Monday, January 18, 2010

Investing like Branson & Buffet:-
Following is taken from a very popular book called "The Dhandho Investor" by Mohnish Pabrai where the author explains a lot about Low Risks and High Returs, main principle concentrated is "Heads I win, Tails I don't lose much!". Below that I have added a few points for readers, its a little long story but its very interesting and worth the time.

The year was 1984 and Richard Branson knew nothing about the airline business. He started his entrepreneurial journey at 15 and was very successful in building an amazing music recording and distribution business. Somebody sent Branson a business plan about starting an all business class airline flying between London and New York. Branson noted that when an executive in the music business received a business plan to start an airline involving a 747 jumbo jet, he knew that the business plan had been turned down in at least three thousand other places before landing on his desk. He was also aware that the other businessmen with strong domain knowledge had turned it down. The business plan claimed that the sector was underserved by the existing players. All weekend long he tried calling the other major discount airlines flying that route but could never get through.

1)  His conclusion was that they either were lousy businessmen or were overwhelmed by demand—which meant that there was an opportunity to start competing against them.
He also changed the original business plan significantly—opting for a unique dual-class service. He thought about it carefully all weekend long. On Monday, he went to his partners and senior executives at the music business and told them of his interest in starting the airline. They told him, “Richard, you’ve got to be off your rocker.” They told him he’d need a 747 jumbo jet, the most expensive plane around. And they asked, “Do you know what that costs?” They told him they had no interest and did not support this wild idea. Branson persisted. He called directory assistance in Seattle to get the main number for Boeing. When the receptionist answered, he said that he’d like to talk to someone about leasing a 747 jumbo jet. After he was transferred several times, he got to what seemed like the right person and asked if Boeing had an old jumbo lying around? The guy said they did, and Branson asked if they would consider doing a one-year lease. The Boeing employee, likely amused by the British accent, said that they have a small list of customers but they might consider doing such a lease with one of their regular customers. Branson persisted and asked for some numbers.

2)  Boeing gave him some ballpark numbers, and Branson figured out that his total outlay and maximum liability for starting Virgin Atlantic Airlines (if it failed) was just $2 million. His record company was on track to earn $12 million that year and $20 million the next year.
Branson noted that in the airline business with a single plane, he would pay for the fuel 30 days after the airplane landed and for staff wages 15 to 20 days after the airplane landed, but he would get paid for all the tickets about 20 days before the plane took off. Working capital needs in this scenario were pretty low and, with a very favorable short-term lease from Boeing, there was no need to buy an airplane. Branson figured he could hire a small ground staff, place a few ads in the paper, and start taking reservations. Boy George’s records were produced by Virgin, and Branson and he were good friends. To boost the morale of the early Virgin Atlantic employees and get them all excited, he took Boy George over to the cargo hanger at Gatwick Airport,
This served as the headquarters for Virgin Atlantic, to meet the staff. The employees loved it, but Boy George was quite stunned at the apparent chaos at the facility. He later told Branson, “I’m glad my feet are firmly on the ground.” It was a very messy startup.
3) Now if someone came up with this idea in Silicon Valley, there would be a fancy   business plan put together along with the mandatory elevator pitch. It would be based on at least $60 million in startup capital to build out the basic infrastructure, and so on. Branson did not go down this path. The “business plan” was done in a weekend and resided in Branson’s head.
There was no business plan ever written, there was no board of directors or advisors at startup, no venture capitalists (VCs), or angels. It was done by a person with no prior experience or expertise in the airline industry. My take on Virgin Atlantic is simply this: if you can start a business that requires a $200 million 747 jumbo jet and a boatload of employees in a tightly regulated industry for virtually no capital, then virtually any business that you want to start can be gotten off the ground with minimal capital. All you need to do is replace capital with creative thinking and solutions. Branson found a service gap and went after it. By the time that gap narrowed and British Airways and his other competitors woke up, he had already built a strong brand. Even today, Virgin Atlantic offers a very unique product in a very tough industry. The Virgin Group today is a privately held group of 200+ businesses with about $7 billion in annual revenue. It generates about $600 to $700 million a year in free cash flow. The common ingredient in virtually all 200+ businesses is that there was very little money invested in any of them at startup. Heads, I win; tails, I don’t lose much! In 2005, they put a line of electronic products called Virgin Pulse into Target stores.
4) Target asked them to develop an exclusive line of designer personal electronics only for Target. Target guaranteed them prime floor space, so Virgin had zero distribution cost or risk. It had Ecco, a chic design shop, create the line, and they found a Chinese company to manufacture it—retaining good margins for Virgin. Its downside was very limited and upside was huge. The parties who took much of the risk were the manufacturers, who had to commit capacity beyond confirmed orders, and Target, which had to set aside valuable shelf space in every store. To launch it, the Virgin Group leveraged Branson at a New York party dancing with some hot models wearing the Virgin Pulse line on their person. It put very little money into it— 
Another example of classic is Virgin Mobile, Virgin’s cell phone service in the United States. Virgin Mobile does not own or operate a cell phone network. Sprint provides the entire backend and delivers the service under the Virgin Mobile brand. Virgin targeted teens with this service and focused the offering to be very attractive to teens—cool phones and phone skins, prepaid phone cards, and the teen-centric Virgin brand. Virgin’s investment was very low. If it failed, it had virtually no downside. Sprint provided all the technology, billing, and customer service infrastructure. Virgin provided the branding and product positioning, and it took a large chunk of the profits. If it worked, there was huge upside for Virgin and a negligible downside if it failed. Virgin Mobile scaled very rapidly. It set a record for the fastest business to move from startup to over $1 billion in revenues—less than three years.
5) Branson owns his own private island in the British Virgin Islands called Necker Island.6 It is a spectacular property and was featured in the last episode of The Rebel Billionaire on Fox. The island was on sale for £3,000,000 a few years ago. Branson’s starting offer: £150,000—95 percent off the list price. His offer was laughed at, but a few weeks later he bought the island for just £180,000. Needless to say, Sir Richard has had a very spectacular return on his vacation home investment over the years. Now you and 13 other friends can spend time on Necker Island for just $30,000 per night.

