Ownership Mind: A Prerequisite for Equity Owning

There is an old fashion idea that one “should dress for the position that you want.”  If you want to be a bank executive, you should wear a suit and tie even if your current role does not require it.  Not sure this reference is totally relevant today except as a metaphor, but that’s for another conversation.equity ownership

The phrase came to mind as I was thinking about how some leaders have an “equity mindset,”  an “ownership mindset” and some simply think like a hired hand, no matter how much they may think that they want to own equity.  To truly have an equity mindset, one usually has understand how to “sacrifice now for gain later” as Charlie Munger would say.  It means making sure that others (customers, employees, other shareholders) are taken care of first, and some days there will be something left over and some days there won’t be.

Equity Mindset

In my experience, people usually have to start thinking like an owner, or thinking with an equity mindset, before they really are in a position to gain true equity — either by starting something themselves or by earning it in their current organization.  An attitude of “I eat first” does not usually inspire others to share equity with you.  If you are to be their partner, they want to see the sacrifice and responsibility to put others first and to share for the benefit of the greater organization.  This is usually vital to the long-term health of any organization, and therefore the long-term health of the organization’s equity. As George Gilder has written: capitalism gives first and then receives.

An equity mindset conveys another subtle and important signal to others: confidence.  Confident people demonstrate the willingness to sacrifice now, and bet on their own ability for gains later.  This confidence is attractive.  Knowing that we will win together or lose together is attractive.  The opposite would be: I will win first and then maybe share. Many examples of the opposite which are not attractive can be seen in the daily press.

Ownership Equity Definitions

Ownership is often an over-used term so it may mean different things to different people.  Some people may see an attitude of “this is mine” like a 2-year old, or a lack of consideration of others.  To me, ownership means being ultimately responsible for the long-term health of an endeavor and for all of the constituents of that endeavor.

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Rational Investing vs Irrational Entrepreneurship (Admirable Idealism)

When asked at this year’s meeting, “What matters most at Berkshire Hathaway?”  Charlie Munger and Warren Buffett quickly agreed: “Seeing things the way they are.”keep calm and be rational

Rational As Opposed to Smart

Warren and Charlie then went to one of their favorite topics about how the success of Berkshire hinges on their ability to be “more rational” than others.  Charlie explained, “We are good at being rational.  Our main duty is to be as rational possible.  It is a moral duty.  Confucius said it is dishonorable to be more stupid than you have to be.”

This is a theme that has been present in many of their interviews, books and speeches over the years.  They believe that each of us has a responsibility to keep learning and to keep getting wiser and more rational.  Note that they use “rational” as the opposite of “stupid” (rather than the opposite of stupid being “smart”).  This is intentional as they often say that intelligence can be a disadvantage and can lead people to do stupid things.  To them, life success is more about being wise and rational than smart.

Rational Investing and Entrepreneurship, Different Yet Similar

For me, these comments prompt thoughts about the differences, and similarities, between being a good investor and a good entrepreneur.  Neither is better or worse than the other.  They are just different.  Each of us may focus on such different skills at different times in our life, or different moments in our same job.  We all must find a balance between these effective mindsets.  As an investor, it is important to watch the world happen and seize on opportunities.  In a sports analogy, you should take what the defense gives you.  Do not try and force a personal belief or hypothesis on the world.  Do not fool yourself or fall in love with an idea.  Do not fall into confirmation bias.  Focus on seeing the world as it is, seeing things as they are, and then utilize an incorrectly priced asset, a misallocation of risk, or another opportunity to your advantage.

As Benjamin Graham wrote, use Mr. Market to your advantage rather than as your guide. Learn the skill to be patient enough to watch and react (and remain disciplined enough to react only when the opportunities are particularly good). Use rational investing as an advantage.

Entrepreneurship is often described as “changing the world” and thereby putting the stamp of your idea on the world.  It is the art of seeing things the way they COULD be.  It is being proactive, not reactive.  Entrepreneurship may require more outward convincing of others of the opportunity — rather than the investor being able quietly to make his move without having to convince anyone else.

