Electro Optic Systems (EOS) – a unique defense company

Years ago, when I worked as a hedge fund analyst, I dove deep into the satellite + space imaging industry.

The most interesting thing I learned was that space debris is a huge problem for humanity.

This scene from the movie Gravity demonstrates the problem pretty well.

Orbiting space debris travel 7x faster than bullets. And at that speed, even small paint chips can cause a lot of damage.

Every time we launch anything into space, debris naturally accumulates. And the problem grows exponentially.

EOS – a defense company working on the space debris problem

In 2014, I discovered Electro Optic Systems (EOS) via a news release that this tiny Australian company signed an agreement with Lockheed Martin—the giant US defense contractor—to tackle this issue.

EOS is listed on the Australian stock exchange. As of 9/30, it comprised 5% of my portfolio. Not only does the company track space debris, it also enables space communication,

However, both those items are a small portion of EOS’ business. Communications was 11% of first half 2020 revenue, while space debris tracking was a negligible 1%.

At its core, EOS is a defense business (88% of its revenue) at the forefront of modern warfare.

It sells Remote Weapons Systems (RWS) –automatic guns mounted on vehicles. And it sells Counter Unmanned Aircraft Systems (CUAS)— lasers that destroy drones.

Over the past 4 years. EOS’ Revenues have increased dramatically, driven almost entirely by the popularity of its remote weapons systems.

Geopolitical tailwinds that help EOS

EOS sells its products globally beyond Australia. They sell to the US and countries allied with Australia and US. 59% of 2019 revenue came from the US, and 27% came from the Middle East.

The company is fortunate to benefit from America’s changing geopolitical stance.

For better or worse, America’s allies are realizing that they need to fend for themselves and invest more in their own defense.

Whether Biden defeats Trump – now that the seal has been broken, the genie cannot be put back into the bottle.

This is quite the favorable trend for EOS—the national champion of Australia’s defense sector.

Risks

Of all the companies in my portfolio, EOS is the most dependent on advanced technology.

3 interesting assertions from the company:

  1. Its remote weapons systems and anti-drone systems are the best.
  2. It is reaping the reward of many years of R&D.
  3. Much of its leading technology is fueled by research derived from their space business.

Today, these statements are being proved out in their financial results.

However, it’s hard to get comfort on how durable their technology is.

On the other hand, your technology risk as an investor in EOS is mitigated by the nature of defense procurement procedures, which are quite onerous and result in a huge barrier to entry.

Governments can’t buy this stuff from just anyone. Not only are lives at stake, but the existence of the nation is also at stake.

Success in the defense sector requires trust, which can take decades to build. There is a lot of information-sharing that happens in order to design a cohesive product. Fortunately, EOS was founded nearly 40 years ago and it has those critical relationships in place.

A more pressing risk is EOS’s relatively small size. While the company is profitable, earlier this year, COVID wreaked havoc on production and deliveries. As a result, EOS faced a cash crunch and had to raise dilutive equity.

Valuation

The company has a sizable and growing backlog (A$570 million as of 6/30). Backlog generally means orders placed but not yet paid for because the orders either a) have not yet been produced or b) have been produced but not yet delivered to the customer.

The company is also tendering for A$3 billion of new orders. “Tendering” refers to the process by which EOS and other companies bid on new projects. If EOS wins the tender, then revenues move to the backlog. Petra Capital, a 3rd party research firm, indicates that historical tender win rates are around 25-40%.

I don’t think it is unreasonable that revenues can grow 50% a year for the next 3 years. And if you assume a 10% margin, you are paying $10 today for $1 of net income in year 3. That is slightly cheaper than the much larger US public defense companies.

What I like about EOS is that that you get a free call option on the space-related business – which is what first caught my attention years ago.

The flourishing defense side of the business reduces your risk and pays you to wait. EOS like a VC investment with a non-binary outcome. It’s a call option that does not expire. It aligns with my philosophy of upside optionality.

Lastly, beyond the standalone value of EOS, I like the company even more in a portfolio context.

EOS is a hedge against bad things happening in the world—(i.e. global conflict, or satellites exploding). And it is uncorrelated with the other stocks in my portfolio.

Parallels between space debris and COVID

For decades, just as experts have warned about a potential global pandemic, so too have other experts warned about the dangers of space debris.

It’s the same type of problem—simultaneously inevitable and unpredictable. And the problem will not be cheap to solve.

At the rate we shoot things into space, near-misses are now common place. The problem is growing exponentially, not linearly. And it’s just a matter of time before something disastrous happens.

There are several private companies, as well as a couple of large American defense contractors working on the problem. And I am optimistic that human ingenuity can solve this problem.

I’m betting that EOS will have a part to play in that solution and be rewarded for the value that they provide. But even if I’m wrong on that, I’ll have a profitable and rapidly growing defense business in my portfolio.

Why I write about my portfolio

I want you to challenge my beliefs. I’d love for you to tell me what I’m missing. I want you to tell me about public companies that I may not know about. And I’d love for you to teach me more about the companies that I already know.

Drop me a line if you have any questions / comments or just want to get in touch! yz@yishizuo.com

Disclaimer: I am not a registered investment advisor. Nothing I write should be construed as investment advice or the solicitation of investment.

Silvergate – Hidden Network Effect in the Crypto Industry

I have a decent grasp of the technology and utility of blockchains. I think that digital currencies add value to our world. And I think they will be here to stay.

If you can feel comfortable that the entire blockchain ecosystem isn’t a scam—a BIG IF given that Warren Buffett is convinced that Bitcoin is a Ponzi scheme – then Silvergate (NYSE:SI) is a great way to ride this trend.

I first heard about Silvergate nearly a year ago from the newsletter of my favorite journalist, Matt Levine.

On the surface, Silvergate is a bank. Their core business began by taking customer deposits and doing boring bank things like investing in municipal bonds.

Silvergate has actually been around for 40+ years, and they were one of the first banks to serve the digital currency industry 2013.

Since that time, Silvergate has pivoted to focus 100% on digital currency customers, carving out a nice niche for itself.

What makes Silvergate truly special is the Silvergate Exchange Network (SEN). SEN lets Silvergate’s customers transfer assets to one another instantly around the clock. It creates a classic network effect, and Silvergate has first-mover advantage.

Some of Silvergate’s core customers are the digital currency exchanges who actually handle crypto assets.

Think of it like this: SEN is an exchange for those exchanges. It also serves the broader ecosystem of crypto investors, developers, miners and more.

No other bank has the SEN. It would be difficult to replicate today, and that difficulty is only going to increase over time.

Imagine if JP Morgan owned the NYSE, and the NASDAQ didn’t exist. That would be a very powerful bank.

Silvergate is a bet on crypto without having to choose any specific currency. Silvergate has a strong brand in the digital currency world. They are headquartered in San Diego, and they generate real profits with real $USD.

Risks:

In general, the world of digital currency seems to attract a lot of young, sketchy, self-promoters. With Silvergate, however, management seems scrupulous. They have decades of experience and lots of gray hair.

