Business Models--some of the best for small AND big businesses

[netnet]

I wanted to kick off a discussion of business models, what are some of the best ones?  I think looking at this as an entrepreneur and an investor.

 

1) What are some of the best small business models,  really the best businesses and

 

2) What are some of the best larger businesses (models).

Please explain the model not just say that BRK has a great business model.

 

There are of course the business that are great if you happen to wind up being one or (sometimes) two in the market.

 

 

My current pick for both a large and small business model:

 

* operating or buying mission critical software companies--see Constellation on this board.  The beauty of this business is that you basically 'win' on the purchase.  There are some limited synergies (in Constellation's case)and generally you can ramp back on the sales and R&D expenses.  The businesses are stable and your customers can't live without you.

 

Otherwise:

 

* small business, a geographically concentrated number of laundromats.

 

* large business, Google, of course!

[bizaro86]

Businesses where there is a natural monopoly provided by location/transportation costs, but the market size isn't big enough for two competitors (natural monopoly). Once the monopoly is established, the business can charge prices just low enough that nobody else enters.

 

Trash collection in smaller centres, gravel pits, recycling plants all meet this definition.

[dabuff]

The book Hidden Champions by Hermann Simon explains much of this in a wonderful way.

[ScottHall]

Amazon, for large businesses.

 

WWE has a pretty interesting little niche in the sense that there are no real competitors, a few small outfits that are more like gnats in comparison. Every once in awhile they get the desire to expand beyond their niche though, and it costs them. XFL and their movie studio being obvious examples. I'm surprised it's even public, honestly.

[NewbieD]

Small: Software IPs that fit the natural monopoly mention above. When somebody has made a targeted software for a specific application, and charge just little enough for it that nobody wants to build a copy. Fixed costs can be extremely low.

 

Large: Insurance if done well b/c of investable float. It can yield decent return at low risk.

[oddballstocks]

There are a TON of businesses that make an owner, or an owner plus a few partners a LOT of money, but are locally restricted and not scalable.

 

Some of the problem is a lot of investors on here have stars in their eyes and want to grow a pile of money to the 10's or 100's of millions range or more.  There are a few well known models that support that.

 

Otherwise find a niche and exploit it.  I've talked to numerous entrepreneurs who are making great money in little niches.  They aren't scalable though.  Maybe you can ramp up to $500k or $1m a year in income, but that's probably the ceiling.  For 99% of America that's fine, but my guess is most on this board would want to take it higher.

[netnet]

There are a TON of businesses that make an owner, or an owner plus a few partners a LOT of money, but are locally restricted and not scalable.

 

 

Like what.... (not to be that guy ;), but the purpose of the thread was what are some of those business models.)

[Guest Schwab711]

There's a lot of these threads all over the place. I think the 2nd or 3rd page of GD section has a "wide moat stocks" thread. I'm assuming you looked at those and wanted a thread discussing types of businesses that tend to have moats.

 

Anyway, the best companies are ones that rate people or things. With gravel pits/garbage dumps, although there is little competition, there is still research into alternative options. It seems possible that new technology/methods could drastically alter the economics of these advantages. When it comes to rating people, it's seems pretty unlikely that we will find a more efficient formula/algo that is drastically different from the methods currently used. It seems more likely that FICO's or MCO's of the world will continue to moderately improve their methods as opposed to a new company drastically changing how we rate credit. That rule of themub  is pretty consistent for all rating businesses.

 

They are distributed by non-profits, but I was always jealous of the SAT/ACT/GRE tests for the above reasons. Does anyone know of any public companies who earn a non-trivial amount of profit from certifications or tests?

 

When I research companies, I try to look for the below "moat" classifications. I pretty much ignore MORN classifications for the reasons mentioned below.

* best rater of people or things

* have a location or non-expiring IP advantage (e.g. land or water rights, sole-source contracts with AM sales, ect)

* exchanges or middle-man services

* brands with extremely high replacement costs.