Yet, at the same time, one could look at the best entrepreneurs as shades of the best investors and vice versa.  They see an opportunity that does not seem as risky to them as to the rest of the world.  They take rational risks to move their idea forward, not gambles that bet the company.  They assess the risk and reward of a new opportunity and deem it worthwhile.  Even the most aggressive entrepreneurs have the wisdom to be patient at times.  Entrepreneurs need to be idealistic to get themselves and others motivated about the opportunity, yet realistic with themselves about “seeing things the way they are” today so they can plot the best course possible toward the ideal state they are seeking.

Two up and two down

I have been all of the above in my life: A) an irrational (and too hopeful) an investor which is the most damaging sin as an investor, B) an irrational entrepreneur (when I was too young to know any better), C) a rational investor, and D) a rational entrepreneur.  Better results come from the last two than the first two.

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Diverse Fundraising Market Requires More Filtering than Ever

Private company fundraising is becoming more diverse, robust, and complicated by the day.  This is good news for private companies, but not without some downsides.

When unique (and often better) doesn’t fit traditional fundraising

A core hypothesis of my investment fund, Greybull Stewardship, is that there are huge numbers of awesome companies that do not fit the traditional venture capital or traditional private equity mindset.Greybull Focus of Smaller Profitable Companies  Greybull exists to provide certain companies an ideal investor.  Usually, that means the companies value our ongoing structure and strategy.  We do not swing for home runs (and therefore we do not have strike outs).  We have an evergreen fund structure (no fund expiration after ten years) that allows us to avoid placing fund-level limitations and restrictions on our portfolio companies.  We are also not a family office, thank goodness, that shifts strategies as the hired hands come and go and the family members have changes in their lives (and drama).

Our investments are free to pursue the strategies, growth rates, and exit timing (or not) that makes sense for their businesses. This graphic shows the focus of Greybull Stewardship from a broad perspective that is different from the traditional private equity or venture capital flips.

More excellent companies every day are deciding that the traditional financing models are not ideal for their businesses. And there are more diverse capital sources that could be potential matches of fit and focus.

A riff about fundraising

The latest example of this broke out last week in a blog from Henry Ward at eShares which was then was riffed about in the blogs of prominent venture capitalists: Fred Wilson in ‘Go East Young Man (or Woman)’ and Brad Feld in ‘Unicorns Without the Magic’.

Here are some key points made by Henry Ward in his blog about his Series A financing — and he even includes his impressive pitch deck here:

Fundraising is a filtering process, not a popularity contest.  I could tell within 5 minutes of meeting an investor whether he or she would invest. . . . . Fundraising is simple: find investors that get excited about your company.  It is a filtering exercise.  Too many founders believe they have the wrong pitch instead of realizing they have the wrong audience.

We were 0 for 21 with Silicon Valley VCs.  I never got close.  Most of the big firms wouldn’t even meet.  By Silicon Valley standards, we’re a weird company.

Our company culture proved a mismatch too.  In our pitch, we were very open about our strategy: “We will never ‘bet the company.’  eShares has too much responsibility to our customers.  We can never disappear.  We will always prioritize protecting the downside over maximizing the upside.”  That doesn’t fit most VC strategies of “swinging for the fences.”

How to filter effectively for fundraising?

These thoughts raise the question how of a founder or management team can filter effectively, particularly when their time is limited and the marketplace is becoming more diverse and complicated every day.  Here are some tips that may be helpful:

