(The Value Created by Long Term Control over a Sustainable Competitive Advantage or Factor of Production)
I
read in October 2004 that Ottawa-base QNX Software Systems was sold to Harman International
for $138 million USD. I know that some of my students and clients read it too
and they will be thinking build something and sell it for A LOT OF MONEY. The
only problem is that most of them might not read to page 2 of the Ottawa
Citizen article (October 28, 2004) which says: “For Mr. Dodge, 50 and his
partner Gordon bell, 49, the deal marks a vindication for their effort to build
a profitable company without venture capital over 24 years.” (The emphasis is mine.)
I
am not saying that you should never sell your business but what I am saying is
that it takes time to build a great business.
People
who build and sell quickly are known as flippers. Most of them flip ‘til they
flop. If you have built a successful business, you have climbed
It
is so hard to build a successful business, it takes so long to do it, you use
up so much of your lifetime storehouse of luck doing it, that you should think
very carefully before you sell it. Successful entrepreneurs often think: “Well,
I did it once, I can do it again and again”. Bad news, people, often you can’t.
If
you have built a great business, why sell it? What exactly will you do next?
Start again? Why go through all the heartache and risk again when you already
have a fine business you built yourself?
I
didn’t feel that an essay on Building and holding onto your business (and
helping to creditor
proofing yourself at the same time) would be complete without mentioning
this trap that so many of us fall into. It’s called hubris.
One
of the best ways to get out of creditor hell is never to get into it in the
first place. One of the ways to do that is to not sell your successful business. In almost all cases, a
successful business will sustain you and your family and your employees and
your suppliers and your other stakeholders far, far better than cash in the
Bank.
Let
me tell you another story, this one about Sean (not his real name). Sean was a
by the bootstrap kind of guy and he had one great thing going for him—he had
charm. He was a born salesperson and in the game of entrepreneurship, if you
can’t sell, you’re out of the game before you can begin. (The three most
important things in entrepreneurship are SALES, SALES, SALES.)
Well,
one day about fifteen years ago, Sean found himself working in the fish
department for a large supermarket chain; he was wearing one of those hair net
things and he was developing arthritis in his hands from the cold and ice he
was constantly exposed to. He and his spouse, Freda, had their first child (of
what would eventually be a clan of three kids).
Sean
thought to himself: “I can do better than this.”
The
next day he went out and bought himself his first computer (never having even
booted one up before) and started an advertising and promotion business in his
basement with nothing other than guts, charm and a high school diploma. (I have
changed his industry too to protect their identity. I apologize to my readers.)
I
met Sean one day, about two years after he started working out of his basement,
and he convinced me to move our entire advertising and promotion account over
to his company. He was that good. I certainly asked him about his bona fides.
Could he produce the volume we needed? How was his Quality Assurance program?
Yadda, yadda, yadda.
I
didn’t know until years later that this was his big break—it allowed him to
finally move his business out of his basement, buy more equipment, hire more,
better people, etc. But when he told me, we laughed about it together and I was
doubly glad—glad that he was a success and glad that he didn’t let us down.
A
few years later, Sean called me out of the blue. He had an offer to buy his
business from a larger competitor for TWO MILLION DOLLARS IN CASH. I told him to
slow down and think about it a bit more. I asked him a few questions. How much
are you taking out of the business? About $200 to $250k a
year. How much do you pay Freda to do your books? Oh, about another
$50k. Do you have any company cars? Yeah, reckon so—two of them in fact.
In
total, Sean and his family were getting about $300,000 a year from the Company,
year in year out—it was a sustainable number.
I
asked Sean, do you know what interest rates are on term deposits right now? No.
Well, they are about 1.7% p.a., which means that even if this sale was tax
free, your income from your two million dollars is going to be 34,000 bucks a
year and every year inflation is going to eat away your principal. Now why
would you give up $300,000 a year and a business you love and built yourself
for that?
Let
me quote actor and comedian Chris Rock:
“Shaq
(Shaquille O'Neal who plays for the NBA’s
Miami Heat) is rich but the man who signs Shaq’s pay
check is wealthy.”