 

It seems like there are a few companies that have an advantage due to their effect on human senses, but these are uncommon (KO/PEP/DPS, chocolate, IFF, and so on). Some of these may fit in a Morningstar moat classifications, but I think MORN captures too many false positives while missing a few obvious false negatives. Luckily, there is no known formulaic method to identify these excellent businesses. Even if there were, there's been very little research into how to value these advantages. It's a bit controversial, but since companies are hard-to-value and have higher earnings predictability, I think moats tend to be more commonly mispriced than your average public comapny, even though they usually have a strong tailwind : headwind ratio.

 

The big-3 CRAs (MCO/MHFI/FIM.PA) are public corporate credit rating agencies. Most folks know how great these companies are. MCO has been described by more than a few great investors as the greatest business model in the world.

 

Personally, I think FICO credit scores is far and away the best company in the world to own and it's not even close (ignoring valuation). I one tried to estimate their replacement cost in 2011 and I thought it would take at least $5b-$6b to replicate FICO and market it worldwide even though they only generated ~$80m in earnings. The advantage is likely larger now than it was in 2011.

 

Another company with a large market share and high replacement cost is Bic (BB.PA). They have incredibly consistent margins, ROIC, and ROE. I love these types of companies where they have strong margins, ROIC, and ROE, a simple product, but no competition due to the costs to create a new competing brand. It's almost better than a legislative monopoly because you don't have to worry about politicians, just the relative value between them and direct or alternative competing solutions, which is generally feasible to measure and track.

 

TDG gets mentioned often and I'm a huge fan of their business model. There are two other similar companies, SPR and TGI. Suppliers for aircraft (airplanes or helicopters) in general results in a pretty sweet business, if you can have sole-source contracts.

 

Water rights or well-located land is another great place to find moats. I love the water bottling industry. Some spring water bottlers can command 95%+ gross margins! The operating leverage with water bottlers is on-par or better than some software companies.

 

Mass-market chocolate generally has a moat within a country. For whatever reason, chocolate brands don't seem to travel well and humans tend to notice small differences in chocolate recipes more than other foods. I can't think of any premium chocolate companies that are publicly traded a la See's. Russell Stovers always seemed like a great investment if it were public.

 

Last one is the atmospheric gas companies (PX, AIR, APD). This is due to location of resource rights, those resources being necessary inputs, with stable and growing demand, and a large gap in value between these gasses and alternative solutions or supplies. Hydrogen, helium, and noble gasses in particular cannot be recaptured or economically created artificially so they are becoming increasingly rare each year. Customers expect annual price increases for these gasses.

 

Some other great business models:

SLP (best rater) - software significantly improve value/efficiency of Phase I pharmaceutical trials

EA (SS) - Introduced a gambling-based business model to sports games, which are significantly more stable than any other video games

VRSK (best rater) - Best risk management software for insurance industry. Similar to V/MA origin

VRSN (SS) - Distributes ".com" website domains to registrars (consistently renewed sole-source 5y govn't contract)

EFX (best rater) - credit reporting agency; licenses FICO's algo to provide branded credit/background reports.

CME (MM) - Commodity exchanges and largest derivative exchanges

CBOE (MM) - Options exchange and more

ICE (MM) - futures exchanges, clearing houses, and more

OTCM (MM) - sole-source OTC equity exchange

[Aurelius]

Drive-now.com was recently introduced to the city I live in – Copenhagen. I do most of my commutes by bicycle:

-groceries 250 meters away

-kindergarten 5 minutes bike ride

-work 5-10 min bike ride

-etc

I do some by public transportation as well and occasionally I'll be calling for a cab.

 

There really is no reason for me to own my own car. Having said that, it would be nice to have the opportunity to jump into a car every now and then without 1) having to rent a car for the whole day, 2) going through the hassle of contacting costumer service, signing papers and picking up the car.

 

Drive-now.com lets me do that. I just signed up and had my first ride. It was pretty cool to drive an electric car. The cars are not meant for long travels as they only have a range of about 80 km. I deliberately picked a car that was low on energy, because you get a bonus 20 minutes of driving if you plug it to a charger after you are done, if the remaining energy is below 30%.

