Blue Dots Partners

Like thermodynamics that is governed by three main laws, most businesses have to follow three laws as well.

The first law of business: The “Law of Shareholder Value Creation”

At the moment one single share of a company has been sold or given (other than for the purpose of passing the business on to the next generation), the job of the CEO has irreversibly been altered. The game has changed. It’s a subtle, sometimes un-noticed, but profound effect. It puts the CEO on a different path. The quid pro quo now forces the CEO to run and lead the company to build sustainable shareholder value because shares that were acquired at a particular moment at a certain price are expected to be, in the future, sold at a higher price. That’s the new job of the CEO.

We call that the “Law of Shareholder Value Creation.”

In a company, once the first dollar is raised in exchange for a number of shares in the company’s stock, then while there is no legal obligation dictated by corporate law, there is a moral and ethical obligation to do everything one can reasonably do to give the money back with a profit sometime in the undetermined future. It can be done by buying back the shares or selling part or all of the business or going public to offer shares on a publicly traded exchange. Maybe with the exception of capital provided by close family members, capital raised outside is expected to be returned with a profit to those who provided it. Investors are not philanthropic (otherwise, they would simply make a donation to businesses or other causes they believe in) and they do it mainly with the motivation to make a financial investment. They why they expect a good return in whatever time horizon they have in mind at the time they write a check.

Again, a tacit but nevertheless real alignment is established: you give me money and I will create shareholder value and increase the value of your shares over time and at some point, will provide a liquidity mechanism so that you can elect to sell your shares at what we all expect will be a significantly higher price. For publicly traded companies, the liquidity mechanism is already established, like buying a share of Walmart on the Nasdaq exchange: I can sell that share at any time I want.

The measure of the success of a CEO is now clear: he or she must create sustainable shareholder value and provide, sometime in the future a liquidity mechanism if it does not already exist.

The second law of business: “Value Only Comes from Growth”

At Blue Dots, we strongly believe that there is only one way to created sustainable shareholder value. In fact, we are not aware of any other way.

That way is to run and manage the business so that its top-line grows faster than the market in which it operates. In other words, a company’s goal should be to beat the market, to be one of the top winners of the market race.

The second law of business states that sustainable shareholder value creation only comes from growing revenue faster that the market. Top-line growth (compared to the market) is the only source of sustainable shareholder value growth, hence the statement “Value Only Comes from Growth.” There is simply no other way.

Of course, the temptation of a newly appointed CEO in a company is to cut costs or, put in more mundane terms, “manage expenses.” This certainly creates shareholder value as the Earnings Per Share (EPS) goes up. However, this can’t be sustained. Once Wall Street has taken into account the increase in EPS via cost reduction and factored it in the Price Per Share (PPS), additional shareholder value will need to come from somewhere else. From where then? It will come from growing the top-line faster than the marketplace. In other words, from gaining market share and consolidating toward a dominant position. It is interesting to observe that the same word is used in shareholder value and gaining market share. Dominant players are rewarded by an unfair value from investors. There is no one-to-one correlation. For example, a company that has 32% of a market and is the leading company in its market does not receive 32% of the market capitalization. It will have a disproportionate share of the value, i.e. much larger than 32% in this particular example.

Mathematically, a company that is growing slower than its market is losing market share. This is the sure path to becoming irrelevant. Growth compared to the market is the antidote of sinking into a state of irrelevancy that eventually leads to death. There are simply no leading company in a field that did not get there by increasing its market share. A business can’t become the number one company in a market by losing market share!

The third law of business: “The Law of Alignment”

The key question for a CEO who has the goal to manage his/her business so that its revenue grows faster than its target market is: what do I do in a pragmatic and efficient manner to make that kind of growth happen?

Introducing the third Law of Business. It states the following:

“The optimal growth rate of a company can only be achieved when the company is perfectly aligned with its market.”

Of course, it assumes there is a solid internal alignment between all functions of the company and that roles & responsibility, communication methods, processes, planning, measuring and tracking are all well-defined and well executed. This is the internal alignment. A dysfunctional organization won’t successfully exhibit a good external alignment.

External misalignments create frictions and affect the business momentum. The business machinery, the gears, the movement slow down and soon enough, in a subversive way, market share starts to erode.

A mechanical watch can only work well for decades and keep its precision movement if it preserves its perfect alignment. Essentially all gears need to maintain a perfect vertical position relative to the two plates that encompass the mechanism.

Similarly, when a company starts to be misaligned with its market, friction is introduced, and sales momentum is negatively affected. Customers are not buying at the same rate because something happened, and a misalignment was created. It’s a little like an instrument that plays out of tune in an orchestra. There is something wrong. It may not be obvious initially, but eventually it throws off the whole performance.

Now, the interesting question is: “What do you do on Monday morning at 8 o’clock to obey the Third Law?” That question is what keeps our Clients up and night and what we at Blue Dots help them with.