How Billionaires Become Billionaires

A New Business DNA Evolving

A few hours after making this post about the benefits of industry aggregation, I came across a memorable quote in a Harvard Publishing blog.  The piece discusses the changes in strategy that will be required of businesses which are committed to prospering in the new century. The post, dated October 21st, is titled Why Traditional Recession Tactics Are Doomed To Fail This Time and is written by Umair Haque. The entire piece is worth reading, so I will just quote the sections I found relevant.

Tomorrow's sources of advantage aren't like yesterday's. ... Ultimately, they are about a true advantage -- one that accrues not just to the corporation, at the expense of people, society, or the environment; but one that accrues to all.

and

Discovering new sources of advantage depends on new DNA -- on building new kinds of institutions with entirely new capacities. Because, at root -- and as we'll discuss at length shortly -- the macro crisis isn't really a financial crisis, an economic crisis, a liquidity crisis, or a solvency crisis. It's an institutional crisis: the economic institutions of capitalism are in shock.

And though it's a scary, frustrating time -- the cool part is this: it's up to us to reimagine, reconceive, and reinvent them. We get to rethink the institutions of capitalism for a new century.

What could be cooler than that?  (Source)

I personally can't think of anything and will be writing more on the topic of industry aggregation.

Industry Aggregation: Depression Proofing Your Business

May you live in interesting times. - Ancient Chinese curse

Changing conditions call for changing ways of doing business. The world has now entered a period of economic turbulence caused in part by global hyper-competition, skyrocketing energy costs, financial uncertainty, and waves of new technologies. This will most likely be a prolonged period during which the status quo will be upset by rapid changes in how business is conducted within your industry. The old business models and rules are being swept aside by new ones.

 The Industry Aggregation model can best be explained by comparing it with the Japanese "keiretsu" model which was highly instrumental in that country's post WW2 "Economic Miracle". In the keiretsu model a number of publicly-owned industrials band together for mutual benefit along with a bank. The collaboration includes cross-ownership of stock, access to bank loans,  joint ventures, and preferential treatment with the group.

The Industry Aggregation model is fine-tuned for small to medium sized privately held companies with revenues in the one to fifty million dollar range to deliver the same set of benefits. Replacing the bank is a public company which serves as both the group's anchor and banker. The benefits of Industry Aggregation are:

• Member companies swap privately held stock for trading shares which sell at significantly higher multiples. This creates the liquidity for shareholders which is absent in private companies.
• Various forms of cross-marketing and joint ventures by group members help everyone to increase revenues.
• Operating costs are decreased through both group purchasing power and preferential intra-group pricing.
• Access to scare resources such as capital, human resources, and IT is improved substantially.

As is probably obvious, the goal of Industry Aggregation is to empower entrepreneurs and help them grow their companies further.

Industry Aggregation is not suitable for startups. However, some exceptional early-stage companies with bona fide revenues maybe considered.

 

Industry Aggregation: the Business Model for the 21st Century

 Industry Aggregations A - Z

There are basically two ways to expand your business interests. First, there is the obvious way wherein you focus on building one company year after year and possibly decade after decade. This method frequently leads to early burn-out on the part of the entrepreneur. After all, how many times can anyone return to the same office to repeat the same basic day? Many of us have a low threshold for this type of routine.

The second way to expand your business interests is through deal-making. Specifically, this involves the purchasing, fattening up, and reselling of businesses and other appreciating assets. If you believe that variety is the spice of life, you should take a good look at this option. If you study the strategies of billionaires, you will see a common theme in how they succeeded: deal-making. Most built their empires through a series of deals involving the acquisition and flipping of various companies. Some they held onto for a long time while others were flipped in as short a time as a year.

A seeming benefit of this second approach is that it keeps them young. Most billionaires are active well into their 70s, 80s, and even 90s (e.g., Kirk Kerkorian).

So let's summarize various deal-making business models and introduce a new one as well.

Conglomeration

Conglomeration hasn’t been seen in any significant scale since the late 1960s conglomeration frenzy. Conglomeration is considered a failed strategy today because it involves aggregating companies from totally unrelated industries, thereby not affording any opportunities for economies of scale and other benefits which accrue to aggregated companies from the same industry. Perhaps the most high profile exception today is Warren Buffett’s holding company Berkshire Hathaway.

