Those who manage the arts enhance our culture – but how are they at enhancing the bottom line? Chris Higson, Oliver Rivers and Martin Deboo propose a value narrative to analyze how creative industries can become better businesses and alluring investments.
Creative industries form a large and growing part of the modern economy – for example, Martin Scorsese’s The Departed, by the time it won Best Picture at the 2007 Academy Awards, had generated more than $131 million in US box office receipts alone. Yet, from the perspective of an investor, creativity can look like a risky endeavour. When speaking about businesses that revolve around fine art, theatre and performance, literature, music in all its forms, television and film, and recent derivatives such as games, two pervasive prejudices persist: first, that they need large commitments of resources to create an intellectual product that has no certainty of finding a market, and, second, that they are run by people who put art before profit.
To us, creative businesses are no different from other businesses, and the tools of financial analysis are equally applicable to creative firms. It is a fact that creative product businesses operate with a high degree of uncertainty, and this affects the way in which investors view them. Sources of uncertainty include demand (in advance of release, no one knows whether a film, recording or play will be a success or a flop), and technological and regulatory change. For example, Steve Jobs, the CEO of Apple Computer, was in the news last February with a proposal to recording companies that they remove digital rights management from all music. This drew a heated response from Warner Music CEO Edgar Bronfman, but one can readily see how the proposal could affect investor confidence in Warner stock.
When they talk to investors, managers of creative businesses need to be able to craft a convincing value narrative that explains the risks and returns – why money will be made and how value will be created for investors. Viewed from the other side, investors need to use just the same framework to consider the prospect of placing their money behind creative businesses. So we pose the question of value creation in terms of a dialogue.
Crafting the value narrative
From a financial perspective, a firm creates value for investors when it earns a return on capital in excess of its cost of capital, and it creates more value the more it grows. So value creation is a function of the firm’s ability to earn and sustain a superior return on invested capital. But in a perfectly competitive world, firms just earn a fair return and no more; the firm that achieves a superior return gives a signal for others to enter the market and drive down the rate of return again. So the sceptical investor should start with the presumption that a firm cannot create value; accordingly, the creative firm’s value narrative needs to explain convincingly why it can. In sum, this process is about creating a narrative, using a framework built on three stages.
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