Silvergate’s interest-yielding loan portfolio looks boringly vanilla which is what their depositers and investors should want. Plus, they have great relationships with banking regulators – with whom they’ve collaborated closely from the beginning.

The real risk is that the entire cryptocurrency ecosystem is a house of cards as Warren Buffett asserts. I disagree with the Oracle of Omaha here, but you must decide for yourself.

Valuation & why now:

Silvergate is profitable. But looking at the profits alone would obscure the underlying growth.

Here is the quarterly growth of activity on the SEN, as measured by the volume of cash transactions amongst the bank’s customers to one another.

And here is the associated fee income generated by digital currency customers.

One note: Q3 digital currency customer fee revenue has not yet been officially released (Earnings release on 10/26). $3.7M is my estimate based on Silvergate’s October 6th press release.

For comparison, Q2 net profit for the entire company was $5.5M, so ~$1.3M sequential growth in this revenue line item is very meaningful to the bottom line.

As fee revenues continue to grow, the market will be forced to realize that Silvergate is not just a bank. It has something that few banks have – a network effect.

As I write this, the stock has run up 30% this month and sits at an all-time high.

It’s still quite cheap. You are paying around $15 for $1 of net income today.

But if you think digital currency fee revenue can continue to grow 100%+ a year for the next few years, then you would be paying $5 today for $1 of net income in year 3.

(August 2020 Silvergate investor deck, Coindesk September 2020 Research Report on Silvergate)

Why I write about my portfolio

I want you to challenge my beliefs. I’d love for you to tell me what I’m missing. I want you to tell me about public companies that I may not know about. And I’d love for you to teach me more about the companies that I already know.

As of 9/30/2020, Silvergate was the 4th largest position in my personal portfolio.

I bucket the company as a “Hidden Gem”. Next time, I will dive deeper into another Hidden Gem – Electro Optic Systems.

Drop me a line if you have any questions / comments or just want to get in touch! yz@yishizuo.com

Disclaimer: I am not a registered investment advisor. Nothing I write should be construed as investment advice or the solicitation of investment.

Stock Bucket #2 – High Growth Beasts

These “High growth beasts” comprise 38% of my portfolio as of 9/30/2020.

These 6 companies are growing rapidly and are priced at a premium. I believe that the strengths of these businesses justify their valuations, but decide for yourself.

Atlassian – NASDAQ: TEAM – (15% of portfolio as of 9/30)

Atlassian makes collaboration tools—primarily for software development.

Their flagship product—JIRA—is as important to software development as Microsoft Excel is to financial analysis.

Just like with Excel, users start with JIRA because it’s the industry standard. Once they become familiar, there are few reasons to switch.

Atlassian products are priced via a freemium SaaS model. It’s easy to get started, and costs scale naturally with the customer’s success. As such, relative to its fast-growing SaaS peers, Atlassian spends very little on sales and marketing.

Founded in 2002, the Australian-headquartered company raised very little capital until their 2016 IPO, and the two co-founders own a shade under 50% of the company today—a rarity amongst tech companies at this stage

Key risk(s):

The enterprise collaboration / productivity space is extremely crowded. While Atlassian does have tools beyond JIRA, they haven’t made much progress outside of its core developer market.

They tried to compete against Slack, but they called it quits in 2018 and instead transferred some IP and cash to Slack in return for an equity stake.

I wouldn’t be surprised if Atlassian bought Slack one day. After all, the 800-lb gorilla in the room is Microsoft, which is starting to encroach upon Atlassian’s core.

Can Atlassian ever expand beyond its core software developer market? That would be nice, but I don’t think it needs to.

Valuation:

You are paying $17 today for $1 of gross profit 3 years from now. (I assumed 25% annual growth)

(Most recent Atlassian investor deck)

InMode – NASDAQ: INMD – (8%)

InMode is an Israeli-headquartered medical device company that makes products used in non-invasive, aesthetic procedures.

My friend Jay Vasantharajah wrote this sharp, much more detailed analysis of InMode a few months ago—I suggest you read it!

Consumer demand for InMode’s products is growing rapidly, and they have a superior distribution + pricing model relative to its competitors.

Not only that, but relative to those players, InMode has better product, better marketing, and overall better management.

In recent years, InMode has grown much faster than its competitors, just this week management announced that Q3 revenue increased by ~100% from Q2 (which to be fair, was depressed by COVID).

Key risk(s):

There are many players in this space—some standalone, some owned by private equity, some owned by larger medical device companies.

Valuation:

You are paying $4 today for $1 of gross profit 3 years from now. (I assumed 60% annual growth)

(Most recent InMode earnings release)

Match Group – NASDAQ: MTCH – (8%)

Match Group is the dominant global player in online dating.

These products fulfill a core human need and are not going away. The market is far from saturated and monetization will continue go up.

Online dating is a tough business to enter. Users naturally leave the service, and customer acquisition costs relative to lifetime value is very high.

Fortunately for me as an investor, Match Group has first mover advantage, brand recognition and economies of scale. They have the ability to buy companies for cheap, cross-advertise across their properties, and monetize where others cannot.

Key risk(s):

Facebook announced in 2019 that it would enter this space. While Facebook certainly has the userbase, its attempts have so far to penetrate the dating space not made a dent.

Valuation:

You are paying $13 today for $1 of gross profit 3 years from now. (I assumed 10% annual growth)

(Most recent Match earnings release)

Duck Creek Technologies- NASDAQ: DCT – (2%)

Duck Creek is a US-based vertical software provider similar to Constellation and Enghouse; however, unlike those companies, Duck Creek only operates in one vertical—property & casualty insurance.

Byrne Hobart, who publishes a paid newsletter that I subscribe to, wrote a great feature on Duck Creek in August.

The company is in the middle of a transition to SaaS. Looking at the financials alone, Duck Creek’s 70%+ SaaS annual recurring revenue growth is obscured by its legacy business.

On the SaaS front, returning customers spent $1.13 for every dollar that customers spent last year – and this includes the negative impact of customers who left.

And according to management, Duck Creek wins 2/3 of all potential new business opportunities (including ones they are not asked to bid on).

Key risk(s):

Insurance isn’t going away, but you are exposed to one industry.

Valuation:

You are paying $7 today for $1 of gross profit 3 years from now. (I assumed 20% annual growth)

(No deck – but here is the Duck Creek IPO prospectus)

Bill.com- NYSE: BILL – (2%)

Bill.com is a SaaS platform that helps small-to-midsize businesses (SMBs) collect and pay their bills.

As a leader at a small company, I’ve personally used this product and am familiar with the value that it provides. Collecting and paying bills can be a pain in the butt

Interestingly, I see parallels between this product and Zoom 2-3 years ago—the same people who were early adopters of Zoom’s video conferencing software are the same people I see first to use Bill.com.

Returning Bill.com customers spent $1.21 for every dollar that customers spent last year – and this includes the negative impact of customers who left.

Bill.com’s opportunity extends beyond SMBs. The most agile, and ultimately successful, large enterprises will empower their smaller team to choose their own tools. The Bill.com’s of the world will penetrate large enterprises at the grass roots level and expand upward.

