The Difference Between Value and Valuable

A few weeks ago, Fred Wilson mentioned that Google was the most important company in the world. He caveated that Google may not be the most valuable company in the world, but that doesn’t preclude them from being the most important. Since that time, I’ve been thinking about the distinction.

The more I consider it, the more important the distinction seems.

Google is a business worth more than 400 billion dollars. In that sense, it’s valuable. The financial worth of the organization today is derived primarily from its advertising business. And while we all enjoy being prompted with recommendations before we even realize we need them, many of us derive the most value from activities that don’t make the company significantly more valuable. Google creates value in the world by extending productivity software at near zero costs through Google Documents. Google creates value in the world by supporting ubiquitous internet access. Google creates value in the world by investing in driverless cars, modular phones, and novel medical technologies.

Even if Google never turns its ancillary activities into businesses that generate significant cash flows for its investors, they will have created enormous value.

As a venture investor and former founder, this difference between value and valuable couldn’t seem any more striking. Every day I meet with hungry entrepreneurs - the vast majority of whom are truly passionate about making a dent in the world through the companies that they’re building. All of them are dedicated to creating value. When I was a founder, I was one of them. The challenge on the other side of the table is respecting their drive to create value in the world and also looking for young companies that can be valuable.

Despite a desire to invest in every world changing organization, venture capital firms succeed or die based on delivering valuable portfolios back to their investors. If the impact of an investment can’t be boiled down to dollars and cents, they can’t be used to raise subsequent funds. So while VCs certainly want to invest in companies that create value, the prerequisite is that they will be “valuable” in the future. Value-ability precedes value creation.

So the question for entrepreneurs is what makes a company valuable? The short answer harkens a required text in every MBA student’s first year strategy course: competitive advantage. But what does that mean?

How to create a valuable business:

Economic theory suggests that in a world of perfect competition, no business will stay profitable for too long. The thinking is that if you - the entrepreneur - discover a new profitable way to solve a problem, others will quickly enter the market and replicate your strategy. As more people enter the market, competition will cause prices to drop or increase the level of investment to acquire customers. The thinking is that profits won’t exist at the end of the process.

You can surmise pretty quickly that we don’t live in a world of perfect competition. Google, Apple, and Microsoft are just a few examples of companies that have created and sustained advantage over an extended period of time. Sometimes building this competitive advantage comes from creating a complementary set of replicable activities inside your firm -- forcing others to recreate your business exactly in order to compete with you (the Southwest Airlines model of competition).

More often in the world of technology, building and sustaining competitive advantage comes from the characteristics of your product itself. When your business creates exceedingly strong network effects, when you maintain intellectual property, or when you have access to asymmetric information, you put yourself in a position to continue outperforming your peers over time. In the words of Brian Arthur, your business puts itself in a position for increasing, not diminishing returns. For example, Apple’s sustainable advantage comes not just from its focus on design but by getting you to put its computing device in your pocket and helping you grow accustom to an app ecosystem for its operating system. As more and more people adopt its infrastructure, it becomes more compelling for app designers, and makes it more difficult for others to enter the market and create price pressure.

Knowing how a business will build increasing returns is critical for figuring out how valuable a business might be. Investors are constantly asking questions about defensibility, cost of customer acquisition, network effects, and switching costs to glean exactly how all this works. It’s not enough to create value for your customers. Because if it’s easy to replicate your model for creating value for your customers, you won’t have much bargaining power when it comes to price and profit. To create a valuable business, you need to solve a big problem in a market where there are buyers waiting - but you also need to do it in a way that is defensible over time.

Why building a valuable business isn’t necessarily the goal:

As an investor, I’m constantly looking for companies that can be extremely valuable. But as a resident on planet Earth, I’m constantly hoping that startups and big companies alike find ways to create real value. Traditional venture funds might not be structured to invest in moonshots, but I’m enthusiastic every time I hear about a new project in the vein.

There are certainly companies that are both creating value and becoming valuable. Facebook is investing in ubiquitous connectivity through drones. LinkedIn is helping to solve unemployment issues amongst veterans. SpaceX is trying to get us to Mars. But creating value at the expense of being as valuable as possible might require making tough decisions. SpaceX is trying to stay private in order to execute on its mission of getting us to Mars, despite its strong profitability. It could IPO, but it’s shareholders would likely push to minimize Mars research. Personally, I’d rather have those brilliant minds focused on the audacious goal of getting to Mars. If population growth continues to push us toward the inevitability of becoming a spacefaring people, the whole planet will look back with gratitude towards the team regardless of how valuable SpaceX becomes. But that’s a question of creating value, not becoming valuable.

Investing in valuable businesses is the goal of investors who’ve signed up to steward capital from people’s retirement accounts. But it’s important that innovators remember that building a valuable business isn’t necessarily their goal. The Bill and Melinda Gates Foundation might not be an investable institution for most people, but it is more important to the world than any startup in the valley at the moment.

Building a valuable business is not the goal in and of itself. I hope people continue to do the bold, audacious, things that create value - even in the absence of becoming “valuable.” The world would be a better place for it. And that’s important to remember.