 

The cost is at least twice as cheap as a cab and potentially a lot cheaper depending on distance/time as there is a maximum cost per hour. If you need the car for several hours it still better to rent for a day.

Also worth mentioning: this service will be cheaper than public transportation if you are 2 or more travellers depending on distance!

 

It's pretty exciting to imagine the future for services like this. They started with 400 cars in the city. There's usually several cars close by where I live. But if this thing catches on it'll be a virtues cycle of more costumers → more cars → better product experience → more costumers etc.

 

There will be winners & losers.

 

As a costumer I'm pretty excited!

[ATLValue]

One business model that I think is really compelling is a type of business that provides a critical resource to an industry with extremely low barriers to entry. The prime example of this for me is a website like Linkedin. It is invaluable for recruiters / headhunters, a profession with extremely low barriers to entry. Another example of this is Uber, providing a critical resource to allow anyone with a car to become a taxi driver another low barrier to entry profession (made even lower by Uber).

 

[oddballstocks]

There are a TON of businesses that make an owner, or an owner plus a few partners a LOT of money, but are locally restricted and not scalable.

 

 

Like what.... (not to be that guy ;), but the purpose of the thread was what are some of those business models.)

 

A local custom home builder.  Niche landscaping, or landscape supply.  Monopoly on a supply business (plumbing, electrical etc).  In a rural area barn builders do very well, same with self storage units.

 

Met one guy who runs a "bee hunter" business.  Makes $4-5k in a day, you need to be willing to put on a full body suit, tear into wall and destroy nests.  Lucrative, sure, desirable, nope.

 

Dealerships are a great small business, especially a tractor dealer in a rural area.  You're granted a monopoly, parts are essential for farmers and they're expensive.

 

Have an acquaintance of a friend who's grown a sizable plumbing business from zero by showing up on time and always answering the phone.  A friend's brother has a custom cabinetry business that's the same.  Always returns calls and shows up on time.  He builds and installs cabinets in high end homes in Philly, it's physical, but great money. 

 

None of these can scale well.  The dealers can, but that's about it.

[thepupil]

 

Met one guy who runs a "bee hunter" business.  Makes $4-5k in a day, you need to be willing to put on a full body suit, tear into wall and destroy nests.  Lucrative, sure, desirable, nope.

 

 

my parents recently paid $1500+ to remove a giant beehive from their roof...was it exorbitant? Yes. Were my 60+ yr old parents going to get on a decently sloped roof in 95 degree florida weather in full body gear and remove a bee colony? Nope. 

[Jurgis]

Great posts Schwab711 for investment-size business models and oddballstocks for personal-size businesses.

 

 

[bizaro86]

 

Anyway, the best companies are ones that rate people or things. With gravel pits/garbage dumps, although there is little competition, there is still research into alternative options. It seems possible that new technology/methods could drastically alter the economics of these advantages. When it comes to rating people, it's seems pretty unlikely that we will find a more efficient formula/algo that is drastically different from the methods currently used. It seems more likely that FICO's or MCO's of the world will continue to moderately improve their methods as opposed to a new company drastically changing how we rate credit. That rule of themub  is pretty consistent for all rating businesses.

 

 

This is an interesting paragraph to me, (I disagree, but that's what makes a market). I'm curious what type of technological change you think would cause humans to stop using gravel pits? It seems likely to me that we'll still need roads and concrete structures well into the future, and I would observe that technological change seems to be affecting ideas and information much more than large physical items.

 

As an example, in the last 20 years small scale electricity (electronics) has changed dramatically, whereas large scale electricity (transmission lines) not so much. It seems to me that Berkshire Hathaway's utility businesses have much less to fear from technological change than a consumer device company. (Although distributed generation and electric cars are both potential disruptors). I don't see a potential disruptor to gravel pits or garbage dumps, although improved recycling could dent the second slightly.

