What is a capital-intensive business?

Illustration: Charles Graham, Harper’s Weekly. Source: Wikimedia

Capital is what makes things. Factories and design studios and drilling rigs and construction equipment. To build the Panama Canal, the managing engineers employed thousands of steam-powered excavating machines, rather than millions of workers with shovels.

Today, our economy runs on ideas, rather than steam-power. It needs people who are creative, who can pull innovations and material and suppliers and delivery together on a mobile platform that is elegant and easy to use. Aggregators have been the way to do this, like Uber or Airbnb, which allow people to use their spare time and spare bedroom to make a little extra money – that is, their spare capital. Or Amazon, which started by selling books, but gradually became “The Everything Store,” aggregating sales from millions of sellers to millions of buyers.

Illustration: Ben Thompson. Source: Stratechery

Aggregation is hard work. Content needs to be digitized, and a gatekeeper has to figure out how to organize and deliver this digital content in a way people understand. Google organized digital information, like news; Amazon organized digital sales; Uber organized digital ride-sharing; Tentrr wants to organize digital camping services.

The distinctive thing about aggregation businesses is that they don’t need a lot of capital. The frontiers of our economy don’t require steel mills or construction equipment, they need bandwidth and coding design. The biggest companies in the world – Google, Facebook, Apple, Amazon – got that way by forging connections. They’ve created trillions of dollars of wealth as they’ve made our lives more efficient. And they did it quickly because ideas move faster than steel mills.

This is why the tech giants have such high valuations, price-earnings ratios that seem to defy the law of gravity: they’re incredibly profitable. Apple is a cash flow machine. Facebook’s return on invested capital isn’t something business school finance prepared anyone for. The information economy seems to break the rules of finance. We don’t need capital to make money anymore. We need ideas.

There is a downside to running a business on good ideas, though. Someone else will always have a new one.

Douglas R. Tengdin, CFA

Charter Trust Company

“The Best Trust Company in New England”

By |2018-05-07T06:47:47+00:00May 7th, 2018|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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