Cai Lei: About Enterprises and Entrepreneurs | JD Opinion
This article is based on Cai Lei’s speech delivered on “JD Capital’s 2016 Annual Conference” on January 3, 2017.
Today I want to talk about something of great significance, enterprises and entrepreneurs. I publically mentioned these once last year, but it is so important theme that I expect for some view exchanges once again.
Here, we have many entrepreneurs JD Capital has long been working with. Notably, many of our colleagues are still striving to become one. To run a successful business or make smart investment decisions, however, requires thorough understanding of both enterprises and entrepreneurs in the first place.
I. On Enterprise
As a common form of organization in modern society, the enterprise is a key source of social wealth. Any organization, enterprises included, cannot survive or thrive without input and consumption of social resources. In return, output is needed to balance the input and also “repay society”. Therefore, all organizations can be assessed or researched from the perspective of input and output.
Take family (also a kind of social organization) for instance. Family is a basic unit responsible for human reproduction, with couples being the basic organization and offspring the basic “outputs”. The stable emotional bond family provides can also be deemed as its output. As many countries have legalized homosexual marriage, as I see it now, output of a family mainly refers to emotional ties.
Take a nation for another instance. If there is no national security, social stability and economic growth as its output, it would be pointless for a nation to exist.
On Enterprise #1: Products
As outputs of an enterprise, diversified products help us form the impression of the enterprise. Therefore, to know about an enterprise, we can start with its products.
The product is not only a starter for us to know about an enterprise, but the ultimate goal for the enterprise itself. The market value of an enterprise lies in its products, and the level of its value is determined by the level of its products. We classify enterprises and products into four levels: mediocre, qualified, excellent and great.
At the first level, products are those in general terms, simply produced and without high quality standards. At the second level, products are largely qualified and can basically meet customers’ demands; take a bottle of water for instance, it’s qualified if it’s drinkable. Enterprises producing first/second-level products (or low-end products) cannot survive the long-term competition.
What an enterprise should make are third/fourth-level products (or high-end products). Only genuinely innovative products can be classified as “excellent”, otherwise they are merely “qualified”.
Innovation is to create something completely new (from 0 to 1 like the first car or first cellphone) or make visible improvement in existing products (from 1 to n, e.g. higher cost performance or lower costs).
Products at the fourth level, namely the “great” ones, are those capable of bringing substantial innovative changes to human society and life. Such products include car, airplane, phone and Internet. A great product should be a pioneer that promotes human equity and welfare. For me, enterprises like Ford, 亚马逊 and 谷歌 fall into this category.
As an asset management enterprise, JD Capital mainly provides asset-related services. Our mission is to find the best investment target for social capital and match investors with potential entrepreneurs. We endeavor to bring more social fund together and allocate the capital to entrepreneurs with the determination to make excellent or great products.
If JD Capital can help an enterprise become excellent or great with the social capital JD Capital manages and operates, and deliver solid return or excess return to its investors during enterprise development, we can justify ourselves as excellent or even great.
Just like human beings, enterprises also have lives. As I see it, all kinds of life entities, no matter protein-made ones or organizations, realize their value through giving rather than taking. When you only focus on gains, it would all become a “zero-sum game” as you would always gain from others’ loss. However, you could make a “positive-sum game” given that your output enhances social value.
Hence, we have our first law and its deduction: product value = enterprise value, product level = enterprise level, and excellent products = excellent enterprises.
On Enterprise #2: Return
Next, let’s continue with the study of enterprises from the perspective of output. Investment return comes first.
Many believe that the core value of an enterprise lies in creating investment returns. Is it a conflict with my argument that corporate value lies in offering excellent or great products? What exactly makes the difference?
From my viewpoint, product levels and investment returns are highly positively correlated.
In essence, the return for an enterprise is actually the return for production factors it inputs, hence the term “internal return”. The factors range from capital elements (shareholders and creditors) to non-capital elements (staff). Nevertheless, products of an enterprise could be deemed as its external return for social resources.
For any enterprise, the internal and external returns should be consistent. In the long term, the internal return normally comes along with external return. The two are the result of one the other, and the mere pursuit of either of them is futile.
