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Hazelton: If It Were So Easy, Everyone Would Be Doing It

Hazelton Capital Partners third quarter 2014 letter to investors.

Hazelton Capital Partners – If It Were So Easy, Everyone Would Be Doing It.

In his recent book, “Zero to One: Notes on Startups, or How to Build the Future,” Peter Thiel draws upon his experience as a serial entrepreneur in defining the key elements needed to create a successful and sustainable startup business. Thiel’s approach is very simple: Avoid competition. This advice appears to be in direct conflict with the precepts of capitalism, where competition amongst private companies operating within free markets determines the clearing price. Competition is generally considered good for business because it shakes off complacency, spurs innovation, expands the scope of the field and gets businesses to focus on their customers. But what Thiel is suggesting is that competing for the sake of competition is a fool’s errand. Instead, when evaluating a business, Thiel searches for two key elements: Does the company provide a unique solution to a problem, contributing to the overall growth or progress of an industry, and is the company focusing on a niche segment of the industry before it expands its reach?

Hazelton Capital Partners-  Apple a legendary startup

Apple is a legendary startup company with a strong history steeped in entrepreneurship, including the tradition of beginning in a garage. At nearly 40 years old, Apple Inc. (NASDAQ:AAPL) defies convention by continuing to judge each new and existing opportunity through an entrepreneurial prism. Apple did not create the smartphone or the smartphone market, but its decision to manufacture the iPhone was driven by the belief that the BlackBerry Ltd (NASDAQ:BBRY) (TSE:BB) (the default smartphone of the time) was ignoring the needs of the consumer market. Before 2007, smartphones were purely a business tool, complete with a keyboard to keep up to date with emails when out of the office. When Apple decided to launch the iPhone, it did so with the primary focus on what would benefit consumers. Additionally, Apple limited the size and scope of its iPhone release. Instead of producing multiple models, Apple began with its “one size fits all.” Instead of releasing the phone to all mobile carriers, AT&T Inc. (NYSE:T) was given the exclusive right to distribute the phone. And instead of blanketing every country, Apple has moved methodically over the years to expand into foreign markets.

In 1994, Jeff Bezos, keenly aware of the hidden potential of the burgeoning internet, began searching for a way to leverage its power. After months of investigation, Bezos determined that the best opportunity available was in retail. He further refined his focus to selling books over the internet and was born., Inc. (NASDAQ:AMZN)’s initial purpose was to provide book buyers with 7 times the selection of a brick and mortar store at prices that were 30% cheaper. At first, like most entrepreneurial ventures, the established booksellers disregarded the internet upstart and continued to operate in the same manner it had for over half a century. Soon, the national booksellers could no longer ignore Amazon’s competitive advantages and began their own online operation. But, it was too little too late for businesses like Borders, which could not compete with Amazon’s low overhead costs, robust logistics system, and improving relations with book publishers. After its initial success in online book retailing, Amazon expanded its offerings to include DVD’s, CD’s, video games, electronics, apparel, furniture, food, toys and jewelry. With each new expansion and increase in sales, Amazon has been able to continually exploit its sophisticated and improving logistics system. Cost savings from economies of scale were funneled back to their customer in the form of lower prices in order to build greater market share and customer loyalty. Well aware of the negative impact these choices were having on net profit margins, Amazon addressed its business strategy in a 2009 Letter to Shareholders:

“Our pricing objective is to earn customer trust, not to optimize short-term profit dollars. We take it as an article of faith that pricing in this manner is the best way to grow our aggregate profit dollars over the long term. We may make less per item, but by consistently earning trust we will sell many more items. Therefore, we offer low prices across our entire product range.”

The biggest challenge facing any business is remaining true to its roots while replicating its initial success. Twenty years after its founding, Apple was on the verge of bankruptcy. Instead of focusing on what made the company successful, its creativity and design, Apple allowed itself to become preoccupied with gaining share from the personal computer market. This competition negatively impacted the company as its once cutting-edge products lacked innovation and became commoditized. In 1997, Steve Jobs returned to Apple and revitalized the dormant entrepreneurial culture. He slashed the number of products by 70%, reminding Apple employees that “Deciding what not to do is as important as deciding what to do.” By 1998, Apple regained its creative footing with the release of the iMac and began a streak of innovative products that once again married design with function.

Entrepreneurs are often portrayed as disrupters of industry, the underdog willing to assume great financial risk in order to challenge the conventional wisdom of the time. The truth is just the opposite. Entrepreneurs create businesses because they are able to narrowly focus their scope to address a specific need unmet within the marketplace. The disruption that occurs is the byproduct of their success. Apple began its journey by following an entrepreneurial path, but over time it diverged from the initial route that made it unique and successful. By returning to its entrepreneurial roots, Apple has not only been able to regain its bearings but has developed an uncanny insight and vision into what currently is lacking in the marketplace. Even more remarkable is how Apple was able to ascend from near bankruptcy to a robust market capitalization in excess of $600 billion with over $170 billion in cash/securities in less than 20 years.

Even though Amazon has been able to create one of the strongest and best known retail brands, its future remains uncertain. By providing exceptional customer service and competitive pricing, the company has left a growing sea of bankrupt and failed businesses in its disruptive wake. But to what end? Unlike Apple, whose near death experience has shaped its view on competition, Amazon is committed to gaining market share solely on service and price. But do these two fundamentals create customer loyalty? Recently, Alibaba, a Chinese online retailer and a business to business portal, went public on the New York Stock Exchange. In an interview with its chairman, Jack Ma repeatedly talked about his priority: To build a world class online commerce company that is focused on its customers first. With companies like Alibaba, it is hard to imagine a time when Amazon will not be forced to compete on price. I love using Amazon; it is so easy. It is the first place I go when shopping both on and off line. But I am sure, over time, I could learn to love Alibaba, as well. The question is what problem is Amazon currently solving? Although

I do not see the company’s competitive behavior leading to its ultimate demise, I also do not see the company able to leverage its growing sales into greater profitability.

Thiel’s book can be distilled down to a singular idea: Success comes from solving unaddressed needs while avoiding competition. The roadmap to become a successful entrepreneur is easy to follow but remains a challenging journey. Just like investing, an entrepreneur must be courageous enough to swim against the conventional tide while he waits for his idea to gain acceptance, which can be lonely at first and overtime appear to be madness. Of course, the difference between madness and genius is timing. In 2004, Peter Thiel invested $500,000 in Facebook for 10% of the company. He was the first outside investor, but not the first potential investor as many individual and venture capital firms passed on the idea. With less than 1 million users, Thiel believed that Facebook would be “the social platform” for users of all ages which, up to this point, did not exist. In May of 2012, Facebook went public and currently has a market capitalization over $200 billion. Today, with over 1.2 billion users, Thiel’s prophecy has come true. But the question is: Would you have been courageous enough in 2004 to have made the investment when the rest of “the market” was sidestepping the deal? The prevailing maxim: If it is such a great idea, why isn’t anyone else doing it? should be rephrased to say: If it were so easy, everyone would be doing it.

See full Hazelton Capital Partners letter here.

Zero To One Hazelton Capital Partners