Key risk(s):

Valuation is very high.

Valuation:

You are paying $27 today for $1 of gross profit 3 years from now. (I assumed 40% annual growth)

(Most recent Bill.com investor deck)

Adyen – Euronext: ADYEN – (2%)

Adyen is a Netherlands-headquartered payments platform.

They enable “unified commerce”. In other words, they make it easy for their customers to accept payments in different countries in different formats.

Behind the scenes, the world of payments is incredibly complex and constantly evolving. And that is great for this company. When complex systems change so quickly, customers need tools like Adyen to adapt.

Because Adyen owns the merchant relationship, it doesn’t matter whether Visa, Mastercard, Unionpay, Apple Pay, Google Pay, Wechatpay, Alipay, Grabpay, or anyone else will prevail on the consumer side–ultimately, Ayden wins.

Key risk(s):

Valuation is very high.

Adyen competes with Square, which is US focused, and to a lesser-extent – Stripe, which is focused on digital businesses.

Adyen’s forte is multi-channel payments, and its core market is retailers with a physical presence.

Right now, there appears to be enough room for all these players to coexist

Valuation:

You are paying $48 today for $1 of gross profit 3 years from now. (I assumed 25% annual growth)

(Most recent Adyen investor day presentation)

Why I write about my portfolio

I want you to challenge my beliefs. I’d love for you to tell me what I’m missing. I want you to tell me about public companies that I may not know about. And I’d love for you to teach me more about the companies that I already know.

Next article: Silvergate – Hidden Network Effect in the Crypto Industry

Drop me a line if you have any questions / comments or just want to get in touch! yz@yishizuo.com

Disclaimer: I am not a registered investment advisor. Nothing I write should be construed as investment advice or the solicitation of investment.

Yishi’s Stock Bucket #1 – Stable Cash Generators

These “stable cash generators” comprise 47% of my portfolio as of 9/30/2020.

These 4 companies aren’t growing particularly fast, but I like the risk-reward trade-off.

It is unlikely that any will double in 6 months. But the chance of permanent loss of capital is low.

In a downturn, these businesses should do fine.

Equinix – NASDAQ: EQIX – (26% of portfolio as of 9/30)

  • Equinix is a US company that operates global “Interconnection facilities”— locations where the internet physically connects
  • Imagine the pipes that carry data across the internet. These pipes come into an Equinix facility. Within each facility, enterprises can connect directly to one another
  • Enterprises have a lot of reasons to share data, and those reasons are growing
  • For these enterprises: latency matters, proximity matters, and having a one-stop shop matters.
  • As a result, Equinix is the dominant global provider and enjoys winner-take all network effects and customer lock-in

Key risk(s):

The internet is becoming multi-polar with increasing local regulations. In such a world, a global interconnection provider like Equinix could matter less.

Valuation

You are paying $23 today for $1 of adjusted funds from operations 3 years from now. (I assumed 10% annual growth)

(Most recent EQIX investor deck)

Slate Grocery REIT – TSE: SGR.UN – (11%)

  • Slate Grocery REIT (SGR) is a Canadian company that owns grocery-anchored real estate across US suburban areas
  • Their most recent rent collections through COVID have been relatively steady at 90%+
  • On the downside, the company’s cash flows are currently not growing
  • But they have plenty of liquidity
  • My hypothesis is that SGR will eventually recover to pre-pandemic levels, and their sizable dividend will remain reasonably steady and afford me time to wait

Key Risk(s):

While SGR doesn’t operate grocery stores, the more anchor tenants they have, the better. Amazon is a perpetual threat to the grocery industry given their Whole Foods acquisition + Amazon Fresh. And in the longer run, digital grocery delivery could disrupt the industry entirely.

Valuation

You are paying $8 today for $1 of adjusted funds from operations 3 years from now. (I conservatively assumed 0% annual growth)

(Most recent SGR investor deck)

Constellation Software – TSE: CSU – (5%)

  • Constellation Software is a Canadian-based company that acquires and grows vertical software businesses mostly in North America but expanding globally—especially Europe
  • Vertical software means selling software tailored to the needs of a specific industry (I.e. utilities, hospitals)
  • Generally, vertical software is a great business to be in given that the product, once installed, becomes critical for the customer. And switching costs become very high
  • As a result, you have predictable, recurring revenue with high margins and annual price increases. Costs are predictable too
  • Management is superb. For decades, Constellation has executed nearly flawlessly

Key Risk(s):

The company is expensive relative to its growth rate.

Valuation

You are paying $55 today for $1 of net income in Year 3. (I assumed 10% annual growth)

(No deck but CEO Mark Leonard has published annual letters that reflect his intellect and clarity)

 

Enghouse – TSE: ENGH – (3%)

  • Similar to Constellation, Enghouse is a Canadian-based company that acquires and grows vertical software businesses mostly in North America but expanding globally—especially Europe
  • Again, vertical software is a great business model
  • Management seems cut from similar cloth as that of Constellation
  • Relative to its larger “cousin”, Enghouse is less proven but the playbook seems similar
  • Relative to Constellation, Enghouse is growing faster, but priced more cheaply

Key Risk(s):

Can Enghouse continue to execute as it scales?

Valuation

You are paying $30 today for $1 of net income 3 years from now. (I conservatively assumed 10% annual growth)

(Most recent ENGH investor deck)

Disclaimer: I am not a registered investment advisor. Nothing I write should be construed as investment advice or the solicitation of investment.

Why I write about my portfolio and specific stocks

I want you to challenge my beliefs. I’d love for you to tell me what I’m missing. I want you to tell me about public companies that I may not know about. And I’d love for you to teach me more about the companies that I already know.

Next article: Stock bucket #2 – Fast growing beasts

Drop me a line if you have any questions / comments or just want to get in touch! yz@yishizuo.com

Hidden in plain sight – how corporations exploit the power of lotteries

Take a look at the economics of a lottery, and you’ll realize that these things are extremely profitable.

From the Roman Empire to the Han Dynasty, governments have long recognized that lotteries are a license to print money.

And of course, even the dumbest emperor would not allow this type of power to go unchecked.

Throughout the course of history, the state has erected a monopoly around this cash cow. And in every developed country today, lotteries are strictly regulated.

However, companies have found clever ways to exploit the power of lotteries to their advantage without breaking the letter of the law.

5 examples of how companies exploit lotteries

#1 Sweepstakes

Sweepstakes have also been around for centuries and are completely legal.

The McDonalds Monopoly partnership is a good example. Cereal box tops are another example. Consumers buy your product and earn a chance to win a prize.

The only catch is that in the United States, you have to let people enter your sweepstake without purchasing anything.

However, you can get around this regulation by making it difficult for the public to enter your sweepstake without buying your product.

Two common practices:

  • You require people to mail a physical letter
  • You require the letter to be hand written

Both these steps add friction; so instead, most consumers choose the easy path and just buy your product.

In effect, you force people to buy your product to enter your lottery. You can then call it a sweepstake, and it’s a completely legal sales tactic.

