I’ve been thinking a lot about mapping companies.
On one hand, they are typical “information goods” companies, most of which have had their economics turned upside down by digital. Everything from encyclopedias and phone books to videos and music has been hit. There is a long list of previously good businesses that have been transformed, disrupted and/or destroyed by digital.
On the other hand, maps (an information good) have emerged as one of the critical services and complements to smartphones, other smart devices and apps. You’ll notice that while the iPhone offers a massive suite of apps from external developers, they developed Apple Maps internally. It is a critical control point in their ecosystem – so they do it themselves (even though they don’t make any money from it).
Recall my article on control points.
The most common pattern for information goods (like maps and books) is they evolve:
- From a physical product to a digital product.
- And then from a digital product to a platform product or complement.
For example:
- Photos went from physical items (Kodak sold film and development services) to digital items (i.e., JPEGs) . And then to shareable items (i.e., Instagram and Facebook).
- Songs went from records (physical) to iTunes downloads (digital). And then to Spotify and YouTube.
- Phone number lists went from physical phone books to online lists to search engines.
And so on.
So I thought I would walk through this pattern for maps, starting at the beginning with a physical map company (Sanborn Map). And then take a look at digital maps (Google Maps) and map platforms (Waze).
First, physical maps.
Young Warren Buffett Goes Activist On Sanborn Map Company
Today, Warren Buffet buys great companies at good prices. And he holds for a long time. He is trying to capture the economic value that will be created long-term. And this requires him to predict 5-10 years into the future.
So he looks for value creating enterprises (per share) with stable demand trends, competitive barriers, good management and little tech uncertainty.
However, young Warren Buffett was very different. From his mentor Ben Graham, he learned how to buy crap companies cheap, extract a little value and move on.
He was a “cigarette butt” investor. This is someone who finds a cigarette butt on the sidewalk. Nobody wants it so it’s free. And you can get 1-2 puffs. Buying companies cheap and capturing a margin of safety was his modus operandi. This is why he bought a dying textile company called Berkshire Hathaway in the mid-1960’s.
His investment in Sanborn Map Company was similar. And was one of his first investments. Buffett worked for Ben Graham in New York from 1954 to 1956. When Ben retired, Warren, then 26, returned to Omaha and founded his partnership. His investment in Sanborn began two years later, at age 28.
Sanborn (discussed below) was a previously very successful mapping monopoly. It created and sold maps to insurance companies, which used them for fire risk assessment. Their approach to mapping was in-person surveys and information gathering. This very successful, labor-intensive approach to fire risk assessment was being replaced by a more technological approach. Profit margins and net income had been falling since 1950. And the share price had dropped from $110 in 1938 to $45 in 1958.
So this previously successful but now dying company was very cheap and this caught young Warren’s attention. He bought 23% of the company at around $45 per share. Mostly because the stock and bond portfolio held by the company was worth $65 per share. The market capitalization was $4.75M but the stock and bond portfolio was over $7M. Buffett bought based on liquidation value and then went activist to liberate that value.
Buffett recruited other shareholders and pressured management to sell Sanborn’s investment portfolio and/or buy back shares. Eventually, the company did buy back shares and 72% of investors turned in their shares. Buffett pocketed a +50% return in two years. It was an activist strategy and in 1961 the business was split into an operating company (that survived) and an investment company with the financial assets. based on the liquidation value of its investment portfolio. It is actually very similar to the approach Carl Icahn would make famous in the 1980’s.
But the interesting question for us, is how a physical maps company became so successful for so long.
Here’s my breakdown.
Sanborn: The Rise and Fall of America’s #1 Fire Mapping Company
Most of this company information is from Yefei Lu’s book Inside the Investments of Warren Buffett.
In the 1860’s, Daniel Sanborn, a civil engineer and surveyor, was hired by the Aetna insurance company to prepare a fire insurance map for parts of Tennessee. This required him to assess each building in an area for various factors related to fire risk. For example, the:
- Type of construction
- Construction materials
- Number of windows
- Related and surrounding areas
- Distance to the fire house
- And other factors
Basically all the factors related to fire risk for a building. From these surveys, Sanborn created a map for that area that Aetna could use to price and underwrite fire insurance policies.
This turned out to be a very good business and the Sanborn map company was born.
Over the next +60 years, by expansion and M&A, the company created a monopoly on maps for fire risk in the United States. These maps would be sold to insurance companies in big printed volumes (sometimes up to 50 pounds). Insurance companies would pay an initial fee for the books and then pay subscriptions for updates. Note: these updates required Sanborn staffers to paste new map sections in the books of their customers. Then entirely new versions of the map books were sold every year or so.
There is a lot to like in this business. And it’s easy to see how it became so successful. Five main factors jump out at me.
First, it’s a scalable, recurring revenue information business.
They are selling information, which is scalable with high fixed costs and close to zero marginal production costs. It’s not digitally scalable where you can send it everywhere in the world online (i.e., Netflix). But the map books could be printed and shipped to multiple customers. The same information can be sold to lots of people.