In my memory lingers a picture of an editorial cartoon from long ago that I saw as a child. It appeared in Newsweek or Businessweek and showed a cluster of old style smokestack factories. Each one had a sign on its roof displaying the name of the company. They read from left to right: Little Baby-Boo Baby Food Products, Little Baby-Boo Aerospace, Little Baby-Boo Fashions, Little Baby-Boo Pharmaceuticals. The names underscore why the conglomerate strategy proved unworkable. It was simply too diverse in its components to be manageable.

James Ling the Merger King of LTV fame was one of the most famous conglomerators of the 1960s, if you’re interested in reading up on this era.

Consolidation

In the post bubble phase of an industry cycle one will frequently observe consolidation activity. In a consolidation, the consolidator typically acquires under-priced assets with its own particular industry. The goal is to achieve various economies of scale. In contrast to the conglomerate, the consolidation is tightly focused around a theme.

Rollup

A rollup is performed by a platform company which intends to go public once it has achieved the critical mass necessary for an IPO. The bolt-on companies it acquires tend to be small businesses whose owners are interested in either cashing out or retiring. Oftentimes, the rollup is the only means possible for these owners to achieve a liquidity event because their businesses are usually small unattractive assets operating in mature industries. In the 1990s, rollup activity was high in the stationery and florist industries with rollup king Jonathan Ledecky’s platform companies swallowing up hundreds of mom & pop shops from both industries.

Keiretsu

This keiretsu is a Japanese variation of long-term, basically permanent, cross-industry aggregation for purposes of maximizing synergy and economies of scale.

From wiki:

The prototypical keiretsu are those which appeared in Japan during the "economic miracle" following World War II. Before Japan's surrender, Japanese industry was controlled by large conglomerates called zaibatsu. The Allies dismantled the zaibatsu in the late 1940s, but the companies formed from the dismantling of the zaibatsu re-interlinked through share purchases to form horizontally-integrated alliances across many industries. Where possible, keiretsu companies would also supply one another, making the alliances vertically integrated to some extent.

The major keiretsu were each centered around one bank, which lent money to the keiretsu's member companies and held equity positions in the companies. Each central bank had great control over the companies in the keiretsu and acted as a monitoring entity and as an emergency bail-out entity. One effect of this structure was to minimize the presence of hostile takeovers in Japan, because no entities could challenge the power of the banks.

Venture capital firm Kleiner Perkins began describing its portfolio companies as a “keiretsu” back in the 1990s. Other top tier companies which claim to employ the keiretsu model include Cisco Systems, Richard Branson's The Virgin Group, and Deutsche Bank.

Industry Aggregation

While aggregation strategies such as conglomerations, consolidations, and rollups, come in and out of fashion, the keiretsu model remains a stable long-term aggregation model. One can think of the industry aggregation model as a variation of the keiretsu fine-tuned for smaller companies with sales typically in the $2 million to $50 million range. Folding a number of successful companies of this size into a publicly traded vehicle then enables owners to “warehouse” their equity in a liquid form made possible by free trading shares. This concept begins to make all the more economic sense if we redefine what we mean by an “industry”. Traditionally, the term industry has been defined as the “aggregate of manufacturing or technically productive enterprises in a particular field, often named after its principal product: the automobile industry; the steel industry.” (From www.dictionary.com)

The industry aggregation approach is to define industry by the demographic market the group serves. This allows the aggregation to include diverse companies from a variety of “industries” using the traditional definition. For example, a “hot” demographic market niche today is the rich and newly rich. (Read the book Richistan: A Journey Through the American Wealth Boom and the Lives of the New Rich by Robert Frank to get a sense of this market.) An industry aggregation can be created consisting of companies which provide everything to this market from luxury automobiles, private jets, and vacation homes, to high net worth financial planning services.

What makes the industry aggregation model work is retention of each member company’s management. Under the conglomeration model, the acquirer fires the managers of its portfolio companies and attempts to run all operations from head office. Under the rollup model, the owners of the bolt-on companies are expected to cash out and disappear. The industry aggregation, in contrast, prefers companies whose management is committed to staying on. The model also offers each member company a wide degree of autonomy to carry on its successful policies.

The main benefits of participation to businesses are threefold:

1. Increased revenues through various cross-marketing opportunities

2. Decreased operating costs via group purchasing power and preferred pricing for members. (In some cities there will be jointly owned business centers offering space and resources to members.)

3. Shared liquidity via a stock swap with a publicly-listed company.

Industry aggregation is the model for the 21st century. Expect to hear a great deal about it in the coming years.