  1. Use the associates at investment firms for your purposes. Use the quick 15-30 minutes phone calls from investment firm associates to gather information.  In many cases, they will be reaching out to you to see if your company fits their profile and will ask questions such as your revenue, growth rate, total addressable market, competitors, etc.  Answer their questions succinctly and you will be able to tell whether you fit their filter.  Whatever you do, do not try and morph your company to fit their filter as it is better to move-on quickly than try and fit with a fickle firm.  Then, have your own filtering questions such as their typical check size, company stage, capital and time left in their current fund, profile of their target investments, industries or market focus, and probably more company specific questions relevant to your situation.
  2. Filter without using up your own time.  Be clear in your communication and use other tools and provide information designed to filter.  Blog posts, the initial info you provide about your company, your website, etc. should all be tools to help you find your especially excited investors without wasting too much of your time.  Most importantly, you should describe your company clearly and succinctly and describe what you are seeking.  Some people think that they will keep it vague and then morph their company and opportunity to the tastes of the investor.  That is the easiest way to waste a ton of time.  You are better off getting early ‘No’s’ by being clear — than keeping a lot of vague prospects on your mental list.
  3. Ask for referrals.  Tell people exactly what you are looking for and ask for referrals.  There is a reasonable chance that a chain of referrals will lead to a firm that is a good fit.  For this to work, you need to be very clear for what you are looking.  This is sort of like job-hunting — it is easiest for people to help when they know exactly what you want (even if you are faking your conviction a bit).
  4. Look for geographic and philosophical diversity.  Try looking in different areas of the country and investors that are likely to think differently than the traditional venture lemmings (I mean ‘vc’s’).
  5. Spread the work out over time.  With a short time deadline, it is difficult to make the diversity of financing sources work to your advantage.  It is better to spend little amounts of time every week well in advance of needing any capital.
  6. Filter without traveling — until you find people who are excited about you.  Do not waste time traveling until your filter has identified financing sources that have made it through the biggest filters.

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Angel Investing Not As Prevalent nor Effective As You May Think

Angel investing has reached a new level of interest by the general public because start-ups are doing well and there are new ways to be an angel (AngelList, crowdfunding, etc.).angel investor  The New York Times recently published an article about the pros and cons of angel investing for entrepreneurs and investors.  In the late 1990’s dot-com era, I did some angel investing and quickly learned its shortcomings both for the entrepreneur and for the investor.  Yet, that does not mean that angel investing isn’t perfect for some situations.

The bottom-line, for me, is that there is no one best source for early-stage capital.  I recommend putting in the hard work and the time to find the investors who are best aligned with your goals and your needs. It could be your own 401k, or friends and family, or a bank loan.  Or, the best of all – existing and potential customers!  I wrote an earlier blog post about customer financing.

90% researching, 10% pitching

In fact, 90% of your time and work should be spent thinking about, locating, and researching the best sources of capital given your objectives.  If you do that, only 10% of your time will actually be pitching and closing the financing.

Funding Sources from Kauffman Foundation

Now, a few things to keep in mind with raising capital:

  • Venture Capital is a very small percentage of the early stage financing.  Unless you are ex-(pick a successful Silicon Valley company) and have an idea where it is obvious how it will reach $100 million in revenue within 5 years, do not waste your time.  In a large study by the Kauffman Foundation, they found that only 4.4% of startups utilized venture capital (see chart nearby).
  • Angels are also a small percentage of financing (only 5.8% of startup financing), and they come with some baggage.  The New York Times writes about how angels subject the entrepreneur to dozens of opinions, and there is no one person to step-up and contribute real effort and time when things are not going as well as expected.

Angel results not predictable, most unexpected

If you are an investor type anxious to participate in the productivity boom represented by Silicon Valley type start-ups, I would think twice.  If Peter Thiel is your best friend, then go for it.  If not, you probably do not know the right people to get access to the best deals.

Fortune magazine’s Dan Primack wrote about angel investing that “just because it is legal does not mean it is good for you” in this column titled “We’re all investors, but we’re no angels.”  I have a friend who has invested as an angel in over 70 companies who said it was the most unexpected ones that made the best return while most turned into “zeroes” – angel parlance for a total loss.  In my opinion, the large portfolio strategy is the way to do angel investing if you must. The reason is that angel investing is nothing more than gambling and you need a large portfolio to make sure that you hit some winners.