In the real world, there are four different scenarios for product levels and actual returns, or external and internal return.
In the first scenario, there are low-quality products (products of the first and second levels) and low returns. This is easy to understand, as such products are unlikely to pay back to employees, shareholders, creditors and other factor suppliers.
The second scenario is where high returns come from low-quality products, which was quite normal in the shortage-economy era due to serious supply shortage. However, that era has already come to an end and it is now a time of surplus economy.
The other possibility is that monopoly secures excess returns despite less-competitive products or services.
Nonetheless, this situation can never sustain in that enterprises pursuing innovation and excellence would always offer society with third/fourth-level products. Once they do, they will break the monopoly and take fat profits away. It is also a result of competitions.
The third scenario is where enterprises gain little from even high-category level products as customers refuse to pay.
Some products appear to be high-quality yet fail to win the market, let alone create returns for shareholders and employees. As a matter of fact, such products are hardly excellent in real sense, as they either have too high costs or do not match the actual market demands.
Another reason for this scenario is an economic concept, externality. Take railway for instance. Such public utility requires extremely heavy investment yet yields limited immediate returns. However, it is of great importance for society. So to speak, it’s better that for the government responsible for public service rather than enterprises to provide public products.
The fourth scenario is that high-level products bring in decent or higher-than-average returns. This should be the ultimate goal for all enterprises.
In the long run, the competition would compel products and returns to go toward the same level, i.e. high external and internal returns or low external and internal returns.
From the above discussion, we can draw our second law and its deduction: external returns (products) = internal returns, product level = return level, and excellent products = excellent returns.
On Enterprise #3: Competition
The products and returns of an enterprise are not fixed, but dynamic results of competition and could be changed anytime by other market participants. We can’t possibly understand enterprises, products and returns without understanding competition.
JD Capital has been studying enterprises and making investment for years. A few years ago, it reached a conclusion, also a basic formula about enterprises: excess return = competitive edge. This equation is identical and reversible. To emphasize how important it is, we’ve even dubbed it the “Newton’s Law of Investment”.
The Law shows that enterprises which generate excess returns from capital input must have competitive edges; also, those with competitive edges would definitely realize excess returns. If an enterprise has excess returns but no proven competitive edges, then the returns are either false or unsustainable.
Obviously, there are four combinations given the fact that an enterprise can have competitive edges or not, and can generate high returns or not. So it’s either “competitive edge + high returns” or “no competitive edge + low returns”.
Based on the above interpretation of product and return levels, we’ve established that there is high-positive correlation between the two. And now we know that there is high-positive correlation between return level and competitiveness. So it can be deducted that there is also high-positive correlation between product level and competitiveness.
In fact, we often judge the competitiveness of an enterprise based on its product quality, cost, brand, customers, channels, franchise rights, special raw materials, as well as specific business models, operation efficiency and capital convenience. All of them, nevertheless, can only be reflected through specific products after being used in production.
We can therefore reach the third law and its deduction about enterprises: competitiveness = product value, and competitive edge = quality products.
Now we have reached a fundamental theory based on all the above laws:
Enterprise value = product level = competitiveness = return level
And here is the most important conclusion about enterprises based on this theory:
Excellent enterprises = quality products = competitive edge = good returns
If there are some basic law to follow when operating and investing in enterprises, then there you have them. We often say that enterprise operators should always “stick to the initial commitment”. By “initial commitment”, we know it means quality products, competitive edges and good returns. All enterprises should consider them a lifetime mission, and pursue relentlessly.
II. On Entrepreneurs
We have looked at enterprises from the perspective of output. But for a full understanding, that’s not enough. We also have to look at the input, especially two special inputs: capital and entrepreneurs.
From establishment to development, the operation of an enterprise requires various kinds of inputs: employees, equipment, plants, technologies, patents, channels and brands, etc.
These are physical forms of inputs. And they can be divided into two categories by nature. The first category include factors directly related to human – human capital or labor for short. The second category highlights factors indirectly related to human – non-human capital or capital for short.
