Paying $100 for a pound of coffee – Thoughts on Positioning

Actually more like $110 but that’s not the point….

Good Experience –> Expensive Coffee

Nespresso is the “Apple of coffee” and it’s another instructive example of the relationship between strategy and margins.

Investors are obsessed by margins. In fact many growth investors won’t even look at a company that doesn’t have business with 50% or greater gross margins. This is why software and internet companies get so much attention. Once they become commercial their incremental costs are so low they can generate circa 70% to 90% gross margins.

Most technology investors realize that Apple has tightly integrated software (and content) with hardware to create a business with 40% gross margins (and rising) versus what some felt were comparable companies years ago (like Dell) that have gross margins around 20%.

Turning back to coffee we can use a wholesale cost for a pound of outstanding coffee to be about $10 for a large buyer. Nespresso uses some pretty nice capsules and boxes for the coffee so let’s just double the figure to account for packaging and production. That puts their gross margin on a commodity at just over 80%.

How is this possible? It’s not software. This brings us to our main point.

Nespresso is selling experience as much as coffee. We’d argue that this is also the case for Apple. Apple does it with software and design. Nespresso does it with good coffee, an innovative preservation and preparation method and a retail brand image that cultivates idea of great coffee you make yourself with one of their little machines. The Nespresso model has some shades of razor/razor blade businesses as well. The machines themselves combine function and unique design that appeals to a stylish, upscale consumer.

Indeed the Nespresso retail experience is distinctly Apple-like. Including the primo locations, spiral staircases and in place of a “genius bar” they have their coffee bar, also now with their own chocolates. Clients enjoy a cup of their favorite brew with a chocolate of their choice.

In short the *reason* one pays over $100 for a pound of coffee is that the experience is worth it. To achieve something similar would involve going to a good cafe which takes time and is even more expensive. Same or better experience, lower cost – even though it’s 10x the price of the coffee itself. That’s genius!

Positioning –> Margins –> Valuation

Companies and management teams focus their time and attention on technology development, product design, customer acquisition and support as well as the business side of running a company. But if we could “hold success measures constant” there would still be a wide variation in terms of margins and valuation.

Many management teams think along the lines of “if we just execute and generate results then valuation will take care of itself.” While that’s true at some very high level and long periods of time it begs for a more thoughtful and strategic approach.

A complete strategy should include not just moving forward as a company but also thinking backwards in terms of future endpoints and valuation. ¬†We see many IPO presentations that are better at this than existing public company investor decks. Many IPO companies include a slide showing their “target model.” To be fair some of them don’t provide enough information to connect the dots to the current business and the future target model but in almost all cases investors give them credit for where they are trying to go.

Every industry and every company has a different positioning challenge. For example some technology companies have an OEM model. That means they create technology that gets embedded in final products. They don’t have a direct relationship with the end customer and have to contend with fluctuating component costs. The final result is that they get “squeezed” from both ends of the market and despite all their efforts get a low valuation multiple because their positioning is stacked against them.

At the technology component level most of these companies suffer from commodity style positioning which means margins are cyclical rather than secular. One good case in point is Micron Technology (NYSE: MU $5.63). Back in 2007 (!) we wrote a short note called Struggling with Memory which seemed to conclusively rule out Micron as an investment based on their positioning. No amount of market improvement, company execution, or external events (other than the permanent destruction of all other memory makers) was going to make a difference. The shares were around $9 at the time and have traded between $2 and $11 since. It’s been a wasted 1/2 decade for the company and investors. Without a strategic plan that changes positioning towards better margins we can expect more of the same.

There are lots of strategic weapons that can be used to create a strategy that improves positioning and paves the way to an improved target operating model – licensing, channels, vertical integration, adjacent product lines to name a few.

It’s not enough just to be in a growth area and do a great job. Carve out some time to consider positioning, long-term operating models and valuation and it will help inform your strategy.

Want to know more about how we can help? Either view our short slideshare presentation or contact us.


Good investors are hard to find

Many company managements believe that making to the public markets will be enough to ensure that investors will discover, study and appreciate their outstanding investment merits and become long term investors – all they have to do is execute and get the word out.

Getting a new investment in an institutional portfolio is a huge effort that can take easy takes months or even years. Here are a few reasons why that is so:

Having said all that investors are still looking for good ideas and outstanding investments. Even though they have elaborate defense mechanisms against noise and unhelpful information, they are open minded if you can find a way to capture their interest and then present them with the right information in the way they are accustomed to seeing it.