#2 Robinhood’s sign up bonus

Robinhood’s referral rewards mechanism is ingenious.

While other, less creative companies give you cash, Robinhood gives you—the new customer, and the person who referred you—a free share in a random company.

You might get a $5 stock, you might get a $200 stock– you have no idea. That’s what makes it so exciting.

When I joined Robinhood in September 2018 via my friend’s referral code, I received a share of Denbury Resources. It was worth $5.30 when I got the stock for free. And about a month ago I saw this email:

Despite my 100% loss on my 1 share of Denbury, I am a fan of this referral rewards program. It’s much more fun than just straight cash, and very on-brand for Robinhood.

P.S. If you don’t have Robinhood – would you please do me a favor and sign up with my referral code? I hope that one of us will get a share of Kodak, Nikola, or if we’re really lucky – Hertz 😉

 #3 “Do us a favor for the chance to win something”

Here is an ad that I saw on Instagram just this week.

Note the fine print: “No purchase necessary”. $30,000 is a lot of money. And Fidelity is treating this like a sweepstake.

This is commonplace on a smaller monetary scale too. Companies, even big ones – request user feedback for the chance to win $50 – $500.

I get these emails all the time. And I’ve sent a few of these myself.

From my personal experience:

  • This lottery mechanism works well, and you will see higher response rates.
  • People do not think about the amount of time spent relative to the chance of winning.

None of these “Help us for a chance to win $50” surveys I’ve seen or sent include the line: “No purchase necessary”.

It’s a legal gray area. To participate in your lottery, consumers are not allowed to pay with money, but there seems to be no restrictions on their time + attention.

#4 An incredibly successful start-up built on-top of a lottery mechanism

Let’s play a trivia game. Try to guess the name of this company:

  • This company was centered around a daily lottery
  • This lottery was free to play.
  • But it required your time and attention, and some degree of skill.
  • They made the lottery drawing a regular event, with a highly charismatic host
  • The prizes started out small at first, but eventually grew to 6 figures
  • At the height of this lottery’s popularity, 1M+ users would tune in for the nightly drawing

Any idea what this company is?

The answer is HQTrivia

A trivia contest isn’t the same as a lottery, but the core mechanics of HQTrivia are very much lottery-like.

The best part was that it was completely legal. After all, users didn’t have to pay money to play this lottery. They paid with their time and attention, and HQTrivia sold that time and attention to advertisers.

HQTrivia rose like a rocket, largely due to that lottery mechanism. Later, they crashed spectacularly and quite tragically. For more information, I highly recommend that you check out The Ringer’s “Rise and Fall of HQTrivia” podcast.

#5 Loot Boxes

Loot Boxes are the modern version of Magic / Baseball / Pokémon cards. You buy a pack and have the chance to win something really valuable.

In essence, it’s a mini-lottery.

With Loot Boxes, video game companies have taken the baseball card concept and digitized it so that it is even more profitable and scalable.

Video game players (“gamers”) can buy virtual, in-game currency with real money. (They can also earn virtual currency during normal gameplay). And gamers use that virtual currency to buy Loot Boxes. The contents of those Loot Boxes can then be sold on various markets for real money.

Just think. You are a video game company. Your customers—your gamers—come back to you day after day, week after week. You take this mini-lottery model and multiply by millions of gamers and make your product even more addicting.

Your costs are minimal since everything is digital. And you have a money-printing machine. You now wield powers that were once limited to emperors.

Loot Boxes have been controversial. Parents are complaining that this is encouraging children to gamble. And lawmakers across the world are starting to scrutinize the practice.

I think they have a point. As far as I can tell, this is the closest thing to a privately-run lottery that exists today, hidden under the virtual currency façade.

In conclusion

Hopefully these examples inspire you to try some of these models in your own businesses.

I hope you do it in an ethical way – because this stuff is powerful.

I certainly missed a ton of other examples. If you know of any other interesting hidden lottery mechanisms being used today, please drop me a line – I’d love to learn more! yz@yishizuo.com

How YOU can become a millionaire Tiger King – An MBA’s tongue-in-cheek analysis

Can tigers be a sustainable business model?

Maybe.

Photo Credit: Vlad Tchompalov via Unslpash

Viewed from conventional business lens, tigers are an awful asset class.

The fundamental problem: timing of cash flows

In any business, you want to match the duration of your assets and liabilities. More simply, you want your bills to be due at the same time cash flow comes in. Otherwise, it’s easy to get into trouble.

Let’s pretend you own a tiger cub. Let’s call him Tigger. And let’s look at the timing of cash flows over the course of Tigger’s lifetime.

People adore tiger cubs and are willing to pay big bucks to pet them. For example, Jeff Lowe, who still owns GW Zoo, charges the equivalent of $500 / hour!

So Tigger generates some serious cash while he’s young. But as we saw on the Netflix show, after a mere few weeks, he is no longer be cute and cuddly. Tigger quickly becomes a dangerous liability both physically and financially.

According to the one and only Carole Baskin, who is an expert at maintaining and feeding big cats – the upkeep for an adult tiger is $8,000 / year. And a captive tiger can live up to 20 years.

So all of a sudden, you are making no income and you have some big bills to play with no end in sight.

You are scrambling for ideas, and the thought comes to mind, what if you exhibited adult Tigger and charged admission?

You realize that is almost certainly not feasible from a business standpoint, or else there wouldn’t be a big cat crisis in this country. So you scratch that idea.

Now what do you do? You are getting desperate.

Morally dubious tiger business practices

Well, there are two morally dubious shortcuts you could take to mitigate liability.

Option #1: Joe Exotic taught you that the market rate for tiger cubs is ~$3,000. You find Tigger a girlfriend, breed cubs and sell the cubs. You generate immediate cash for yourself and shift liability to someone else. When Tigger Jr. grows up, those costs will be someone else’s problem. Congrats, you have just made the big cat crisis worse.

Option #2: If you think Option #1 is bad, Option #2 is even worse. In the Netflix show, you learned about the allegations of euthanasia against Joe Exotic & Doc Antle. That’s certainly one way you can end your liabilities immediately. Are you barbaric enough to dispose of your beloved Tigger?

Assuming you don’t want to take either option. Let’s start over and see if there is a principled AND profitable way to operate a tiger business.

Brainstorming an ethical tiger business model

You can try to pull a Carole Baskin and operate a rescue park, but good luck if you wish to compete against her. After all, you’ve seen what happens to her enemies!

You could sell tiger naming rights (maybe even multiple times over like a timeshare model).

You could sell sponsorships or “adopt-a-tiger” programs, but Carole Baskin seems to have cornered that market.

Gimmicks aside, realistically, cub petting is the only feasible path for you to become the next Tiger King. But running a tiger petting operation humanely is expensive.

To avoid animal abuse, you shouldn’t allow petting until Tigger is 8 weeks old, after all of his vaccinations are complete. And according to the USDA, tiger cubs become too dangerous to pet after week 12.

