Value Extraction

A large pool of resources always has a certain amount of surplus that can be "skimmed" by players who want to maximize their own positional benefits. When this happens, those surplus resources cannot be used for expansion efforts or defense of the pool. This activity, known as value extraction, is a zero-sum set of behaviors. The core of value extraction is that one stakeholder (or a small group of stakeholders) pull resources out of the pool at the expense of other stakeholders.

At some level, extraction is one of the primary goals in Valuation Games. While some players may be motivated by hopes, dreams and desires, everyone wants their own pool. One of the fastest ways to build your own pool is to simply drain someone else's and put it into yours. That's not to say innovation or value creation are not important parts of the game—they are. This is simply a reflection of the realities inherent to high-stakes Valuation Games.

To be clear: downsides of value extraction can be substantial. A motivated, capable extractor can severely diminish or even destroy pools and create ripple effects through a market. If it becomes a trend across multiple pools, then entire domains can stagnate into puddles of mediocrity while insider extractors get rich. When it reaches a critical mass, players soon realize there's little incentive to innovate and build their strategies around extraction exclusively.

Extraction Methods

There are ways to extract from a pool, but for our purposes it takes three primary forms:

• Siphoning: Drain your current pool for your own benefit.

• Liquidation: Drain someone else's pool for your own benefit (usually after an acquisition).

• Subversion: Drain a pool after gaining some degree of non-controlling access to it.

There's a whole spectrum of legality involved here. Some forms of extraction are entirely legal, while others are felonies. In some cases, the rules aren't clear and the players have to make a call about what level of risk they want to take. Methods are also often combined in order to maximize insider benefits, creating a much messier reality than this taxonomy suggests.

None of what follows is a judgement of the methods described. This is just how the game is played, and anyone who wants to succeed needs to see it with clarity.

Siphoning

This is most commonly executed by Commanders, Owners and Managers alike, because it requires substantial control over the pool. Any time a powerful insider can convert their position of influence over a pool directly into a payday, siphoning is underway.

Stock buybacks are a typical example from the world of corporate finance. Executive compensation at large public corporations is tied to the price of the company's stock. If the executive staff want to give themselves a quick path towards making a lot of money, all they have to do is use company profits to purchase their own stock. This allows them to use money from the pool to raise share prices artificially, giving them a free payday at the expense of any form of reinvestment in the company.

A less legitimate form of siphoning is the way the Mafia ran a "skim" operation on the casinos they owned in Las Vegas throughout the mid-to-late 20th century. Because they controlled the casinos and most of the local political and legal power in the area, these gangsters drained millions of dollars from their casinos.

Siphoning tends to be a lower-impact form of extraction, if only because the players involved don't want to kill the golden goose. It makes sense to keep the siphon to a respectable level in order to not make waves while you build your own pool in the background.

Liquidation

Expansion through acquisition is a difficult, complex process. You have to think through how that asset will integrate with your existing infrastructure, find ways to protect your downsides, etc. Sometimes, it's just easier to just buy someone else's pool and then drain it. This is the main idea behind liquidation.

Private equity is a contemporary example of this concept at work. They use large pools of other people's money in the form of debt, then use those pools to buy companies with valuable assets. Although their goal is often to buy low and sell high (known as multiple expansion within the industry), in some cases they go for pure liquidation in the form of asset stripping. They load the target company with debt, then use that debt to pay themselves in various ways.

For example, many PE firms will execute what are called dividend recapitalizations, or dividend recaps for short. A divided recap involves using debt to pay back the PE firm after the acquisition—a dividend paid for by the company that was just acquired. Another tactic is to sell the land the business is to the PE firm, then have the company pay rent on land it used to own. The list of liquidation possibilities in private equity is extensive, and incredibly profitable.

An illegal example is what's called a "bust out." This can happen for a variety of reasons, but the usual culprit is when a gangster ends up in possession of a cash flowing business as a result of a debt (usually a gambling debt). The person who took out the loan can't pay it back because of the high interest (also known as a vig), so the gangster becomes a silent partner in the company.

Once they're in a position of influence, they use the company's credit to purchase goods. These goods are then sold, often at a steep discount, outside of the business and the criminal keeps the proceeds. This is repeated until the business is so deep in debt that no more credit is extended, which will kill the business before too long.

Liquidation is a much more high-impact, zero-sum style of extraction. Players who prefer to liquidate enact a transfer of resources and power from another player's pool to their own. In the case of PE, the company may close due to their debt obligations even though the firm made a profit on the transaction. The same can be said for the bust out, where a productive business has to close in order to benefit the gangster.

Subversion

Unlike the other methods, which have legal, illegal, and "gray area" possibilities, subversion almost always requires some form of illegal activity. With siphoning and liquidation, there are conflicts of interest, but it comes from the legal owners of the pools in question. When a player utilizes a subversive strategy, they are tampering with other people's property.

It's also one of the few methods readily available to Contenders. The other two tend to require a level of control that requires a player to at least be a Manager in the Commander echelons. But subversion is possible for more unscrupulous Contenders if they're willing to take some risks.

The classic example of subversion is embezzlement. An accountant or other employee with access to the company bank account or safe decides they'd like a raise and simply moves money from the pool into their pocket. If the pool is big enough and the player's greed is kept in check, this form of subversion can go on for extended periods of time—years, even decades in some cases.

Another form of subversion is trading with inside information, which can be used by Commanders and Contenders alike to profit at the expense of other market participants. Some slice of the pool's resources flows to the trader at the expense of others both inside and outside the pool. You don't need to be in a controlling position to benefit, you just need information.

Subversion can act as a sort of ticking timebomb, especially when it comes in the form of embezzling or other fraudulent activity. The Commanders at the top may not realize what's going on until it's too late and they can't save the pool from collapsing. A smart practitioner of subversion understands this and doesn't go overboard: they drain just enough to benefit but not so much they'll draw attention to their activity.