Factors such as employees and plants evidently fall into one of the two categories, while others can be both. For example, technologies can be a labor factor when it comes to technicians, and also a capital factor when talking about specific equipment.
Any enterprise is a combination of labor and capital, or of human and capital factors. As is mentioned above, at the output end, an enterprise has to have quality products, competitive edges and good returns. The real source of all those lies in the characteristics and differences of labor and capital factors.
So what are the characteristics of these two factors that contribute to the existence of an enterprise, and how are they related?
Both labor and capital are inputs of an enterprise, which cannot sustain without labor and capital returns and compensation. So let’s find some answers by looking at the return distribution for the two factors.
On Entrepreneur #1: Capital Employs Labor
Over the course of history, there has eventually emerged a fundamental phenomenon in distribution of the fruits of labor: in the long run, capital always enjoys more while labor obtains less, as capital plays a dominant role in distribution, while labor takes only a subordinate position. In brief, after a long-term revolution, it turns out that capital employs labor and labor serves capital.
Let’s take a common example. People engaged in business and investments need to analyze financial statements of enterprises. We all know that the balance sheet, which can reflect an enterprise’s ownership, contains the item “owner’s equity”, namely shareholders’ equity. It also contains various items of debts, which stand for creditors’ equity. However, there is no such a thing for employees’ equity and value of labor. Shareholders hire employees, so the modern enterprises are all centered on shareholder value. Manifested almost everywhere in modern society, this logic must have its rationality.
There are also some special cases in which, due to the strong uniqueness of labor value, labor employs capital and employees hire shareholders. In football clubs like Barcelona, for example, most of – sometimes even all of – their earnings are divided among employees and players, and the shareholders can hardly earn a penny. In this case, the shareholders are actually working for the employees. Nevertheless, this is only a rare case.
There is an Enterprise Theory in modern economics, which defines capital, especially equity capital, as residual claims. With a huge amount of uncertainty, the residual claims can be achieved only after deducting labor cost, cost of raw materials, manufacturing expenses and taxes from enterprise revenue. Yet for society as a whole, the “residual” equity still enjoys the largest share.
Why would capital have a louder say in the distribution process? Here is my explanation: labor, essentially, stands for individuals. The most notable features of human beings, in the first place, are uniqueness and creativity. Different in physical and mental conditions and capabilities, the biggest value of human beings lies in his/her special creativity. Labor is related to every individual. As people work separately, each has his/her own fruits of labor with different values. Hence, it is impossible to put them in one single picture or simply sum them up.
The second critical feature of human beings lies in the finiteness of life. There is a limit to everyone’s life. As long as one’s life ends, his/her labor value and creativity, impossible to be accumulated and passed down, dies as well. However great a person is, the labor value attached to him/her will disappear once he/she dies.
Capital, created by labor, has completely different features. It is “soundless”, “thoughtless”, and non-creative; but can be measured, and easy to price and barter. More importantly, with an infinite life, it can be passed down over time. In this way, even though one dies and the labor value disappears, both the tangible and intangible wealth, namely capital, produced and saved can still be sustained. This is exactly what makes capital great.
I think, capital is the accumulated wealth created through the labor of many generations, namely an accumulation of collective labor. So to speak, labor is individuals’ capital to be accumulated.
In the competition between labor and capital in the distribution of social wealth, it remains to be seen which of the two will gain the upper hand in the short term. In the long run, however, it will evolve into a competition between the labor of individuals currently and the labor collected for generations – it is obvious which will be the winner. This is why, for so long, capital employs labor, not the other way around.
As this is an objective phenomenon in history, we don’t need to determine its value in ideological terms. But it is impossible for us to bypass the ideological issue. The biggest problem in ideology of the human society is the issue of distribution. It is so important that its solutions can directly influence and change human history both at present and in the future.
