This week’s podcast is on Ant Financial vs. Square. And has an introduction to the inside vs. outside view and base rates.
Key question: What will drive Square’s growth?
Common metrics for base rates:
- Sales growth
- Gross profitability (gross profits / assets)
- Operating leverage. Change in operating profits relative to change in sales.
- Operating profit margin
- Earnings growth
Related podcasts and articles:
From the Concept Library, concepts for this article are:
- External vs. Internal View
- Regression to the Mean (average / base rates, rate of regression)
- Payment Platforms
- Marketplace Platforms
- Complementary Platforms
From the Company Library, companies for this article are:
- Ant Financial / Group / Alipay
I write, speak and consult about how to win (and not lose) in digital strategy and transformation.
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This content (articles, podcasts, website info) is not investment, legal or tax advice. The information and opinions from me and any guests may be incorrect. The numbers and information may be wrong. The views expressed may no longer be relevant or accurate. This is not investment advice. Investing is risky. Do your own research.
Welcome, welcome everybody. My name is Jeff Towson and this is Tech Strategy. And the topic for today, what Ant Financial tells us about the future of Square? And sub question, why the external view is so difficult in digital? Now, both of these companies have been in the news a lot in the last six months. Square has just surpassed $100 billion in terms of market cap. Ant Financial, renamed Ant Group, was supposed to IPO in the 330 plus billion dollar range, making it the largest IPO in history. Although it has been subsequently delayed and it’s probably coming out, who knows, maybe next year or something like that. But the nice thing is that Ant is still rockin’ and rollin’, especially in China, but increasingly internationally, and it does sort of chart the way. for Square, which is much earlier in the process, much smaller of a service. So I think we can kind of maybe get some insights there in what Square might become and what its major next moves might be. That’s kind of the goal for today. And the question I’m going to ask you to try and answer is what do you think is going to be the major driver of Square’s growth going forward, three to five year time frame. Now for those of you who are subscribers, I have been sending out Quite a bit of information about Ant and in the last couple of days also about Square sort of taking apart this question in greater detail. I’m going to touch on some of that but not most of it. I like to keep sort of my best thinking for subscribers. So touch on it a bit but yeah there’s a lot more information I put out. You can easily go to my webpage, go into the company library or go into the concept library. both of which are now active, and you can just search by concept or company and pull up all of that. So hopefully that has gotten dramatically easier in the last week. And for those of you who aren’t subscribers, feel free to join in. You can go over to jeffthousen.com, sign up there, free 30-day trial, see what you think. And my now standard disclaimer that nothing in this podcast or in my writings or in the website is investment advice. The investments and opinions made by me or any guests I have may be incorrect. The numbers and information may be wrong. The views expressed may not be accurate or may become less relevant or accurate over time. Overall, investment is risking. This is not investment advice. Do your own research. That said, let’s get into the content. Now Ant Financial has been floating around for 15 plus years. Started out as Alipay. grew in lots of dimensions and I don’t think it’s really being described terribly accurately from my point of view. I think what they have, which I’ve put in previous articles, is they’ve effectively built three complementary platforms. And complementary platforms is one of the ideas I’ve put in my digital strategy pyramid, which is that same pyramid I keep sending out. And it’s really at the top of the pyramid under winner take all. I mean, that’s where you wanna be. You wanna build a business that is effectively impossible to compete with. There’s a couple things you can do to get there. One of them is to create complimentary platform business models. And I think Ant basically has three plus platforms at this point. The first one is a payment platform, which is one of my five platform types I keep. pointing to and within that I include the use of credit. So that’s a three user group platform, not just a two sided platform. Other one they have is a digital finance marketplace platform where you can buy lots of things, insurance, money market funds, mutual funds, things like that. They refer to that in their description as their digital finance portal or InsureTech or InvestTech. I think it’s a marketplace platform for digital finance products. And then the third one is a daily sort of services marketplace, basically Meituan. They call that daily services. It’s basically Meituan, but you’ve got these, you know, that’s a platform business model for services. You’ve got these three platforms that effectively work together. They complement each other. They support each other. You get a lot of immediate benefits in terms of data sharing. resource sharing, which can be financial, it can be technology. You get obviously shared users, which makes it a lot easier to launch new things. You can cross-sell, your customer acquisition costs are quite low, and then it also opens up the door to some things I think they’re going to do in the future in the area of bundling and subsidizing one product or service with another. And for those of you who’ve been longtime subscribers, you know I’ve… frequently said that you build digital platforms based on four intangible assets, which are users, participation, data, and money, revenue produced, although that last one, I guess, is not intangible, kind of. And each of those platforms that Ant is doing sort of contributes a different part of that asset base. The payment platform, which includes what they call credit tech, That gets you your users. That is the most powerful mechanism for capturing users is payments because it’s naturally viral. The use of the product itself gets you more users because if you want to send money to someone, they sign up. Certain