In this episode of Industry Focus: Consumer Goods, join Motley Fool analyst Asit Sharma and host Emily Flippen as they dig into the business of “aggregating Amazon (NASDAQ:AMZN)” and the small private and public companies creating a $200 billion industry from the ground up.
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This video was recorded on April 27, 2021.
Emily Flippen: Welcome to Industry Focus. Today is Tuesday, April 27th, and I’m the host of this consumer goods focused episode, Emily Flippen. Today, I am joined by Motley Fool analyst, Asit Sharma, as we dive into the elusive world of third-party aggregators, people who go up and buy businesses that sell on sites like Amazon and Walmart. Asit, thanks so much for joining.
Asit Sharma: Emily, thank you for having me. This is a really exciting topic for me. Well, I thought it was going to be an exciting topic because I thought this was about those people who sell me a product with five stars, but when I use it, it’s more like a two or a three-star [laughs] product on Amazon. That’s not what we’re talking about today, is it? [laughs]
Flippen: This is the weirdest kind of underbelly that I think you’ve ever exposed me to, Asit, and you’ve exposed me to many weird underbelly of the consumer goods industry, but this is certainly a weird one. We’re going to be talking about the third-party sellers. I think everybody is probably familiar with them if they haven’t purchased directly from them on sites like Amazon and Walmart, where small entrepreneurs who have ideas for products or have connections with somebody in manufacturing, come up with an idea and they produce a product to sell on a third-party site as a third-party seller. Oftentimes, this is Amazon because of their Fulfillment by Amazon services that do a lot of the legwork for these entrepreneurs, and then they really get off the ground running. At some point, they reach a point in their life where they have a choice. They can either continue to invest a ton of time and money into scaling up a product that maybe they didn’t intend for that to be their full-time job, or they can sell it. Increasingly, there’s a lot of money and a lot of businesses and businesses that are just buying these third-party sellers, looking to sell their products and creating interesting portfolios, a Motley portfolio, if you will, of different products sold on sites like Amazon.
Sharma: Yeah. I think of this as a cottage industry because Amazon is so big. Emily, you had pointed out when we were prepping for this episode that third-party sellers represented over $200 billion in digital sales on Amazon alone in 2019. That’s about 60% of the business of their marketplace that year. Why is this even possible? It’s because Amazon has spent so much money in the fulfillment side of their business and delivery so that they’ve got the tools there, third-parties use them. Almost anyone can now do this, just become a successful entrepreneur overnight. I don’t mean to oversell that because I guess if it was that easy, then you and I probably wouldn’t be on this podcast. [laughs] We may be doing something else, trying to mind our store. I wouldn’t call it easy, but it is not impossible if you have a bench for marketing, if you understand what products can sell and you become good at this sort of business. Amazon has leveled the playing field. They’ve taken the capital out of the equation. You don’t need really much capital to start, although you might need it to grow.
That might be one reason you decide to sell to one of these third-party aggregators. But there is the cycle in the normal business world of small entrepreneurs deciding at some point just to gather what they’re doing, take the money, invest it elsewhere, or maybe retire. I really love that we’ve got a case study in Amazon, since it is the biggest fish in the e-commerce pond, at least here in North America so we can wrap our heads around this. I don’t know if this is going to be a growing phenomenon where we’ll see a lot of companies that actually become public which aggregate revenue streams like this, we’ve got actually one to talk about later in the episode. But I do know it’s something that we want to pay attention to. Just to reiterate, this market, we’re loosely going to call it the Fulfillment by Amazon market or FBA, if we say that during the podcast, that’s just shorthand, referring to these small third-party sellers that are using Amazon’s fulfillment capabilities to sell their products.