Chris
Rock got it exactly right. You can get rich by winning the lottery, becoming a
NBA Star, speculating, asset flipping, gambling, picking the right parents or
prospecting for gold, diamonds, nickel, whatever, but you can’t become wealthy
doing any of these things.
Wealth
derives from control over a factor of production, a license, a franchise, a
territory, a concession*, some IP (Intellectual Property like the secret
formula for Coca Cola or the 11 secret herbs and spices that the Colonel uses
to make fried chicken), a competitive advantage, a comparative advantage,
property ownership—anything that creates a sustainable, repeating and renewable
income stream; it is your ‘pixie dust’—the
magic that really makes your business work.
(* What was the grant by the
Crown of exclusive fur trapping and trading rights to the Hudson Bay Company in
Rupert’s Land (all the lands (all 3.9 million square kilometres of it) that
drained into Hudson’s Bay) in 1670 worth to that firm? Well, they became one of
the longest-lived corporations ever known—in continuous operation to this day.
Their great wealth and economic and political reach was based not only on their
fur trading rights concession but also on their control of real estate—they
later came to control some of the most valuable sites in many Canadian cities.
Long term wealth is often
based on these types of privileges gained through political maneuvering. The
Fred Harvey Company controlled the Mule Train concession to the bottom of the
If you are the Emperor of
Japan, head of the House of Windsor (aka, the Queen of England) or head of the
Holy Roman Catholic Church (aka, the Pope), you have a different type of
concession but ones that have proven to be hugely long lasting. But maybe they
aren’t quite so different after all—their fortunes are based on real estate as
well as hereditary or faith based positions of power. The Queen is a huge
rentier (basically, a landlord with residential and commercial properties as
well as broad acres for lease); the value of the Emperor’s estate in downtown
Tokyo (the Imperial Palace) is incalculable and the Church has developed one of
the greatest portfolios of property on the planet by colonizing some of the
best sites in every city and town where the Church was represented. Astutely,
they almost never sell their property, calculating, correctly, that land leases
of 49 or even 99 years were the right way to produce income for an institution
with a time horizon measured in millennia. They can enjoy income from their
properties without having to give up long term control over their lands. After
the completion of a land lease, the property reverts back to the Church and the
process begins all over again—perfect inflation protection and, since they are
tax exempt too (in most instances), the Church has one of the most stable
financial platforms imaginable. In my view, the Queen seriously eroded the long
term stability of the House of Windsor in the last decade of the 20th
Century by voluntarily giving up the Crown’s tax-exempt status in an attempt to
appease her critics. It was very democratic of her but certainly will have
adverse consequences for the future of her heirs.
There is no better business
to be in than the Government business—they keep all the best businesses for
themselves. For example, there is no higher margin business than the Casino or
lottery business and governments everywhere seem to either keep the business
and operate it themselves (as they do in Canada) or regulate it and tax it
heavily. The dole out other choice concessions to their friends or influential
people who can help them get re-elected. If their costs go up, they simply
increase their prices (aka, taxes) and, if you don’t pay the higher prices, a)
you have no where else to go for service anyway (e.g., for your water and sewer
connection) and b) they can force you to pay either by taking away your
property or your liberty or both.
Governments love the liquor
business too—again, either they control it and operate it themselves or they
simply control it and hand out concessions to private operators and tax them to
the max. Yesterday’s bootlegger is today’s protected oligopolist.
Just how important are these
types of ‘concessions’? Well, look at what the professions do. Professional
Associations (for Architects, Engineers, Lawyers, Accountants, even Real Estate
Agents, etc.) are based on the tradition of guilds made up of artisans who band
together to: a) raise prices and b) restrict or otherwise raise barriers to
entry for newcomers. They always cover their tracks (it’s called political
cover) by claiming that they are raising standards to protect the consumer and
the public interest which no doubt they are doing at least in part. Not to be
too facetious about it but self-interest is a top consideration for these
organizations. Unions (like, say, the NHL Players’ Association) perform exactly
the same function for their members BTW.