[Guest Schwab711]

To be honest, I have no clue bizaro. If you watch Shart Tank, some guy claimed he has a substitute for peat moss (used in the plants at greenhouses) that is 20% cheaper and easier to supply. I'm not sure whats going on in the gravel/filler business, but I'm sure someone is looking for a substitute (or thinks they currently have one). I think gravel pits also require water, which is going to increase the overall costs throughout the west cost. As costs increase, other substitutes become viable economically. Gravel pit operators may be required to clean up their sites for years or decades later if folks become concerned with the environmental effects. There just seems to be hidden costs with any physical object as opposed to non-tangible ratings (which need to be replaced often, but don't add additional COGs). I didn't mean to imply that gravel pits do not have a moat. It sounds like they may, at times. They seem like good businesses, but the demand for their product is very elastic (price sensitive). I also live within an hour of a half-dozen closed gravel pits, so I don't really see the economics that I read about. I probably have a negative bias and it could very well be incorrect from a general perspective.

 

Rating businesses (generally just the high-quality rater) tend to have very inelastic demand and gravel pits was the last moat that was mentioned so I compared them (Google ads are much more inelastic than Bing ads).

[jawn619]

Small - Food Trucks. No taxes, Little overhead, Free Cash flow generative

 

Large - Bloomberg

[netnet]

Small - Food Trucks. No taxes, Little overhead, Free Cash flow generative

 

Food trucks, I think not.  Take a marginal business, restaurants, and make it mobile? You can't even really sell it if you are successful.  To paraphrase Munger, avoiding taxes does not in general make a business good.  Now if you could franchise them well... I was just talking to a food truck owner this weekend, boy oh boy he was not a happy man.

[bizaro86]

To be honest, I have no clue bizaro. If you watch Shart Tank, some guy claimed he has a substitute for peat moss (used in the plants at greenhouses) that is 20% cheaper and easier to supply. I'm not sure whats going on in the gravel/filler business, but I'm sure someone is looking for a substitute (or thinks they currently have one). I think gravel pits also require water, which is going to increase the overall costs throughout the west cost. As costs increase, other substitutes become viable economically. Gravel pit operators may be required to clean up their sites for years or decades later if folks become concerned with the environmental effects. There just seems to be hidden costs with any physical object as opposed to non-tangible ratings (which need to be replaced often, but don't add additional COGs). I didn't mean to imply that gravel pits do not have a moat. It sounds like they may, at times. They seem like good businesses, but the demand for their product is very elastic (price sensitive). I also live within an hour of a half-dozen closed gravel pits, so I don't really see the economics that I read about. I probably have a negative bias and it could very well be incorrect from a general perspective.

 

Rating businesses (generally just the high-quality rater) tend to have very inelastic demand and gravel pits was the last moat that was mentioned so I compared them (Google ads are much more inelastic than Bing ads).

 

Fair enough. Although I don't own any gravel pit stocks (most seem to be privately owned) I do buy gravel in my day job, which I pay relatively high prices for due to remoteness of the operation. If there was a legitimate substitute, I'd be interested. Although the prices are high for gravel, they're low for almost any other material, which means that most substitutes wouldn't be economic.

 

I'm trying to grow as investor into the "good businesses at fair prices" which has not been a historical strength of mine. When I think about ratings businesses, I try to go through Porter's five forces. It seems to me that the customers could have a lot of market power if they wanted it. If a few big banks/card issuers decided to get together and build a FICO competitor, what would stop them from doing so? Just the fact that FICO isn't actually that expensive for them to use? Anyway, just trying to learn as past results suggest these businesses are profitable to own...

[Broeb22]

They are distributed by non-profits, but I was always jealous of the SAT/ACT/GRE tests for the above reasons. Does anyone know of any public companies who earn a non-trivial amount of profit from certifications or tests?

 

 

Post-Cable One spin, Graham Holdings earnings are in part driven by the education segment which includes these kinds of tests.

[ATLValue]

mcgraw hill?

