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Theory
2 keys to succeeding as a capitalist enterprise:
o Increasing returns to scale
o A “grip” on multiple sections of the value chain
Examples:
o McDonald’s: real estate and franchise
o General Motors: brands and assembling cars
o Publishing house: editing manuscripts and distributing print copies
Industry value chain is a world of platforms, not pipelines. Many moving parts.
It’s raw resources (top) and job to be done (bottom). The value chain is the transformation of raw resources to meet the customers’ needs.
Goods are top-down (extract resources —> transform —> sell —> ship, etc)
Services are bottom-up (originates with a customer)
Industry value chain is in the perpetual state of imbalance.
o Many moving parts struggling to get a higher proportion of the total value in the chain.
o Some links feature increasing returns to scale, and some – diminished.
Examples:
o Selling cars – diminished (very hard to scale up a dealership)
o Manufacturing cars – increased (better productivity)
Conclusion: large companies have increasing returns to scale, smaller companies – not.
o Can’t defend their share of the value-add and live with diminishing margins.
Grip
As far as I understand it, it’s domination of 2+ links in the value chain.
The reason for the need is that another leader may emerge in the lower/upper link in the chain and squeeze the margins.
o Can’t capture the entire value added
o Need to have the highest increasing returns, otherwise you’ll be outcompeted.
Need to have 2+ legs to stand on (see above)
o Example: Netflix. Distribution of others’ content doesn’t offer the highest returns; producing own content at least lets control the margin of it.
Defensibility
o You don’t OWN your users the way you own a factory. Users’ interests shift.
o Assets are more sustainable than users. Assets may also mean IP.
Controlling ONE strategic point in the value chain is cool, but controlling TWO is better.
Risks
No chance for self-inflicting wounds (Uber 2016, departure of Travis Kalanick)
Context shift (Facebook and Trump’s posts – alienation of a bunch of users)
4 Paths to get to solid grip
Vertical integration. Fingers in all pies. Ex: Ford Motors. Top-down.
Vertical integration out of gradual growth for the purpose of securing resources. Ex: Standard Oil. Bottom-up.
Strong brand + Cheap cost of capital. Ex: Berkshire Hathaway.
Exclusive use of resources. McDonald’s. Logic: buying land and using it as collateral for loans for growth; also forcing franchisees to build on this land —> getting higher margins.
Conclusion: the grip on 2+ links is more important than the highest margins in 1 link. Examples:
Netflix (see above)
Aviasales and Travelpayouts (huge exposure and independent distribution).