things have virality to them in terms of growth. Payment is one of them. Communication tools is another, group buying is another. So that payment platform really is their most effective mechanism for getting users and growing the network. It doesn’t necessarily throw off money. It doesn’t necessarily throw off a lot of participation, although the data is pretty good. The second platform, the digital finance marketplace, you know, if you’re gonna sell people insurance products, mutual funds, things like that, and the user groups you’d have there would basically be three. You’d have consumers as one user group. You’d have insurance companies as another group, and then you’d have asset managers as a third user group. People don’t buy those very often. They’re very rare in frequent purchases. So it’d be very hard to build a platform business model like that on its own. You’re not going to get a lot of frequency. You’re not going to get a lot of participation, but it can throw off quite a bit of money when you start talking about investing the rising wealth of Chinese families. So that’s kind of complimentary. And then the third one, daily life services, sort of the Maytuan model. Well, a lot of those services like food delivery, movie tickets, you don’t actually make any money on that stuff. but it gets you a lot of engagement. That’s kind of the, and some of those services are profitable, like hotels have pretty good gross margins, hotel reservations, flight reservations no, train reservations no, but hotel and restaurant reservations tend to have pretty nice margins. So between those three platforms, not only do they complement and reinforce each other and effectively eliminate most of your competition because anyone who’s competing with you would have to offer all three, which is very, very difficult. They also offer different sort of assets within a platform and they all kind of go together. So I call that a complimentary platform. I think when you get those, it is very hard to compete with. And that’s pretty much how I view Ant Financial within China. Now outside of China, which is what they are absolutely doing, Southeast Asia in particular, it’s mostly been a story of payments and to a lesser degree merchant services, but that’s really kind of tying with. AliExpress, and Lazada. So that’s a bit of a tangent, I suppose. But that’s kind of one of the key ideas for today’s complementary platforms, which you can see on my pyramid and find in the concept library very easily. The other ideas for today, marketplace platform, payment platform, which I’ve just mentioned. And the new one, which I’m gonna talk about in the second half, is this idea of the external or the outside view, something investors talk a lot about. And managers. as well. I haven’t talked about that really before so that’ll be kind of the new concept for today. So four concepts complementary platforms marketplace platforms payment platforms the external or outsider view. Alright let me switch over to Square and let me put a qualifier on this. I am not an expert on Square. I mean I know the basics I’ve gone through their stuff. It’s not a complicated company to understand at this point in time. I think its future trajectory is a complicated question. And that’s why I’m kind of using Ant as a comparison. But I don’t want to come across like an expert on Square. I’m not. I mean, I study Asia and Chinese companies in the tech space. And there are certainly people who are dramatically better at Square than I am. So they’re probably gritting their teeth as I talk about it. So sorry about that. But it’s a little on the edge of my strike zone. But they started with a very good question, which is how do we serve very small sellers in the area of payment because most small sellers online on the street corner, somebody with a walk on the side of the street, you know, they can’t take credit cards in the US. Now China, Asia, QR codes are already pretty much addressing that problem. And if you see street vendors in China, they’ll they’ll take QR codes and they probably won’t take cash. But in the US, it was the opposite scenario, which Jack Dorsey started thinking about with his partners, obviously he’s a co-founder. Now, how can you help these local service businesses in particular take credit cards? And in this, I mean, he really targeted what digital does best. Yes, disrupting a current business is fun, and that definitely happens, but what is more interesting is addressing an unserved or an underserved demographic and expanding the pie. such as, look, these local merchants, these local one-person coffee shops, maybe they have a little cart, maybe it’s a two-person operation selling bubble tea down the street from a university, they simply don’t have the ability to take credit cards, and they certainly don’t have the ability to get credit. They can’t go into a bank and apply for a small business loan. They’re too small. They are underserved or completely unserved as a business. So applying digital tools to that was very clever. Now we could look at the same question with Ant Financial in China and it’s a bit bigger because that is absolutely what they’re doing. They are trying to serve the unserved and the underserved small merchants of China and increasingly Asia. Increasingly you hear them talking about one to two person retail shops in the villages of Indonesia, which you know. are very primitive operations. You know, it’s two people sitting in a shack, literally a shack on the side of the road. You know, what digital tools can you bring to them? They can’t get credit cards. They can’t accept credit cards. These little businesses don’t even have bank accounts, let alone, you know, credit. So on the merchant side, we definitely see this as a story, but in Asia, China, and definitely Africa. We also see a similar question on the consumer side. M-Pesa, very cool mobile payment initiative in East Africa, Kenya, Tanzania, that sort of place. I mean, they went after people, forget they didn’t have credit cards, this population didn’t even have bank accounts. Tremendously underserved, unserved demographic. They started to give them mobile payments so people could then deposit money at the local retail shop. And then suddenly their mobile phone, which they all have now, can make mobile payments and they start buying things online. So somewhere like Africa, you had big underserved demographics on the consumer and