Flippen: I have to be honest, when you first mentioned this idea to me, my instinct was, this can’t really be that big of an opportunity. But the $200 billion in 2019 sales from third-parties on Amazon, I think encapsulates why there’s so much interest in the industry. In fact, just over the past two years, they have estimated to be over a dozen companies that have raised at least $100 million or more to buy and roll up third-party sellers on Amazon, these FBA customers. That industry itself is so unique and interesting. In fact, before we start taping this, you said a couple of really interesting articles describing the industry. There is one really good Forbes one, which to your point, I think encapsulates everything in a very succinct way. They had an interesting example of the type of person these businesses go after. They highlighted a man who had a really great idea for an odor eliminator, a pet odor eliminator.
Sharma: That’s always a problem that needs to be solved in the market by someone, never ending problem.
Flippen: [laughs] It’s so true. I’m actually doing this research, maybe want to go out and buy this product myself. But he got a lot of success selling this odor eliminator that he’d created on Amazon and it got to the point where he didn’t want to run the business anymore. He is one of the successful entrepreneurs and he decided that he was going to sell it, and he sold it to a roll-up company for nearly $1.5 million. He got himself off on vacation and a new fishing boat. Then that company that he’d rolled it up with, was able to increase annual revenue for that odor eliminator by eight-fold to nearly $17 million annually. They buy these products they love, they scale them up, and they buy out the existing producer of it and just create a portfolio of businesses. One of the businesses that it’s not public that we’ll talk about, and I think was actually the brains behind this odor eliminator roll-up was, I’m going to horribly mispronounce it; Thrasio, thras.io. I’m not sure how you pronounce it, […] business.
Sharma: I was thinking Thrasio when I was reading through. But that is the power of the spoken word. We get to determine how we’re going to pronounce this company until we get a nice letter from their internal communications department. It’s not pronounced Thrasio or Thrasio. I like Thrasio. [laughs]
Flippen: Well, Thrasio, if you’ve gone to their website, I think it’s T-H-R-A-S.I-O, which was what led to my confusion in the first place. But if you go to their website, everything is aimed not at an outside party coming and who’s looking at giving them capital, for instance, but it’s all aimed at third-party sellers. They’re like, you want to sell your business, you want to sell your Amazon store, sell it to us. It’s a big enough market that Thrasio is out here, actively trying to recruit people who have products like this odor eliminator.
Sharma: It sounds like it could be a win-win. Thrasio can increase those revenues 8X, and this gentleman, he got a vacation and a new fishing boat as you point out, and what more do you want? You need a vacation.
Flippen: He knew what his priorities were. [laughs]
Sharma: Exactly. You know, I love that you alight on this example because the story encapsulates for me how this cottage industry functions. It’s geared to entice the sale of these brands from entrepreneurs to the bigger players. If you are curious, how do the dynamics of this FBA market work? Let’s say you’ve got a product out there, listener, and you’re thinking, “Hey, I’ve been doing pretty well. Maybe I should sell this.” To me, it’s so interesting because it’s not that much different than how things work in real life for anyone who’s ever sold a small business. We are often talking on Industry Focus about public companies, merging, acquiring other companies. We’re talking to venture capitalists making investments and private equity buyouts. But there is this really vibrant section of the private business sale market. Think mom-and-pop going to finally sell their business and retire or get a boat, in this market, small companies are sold by thumbnail multiples that are applied to their adjusted cash flow. By thumbnail multiple, I’m simply referring to a current acceptable multiple within a particular industry. For service business, this could mean that your business is worth, let’s say, two to three times your annual cash profit after you make some adjustments.
In my good career as the accountant, [laughs] I’ve worked on valuing deals in what’s called the middle-market, so these are slightly bigger companies with millions and millions of dollars in revenue, and I’ve also valued a fair number of smaller companies in the private market, and I must say, the multiples that are used in this FBA model are pretty attractive, especially when you think about the potential, as a seller, to increase your payout through what are called earn-outs, meaning, thereby, if you had this great scenario that Emily curved out, that the company which acquires your product can increase your sales eight-fold. They may have in the contract that you’ll get a piece of that for x number of years. In this industry, current multiples range from about 3.5 times to five times a seller’s annual adjusted cash flow, which in this brand new industry, they call sellers discretionary earnings or SDE’s. I’ll pause here, Emily, because even though I’m loving this, I don’t want to get too far into the weeds before pausing here to ask your thoughts on that.