Gist of all:-
  • With minimal downsides, failure rates don’t matter to Sir Richard Branson. Even if half these ventures fail or never scale up, it doesn’t matter. He was so focused on his business and its profits that he always found some creative thinking to get the business started with minimal capital. There’s virtually no money put into them to begin with. Venture capitalists ought to look at the Virgin model because the Virgin model is the VC model of the future. Branson is an ultra low-risk, ultra high-return VC. People keep feeding him ideas, and he acts on a select few. He gets large equity stakes, sometimes 50/50 equity stakes in these businesses without putting any money in them. In some cases, like Virgin Atlantic, it is a 100 percent stake with very little invested.
  • Virgin has also invested in India through their JV with TTSL here, Virgin Mobile where many new schemes were launched, and now they are starting GSM services also. Virgin Mobile attracted customers through making them aware of a need for a new brand, same way they tried with Virgin Atlantic. They promised people with everything that can become an excuse to switch from existing service provider, they tapped the youth of India with words like "simple tariff plans, no hidden charges, totally dedicated and caring customer care, awesome downloads, games on the go, wallpapers, superior coverage, top-notch call quality, blazing new technology" and much more. Virgin has used TTSL network for CDMA with a revenue sharing agreement, two brands came together to create an important image in the minds of mobile users, which really worked.
  • But there is something which didn't work for Sir Branson also: He tried to compete with Coca Cola with Virgin Coke but the idea didn't succeed so well as others, Warren Buffet in one of his AGMs told his shareholders - "Richard Branson is a marketing genius. He came in with Virgin Cola, we're not sure what the name means, perhaps it turns you back into one, but he couldn't knock off Coke. We look for wide moats around great economic castles. Growth is good too, but we prefer strong economics. 

  • Buffet summarizes by saying that there are 3 kinds of businesses, The Great, The Good and The Gruesome!These investments are like three savings account where the great one pays you an extraordinarily high rate of interest which rises as the years rise, the good one pays an attractive rate of return which will be earned also on deposits that are added. The gruesome is one which pays an inadequate rate of interest and also makes requires an investor to keep adding money in order to make that low interest rate. As investors, we have to choose businesses that are simple to understand, Mr Buffet likes to invest in companies that have: a) a business he understands; b) favourable long-term economics; c) able and trustworthy management; and d) a sensible price tag.
  • All of us can't be as great as the Oracle of Omaha but at least walking on such principles one can invest in solid companies. As small investors, we have to always diversify, we need to take calculated risks, and take them on regular basis. Ideas must always be welcomed!


Miraj Vora said...

hey tanmay that was a great story really worth the time

great work and keep posting such stuff

IndianTiger said...

Nice article that boosted my morale.