the merchant side. In China, it was a bit halfway in between. When mobile payment came up, virtually everyone in China has a bank account and has had a bank account for a long, long time. They just didn’t have credit cards. They had debit cards, usually, but no credit cards. So that was kind of where mobile jumped in. We moved to the US with Jack Dorsey doing his thing. Okay, he’s mainly addressing the merchant or the seller side, because virtually everyone in the US has a credit card and a bank account and a debit card. There wasn’t that much of an opportunity on that side. So you see the same approach with digital playing out in different parts of the world. And he very smartly. targeted underserved sellers, particularly in the service space, and use that as a wedge to jump into payments, building a payment platform from day one, which is absolutely the place you wanna get to in life if you can, and this turned out to be a very good sort of landing ground to get into that. So a lot of cleverness all across the board. And how did they launch? Well, they offered a combination of hardware, software, and services. which is, you know, if you have a mobile phone, we’ll give you this little cool piece of hardware you can plug into your phone, or you can put a little POS device on the counter, and you can immediately start taking payments. So it was hardware plus software plus services, targeting this one demographic, and then you tie and lever that into your own payment platform, which, you know, if there’s a handful of businesses you really wanna get into in life. One is a marketplace platform for products or services, and the other is a payment platform, if you can get there. And then a gaming platform would also be awesome. One of the reasons I like C Limited so much is because those are the three businesses they’ve targeted, a gaming platform, an e-commerce site, Shopee. The first one’s Garena, second one’s Shopee, and the third one is a payment platform, which is Airpay. I mean, really good strategy. So they’re trying to get there. And one of the immediate benefits of launching a payment platform is it has viral growth. You know, you want to send people money, they have to sign up to take the money. The very usage of the product gets you growth. It’s one of the few platform business models that does that. So bam, they got the payment platform and they’ve got some virality to some degree. Good strategy. Now, big qualifier on all of that with Square. is basically dependent on the banking network of the West and the fact that, look, they’re not actually doing payments themselves. They are dependent on these banking connections and they’re piggybacking that. That’s why when you signed up for PayPal, you had to put in your credit card because most credit card companies, I mean, basically it’s a second layer that the banks do the processing and they charge their inner banking fees and… such and then credit cards which are issued by the bank sit on top of that. Well PayPal sits on top of that. So lots of fees on top of fees on top of fees. Square unfortunately was in the same scenario so they’re sitting on top of that and they’re you know they’re paying access to that network every time they do a transaction. That’s not awesome. You know true mobile payment is better if you can get to it which is why when we’re in China. when you’re paying a payment fee, if I’m sending money to another consumer on mobile payment, there’s zero fee, it’s free. If I’m sending money to a merchant paying for something in a store, I’m probably paying 60 basis points. If you’re on PayPal, you’re paying 5%, international 4%. If you’re on credit cards, you’re paying 1%, 2%, 3%. I mean, payments in the West, there is a long history of gouging merchants. and that is still in place and someone needs to really bust up this system because it’s long overdue. And that’s kind of where Square is today. You know, it’s a major weakness, it’s a major problem, but you know, you don’t get everything you want in life. You know, their hand is really outstanding. It’s not a perfect hand, but they’ve got some good cards. From there, they start to build out what they call in their filings their cash ecosystem. I would call it just a payment platform. You know, you get more merchants to accept. you get more consumers to start using, you get greater number of transactions, and their gross payment volume, if you look over the last three to four years, has been great. I mean, it’s just growing, growing, growing. They’re taking transaction fees across that, so their revenue is growing, growing, growing within the transaction area, which is still most of their revenue. That all looks fine. It looks like a payment platform. And I would call that sort of their first major vector of growth is just… you know, payment transactions and fees. Now within there, they start talking about offering credit. And I would put this as part of a payment platform. I mean, I consider Ant Financial to be a three user, three sided payment platform, one of the three platforms. And within that, the three user groups would be consumers, merchants, and banks. And the banks offer credit. that can be supplier credit, giving it to the merchants, or it can be consumer credit, which is, you know, we’ll give you a microloan, we’ll give you a major loan, we’ll let you pay an installment, lots of creativity happening there. And if you’re starting to deal with small merchants, then actually the supplier credit side is really important. When I was in Brazil meeting with Didi, well, it was 99, then it became Didi and 99. One of the initiatives they were doing was they were trying to get drivers on their platform, groups that offer rides versus people that take rides. And one of the issues they had identified was the drivers just didn’t have enough money. They couldn’t keep driving people because they didn’t have enough money to pay for the gas. So they would drive someone until they had no gas and then they’d wait to get paid. and they wouldn’t take any more rides. So what DD slash 99 was doing had issued them cards. And as soon as they had basically done a trip, they would send the money to that card and then the people would get it very, very quickly, I think within an hour of the ride, and then they could use that to buy more gas. A lot of small sellers are like that. They have very limited ability to buy inventory and sell, to buy more coffee, to