So unless you are okay with young Tigger getting sick, or your customers getting maimed by teenage Tigger, you only have 5 full weeks in which you can earn serious income from the animal.

Running the numbers to try to make it work

Remember, after Tigger is no longer cute and cuddly, he will become a financial burden.

Using Carole Baskin’s $8,000 estimate as the annual all-in cost of supporting Tigger for the next 20 years, the total lifetime cost adds up to $160,000.

Can you make $160,000 profit in 5 weeks?

Assume 6 exhibiting days (1 day of rest / week), 6 hours of petting time a day, a couple of employees, insurance, etc. You would need to make somewhere around $1,000 an hour to break even.

That’s double what Jeff Lowe charges at GW Zoo, which I would assume to be market rates.

It’s hard to adopt ESG (Environmental, Social and Governance) best practices when less high-minded competitors are able to undercut you.

Now, maybe my assumptions & calculations are wrong. And maybe I’m being unfair to Jeff Lowe, and he is in fact an upstanding businessman who a) really cares about animal welfare and b) is running an ethical operation. I can’t really opine on that, but you should just watch the show and decide for yourself . . .

A solution to market failure

Hypothetically, if everyone in the tiger industry agrees to a set of sustainable business practices and abides by them, then the supply of tiger cubs should decrease. Naturally, the price of tiger petting will go up, which can support the ethical model outlined before.

The problem is that as the price of tiger petting goes up, the incentive to cheat the system and breed more tiger cubs grows. Without someone to enforce the rules, any kind of industry agreement is unworkable.

We need someone with the power to punish the rule breakers. But as you saw in the show, it’s been politically difficult to pass any such legislation.

There is a solution though – in the absence of the law – we have the Carole Baskins and PETAs of the world.

As the next Tiger King, rather than antagonize the animal rights people as Joe Exotic did, why don’t you work with them?

You could put in safeguards against abuse and publicly showcase your humane practices. You could livestream each animal 24/7. You could be transparent about everything, i.e. share medical records, food records, financial records, and more.

You saw the animal rights people chase Joe Exotic out of the malls. They are powerful. Get them on your side. Not only can they help you acquire demand, but they can also hinder your less honorable competitors.

Tiger cub petting doesn’t seem likely to disappear, so the industry might as well be led by someone ethical.

That someone might as well be you!

**

About the author: Yishi is a former hedge fund investor and current entrepreneur who enjoys thinking about businesses in his free time. http://www.yishizuo.com/about/

He is the CEO of DeepBench. We connect users with experts on any topic in any industry, and we also license our software to enterprises to help them build their own knowledge networks. (Check us out if you are interested in joining our network or using our product!)

Business Opportunities in Chess: Pay-to-play Micropayments

I’m a casual Chess player.

I once took classes as an 8-year old. I remember playing a decent amount on Yahoo! Games as a teenager. But mainly, it was the in-person, banter-filled games with my best friends in high school that I loved most.

One thing that I’ve always liked about Chess is how universal it is. This is a picture of me in Uzbekistan in July 2013, encountering a few local kids at a sidewalk café, and stopping to enjoy a cup of juice and a quick match.

We didn’t speak one another’s language, but Chess created a mutual connection and a lasting memory =)

Nowadays, I play Chess on an app.

I prefer the untimed variety. I like having plenty of time to think without stress. I like that I can play asynchronously on my own schedule. And I love the strategic element of the game.

And of course, my mind can’t help but wander to the business side of Chess. First, let’s analyze the core product, which I think benefits from a few unique advantages.

Chess as a Product – durable appeal and accessibility

Chess dates from the 1st millennium and is the most popular board game in history. Some sources estimate that there are 600 million Chess players globally.

Unique amongst games, Chess is seen as less of a frivolous pastime and more of an intellectual sport. (Anecdotally, my parents limited how much StarCraft I was allowed to play as a kid – but there were never any restrictions on Chess!)

That may also be because Chess is easy to understand. After all, the rules are easy to learn, but the game is hard to master. This makes the game very accessible to beginners, and further enhances its popularity.

Furthermore in Chess, it is extremely easy to handicap the better player to balance the playing field and provide a learning opportunity. You could remove a piece, give one side more time, or provide takebacks. Easy handicaps help make the game more fun & accessible for all.

Lastly, Chess is very spectator friendly. As an observer, you can think through moves alongside the players. And given the turn-based, mental nature of the game, it’s almost as if you are playing the game yourself. No other competitive event can come close – except perhaps televised Poker – another of my favorite games.

The Chess business landscape

A very interesting thing I noticed is that the Chess app I use has Twitch built-in. They regularly advertise on the home page, and with the click of a button –I seamlessly navigate to a livestream of Alexandra Botez – a popular Chess influencer.

Overall, Chess streaming viewership is up 500%+ since 2016.

Technologies such as Twitch make it easier for Chess influencers to earn money via advertising and sponsorships. And there are others ways to make money too. For example, a Grandmaster with the pseudonym Chessbrah sells branded clothes.

Another Grandmaster named Simon Williams sells instructional material.

While I can’t speak to the quality of Simon’s paid material, I did watch a free YouTube recording of one of his Chess streams. I would recommend as it is not only highly instructional, but also a great look at the modern Chess economy in action.

In the video, Simon mentions that the bulk of his income comes from sales of instructional materials. And notably, several people tipped Simon during the livestream. Most tips were about ~£5-10 , but there was one £50 donation!

Just like other professional sports, Chess seems to follow a power law. It’s very difficult for players outside the top 20 to earn significant money from tournaments and endorsements. And there are only so many Alexandra Botezs, Chessbrahs, and Simon Williams’ that the industry can sustain.

But I think that there is another economic model for Chess that is being neglected.

Pay-to-play micropayments – a new business model for Chess

If you’ve ever walked around Union Square in Manhattan – you’ve seen the Chess Hustlers sitting around. You can walk up and pay ~$5 / game to play them. Demand is brisk, and some of these hustlers make $400+ / day.

I think that there is an opportunity to take that pay-to-play model and apply it to digital Chess. And I see no reason why micropayments can’t be integrated into a Chess app directly.

Another key feature that would enhance this economic model is asymmetrical time limits. For example, an expert could be allotted 15 seconds per move, but an amateur could have 15 minutes per move, or even unlimited time.

Under these time constraints, if an expert can complete games in an average of 40 moves and charges $20 / game, she would make $120 / hour – whether she wins or loses.

I used $20 / game as the benchmark because I would personally pay at least that amount once a month to play with an expert who can help me improve. The expert limits her precious time, and I as the paying customer have all the time in the world to work on my game. Plus – it would be an interesting social interaction, something that I would tell my friends about.

You can do other creative things too. For example: the challenger pays $100, but if he beats the expert, then the challenger gets $50 back. Want to takeback a move? That will be $10!

How to capitalize on this?

There are 3 major chess platforms in the world. Any one of them could build this. Chess.com, the platform that I use, seems to be relatively tech-forward. They have that neat integration with Twitch shown earlier.

