Thursday, July 1, 2010

The Real Deal of Business Deals and Investments


I have been out on my own for a period of 8 months so far - re-skilling, traveling around the world from Hawaii to New York to Germany and China to shake hands and establish material sources, all the while burning up what little savings I have. And it was only until just recently that I managed to ink my first deal, a small sum that is just sufficient to cover my costs in exchange for a good project reference.

This 8 months has been a great journey, and a very humbling experience. The most important of all my takeaways was understanding the real essence of conducting business in the real world. It is truly something that can never be learnt in classroom, or just talking to friends.

Commonalities in the lines of the greatest investors - importance of management and ethics

It dawned on me why the greatest investors of all times always talk about a similar topic - Phillip Fisher in "Common Stocks, Uncommon Profits" spoke about using the 'scuttlebutt' approach to assess the management team; Warren Buffett spoke a lot in his letters to shareholders about ethics and how a company management ought to behave in terms of being shareholder oriented and proper accounting of options. Or in Collins' "Built to Last", which he spoke of the importance of a management team that focuses on building a clockwork system instead of being ego-centric. I could finally appreciate it all, firsthand.

The essence of a business - people, ethics and responsibility

If one analyses a business, takes away the financial accounts, mysterious cloak of systems and strip it right down to it's most fundamental essence - we are really talking about people, their ethics and sense of responsibility. People run the systems, they select the products and sell their services to meet a real world need. In essence, a business transaction is a case of a client taking a risk on another person to address certain needs, value add, or solve some problems. It does not matter whether the transaction is a few dollars, or millions; what remains unchanged is the trust and responsibility that is placed upon one when money exchanges hands.

A second dimension of business ethics is the treatment of the staff - hiring someone is more than just that getting someone to fill a gap or another hire-and-fire HR concept. It means providing that person a livelihood, a stable income so that he can pay his housing loans and bring the bread home to feed his family. It is an added responsibility on the employer to then ensure that the business is sustainable to keep everyone on the payroll.

Doing business calls for one to have a high order of character and leadership, only then, can one build a strong team around him to effectively run different parts of the business machinery. Only then, can one talk about moving from goodness to greatness.

Conducting investment in the words of a venture capitalist

I once asked a venture capitalist on how he decides to make an investment in business proposal, and he tells me "All business proposals appear similar - payback period of 2-3 years, 50% absolute returns, exit strategy of public listing in 5 years, marketing plans, strategic positioning, etc - almost impeccable. But at the end of the day, the determining factor is my assessment of the person and the team running the show. I just want to know if this person is credible, trustworthy, and responsible enough to make the best of my money" What an enlightening last liner, that all of us always fail to see.

The real deal

In all our stock investments, we should carry with us that same eye for this critical detail - the effectiveness and trustworthiness of the management and the staff. Accounting numbers can be fudged to show stellar PE/gearing ratios, such reports are custom made to impress. So place some focus on assessing the people running the company. The real deal comes when you pose as a customer to walk the production floors, and when you meet the company staff in person.

Friday, February 19, 2010

Re-defining 'Competitive Advantage' - Reflections of a practitioner


I recently took the first step in my quest to build a family business empire with my father. It started when I witnessed how my dad has transformed my uncle's firm from a 250k firm into a 4mil annual revenue firm in just 1 year. So, why not churn the money in our own backyard instead, I thought. The concept then was simple - one has a 30years of experience and business contacts behind him, while another makes up for it with energy, youth and a hunger to learn and achieve. I thought a father-son team is just perfect.

As with any company, the importance of having clear directions on the outset cannot be overstated - it provides the bearings that will keep the company moving forward and not straying out of tracks. And one of the most important question is always to determine where is one's competitive advantage in the slaughterhouse of a free-market system.

I am never a hard-core theoretician; ideas like 'cost-leadership' from those conventional books by Michael Porter and the academics alike never seem to register in my head regardless of how many times I read them. And no, neither is this going to be another chapter from Jim Collins' "Built to Last"; I prefer to form my own ideas/definitions of things from my own experience.

What is a competitive advantage?

Put simply, a competitive advantage is like a moat around a castle which prevents profits from being eroded away from the company. It demarcates and protects one's territories from potential aggressors. Without a moat, you are no different from mediocre rest and it is only a matter of time that you are banished into ignominy by ceaseless tides of new entrants.

A current-day business moat can take many forms, depending on the nature of the business. If you are in a trading/distribution business, an exclusive/sole distributorship will be your moat - you and only you will be allowed to represent/sell the product in a specified geographical region. If you are in manufacturing/technology, patents/trade secrets and technical know-how that meet the needs of the industry will keep the company bloodlines flowing. If you are in consumer-related products, brand and product quality are the ones that will roll in those paychecks for you.

Let's not talk about intangibles like customer brand loyalty, relations with suppliers, etc. These are too elusive and hard to pin some numerical values. We focus the discussion on what can be measured, and controlled.