buy more whatever. So you wanna get them cash as soon as possible, either directly or offer them credit. One of those two things. So the supplier credit side is very interesting. Ant’s doing a lot on that space. And then the consumer credit side is also getting very interesting because they do, you know, a lot of these companies or a lot of these people don’t have credit scores. And there historically have not been credit scores in China and in a lot of Asia. Well, if you’re… doing things on someone’s platform, you’re getting a lot of data. It’s very easy to offer sort of micro credit, $20, $30. And then as people develop a track record, then you step them up to the next level of credit, which is $100, $200, $1,000, which is exactly what Ant Financial does. They have two tiers based on sort of track record. And then they step you up. And that can be, you know, installments or credit or whatever. And… Ant Financial doesn’t carry those balances. They are handed off to the banks. So what Ant Financial is really doing is they are designing the credit products themselves. The banks don’t do that. And then when they start to an issue alone, that is when the bank, which could be a small rural bank, it could be a city bank. There’s a lot of city banks in China. Not city bank, but city level banks, and then the larger banks and development banks and things. So hundreds of banks would be in this user group. They would then agree which one they want to fund. They could do some degree of due diligence, but they don’t design the credit products. Ant Financial does that, but they’re in the approval phase of the process. Once that is made, the credit is extended. The balance sheet sits with the bank, not with Ant Financial. They take what is called a technology processing fee, which is then paid out of the interest payments. So they sort of take their cut there. Now the Chinese government has weighed in and this had a lot to do with why I think they got delayed in their IPO. That they’re not comfortable with this. If you’re going to extend credit in China, you need to carry the credit on your balance sheet at least to some degree. And it looks like about 30% of those loans are going to have to sit on the balance sheet of Ant Financial. They can’t just look like a technology service company. Now they already actually have a private banking license. So they were making some of these loans themselves pretty much just to get the system going, I think. And I think the idea was most of the loans would eventually be done by this user group, not by Ant itself and its own banking license. That appears to be changed and they are gonna look a lot more like a bank than a technology company going forward. We’ll see, but that’s pretty much what everyone’s saying. Okay, we see pretty much the same thing happening Square that they have started to extend credit on the supplier side in particular. They’re doing this with as far as I can tell Sequoia Capital where Sequoia is accessing the money and then placing the money. So they’re kind of almost securitizing this use of credit and it’s being handed off to other parties. So they’re doing a little bit of what Ant Financial but instead of having hundreds of banks enrolled as a user group on their payment platform, they’ve got sort of a strategic partner at this point. But I think it’s possible that this would be another vector of growth for them, which would be credit tech. Building out a payment platform that has three user groups, this is my language, merchants, consumers, and banks. No. Ant Financial calls that credit tech, Square uses other language, but I think that’s the second vector of growth. Are you gonna be in the payment processing business and taking transaction fees, or are you gonna be in the credit business, credit tech business? That would be another vector of growth, and I think that’s probably the most attractive area for Ant Financial over the next three to five years is their credit business. The money’s huge. They’re carrying 200 plus billion dollars. of loans right now, although a lot of that’s on the bank balance sheet, but it’s already in the 200, 300 billion dollar range. And they’ve made, you know, loans to small businesses in the 60 to 70 million company range at this point. Don’t hold me to those numbers exactly, but it’s about in those in that range. So I think those are sort of the first two lessons for Square from the history of Ant, which is number one. There’s every indication that their payment platform business is going to continue to grow in gross payment volume. And second, there’s every indication, depending on the regulations of the US, that their credit business could grow into something very, very large as it already is at Ant Financial. The third area I think is compelling is what Square calls their seller ecosystem. So you’re offering payment solutions very small retailers, service companies, and that’s mostly transactions for them. It’s a very natural thing to, okay, let’s build that out and let’s offer more services. And they have a pretty reasonable list at this point. They have, I’ll read the list, it’s virtual terminals, point of sale, square appointments. This is for service companies, beauticians, things like that where they can do their booking and invoicing and payment for these sort of service businesses. Square for retail this could be you know barcode scanning cost of goods sold things like that square for restaurants square invoices Loyalty marketing and gift card programs and really dashboards that start to give these small sellers Sort of real-time data insights. This is what Alibaba has traditionally called the uni marketing Which is these sort of real-time dashboards that companies are starting to use to get better insights into their business So if Ant Financial has three complementary platform business models, you could argue that Square is building out their second one, which they call the seller ecosystem. I would tend to call it a marketplace for enterprise services or SME services. However, I’m not real bullish on that one. I think, you know, they’ve got sort of 30 services, 30 plus services they offer to these small merchants. You know, when I look for a marketplace platform, I’m looking for thousands of sellers. I’m looking for tens of thousands. I’m looking for millions. At the minimum, it’s gotta be in the hundreds. Well, this is in the 30 range. I don’t really think that’s