Many entrepreneurs chase fast money. But slow money can be very sweet.
Silicon Valley mythology is about rocket ship startups. But many great businesses are just nice, profitable tugboats.
For those of us in Silicon Valley, it’s easy to get sucked into the notion that every startup has to be a “high growth opportunity in an exploding market”. The fact is, of course, there are many great businesses that don’t fit that description at all.
I was thinking about this last week as I was reading one of Warren Buffet’s letters to shareholders. He writes about how some of the the favorite companies he owns are the really boring ones.
“Let’s look at the prototype of a dream business, our own See’s Candy. The boxed-chocolates industry in which it operates is unexciting: Per-capita consumption in the U.S. is extremely low and doesn’t grow”, he writes.
When he bought the company in 1972 its sales were 16 million pounds, now they are 31 million pounds, which is a growth rate of only 2% annually. Boring! “Yet its durable competitive advantage, built by the See’s family…has produced extraordinary results”, he continues.
What he loved about the company when he bought it was the fact that is was such a capital-efficient business. “We bought See’s for $25 million when its sales were $30 million, and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million. Consequently, the company was earning 60% pre-tax on invested capital. Two factors helped to minimize the funds required for operations. First, the product was sold for cash, and that eliminated accounts receivable. Second, the production and distribution cycle was short, which minimized inventories”. This is a company with very solid underlying economics.
The point of this, for me, is that too many entrepreneurs today are obsessed with creating a rocket ship startup (high growth, huge blue sky opportunity), and not concerned enough about the underlying economics. And the venture capital industry is partly to blame for this, of course: the traditional VC model is to launch ten rocket ships, watch nine of them crash, and get rich on the tenth. That’s a successful model for them, but it comes at the expense of the nine entrepreneurs who crashed because the economics of their operation turned out to be fatally flawed.
Meanwhile, a boring low-growth business like See’s Candies has excellent fundamental economics and makes money for Warren Buffet year after year. “Long-term competitive advantage in a stable industry is what we seek in a business”, Warren Buffet writes.
While others chase fast money, Warren Buffet likes slow money. And he’s made a lot of it. That’s an important point to remember, for entrepreneurs everywhere.
This was adapted from a previous edition of my newsletter for entrepreneurs and innovators.