The real game of patents: you do not own what you cannot defend

A patent is essentially an exclusive right granted by a government to an inventor in exchange for this public disclosure of the know-how. The intent is that the public domain 'body of knowledge' is enriched, at the same time the government has provided a commercial incentive to drive innovation and development in the private sector - the inventor can ask for a fee from anyone who utilizes their ideas. Patents can last for 25 years before they expire and become freely available public information for anyone to use.

The problems with patents is that who to enforce it? No one is going to do the enforcing on your behalf. You can own 1,000 patents, but if you do not have the capability to actively monitor for infringements, have large-sums of money for lawyers to file for litigation claims internationally, these patents are just like academic paper publications.

Moreover, it is never too hard to modify a patented idea and then re-classifying or re-terming it and taa-daa, it's a new idea all over again. If this new idea is highly lucrative, it is a natural magnet that will attract a bevy of competitors who will twist your idea around to create look-alike & then file for their own patent. And if you do not know or have money to challenge them, you lose the game.

So, patents as a competitive advantage? I will rule this out for a majority of the businesses in the small-medium phase, unless I am in the likes of HP (which has a dedicated department just for patent infringement monitoring and litigation claims).

Trade secrets: today's subordinates tomorrow's competitor

Keeping secrets in one's closet is a very challenging act, you need to judiciously monitor your crew to detect any signs of ill-intent. It can take ten years to create your own restaurant brand like Fish & Co, and all it takes are some moments of carelessness and a staff will start another restaurant like Manhattan Fish Market with very similar recipes and menus. Yes litigation claims can take place, and your competitor will take the profits earned to pay for your damages and then life goes on. Today's subordinates will become tomorrow's competitors easily, as long as they have worked long enough and snooped enough details. So, trade secrets as my key competitive edge? It's too weak to stand on its own.

Exclusive/sole distributorship agreements

These agreements have a caveat - generally you will need to sign a supply agreement with the supplier with a promised minimum sale of products worth, say, US$1mil per year. Then you will be offered discounted prices for their products. In the event that you fail to meet the quota, a penalty will be levied upon your company.

Exclusive/sole distributorship are very rare because there are a lot of unwritten penalties on the supplier's end - they will rely on you and you alone to expand their sales and business in that particular geographical region. Exclusive/sole agreements rarely take place in the real world unless you have a very strong and established presence in that industry that the supplier wishes to leverage on. Besides, nothing is really stopping your supplier from using other means like setting up another company to sell his wares to a different distributor.

So, unless you have sales offices all over that particular region and has a very strong marketing ability, securing exclusive distributorship agreements is really just another dream.

The dimension of time, the state of flux and their influence on competitive advantage

These existing competitive advantages function like a moat for any company, but what is often ignored is the factor of time and state of flux. New markets called '
blue oceans' may be discovered as one finds a new societal need or more efficient way of doing things, but over time, barriers to entry break down and entrants enter; new markets become old ones; blue oceans turn into 'red oceans'. These conventional definitions do not take into account the dimension of time and decay. Just as the water in the moats can dry up over time, there is no silver bullet to keep a company going endlessly; no one thing can sustain an entity long enough beyond your productive years.

Therefore, if one seeks to undertake a quest to build an empire from the smallest building blocks, yes you need barriers like the above but they do not last long - you need something that is more durable, timeless, maybe even formless.

My perspective? A concoction of First Mover's Advantage, innovation, and a stretched goal beyond profits

First Mover's Advantage (FMA) is a concept that derives its origins from military warfare doctrine. It is the idea that the one who makes a pre-emptive maneuver and secures key resources or vantage points will be one-up against the competitors. In business, the company to secure a footing in the provision of a new product, new service, or in a new market - wins. Because the company will have established a reputation and a track record of being tried-tested-proven as well a good front-to-back-end systems, while the rest will now try to play catch-up.

However, FMA will only guarantee the company an initial advantage; it is only a matter of time that other companies will catch up - the speed of your competitors correlates to the lucrative profits. As barriers to entry break down, you need a strategy that is more than FMA to stay afloat.

Although this sounds cliche, it is quite the truth: the importance of innovation cannot be overstated. Put simply, it means a spirit, an attitude to constantly seek new ideas, new ways of doing the same thing, new products, new solutions; inventing and then re-inventing. Only then, can you be ahead of your competitors. While everyone is grappling with playing catch-up, you are in front of the game.

But innovation cannot stand on it's own - the underpinning structure has to be one that is currently a profitable venture with excess to spare. And more importantly, it has to foster a certain related outcome that is oriented in an aligned direction. The company leaders must also aspire for a stretched goal that goes beyond profits - one that may not happen in the next decade. It is this goal that will drive it forward to new unexplored frontiers, keep it churning ceaselessly. It is also this goal that will help to draw in and retain the best talent.

Building an empire is not an easy task, it will take a lifetime of dedication, day-to-day persistence, hard work, a strong committed team of employees, plenty of goodwill with everyone in the industry, and a little bit of luck to top it off.