The following article is extracted from the Bamboo Innovator Insight weekly column about the process of generating investment ideas among wide-moat businesses in Asia. Each month, an in-depth presentation on one such business is featured in The Moat Report Asia.
Why do “hidden champions” thrive in uncertainty, even chaos, and others do not?
Over our years of interacting with Asian wide-moat “hidden champions” who are quietly innovating value to dominate their specialized market with hard-to-imitate products, we find that they concentrate their organizational resources to solve a specific burning problem for a well-defined customer group better than anyone else. Successfully solving this customer problem would then create a success spiral. A key source of their wide-moat is their commitment to customer needs. The hidden champions have control over the value chain and deep knowledge in understanding and serving their customers which allow them to feed knowledge from customers into organizational learning processes and a high performance work culture that generate a continuous stream of innovations that enabled the champions to stay resilient with pricing power and outperform in difficult economic conditions.
However, the journey of a hidden champion is riddled with paradoxical tensions that challenge the innovative behaviour. Doubts will emerge in the paradoxical tension of handling tradition and change, control and autonomy. Facing the tradition-change tension, we find that Asian family firm leaders often fall into the “strategic simplicity” trap, clinging to what has worked in the past despite needed change. With many Asian firms at the critical transition phase in managing the fragile succession process, we find that while founders are often highly innovative, subsequent successors may feel constrained by ingrained routines and norms. Founding generations tend to be creative risk takers, yet reliance on their early ideas can foster stagnation, hindering stagnation. If only one side of a tension is stressed (tradition, control), demands for the other side (change, autonomy) will intensify. The result of paradoxical tensions is growing anxiety and potential decision-making paralysis, inhibiting innovative behaviour.
We find that hidden champions approach paradoxical tensions as opportunities to explore, experiment and learn. Paradoxes fuel creative problem solving that energizes firm innovation. We discover over the years that the leaders running these hidden champions have “paradoxical thinking”– the ability to embrace and synthesize competing demands with a sense of speed, scope and significance of change. Interestingly, this is also the insight of a recent study “The CEO Report: Embracing the Paradoxes of Leadership and the Power of Doubt” jointly conducted by the professional services firm Heidrick & Struggles and the University of Oxford Said Business School based on over 150 conversations with CEOs from a wide range of sectors around the world.
In our investment process to identify and evaluate hidden champions, we like to probe deeper the question of ‘how do the hidden champions manage paradoxical tensions?” We look for strong signals that they embrace the founding traditions that made the firm successful while simultaneously searching for novel associations and new opportunities that fuel innovation and there are pressures to explore new ways of doing things. Some of these signals that we like to observe and evaluate in the potential hidden champions include whether they:
- Create new ideas for improvement?
- Mobilize support for innovative ideas?
- Search out new work methods, techniques, or instruments?
- Acquire approval for innovative ideas?
- Transform innovative ideas into useful applications?
- Generate original solutions to problems?
- Make organizational members enthusiastic for innovative ideas?
- Thoroughly evaluate the application of innovative ideas?
“CNN/Bloomberg of Weather” – Stock Price Performance (Red) vs Index (Blue), 2003-2016
Last week, we highlighted an Asian wide-moat hidden champion who is the CNN/Bloomberg of weather as the world’s largest and most comprehensive private weather information services company. From the excerpts of the conversations below, we can see that the business leader of this hidden champion exhibits “paradoxical thinking” in founding and building the company. The founder Mr. I was just a desk worker in charge of transporting wooden lumber when tragic marine accident for which he felt responsible persuaded him to move towards starting a business with a “demand-side of thinking” to solve a specific customer problem with focus and deep knowledge:
Q: “So how do you go about setting up a business around that idea? What did you do?”
