The market caps of just four companies, Apple, Alphabet, Amazon, and Microsoft, now exceed $3 trillion. Their combined assets of $944 billion are an order of magnitude lower than the combined assets of $7,700 billion of the largest 3,177 companies in 1986, when the aggregate market capitalization reached $3 trillion for the first time. In our recent HBR article, we argued that financial statements fail to capture the value created by modern digital companies. Since then, we interviewed several chief financial officers (CFOs) of leading technology companies and senior analysts of investment banks who follow technology companies. We asked: (i) what makes the valuation of digital companies more challenging?; and (ii) how can digital firms improve their financial reports to communicate sources of value creation in their businesses? We distilled seven key insights from those discussions. Some of these ideas contradict traditional financial thinking whereas others seem highly controversial or pessimistic.
Why We Need to Update Financial Reporting for the Digital Era
The authors interviewed several chief financial officers (CFOs) of leading technology companies and senior analysts of investment banks who follow technology companies. They asked: (i) what makes the valuation of digital companies more challenging?; and (ii) how can digital firms improve their financial reports to communicate sources of value creation in their businesses? They conclude from these interviews that the time has come for investor bodies and companies to rethink the financial reporting model from scratch. For instance, standard-setters might want to encourage disclosures related to (i) value per customer; (ii) earnings or revenue outcomes or other specific metrics related to specific projects in progress; and (iii) data on how the R&D and software talent of digital firms is being deployed. Relying on firms’ voluntary initiatives is unlikely to work because executives told us time and again that they will not disclose sensitive information, unless their competition is forced to do the same.