The Competitive Advantage of an Owner-Operator

By John Huber

I gave a talk at an investing conference in Philadelphia last week where I discussed my overall approach to investment along with three broad categories where I think investors could focus to gain an edge (I’ll share the slides in a later post). I don’t attend many of these industry events, but it is fun to attend them occasionally, as I got to meet with a few Saber Capital clients who live in the NYC/NJ/Philly area as well as other friends I have in the business. One friend was telling me about a research project he is working on where he is testing out a few key fundamental variables that have had a meaningful impact on stock prices over a period of time. This got me thinking later that evening about one variable (unrelated to his research) that I think has an enormously valuable impact over time.

Learning From Successful Businesses

These are just some rough scratch notes on the subject. Before I get the inevitable questions on bias—no, I haven’t tested this, and no, I haven’t tried to eliminate survivorship or hindsight bias in any way. I’ve always felt that studying successful businesses is a valuable exercise. I understand the flaws of survivorship bias (basically this is drawing conclusions from successful companies that have “made it” and then ascribing reasons for those successes). This idea was probably the biggest criticism of the excellent books Good to Great and also The Outsiders. But I thought both were outstanding books because I think it is always helpful to study successful businesses.

In other words, the risk of succumbing to survivorship bias is a risk worth taking. I’d rather risk that bias in exchange for the reward of potentially learning something useful from these success stories.

I’ve used this example in previous comments on posts: there are reasons other professional sports teams study the New England Patriots or the San Antonio Spurs (who just clobbered the pre-anointed Super Team, the Golden State Warriors in the first game of the regular season last week). The Spurs, like the Patriots, always seem to be near or at the top of the list, but even when there are teams with flashier players, those organizations found ways to win more titles than those teams who had more”buzz” surrounding a star player.

I think it’s worthwhile studying organizations (businesses, teams, schools, or any other entity) that experienced a lot of success. They key is trying to reverse engineer their success while simultaneously being aware of the inherent bias can occur when analyzing these situations. I think it’s possible to do the former without succumbing to the latter. I also think the rewards of doing these case studies greatly exceed the risk of coming to some conclusion that isn’t relevant or happens to be rooted in bias. There are all kinds of tangential benefits to reading about great businesses, and those benefits accrue over time and build on each other like compound interest.

So it’s good to be aware of bias (hindsight, survivorship, etc…), but it’s not worth letting those biases restrict you from trying to learn why something or someone became so successful.

Profiles of Successful Founders

How I Built This is a new podcast from NPR, and it is excellent. One of the first episodes featured an interview with Sara Blakely, and it is an excellent glimpse into why sometimes great businesses come from industries/businesses that many would describe as lacking “competitive advantages” or “moats”. Spanx really had no business succeeding in the product category it tried to enter. And most rational minded, probability-focused business experts would have said it really had very little chance of success—except, of course, for the fact that Spanx was started by Sara Blakely, who is a passionate, driven entrepreneur who was 100% determined to make the company a success. I highly recommend listening to that podcast as well as the other interviews also.

I’ve spent a lot of time thinking about factors that influence the long-term success of a business, and I think firms (public or private) that are run by the founders often have a huge intangible quality to them—one that is crucial to the firm’s ultimate success. This intangible quality is that the founder is often motivated by much more than money. And that is a driving force that can be incredibly powerful, and incredibly valuable for the owners of those firms.

“What’s an exit strategy?”

According to the podcast, Blakely was approached numerous times by investment groups wanting a piece of Spanx. They asked her what her exit strategy was, something she hadn’t even ever thought about. She said it never occurred to her to consider selling her business, and as all of these money guys kept calling, she realized that other people started businesses with the intent to sell them.

Even today, she owns 100% of her company, which is remarkable for a business that has become so massively successful.

Blakely’s vision for her firm, her relentless focus on executing her business model, her passion for the day-to-day process of building her company—none of those things show up in her company’s financial statements. But all of those things have had an incredibly meaningful impact on those financial statements and are a critical component of the company’s value.

Firms like Under Armour, Starbucks, Alibaba, Facebook, Workday, Amazon, Google, Atlassian, and many others have founders who are maniacally focused on pleasing their customers and thinking about strategies that will impact their companies’ values ten or twenty years down the road.

Incentives Matter

Charlie Munger talked a lot about incentives. He once said he feels like he understands incentives better than just about everyone and yet he even underestimates the power of incentives.

We usually associate incentives with money. People are obviously motivated by money, and will adjust their work habits in such a way that will maximize their own earning power. Incentives are often designed to try and encourage certain behaviors that will maximize the long-term value of the company; other times, incentives encourage certain short-term behaviors (which may or may not be at odds with long-term value) such as market share, revenue gains, EBITDA, etc… But one thing you can generally count on is that corporate executives will behave (despite what they say) in such a way that will maximize their own pocket books.

The Intensity of the Founders

But there is one form of incentive that transcends money. Some might look at this as cliché, but I believe there is absolutely something to be said for the passion and drive that certain people possess. Some athletes have this quality, certain musicians have it, some business people have it, and it can be found in all walks of life when evaluating the most successful people—the people that have reached the pinnacle of their chosen endeavor. I’ve studied a lot of these people, and while many of them are certainly motivated by money, I think money is rarely if ever the primary motivating factor. These people all have huge amounts of competitive spirit, and they are generally motivated by the day-to-day process of building something. They are motivated by the process itself more than the end game.

I think that while it’s hard to identify this quality early, it’s worth considering because I think it’s very valuable and it’s often underrated.

All of the companies mentioned above compete in significantly competitive businesses (what business can honestly say it isn’t competitive?). All of these firms in theory shouldn’t have been able to develop the staying power that they did; but the common denominator is that they were all led by passionate, long-term, relentlessly focused and driven people who founded them. They had the hugely important intangible benefit of being led by a manager who had real skin in the game; and more than just money on the line. Sears Roebuck didn’t have a chance at matching the intensity of Sam Walton, despite having just about every other advantage over the small Wal-Mart in the early years. But it was Walton’s drive and intense focus on execution that mattered over everything else in the end.

Many of these businesses engulfed their founders’ lives. Their egos and identities were/are tied to these firms. Money is a byproduct of their success, but it wasn’t the driving factor. In many cases, it wasn’t even close to a driving factor in their motivation. The common denominators that I get from studying these individuals through various biographies and interviews is that they love what they do, they are more interested in the process, and they absolutely live for their businesses.

It is tough to compete against these types of individuals, and it’s hard (if not impossible) for an unaffiliated corporate manager (even if he or she has skin (i.e. stock) in the game) to match the same level of intensity that these founders bring to the table.

Bet on the Founders Who Have Already “Won”

This is a good time to point out the obvious: there are many more firms that fail that were led by founders, many of whom had the same level of passion and intensity. The latter doesn’t guarantee success by any stretch. But once success has been clinched—at least initially—these founders tend to be very difficult people to “dethrone”. I think it’s a valuable competitive advantage in many cases.

Again, this isn’t a scientific or data driven analysis. This is just my own observation from studying some of these firms—and my thoughts and research have accelerated lately on a few of these companies.

Regardless of the risk of hindsight or survivorship bias, I think it’s still worth studying the successful organizations (teams should continue to try and glean clues from how the Patriots and the Spurs run their organizations). It doesn’t guarantee that such study will lead to similar results, but to me, there is no downside to studying the best to try and add a few more strings to the web of cumulative knowledge that we are all trying to continue building as we go about our day to day investment process.