Flippen: It sounds like a smart move for every party involved. I think there is a point at which small sellers have to make a choice in the life-cycle of their product that involves them going out and finding more dedicated capital to grow the business or looking for a way that’s kind of, I’m going to say an out, an out maybe is too aggressive, but are looking for alternatives. I think there are a fair number of people who are out there with the product who aren’t ready to go on shark tank and get a huge influx of money to spend the rest of their lives dedicated to making their pet deodorizer the next best thing, but still want to retain the upside while taking the stress out of their daily life, and maybe that involves finding a new product, creating that next new product that they sell. But it’s good on everyone’s part because it lets people want to get an opportunity to get out while still retaining upside and then gives the expertise over to these roll-up businesses, which I think I need to find a better name, I don’t know how to describe them otherwise. Do you have a word for them, Asit, that I’m just missing?
Sharma: No. Because in different industries we refer to them as different things. I like your term aggregator, that’s a really well accepted term. I heard consolidators [laughs] , roll-ups. This is what they’re doing, they’re rolling up companies, but I never heard someone call them roll uppers. [laughs] That’s why you’re doing the role uppers.
Flippen: All these aggregators, these consolidators, these role uppergators.
Sharma: I’m setting a rule [laughs] for the rest of this podcast. We can say call nothing but roll uppers. Are you game?
Flippen: I love it. Consistency it’s key.
Sharma: [laughs] Okay. Cool. Makes it easy.
Flippen: [laughs] Well, these role uppers have all the experience, and that’s what these entrepreneurs need.
Sharma: Yeah, I agree. I think it adds a new element to the game. If you are a budding entrepreneur who has only thought of amazon.com as a place where you could create a good side hustle. Let’s say you decide to master SEO and how to advertise your products, and you’re really into selecting products and reading and writing reviews and think to yourself, “Hey, I could do this. I could do some third-party manufacturers and get into this game.” Now, you’ve got this whole other element where if I create a revenue stream, maybe I can sell it for several times my annual profit. Before we move on, I want to actually define, for those who are interested and for our future knowledge, what actually this seller’s discretionary earnings is. It’s a really simple concept. Basically, you take your net cash or whatever your proxy for a cash profit is in your business for one year, and then you add back certain items. What are these add-backs? Well, it’s not that mysterious. One big one, I think the most important one is adding back the salary and benefits you might have paid yourself over the year because to the buyer of the business, they’re not going to pay you that salary or give you [laughs] those benefits. That’s not an expense to them. That actually increases the value of your business if you remember to add that back because you are getting paid on a multiple of that profit stream. It’s a really simple equation.
Again, anyone who has ever sold, let’s say, a restaurant or a dry cleaning business or bakery, any number of small businesses. You remember this exercise where you took the books that your accountant had, discussed it with the buyer and your salary and some other expenses were added back in, you got paid a multiple of that, and you bought the boat. Having said that, I just want to reiterate something that you mentioned because it’s so important here, Emily. There’s two types of buyers, there are financial buyers and there are strategic buyers. A financial buyer just wants to run the financial equation that’s already in place and just get an annuity from the purchase. A strategic buyer is going to add something to the equation after the transaction is completed. They will add capital, they’ll add expertise, they’ll add technology. These role uppers are doing all of those, all three of those, to increase the value to themselves and in some cases, give a bigger earn-out to the person they bought the business from.
