Rent or Buy?

"It’s this commoditization of supply and associated end of fixed costs that’s now starting to give rise to a long tail of providers. Thanks to lower and variable input costs, it’s possible to make money at lower volumes than in the past, which in turn means a higher number of providers can co-exist."

To buy or rent? This is a fundamental question for all businesses that touches nearly every area of the enterprise. Buying vs. renting is also a very strategic question that requires balancing capital needs for the business, capital availability, and strategic importance of the system in question. This week, we wanted to highlight and contrast two pieces that offer direction: an excellent piece by Ben Robinson that explains the transition to a post-fixed costs (rental) economy, as well as an article by Chris Mayer explaining how (buying) fixed investments can be a source of competitive advantage. 

40 years ago, nearly every business was required to invest heavily into its physical operations to generate sufficient scale that would lower costs per unit over these fixed investments. But as the internet and software digitized pieces of every business, the economy shifted from heavy capital expenditures (buying) to heavy operating expenses (renting): 

"In the industrial age, scaling supply meant mass production to spread the fixed cost of large capital investments over large volumes. And the industrial age was an age of mass produced, relatively standardized goods. This applied to goods and services provided by the private sector, but also to state-provided services, such as education and public services. Since the advent of the internet, this is changing. We first noticed the shift in industries where both supply and distribution could be digitized (e.g. media) because supply became abundant faster and this highlighted our limited attention sooner. But it’s becoming increasingly apparent that all industries are being disrupted as software has eaten the world. More and more physical goods have software components to them, making supply more digitized."

In most cases, we would argue that businesses that continue to operate in a pen and paper world will not be as efficient or flexible with its capital base as organizations who run their business in the cloud, on rented servers, with rented warehouse space. As the cost of starting businesses has plummeted along with the cost of supply (which became heavily digitized), the constraint of businesses ceased to be supply. Instead, the constraint became demand (our attention). This in turn led to the rise of the aggregator. And as the supply side (businesses) quickly became commoditized in many industries, the owners of demand (the aggregators) began to capture more of the value:

"The constraint on all digital-era businesses is demand and the gatekeepers of demand — the most profitable actors in the digital ecosystem — are aggregators... As Clayton Christensen predicted in the Law of Conservation of Attractive Profits, as one part of the value chain commoditizes, the value is captured elsewhere. As platforms helped generate an economic surplus, aggregators increasingly captured that value — especially Google and Facebook. While it has become cheaper to start a business, a sharp increase in customer acquisition costs more than offset these savings."

This leads us to the ironic conclusion that it's never been cheaper to start a business than today but never been harder to defend and scale it, because the internet has lowered barriers to entry and eroded competitive advantages for nearly all industries. 

So what does this mean for small business owners learning to best position their enterprise in a digitally native world?

Robinson answers with two solutions: 

"In a digital world, where returns to scale are bigger, incumbents will be harder to displace. Therefore, it follows that any startup should focus either on creating a new market or, more likely, on market blind spots: the niches where consumers are underserved or overserved."

Fish where the fish are. Competition leads to a zero-sum outcome in most business contexts, so find a pond where there are ample fish and very few fishermen. 

While Robinson makes astute points on why businesses should transition to a more heavy rental model for server space, compute time, digital ad space and more, sometimes the most strategic assets need to be owned outright. The beauty of the modern day economy is that every part of an organization can be 'rented' or outsourced, but that doesn't mean an owner necessarily should pursue this route.

Chris Mayer explains how Copart built its massive competitive advantage in the virtual car auction market by buying its industrial land instead of leasing it:

"I asked one industry veteran, “How hard is it to compete with Copart?” And his answer: “You’d be crazy to want to compete with Copart. For one thing, they own so much land…” Land. Copart, too, invested a lot of money in land over the years. Hundreds of millions of dollars in land. But here’s the thing: IAA did not. It chose to lease land. Over time, the consequences of that decision loom large. And it is no easy fix for IAA. A fellow investor told me that he discovered the land Copart bought around Los Angeles years ago is worth ten times what they paid for it. That’s a pretty good moat. You want to come into our market? Go ahead, pay 10x what we paid - or good luck leasing it... I mean, if you don’t have the land, you have no place to put the cars."

Copart decided to buy instead of lease its land to hold inventory due to the strategic nature and scarcity of well-placed locations around booming metropolitan areas. Over time, this one decision to own instead of lease their land led Copart to take a huge piece of the market simply because their competitors were economically locked out of competing in the same MSAs. While we would generally recommend the 'rent' over 'buy' decision in most cases, sometimes the strategic nature of the resource in question can lead to an opposite conclusion.

