Economies of Scale, Vertical Integration, and the Brand I Love Most | Ep 989

0:00Economies of scale. And so there's two different ways that you can attack this. One is cost advantages. And so basically you achieve a lower cost basis per unit sold through larger scale production. And so that allows you to undercut prices and deter smaller competitors. It means other people who are smaller can't buy in the volume that you can. And so as a result, can't price as low as you can. And so this is a price-based strategy, as in you can still make a profit at a lower price than all of your competition. And so this is a low-cost leader strategy, which typically is paired with economies of scale.

0:39Where you don't want to get into, and I want to make this a clear cautionary tale, is that if you're getting into one of these markets, there's no advantage, this is Dan Kennedy quote, there's no advantage to being the second cheapest player in a marketplace. The cool thing with this strategy is that it gets better with time. And so that's what you'll notice is a common theme with each of these points is that as you have a greater network or as you have a more robust ecosystem of products or you have larger economies of scale, most businesses, like I said, degrade with scale. They get worse and harder with scale.

1:12Whereas if you have one of these strategic advantages woven into the fabric of your business, as you get bigger and the business becomes more complex, you have another force that's driving your competitors away. So you have something that's very strong and working in your favor as you scale, which is one of the key traits of becoming a very large business is having one of these thoughts into your DNA woven day one. So for example, my software company, Allen, we started scheduling appointments, 100 appointments a day, 1 ,000 appointments a day. We got up to 4 ,000 or 5 ,000 appointments a day, and we still continue to do that in that company.

1:45And so as we acquire more data and we send more messages, we get economies of scale on literally messaging itself. And so if somebody else wants to come in and we're sending millions of messages a day, they're going to have to pay more per message than we do. And so with that, we know that we actually have increasing margins as we have more messages that go out in addition to the data that we have that no one else has. And so that is a compounding advantage that makes it harder to compete if someone starts two years later than us. And again, any one of these competitive moats will be enough to build you a massive multi-billion dollar company.

2:22And so you don't need more than one of these. You just need to do one right all the way. The fifth way to destroy competition is vertical integration. Now, this is one of the sweethearts of private equity because it's something that usually capital can come in to do. And this is something that we've done in multiple portfolio companies, which we'll talk about in a second. So there's two kind of common ones that people have. One is control over supply and the other is distribution networks. So control over supply means that you own everything that is required from kind of click to close. And so in the De Beers example I gave earlier, they own the mines all the way to owning the front store, right?

2:55Or Tesla, right? When Elon is building the cars, he wants to get as close to the supply chain of like, where do I get steel from all the way to the actual retailers, which are just Tesla retailers that sell online to the customer. So he vertically integrated the entire chain end to end, and he was able to capture margin at every step. And by doing that, you can have a more profitable business and or sell products that are better than other people at lower prices because you can eat into your own margin and then put everyone else out of business. And so there are multiple advantages to controlling your supply.

3:29One is that you can control quality all the way through and everyone is aligned with the end user and the ultimate business at large. The other piece is that you control disruption, because if you have vendors that you rely on for key components of your products, if those vendors go out of business, then it threatens your business. And so by controlling all of these things, like control is kind of the opposite of risk in a lot of businesses, if you control those elements, then they are things that you can manipulate and adjust more proactively than being reliant on third parties. So you not only capture the profit and have higher quality, you also decrease the risk of the business.

4:04So let me give you a 1.0 example of how this would work. So by being a self-publisher, which I am, instead of hiring a publisher to publish my books, I take over a second portion of the business. And so rather than relying on publishers to print and distribute the stuff that I have, I print and distribute the books that I sell because I have the relationship with the customer, you guys, and I'm the one who wrote the book. I didn't ghostwrite it out. And I now can make sure that the size of the book, which is a little bit unique, which I did on purpose because I want it to be like a kid's book and very approachable.

4:38Those are all things that somebody else might not be willing to do. Now, if I wanted to keep eating up the supply chain, I would then go to buying the warehouses that do it rather than just simply using the warehouses that do the distribution. And if I want to take another one, I would buy the printing presses. And if I were to take another chunk up the ladder, it would be, I would buy paper mills, right? And so you can keep vertically integrating until it's I own forests that I take to my paper mills to make paper. And then they go to my warehouses where I distribute the books that go to my retail, which is me fundamentally as the storefront that actually get the customers to purchase.

5:13And so that would be a completely vertically integrated product line. And if you think about that, if you think about your products in that way, then you think, wow, think about all the margins that's included in a book, right? So it goes from literally water and sunlight, which is what it takes to grow trees and time all the way to a quote influencer who has lots of impressions and free media that can drive sales. So you're, you're basically selling free media with sunshine and water. And that's where you have, And everything in between is where all the middlemen take a slice. And if you can eat all of that up, you have all the control.

5:49The sixth way to destroy your competition, and my personal favorite, is a strong brand identity and customer loyalty. And the reason I like this one so much is that some of the other ones I mentioned, sometimes they require a huge amount of time or a lot of complexity like government regulations. And some of them just require a ton of capital, right? Which if you're starting a business or you have a small business, it might be harder to develop over time. But this one is one that you can make with skill, which is why I love it so much. which with brand power, you can build powerful associations and then your brand becomes synonymous with the product itself.

6:19So for example, Google is synonymous with search engines, Kleenex for tissues, band-aids for, I don't even know what the actual name for band-aids is because it's so synonymous, like tissue-based, who even knows, right? And so the advantage when you have a strong brand like Nike is that you can simply take your logo, put it on a commoditized product and get higher conversion rates, lower cost to car customers at premium prices. And so you get massive improvements to the business because fundamentally, if you can price above your competition and increase the demand for what you have, what a competitive advantage.

6:53And the thing is, is that you can simply build it with time and skill, which is why I love it. And anyone can build a brand if they know how to keep their promises and make associations clearly and deliberately over a long period of time with what their customers value and then strongly disassociate with the things and the people that their customers don't value until over time, people just have associate that value intrinsically with the brand itself. And so me personally, I've tried very hard to teach lots of business stuff to business owners because I believe that private enterprise is the only way that we can save the world.

7:31And so I want as many entrepreneurs getting as big a businesses as they possibly can to help the most customers and do it the right way so they can build businesses that last so that capitalism has a fucking chance. If you're a business owner and want to figure out which of these strategies is right for your business, come out to a workshop. We just started running these at our headquarters here in Vegas at acquisition.com. And so if that's you, you can go to acquisition.com, click scale, and if you qualify, maybe we'll see you here.

8:03Thank you.