Flippen: I know we want to talk about one public company that’s playing in the space. But I think it’s worthwhile to dig into the private side more because there are just so many smaller private companies that are defining this industry. While they may not be relevant for investors today, I think they do paint an important aspect of the picture of what it’s like on this back-end of mainly Amazon, if for being honest, and to talk about that, I’ll further highlight Thrasio. There are a number. I’m just highlighting this one because it seems to have the most information available for it. But Thrasio has spent over $100 million the past two years to buy nearly 100 third-party sellers. They’re posting revenue of over $400 million from these 10,000 different items. The big aspect for Thrasio is just taking a really lean team and then just doing simple stuff like, hey, we have a checklist, a 300-, 500-point checklist for key terms that we can add in to certain listings just to increase the organic search that comes up on sites like Amazon to increase sales. They’re not going through and having to. Well, they will for some products, they’re not remaking the wheel for these businesses, for the most part. It might be negotiations with the manufacturer, it might just be changing SEO. But the idea is that we can do a better job about running this business because we have the money and the expertise and the skill to just really quickly integrate these 10,000 different products and to a business that is really just a machine of machines.
Sharma: [laughs] I love that phrase. This is something that fascinates me is the way that Thrasio can close an acquisition, in many cases, in just over a month from looking at the terms of the deal to completing the sale and the money is in the seller’s account. How can you do this? If you think about a typical deal where, let’s say, the revenue stream is, I don’t know, $2 million, $5 million, $10 million. In most businesses, just the due diligence portion of that transaction could take three to six months. Easy. [laughs] How is this such a fast turnaround? Well, the answer is, it’s built on something that’s completely visible. The person that Thrasio is buying from, in most cases, never really did any contract manufacturing with any significant sort that’s outside of the Amazon ecosystem. They chose Amazon as a fulfillment arm. They use Amazon’s tools [laughs] to sell their products. They work on Amazon’s SEO to have their search results rise up.
It is a really simplified business model to begin with. There’s not a lot, when you kick the tires, to really uncover. It adds to the speed of Thrasio and how Thrasio is able to buy these companies quickly. I think too that the speed indicates the size and the scale of this industry. You had mentioned, boy, at least 10 other competitors that have hundreds of millions of dollars among them in the same type of business available to buy other companies. I just have a few here to name, there’s a company called Heyday, this one is called Perch, there’s another called SellerX, a fourth call boosted commerce. Just these four names between them have raised about half a billion dollars in capital to implement the Amazon FBA roll up business model. But I did want to ask you something. Emily, you had identified, is a really great risk, and we’ll probably touch on this before we wrap up this podcast, but it’s so big that I think it’s worth mentioning here before we go forward.
Flippen: I assume that this risk is the Amazon risk. Feel free to correct me if my assumption is incorrect, but as we talked about, we’re talking about third-party sellers. The reality is the vast majority of these sales are happening on sites like Amazon. It’s wonderful because that’s where a lot of consumers automatically go to make purchases. But the flip side of that is you’re operating in an environment where Amazon makes the rules and they can change the rules at any time. Being flexible and adaptable is key, but also predicting the unpredictable that exists with dealing with a single party who controls your business, I think is really an outsized risk. But the other aspect too is like Amazon is not dumb. They see third-party, say, coffee makers that’re selling really well. They’re going to make their own private label coffee baker and then sell it under the Amazon basics brands. While they claim to not do this and there’s all these lawsuits and legal issues around, if they do do it, how much can they do it? Is it anti-competitive? But I think it’s fair to say on some level, this is happening, or if it’s not happening, if you can claim it’s not happening, it’s a risk that could happen. Those two things alone just mean that there’s just a lot of Amazon, a lot of basis risk.
Sharma: [laughs] Basis risk. I like that. I think it’s something that you go into with eyes wide open if you are investing in a company in this space. As an investor, you could be a company that is contributing capital to a role upper. I should say, so we are shameless plug here for those of you who have a Motley Fool subscription, you can catch us live on Tuesdays as we’re recording. I was just glancing at our Q&A and we’ve got a suggestion from a viewer who says, “I would call them role upperators,” so combining the role uppers [laughs] with aggregators, which I love.