Mr. I: “I thought that first the government weather services would say, ‘We’re issuing warnings and it’s up to the captain and we’re not responsible’. The government weather services is very much saying I’m doing my job, which is in my words, a supply side of thinking. And the captain would say ‘I need information that would help me to make a decision.’ And the official services are very much just about data provision. What the captain would like to have is content. And the captain say ‘Should I move the ship out of the harbour or not?’ Government services is very much concerned about the accuracy of wave height, wind speed and so forth. But captain’s idea is ‘Should I move the ship outside of the harbour or should we prepare for this contingency?’… And now we working with over 2,000 shipping companies in the world. And all these top 25 liner companies around the world are our customers. We are very much worldwide in that respect… We are very much driven by the need and want of the customer. So it’s not a supply side of thinking like government weather services. It’s a demand side of thinking.”
The hidden champion also mobilize the support of both internal employees and external stakeholders and customers for innovative ideas:
Q: “[Company’s name] has continuously launched a series of innovative new services, like alerts about the approach of tornadoes. Where do these ideas come from?”
Mr. I: “Our company’s speed in responding to supporters’ needs is tremendous. We get requests for services, and our biggest strength is our workers being able to quickly kick off new offerings. For example, in the construction industry, [Company’s name] offers advice on when to build a roof, while Tokyo Disneyland pays for counsel on how to stage its fireworks shows when the winds are stiff. Weathernews tells gas stations when to advertise tire chains in advance of snowy weather and instructs 7-Eleven on when to stock up on certain types of beer – sales vary according to changes in humidity and temperature.
In order to begin any new undertaking, workers don’t need to get approval from me or the president for every little thing. Since personnel have the right to make decisions, when there’s a request from supporters for a service, it’s vital to quickly get it up and running. Of course, employees are always thinking about services as well. We always want to be half a step in front of our supporters. Rather than a full step, we’ll stay half a step ahead so as not to leave our supporters behind. At the same time, the mark of an entrepreneur is originality. [Company’s name] presidents must each year develop a completely new market or technology. My successor Mr. K established a market for the aviation industry. And recently, we’ve created a market for disaster-prevention content.”
Q: “With weather information services almost completely dominated by government meteorological bureaus, providing such data is a rare undertaking in the global market. There are few or no publicly traded companies like yours. How do you sum up your approach to entrepreneurship and what you can achieve?”
Mr. I: “We see ourselves as the CNN or Bloomberg of weather. Essentially, we’re a content provider. For things to go smoothly, hardware and content production must be in harmony. In the 20th century, Japan prospered from producing hardware. I wanted to be a contents provider… We’d like to see the World Meteorological Organization privatized. This would trigger a global shift taking weather businesses away from governments to the private sector… The weather information business should be developed by people who know local conditions. I’ve set the goal of becoming a weather station for all of the 6.4 billion people on the planet.
My original paradigm was ‘How can I make money for this company?’ But in weather, it was ‘What can I do for seamen? What can I do for you?’ It was so mentally rewarding. It’s not ‘We are making money, so OK’ but ‘What kind of contribution are we making to society?’ Get that right and the business success will follow. Weather information is a public resource and an asset shared by all. It’s the same as water, electricity and transportation. But unlike electronic appliances, there are no quick hits. This is the reason we switched to providing content based on long-term agreements to pocket ongoing revenue. We’re still pushing ahead with plans to have 150,000 of our 2.5 million [paying] supporters become shareholders. We want supporters involved in content and engaged even more in management. We want to be the first stakeholder-type firm… An inward-looking company is in danger. But [Company’s name] is in good shape now because our supporters encourage us to improve.”
Above all, we peer deep into the hidden champion for that overarching sense of purpose which is a powerful source of internal resilience to resolve the paradoxical tensions for being adaptable yet authentic and steer their way with resilience through the many challenges in the entrepreneurial journey. As Mr. I commented:
“My original paradigm was ‘How can I make money for this company?’ But in weather, it was ‘What can I do for seamen? What can I do for you?’ It was so mentally rewarding. It’s not ‘We are making money, so OK’ but ‘What kind of contribution are we making to society?’ Get that right and the business success will follow.”