This week, we'd like to hear from our subscribers: when allocating capital to a resource (real estate purchase, inventory storage, warehousing, compute power, full time employee vs. 3rd party, etc.), what do you take into consideration when choosing whether to rent or buy?

The role of governance in family enterprises: navigating purpose, power and performance (Deloitte)

+ "Once you have a clear purpose, it’s easier to share power. Roles and decision rights crystalize around what’s important to each individual family member, and they gain ownership over certain aspects of running the business. Once these responsibilities are carved out, the family can devise policies and create forums to strengthen communication, aid collaboration and learning, and address differences and any disputes that might arise. By sharing power through purpose, succession planning becomes a far more inclusive and collaborative process, instead of a highrisk event that can harm both family and business."

Strategy in the post-fixed costs economy (Ben Robinson)

+ "In its simplest expression, digitization flips the industrial age equation. What was scarce in the industrial age was supply; what is scarce in the digital age is demand (attention)."

The economics of vending machines (The Hustle)

+ "The daily minutiae of owning a vending machine seemed a bit dull: buying bulk candy at Sam’s Club, stocking machines, collecting weathered bills and buckets of coins. But Pippens saw an opportunity to be her own boss. She partnered up with her boyfriend and another business partner, bought a vending machine on Facebook Marketplace for $1.6k, and plunked it down at a local auto parts store, where it now grosses $400 per month."

The company that has a monopoly on ice cream truck music (The Hustle)

+ "In 1973, an electrical engineer named Bob Nichols was watching the film The Sting when a song on the soundtrack — Scott Joplin’s 1902 ragtime hit, “The Entertainer” — caught his ear. The right clip of that song, Bob realized, would make for an irresistible ice cream truck jingle. He could imagine trucks gliding through the American suburbs, the tinkling notes summoning children to buy snow cones, sundaes, and bomb pops.  And he was uniquely poised to make it happen: as the founder of Nichols Electronics, a tiny Minnesota-based company, Bob supplied the music boxes — preloaded with dozens of jingles — for the vast majority of the country’s ice cream trucks."

How Airbnb pulled back from the brink (Wall Street Journal)

+ "The industry at large, he said, was betting on business travel recovering faster than leisure, because that’s what happened the last time travel shut down in the wake of 9/11. Airbnb’s hotel-centric rivals, Booking Holdings Inc. and Expedia Group, would stand to gain if so. Mr. Chesky was betting on the opposite, for a simple reason: “9/11 was before Zoom,” he said. Unlike hotels, Airbnb didn’t own any properties. Its overhead costs were low, and it didn’t need a minimum occupancy to keep doors open. He chose the debt. Bankers cranked out a term-sheet in 72 hours. Silver Lake and Sixth Street lent the company $1 billion. An additional $1 billion loan followed from another consortium of investors."

What 800 executives envision for the postpandemic workforce (McKinsey)

+ "Across all sectors, 15 percent of executives surveyed amid the pandemic said at least one-tenth of their employees could work remotely two or more days a week going forward, almost double the 8 percent of respondents who expressed that intention before COVID-19. This varies by country, with 20 percent of executives surveyed in the United Kingdom and Germany saying that at least one-tenth of their employees could work remotely two or more days a week going forward, which drops to only 4 percent among respondents in China. Extending remote work beyond two days a week, however, was less popular among respondents overall, with just 7 percent saying at least one-tenth of their employees could work three or more days a week remotely."

America is experiencing a startup boom (The Hustle)

+ "Based on the most recent data, people have been getting their startup on. Through the 40th week of 2020 (ending Oct. 3), business applications were up a record 40% YoY. This builds on the 883k+ biz applications submitted in Q2 and is an all-time high, including for “high propensity” businesses, which are linked to firm creation and staff employment, The Economist reports."

What psychedelic mushrooms are teaching us about human consciousness (Discover Magazine)

+ "Growing evidence suggests the claustrum orchestrates consciousness — gathering, sending and integrating information from almost every brain region. Some, like neuroscientist Christof Koch, believe that the sense of self and ego rest here. Several years ago, Koch and colleagues of the Allen Brain Institute for Brain Science found anatomical evidence in mice to support this idea. They identified several large neurons projecting from the claustrum, with one wrapping around the circumference of the brain. Around the same time, they published a paper in the Journal of Comparative Neurology describing the vast connections between the claustrum and various brain regions in mice."

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