Clients make investors, businesses are systems
and one joke about a disco roller skating joint in the 70s
Most investors are investing other people’s money. You might be wondering the same thing I wondered when the Weasley’s couldn’t afford to buy Ron a new robe for his first year at Hogwarts: you have magical ability, why not just make the money you need? I can’t speak for the Weasley’s but the simple answer for investors is greed and necessity. Greed: the more money put in, the more profit comes out. Necessity: many investment strategies can have large upfront costs to actually work:
Great businesses need great clients
Say you’re a great investor. You have the ability to make a ton of money and you need people to give you money to get started. The obvious choice is to create a chain email explaining your situation and forward it to as many strangers as possible. For credibility purposes, maybe you say you’re a wealthy prince from an obscure country and you’re facing some kind of personal dilemma. That should work, but if it doesn’t, where do you get the money from?
Herein lies one the real challenges of investing: clients. The people who give investors money. As with any business, clients can be finicky. Imagine, back in 1972, Warren Buffett borrowed that $25 million to buy See’s from a group of friends. “We can make $2 billion off See’s Candy” he tells them “but it will take a few decades. If we are forced to sell early, we’ll probably take a loss.” A few months later his buddy Lemuel Spimoni calls him up. “Warren, sorry bro, I need my $40,000 back, I’m installing a timeless shag carpet in my kitchen.” Warren has to sell See’s at a loss in order to process the refund and just like that, the Sees investment is ruined. In this way bad clients ruin investors, and great clients enable them.
In reality, Buffett never had a Lemuel. The unsung genius of Buffet’s Berkshire Hathaway is its organizational design. In the 1960s Berkshire started buying insurance companies. Insurance companies collect upfront premiums from customers, sit on that money, and they pay it out later when a Vespa get stuck in a pothole and the owner files a claim. Buffett’s insight was that by buying insurance companies, he could own his clients. He takes money from his insurance companies, invests it, and then repays it later when insurance companies need it. Buffett’s clients work for him. It’s hard to imagine a better client. Not coincidentally, it’s hard to imagine a better investor.
Buffett isn’t alone - many of the world’s great investors have the world’s great clients. Renaissance Capital, the quant fund that owns the highest 30-year performance in history, only invests its own employees' money (be your own client, great hack). David Swensen, the longtime head of Yale’s Endowment, had a university as a client, which proved to be a great client.
Businesses are systems
The list of great investors with great clients is so long that it’s clear this isn’t a coincidence, and it isn’t even a strategy, it’s a prerequisite. To be a great investor requires having great clients. Of course, being a great client means identifying great investors. There’s this chicken-and-egg flywheel effect and it very quickly becomes impossible to disentangle great investors from their clients. What makes great investors great is the value they generate for clients - so really, great investing isn’t done by investors, it’s done in the space between investors and their clients. Investors bring the skill, clients bring the capital, and they work together to create more value than either party could alone. Great investing is a partnership that works well for all parties. The secret to great investing, then, is creating a system where investors and clients share the same goals and incentives. The best functioning systems will naturally attract the greatest clients and investors, and naturally produce the best results. Principally, then, investing is about organizational design. Businesses are systems; profit generation is a byproduct of the system.
This concept extends beyond investing. Great businesses need great customers the way investors need clients. Great businesses also need great suppliers and great owners. Therefore, businesses should be thought of as a system of stakeholders who come together to create some sort of value for one another. Jeff Bezos basically wrote a whole book about this: Amazon was designed to be an organization that invents and delivers solutions to people.
“Obsessive customer focus is by far [Amazon’s identity]. Customers are always beautifully, wonderfully dissatisfied, even when they report being happy and business is great. Even when they don’t yet know it, customers want something better, and your desire to delight customers will drive you to invent on their behalf” - Jeff Bezos 2016 shareholder letter
Amazon isn’t an e-commerce company, it’s not a cloud computing company, it’s just a system that partners with people to solve whatever problems they need solved. The trillion-dollar company evolved from that point. Or, as Steve Jobs put it:
“Some people say, "Give the customers what they want." But that's not my approach. Our job is to figure out what they're going to want before they do.” -Steve Jobs
That Steve Jobs quote is often misunderstood as arrogance - as if Jobs is suggesting customers are ignorant or stupid. That’s not at all what he means - he’s saying the best way to serve customers is to figure out what they want before they figure it out themselves. Apple, the tech company, was his way to build a system that can do that.