We look forward to participate in the long run way to compound growth with resilience for these Asian wide-moat hidden champions and we target to invest with high conviction to be in their Top 20 shareholders list in the annual report.
PS1: We like to share our Investor Day Presentation held on 1 December 2015 for our shareholders. The presentation material is available for download on the ASX website:
http://www.asx.com.au/asxpdf/20151102/pdf/432nk9r3hhw4nf.pdf (pg 10-14)
and our Value Investing Summit 2016 presentation “Quietly Innovating Value with Hidden Champions”:
PS2: We will be back on the week of 7th March with the Riddle to the Monthly Moat Report.
A new monthly issue of The Moat Report Asia is now available!
Access the in-depth idea presentation:
In this month of February 2016, we investigate an Asian wide-moat innovator who is the CNN/Bloomberg of weather as the world’s largest and most comprehensive private weather information services company, providing customized mission-critical weather information with a recurring-income “toll-gate” business model to help its worldwide customers to access accurate and timely weather information to make better decisions in a world with abnormal weather accelerating.
In its B2B (business-to-business) segment (57% of sales), [Company’s name] provides Total Fleet Management Service (TFMS) with optimal ship routing, performance monitoring, safety status monitoring for over 2,000 shipping companies from 31 offices around the world and commands a 90% domestic market share and 35% global market share (7,000/20,000 vessels). According to CEO Mr. K, “Cargo movement has slowed in the last fall of the Lehman shock, but demand for TFMS is increasing” with the company growing its market share from 5,000 to 7,000 vessels.
The B2B business also helps multiple industries that range from sea (shipping, fishery, oil & gas) to land (road management, railway, logistics, retail, local government) and sky (aviation). For example, in the construction industry, [Company’s name] offers advice on when to build a roof, while Disneyland pays for counsel on how to stage its fireworks shows when the winds are stiff. [Company’s name] tells gas stations when to advertise tire chains in advance of snowy weather and instructs 7-Eleven on when to stock up on certain types of beer as sales vary according to changes in humidity and temperature. This deep accumulated and insight becomes more valuable over time and creates a long-lasting relationship with their customers.
In its B2C (business-to-consumer) segment (43% of sales), [Company’s name] designs and produces weather programs for radio, TV, digital media, including digital signage with original weather content for train stations, airports, elevators building lobbies, vending machines and restrooms. [Company’s name] provides content for over 90 commercial broadcasting stations in its country (80% share of the domestic market) and for over 200 cable television station in its country reaching 15 million households, as well as for Hong Kong and Taiwan satellite broadcasts. The B2C business also co-creates user-generated and crowdsourced weather information for its 20m users/”supporters”, of which 2.5m pay around US$2-3 per month for premium version of the service. As a result of this powerful crowdsourced and user-generated social data, [Company’s name] has been able to build a mechanism, such as putting out a warning forecast alert via smartphone service to occur 30 minutes to an hour before the local thunderstorm and has succeeded in capturing more than 70% of local thunderstorms since 2008. This network of users has created a network effect in that the system of localized content becomes more accurate and the usefulness attracts even more users to participate in the co-creation process, and the network becomes a valuable intangible property and competitive asset of the company.
Mr I.’s family and management continues to own 44.6% of the company which was listed since 2000 and its shares outstanding has reduced by 4.4%, demonstrating its prudence in capital management policy, and its net cash has also more than doubled since 2013 that is now 18% of its market capitalization. The company generates ROE of 27.2% and trades at an attractive EV/EBIT 9x, EV/EBITDA 7.5x. Sales has increased 12% in the past four years and EBIT and OCF (operating cashflow) growth is faster at 23% and 53% respectively due to the scalability of its toll-gate business model in launching higher value-added innovative services and effective cost management. We believe the company can build on the growth momentum in the next 4-5 years, spurring an upward valuation re-rating towards a potential doubling in market cap.