What Makes a Good Investment?

Author：Vins Kuo     Time：2022.10

A good investment rests on three prerequisites

1

2

3

Assessing a Business

Getting just the first step right, how to identify a good business, substantially reduces losses.

A simple example, the owner of a regional coffee chain in Kaohsiung asked us to invest in his next store, which he was about to open. The site sat diagonally opposite an established coffee shop, which we will call Store A, in one of the city's prime banking districts, and that store did consistently strong business.

The team spent several weekdays observing from across the street. In the early morning a steady stream of office workers from the surrounding area got out of their cars to buy takeaway coffee, and in the afternoon the store drew customers holding business meetings. After a few days we judged the location to be a good one. There was no need to create demand: consumers in the area who wanted coffee had already settled into the habit of gathering at Store A.

We put a question to the owner.

"We had no doubt that consumers would see your store. But how did you intend to get customers across the street, having seen it, willing to cross over and buy your coffee?"

Several days later, when he called, he was still talking about the carpenter he knew and how much could be saved on the fit-out. We concluded that we would not participate. Saving cost is of course welcome, but where no time has been spent thinking through business model positioning, the primary customer group and the core operating strategy, then rather than spending several million to lose it slowly, it is better first to bring the business within the conditions under which it can make money.

How do you identify a good business？

A business breaks into  ① What is it in other people's eyes? ② What does it actually make its money from?

Take the traditional multiplex cinema model. In everyone's eyes it is a cinema, but on closer examination it makes its money from popcorn and drinks rather than from tickets.

This gives rise to two principal questions：

① Drinks are easy enough to understand, but why popcorn?

② Is the association between watching a film and eating popcorn an intuitive one?

On further analysis, a cinema selling something like potato chips could not hold a high gross margin for long, because anyone can buy them at another shop beforehand and bring them in. The decisive point is that the product must be one the customer cannot prepare in advance. Popcorn, which is good only while hot, unappealing once cold, difficult to prepare ahead because it has to be popped, and inexpensive to make, therefore becomes a far more reasonable candidate.

Solving that problem does not mean the business model is in place. People also have to reach the point where, when they watch a film, it occurs to them naturally that a film calls for popcorn.

Is that association instinctive? Is the link innate? Clearly not.

To establish the model, early Western television series and films consistently showed people eating popcorn while watching a film. Placed in front of audiences over a long period, this shaped consumer psychology, so that in the formative memory of our generation the thought of watching a film brings popcorn to mind on its own.

With both of those problems solved, can the cinema now make money? No.

The question of "what a business is in other people's eyes" matters a great deal.

This is the essence of the business. If a person experience at a cinema is poor on a single visit, his willingness to return drops sharply, and the cinema loses the high-margin profit on popcorn and drinks that he would have generated on every visit thereafter.

How much a company invests in the essence of its business model is therefore critical. This is expenditure to be made rather than saved, and the cumulative result of sustained investment is what gradually forms "the moat" we so often hear about.

Taking all of this together, is the business now investable? Not yet, because other cinema chains remain available as alternatives. Under a competitive analysis of the market, how does this one stand apart?

Author：Vins Kuo   Time：2022.10

※ This touches on the second and third prerequisites set out at the beginning, which we will addressed separately.

※ Primary market (startup investment).