Living in a world without financial rules

Facebook’s $19 billion purchase of WhatsApp was all about owning connections in the digital world

Mark Zuckerberg CEO of Facebook

By Robert McGarvey : Financial Times said it best: “If a company that has designed a single successful mobile phone game (Candy Crush) can be worth $5 billion, anything can be worth anything, and we live in a world without financial rules.”

For this titan of the Establishment, markets today are “living in the post-financial candy land”

Admittedly the financial world is still suffering ‘Shock and Awe’ at Facebook’s acquisition of WhatsApp – a new mobile texting App. Mark Zuckerberg paid $19 billion for a digital company with no (proprietary) intellectual property, almost unlimited competition and – remarkably – an anti-profit business model.

None of this makes any sense to traditionalists. The inventory of the lost is formidable; neither the legions of business journalists, nor technology specialists, nor the financial guru’s resident in major investment banks have the foggiest idea what’s going on. They find themselves (once again) in a market where they have no ability to pick the winners and have no rational basis for valuations.

So, why did Facebook make the plunge with WhatsApp’s? 450 million users.

For Silicon Valley it’s all about owning connections in the digital universe. WhatsApps has almost half as many users as Facebook itself and is growing its user base rapidly. Facebook (itself a dubious proposition to many traditionalists) has laid down the digital gauntlet. The ‘value is in the network’: own the network first, and find a way to profit from those connections later.

It seems the financial universe has been turned on its head. Traditional companies like Coca-Cola (which reported growth of just 1 per cent for the fourth quarter) are feeling the pinch of a stagnating global economy, while digital dreams are capturing all the headlines.

Why is this happening?

The best-kept secret in the modern world is that we’re in the midst of a paradigm shift that is turning our orderly civilization inside out. An embryonic Creative Revolution is sweeping across the historical landscape undermining the old industrial order. Unfortunately, the force and depth of this Revolution is creating massive challenges for peoples who have not experienced this scale of change for centuries.

There could hardly be a greater contrast than a factory-based economy that produces ‘things’ and a creative one where value is driven by relationships and intangibles. Value and productivity are defined differently in a creative economy. In a world of digital intangibles such as software, the Internet, mobile apps, brands and networks, value is created in networks of collaborative individuals not in disciplined factories.

For example, consider the software industry, where the ‘product’ is generated digitally. Basically it is just lines of computer code, generated by the creative imaginations of teams of developers who are often continents away. The reproducibility of the software ‘product’ (nowadays) is virtually without cost or time limitations and it can be instantly distributed around the world to customers freely through the Internet.

Contrast this model with the traditional Factory Model of production. In a factory, costs are impacted by scarcity of labor and materials, market penetration models are limited by the constraints of physical distribution systems needed to transport tangible goods to market and then further constrained by the need to retail these goods through outlets in national regulated economies.

In the old days businesses grew slowly, capturing regional market share and then – years later – expanding to global markets. Today you’re global from day one, and if you capture the imagination of youth, growth can be instant. There is no historical precedent for this kind of limitless acceleration.

Given these changes in the dynamics of the global economy, are valuations just a crapshoot?

Not according to accounting specialist Joseph Batty. The problems with modern valuations begin with a lack of understanding about the unique qualities of intangible assets in the global digital economy: these new asset have broken the mold and all the old industrial rules. Bottom line, we’ve all failed to keep pace with these changes.

Batty’s secret: identify the (intangible) assets and analyze them separately from the company they’re contained within. The assets should be valued on a Highest and Best Use basis which captures their full ‘Enterprise’ potential and not on the (much lower) ‘historical cost’ basis. Understanding the full global potential of the assets and valuing them accordingly is in the best interests of technology developers, investors and the market.

Mastering intangible assets with all their strengths and weaknesses is the true revolution that, once appreciated, will bring order and sensibility back to the market and – maybe, just maybe – help prevent another major financial disaster.

Robert McGarvey is an economic historian and co-founder of the Genuine Wealth Institute, an Alberta-based think thank dedicated to helping businesses, communities and nations built communities of wellbeing. Robert is the author of The Creative Revolution, an historical guide to the future of capitalism.

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