Why is it so hard? Here are a few reasons:

  • The more worthwhile an investor is the greater lengths they have gone to in order to insulate themselves from the hundreds of calls, emails, messages and other distractions they have in managing their portfolio. Many of the best ones avoid all the “news” and do their own work.
  • Monitoring and managing their existing portfolio which may contain hundreds of positions is a full time job. Add to that servicing existing clients and marketing to new ones and they are booked pretty solid, even if they don’t make a single new investment.
  • Often they are focused on a theme that your company may not fall into. It’s not unusual for a fund to spend a few weeks looking at a specific space like wireless networking, information security or business analytics. During this time they tend to pay attention to little outside the area and their existing portfolio. However if you fit into an area they are actively working in it’s a golden opportunity and you will be welcomed.
  • There is a process. Although there are funds that have a single decision maker most have a process and an investment committee. That means quite a bit of work and preparation. So it has to be worth the effort. Your story has to be compelling, long-term and be backed by strong management and a record of execution. “Seeming like a good idea” won’t be enough.

Having said all this if your fundamentals are improving you will be discovered and ultimately find good long-term investors. Besides patience there are a few things to consider:

  • When they look for you – be easy to find. This is not just an IR area, it’s a research one as well. For our part we use partners to distribute our company research and positioning across all major institutional channels. When an institutional investor does a search on your industry or related companies, research on your company should come up.
  • Don’t be promotional. It’s a fine line. You need to be visible and communicate but not go over the line. If investors, particularly institutions, see your PR/IR programs as an attempt to “paint the tape” they will take it to mean that management is focused on the short-term and trying to attract traders and trading volume. Be like IBM.
  • Work on developing relationships with the best institutions given the chance. A monthly call to a portfolio manager is a wise investment if they have expressed an interest. They love to get industry perspective and updates on what you have observed not just in your own business but in general. It also makes it much easier to meet again when you are both at a conference or in town.
  • Conferences are worth presenting in but go to the best ones you can get invited to. It’s better to have a small part on a panel at top event than your own presentation at a bucket shop investor conference full of service providers and podiatrists.
  • Your investor presentation is critical. Make sure it is as good as it can be and have the most recent version easily accessible on your website. Don’t bury it or force people to listen to a webcast without the slides. Put it on slideshare, ask us to post it on Bloomberg for you and make sure it’s out there. In terms of your own content this is the single most important thing to do right.

It’s a process and a journey rather than a destination – figure out how to have fun with it!



Advisory vs IR

Both the advisory and investor relations businesses are changing and the intersection of these services is becoming more important to understand. In the past the two often didn’t meet but today there is mutual benefit to working together.

We put the diagram together to illustrate the difference between what we do as advisors and what an external investor relations firm (or internal IR function) does for a company. The primary role of an IR function is communication. It is demanding and has many facets even beyond what we show here but it is fundamentally different from the independent advisory work and deliverables that we provide. In many ways IR about amplifying your internally sourced information and development to the investment community while what we do is put those in an externally aware investment context.

Here are the key elements:

  1. Our own independent positioning of the company is based on work both inside and outside the company that includes an analysis of the market, customers and competitors. Investors value supported facts and information discover more than company-sourced information.
  2. We develop a financial model and apply our proven intrinsic valuation model to provide a firm estimate of how the market will eventually value the company as they execute and fundamentals are more fully realized. Before a prospective investor takes the time time and effort to do their own work, meet with management and propose an investment in your firm they like to know if there is an exploitable gap between market expectations and company valuation.
  3. Because we have had scores of advisory relationships over the years we are in a position to assist in other areas like strategy, capital raising, M&A and business development. We’re not an investment bank but we can provide input and make direct introductions in all these areas when there is a good fit. It’s an extra benefit that clients get that sometimes ends up being the most valuable part of what we do.
  4. Although it’s not mandatory we suggest that clients take advantage of our research distribution capabilities at Research 2.0 (R2) which uses numerous online channels to reach hundreds of potential institutional and retail investors as well as sell-side research organizations and broker/dealers.

The two functions complement one another. We see IR as a necessary function for any public company and one that’s important to do well. At the same time investors are looking for independent analysis and research on the company as well as estimates, a financial model and informed views on valuation.