Two Kinds Of Investors -- And The Operators Who Love Them?

There are, it seems, two ways to establish a competitive advantage -- in the restaurant industry, as well as other fields.

[N.B. We’ve all read or heard those attempts to categorize mankind which begin “There are two types of people” ... and go on to divisions as profound as “Those who embrace new experiences, and those who shy from them” or as inane as “Those who say there are two types of people, and those who don’t”. I doubt we’ll achieve profundity in this or upcoming columns, but perhaps we’ll at least avoid inanity.]

Back to the two ways to establish competitive advantage:

The first is to do what others do, but do it better than anyone else.

The second is to do something no one else is doing.

It should be noted that these are not necessarily mutually exclusive, and in fact the best organizations find ways of doing at least some of each. Still, they’re very different mindsets, for operators and investors, and that’s what I want to focus on for this week and the next few columns.

Let’s call the first method “operational excellence”. It consists of addressing, and re-addressing, and continuously re-re-addressing, each step in the production and service process, insuring that each is done correctly each time, and that each is really necessary for the desired outcome.

Let’s call the second method “conceptual uniqueness”. The unique aspect may be a product or menu item (think of the first time you encountered a fried dill pickle, or Bison as a featured protein); it may be a service model (think of the first time you encountered a salad bar, or ordered by computer keypad from your table); or it may be geographic (think of the first time you encountered Arctic Char in Fort Worth, or fried plantains in Toledo).

We’ll leave for another discussion the belief that there may, in fact, be two types of people who are inclined to favor one or the other of these methods (operators versus marketers, perhaps?) and whether they can truly be separated over the long term in any successful operation. Instead, I want to focus, for today and beyond, on two very different investment viewpoints which favor one approach over the other, how equity investors make their investment decisions based on those viewpoints, and what the implications may be for the operators who partner with them. Let’s acknowledge up front that (1) this is a complicated topic, (2) I’m not licensed as an economic psychologist (although it wouldn’t surprise me to learn that such a field exists), and (3) out of necessity I intend to oversimplify -- and perhaps even caricature -- in order to make my points.

Remember first that equity investors are human too, and that many (most?) are investing on behalf of others (partners? clients?) whose funds they manage. The fund manager, or venture capitalist, or whatever title applies, must therefore be able to justify/explain/sell his or her decision to others with (probably) less involvement in the process. Partly for this reason, most funds or money management agreements have certain investment guidelines, to limit the range of possible choices in advance.

The investor also has a goal -- either established via dialogue with clients, or via a partnership or management agreement -- of a certain rate of return over a certain period of time. Each investment decision is made with that goal, and the more-or-less restrictive guidelines referred to above, as starting points.

So ... in coming weeks, we’ll look at why certain investors favor “operational excellence” as an investment thesis, while others lean to “conceptual uniqueness”, and some results of those differing viewpoints -- some quite predictable, and others rather surprising. Meanwhile, think about some of the recent transactions in market, and try to characterize them as one or the other.