Flippen: I love that. [laughs]
Sharma: New rule [laughs] for the rest of this podcast, they’re going to be called role upperators. You could be giving money, infusing a role upperator with capital, or you could be a retail investor like us, maybe looking at shares of a publicly traded company which we’re going to talk about in just a second here. But you got to be aware of this risk, it’s a big picture and it’s something that could change a company’s success overnight with a leading product. Amazon can move pretty quickly when it sees that there is a product that they can copy and make their own, and not necessarily dislodge the incumbent who came up with the idea but poke their cells down a bit.
Flippen: As you mentioned our live audience here, I see there’s already a comment from somebody who has smartly predicted the public company that we will be talking about in this space. But before I pass it over to you, Asit, to talk about this business, I want to provide a little bit of a small-cap warning. This is a sub one billion dollar business. When we talk about this company, I think it’s just important for all of our listeners, both podcast and live, to know that we’re not recommending this business. It contributes to a broader conversation about the industry but because of its small size and because of how new this industry clearly is, there’s a lot of outsized risk involved. With that probably somewhat necessary or maybe unnecessary, I don’t know, disclaimer — Asit, what’s the company?
Sharma: I like that. Emily, the company is called Mohawk Group Holdings (NASDAQ: MWK), the symbol is MWK. Full disclosure, I don’t own shares. I don’t think, Emily, you do either.
Flippen: I don’t.
Sharma: I think difference in style to our deep dive. We spend a whole hour, [laughs] sometimes. We get long-winded. But we shoot for 30-40 minutes maybe looking at the prospectus of companies that just come to market or we look at a company that’s been around a while. We’re not really doing a deep dive of Mohawk, but using this as an example to extend the conversation around this ecosystem. What does Mohawk do? Well, it claims to use proprietary machine learning and artificial intelligence algorithms to identify the most attractively positioned products that the AI can come up with and then bring them to market so they can acquire smaller sellers as Thrasio does, or if their artificial intelligence sees an opportunity, they’ll create the product themselves. Here again, speed seems to be of the essence, Emily. They claim that if they create the idea themselves, they can bring that product to market in three to six months.
Flippen: It’s an incredibly fast turnaround that’s a little bit hard to believe and maybe indicative of just how quickly moving the space is and how new, I guess, these roll operators are [laughs] throughout the business. I like the fact that Mohawk leaves a certain level of optionality on the table. They’re not out there 100% competing with these private companies for third-parties looking to sell their businesses, that could lead to them to pay multiples, that maybe they’re not comfortable paying. They have the option where, hey, maybe we like that coffee grinder, but maybe we’re nervous that Amazon is going to knock it off, so we’ll do something else. Or maybe we like that coffee grinder, but we don’t want to spend that much money to acquire that specific coffee grinder, so we’re going to make our own. The fact that they can bring them in three to six months to market on Amazon is particularly interesting. This is still a business that deals mainly with Amazon though. All of those risks that we talked about still pull-through on this business, but I like the fact that they play it both ways. They can target successful sellers or just target successful products themselves.
Sharma: Yeah, that’s smart, and the idea of developing your own platform is always something that attracts me in a space. I love marketplace businesses, that is businesses that present the marketplace. Well, Amazon.com is one, but I like platform businesses too that think through how do we do something great in an industry from start to beginning and then you sell that model to users. Let’s say that this company, if they had to dream up an engine to do all this, what would they call it? Let’s say they would call it something like AIMEE, which I don’t know if we’re pronouncing that correctly either or is it Ami or AIMEE.
Sharma: AIMEE, right, because our Artificial Intelligence stands for AI Mohawk E-commerce Engine. I’m going to call it AIMEE until we get that plight letter from the internal communications [laughs] department. Let’s break down what AIMEE does. This is the software that runs the whole platform in which they dream up products and bring them to market. The first part of AIMEE is automated research. The software is tracking real-time data and trends on Amazon.com and identifying products that are trending. Similar to what you or I might do if we had a business and we just decided, look, we’re agnostic as to what we’re going to do. I don’t care if we’re selling laminated clamshells. If people want laminated clamshells, that’s what I’m going to sell because I see that clamshells are trending and I see that laminated products are trending.