I’m not sure why Chess.com hasn’t gone down the micropayment route. This article is a great overview of their history + vision. They are a distributed company, have bootstrapped for years, and raised a very modest amount of capital in 2015. My hunch is that they looked at their own resources, made a strategic calculation to partner with Twitch in 2017 rather than build in-house.

As an outsider, I have no idea what the partnership agreement between Twitch and Chess.com looks like. Theoretically, if Chess.com started building micropayments as outlined above, it could eventually bring them into competition with their partner. So that potential conflict of interest may be all the opportunity that another entrepreneur needs.

As we saw with Simon Williams, Twitch’s platform does enable donations. But that model is clearly a blunt instrument and you can’t unleash Simon’s full potential with it.

There is an opportunity for a micropayment-focused chess app to revolutionize the industry. Building the product wouldn’t be cheap, and gaining an audience won’t be easy. But in this modern influencer era, success is very possible.

How big could this be?

To estimate the market for this let’s start by focusing on Chess.com. It alone has over 20 million members, and over 1 million are active daily. (Apparently, Coronavirus has accelerated the popularity of the game. Chess.com expects to see a decade’s worth of growth in the next few months!)

Let’s say you can capture just 10% of those daily active users and get them to pay $20 / month. And let’s assume a 25% take rate – you would generate $6 million / year.

This doesn’t include advertising or any type of add-ons—i.e. subscriptions, 1-on-1 coaching, group lessons, etc.

But let’s not stop there. Let’s look beyond Chess.

The real long-term opportunity is to take on Twitch, acquired by Amazon in 2014 for ~$1 billion and estimated to be worth ~$4 billion today

After all, if micropayments work in Chess, there is no reason why the same model couldn’t be applied to other games. For ANY player who wishes to monetize her talent, you could provide a credible, more flexible alternative to Twitch.

If you build the platform, you can control the flow of money. And if you control the flow of money, you control the world.

It would be very cool to see an entrepreneur give this a shot, and I’d love to help in some way.

Lastly, apart from the business idea – my handle on Chess.com is @yishizuo. Feel free to shoot me an invite =) I’m always down to meet new friends via a casual game!

**

About the author: Yishi is a former hedge fund investor and current entrepreneur who enjoys thinking about businesses in his free time. http://www.yishizuo.com/about/

He is the CEO of DeepBench. We connect users with experts on any topic in any industry, and we also license our software to enterprises to help them build their own knowledge networks. (Check us out if you are interested in joining our network or using our product!)

Knowledge as an addictive drug — an investor’s guide to the expert network industry

In 1995 Jeff Bezos could have started Amazon by selling any product, but he chose to sell books for two reasons:  1) high number of SKUs and 2) low storage costs.

Question: What has infinite SKUs, and zero storage costs?

Answer: Expert knowledge.

A modified version of this article first appeared in Integrity Research.

What are expert networks?

Expert networks are a marketplace for knowledge.

The core product is a paid 1 hour phone call between a customer (often an investor or a consultant) and an industry professional with several years of experience.

There are variations: 30 minute calls, video calls, in person meetings, written surveys, group conferences, and more; however, the general concept is the same. Expert networks find and connect industry professionals with paying customers via paid interactions where knowledge is exchanged.

This marketplace isn’t about connecting the same industry professional to the same customer for repeat interactions. After all, one day you want to learn about X, and the next week you need to learn about Y.

This market is about connecting:

  • the same customer to different experts, or
  • the same expert to different customers.

(Jeff Bezos doesn’t sell the same book to the same customer either.)

Macro industry driver – the growing complexity of our world

As the world becomes more complex, existing data platforms cannot keep up – and a lot of valuable knowledge remains trapped and not written down anywhere. Not even Google can index what is in our minds (not yet anyway). Some of the most valuable data in the world is the unstructured, tacit insights in our heads.

Sometimes we don’t even know what we know until someone starts speaking to us, and the ensuing conversation leads to the synthesis of new and profound insights that are useful for both parties.

In our modern, fast-moving, and complex world, the ability to connect and speak with industry professionals becomes ever more important. And that is the value that expert networks provide.

Knowledge as a drug

Paid expert calls are an addictive product. And here is why.

In a previous job as a hedge fund investor, I used to be on the client side of these expert network calls. Even if the industry expert can’t answer my questions perfectly, guaranteed – she knows more than I do about her field. And no matter what, I will certainly learn something new and useful.

A good analogy for learning is like swimming in a magical pool. In this magical pool, you can sort of see the floor in the shimmering water, but as you dive deeper, you realize that the floor is farther than you realized, and you can never reach the bottom. Similarly, as you swim horizontally, the sides of this pool expand farther away—like a fleeting mirage.

As such, I have always walked away from expert conversations with new insights and new questions. Not only am I a satisfied customer, but the more I eat the hungrier I get.

And not only are paid expert calls addictive at the individual level, but once you start using the service, eventually your competitors have to use it too. Otherwise, they will be left behind.

Peer pressure is tough to resist.

A human-centric business model

The barrier to entry to starting an expert network is relatively low.

Not a lot of capital is required. All you really need is one employee with an internet connection.

However, there are a lot of nuances to connecting expertise as the business scales.

  • We are not dealing with sterile bits and bytes of data.
  • Neither are we dealing with pieces of dead trees bound together by a colorful cover.
  • Rather, we are dealing with human beings & all the emotions and personalities that epitomize our species.

At their core, expert networks exist to help people communicate complex topics to one another.

Effective communication is rarely easily accomplished, and sometimes – a great deal of human hand-holding is required to establish the trust & comfort required to enable strangers to have a deep, meaningful conversation.

One can try to replicate that trust-building via technology, but such is easier said than done. As such, the traditional expert network industry is largely a human-centric, customer service business.

The demand side of the business

First, a few quick facts about the industry

  • Longevity: Expert networks have been around for close to 20 years.
  • Growth rate: 20%+ year.
  • Size: ~$USD 1bn in annual revenue, with a few large existing players. GLG is the biggest at ~50% of the market

There is a bit of “a rising tide lifts all boats” dynamic in the expert network industry. Given the aforementioned macro trends and fundamentally addictive nature of the product, it’s a good industry in general to be in. And there are more and more new customers, non-traditional users of expert networks, such as Fortune 500s, start-ups and market research firms trying these services for the first time.

The core group of traditional expert users are investors and consulting firms, who make up 70-80% of traditional expert network demand today. And this group is well covered by entrenched market incumbents.

