One of the reasons I started interviewing entrepreneurs and business owners was that I wanted to explore a wide variety of businesses (and other opportunities), and then use that information to help decide what kind of business I want to run. Through this lens, the podcast is basically a giant research project that combines lessons from my investing and analytical experience, with the “boots on the ground” realities of business ownership as offered by podcast guests.
One area that’s surprised me is how this podcast has inverted my perspective on low-margin businesses. Prior to this podcast, I would have been extremely reluctant to get into any business with less than a 10% net margin. But now I feel strongly that margin “thickness” alone isn’t a sufficient or reliable indicator of the quality of a business. Many other factors need to be taken into consideration in conjunction with profitability: cyclicality, stability of consumer preferences, ability to finance cheaply, inventory turnover, seasonality (and many, many others, that would take way too long to list here).
So rather than analyze businesses based solely on financial metrics (like profitability, working capital requirements, fixed vs variable costs, etc), I started looking for business that I think I could run smoothly and successfully, even with only minimal experience. And what I found was that I started looking at companies the way Warren Buffett does (or professes to). In other words, I want to find businesses that even an idiot could run successfully. Because, I am, for all intents and purposes, an idiot when it comes to running a business. I know almost nothing about it that isn’t already widely understood by the incumbents, I have zero experience and that is a massive liability. So I need something that is incredibly resilient, that tolerates mistakes, and that will let me learn on the fly without going broke. I went through the businesses run by guests one by one, listed out their strengths and weaknesses, and a put together a list of traits that characterize a wonderful business. It might not be possible for a single business to have all of these, but you want at least a few of the following:
- Customers Pre-Pay, preferably far in advance
- Recurring Revenue
- Can finance with OPM, minimal personal risk
- Differentiated Value Proposition
- Minimal Cyclicality
- Fragmented, Diverse Customer-Base
- Product is Small Percentage of Customer Budget
- Consumer Preferences are Stable, Preferably Nostalgic
- Industry Growing Faster than GDP
- Low Inventory Risk
- Product is Important to Customer
- Low Cost Producer
- Minimal Capex Requirements
Likewise, you should try your hardest to avoid businesses that have none of these or that have traits that are the opposite of those on this list.
Really, these 13 factors triangulate (tridecalate?) on 1 concept, Predictability. The ability to make money year in, and year out without having to deal with competition, pricing pressure, changing inventories, fickle customers, economic sensitivity, and pushing around working capital. Now I’m not saying “only dumb people run these kinds of businesses.” I’m saying, you want to seek out situations where it doesn’t take a genius to run it successfully. You want to use your genius to help grow it, not to keep a crappy business afloat. You want your business to be able to stand on it’s own without you dumping 70-80 hours a week into it. You want to be sailing with the breeze at your back, not struggling to stay afloat. Do you see what I mean?
A lot of this thinking crosses over into investing (hence the Warren Buffett reference). When I think about companies I want to invest in, I look for the factors I described above, and I think about it through this lens, “do the people running this company (the operators) have a strong enough position that they can focus on growing this company 10x, or are they entrenched in a bloody, WWI-style battle for no-man’s land?” Pricing wars, massive investments in machinery, the need to stay cutting edge on R+D, and changing customer preferences are all things I want to avoid because they increase risk and difficulty.
Very few people, I think, are smart enough and energetic enough to be able to fight these battles while simultaneously growing their business. I want businesses that require a two-foot putt (ideally a two-inch putt), rather than a hole in one. And you need to think about what the business will look like in the future. If business is good now, will it continue to be good forever? How much warning will you have before a slow-down occurs? How much capital do you have at risk when a slow-down happens?
Thinking this way puts me the closest I’ve ever been to internalizing Warren Buffett’s process for selecting businesses to invest in. In fact, what I’ve described is very similar to how he talks about moats. You want businesses that can grow earnings for many years, but you want those earnings to be defensible; you don’t want a business that can have its livelihood stolen away by a competitor. Shelter from competition is a key feature of my “idiot-proof” framework, and Warren Buffett’s “moat” philosophy. I don’t want to have to compete with people on the basis of who will work hardest, fight dirtiest, or think hardest. There’s always someone else who wants it more than you do. You want their tenacity to count for as little as possible.
Throughout this exercise, I kept thinking about Buffett’s line, “I am a better investor because I am a businessman, and I am a better businessman because I am an investor.” Thinking about investing or business, through the lens of the other, is really helpful for gaining better understanding and making better decisions. Having actually started going through this process, his words are more true to me now than ever.