Flippen: You’re not making me want to invest here, Asit. If Mohawk’s out here selling laminated clamshells [laughs].
Sharma: Hey, you know what, I’ll take novelty over marketability any day, and that’s been my big fall in life. If I had focused on marketability, I would’ve gone places, but I stuck with novelty, and here I am, though, with you [laughs].
Flippen: I’d rather have you here any day.
Sharma: [laughs] Well, I appreciate it. I really like this part of the software, the AIMEE idea generator, is what they call it so much more acutely than I think you or I could as humans. The software combs lots of data in real-time and then starts suggesting products that can be created, brought to market, as you mentioned, Emily, in a very short time frame. Then they’ve got a second module, which didn’t impress me all that much, they call it their financial module. I think this is pretty much just basic finance and accounting software. Although they do claim that they drive some data driven analytics out of that, that can help a user. We should reiterate here that the software can be used by the company, but it can also be licensed. Or I think you are going to mention that actually, if we haven’t already, so they do license this to a few other companies.
The thing that really interests me and I’d love to hear your thoughts on this, Emily, is the trading engine. When I looked at that, just in an investor presentation, I thought, what is that? Are they also trading some of the capital, or using some money to day trade on the side. I realized that they’re referring to a term of art in the consumer goods industry. It’s actually a British term, but trading in this industry is the money that you spend to promote your product, to advertise your product so that AIMEE trading engine uses its AI to make automated decisions on where and how to market products on Amazon site. I thought that was pretty robust. This is the thing. Maybe next to the next piece we’re going to talk about that interests me the most. What were your thoughts on that?
Flippen: It’s really interesting and there’s certainly a strong argument that they’re at the right place, at the right time. For me, I think the question becomes, how valuable is this software, is this algorithm and the AI, I guess that’s happening behind the scenes if and when the paradigm changes? I think that’s my concern with a business like Mohawk, as they have developed something that has, to this point, been really successful for products on Amazon, and their algorithm gets smarter every single day and figuring out where we should be or where they should be investing money for advertising. What type of products are trending, what keywords are important to pull-through, and it’s been so successful that they have licensed that to other FBA acquirers or role operators, if you will.
There’s clearly something that’s working there today. I think my concern is, no two sites are alike, and to the extent that any purchasing moves away from Amazon, as we’ve seen with the success of businesses like Shopify, that allow third-party sellers to create their own site to sell their products. The success of businesses like Etsy. How transferable is this software when you move it away from just Amazon? I think it’s successful now. I’m just not sure if it’s enough that makes me really interested to go out there and buy shares.
Sharma: That’s a great insight. I also wonder too about the same thing, the nature of the markets changing. I remember way back in the day, they had these trading black boxes, still have them today. Today we say they’re based on artificial intelligence and I’m using trading in the investing sense that most of us know. There were lots of quantitatively brilliant people who used something called NLP, Neuro-Linguistic Programming, who studied neural networks before we had these artificial intelligence tools and they developed trading black boxes. Some of them worked really well for a year or two years, and made their investors a lot of money, but then the markets changed. The nature of the markets are always changing and the black-box has become useless.
The other thing was that it was subject to what’s human intervention. When you give over the idea to artificial intelligence, there is this documented tendency of the human maker to intervene. What happens to Mohawk? Let’s say they’ve got a run of products that AIMEE said, this is going to be a hit. Now, AIMEE, I’m sure, talks in a much more sophisticated language than that, talks in binary language, but AIMEE suggests that this is the product. We run that product through the whole system and it flops, and this happens two or three times in a row for whatever reason. Then it provokes the human tendency to look a little more closely at the next suggestion and maybe tinker with it. There is a potential pitfall there.
