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Be a small, fast-paid component
Margin and speed
Two factors drive which businesses Permanent Equity chooses. One is margin. The higher a business's margin, and the faster it gets paid, the more important it is to its customer, and one with both is really important to a customer.
Small components
The other factor came out of turbulence. The large components of a larger business ecosystem get the most scrutiny, and the small components get less. The firm did not think this way ten years ago. Now it looks to be a small component in a much larger ecosystem with durable demand, playing a role that is smaller but highly compensated and quickly paid.
The firm made plenty of mistakes along the way and learned these lessons the hard way, and the businesses it gravitates toward today follow this pattern.
Why does a high margin signal importance?
A company that can charge high margins usually has pricing power, meaning customers keep paying even when prices rise. Warren Buffett told the U.S. Financial Crisis Inquiry Commission in 2010 that pricing power is the single most important thing in evaluating a business. Customers pay high prices when a supplier's product matters to them and few substitutes exist.
Why do large suppliers draw more scrutiny?
Procurement teams focus on the categories where most of their money goes, a method known as spend analysis. In the related ABC analysis, a small number of suppliers that account for the bulk of spending get the closest review. A supplier that accounts for a tiny share of a customer's costs rarely justifies the effort of renegotiating. Pareto's observation that a few causes drive most effects underlies this approach.
How does payment speed affect a business?
The cash conversion cycle measures the days between paying for inputs and collecting from customers, and a shorter cycle means less cash is tied up. Dell Computer was famous in the 1990s for collecting from customers before paying its suppliers, giving it a negative cycle. Businesses paid slowly must borrow to cover the wait, which raises their costs.
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