipping, Cambridge University Press.
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