In
Now
let’s just look at some numbers; let’s say someone controlled the early Beatles
catalogue (say, someone like Michael Jackson). Mr. Jackson is reputed to have
bought the catalogue in 1985 for $47m (but he lost his friendship with Paul
McCartney along the way). By 1993, MJ’s company was reportedly earning $30m
from it (albeit, MJ had added other songs by other artists by that time but
let’s ignore this for the moment) and it was estimated to be worth $300m at
that time. This yields a cap rate (capitalization rate) of 10, which is pretty
typical for this type of privately held asset. No one knows what kind of income
stream he gets from this now but it has a rumored value of $1 billion today. MJ
still owns 50% of it, the balance is owned by Sony.
With
a cap rate of 10 and given that MJ owns half of the catalogue, we can guess
that MJ gets $50m a year in income from his ownership. Plus the Beatles are
making a huge comeback—just ask my 14 year old daughter, Jessica, who only wants
Beatles CDs for her birthday and knows just about every word to every tune the
Beatles ever recorded. So it wouldn’t surprise me if MJ’s income is going up
every year from this source. This is called wealth. However, let’s say that MJ
is in need of some quick cash and sells his interest to Sony for $500m. Now MJ
would be rich (for a while) from
selling his interest in the catalogue but he would no longer be wealthy because he has lost the ability
to renew his wealth every year by producing an income stream from control over
this particular factor of production.
But
what’s that you say? He could invest the proceeds in T-Bills, Muni Bonds and
GICs (Guaranteed Investment Certificates). Sure he could, but they produce puny
1.7% to 4% rates of return. If MJ paid $100m in taxes, he would be left with
$400m, which would give him an income stream of $6.8m to $16m a year with no
inflation protection. I mean if MJ were to continue to control the catalogue,
he could always increase the price (aka royalty) paid for each tune if
inflation takes off and starts to bite into his revenue stream. But even
ignoring inflation, why would MJ trade an income stream of $50m a year that
makes him wealthy to become a remittance man getting $6.8m to $16m a year? MJ
has already turned down offers to sell; presumably he understands the Chris
Rock difference between becoming rich and being wealthy*.
(* Somehow I doubt whether
Lisa Marie Presley has read this piece. In December 2004, it was announced that
Lisa had sold her father’s image and name as well as 85% of Elvis Presley
Enterprises Inc. to Robert Sillerman-controlled SFX Entertainment for a
reported $100 million, which included some stock in a new SFX controlled
business. So not only does Lisa no longer own, control and direct a valuable
franchise (her father’s estate, which brought in $45 million last year), she
didn’t even get all her compensation in the form of CASH. As any entrepreneur
knows, cash is KING. (Pardon the pun, Elvis). Now compare that with J.K.
Rowling’s absolute and tight control over her creation (the Harry Potter series)—not only the
publishing rights but also the film rights and other media rights as well. It
has made her the richest woman in the
Did
you know that many, maybe most, lottery winners blow their entire wad in less
than five years? By that point, their spouses have left them, they are
alienated from their old friends, they have got a whole new set of ‘friends’
who are only around while the money lasts and they don’t even have their old
job to go back to. Many of them have picked up nasty habits along the way like
taking drugs. It’s absolutely amazing how many of them end up in bankruptcy.
They are much worse off for their ‘good fortune’.
People
are meant to work. They are built for it. If you have built a good business,
control a great concession, own a valuable franchise, possess a ‘secret’
formula, whatever, hang on to it, fight for it*—it is your security against
creditor phone calls in the middle of the night asking you: “Mr. Jones, when
can we expect payment?”
(* I was doing some work
recently with a mega real estate agent. He is a salesperson for a large
brokerage and is vying for one of the top national spots in terms of sales
volume. He has developed a team approach to selling residential real estate and
will sell more than 120 homes this year (2004).
I was surprised to learn (and
it surprises me that after a great deal of experience with the real estate
industry that I didn’t already know this) that he has developed a long term and
sustainable competitive advantage.
Remember, this is an industry that has no minimum educational requirements, not
even a high school diploma is required to get your license. After successfully
completing a three phase course in
There are more than 40,000
real estate agents (more properly called ‘sales representatives’; technically,
‘agency’ is a term reserved for the relationship between the broker and the
client.) in
Well, first of all, John (not
his real name) treats his position as a salesperson as if it were a stand alone
business. It is my personal belief that every salesperson in every industry
should consider himself or herself as a quasi-independent entrepreneur.