gonna be a platform business model in itself at this point. I think it’s more going to be a suite of services that they offer. to their user group, which is these small merchants, that is helpful to them and helps them with their operations and that’s fine. But I don’t think it’s gonna evolve into a fairly robust marketplace platform and I don’t think it’s gonna throw off that much money because I think you’re targeting very small parts of their income statement. Now when the CFO of Alibaba gets up and talks about where their major growth is gonna come from, what she will say, is their total addressable market on the consumer side would be the share of wallet. How much do consumers, in this case Chinese, spend? What percentage of that wallet could we get? That’s their total addressable market. They go from products to services to digital goods to everything else. On the merchant side, which is their other user group usually, their total addressable market, she basically shows a picture of the income statement of the traditional typical merchant. And on that we see revenue, we see cost of goods sold, we see gross profit, we see logistics costs, we see payment costs, we see operating costs, operating systems, various things like that. And they are trying to build into every level of that income statement and offer value there with the idea if we can add value to every level of the income statement of a typical merchant, we will end up taking a small percentage of that. That’s their total addressable market. which I think is a nice way of thinking about it. Okay, but all things are not equal. When you look at that, you realize the huge money, the big money is in cost of goods sold, it’s in marketing spend, and it’s in the revenue line. And that’s where a company like Taobao makes most of its money. It makes it in the sales of goods, the transaction, and it makes it in the marketing spend of these companies which they use to grow their revenue. That’s the big money. After that, okay, logistics is actually a significant line item. You can make some money there. You go down a little bit further, then you start to get payment, which is kind of where square lives. Everything below that is much smaller, and it looks as a non-square expert that they’re moving from payment, which is midway down the income statement, to the smaller items instead of going up into the larger items. So I’m not totally bullish on that as a major revenue idea. I don’t think it’s big enough to get to a marketplace platform in itself. Um, fine. It’s not bad. Nothing wrong with it, but I I’m not, I’m not a super impressed with that as an I, you know, as a complimentary platform. Now what does jump out at me as a complimentary platform is what Ant Financial has done, which is two buckets. The daily services marketplace. ride sharing, all that sort of stuff. I don’t think Square is going there. The other one is what gets my attention, which is the digital finance marketplace, where look, as these companies and as consumers get more and more money, we are gonna help them place that money into insurance products and into wealth management products into various investable assets, which Ant calls their InvestTech and their InsureTech. And we can see that Square has already somewhat put a foot in this camp. by helping these companies. You know, if you’ve got a lot of money in your digital wallet, well, we’ll put that into a money market fund for you. They’ve already got a foot there. I think that’s the other dimension that’s interesting. And that is a low frequency activity. So it’s very hard to build a standalone marketplace on that, but it is a very nice thing to build a complimentary platform to, if you already have a payment platform. That’s kind of what I’m thinking about for Square is, okay. You’ve got your payment platform, bam. That’s sort of driver number one. That’s growth trajectory number one. Number two, credit tech, which I think is part of a payment platform. That’s very interesting in the near term, three to five years. Third, invest tech. The idea of a digital finance marketplace that offers insurance and wealth management. And that doesn’t grow with frequency, it grows with assets under management, which could be very large over the long term. And that’s kind of how I break down. Square and what I think the takeaways are from Ant. Well, it’s some of it anyways. The rest of my thinking on this, you’re gonna have to be a subscriber because that all goes out in the emails. Okay, before I put the question to you, what do you think will be the biggest driver of Square’s growth going forward? Let me talk a little bit about the external view or the outsider view and why it’s so difficult in digital. And I think Square and Ant Financial are a very good example of this. Now, a lot of you who are investors, you know, you’re very familiar with this idea. People talk about it all the time in the investment community. I’m going to basically cite some of the thinking from McKinsey & Company, which has been talking about this a lot over the last, really, 18 months, two years. They’ve been publishing a lot on what they call the outsider view or the external view. But I mean, there’s pretty standard investment thinking on this. papers about base rates and things like that. So I’m mostly paraphrasing other people’s thinking here. But the basic pitch, the basic idea, is we view the world with an insider’s view. We tend to focus on something like a company we’re running or one specific company we’re looking at. And it’s a very micro view. And our brains tend to work this way. We tend to look at things that have happened in our own lives. We tend to look at experiences we’ve had. We tend to look at one company we’re familiar with that. And then we kind of extrapolate that forward. We glean lessons. This is what I learned working at three of these companies. We kind of glean lessons out of that. And then we sort of project those forward. Okay, this is what’s gonna happen. And we extrapolate from our experience and… we tend to emphasize the differences. Okay, here’s company A, here’s company B, here’s company C. I’ve studied all three. Here are the main differences between A, B, and C. Those differences are really important. I need to think about why Coca-Cola is different than Pepsi, then different than Dr. Pepper. And we tend to then project that forward. And that’s kind of what human brains do. And the net