Anyway, the last part of the software that we want to talk about is just the logistics piece. AIMEE helps manage this whole manufacturing and supply chain cycle, which is already fairly easy. Again, if you are someone who sells on Amazon.com, you understand that this is basically just interfacing with other parties to have your product manufactured and to make sure you’ve got enough inventory. It’s no longer rocket science with tools that are already there and available on Amazon, but AIMEE makes this even a little bit more efficient according to Mohawk. With all of these different parts of the software, they think they have an incredible tool which can help them grow in excess of the market. Indeed, Mohawk is showing pretty great revenue growth. They’ve got I think a three-year compounded annual revenue growth rate of about 72%, and they just became cash flow positive on an operating basis last year. I will though, just caveat this, that I’m a skeptic [laughs] of this company, although I see the potential and I’m going to watch it.
The first thing that makes me skeptical, Emily, is that 88% of the company’s revenue was derived from the Amazon Marketplace last year. Now they are expanding to other marketplaces, including Walmart’s, including Shopify. They’ve got some SKUs on Shopify stores. The CEO, Yaniv Sarig, has stated the company’s interest in expanding into e-commerce marketplaces in India, China, and Japan, which sounds great. But man, that’s a concentration at the moment.
Flippen: I agree, I think, with your skepticism. But before I get into why, I think I tend to be a little bit of a skeptic for this business. Before I get into that, I will give them credit where credit is due. I do think the trend away from brands is probably really real with younger consumers. So I don’t worry so much about them having to compete with bigger brands. I think there’s going to be a big difference between the successful Nikes of the world, the Lululemons, if you will, of the world in the pelotons that have this great brand that we always talk about, but then everything else. I think everything else is more price-sensitive, less quality focus, and I think that is where Mohawk can thrive.
The reason why I tend to be a little bit worried, and I know that they’re on Amazon because the vast majority of third-party sales come through Amazon, they’re not specifically targeted for any other reason than that’s where the market is right now. I think my worry is just, succeeding as a third-party seller on Amazon is increasingly challenging. Especially as steak products or illegitimate products crop up, I think it degrades trust in non-branded sellers on that platform, which can be hard, I think, for consumers to overcome that hurdle, which is why we’ve seen that number generally go to other sites. I think all-in-all, it’s a good business. They are certainly at the right place at the right time, and I don’t think there’s any denying that their algorithm and their software has worked to this point. I think my skepticism comes in and recreating this success for the long term in many different markets on many different sites.
The good thing is, this is a type of business where it’s very small, like I said, a sub $1 billion business. You can keep an eye on it, watch, listen to their quarters, listen to management talk, and start to see if they are able to execute on this strategy, use their software on different sites and in different countries. You can be one of the first people who realize that business is in fact scalable in a way that maybe I’m discounting right now. But for those reasons, because I can’t wait to get in, I probably would wait to get in.
Sharma: Yeah, sure. I’m the same. I heard you use the word different a lot in your explanation. There are different products, different sites, different countries. That word “different” sticks with me a lot because I’ve had one beef with the long term economic equation here. That is in the consumer goods industry, the really, I think highest end companies, or the best-in-class companies. They build these advantages and then start to reap the true cost advantages over decades because they focus on homogenous stuff. If you think of a company like Mondelez, it has just a whole division that is only centered on chocolates, and they do chocolates really well under Cadbury’s and a lot of different brands.
Most of the big CPG companies, consumer goods companies, are focused on specific product lines. They own manufacturing, and overtime they get better and better at it. With Mohawk, they have so many different products in just wildly different lines, from ice makers, to hairdryers, to electronic keyboards. Over time, it’s really hard to improve those margins because you’re, first of all, starting out working with contract manufacturing. You are not manufacturing your own product, but you’re working with different contract manufacturers and an ever new evolving slate of contract manufacturers. As Aimee comes up with her next big thing, which she decides, look, it’s not laminated clamshells, but oyster shells encased in blue velvet.
