Buying Intangible Commodities

What is a commodity? It’s often a raw material that’s lacking in special distinction. Some are tangible like water, coffee beans, corn, silk, or cotton. Some are conceptual like time or promise. But what about a person or something a group of people build? 

I understand it’s tricky business referring to people as commodities, but is that any different from how generals treat soldiers or governments the national statistics in front of them? It’s undeniable that as the number gets larger, the individual will be dwindled to the state of a commodity. 

Humour me and come along my thought train. Buying commodities, refining them and turning them into brands has been the crux of business success for a long time. It’s no secret. 

“'Buy commodities, sell brands' has long been a formula for business success.” - Warren Buffett

With ideas what commodities are, what’re brands? We can think of some easy ones like Starbucks, Nestle, and Lululemon. They buy commodities like coffee beans, water, and cotton, work their magic, and charge a premium with their logo on the products. 

But what’s at the crux of a brand? Why does it matter? We know not all brands are equal. Every product has a logo on it but some logos are better than others. Why is that? 

I think the value of a brand increases the more they reduce risk. It could be career risk, health risk, social risk, etc. 

I’m in Hanoi and looking for a bottle of water. I know the tap water isn’t ideal to drink out of for my soft Canadian body. A Nestle water bottle is a less risky proposition than a brand in Vietnamese I can’t even read. I don’t know if it’s factually true. But I “think” it reduces the health risk of spending the next three days stuck in the toilet in a country where I’m unfamiliar with the medical system. 

There’s career risk for the director of a bank who doesn’t hire a consulting firm with a reputable name. The top consulting firms make a living out of selling how unique and special each of them are. But to most executives, they’re all the same and they’re just perceived to be less risky than John Doe Consulting from Saskatoon. At least, if the big consulting firm fucks up, the director can easily blame them and that’s part of the package for why they cost more. 

Some might wish to use fashion to depict their status in society. They might want the clothing to say something about them—wealth, health, creativity, etc. An obscure brand might serve one purpose while one with a hundred-year heritage might serve another. Paying a 30% premium on top of a b-class brand to get an LV bag might reduce the social risk of not getting the correct wealth perception. 

Some commodities can’t charge a premium for their brands. Consider insurance companies or banks. They sell promises and financing, the same commodities that their competitors sell. The product is interchangeable and it doesn’t really matter what bank or insurance provider. Most will choose the one with the lowest rate and price. While some brands aren’t worth the premium, some charge premiums for mere stamps of approval (i.e. tribal association). 

Such is the case for universities, employers, and even investors. Some will pay a far greater premium for a Harvard diploma, receive lower pay for a Deloitte brand, or give up more equity to have Sequoia invest in their company. Buying commodities to sell brands was an easy concept to grasp for companies selling tangible goods but could that model be applied to the world of intangibles like a Harvard or Sequoia? 

In accounting lingo, software companies are considered asset-light businesses. It’s because the output software is considered intangible and the raw ingredients are lines of code, even if the people writing the code are very tangible. Still, various tech companies, professional services, or educations will be considered asset-light because the only input is people. 

Does that mean software companies buy commodities (i.e. lines of code) and turn them into brands? Maybe the equation should start earlier and the commodity purchased is the army of developers? 

Well, it depends. While one all-star developer might make all the difference in a 20 person company, that might not be the case in a company with 5,000. Some developers are better than others, as in all professions, but with layers of bureaucracy, individual abilities may be rendered useless. 

Still, an army of developers might be able to band together to sell branded software like AWS or Atlassian that might warrant premium prices. But the question is not on the output of brand but the input. 

Can some companies acquire commodity-level developers and sell brands? Some companies will only hire all-star developers. They aren’t commodities and they will demand a premium price tag. The financial equation there isn’t as magical. 

I’m sure the data scientists who are paid millions of dollars a year at Google are truly special. But I doubt they were worthy of such high price tags early in their careers. Unlike a car that appreciates as soon as it turns on, developers—and people in general—compound their value over time. They slowly move up the chain from rookies that are commodities to unique gems as they showcase their abilities over and over. 

Consider professional service firms (i.e. the big accounting, consulting, and banking firms) that hire armies of university grads. These students hit checkmarks in arbitrary determinants of success like grades, extra-curricular, etc. But most haven’t “done” anything of value for society. 

If they did, they would be running a company or something the market would beg them to not stop doing. But the professional service firms ingest these commodities and sell all kinds of services (i.e. advice). They give stamps of approval with their army of commodities—“you’re financial statements look good!” or “Here are three options to improve sales you can take to your board!”. 

It’s odd, isn’t it? That a 22-year-old would immediately have something valuable to say because of mere association with a brand? But alas, that became my experience. An army of us, each thinking the self to be better and unique, but are truly indiscernible will pump out slides and models that will be branded and sold at a premium to reduce some risk for the paying executive.  

The firms buy commodities (university grads that need the prestige) and sell brands (the stamp of approval of the brand). It’s quite like a rating agency, whether it’s for debt or trading cards. 

Universities are the same. They ingest a bunch of kids that fit arbitrary metrics of success and ambition and charge high fees for the environment and stamp of approval. 

Consider the Series A venture fund or a prized incubator, they ingest a ton of commodities and sell brands. The Series A venture fund or incubator stamps the unproven startup companies they buy equity in with their brand. Brands like Sequoia or Y-Combinator give value to each startup company, which is an unrefined commodity until it does something useful. The brand helps the companies get future financing and this allows the early investors to exit with high IRRs. 

Whether it’s a young person looking to enter a branded university to have a higher chance of getting a great job, a graduate trying to get a great employer to secure their long-term career, or a startup hoping for great early investors to secure them a chance of survival in three years time, all are unrefined raw materials that could be bought by a business that sells a brand. 

Whether it’s coffee beans at the earliest stages, water from a river, or a startup with no sales, they are all materials at the rawest forms that are of no value to the end consumer yet. That makes businesses like Y-Combinator, Sequoia, Harvard, or Deloitte great businesses. 

In fact, the unrefined talent could be a less volatile commodity to manage as the salary for people isn’t traded on a daily commodity exchange. Salaries and raises don’t happen every day and changes are often long-dated, resulting from changes in economic factors around us. That could make the businesses that can purchase unrefined talent and sell brands a far better business than those that buy physical commodities and sell brands