More than one or two hundred years ago, capital was going through the historical process of primitive accumulation. As the capital employed and even exploited labor, social conflicts were highly intensified. But why did that happen? Was it fair? Could it sustain? At that time, Karl Marx, in Capital: Critique of Political Economy and some other books, proposed a new solution to this critical social problem – launching communist movements and depriving capital of the power over distribution through proletarian revolution. For more than a century, the world has witnessed several large-scale social movements and wars. Since the end of World War II, dramatic changes have taken place in the distribution of social wealth: capital and labor are running neck and neck in the distribution process, with quite expensive and tragic costs.
Since the era of Marx, especially after the World War II, a series of social reforms have more or less delivered results in almost all countries, such as public ownership, state capitalism, welfare society, secondary distribution mechanism featuring taxation and charity, joint-equity enterprises, and intellectual property system. With these initiatives, we are strengthening our efforts to address inequality with regard to wealth distribution.
However, the latest results went beyond our expectation. With mass data-based empirical analysis, the French socialist Thomas Piketty drew his conclusion: In the most developed countries such as the US, Japan and European ones, the current wealth structure is back to the way it was before WWI, where capital far outweighs labor in allocation. The only difference is that the owners of land and property from a century ago have been replaced with those of large and emerging enterprises as well as creators of key business patterns and technologies. More details can be found in Capital in the Twenty-First Century, his sweeping economic work.
In fact, as long as the essential difference between capital and labor remains, capital inevitably has a louder day than labor in wealth distribution. Although there has been no ultimate and ideal answer to the problem, in modern society, it should be able to be solved without revolutionary movements or ethnic wars like in the days of Marx.
Back to microscopic business practices, we should realize that: First, for every single enterprise, capital and labor are mutually dependent in contractual cooperation, and neither can be neglected. Second, with the full development of market economy, both labor and capital can realize efficient market pricing and exchange. The capital itself can also be influenced by supply-demand relationship and internal competition, and for individual enterprises, they may sometimes face an advantageous situation of excess capital. Third, in the modern market economy, any kind of unique labor can be quickly capitalized, which include not only technological invention such as intellectual property, but also corporate management, i.e. the value of entrepreneurs.
As a kind of collective and accumulated labor, capital is overwhelmingly superior to individual and to-be-accumulated labor in terms of allocation. As a result, capital can turn into a large amount of real and quality labor under the market principle, or even unique technological labor and productive labor, from which come distinctive products and enterprises. Therefore, the possession of mass, stable capital with reasonable required return, or quality capital, has become a key factor for modern enterprises to gain competitive edges and sustained success.
Based on the above analysis, we can draw another law and deduction about enterprises: enterprise = labor + capital, quality capital = the first elements of excellent enterprises.
From this, we understand why outstanding enterprises must enter capital market and go public. Entering the capital market helps enterprises gain quality capital, establish competitive advantages, upgrade products and finally gain excellent returns in the long term.
On Entrepreneur #2: Entrepreneurs Dominate Capital
Capital hires labor is the result of long-time development of human society. However, this is not the full story.
In modern society, “capital never sleeps.” Capital itself is not live: its vital power is endowed by human, and it is the operator behind the never-sleep capital. Capital should be dominated and operated by a kind of special labor with great vitality.
Among all the input factors for enterprises, there is a special kind of labor that is able to dominate other labor and capital - entrepreneur.
What is the basic function of entrepreneurs? Resource allocation and corporate management. In detail, they have to proactively dominate and operate resources, including labor, capital and other tangible ones, to produce products, face competition and gain returns.
On what basis are enterprises classified into different levels? As mentioned above, the answer is product. Then, what about products? The final decisive factor is the steersman of the ship – entrepreneurs. The difference of entrepreneurs determines the difference between enterprises and products, and the level of the former decides that of the latter. An entrepreneur’s uniqueness is decisive for the uniqueness of his/her enterprise and products.
At the initial development stage of an enterprise, the theoretical boundary is basically decided by its resource factors, competitive pattern and time background. Nonetheless, under this theory, the actual still depends on the entrepreneur.
The responsibility of an entrepreneur is to continuously maximize the actual boundary of his enterprise and approach the possible theoretical boundary to the greatest extent. Excellent entrepreneurs can do. For instance, Jobs pushed Apple to its largest theoretical boundary, or the edge of the industry. Prominent ones may even break through the pre-set boundary and continuously gain new resources, make new endeavors and break a new ground with remarkable innovations.