When she says that you got to find a completely new contract manufacturer. This idea of scale, homogenative product, improving your supply chains and manufacturing, just isn’t there for the long term here. But maybe I am wrong and I’m not seeing how magical the idea of introducing these winning products is based on what’s trending, automating the product research and development, automating the marketing spends. Maybe I’m missing right now how powerful that will be, and that’s going to make up those lost points on the manufacturing side. The beauty of it is, Emily as you point out, we don’t have to jump in and buy today. We can watch this over the next few quarters. Get in when it really looks like it is an unbeatable proposition. I look back at Amazon.com and you could have made money, wonderful money, buying Amazon in the first year, second year, third year, fourth year, and holding it ’till today. So in some ways, we often have this desire to rush into a really cool investment, but patience can often serve us well.
Flippen: I will just add my one last thought, which is, I think the hardest part about my job, and speaking personally here, is trying to differentiate what is luck versus scale. For instance, if I open up a tech portfolio in March 2020 and I’m up 100% in March 2021, how much of that was, “https://www.fool.com/”I’m so good at picking tech companies.” How much was that was, “https://www.fool.com/”I launched a portfolio at a market bottom right before pandemic hit when everybody started using tech way more.”https://www.fool.com/” It’s a challenging proposition for somebody, at least somebody who doesn’t have a really quantitative background like myself, to start trying to identify how much of what I do is because I’m good versus how much is uncontrollable factors or factors that I didn’t specifically pick? I think that the same level of criticism that we apply to ourselves as investors needs to be applied to the Aimee platform. I’m not familiar enough with Mohawk as an investment to know if they’re doing that on the backend, but I’d want to know that Aimee is good at picking products, in particular, specific products, an ice-maker over coffee maker. As opposed to just picking products on Amazon when everybody is shopping on Amazon and everybody is moving their sales online, so the rising tide has in fact lifted this boat. Is their proprietary algorithm really better than an anecdotal investing [inaudible] what is that word? [laughs] Metaphor, I guess.
Sharma: Yeah, metaphor. We’re throwing out metaphors all the time. We just forget what the word is, switching for two.
Flippen: I’ll try that again. It’s like that metaphor of the monkey throwing darts at a wall and picking stocks based up where the dart lands. You want to make sure that the algorithm is doing a better job than an algorithm that just picks, throwing darts across a wall. I hope, and I trust that is the case, that the AIMEE platform is doing that. But I think that would be my, if I was going to go one level deeper here, that’s what I’d be trying to suss out with this business.
Sharma: Such a nice analogy to find your alpha, so the difference of your performance returns versus the market. The best indicator is often when that’s associated with time. If Emily is beating the market year-after-year-after-year, whether we do something called an attribution analysis.
Flippen: There we go, that’s what it is.
Sharma: I just learned about this, [laughs] it shows you how ignorant I am. We find out what is creating Emily’s alpha versus the market, what’s creating her outperformance. Over time if she is doing this year after year, after year, we don’t even have to do that analysis. We know what we can do and we’ll find out what it is. But we can see that Emily’s got an edge of some sort or another. The shorter time period, it could just be luck. You could just be getting lucky. I love the way that you put that because it helps relieve the anxiety of innovative products in the marketplace and innovative tech, which as an investor makes you want to buy those companies. Alternative always is to get a little skin in the game. We only often say this. Just to buy a little bit of a company and start falling just so you get your feet wet and remember to look at that company every quarter. But I love that analogy.
Flippen: Well, also to the extent that that was an analogy. Thank you for your comments. But even more so, thank you for coming on, bringing this idea to us and giving us your thoughts today.
Sharma: Yeah. This was a really interesting one, and I’m sure we’ll revisit it at some point in the future. Thanks so much, Emily.
Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say “Hey,” shoot us an email at email@example.com. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don’t buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I’m Emily Flippen. Thanks for listening and Fool on.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.