result of that sort of approach is we tend to focus. just on a couple companies or one specific industry. We tend to overweight the analysis of those couple of companies. We tend to overweight our personal experiences. We rely on case studies. It’s a very data light sort of case study driven approach. And it does tend to play into our overconfidence and our belief in ourselves that we can analyze things we can’t. Now that is. the inside view, the external view, the outsider view is the exact opposite. It’s forget your own experiences, forget one or two companies, forget your own information. Let’s look at a reference class. Let’s look at a hundred companies that do this and see what happened to all of them. So very data intensive. And we’ll look at the averages. And the idea is, look, most companies are going to end up in those averages. We’re not going to project one to two or three companies forward. We’re going to look at a whole slew of companies, take the average, and realize we’re probably going to end up in that. And our brains don’t do that very easily. We don’t think in terms of massive amounts of data. And we don’t think in terms of statistics like that. It’s just not how we work. You can have all the… I can study my brother’s dental practice all day long. and I can think of all the strategies he should do, and we should do marketing like this, and you’ve got four main competitors in your part of town, and here’s how we’re gonna beat them, blah, blah, blah. Or I could say, look, forget all that, let’s just look at the average revenue and average profits of 500 dental practices in Northern California, and recognize we are probably gonna end up in that bell curve. There’s probably nothing we can do to move outside of that. We wanna… be on the positive side of that bell curve, but that’s probably our future. That’s a statistical approach, very data-driven, and we’re looking for base rates or averages. And that’s probably where you’re gonna be. So that’s the external outsider view, and both of those things tend to be helpful. I had a long. hard history of learning to let go of the insider view because I like to think that way. I like to study the details of a small number of companies. I had to learn the hard way to sort of force myself to think in terms of broad industry averages and then put those views together. The general rule is if an industry is based on skill, like investing, like running an like hitting a baseball, the insider view is probably going to be more accurate. If you’re doing an industry that’s based probably more on luck, let’s say real estate, it’s hard to be a lot better than other people at real estate or running a restaurant or things like that. If it’s more based on luck, the base rate is probably going to play out over time and you’re better off thinking about that. So this idea of insider versus outsider view, then you see a lot of investors will talk about how do you determine whether something was based on skill or luck and separating those things out. Look, this management wasn’t really that skillful, just looks that way. It was mostly about luck in the short term. And then over time, everything kind of goes back to the base rate and it sits in the average. Luck doesn’t tend to last long term. Maybe skill does. So anytime you talk insider versus outsider view, you usually start talking skill versus luck, and then you start talking about regression to the mean, which I will talk about in a sec. One good example I’ve always sort of liked about insider versus outsider view is maps. Like you can pull up online the old maps of the world, and when people just, you know, let’s say the Greeks and the Italians, you know, they had these maps that were just based on the Mediterranean. because that’s what they knew, that was the insider view. And they would show a map of the world and it was just the Mediterranean and then a little bit of the coast of Africa and a little bit of the coast going up to England. And that was pretty much it. That was the insider’s view of the world, but then you put that against a map of the entire world and you realize that’s the external view, that’s the outsider view. And a lot of times when we’re looking at companies or industries, that’s really what we’re seeing. We’re seeing that Mediterranean thing and we’re spending a lot of time studying. the various intricacies of that when we really want to pull up to the next level and look at everything. And that requires a ton of data and usually some industry wide analysis and some aggression analysis and all the statistics of. I always kind of like the map view of it. I think it sort of makes it nice and clear. So how do we take the outside view of an industry or something like a payment platform or let’s say a simpler company like a CPG company, Heinz Ketchup. Kraft cheese or something like that. Well, the standard approach is you start looking for the average and then you assume that any company is probably gonna regress to that average over time, the regression to the mean. And you wanna know both. You wanna know what is the average performance of this company, a company in this space, and what is the rate of regression? How fast does a company typically go back to the mean? and then you sort of try and tease out luck versus skill. So another example, I think this is Credit Suisse. They said, here’s an example, a teacher assigns 100 facts and one particular student learns 80 of those facts. Okay, they know 80, they don’t know the other 20. The teacher then gives a test and asks let’s say 20 questions only. Now, Over time, you would expect the student to score 80% of any tests they get on those questions. However, in the short term, it could be higher or lower. It may be that on the first test, the student scores 90%. So the teacher asks 20 questions, the student gets a 90%. Well, in that case, we could say, okay, 80% was skilled because we knew they knew 80 of the 100 facts, but the other 10%, that part was luck. and we would expect them to regress to 80% over time. So yeah, you did well on the first test, you did well on the second test, but over time we’d expect that to come back to the mean. So we could look at various metrics for Heinz ketchup, Kraft cheese, something like that. And the metrics you often hear people talk about when they do this is they look at sales growth over time. What is the average sales growth over time? Sales growth tends to be