The rage last year in the investing world is to read Nick Sleep’s annual investment letter. I had spend a couple of days poring over the letters and I could only hope that my thinking/writing could be a clear as his.
One of the most recurrent investment theme he had was that company that has Scale Economics Shared (SES) had done very well by sharing their economics with their customers.
He supposedly recommended the ABC stock recommendation when he closed his funds.
2. Berkshire Hathaway
Out of the three, two had the investment theme of SES.
That got me thinking if there is more forms of SES and if any companies in my portfolio is having that tailwind.
Scaled Economics Shared (SES):
For a start, let’s define what is SES.
And before that, we will need to go back to the concept of Economies of Scale.
In basic Economics 101, Economies of Scale is the concept in which per unit cost declines as production volume increases.
Essentially, what will get SES started is that the company who enjoyed economies of scale starts to share its economic benefits with its customers.
Manufacturer Scaled Economics Shared:
In a traditional manufacturing sense, a portion of the cost saving resulting in the production volume increase is pass back to the customers allowing the customer to sell more and thus allowing the manufacturer to increase the production volume which result in more economies of scale for the company.
So for a traditional manufacturer, it could be
Achieving economies of scale
Sharing cost savings with customers
Customers gain market share with more business goes towards the manufacturer
And then SES kicks in. If your customers happen to be Ikea, then the business will grow as fast as Ikea throughout the globe.
Digital Scaled Economics Shared:
If we move on to the digital economy, then this would be known as a typical flywheel. The “flywheel” is a concept coined by Jim Collins.
Now imagine that your task is to get the flywheel rotating on the axle as fast and long as possible. Pushing with great effort, you get the flywheel to inch forward, moving almost imperceptibly at first. You keep pushing and, after two or three hours of persistent effort, you get the flywheel to complete one entire turn. You keep pushing, and the flywheel begins to move a bit faster, and with continued great effort, you move it around a second rotation. Then, at some point—breakthrough! The momentum of the thing kicks in in your favor, hurling the flywheel forward, turn after turn ... whoosh! ... its own heavy weight working for you. You’re pushing no harder than during the first rotation, but the flywheel goes faster and faster. Each turn of the flywheel builds upon work done earlier, compounding your investment of effort… The huge heavy disk flies forward, with almost unstoppable momentum.
In a online market place, Amazon continues to invest in
Reduce prices and delivery time
Increase user experience and user satisfaction
And then SES kicks in, in which higher volume of goods continue to reduce prices, delivery time, increase more selection and user experience and satisfaction.
Chinese Tech Giant Scaled Economics Shared:
The Chinese company operate in a different type of flywheel. Instead of focusing, they had decided to move into various vertical.
Let use Alibaba ecosystem as an example in contrast to Amazon
Alipay creates trust which allow merchant to provide more goods
More services like like TMall and Cainiao helps to serve wider needs
Services drives traffic to Alipay which allows Ant Financial able to create more financial innovation
Financial products (like Yu'e Bao) are created to keep the yuan within Alibaba system
Alibaba ecosystem grew larger, going into the offline environment allowing them to know more of their customers
More financial products are created by Ant Financial which keeps the consumers buying and …
Chinese government decide to put a stop to Ant Financial’s IPO…
Scale Economies Shared with Competitors:
There is something else we had been thinking about since Ant Financial’s failed IPO.
What if the Chinese government force Alibaba to open up their SES to their competitors instead?
Instead of having consumers stay within their ecosystem, now there is multiple ways for competitors to come in to take away their customers.
Alipay would no longer receive the flywheel effect from TMall. Instead, consumer of TMall could pay through even WeChat or the Digital Yuan. By forcing SES to their “competitors”, Alipay would become another generic payment service. Without the ability to charge fees like Visa or Mastercard, Ant Financial will be like a payment gateway without the “fees”.
That is the way the Chinese government retake back their economic prerogative by denying the tech giants the ability to keep the money within their system.
The same could be said for the flywheel for TMall and Cainiao.
Scale Economies Shared with “Employees”:
In recent days, the Chinese government is going after Didi Chuxing, Meituan and eight other leaders in on-demand transport. These are signs that the government believed that the SES should be shared with their employee - “drivers” instead.
Since most industry players in the industry are hardly making any money, better paycheck for the drivers do not fit into their flywheel equation and the industry model of growing at all cost is broken.
Increase selection of Restaurants
Reduce prices and delivery time through cheap part time labour
Increase users forces more restaurants to use their services and allow them to dictate margins
Scale Economies Shared Government:
During the initial days of the national drug tender in China, no one understood if any of the companies could withstand the continual drop in prices. But what had been evident so far is that by having SES with the consumers and the government, companies like Dawnrays have accidentally achieve SES through a government policy.
won national tenders top provide essential and recurring drugs at lower prices
expanded into the provinces which they do not have a good foothold
achieved economies of scale by scaling their production due to the knowledge that they are definitely getting more orders
As we dwell further, we realised that forced SES is clearly a phenomenon in China now.
While companies such as Alibaba and Meituan may be suffering from this redistribution of wealth, the question we are asking ourselves now is if any of the Chinese government policy will create SES and if the company involved would become stronger or weaker as a result of these policy changes.