Here we go again

Making the same mistakes and expecting different results they say is madness. However looking at trends in these emerging “hot” industries and comparing them to root causes that have led to destruction of value in the real estate industry; one cannot but imagine that there must be some method to the madness. It is thus important to deconstruct the sequence of phases in the industry growth cycle that could in all probability lead to carnage in the short to mid-term.

During early stages of any business or industry, the key value creator is the entrepreneur and his desire to drive change. The value he creates is by looking at how he could change status-quo with the sole objective of creating more value for customers. His resources are limited but his conviction and his passion for his ideas are so strong that his measured risk taking ability is at its peak. He borrows from relatives, draws from his savings and even takes a mortgage on his house. His spending is frugal as resources are limited and his commitment to delivering returns to the shareholders (comprising of close family and friends) is personal. There is a social pressure for him not to fail. The only factors that could go against him are; his evaluation of his market timing and his execution skills. If he has these two areas well covered he mostly succeeds and is able to cross the wide chasm between nursing-an-idea to building a successful business.

This success as well as similar successes enjoyed by early entrants into any industry, be it real estate/ e-commerce, becomes a trigger for a large number of “me-too” business men (with the sole objective of maximising return on equity invested) to enter the industry. This phenomenon then reaches the point where the industry opportunity is big enough to be of interest to venture funds, private equity and commercial lending institutions. It is amazing how the speed at which money reaches you is inversely proportional to your real need for it at that time. The entrepreneur who did not appeal to these institutions until now becomes a hot favourite and they go about appealing to him on how their money is what could take him to “the next level”.

“The next level” typically means a cash-out for the entrepreneur who is suddenly rich and wealthy. This starts the race for investments amongst his peers in the industry who suddenly feel that the acknowledgement from marque investors should be their true measure of success. Their personal priority changes from value creation to growing in size. Once investors are on board, the priority for the business also changes from “adding value for the customer” to “keeping shareholders happy”. This is the stage where the entrepreneur is transforming into a business man. He starts having grand ideas of expanding vertically, horizontally and in all directions to justify the need for more capital. The next milestone in his company’s valuation becomes one of his key motivations.

But capital does dry up for one reason or the other (e.g. Lehman crisis in 2008). During this phase, which is marked by bitter disputes between the promoters and investors, there is a sudden rush for the investors to exit with as much returns as they can contractually extract, leaving the promoter with a high cost to pay. The business’s cost of capital in all probability would have become unsustainable at this stage and sales would have hit a point of stagnation or slowdown as his customers feel neglected and disappointed. Personally, he is in an ego-spiral that makes it exceedingly difficult to get back to a phase of high customer value and extreme frugality. He becomes more risk averse and his strong desire for enterprise wealth creation is replaced by a desperate desire for personal wealth preservation. The industry by this time is on fire again, but this time, it is destructive. It is marked by divestments of non-core businesses at lower valuations, cutting staff, cutting costs and exits from non-profitable markets.

Those who are able to reboot their business operations and rise up from the ashes of this destruction are those who ultimately are able to build a relatively more sustainable business with focus on customer value creation as a key driver for shareholder value creation. Seeing the fire in the e-commerce industry one cannot help but wonder if now would indeed be the best time to invest in one of the existing me-toos in the industry or, wait until a phoenix awakens from the ashes of the fire that is soon to follow.


About the author

Joe Verghese, leads the Colliers International India National Executive team as Managing Director through the second phase of Colliers’ Accelerating Success business plan, aimed at focused client engagement & excellence in service delivery. Joe is a Fellow Member - Royal Institute of Chartered Surveyors (FRICS) and has been a part of Colliers since 2006.


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