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Podcast Interview about Competitive Advantage, Berkshire Hathaway, & Recurring Revenue

I recently enjoyed being interviewed for a podcast with Jock Purtle of Digital Exits where we discuss what Warren Buffett and Charlie Munger would invest in today — if they were young. Hint: competitive advantages, DigitalExitsPodcastlogorecurring revenue.

What would Buffett and Munger invest in if they were young now?

The answer is a surprise because Buffett and Munger often say that they cannot predict technology 10 years into the future — that is their proxy for feeling confident that they “understand the business.”  At the Berkshire annual meeting for a few years now, however, Charlie has said that he would work on finding online or technology businesses that have competitive advantages, recurring revenue, and can scale quickly.  To me, it seems that he sees in these businesses the same characteristics that they looked for in their heyday with newspapers, consumer products companies, insurance companies like Geico, and more.  They strove to find businesses with inherent advantages (economies of scale, network effects, unique distribution channels) that would be strong businesses for many decades.

The podcast can be found here at Digital Exits with Mason Myers.

Some of the topics we covered include:

  • Value of recurring revenue
  • Search funds and independent sponsors
  • What should you plan to do (or not) on the first 100 days after you buy a business?
  • Competitive advantages and network effects

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Transcription from Digital Exits:

Jock: Welcome back to another episode of the Digital Exits Podcast. I’m your host, Jock Purtle. And today, we have Mason Myers, from

MasonMyers.com and also Greybull Stewardship. Mason, welcome to the podcast.

Mason: Thank you very much, Jock. It’s good to be here.

Jock: Excellent. So we’re just chatting on the call beforehand. I actually came across your personal blog when I was doing some research into search funds, and I was telling Mason that I read every single article on his site over a one or two day period, which is a big kudos to him. Love the content. He talks about investing through his company, Greybull, and then value investing, which I’m a big fan of. For those who don’t know, value investing was coined through the book The Intelligent Investor, and then Warren Buffett has built his fortune based on that sort of strategy. So let’s jump over to you. Want to give everyone sort of a quick background of you as an entrepreneur, and then do you want to tell me a little bit about Greybull? Continue reading

Greybull Stewardship Makes Growth Investment in Onsource

My investment fund, Greybull Stewardship, has announced a growth investment in a unique platform that connects insurance companies with third-party vehicle and property photo inspections via smart phone apps.  Onsource LogoThe company, Onsource (www.onsourceonline.com), has a network of over 14,000 independent photo inspectors.  I am very excited to partner with the founders of Onsource, Steve Rubin and Tim Schneider, as they have done an outstanding job growing the company.  Below is the press release about the growth investment.

OnSource receives Growth Investment Funding from Greybull Stewardship

Investment to support rapid growth and to expand existing technology-related products and services.

Braintree, MA March 15, 2015 — OnSource, the platform that connects insurance companies with third-party vehicle and property photo inspections via smart phone apps, announces a boost to its growth and expansion plans by closing a $2.25 million investment from private equity firm, Greybull Stewardship.

“Partnering with Greybull Stewardship and its founder, Mason Myers, is a real win for us,” says OnSource co-founder Steve Rubin. “Mason has a proven record of providing support, both financial and operational, that runs parallel to our motives and goals. This growth capital enables us to move ahead quickly with our expansion plans and maintain flexibility for where we take our company long-term.”

Over the past year, OnSource has developed and released a suite of self-service inspection apps along with real-time photo and video streaming technology. This growth investment will allow OnSource to broaden the development of new inspection technologies while continuing to invest in their industry leading inspection platform.

“Onsource saves insurance companies time and money through an awesomely effective platform of smart phone apps utilized by independent third parties,” said Mason Myers, General Partner of Greybull Stewardship.  “We are pleased to provide the capital to support the very rapid month-over-month growth the company is experiencing.”

OnSource has experienced extensive growth in the first quarter of 2015 and is preparing to move their headquarters to larger office space in Braintree, MA to accommodate the onsite staff and support team.

