Business rhymes, a path to treasure

Be curious. Identify attributes of successful companies and keep an eye out for them repeating in other companies. What do I mean by this? When I invest, it is not enough to only review the financial statements. I’m on the lookout for, what I call “business rhymes”. These are characteristics of successful businesses that appear in other businesses in a similar form. There is a saying that goes “history doesn’t repeat itself, but it rhymes”. The same thing goes in businesses. When you find business that has an attribute that rhymes with something you’ve seen before, do some more digging because you might find another good business.

Let me give you an example. Look at one of my favorite retailers, Costco. They use a membership model to create loyalty. Clients pay an annual membership fee to be able to shop there. Yes, you pay for the privilege of spending money. This fee is a significant contributor to Costco’s bottom line. The membership fee is almost all profits for Costco, i.e. revenues with almost no cost. In 2012, Costco had around 67 million members. The less expensive membership level costs $55 per year. If we did a back of the envelope calculation: $55 x 67 million is $3.7 Billion. Costco makes at least $3.7 Billion from membership fees. The cost to serve attached to this revenue is almost negligible, computers and a database. In addition, the key advantage of membership is the customer’s loyalty. They created a following and locked in the client (member). Those members prefer to buy at Costco before anywhere else. I can tell you from my experience. I love going to Costco. Isn’t it cool to collect $3.7 Billion just for allowing you to shop there? That’s a business I’d like to own.

Coming back to the topic of business rhymes… Let’s look at another of my favorite retailers, Amazon.com. This company is based in the state of Washington, where Costco is also based. It wouldn’t surprise me if Jeff Bezos (Amazon’s CEO) is a member of Costco. A couple of years ago, Amazon launched Amazon Prime. Amazon Prime is a membership service that for an annual fee of $79 gives its members free 2-day shipping, a free selection of streaming videos and an e-book library where you can borrow 1 book per month. If you think about it, Amazon took a chapter of Costco’s play book. They locked in client loyalty by using a membership model. From my standpoint, it works. I’m a member and every time I buy online, I look at Amazon first. As an eclectic investor, Amazon Prime has picked my interest, and I would look for more information.

Both retailers started in Washington State. One is a brick and mortar that started in the 1970’s, the other online from the 1990’s. They have a lot in common: a membership program, a large number of clients, and they provide value to their members. I can’t say that they are a good investment option just because of the membership program. But that was the catalyst that made me take a deeper look into Amazon. Is Amazon an online version of Costco? What are the similarities? What are the differences? Can Amazon benefit from Amazon Prime? Is it profitable for Amazon given they have to pay for the 2-day shipping, steaming videos and books? Those are the questions you should ask and be asking every time you find a “rhyme” as you search for new investments.

It appears that Amazon Prime is loss leader at this point in time. They are building more distribution centers around the country to reduce transportation costs and make the 2-day service more affordable to serve. The free streaming videos and library books are marketing costs to keep members coming back to Amazon regularly. They are there to modify member’s habits and bring recurring traffic to the site. As I researched further, I conclude that the membership program is used as a profit center for Costco while it is a marketing expense at Amazon. However, I found that Amazon has a good business model and it is operationally profitable. Some people don’t like the fact that they are barely profitable and it trades at some enormous P/E multiple. If Amazon decided to moderate the pace of re-investment they would instantly be a profitable business. Is this a business that I would like to own? That’s my question to you.

The message of this post is not whether to buy Amazon stock or not. It is about identifying businesses’ attributes that rhyme and make you curious; curious enough to dig deeper, to look beyond the P&L statements and to see the business from different angles. Eclectic investing begins with curiosity.

Note that “business rhymes” are not limited to companies from the same industry. You can find “rhymes” from across industries. For example, think about what McDonald’s has in common with Simon Property Group? What about Visa (credit card) and Kinder Morgan Partners (oil pipeline), Berkshire Hathaway and Goldman Sachs, or Walgreens and Radio Shack?

Have you seen any “businesses rhymes” lately? Be curious.

Have a profitable day!

Disclaimer: As of this writing I do not hold any positions in COST nor AMZN, and do not plan to do so in the next 2 days. However, I am a Costco member and an Amazon Prime member.

Please note: I reserve the right to delete comments that are offensive or off-topic.