The Family, Business Strategy, and Private Equity Firms

European Straits #54

Dear all,

My firm The Family has always invested in working relationships with traditional corporations. We see it as a way to make the startup ecosystem healthier: those corporations are indispensable allies since they can invest in startups, acquire them, or partner with them. This is all the truer in Europe, where entrepreneurs don’t have the luxury of raising enough capital to buy complete freedom from established players in legacy industries.

In time, our work with corporations has shifted from simply speaking in front of their executives to working with them in an advisory capacity. By advising corporate clients, we would educate them on the startup world and learn from them to better understand technology-related challenges. It also revealed a way of generating revenue to finance our growth as an investment firm.

There are some famous precedents for combining advisory activities with developing an investment portfolio. One is Blackstone, in which advisory has long been part of the firm’s strategic positioning. As recently explained by CEO Steve Schwarzman, the advisory business “required no capital and generated cash, which we could use to hire more people without diluting”.

Another example is that of legendary venture capitalist Lionel Pincus. Here’s the story he once shared with the authors of Done Deals, a book on the history of venture capital:

“I brought a management consultant into the firm. That combination was always interesting to me, and I started a consulting business that provided a combination of financial and investment banking advice, management consulting, and the adversarial, advocacy, ministerial, and psychiatric functions necessary to help managers build their businesses.”

Pathfinder, our own advisory practice, was launched in 2014. It started with a 6-month roadshow that Miguel de Fontenay and I did for executives of France’s big corporations. Then Miguel took over as managing partner and performed his business development magic, building working relationships with many clients and burnishing The Family’s brand in the corporate world.

More recently, we’ve decided to turn Pathfinder into a subsidiary company. We’re convinced it must remain a key part of our ecosystem, but now that it has its own brand and P&L, Pathfinder will be able to expand and diversify without conflicting with The Family’s brand as an investment firm.

I’ve spent spent some time recently with the Pathfinder team to advise a private equity firm on a pending deal. The goal was to assess the sustainability of their investment in the context of the target’s industry’s digital transition. Here’s an overview of the framework that we use in such cases:

  1. The digital transition is not about transforming the organization (management); rather it’s about repositioning within the industry value chain (strategy). You can see the transition as an exogenous perturbation that creates the opportunity for startups to enter the industry. As a result, the cards are reshuffled, not without strategic consequences all along the value chain. Strong links become weaker, whereas previously weak links emerge as the best position to have once the transition is complete. Within this framework, the stakes for traditional players are not about changing things internally; rather they are about repositioning to where value will be more easily created or captured once the industry’s transition is complete.

  2. Every industry follows the same pattern. As the transition progresses, value escapes the middle of the value chain and concentrates at the bottom, close to the end users, and marginally at the top, where certain players secure control of essential assets. This can be seen in the music industry. It used to be dominated by record companies controlling the middle of the value chain; now it’s dominated by consumer-facing tech companies such as Apple, YouTube, and Spotify. Also rising is a new breed of player up the value chain, such as the Bertelsmann Music Group. Contrary to what the old BMG used to be, the new BMG’s business is not to sell records, but rather to manage rights on behalf of artists, performers and producers who ultimately hold the industry’s essential assets, works and digital masters. Likewise in the publishing industry, Amazon is focused on both extremities of the value chain: consumers at the bottom (as a bookstore), and authors at the top (with its growing online publishing business).

  3. There’s a radical change in the nature of strategic assets. In the past, the way to secure power in an industry’s value chain was to invest in capital-intensive assets such as factories, logistics platforms, fleets of trucks or planes. Such assets could be replicated in theory, but in practice the amount of required capital turned them into an effective barrier to entry. Behind that barrier, a few large companies could form an oligopoly and then dictate their terms to both consumers and owners of essential assets up the value chain. Tech companies are taking over because they’ve learned to control other, now more strategic assets: a downstream bond forged with the multitude of connected users, and/or an upstream bond with those who control essential assets. As a result, previously dominant companies positioned in the middle are being squeezed out. Assets that enabled them to capture so much value yesterday are now transformed into millstones that risk dragging these companies down.

Obviously this creates a challenge for private equity firms. Those firms got used to investing in targets securely positioned in the middle of their value chain. They could count on steady dividends because those targets had a moat thanks to their controlling strategic midstream assets. But now that value is redistributed both down and up the value chain, private equity firms have to upgrade their decision-making and learn to invest in an unusual manner: either in tech companies that have already taken today’s best positions, or in traditional companies that will have to radically reposition, thus endangering their profitability in the process. This changes the nature of the game—and, obviously, this is where a cutting-edge team such as Pathfinder can be helpful. And here's the website ☛ 😙

I've also prepared a selection of my writings on business strategy, which form a large part of Pathfinder’s strategic framework:

Warm regards (from London, UK),