“The opportunities ahead of us are exciting,” says OnSource co-founder Tim Schneider. “We’re changing the way the industry views and performs inspections and with this investment, we’re able to reach higher than ever before.”

About OnSource

Headquartered in Braintree, MA, OnSource enables companies to get fast, fair and efficient auto and property inspections through intuitive self-serve smartphone apps and an extensive national network of more than 14,000 photo inspectors. Backed by a team of quality assurance analysts and support professionals, inspections are completed quickly, accurately, and cost-effectively each and every time. To learn more, visit www.onsourceonline.com.

About Greybull Stewardship

Greybull Stewardship exists to provide business owners an ideal co-owner and steward of their business and earn attractive long-term, compounding, cash-on-cash returns for investors.  Greybull’s evergreen fund structure and flexible investment horizon is designed to align with the objectives of portfolio company co-owners and management, comprised of growing, profitable companies in the lower middle market with between $1 to $3 million in free cash flow. To learn more, visit www.greybullstewardship.com

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Portfolio Churn — Enemy of Investment Returns

Churn destroys investment return.  Strangely, traditional private equity builds itself to churn.  Churn reduces investment returns for several reasons such as transaction costs, business disruption, and the difference in tax rates between ordinary income and capital gains.compound interest einstein  This last difference is the easiest to quantify as did Charlie Munger of Berkshire Hathaway in a talk to the University of Southern California Marshall School of Business on April 14, 1994.  Whenever possible, a buy and hold strategy has many advantages, including the built-in tax advantage of capital gains.

Munger demonstrates how the difference between ordinary income and capital gains income creates several percentage points of advantage each year, which creates large differences in value over time.  The chart below provides a basic example of how one can make over 2.5 times more by compounding at capital gains rates rather than ordinary income rates.

Charlie Munger on Compound Interest, Tax Rates, and Investment Returns

Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes.  If you’re going to buy something that compounds for thirty years at fifteen percent per annum and you pay one thirty-five percent tax at the very end, the way that works out is that after taxes, you keep 13.3 percent per annum.Tax Rates and Compound Interest

In contrast, if you bought the same investment but had to pay taxes every year of thirty-five percent out of the fifteen percent that you earned, then your return would be fifteen percent minus thirty-five percent of fifteen percent — or only 9.75 percent per year compounded.  So the difference there is over 3.5 percent.  And what 3.5 percent does to the numbers over long holding periods like thirty years is truly eye-opening.  If you sit on your ass for long, long stretches in great companies, you can get a huge edge from nothing but the way income taxes work.

Even with ten percent per annum investment, paying a thirty-five percent tax at the end gives you 8.3 percent after taxes as an annual compounded result after thirty years.  In contrast, if you pay the thirty-five percent each year instead of at the end, your annual result goes down to 6.5 percent.  So you add nearly two percent of after-tax return per annum if you only achieve an average return by historical standards from common stock investments in companies with low dividend payout ratios.

But in terms of business mistakes that I’ve seen over a long lifetime, I would say that trying to minimize taxes too much is one of the great standard causes of really dumb mistakes.  I see terrible mistakes from people being overly motivated by tax considerations.

Continue reading

The Mirage and False Hope of an “Exit Strategy”

At best, an exit strategy becomes overrated and a waste of breath.  At worst, an exit strategy becomes a destructive mirage of certainty and false hope.  exit strategy mirageI realize that it is conventional wisdom for every entrepreneur to specify their exit strategy.  I have even heard investors say that “I will not invest in anything that does not have an exit strategy.”  The problem becomes — every exit strategy is a fantasy.  It is a waste to spend time and energy on such a fantasy.

An exit strategy is simply a made-up prediction of how the world will work in the future and how the stars may be aligned perfectly for someone to make a multi-million dollar decision that works for your company.  It reminds me of trying to predict that your “marriage strategy” will be to meet the perfect spouse on a ski trip in five years at the Squaw Valley apres ski bar while performing karaoke.  No one has any business predicting that.

