How To Be Worth A Billion Dollars in Freight Forwarding
How much is a freight company worth? More specifically, how much is your freight company worth?
It’s something you may have wondered about at times, but as long as business is good and profits are growing you have more urgent matters to think about.
Every so often, however, an event comes along that makes you think long and hard about the value of your business. Last week’s announcement by Flexport of a $100 million investment it received from China’s SF Express was one such event.
News of the deal set off a sharp debate on LinkedIn recently as industry incumbents expressed a deep level of skepticism over the basis of Flexport’s valuation, now in excess of $1 billion, for a business that has considerably less volume and infrastructure than many long-running, established freight forwarding businesses.
Reading the comments in the LinkedIn discussion, as well as feedback we have had from other freight forwarders, makes it clear that there’s a deep misunderstanding of how venture capital financing differs from more familiar sources such as private equity or traditional bank financing. So we thought we’d break down the logic behind valuations to shed some light on how it applies to startups like Flexport as well as traditional freight forwarding businesses.
Hypergrowth and Future Profitability
Traditional freight forwarding businesses are normally valued at a multiple of their profits, or EBITDA, that can be anywhere from 3x to 10x of profits. That’s because they actually have profits to show, resulting from years of business history, volume and successful sales and marketing efforts. In order to finance operations they raise capital from banks in the form of loans or credit lines, and when they want to embark on an aggressive growth strategy they raise private equity capital which means selling a piece of their company based on a valuation of what they currently earn AND what they will earn with their investors capital. The “final” payoff for the company and its investors comes when the business is acquired or goes public, either outcome known as an “exit” or a liquidity event. This is precisely how every American and European freight forwarder in the global top 25 and beyond came to be as big as they are today. They used outside capital to effectively “buy” growth.
By contrast, a freight forwarding or logistics startup is valued at a multiple of sales, which is a “top line” number. Why the difference? Startups don’t have historical performance, and usually, don’t have profits to show in their early years of existence. But what they lack in net earnings, they make up for in rapid growth which is measured in gross sales. For a venture capital investor, this satisfies a key concern: “can this company grow?” Once the growth potential is established, startups then use their capital to apply technology to their core business processes such as sales, marketing and transaction execution, and their ability to deploy this technology successfully results in efficiencies that can ultimately lead to greater profits than those realized by traditional freight forwarding businesses. They use the capital to build tech to also “buy growth”.
The goal for a startup then is to not necessarily turn a profit, but really to grow to a “tipping point” whereby it can execute more rapidly and efficiently than its established competitors. That’s all, nothing more. Flexport has been able to successfully grow to the point where investors believe a tipping point is at hand or achievable based on continued execution of their business strategy.
The Disruption Premium
Flexport and startups like it don’t just earn a high valuation for having a good plan, or even solid execution. The multiplier that really drives their valuation up is the potential for “disrupting” or fundamentally changing the way their industry does business -- resulting in simplified processes and higher margins. This is a significant distinction because the traditional path to scale/growth in freight forwarding requires a company to hire more workers and build more locations or branches in order to hit scale. What Flexport’s approach is proving is that successful, technology-driven improvements to specific parts of a freight forwarding transaction can have a cumulative effect on the logistics chain on the whole. And with more money invested, more efficiencies will be realized.
“Yeah, but We Do the Same Thing!”
Much of the anger directed at Flexport within the freight forwarding industry stems from a very practical observation: the nature of a freight forwarding transaction has scarcely changed even over the past five years since tech startup activity began in the sector. With that being the case, it’s hard for industry stakeholders to accept that there’s anything different about their business model when compared to Flexport’s.
This view is where things start to get sticky. There was once no such thing as social media, so MySpace essentially “invented” it, Facebook replaced it and the rest is history. But freight forwarding has been around for centuries, which means no startup can come along and create a new system of logistics with a few million dollars, or even with a few hundred million dollars. Hence, Flexport has to show it can be a forwarder that manages transactions, runs warehouses, leases aircraft, etc. and only then can they begin to truly affect change in the industry. Whether they will succeed or not is yet to be seen.
What is significant for the entire sector, however, is that freight forwarding and logistics in general is having its “moment in the spotlight.” Capital inflows from venture, private and public equity investors are on the rise because it’s now very clear that no product can move anywhere in the world without the assistance of a freight forwarder. Like it or not, you can thank Flexport for this.
Now Go Get Yours!
So you’re a freight forwarder, business is up thanks to growing freight volumes and international trade, and now your entire sector is getting the kind of attention that used to be on companies like AirBnB, Uber and many others. What can you do about it?
If you’ve got the vision (and stomach) to build a disruptive startup, then, by all means, go out and try. The startup success rate is only 10%, just so you know.
Or, if you want to continue focusing on what you do best like serving your customers and growing your profits (which is awesome, and economically sane) then you need to apply the innovation within your own business. Technology can be built or acquired, but the innovation mindset is what truly powers change. The benefits of re-imagining how your business runs and applying those practices may not get you startup style valuations, but they can massively grow your profits, and that’s no small thing.
Give CoLoadX a try. Sign up for free today to find the best rate for your ocean freight.By: Fauad on May 11, 2018, noon