Plus, information for fire risk decays rapidly. You need to update the information every year. And in rapidly developing areas, you probably need updated information every 6 months. So customers have to rebuy the maps frequently. That’s recurring revenue.
Second, these maps were the critical input for the fire insurance business.
One of my standard question for B2B is: Is this product / service necessary, strategic or critical?
- “Necessary” B2B products (like buying desks and concrete) are usually not great businesses. The buyer’s make a rational decision based on quality vs. price and so on.
- “Strategic” businesses are better. This is when a company spends more on something to make money and/or to beat their competitors (like marketing spending). It’s a strategic cost. They aren’t looking to minimize these. These can be great businesses.
- “Critical” businesses are when it’s a necessary product but you’re willing to pay a premium and/or stick with a vendor even when a cheaper product is available. Because this product has greater risk for the company. For example, people don’t argue price with their heart surgeon. The buyer decides the cost-benefit ratio of a cheaper version is not worth it. Buffett has bought lots of critical B2B businesses over the years.
Sanborn was selling critical products to insurance companies. If you were in the insurance business then, you might cut costs on paper and desks or on some information. But not the information you use to assess fire risk in your written policies. Think about all the big fires that used to happen in cities. For example, the Great Fire of England in 1666, +13,000 homes burned. You go with the trusted name, even when cheaper alternatives are available.
Third, Sanborn was a trusted name. Almost to the point of blind trust.
How do you know if one company’s information on fire risk is good and another company’s is bad? How can you test it?
Basically, you can’t.
You have to go with the trusted brand everyone uses. The name and format that the industry accepts. The company you have used in the past. The choice that won’t get you fired if things turn out wrong anyways.
Generally, a critical product where quality can’t easily be tested is a great business.
For example, the company that makes the structural frames for Boeing and Airbus airplanes is just trusted. Because how can you really know if the plane structure is going to be ok in 15 years? There’s not a great way to test that. So you just go with the company you trust. FYI: that airframe company is another Buffett investment.
And from what I have read, the insurance companies basically just took these Sanborn books at face value for issuing fire policies. They just underwrote and priced based on the Sanborn maps, without much additional information. You could argue there was a standardization network effect here to some degree. Sanborn maps became the trusted standard that the whole industry used and that all the surveyors trained on.
Fourth, there are the economies of scale and IP cost advantages.
At its height in the 1920s, Sanborn had +700 employees, including + 300 field surveyors and +400 cartographers, printers, managers, salesmen, and support staff. Creating these maps for the country was very labor intensive and expensive. And these ongoing surveys by trained professionals were basically a fixed cost based on both current and past spending. Both current and accumulated spending mattered.
So as the market leader in sales, Sanborn had lower costs per map produced, relative to their competitors. It had economies of scale based on fixed capital and operating costs. And Sanborn was, in theory, the lowest cost producer. Although, from my reading, they used their monopoly position to charge very high prices to their customers as well.
Also, Sanborn did not need to remap every building and street. It just had to update the existing maps, which was much less work relative to a new entrant. This is similar to how Microsoft does not have to rewrite Windows every year. It just updates and upgrades its existing IP (mostly). So if you are competing with them, you are not just competing with their current development spend (where they have scale advantages), you are also competing with all their spending for the past +5 years (i.e., their IP). Sanborn had serious cost advantages relative to smaller competitors.
Fifth, this business has high barriers to entry and no substitutes.
Imagine you are an aspiring mapping company.
How would you break into this business at the state or national level? Before you could earn one dollar of revenue, you would have to send out hundreds of expensive surveyors and create maps for every building and neighborhood.
And as nobody wants a map book with only some of the buildings, you would have had to do the entire city or state.
This business has a high barrier to entry and the first step is very expensive. And then if you did pay that price to enter, you would be at a cost disadvantage relative to the market leader.
Plus, I don’t think there were any substitutes (not sure). If you were selling fire insurance policies, what else could you use to price your policies? Your only substitute was to hire your own surveyors, which was expensive and probably unworkable at large scale.
You’ll note that Buffett likes to buy companies with high barriers to entry and no low cost substitutes.
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Overall, we can see in #4 and #5 the common picture for information economics businesses. Lots of upfront costs. And then valuable IP, scalability and mostly fixed costs going forward. With recurring revenue.
Doesn’t that sound like most software companies?
The Sanborn Map Company is an excellent example of the rise (and fall) of a great company in the physical maps business. And there were a lot of information businesses just like this back then (encyclopedias, atlases, S&P company profiles). It just turns out that selling mapping information for fire insurance was a particularly good niche.
However…
By the 1950’s, Sanborn was in serious decline. From the 1930’s to the 1950’s, annual profits fell from $500,000 to just $100,000. This was mostly due to three factors:
- Insurance company consolidation. Sanborn was eventually getting +90% of its revenue from 30 insurance companies. So, yes, Sanborn had market power but so did its buyers. Over time, these companies continued to consolidate. This put pressure on Sanborn’s high prices and also reduced their sales volume. Merged companies didn’t need two subscriptions.