the biggest driver of value over time. And your typical company regresses to the GDP growth over time, usually. And there’s outliers. Software in particular is an outlier. But your typical ketchup company will regress as a growth rate to the average of the GDP of the country. So we can figure out the average. We can figure out the regression to the mean, the rate. And we can kind of get a good outside view, external view. Another metric people tend to look at, gross profitability. which would be gross profits, you know, revenue minus cost of goods sold as a percentage, gross margins divided by the assets deployed. You don’t just want gross profits as a percentage, you want it over the total assets deployed. That tends to be a pretty good metric over time within a particular industry, particularly CPG companies. Operating leverage, again, this would be the change in operating profits relative to the change in sales. not operating leverage like operating margin as a percent, but operating leverage. If we change the per sales by 5%, how much do the operating profits change? It’s the ratio of the two changes that we want. That’s a pretty good number to have. I’ll put these in the show notes, but I’m just gonna read them off to you. This is standard stuff. None of this is my thinking, by the way. Fourth one, operating profit margin. Okay, that’s just operating profit divided by sales. That tends to get you the notepad, the net operating profit or loss after taxes. That tends to be very helpful because that leads you to return invested capital. Earnings growth, that’s helpful. And then the CFROI, the economic return on capital deployed, that’s cash return on investment. Anyways, I know reading these to you is not terribly helpful but I’m gonna put them in the show notes. If you don’t know these, write them down. They’re super important. You know, any business you’re looking at, CPG, automotive, real estate, whatever, I mean it’s really worth your time to take a moment to do the averages and i.e. the base rates for these five numbers in that industry. It gives you a really good sense of what probably will happen. And then you can decide how much of an outlier is this particular company. Now if we were talking about ketchup, I would have those numbers. But if we were talking about Heinz. I would then start to think about the fact that this company does have a pretty good competitive advantage under the sort of share of consumer mind, brand loyalty, things like that. There is a reason Warren Buffett bought Heinz Ketchup, right? So then I would think about, okay, how powerful is that versus the base rates? And I’d sort of blend the inside view, which is competitive barriers, competitive advantage, with the base rates for a typical staple CBG product. That’s a judgment call, but that’s usually what I do. And that brings us back to the question of Square and Ant Group slash Financial. How do you do the base rates for a digital company like this? I mean, everything I’ve been talking about, all the strategy, all these drivers of growth, all the platform business models, the network effects, the switch, all those things I spend all my time talking about. How do you reconcile a strategic view of these companies, which is what I do? Right? If you’re an investor, you know… I’m trying to help you three to five years down the road. I’m not gonna be helpful in what’s gonna happen next month with their latest earnings results. I’m the strategy guy, strategy meets the digital. That’s my strike zone. Okay, how do I reconcile a strategy view of these companies against the base rates? Can that even be done? I think it can be done in some cases. And I’m working on this actually quite a bit. What would be the base rates we would expect for a payment platform where their money is gonna be made mostly from a percentage transaction of payments processed, which is kind of what Square is doing right now. And it’s still one of the main drivers revenue sources for Ant Financial. I think I can get my brain around base rates for a payment platform. Now as that payment platform shifts from two user groups to three user groups, i.e. banks, and credit starts to become a bigger part of the equation, it’s getting harder for me to do that. And I’m struggling with that, to be honest. But I think I can get there. I think I can get there for e-commerce companies. Standard marketplace platforms for products. That’s Lazada, that’s Shopee, that’s Taobao. I think I can get base rates for that pretty solid. When you go from marketplace platforms, from products into services, I have more difficulty because I think that space is still evolving and it’s not terribly settled. And then when you go from marketplaces, from products to services like a Maytwan or a C-trip, and then into digital goods, like an iQiyi, like a Youku. I find that even more difficult. I can’t really get a good base rate there yet. But those first two I’m feeling pretty solid in. Marketplace platforms for products and payment platforms where it’s mostly about processing payments. I can get a good external view at this point. In China, I can get there in the US. I can get there in some parts of Southeast Asia. Definitely I can get there in Korea. India’s all over the map right now. And Facebook is actually doing really well in payments in India in the last couple months for those of you who are paying attention to that. It’s pretty impressive whoever’s doing that. I can’t figure out what person’s in charge of their strategy for WhatsApp in Indonesia and India, but somebody’s really doing pretty well. There’s a lot happening right now. But anyways, that’s where I am in my thinking. And based on that, I can actually get to a pretty solid base rate for Square because it’s a simpler version right now. I can get there about a third of what Ant Financial is doing. I can’t get there to their digital finance marketplace. I can’t get there to their digital services marketplace yet. But I can get there kind of for the payment. And then credit tech is a bit of a question. And Square is actually pretty simple. It’s not that complicated yet. So I can kind of get there. Anyways, that’s about where I am with my thinking on this. But I wanted to sort of tee up the idea of base rates, the external versus the internal view. because I have been so heavily focused on sort of the strategy questions between companies in digital, but it’s an important number. And I