Picks and Shovels - Part I

What is a ‘Picks and Shovels’ business?
 
A strategic business that becomes the key cog in bringing a product or service to market and extracts the most value out of the product chain. 
 
Here is an alternative, and a simpler explanation straight for Wikipedia:
 
A pick-and-shovel play is an investment strategy that invests in the underlying technology needed to produce a good or service instead of in the final output. It is a way to invest in an industry without having to endure the risks of the market for the final product. The investment strategy is named after the tools needed to take part in the California Gold Rush. 

​The strategy is named after the tools used to mine for gold during the California Gold Rush of the 1840s and 1850s. Prospectors needed to buy a pick and a shovel to be able to mine for gold. While there was no guarantee that a prospector would find gold, the companies that sold picks and shovels were earning revenue and thus were good investments.
 
The Microsoft operating system or the Intel chip are great examples.  While the personal computer industry revolutionized the way we worked, PC companies spent most of their time fighting for survival.  It was an undifferentiated industry.  Even Apple, one of the most innovative companies today, had to pivot its strategy, to avoid bankruptcy.  On the other hand, the Microsoft operating system and the Intel chip were the picks and shovels.  It did not matter if Dell, Compaq, IBM, or Gateway won or lost the market share battle.  As long as consumers bought more PCs, Microsoft and Intel won.  Every single time.
 
Here is another example.  While air travel provides tremendous benefits to passengers, airline businesses have never captured this value for their investors.  Why?  Every airline virtually offers the same experience.  The cheapest ticket usually wins.  To make matters worse, unpredictability with operating conditions (weather), volatile input costs (oil), massive fixed costs, and large investments to buy new planes to improve service standards leave the cash coffers always on empty.  However, Aftermarket Parts businesses that support aerospace and defense have enviable track records.  They provide cheap spare parts that are critical to fleet repair and maintenance.  Airline companies want cheaper parts alternatives, to improve airline profitability.  Once a ‘part’ gets approved, it's very sticky.  More planes and more travel - lead to more wear and tear - and a greater need for parts.  Within the entire value chain, these businesses generate the highest returns on capital.  Aftermarket product businesses are the picks and shovels in aviation.
 
This brings us to the newest iteration of Picks and Shovels - The commerce enablers.
 
Covid was a massive catalyst for E-commerce, and I wrote about it early in the pandemic (LINK).  Every business was forced to invest in an online presence.  Lots of new E-commerce businesses were formed out of necessity last year.  To add fuel to the fire - during the time of overwhelming demand - Amazon made a strategic decision to restrict sales to essential consumer goods.  Merchants that relied on Amazon, as their sole sales channel, had to rethink strategy and establish other channels to sell.  As a result, E-commerce penetration grew more in one year than in the previous half-decade.
 
When most physical retail was closed and we (consumers) were forced to search for buying alternatives, getting customers to buy (customer acquisition) was easy and low (no) cost.  Those were the good old days. 
 
However, as the world reopens, and we get back to some of our old habits, these E-commerce companies face a different world.  Instead of customers coming to them, they must seek them out.  Competition has intensified.  The only way to grow is to spend generously on digital advertising to acquire new customers.  In this world, the picks and shovel companies are the digital enablers.  Social media companies - that already have our attention - will attract a disproportionate share of advertising dollars.  If history is a guide, a majority of the newly formed E-commerce businesses will struggle.  E-commerce requires massive scale in logistics and customer acquisition.  The climb to the top of the ‘scale’ mountain is arduous.  However, the best advertising businesses will generate strong returns over the foreseeable future.  They are the key cog in the wheel.  Digital advertising is the pick and shovel play on E-commerce.
 
In Part II, I discuss how Social media companies make money.
 
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This material does not constitute an offer or solicitation to purchase an interest in Latticework Partners, LP (the "Fund").  Such an offer will only be made by means of a confidential offering memorandum and only in those jurisdictions where permitted by law.  An investment in the Fund is speculative and is subject to a risk of loss, including a risk of loss of principal.  There is no secondary market for interests in the Fund and none is expected to develop.  No assurance can be given that the Fund will achieve its objective or that an investor will receive a return of all or part of its investment.

This material contains certain forward-looking statements and projections regarding the future performance and asset allocation of the Fund.  These projections are included for illustrative purposes only, are inherently speculative as they relate to future events, and may not be realized as described.  These forward-looking statements will not be updated in future.