Strange new businesses | Value Research If you can’t make a profit, then accounting should be done differently. That’s what some new-age digital businesses seem to be saying.
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Strange new businesses

If you can't make a profit, then accounting should be done differently. That's what some new-age digital businesses seem to be saying.

Strange new businesses

"Markets don't appreciate our business model." It's an old complaint, first heard widely during the aftermath of the first dotcom crash circa 2001. Any number of (ex) entrepreneurs felt that their businesses' brand value or eyeballs (as the term used to be) should have been richly valued. After all, old-school businesses had profits, and new internet-age businesses had brand value and eyeballs - almost the same thing, hardly any difference. Unfortunately, two decades and three market crashes later, the same snake oil is still being sold to investors, perhaps with little variation.

A few days ago, I saw this video on Twitter, an excerpt from a program on a business TV channel. In this short video, the founder of a 'new age digital company,' Policybazaar, talked about, guess what, how the markets do not appreciate these companies. He drew a parallel to the new 'digital' companies making endless losses and someone setting up a steel plant, explaining that you would have capital expenditure when you put up a steel plant. Then when the steel plant started operating, it would make profits. However, he complained that for a business like his, there was a lot of investment in the brand, the 'platform,' and the product and all that had flown through into the P&L (the profit and loss account).

If these businesses were treated like steel plants, everything they spent for years and years, in the beginning, should be treated as capital. So the argument seems that advertising, salaries, marketing, or simply selling goods and services at a unit loss should all be classified as capital expenses...till when? Till the businesses can make a profit? There is nothing particularly new in this argument. As I pointed out earlier, founders whose businesses cannot make a profit and grow have been saying this for 20 years now. They are saying that we cannot make a profit, so accounting rules should be changed, and then we'll be able to show a profit.

The comparison with a steel plant is quite ridiculous. 115 years ago, when the first Tata Steel plant was being built, the money spent was not being consumed. It was being converted to resources that started a chain of revenues and profits that went decade after decade. Nothing remotely similar happens when a new-age digital company simply overspends and never learns to make a profit.

Some will believe these strange arguments, but investors should simply ignore them. Contrast these companies with those who have built profitable businesses that last for decades. Some months back, Nandan Nilekani spoke about the new age companies during Infosys' 40th-anniversary celebrations. He said, "What worries me is, do they want to build an institution? The hard part is building an institution; it's a marathon race. Today we (Infosys founders) are as optimistic and have worked as hard as 40 years ago. Do these guys have the stamina to play the long game? That's what worries me because too much money is a curse." To some people, it sounded like the complaint that older people tend to make about young people. However, Nilekani went on to explain his point, which was that he did not understand companies being given money to burn, "Once you lose respect for capital, for frugality, lose respect for managing your expenses, then the game's over," he said.

Respect for capital and respect for frugality. That's a most unusual concept today. It sounds crazy from the perspective of normal times, but because of free funding, these companies spend years in a situation where practically speaking, there is a target for spending. In a normal business environment, companies that have grown old and profitable sometimes get bloated and cost-inefficient. Now, we've created a business and investment environment where companies that have never made a profit and appear incapable of doing so are bloated and inefficient. Their solution is to change accounting rules. Investors should smile and move on.

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