Here is a summary of incumbent advantages

  • Affinity for the familiar – existing players have an advantage in any industry, but given the high touch nature of traditional expert networks, those advantages are particularly acute here. Users of traditional expert networks are constantly on the phone / emailing with their account managers – and over time, the relationship naturally becomes stronger.
  • Price insensitivity – traditional expert network users aren’t very price sensitive. If you are making a $50 million investment, what is an extra $500 to you for a call that could make or break the deal? If you are a consulting firm, these costs are generally passed on to your end customer so price becomes further abstracted.
  • Disconnect between end user and economic buyer – the person using expert networks is often an entry-level analyst. (I used to be one of them!) Sadly, any time + effort saved for junior analysts like us does not directly impact the economic decision makers. The average entry-level employee cares about personal career growth and is relatively risk averse. In general, actions that are client-facing and revenue-generating receive more visibility relative to actions that help the firm reduce expert network overhead—hence, this a dynamic that helps the incumbents.
  • “No one gets fired for buying from IBM” mentality – Again this is a common enterprise sales challenge for new entrants in any industry, with multiple risk-averse departments —i.e.: legal, procurement –guarding the gates. Compliance is a particularly unique gate-keeper in the expert network world. As such, adding a new vendor is a hassle that few users have the stomach to deal with. In addition, sometimes customers of the large incumbent expert networks are forced to pay up-front for annual contracts, with credits that roll-over upon renewal—another dynamic that naturally favors the existing players.

The supply side of the business

On a positive note for 1) new entrants to and 2) customers of the expert network industry, there are few supply-side advantages for the incumbents.

Professionals are not bound by exclusivity arrangements to any network. Many experts are on multiple networks. It relatively easy for most expert networks to acquire new supply to satisfy most of their customer requests.

That is the hidden secret of the industry. Check out “The secret of how expert networks operate” for more details.

Fundamentally, industry professionals enjoy being experts for 4 reasons

  • Earn easy money – it’s easy for us to talk about something that we know a lot about, especially in a 1-on-1 setting. As long as expectations are set in advance, the threshold for success can be exceeded. So from the expert’s perspective, it’s easy money, but money isn’t the only attraction.
  • Feeling of power – during these calls, the industry expert is at the center of attention. They get to feel powerful and important. It’s a nice feeling—like multiple shots of dopamine over the course of a 60-minute phone call. Just as knowledge is an addictive drug for the consumers, so too is it addictive for the suppliers.
  • Feeling of altruism – the core part of what experts are doing is sharing knowledge to help another individual. We human beings are social animals, genetically altered through millennia of natural selection to be inclined to help one another. Ultimately, as thousands of industry experts have told us, there is something enjoyable about sharing their knowledge that stretches beyond money and power.
  • Exciting break – modern knowledge workers are intellectually curious and drawn to the new. The vast majority of the industry professionals in our network have full-time jobs. They have a daily routine, and doing a call once in a while is a nice change of pace. They are scheduled to speak with a mysterious stranger. Excitement is in the air. They have no idea where the conversation might lead. And they will likely learn new things as well.

All of these items make for a fun experience for experts and that is why the expert network business model works.

DeepBench’s approach

Our company is approaching the expert network industry from two unique directions

First, we are licensing software to help other organizations build their own knowledge networks.

Second, we are focused on reducing costs and expanding the market for paid knowledge exchange.

Our expert network is already 30-70% cheaper than the incumbents, and we continuously strive to:

  1. Push down our own costs through technology,
  2. Create more user engagement on our platform, and
  3. Capture more data over time and use it to our advantage, creating a virtuous feedback loop

Our long-term vision

The end goal isn’t to beat GLG; it is to create the next social media platform focused on professional knowledge.

Think of us as a LinkedIn focused on what you know, rather than who you know or where you‘ve worked in the past.

DeepBench will be the go-to tool that people visit to learn things that aren’t easily discoverable via Google. (A more detailed product vision to come in a future article, stay tuned!)

Near term & potential partnerships

Meanwhile, DeepBench will keep growing our expert network business. Every day, we add liquidity to our marketplace and build new platform features as we march relentlessly toward our vision.

We hope that this guide is informative. And if you are interested in partnering with us – inquiries@deepbench.io

Sincerely,

-Yishi Zuo (CEO, DeepBench)

Jack the Driver + The Bali Private Transportation Market

I recently visited Bali and had pre-arranged for a driver to take me from the airport to my hotel. This was a 2 hour trip, and I used the opportunity to get to know my driver Jack and his line of work.

riding in Jack’s car

Jack comes from a family of drivers. He has 3 brothers – all of whom drive tourists for a living. Net of nearly all costs, Jack makes $USD 4,800 a year – which is in-line with Balinese GDP / capita . Interestingly, he is unemployed half of the days of the year, and his biggest challenge is finding customers.

Why hire a private driver?

Transportation is not something I usually bother booking ahead of time, but Bali is a special case.

This is part of the reason: As you exit the airport you are swarmed by people with signs.

This certainly feels a bit overwhelming in what should be a tropical paradise. So it’s nice to be able to have a personal driver meet me inside the airport.

In every other part of the world, I’ve used Uber or the local equivalent. Bali is one of the few places where I’ve hired a dedicated private driver – for 2 main reasons.

  • Reason #1: Bali is a big island, and there are lots of places to explore. As a tourist, if I Uber over to some distant waterfall, who will drive me back? Will there even be cell phone reception? What if my phone dies? Hitchhiking no longer feels as exciting to me at age 29 as it did at age 21.
  • Reason #2:  It’s fun to build trust with someone from a different culture and learn new things. It’s nice to meet a local whom I feel safe around and who feels comfortable answering my personal questions like a) how much his car costs and b) how much he earns.

Start-up idea: daily driver booking platform in Bali

This got me thinking. What if there was a company that focused purely on providing daily drivers in Bali?

The Uber model isn’t ideal due to the aforementioned reasons.

And tour guides serve a different function than drivers. Rarely do I want a guided tour, but I will always need to get to my destination.

This potential start-up would fill the gap in-between Uber and a full-on tour agency.

Market size calculation for a private driver matching service in Bali

By my estimates – the market for matching drivers for daily trips in Bali is about $4mm annually.

While this may not be the next Uber, the beauty of this business is that all you need to get started is a smartphone & some hustle.

Simply take requests from tourists via WhatsApp, and match them to drivers via a group thread. (This was how I was originally introduced to Jack).

Acquiring both sides of the marketplace

Finding the supply is easy. I have your first 4 drivers for you: Jack and his brothers. There are 1,000+ candidates waiting at Denpasar airport any given day. Just go and speak to a few of them, size them up, select the best, and get their phone #s.

When chatting with candidates, you should screen for drivers with above-average communication skills & extrovert tendencies. As a tourist, Wikipedia can tell me all I really need to know about the temple I’m visiting. But if I want to learn about the nuances of local culture + economy, nothing beats chatting with a local!

Finding demand will be harder. The first thing I would try is to go to the smaller hotels and offer them 5% to refer guests to your private driver service. The big hotels have their own full-time drivers already, but many small hotels, including one I stayed at on this trip, don’t offer anything in the realm of transportation. Partnering with you would be a win-win proposition.

Vacation-home owners / managers would similarly be a good target. Perhaps you could even partner with AirBnb directly.

Overcoming disintermediation risk

Why wouldn’t drivers and tourists just go off-platform? There are things you can do a) immediately and b) in the future to reduce that risk.