John has a business
model for himself and his team of sales assistants. He views his broker as
one of his suppliers—the broker supplies John and his team with office space,
holds his license, manages the trust accounts, pays the phone bill and keeps
the lights on. He doesn’t really expect much more from his broker although he
counts on the firm (which is a nationally known company) to burnish its
reputation so at a minimum his association with the firm is not a net negative.
Trust in this business is hard earned, important to his success and easily
lost. But what freedom—you don’t have to worry about keeping the lights on,
paying the phone bill or what have you—you just get to concentrate on your own
core competency (i.e., selling) and there is no upper limit on what you can
make. If more people thought this way and they treated their sales as a personal
business for life (PB4L), then we would have a lot more high performance
and happier sales reps.
As a supplier, the Broker
represents John’s major COGS (Cost of Goods Sold), taking a 30% bite out of his
commissions. John is responsible for his own marketing and sales, personnel
selection and HR policies as these relate to his own team.
By thinking strategically
about himself as a separate business unit, John and his team have experienced
tremendous sales growth. But all of this would not have been possible without a
bit more ‘pixie dust’—John has spent the last 15 years ‘farming’ a specific
geographic area—he now controls more than 20% of all listings and sales in
‘his’ area.
Now I realize this is an old
real estate trick—i.e., concentrating your marketing effort in one target area.
In the real estate business, listings are everything. If you control a listing,
then buyers or buyers’ agents have to come to you. Eventually, if you control
enough listings within a designated area (probably around 20%), you become the market maker—sellers have to come to you
to get their properties listed and sold because you have so many buyers coming
to your (already) listed properties that if one isn’t just right for Harriet
and Albert Smith, you probably have another one that is just perfect for them…
John has so many of his signs
in his designated area that: a) it discourages other agents from trying to set
up (poach) in that neighborhood and b) people who want to list and sell would
be think twice before listing with anyone else. The awful thought in the minds
of potential buyers if it wasn’t listed with John’s team might be: “What’s
wrong with this house?” And that is the kiss of death in residential real
estate. Perception is everything.
It turns out that farming a
neighborhood and becoming its market maker are sustainable competitive
advantages in an industry that really shouldn’t have one given its fundamentals.
So think about it—it took John 15 years of incredibly hard work to get to this
position. He sells over $30 million worth of homes a year. He does this with an
average house price still in the $200,000s as compared with other agents in
larger, wealthier markets where average home prices are in the $700,000s or
higher and he still manages to make it into the top 1% of agents in his firm.
Now if decides to cash in his chips and sell his PB4L, what would he get for
it? Well, nada, nothing. That’s why it’s called a Personal Business for Life.
Postscript: John could, of
course, explore a way to perhaps pass on the value he has created. He could
take his broker exams and set up his own shop. In that way, his clients’
loyalty would be to the Brokerage (his Brokerage) and not necessarily to John.
So when it comes time to sell, John has (maybe) something to actually sell—the
Brokerage’s client list and existing listings.. But
there are obvious problems with this approach—a) the clients may not port over to
a new, unknown and untested Brokerage and b) maybe after John retires, the
clients that have followed him to the new enterprise might drift away because
they followed John and like and prefer working with him. I am not sure that
there is any simple solution to this problem because surely one of the
objectives of entrepreneurship is to create something that has a life beyond
your own; in that way, you would have created something that can make money for
you ‘while you are lying on a beach’.
For real estate salespersons
and entrepreneurs, this remains a challenge that requires more thought. What
John has created, so far, is a PB4L that remunerates him richly. This is only
half the equation in entrepreneurship. He and I haven’t (yet) solved the other
half and, unless we do, what he has done is basically create a J.O.B. for
himself, albeit, a highly paid one.) Whatever John does though, he should
clearly and doggedly keep what he has so dearly created—Build and Hold, Friend.
Copyright. Dr. Bruce M. Firestone,
http://www.dramatispersonae.org/CreditorProofing.htm
http://www.dramatispersonae.org/PersonalBusinessesThoughtExperiment.htm