think in some places it’s becoming clear, and I like that. I feel pretty good about it. Other places I have no idea. So that is the last concept for today. So I’ve given you four ideas for those of you who are subscribers that I think are important. Complimentary platforms, marketplace platforms, payment platforms, and the external versus insider view. a subpoint within that would be regression to the mean, i.e. base rates. Those are the four ideas for today. They all go under Learning Goal 19, which is the basics of Ant Financial and Payment Platforms. Now, that brings us to the question for today. And I haven’t been doing this recently, but I’m gonna get back to it, which is I want you to take this apart and to take a stab at this and try to apply this stuff. So my question for you. what is going to be the primary driver of squares growth over the next three to five years. Credit tech, payments, this move into what they call their seller ecosystem, which is providing various tools for sellers, you know, which I listed several of them for you, or something else. Make a call. If you were doing a valuation, what would be the primary driver of their growth that you would sort of hang your hat on? And could you do it? So anyways, pause the podcast. Take a moment. Take out your journal. For those of you who are subscribers, please have a… Please have a journal, write this stuff down. We are way beyond what I think anyone can remember in their head. I can’t remember all this stuff in my head. I have massive notes on all of this stuff that I’m always adding to. It’s like my secret spell book and my secret recipe book that I’ve been building for literally eight years. So pause the podcast, make the call. What is the primary driver of Squares growth? And then come back. So pause now. Okay, did you do it? If you didn’t, pause and try and give it a shot. But I’ll give you my two cents on this just so you’ll have a little bit of feedback. Yeah, the primary growth drivers I’m looking at for Square are the payment processing and credit. I’m not putting a lot of weight on their seller ecosystem. I just don’t think it’s that big. I think the whole enterprise space is different. I don’t think enterprise… can move up from simple merchants to more complex merchants very easily. I don’t think it’s that standard Clay Christensen, you know, coming with a low market product and then move up market. I don’t think that works in enterprise like it does in other sectors. So yeah, those will be the two, credit, tech, and payment. And I think I can come up with the insider view for both, and I think I can come up with the outsider view for payment, but not really credit. And that is it for the content for today. You’ve got the concepts and I’ve put a couple articles and podcasts on the same subject of Ant Financial in the show notes if you want to learn more about this. All this is always in the webpage where this episode will be posted. The base rate notes are also in the notes. So that’s pretty much it. As for me, I’ve been having a spectacularly good week. It’s just been one of the best weeks I’ve had almost in years. There’s no major reason for it. It’s just that I’m really enjoying, you know, this my life in Bangkok, which was not really my plan. You know, I had moved here sort of at the end of 2019 just as a place to commute in and out of. And then I was, you know, usually in China is where I am most of the time. And then with COVID, I got locked down here, which is very strange for me because I’m so used to traveling all the time. And I’ve just been sort of a homebody and it’s great. I spent today, today’s Sunday, I went over to I think Bangkachow, I pronounce everything terribly here. This sort of island in the center of Bangkok which is just all greenery. And I took the scooter over. I just sort of went down and rode my scooter onto the little boat and the boat took me right over. I rode right off and spent the afternoon buzzing around in all the greenery and the little markets. And it was just a great afternoon. And now Christmas is coming and there’s decorations everywhere. Yeah, it’s been such a nice couple weeks. Let’s see, what else? Oh, big news, well not big news, but for those of you who like Star Wars, I’m a huge Star Wars fan. I grew up watching Star Wars, little kid, and they have those books, the Star Wars books, of which I think there’s 95 of them. I’ve read all of them, all 95, like more than once. So it’s kind of been my thing, I just like it. And then Disney took over Star Wars and the movies were terrible. and they destroyed all the favorite characters and it was awful. It was agonizing. Well now it’s all being fixed with the Mandalorian and for those of you who are Star Wars fans, the season finale of the Mandalorian was a couple days ago and the ending was the greatest two minutes in Star Wars since 1983. Like I won’t give a spoiler away for those of you who haven’t done it but the last two The last episode, season two of The Mandalorian was so awesome. I’ve been waiting for this literally for 20 years. It was spectacular. And all the Star Wars fanatics of the world, if you go online, everyone’s losing their minds. Like, people, literally people were crying. I’m not kidding. You can go online and type in YouTube reaction Mandalorian season finale and you know the reaction videos where people post themselves like individually or with you know groups of friends watching it in real time and people were losing their minds like people literally cried watching this it was unbelievable. The reaction videos alone are really interesting and entertaining to watch but if you do that you’ll totally spoil the episode for yourself so you’ve been warned. But anyways spectacular, awesome it put me in a good mood for several days. Like I mentioned a couple weeks ago how when Ahsoka appeared in the Mandalorian which is an animated character this was the first time we saw Ahsoka in live action, which is Rosario Dawson, which is awesome because she’s awesome. That was like huge. I was like, oh, this is so good. What happened in the last couple days is five times better than that. Anyways, that was my weekend. But I hope everyone’s doing well. I hope everyone’s getting sort of psyched up for the holidays. It’s really, it’s a great time of year. But that’s it for me. I hope everyone’s doing well and I hope this has been helpful and I will talk to you next week. Cheers from Bangkok.