Wall Street investors spoke loud and clear when they made Twitter (TWTR) one of the most valuable companies in the world at a $24.9 billion valuation. Twitter has only $500 million in revenue, no major physical assets, and no profit. Its staggering valuation is based on one thing: a great innovation that is changing the way the world communicates.
The initial public offerings of Twitter and others recently demonstrate that we have officially entered the “ideas economy,” where innovative ideas are more valuable than physical assets or existing cash flow.
Shares in several other innovative companies have been on a tear lately. Tesla Motors (TSLA) has sold fewer than 50,000 vehicles, yet it is valued at $17 billion—already about one-third the level of General Motors (GM). LinkedIn (LNKD) is worth $26 billion. Even Facebook (FB), despite a poorly executed IPO 18 months ago, has charged ahead to a value of $120 billion, making it one of the 30 most valuable companies in the world.
A number of other innovative startups are poised to go public in the coming months and are expected to do so at valuations that will immediately place them within the ranks of the S&P 500 in terms of market capitalization. Some of these include Airbnb, Dropbox, Jawbone, Spotify, Pinterest, Uber, and Alibaba—all of which have innovated but have small but growing revenue and little or no profit.
While some may argue this is another bubble like the dot.com bust at the turn of this century, it is actually part of a longer-term trend that is valuing innovation at increasingly higher rates due to the impact it has had on many businesses. Apple’s (AAPL) tremendous runup in value from $2 billion in 1997 to more than $600 billion in 2012 was fueled almost entirely by innovation, notably the iPod, iPhone, and iPad, as well as an expectation among investors that more was to come. When it became evident that Apple was unlikely to continue to launch new blockbuster devices at its historic pace, the company lost $200 billion in value, even though Apple continued to increase its revenue.
Historically, company values have been based on such solid metrics as past revenue, profit, and physical assets, and valuations assumed the business world was operating in a steady state. The most prized companies—blue-chip stocks such as IBM (IBM) and General Electric (GE)—were large, stable, high-market-share companies with large asset bases. But innovation is a wild card that trumps everything else, and it is making these old metrics obsolete.
In the past 10 years, many of those blue chips suffered shocking, rapid defeats at the hands of tiny startups with great innovation. In just a few years, Eastman Kodak lost 70 percent of its revenue, leaving it bankrupt. Blockbuster Video, BlackBerry (BBRY), and bookseller Borders: all innovation victims.
Companies that generated the greatest returns in the past 10 years include Netflix (NFLX), Intuitive Surgical (ISRG), Monster Beverage (MNST), and Salesforce.com (CRM)—all companies that have reinvented their categories.
These successes are leading investors to apply an “innovation premium” that is much larger than it was 10 years ago. Google (GOOG) went public in 2004 at a value of $23 billion, just 25 percent of the level of Facebook. Amazon (AMZN) and Netflix went public in 1998 and 2002, respectively, at values of just $450 million and $750 million—just 2 percent to 3 percent of the level of Twitter, despite having similar risk/return profiles.
Innovation is increasing in value partly because it is becoming easier to convert to higher sales. Products can be made, marketed, and sold faster than ever, so exciting new offerings such as Green Mountain (GMCR)’s K-Cup can become overnight successes. In just a few years, Green Mountain turned into a $4 billion enterprise selling more than 6 billion K-Cups per year.
Many established companies are still managed using old metrics such as quarterly earnings per share, rather than building great innovations. For this reason, many of them are turning in mediocre results.
Most of these companies have R&D budgets that are bigger than a VC fund, so they have plenty of resources to innovate; they just don’t use them effectively. All the effort goes into tweaking existing products instead of developing real innovations.
For these companies, Twitter should be a wake-up call. Innovation today is worth more than cash—so get out there and innovate.