  • Things that encourage tourists to stay with the service
    • Offer roadside assistance: customers receive comfort knowing that a 3rd party is watching over them and can help if issues arise
    • You can collect emergency contact info + address any special requests, i.e. allergies
    • In the future, you can take credit card payments up-front to help consumers a) avoid the hassle of cash and b) receive the benefits that many card-issuers offer such as trip protection.
  • Things that encourage drivers to stay with the service
    • Your 15% commission is much more reasonable than Uber’s 30%. And because this is such a capital-light model (no need to hire engineers for some time), you can afford to scale with a lower take-rate.
    • Make it clear that the more rides drivers do via your system, the more future business you will send their way
    • In the future, you can build-in a rating + review system to further strengthen the marketplace network effects

In conclusion

  • The global middle class is expanding. Independent travel is increasing.
  • At least in Bali, there is an imbalance between the supply & demand of private daily drivers.
  • The gap between Uber and full on tour agencies represents an opportunity not just in Bali but perhaps beyond (Koh Samui, Phuket?)

I really hope that someone out there reads this and gives the idea a shot.

At the very least, I’m sure you’d have fun. After all, there are far worse places to work in the world =)

Alamdhari Resort, Sideman where we stayed in Bali

A couple buddies and me hanging out!

Let me know how it goes!

Author’s note 10/20: I have been informed that Grab (Uber equivalent in SE Asia) does offer daily driver bookings. So while such competition creates challenges, it also validates the market opportunity. There could still be an opportunity for a focused, standalone service to provide a better user experience.

**

About the author: Yishi the co-founder & CEO of DeepBench — We connect users with experts on any topic in any industry, and we also license our software to enterprises to better unlock expertise internally. (Check us out if you are interested in joining our network or using our product!)

The Mystery of Mom’s Medicine

A few weeks ago, my mom and I were chatting on the phone when she brought up something perplexing.

The backstory

A few months ago, my mom goes to her doctor for a routine appointment.

Her doctor prescribes medication, and she goes to a nearby pharmacy – Walmart –to get the prescription filled

At Walmart, based on her insurance + medication:

  • She has to pay $10 out-of-pocket per refill
  • She can buy 30-day refills, but not 90-day refills

A few days after my mom buys her medicine from Walmart – she starts getting letters in the mail from Walgreens – a competing pharmacy chain.

The first letter or 2 she ignores.

“Typical junk mail”, she thinks.

But then she notices that Walgreens is advertising their 90-day prescription refill capabilities.

Amazing – this is exactly what Mom is looking for! She can save $20 every 3 months as well as a decent chunk time if she goes with the 90-day option.

But then she wonders to herself: “How does Walgreens know that I am in the market for a 90-day prescription refill?”

Moreover – what is particularly unsettling was that Walgreens had printed the EXACT NAME of her medication on their advertisement.

 

Unraveling the mystery

By this point on the call, I am intrigued, and I am ready to help Mom unravel this mystery. So we start a process of elimination to uncover the truth.

 

Was Walgreens doing a mass market campaign? And the timing just happened to coincide with my mom’s doctor visit?

Unlikely.

She had never received prescription-related mail from Walgreens before. The timing was too uncanny, and seeing the exact name of the drug on the letter pretty much rules out the possibility of a random mass-market mailing.

She was certain that Walgreens had access to her private medical data. But HOW did they get it?

 

Could someone at her doctor’s office be selling patients’ private info to Walgreens?

Very unlikely.

Multiple people across many organizations would be breaking the law at a massive scale. If it was just one doctor’s office, it isn’t worth it for any small group of employees at Walgreens to bother. If multiple doctors’ offices are involved, the level of coordination would become even more difficult.

In any case, the risk-reward tradeoff wouldn’t be worth it for anyone involved.

 

What if Walgreens had inserted a spy within Walmart to engage in corporate espionage?

Slightly more plausible, but still very unlikely given the risk-reward tradeoff. There are far easier, legal ways for multi-billion $ companies to make money.

 

Arriving at the conclusion

Within minutes, my mom and I have ruled all the possibilities that came to mind – from the reasonable to the outlandish. By process of elimination – I am 99% certain of how my mom’s private medical data ended up in a mail-advertisement.

My degree of confidence is largely informed by my previous experience as a hedge fund investor. I had done extensive research on the Pharmacy Benefit Management (PBM) industry.

PBMs are the hidden middleman that sit in between American patients, pharmacies, and employers. A simple way to think of PBMs is “insurance specifically for medications”.

I took a look at the letter that my mom had received. Sure enough, while Walgreens’ logo is on  the bottom right, the logo on the top left as well as the signatory is OptumRx — one of the 3 major American PBMs that control 70% of the market.

Each PBM has “preferred” pharmacies that it likes to work with. These preferred pharmacies receive better deals from the PBM, and can thereby offer better terms for that particular PBM’s patients – such as 90-day prescription refills.

My educated hypothesis is that Walgreens is a preferred pharmacy for my mom’s Optum prescription plan, whereas Walmart is not. And when my mom’s prescription was filled at Walmart – Optum automatically enrolled her in a mail-marketing campaign.

Therefore, I strongly suspect that Walgreens never had access to my mom’s data.

 

Why this matters

While our journey didn’t result in a Hollywood-worthy tale of espionage, the resolution of “The Mystery of Mom’s Medicine” raises some lingering questions about just how complex the American medical system is. I’d love to know:

  • Why doesn’t Walmart join Optum’s preferred network? Why doesn’t every pharmacy join every PBM’s “preferred network”?
  • How are those special “preferred pharmacy” deals structured?
  • What kind of kickbacks happen behind the scenes?
  • Why is everything so opaque?

Another fascinating implication is what mega-corporations do with our private data and the lopsided power that they wield.

I’m sure that at some point, my mom signed some sort of agreement allowing Optum to send her mail advertisements.

But we sign so many agreements nowadays it’s impossible to keep track of it all, and it’s impossible to think through all the implications. So when my mom received unsolicited mail advertisements with her private medical information from a company she didn’t recognize (Optum)– she found it rather unsettling – and she assumed that Walgreens had her private info.

Despite Mom’s initial unease, to Walgreens & Optum’s credit, their marketing efforts worked! And my mom is now a happy customer saving money using Walgreens rather than Walmart to fill her prescriptions.

My mom’s story is a mere microcosm of what is happening across the world, and especially in the tech sector. Today, there is a lot of political scrutiny around the Facebooks, Amazons and Googles of the world and the power that they wield in our daily lives. But in reality, this is happening in every industry and every geography, and there is no avoiding it.

The fact is, we now live in a world where privacy is fleeting and data is cheap. Not only do I think resistance is futile, but I think that the tradeoff is well worth it for the average citizen.

Walmart is a $320bn market cap behemoth. United Health (the health insurance parent company of Optum) is not too far behind at $240bn. And Walgreens clocks in at a respectable $50bn. And you know what . . . I quite enjoy seeing these gargantuans battle it out to save ordinary folks like my mom $20 every 3 months.

 

**

About the author:  Yishi the co-founder & CEO of DeepBench — We connect users with experts on any topic in any industry, and we also license our software to enterprises to better unlock expertise internally. (Check us out if you are interested in joining our network or using our product!)