The Dodo Club (53rd Edition)- Making Good Money (6) – Sweet Spots (and Art)

A note from me:

Hi Folks,

After the Art History trip to Verona, the last two weeks have been largely administrative for me and without highlights really worth remarking on. We did see a couple of films, but nothing I feel is worth raving about.  

The best single moment came when watching the Everton vs Crystal Palace game.  Everton came from behind and scored a last-minute winner. The crowd went into raptures. You could tell that even through the TV, which was the way I followed the game, as my grandson and I couldn’t get to the stadium this weekend. But don’t worry, our season tickets were not wasted, and the team received equally fervent support from our replacements!  

A couple of years ago, I offered the use of our tickets for an important relegation-avoidance game to followers of the team on Facebook. A mother and daughter were the first to respond, and we have got to know them a little online despite never having met in person. They seem lovely – the mother is a care worker who also gives a lot of time to a charity called Dreamflights, and the daughter is a schoolgirl and a member of a local dance troupe. Whenever we can’t go to a home game and they can, they make, for example, a donation to a local charity in thanks. It’s strange and wonderful how positive relationships can grow from common interests even at a distance.

Probably the nicest aspect of the last couple of weeks was going out a couple of times for nice meals with Mary, my wife. These are enjoyable occasions that enhance closeness and stimulate good conversation in pleasant surroundings.  We did our best to put the world to rights!

My Bi-weekly Guide:

Making Good Money – Sweet Spots (and Art)

As introduced in Newsletter 48, the focus of current editions is on “making good money”, where the emphasis can be placed on both the words “money” and “good”.  This is the last Newsletter in this series and, in several ways, draws together aspects explored in the others and points towards where attention may prove most fruitful – in potential “sweet spots”.

I’ve also found the idea of sweet spots valuable in my growing (but still paper-thin) appreciation of the art world.  Looking at a composition I find pleasing or harmonious, I have learned how that can be related to the presence of sweet spots.  For example, if you imagine a canvas divided horizontally and vertically into thirds by two lines in each direction, the four points where these lines intersect can be particularly effective and pleasing in composition.  

Just pulling out an example photograph from my recent trip to Verona, there is a work by Paolo Veronese in the Marogna altarpiece in the Church of San Paolo in Campo Marzio, depicting the Virgin Mary and the Christ Child surrounded by saints.  Time and the elements have unfortunately degraded this masterpiece significantly, but the composition remains compelling.  Mother and Child are close to one sweet spot, while the face and prominent hand of two of the saints are close to another.  This creates a prominent diagonal picked out by light on several hands of saints that draws attention all the way from the bottom left of the painting up towards Mother and Child.  

Turning now to our theme, let’s consider economic sweet spots, with particular attention to the energy-related arena that is closest to my experience. Energy transitions are clearly an arena to explore for sweet spots combining the potential for upcoming explosive growth rates and the potential to secure competitive strongholds. Finding these sweet spots will be an effective route towards “making good money”.

5 pointers towards potential business Sweet Spots:

1. The potential for explosive business growth:
   As explored in Newsletter 51, very significant market/industry growth rates can be triggered by competitive dynamics in newly emerging sectors. Once the stars align and an early mover demonstrates even the slightest prospect of success, fear of being left behind motivates others to jump in as well. Growth potential is one of the key factors in economic value generation (e.g. see Newsletter 50), and hence a sweet spot indicator. A recent report by Systemiq gives its assessment of current and upcoming energy transition tipping points (Systemiq report).
   

2. Possibilities for building competitive strongholds:
   To generate business value, growth needs to be underpinned by securing competitive advantages that can sustain value creation above the cost of capital. Competitive Strongholds need to be built and sustained. An inability to do this is behind the disappointing performance of several companies that have entered the energy transitions arena, in contrast to companies like NextEra Energy and Tesla that still maintain substantial market value.  As highlighted in the last Newsletter, there are noteworthy opportunities for Early Birds to secure competitive strongholds. It is possible to secure competitive advantages through locking in key supply chains, integrating tacit knowledge that remains obscure to others, developing key advanced markets, accessing key policy supports, and building both a track record and a trusted brand.
   

3. Supply Chain perspective:
   While there are any number of supply chains in the global economy, just eight are responsible for over 50% of greenhouse gas emissions. The Food supply chain makes the largest contribution currently, largely because of the land-use changes that the industry generates. After this comes Construction, Fashion, Fast-Moving Consumer Goods (FMCG), Electronics, Automotive manufacturing, Professional Services and (other) Freight. There are potentially multiple sweet spots here with opportunities to generate value by orchestrating premium end-user markets that can channel funds to motivate upstream supply-chain decarbonisation investments with substantial impact.
   

4. Premium final-use markets:
   Companies that have developed significant market value in excess of capital employed (i.e. have a high value ratio or, equivalently, a low tangible asset intensity) have both an incentive to protect their reputation/brand and also the funds to do this.  There are large businesses with large intangible assets in a number of sectors like healthcare, IT and communications, as shown in the following chart. 
   

   

   
   Engaging with businesses in these sectors in a way that can enhance or protect company reputation in the face of environmental footprint and energy transition pressures will help to surface business sweet spots. (See also Newsletter 49).

5. Connecting premium final-use markets with hard-to-abate sectors:
   The major investments in decarbonising our economies are generally required upstream in business chains, in the heavy industries providing key commodities like steel, cement and chemical synthetics.  Decarbonising these sectors is the focus of attention for organisations like Mission Possible Partnership.  The challenge is that the production of clean/green versions of such commodities generally brings with it high cost premia, while these costs are hugely diluted by value-adding steps down the business chain.  At the final-use end of the business chain, the cost impact is generally less than a few per cent, which is both affordable by many and easily absorbed in differentiation opportunities.  The “art” is to explore and develop business sweet spots in connecting final-users with funding incentives to high-emissions upstream industries along the critical business chains.  There is, for example, a huge gap in our ability to allocate and track credible environmental footprint information down supply chains, which ought to be accessible to cutting-edge IT and data management capabilities.

   

In summary, this Newsletter has taken a deeper dive into pointers for seeking and developing business sweet spots, particularly in the energy transitions arena - although the lessons are transferable.  These are windows for “making good money” in both the narrower and broader sense. Certainly, in the energy transitions and industrial decarbonisation arenas, we would all benefit from accelerated change driven by the successful development of the sweet spot opportunities.

Please note: 

The arguments presented in this Newsletter do not provide investment advice or suggest that you will generally find good investments for your funds wherever you find a high value ratio (with underlying higher than average ROCE and/or higher than average P/E).  Such a high ratio, however, is a signal that a company has been able to generate competitive strongholds of some kind.  If you are able to identify the nature of these and subsequently conclude that they are sustainable and expandable, then that may become an indicator of a potentially attractive opportunity.  

Question of The Fortnight

Every fortnight, I’ll be asking a thought-provoking question in hopes of sparking interesting and enlightening discussion.

I’d love to hear your response! You can do so by simply responding to this email.

Today’s question is:

What examples of business sweet spots have you seen in the past or you believe could be important for the future?

The Dodo Club Online Course

If you would like to learn more about the kinds of topics covered in these Newsletters, then please consider signing up for the introductory online course.

This covers scenario/systems thinking for grappling with uncertainty, an introduction to energy transitions, and the development of strategic character in leadership.

In the interest of avoiding the fate of that unfortunate bird, the Dodo, this course aims to help us secure our own personal legacies within a changing world and the energy transition - and to leave a healthier planet for future generations.

You can access the course through Udemy using the link below!

A series of follow-up courses that treat the main topics in increasing depth and detail will be provided if there is sufficient interest.