- Buildings and cities got better. As building materials and building codes improved, fire risk decreased overall. Plus, fire houses got better. Major fires in cities became much less common.
- Technology created a low cost substitute. In other types of insurance, companies used “carding”, where every building had its own card record. This approach to insurance was more based on data and algorithms than labor-intensive surveys. This technology expanded into fire insurance and fire risk maps eventually disappeared.
This is an important picture to understand.
- A great company is created and grows.
- Eventually, it dominates a market.
- And then, eventually, demand changes and/or competitors take them down, usually with a new technology.
- But the previously successful company had generated a lot of cash so there were a lot of assets on the balance sheet.
Buffet saw a dying company that investors didn’t want. But with a still valuable investment portfolio. So he bought it, went activist and got the last two puffs of the free cigarette butt.
Now, on to digital maps…
Maps Go Digital – and Google Maps is Amazing
I don’t need to give an introduction to Google Maps. Everyone uses it all the time. It’s amazing. Satellite views, street view, traffic patterns, directions – and its APIs that are integrated into everything from Uber to Airbnb. It’s a core functionality of the digital world. It’s also basically a search engine.
The history of Google Maps as a company is not terribly interesting and I’m not going to detail it. It was a just a PC program at Where 2 technologies, a company Google bought in 2004 mostly based on personal relationships (I think). This turned into Google Maps, which launched in 2005. And then smartphones arrived and Google Maps appeared in the App Store in 2008. Suddenly, everyone’s smartphone was relying on mapping all the time. Today, over a billion people are using Google Maps monthly.
But Google originally created these maps similar to Sanborn. They created the maps by buying the information from satellite companies (and other sources). And later deployed their mapping cars around the world (which added street view and decreased dependence on satellite companies). They have since expanded and are gathering information from other sources.
Today, like Sanborn, Google Maps has a wealth of IP and are mostly updating and upgrading current maps. So the business model and economics are similar. However, it is much more powerful.
- Google Maps uses APIs and extends its map out into a connected world (powerful).
- It is global.
- It has all types of information on its maps. Not just fire risk.
- It is an innovation platform as people add all sorts of information to their maps.
- It’s basically a search engine as well.
Enter Waze, a True Map Platform
Recall, my earlier description of a common pattern for information goods (like maps and books):
- From a physical product to a digital product.
- And then from a digital product to a platform product or complement.
Google Maps went from a physical to digital product. And then to a platform. Israeli-Waze has arguably taken it one step further.
Waze was founded by Ehud Shabtai in 2006 as a community project called FreeMap Israel. These were the earliest days of smartphones (i.e., when everyone started carrying them in their cars) and the approach was crowd-sourcing. They attracted a community of users who would continually submit and resubmit traffic information about Israel (for free). The users created and continued to recreate a free digital database of Israel, which was monetization via advertising. And there were (initially) no surveyors.
Later renamed Waze, the company evolved into a service with map data, travel times, and traffic information from users. From Wikipedia, users can “report accidents, traffic jams, speed and police traps, and, from the online map editor, can update roads, landmarks, house numbers, etc.” Based on its user network, Waze can provide real-time routing and real-time traffic updates. This is something neither Sanborn nor Google Maps could have done.
The important point here that the value of Waze is not just the mapping product (which is far more limited than Google Maps). It is the user network that continually recreates the maps with their engagement. That is what is very difficult to replicate. This is user generated content. Like Wikipedia. Google bought Waze in 2013.
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Ok, those are my mapping stories for today. I’m still trying to figure out this space. But my take-aways thus far are:
- Real-time mapping data degrades in utility quickly. Nobody wants yesterday’s traffic maps. This really changes the economics. It means ongoing costs to recreate it but also recurring revenue.
- If users re-create your information, this is fantastic.
- If you must re-create the information, this means big fixed costs.
- There are varying degrees of criticality for mapping information. Fire maps were critical for insurance companies. Mapping data is also critical to Android as a platform. But basic road maps are free commodities. Most mapping data is free and cannot command any monetizable value.
- Maps can have big barriers to entry and economies of scale. You can’t offer partial maps. It has to be at least a country, if not a continent. So you have the big upfront costs and then the ongoing fixed costs of an information business.
- There is a constant threat of tech disruption and new substitutes in information goods.
That’s it.
Cheers, jeff
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From the Concept Library, concepts for this article are:
- Value Add and Financial Engineering (Ques 5)
- Control points
- Barriers to Entry
- Substitutes
- B2B Customer View: Critical, necessary and strategic
From the Company Library, companies for this article are:
- Google Maps
- Sanborn Map Company
- Waze
- Warren Buffett / Berkshire Hathaway
Photo by Maarten van den Heuvel on Unsplash
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