Interestingly, in Chinese, the terms for entrepreneurs, statesmen, strategists, litterateurs and alike all share the same last Chinese character “Jia”, meaning “experts”, but also “home”. These terms identify and describe those who take enterprises, politics, warship, literature, or certain other fields or occupations as their homes. Entrepreneurs usually have “two homes”: One is a personal one, where he/she shoulders family duties; the other is the enterprise, where he/she forms another family with other corporate elements, and takes social responsibilities. Sometimes, when conflict arises between these two homes, excellent entrepreneurs often take their second home as priority.
In a corporate family, capital and other labor factors are both replaceable, but not entrepreneurs. An enterprise, after replacing its entrepreneur, will not be the same. Like other specialists, entrepreneurs are the scarcest resource in the entire society and an era.
Likewise, we can also grade capital. The level of capital is actually determined by the underlying controller. Capital can be divided into at least two grades: primary capital and advanced capital. Primary capital is controlled by mediocre controllers, and advanced capital is controlled by excellent ones. Besides excellent entrepreneurs, outstanding and professional financiers and investors also control a large amount of capital in modern society. In essence, they are the entrepreneurs in the fields of finance and investment. By investing capital controlled by financial enterprises and investment institutions into real enterprises with continuous value addition and excellent or excess return, financiers and investors continuously combine capital with excellent entrepreneurs.
Based on such understanding, we can reach another deduction about enterprises: excellent entrepreneur = the second element of excellent enterprises.
Then we can come up with the second basic law about enterprises and its deduction: capital = labor + capital, excellent enterprises = excellent entrepreneurs + quality capital. The following can be added to our previous research conclusions:
Excellent enterprises = excellent products= competitive edges = good returns. Excellent enterprises = excellent entrepreneurs + quality capital.
Excellent enterprises = excellent products = competitive edges = good returns. Excellent enterprises = excellent entrepreneurs + quality capital.
Excellent enterprises = excellent products = competitive edges = good returns. Excellent enterprises = excellent entrepreneurs + quality capital.
The most important thing should be reiterated for three times. In my understanding, the two formula above are the most important research conclusions about enterprises.
On Entrepreneur #3: Entrepreneurship
Last, I would like to talk about entrepreneurship.
Entrepreneurs decide the difference in an enterprise’s products, the efficiency of its resource allocation, and finally its life and value.
An enterprise is a life entity in form of an organization, and an entrepreneur represents its life. Like any other life entities, an enterprise should have two basic pursuits:
The first is to keep alive. The essence of life is to live on. An enterprise has to spare no effort to stay alive.
The second is to live decently. Life is precious for its finiteness. Now that life is limited, one should live a splendid life and demonstrate as much value as possible.
I would like to express these two pursuits with two Chinese characters “SHANG”. The first one signifies early death, meaning that all living entities, including enterprises, should try to avoid and fight with early death.
The other one describes the degree of disorder in a system. The final end of any system will be in the process of “entropy production” without the input of external energy, where the degree of disorder continuously increases until death. All life entities including enterprises should also try to avoid and fight with “entropy” with continuing with innovation, contributing quality output and products to the society, and helping the entire human society realize “entropy decrease”.
In my opinion, the only way for all business to survive is to realize positive implications of the two characters.
Based on such understanding, I gradually have the following understanding of the so-called entrepreneurship, which fully illustrates the value of entrepreneurs:
Entrepreneurship is the spirit of survival, the spirit of fighting to the end, and the spirit of never saying never.
Entrepreneurship is also the spirit of innovation, the spirit of maximally adding social wealth, and the spirit of striving for excellence.
The real entrepreneurship is not only realism that loves and cherishes life, but also idealism that pursues excellence and transcends life. In other words, it is heroism in such an era with few heroes.
Above are some of my views about enterprises and entrepreneurs to share with those endeavoring to become excellent entrepreneurs and investors.
- Jiuding Group
- JT Asset Management
- JX AMC