Before we jump in:
My friend Sahil Bloom wrote a new book called The 5 Types of Wealth. It's phenomenal. You should buy a copy here.
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People watch too much Shark Tank and think too much about entrepreneurship through a new-idea lens.
This makes them delusional.
If no one has succeeded before or if your business doesn’t exist yet, it is because nobody has been able to win the game and make money doing what you want to be doing.
And if nobody has won, why would you want to play that game?
It's time for you to think differently.
These are my three vectors for evaluating any opportunity.
Competition, profitability, and my odds of success.
To analyze a business, just ask these three questions:
- How strong is the competition?
- What are the profit margins, industry wide, in a given business?
- What percentage of people who try to start a business in this field end up succeeding?
Then you do the math.
A business that has strong competition + low profit margin + high amount of failure = bad business.
For example, an app startup. If you want to build an app, your competition will be Stanford graduates with millions in venture capital.
The margins are non-existent for the first several years. And 99.9% of apps die before they make a single dollar.
This is a bad business.
You’re looking for a different sort of equation. Unsophisticated and/or weak competition + high profit margin + low failure rate = good business. For example, a self storage facility.
Your competition comes from contractors, farmers, people without websites, and folks without college degrees who don’t answer their phones. The profit margins, industry wide, are about 60%.
I know all this because we operate 68 self storage facilities at about a 40% expense ratio today. 60% of our revenue is net operating income.
And I’ve never seen a bankrupt self storage facility.
This is a good business.
A few more examples of good and bad businesses.
A note - all of this is region-dependent. There are great operators in certain cities and a shortage of companies in others.
- An HVAC company has relatively unsophisticated operators. It has reasonable profit margins around 20-30% at scale. Very few of them end up going under. This is a big pie with a lot of demand and a good business.
- A landscaping / hardscaping business has unsophisticated owners. Many don’t have websites. Many don’t spend money on marketing. Many don’t work hard enough to recruit and hire employees. It is a mom-and-pop dominated industry. Yet there are 15 of them in my small town that make more than $100k in profit. There are hundreds of thousands of them in the United States that make a good living for their owners. This is a large industry and a large pie. Relatively few of them fail. This is a decent business considering you can bootstrap it with very little upfront investment.
- A software startup has well-capitalized, sophisticated operators. Venture capital funding means it can operate without a profit for years. It has negative profit margins until it reaches maturity. And most people who try new software startups fail. This, in my opinion, is a bad business for the average person.
- A dog walking app idea is a target for dreamers. People who love pets and have too much time on their hands. People who code as a hobby. Marketplaces in general are very hard because you are solving for two sides of an equation: customers and providers. You need people to come in and pay for dog walking. And you need people to walk the dogs. Without one or the other, the whole operation fails. Too much of one and not enough of the other, and it fails. In my opinion a marketplace like this is a brutal business and NOT a good opportunity.
Why The Blue Ocean Strategy is Wrong:
Another common misconception is that entrepreneurs should pursue the blue ocean strategy, an idea popularized in one of the bestselling entrepreneurship books of the past 20 years.
Essentially, the blue ocean strategy says that the path to success involves creating a new market where competition does not exist and is therefore irrelevant. According to the authors, you should expand your offering to new areas through innovation and then you can have all of the market share.
They caution against pursuing any opportunity in the red ocean, a concept which represents all of the current industries in the economy where competition exists, and the rules of competition apply. The ocean is red because it is shark-eat-shark to compete for food.
I see things differently.
I’d rather start a business in a red ocean. I can study the market. I can pick and choose the opportunities I want to pursue. I can assess the way things are done and figure out if I can compete or have a competitive advantage of some kind. I can study my competition.
Most people will read this and gasp. Nick, entrepreneurship is supposed to be cutting edge! In the red ocean, companies are in a fierce competition for customers! It’s a race to the bottom!
But that couldn't be more wrong. A lot of companies are horrifically bad at answering the phone and doing what they say they’re going to do. Many don’t have a website. Many use a fax machine in their offices and still make millions of dollars in profit per year.
Don’t believe me? Call around for home service companies to come do work at your house. Ask them to build a deck or remodel your kitchen. One in five will answer the phone. One in 20 will have enough time to put you on their schedule.
There is a massive shortage of these “old school” businesses. The competition is weak. Most do not spend money on marketing. The owners are resistant to change.
Go after an existing market so you can be certain that opportunity exists and there is money to be made.
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I'm an investor in an insurance brokerage called Titan Risk. They're focused on helping SMBs get insurance policies including general liability, errors and omissions, cyber insurance, directors and officers liability and more.
The insurance guru at Titan, Jon, has helped over 1,500 clients get policies throughout his career.
He's offering 5 free consulting calls to review your current insurance and risk management program.
Just respond to this email if you'd like an introduction.
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A few tweets from this week.
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Onward and upward,
Nick Huber
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