The Skill of Capital - Commoncog

This is Part 2 in a series on the expertise of capital in business. You should probably read the first part here.


This is a companion discussion topic for the original entry at https://commoncog.com/the-skill-of-capital

This week’s article has an example of the Salim group:

Notice how neither you nor Agustiadi’s businesses were defeated by superior product or smart counter-positioning or better, more efficient operations. No: you were defeated by superior access to capital.

I don’t fully understand… this looks like a structural cost advantage (cornered resource) to me? What makes this an example of capital?

This article does remind me of one of the metrics I would look at when analysing companies. Everyone knows to look at ROIC/WACC, but fewer people think about return on incremental invested capital. ROIIC is harder to figure out, but very valuable to get an idea about!

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The resource hasn’t actually been cornered - businesses are still free to buy flour from any manufacturer they want. But because of their structural advantages, Salim is able to sell flour for a price lower than the market price while still making a profit.

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Excellent catch @brian — this is something I’ve been thinking about as well.

Originally I thought that the 7 Powers is about competitive advantage and therefore it rightfully belongs exclusively on the Demand side of the triad. But I realised, as a result of writing this week’s piece, that actually the 7 Powers and the triad model of business expertise overlap in weird ways.

Short answer: yes, Indomie’s advantage was a cornered resource (a structural cost advantage). But I feel uncomfortable putting it under the Demand leg of the triad (it has nothing to do with the market for its customers). So that leaves us with Supply vs Capital. I guess I could put it under Supply — it is an ongoing operational advantage, after all. But here’s my train of thought:

  • South East Asian conglomerates tend to start new businesses by taking an existing business and squeezing some cash to redeploy into the new subsidiary / joint venture.
  • Sometimes cash is hard to come by so they just skip the intermediate state and capitalise using assets.
  • In this case I thought one way of looking at it was that the parent conglomerate basically capitalised Indomie with free flour.
  • In the same way that you could say my hypothetical manufacturer was capitalised with free land that it could later sell / build on

Does this make sense? I guess where my analogy fails is that it continued to ‘capitalise’ Indomie with free flour on an ongoing basis, lol.

One implication of this is that the 7 Powers can be expressions of skill on all three legs of the triad.

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Super interesting - I hadn’t thought of tying the supply/demand/capital to the 7 powers! I guess I see it in a simple way

  1. How good am I at selling things to customers (demand)
  2. How good am I at sourcing and producing things (supply)
  3. How good am I at paying for this stuff (capital)

So I would put it as supply, because I can get resources at a cheaper price than anyone else can. I’m not paying for the goods in a more effective way, I’m just paying a lower price for them. That’s just my personal view though.

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I have an additional example / argument for why I lump this under Capital, but I think I’ll save it for the next members-only post. It requires me to tell a personal business story that I’m not 100% sure I want to be public yet.

I’ll be curious to see if you agree with it.

The short summary is that if you have a guaranteed buyer of your goods, you can start to treat the earnings from that source as a form of funding.

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An added note on Constellation Software. I noticed that:

  1. Leonard raised the initial capital for CSI from OMERS (a pension fund) and some of his venture colleagues in 1995.
  2. CSI IPO’ed in 2006.
  3. That’s about 10 years from company inception. AFAIK, CSI doesn’t really raise capital through equity issuances; it’s not part of its growth model. (Correct me if I’m wrong!)

I wonder if the IPO at the 10 year mark was part of the deal he did with OMERS. As in, he needed to give OMERS liquidity to reap a return on its investment.

I’d be happy to hear any insight for why Constellation IPO’ed when it did. My interest is primarily as an operator, but I know there are several investors in this community, and I’d love to hear your perspective.

Great post as always @cedric!

One point I’m thinking of from the Microsoft story is that there seems to be a cyclic nature in the need for VC in computing specifically. Essentially what I’m thinking is the following cyclic model:

  1. In the 60s-70s, personal computing is all the rage and hardware startups are the thing to do. As a result, companies need up front capital to source materials, develop products, ship to customers, etc. VC funding is critical

  2. In the late 70s-80s, Microsoft demonstrates the amazing economics of software. Massive margins, low COGS, large ROIC. As a result, VC funding is not critical for growth VC funding optional

  3. In the 90s-early 2000s, web applications became all the thing to do. This required companies to buy expensive servers for hosting, which in turn required upfront funding for that capital expenditure. In addition, growth required the purchase of more servers, reducing margins. VC funding critical

  4. In the 2010s, cloud providers became ubiquitious, removing the massive fixed cost for web and mobile startups. Now we return to the days of Microsoft, where software has low fixed costs and is super high margin. VC funding optional

  5. This brings us now to the 2020s with AI, where massive investments are needed in computing infrastructure in order to train custom large language models VC funding critical

So it seems that each new trend in technology has two funding phases:

  1. Fixed Cost Phase: If you want to start a business riding the new trend (whether it be PCs, web apps, or AI), the fixed costs are very, very high. This requires high injections of capital, usually from VCs

  2. Reduced Cost Phase: Now that the new technology has matured a bit, market innovations or new trends building on top of the old trend drive costs down, either through reducing fixed costs or changing the fixed costs to variable costs (or both).

It seems to me that knowing where you are in this cycle is important for understanding how and when to raise capital as a startup. If you’re in the fixed cost phase, you need to aggressively raise money and out-capitalize your comeptitors. More funding means ability to source more materials, produce more goods, etc. If you’re in the reduced cost phase, then you can take advantage of the expanding margins to raise smaller amounts of captial or forego raising capital at all.

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Please suggest books to deep dive into the triad. thank you

HMM. I wouldn’t go so far as to say there are funding phases — but I’ll have to say that your comment certainly made me pause. I … am not sure I’d say that this is entirely predictable.

I’ll be getting to the capital cycle soon, which is somewhat similar to this in the sense that there are periods where returns on invested capital just stink, but it’s driven by a different phenomenon. If you want a preview, my source is really Marathon Asset Management‘s Capital Returns.

I’ll create a new topic to deal with this, so everyone can contribute.

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Thank you. Appreciate it.

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I would like to make a general caution when learning about the skill of capital: someone who gets great results from capital looks almost identical to someone who is taking foolish amounts of tail risk. It is very hard for inexperienced people to tell the difference.

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Thank you.

No notes; Brian is extremely believable on this topic. I will take your warning to heart (I regard myself as inexperienced).

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I found this on Twitter today, from Steven Sinofsky (who was an early Microsoft employee and later on an industry legend in his own right):

https://x.com/stevesi/status/1731806570001129480?s=46&t=YY27CRWpGF-J_iGQovxG1g

Because Steven deletes his tweets after 90 days, for posterity, the full content below:

Microsoft was always cash flow positive + profitable. Bill’s view was to always have 12 months of cash on hand to run the company. He’d seen so many “computer companies” go bankrupt in the early days (1975-80). IPO 3-86.

There was a $1M Series A for a SV connection, not money.

And the really valuable thing is the following table, which gives us real detail on Microsoft’s early economics(!!)

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