[Guest Schwab711]

To be honest, I have no clue bizaro. If you watch Shart Tank, some guy claimed he has a substitute for peat moss (used in the plants at greenhouses) that is 20% cheaper and easier to supply. I'm not sure whats going on in the gravel/filler business, but I'm sure someone is looking for a substitute (or thinks they currently have one). I think gravel pits also require water, which is going to increase the overall costs throughout the west cost. As costs increase, other substitutes become viable economically. Gravel pit operators may be required to clean up their sites for years or decades later if folks become concerned with the environmental effects. There just seems to be hidden costs with any physical object as opposed to non-tangible ratings (which need to be replaced often, but don't add additional COGs). I didn't mean to imply that gravel pits do not have a moat. It sounds like they may, at times. They seem like good businesses, but the demand for their product is very elastic (price sensitive). I also live within an hour of a half-dozen closed gravel pits, so I don't really see the economics that I read about. I probably have a negative bias and it could very well be incorrect from a general perspective.

 

Rating businesses (generally just the high-quality rater) tend to have very inelastic demand and gravel pits was the last moat that was mentioned so I compared them (Google ads are much more inelastic than Bing ads).

 

Fair enough. Although I don't own any gravel pit stocks (most seem to be privately owned) I do buy gravel in my day job, which I pay relatively high prices for due to remoteness of the operation. If there was a legitimate substitute, I'd be interested. Although the prices are high for gravel, they're low for almost any other material, which means that most substitutes wouldn't be economic.

 

I'm trying to grow as investor into the "good businesses at fair prices" which has not been a historical strength of mine. When I think about ratings businesses, I try to go through Porter's five forces. It seems to me that the customers could have a lot of market power if they wanted it. If a few big banks/card issuers decided to get together and build a FICO competitor, what would stop them from doing so? Just the fact that FICO isn't actually that expensive for them to use? Anyway, just trying to learn as past results suggest these businesses are profitable to own...

 

After considering it more, I guess it would be more difficult to find a substitute for a high-density material like gravel than any low density "filler". In that sense, my peat moss example is probably not relevant.

 

In the case of FICO, I can actually respond to this with some confidence and you are dead on. Just considering the % of loan origination fees, FICO is nearly negligible. The cost of creating a model that accounts for various lifestyles, incomes, and spending habits of 200m+ (just in the US) is massive, while FICO credit scores only generates $200m in revenue and $100-110m in EBIT, excluding parent company expenses. So even if you could create a model for $1b (CreditKarma has raised $200m at a $1b valuation and has yet to create a usable product) + recurring R&D costs, you will still only generate 8-10% returns minus the effects of competition. It's just not economical. Also, FICO is really really accurate and no one has been able to come close at large scale. This type of analysis seems to be the most predictable method of determining the quality of businesses; though I don't have many data points and I have only started tracking companies in this way a little over a year. I have assumed Buffett uses a similar analysis, considering his comments on KO.

 

VantageScore started competing 10 years ago and can't overcome the trust issues or the immense R&D costs. They have a 1% market share, at most (which I'm sure is rounded up; they have none of the top 100 US banks). They aren't public, but from everything I've read they're failing miserably. CreditKarma is doing worse. FICO seems to purposely keeps their prices low enough to discourage competition, though they have never confirmed it when I've asked. As you intuitively guessed, banks are really the only corporations in the position to create a competing rating system since they already have many of the necessary expenses. However, the reason FICO gained traction in the 80's and 90's was due to the conflict-of-interest that comes from having the credit underwriter also be the grader. Banks historically cannot be trusted to provide unbiased ratings of their customers. It's too hard to re-sell your loans without FICO ratings. It's the same reason banks can't use internal corporate ratings and have to purchase Moody's and/or S&P.

 

Unrelated, but no one on Dataroma owns FICO and that blows my mind.

[jawn619]

Small - Food Trucks. No taxes, Little overhead, Free Cash flow generative

 

Food trucks, I think not.  Take a marginal business, restaurants, and make it mobile? You can't even really sell it if you are successful.  To paraphrase Munger, avoiding taxes does not in general make a business good.  Now if you could franchise them well... I was just talking to a food truck owner this weekend, boy oh boy he was not a happy man.

 

I think restaurants are only a marginal business because of the overhead/rent/operating costs of waiters. A food truck greatly reduces those expenses. I live in a city where food trucks/hot dog stands/food carts have an consistent stream of people.