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28 February 2020

South Africa is not a Startup

Money isn't worth a thing - blog image.

‘So, you wanna be a rap superstar, and live large. A big house, five cars, you’re in charge’ The lyrics of Rap Superstar, a song by Cypress Hill and Eminem.

Whilst actually being a rap superstar might not work for everybody (drug induced delirium and all-night parties might not be everyone’s cup of tea), it’s safe to say that prosperity and happiness, both on an individual and collective basis, are intricately linked to wealth.

Wealth then, is defined as an abundance of valuable possessions or money – see Mr. Hill above.

Wealth Creation

An economic definition , however, would read something more like this: Wealth is generated in an economy via the market mechanism whereby entrepreneurs combine community savings and the factors of production (land, labour, capital), to invest in and produce goods and services which they’ve judged to be in present or future demand by consumers.

This economic concoction occurs within the ‘vehicle’ of a business. Businesses then, are engines of wealth creation, and the underlying strength of an economy can be determined by looking at the relative health of its business sector.

Wealthy economies then, are those with many healthy, productive business generating vast amounts of goods and services, and who operate in an environment with the right ingredients for them to prosper, namely: large pools of savings, an abundance of land, labour and capital, non-onerous regulations, lower corporate taxes and flexible labour legislation.

The world’s economic powerhouses, America and China, are host to around 32.5 million and 78 million businesses, respectively. Together they produce roughly US$30 Trillion of ‘stuff’!

Startups & Growth

Not all businesses are equal, however, as they tend to move through five phases of life, namely: launch, growth, shake-out, maturity and decline. This lifecycle is shown on the graph below, with the horizontal axis as time and the vertical axis as financial value.

The progression of a business through its five stages of life is described with reference to three financial metrics: sales, profit and cash flow. Each phase can be described as follows:

Launch: Company starts operations and markets to target consumers seeking traction and sales.

Growth: Company finds product-market fit and experiences rapid sales growth – profits begin and surge.

Shake-out: Market saturates with new entrants, so sales growth slows and peaks.

Maturity: Sales and profits decline. Some companies reinvent themselves to extend their life.

Decline: Sales, profits and cash flows decline and company ultimately shuts down.

Note that the greatest amount of financial value is generated during its growth phase – coincidentally, there is a name for companies which grow this fast, and have the highest potential to generate the greatest amount of value: STARTUPS.

Startup: A company designed to grow fast.

Microsoft, Apple, Google and Facebook all began as startups. Today, their market values and sales numbers are staggering.

Company Company Value Sales
Microsoft $ 1.203 Trillion $ 126 Billion
Apple $ 1.197 Trillion $ 260 Billion
Google $ 905 Billion $ 162 Billion
Facebook $ 541 Billion $ 71 Billion

Interestingly, it’s not necessary for a company to work on technology to be a startup – the only essential thing is growth. And usually, we find that startups are simply small companies that take on hard technical problems. Its size means it’s quick and nimble, key ingredients to solving the technical problem, as it can move fast, make quick decisions and alter its direction at whim – something that large, mature businesses aren’t able to do as effectively.

Okay, Growth – How much?

How fast does a company have to grow to be considered a startup? There’s no precise answer to that. “Startup” is a pole, not a threshold. So the real question is not what growth rate makes a company a startup, but what growth rate successful startups tend to have.

By Silicon Valley standards, growth should ideally be 5-10% a week, but growth nonetheless. While it’s hard to find something that grows consistently at several percent a week, but if you do you may have found something surprisingly valuable. If we project forward we see why:

Weekly Yearly
1% 1.7x
2% 2.8x
5% 12.6x
7% 33.7x
10% 142.0x

This is a case of exponential growth, and makes it hard for our intuitions to grasp. The lesson: Small variations in growth rate produce qualitatively different outcomes. That’s why there’s a separate word for startups, and that’s why startups do things that ordinary companies don’t.

Lesson: Small variations in growth rate produce qualitatively different outcomes

South Africa

Recently, two somewhat important gentlemen, a Mr. Cyril Ramaphosa, and a Mr. Tito Mboweni, addressed the South African public with two presentations namely, the State of the Nation Address (SONA) and the Budget Speech.

These men alluded to growth figures for the country- forecast as well as targeted. In his speech, Mr. Mboweni slashed SA’s growth forecast for 2020 to a mere 0.9 percent and said that the growth outlook had weakened significantly, following lower-than-expected growth in the second half of 2019. Similarly, the IMF reduced SA’s growth forecast to 0.8% for this year, as many outspoken economists warn of troubled-SOE’s placing a 1% cap on economic growth.

President Ramaphosa, however, reiterated the State’s strategic objective to eliminate poverty and reduce inequality by 2030 by following the National Development Plan – the policy document which outlines the State’s vision for enabling the prosperity of South African citizens. The document’s main requirement, however, is that South Africa needs to grow at 5% per year, in order to reach these lofty goals.

It’s been roughly 8 years since the NDP was published, and since then SA’s annual GDP growth rate has slid from an average 3% to less than 1% (see graph below).

The Source of 1% Growth – SA Companies

While reports very widely, certain data suggests that the number of formal South African companies has shrunk to below a million, showing a dramatic decrease since the 2008 financial crisis. What’s more, around 388 companies account for more than half of all corporate tax revenue.

SA firms have faced a gauntlet of challenges in recent years – strained labour relations and restrictive labour policy, intermittent electricity supply, a dearth of available capital, ever more draconian laws and politically-driven legislation, an over-indebted and weak consumer, regulatory uncertainty, high telecommunications costs, a lack of skilled labour and the threat of greater State intervention and expropriation of assets.

Conclusion

It is little wonder then that an environment conducive to birthing the future Apples of the world does not exist in South Africa. The economic imperatives of startup hubs like Silicon Valley require free waters wherein businesses can risk big, move fast and create outrageous new futures – which in turn, build an abundant, Rockstar-esque life then for all.

Without a free business environment and market liberalisation, South Africa will have no Apples, no Facebooks, no Googles, and none of the commensurate prosperity created by these. South Africa then, is not a startup after all.

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