Value Extraction vs Value Creation

I recently read Incorruptible: Why Good Companies Go Bad and How Great Companies Stay Great by Eric Ries (author of The Lean Startup), which I highly recommend.

He raises an interesting concept: the difference between value creation and value extraction.

Value creation, as the name suggests, is about creation of something worthwhile or valuable. Typically, new startups in any industry or profession believe they can solve a problem for a sector of the marketplace; that’s why they launch. By solving the problem and delivering value they generate revenues and make profits for themselves, but also deliver value for stakeholders and end users.

Value extraction on the other hand is about taking something that already has value and finding value to extract. There are a few ways that this can occur:

1. Enshittification

Author and blogger Cory Doctorow coined the term “Enshittification” in November 2022 to describe the decline of online platforms.

“Here is how platforms die: first, they are good to their users; then they abuse their users to make things better for their business customers; finally, they abuse those business customers to claw back all the value for themselves. Then, they die.” ¹
– (Cory Doctorow)

Facebook is the classic example (did you see their recent $18BN settlement?), but Doctorow believes many other online platforms are in this cycle.

2. Misalignment

Let me give another example of value extraction in action. ²

In 1997 a UK biotech startup called Vectura, was spun out of the University of Bath. Researchers from the University had created significant advances in inhaler products to help people with Asthma and Chronic Obstructive Pulmonary Disease (COPD). Think emphysema and chronic bronchitis.

Their mission?

To improve the health of everyone globally who suffered from these debilitating conditions.

The company was successful and eventually listed.

Up until this point, let’s call this significant value creation, for users of their drugs, employees, stakeholders and founders.

In 2021 there was interest in acquiring the company by two bidders; Carlyle, the private equity firm, and Philip Morris International. Yes, that’s right. Philip Morris the cigarette company.

And in the end Philip Morris acquired Vectura for just over £1BN, against the protests of health groups (35 health groups in fact, along with anti-smoking charities, including Asthma UK, the British Lung Foundation and even the UK government).

Their logic?

We sell products that people inhale. So let’s build our portfolio of inhalable products.

Just 3 years later, Philip Morris sold Vectura for £150M plus some ongoing revenue: a significant loss.

Let’s call this what it was: a failed attempt at value extraction.

Did Philip Morris care about Vectura’s mission?

It seems unlikely, looking at the facts. And the lack of synergy between the missions of each firm just highlights the cynical stupidity of the move.

3. Financial Engineering

We also see value extraction in action with buyers of once great brands finding ways to destroy the magic that made them great in the first place. Financial engineering is another term that’s been used over the years to describe this type of behaviour.

And if I can be so bold, acquiring and consolidating financial planning businesses could be a case in point of value extraction.

Most consolidators from what I am seeing are not trying to put the purchased businesses together, aligning systems and branding, to create something better (which would be value creation). Typically, they are making a relatively simple play to consolidate assets under management (AUM) and either:

a.) Take a size arbitrage in a future sale (i.e. a bigger entity sells for a higher multiple than a smaller one)

AND/OR

b.) Move clients into a vertically integrated offering (advice, platform, investments), where the fees from each layer all accrue to the same entity. Yes, you could argue this is creating value for shareholders, but it would be hard to argue it’s creating value for anyone else (clients, employees).

(And this is the point of Eric Ries’s book – how to overcome some of the forces that seem to inexorably steer companies toward value extraction as they grow. Like I said, worth a read if you don’t want your future FP business to suffer this fate)

What’s going on?

In all of these value extraction examples, the core proposition that made the businesses worth purchasing in the first place, “client-centric service” is ignored and often destroyed.

Why does this matter?

Clearly there’s nothing technically or legally wrong with extracting value. In fact, it’s the logical outcome in a system where “shareholder primacy” is actually enshrined in law.

However, as a business owner myself and working closely with hundreds of other business owners over the years, I can only get excited by businesses that are trying to create more value.

I think that’s why exploring this idea felt important.

What’s your view?

For me business has always been about more than simply “maximising shareholder returns.” And I know from my innumerable conversations with the owners of financial planning firms over the years, that all the owners I end up working with are not motivated by money.

They want to:

• Build something that serves a group of people (their clients).
• Give the best advice possible for each client.
• Meet their clients in the street long after they’ve sold or retired, and not be embarrassed about what happened after they left.
• Feel proud of the organisation they built and the careers they mentored.
• See successors come through to carry on the great work of the business.

Make no mistake, most owners I’ve worked with earn really well along the way, and also get paid handsomely at the end of their career for the value they created, but it’s not their driver. It’s just what happens when you focus exclusively on value creation for your whole career.

Why should you care about any of this?

I guess you’ll care if you see the world the same way as I do, that business “done right”, adds real value to the full spectrum of stakeholders and society.

If you’re excited by financial rewards on their own, then join a firm that figures out how to extract the value that someone else has created.

However, if that doesn’t excite you, just stay focused on how to create more value.

Let me know how you go.

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1 Pluralistic: Tiktok’s enshittification (21 Jan 2023)
2 Incorruptible: Why Good Companies Go Bad and How Great Companies Stay Great by Eric Ries

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