Build “Exit Options”

In my opinion, the only way to make sure you have exit options is to build the most profitable business that you can. Build a good business with its widest moat; build a business that is not dependent upon the kindness of strangers, that is not dependent on future equity or debt financing rounds, a business managed (by yourself or someone else) in a way that does not drive you bananas, and that you would be proud to own for the rest of your life.  The goal should not be an “exit strategy” but “exit options” that are available whenever you decide.

Such exit options are also a way to make sure that you are never forced to make decisions with bad timing or bad circumstances, and that time is working on your side.  There is no greater strategic advantage than having time on your side, and no greater strategic weakness than being forced to do something on someone else’s timeline.

Recently, an entrepreneur said to me that he never entered something that he did not know how to exit.  Fair enough.  However, no one knows how to exit everything we begin (even buying a house).  And, such an “always exiting” philosophy causes us to be overly cautious.  Thus, I recommend not to focus on that — it is just a waste of energy.  I recommend focusing your energy on the work that creates the best company today and tomorrow.  You have more control over that.  It is more productive. A good business will create plenty of exit options as time goes by so that there is an exit ramp when you wish it.

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Private Equity Trending Toward Longer Term Models Like Greybull Stewardship

Momentum is growing toward private equity structures with longer term time horizons and movement toward more “permanent capital” — structures that are more similar to Berkshire Hathaway and Greybull Stewardship (my private equity fund focused on companies with $1-3 million in profit).super return conference 2015

Blackstone private equity stretches the field

At last month’s SuperReturn conference in Berlin, Blackstone made headlines by pronouncing its interest in forming a “coalition” to invest outside its ten-year funds.  Blackstone’s Head of Private Equity, Joe Baratta, said, “I don’t know why Warren Buffett should be the only person who can have a 15-year, 14% sort of return horizon.”  He continued, “There are clearly assets” that benefit from such a structure, and “it opens up a whole universe of companies that we are not currently accessing.”

Baratta explained that Blackstone’s structure (like most of private equity) is best when transforming a company over a 3-6 year time frame.  “To do that you have to find a company that you can fundamentally transform,” he said.  “But there are a whole bunch of other companies in the world that would benefit from private governance rather than public governance, or a more active owner rather than a corporate owner, that have low volatility, and good competitive positions.”

Private equity long-term already inside Greybull

This is exactly why I formed Greybull Stewardship.  There is a universe of great companies that do not want to sell themselves to a competitor and risk losing their uniqueness or sell themselves to a private equity firm that needs to “transform” the business quickly in order to generate their return and sell the business.

As Fortune magazine explains, This structure “would give Blackstone more investment flexibility, as traditional private equity fund terms require portfolio copanies to sometimes be sold before the firm otherwise would like to exit.  Remember, no one tells Buffett he needs to sell a company because of market-standard fund terms.”

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A Business Strategy to Capture More Value

The best entrepreneurs and business owners know that capturing value, not just creating value, is critical to success. The phrase “capturing value” is not meant to convey a zero-sum concept of one person capturing what another person loses. It is a way of saying that just creating value is not enough.

Peter Thiel explains this when he says, “If you have a valuable company, two things are true.  Number one, it creates ‘X’ dollars of value for the world.  Number two, it captures ‘Y’ percent of ‘X’.  The critical thing that I think people always miss is that ‘X’ and ‘Y’ are completely independent variables.  So, ‘X’ can be very big and ‘Y’ can be very small.  To create a valuable company, you have to both create something of value and capture some fraction of the value of what you have created.”

An example that comes to mind for me is TiVo.  TiVo revolutionized the watching of television and has created huge value for many people, but it essentially did not figure out a way to capture that new value for itself.

Business Strategy Should Focus on Value Capture

Source: Stefan Michel

Source: Stefan Michel

The concept of capturing value should be present in every strategy discussion and decision. To help with this, I came across a recent article in the Harvard Business Review that places a framework to help the discussion. It was written by professor Stefan Michel of IMD in Lausanne, Switzerland and can be found here.  This chart has some of his ideas and methods for capturing more value.

In his article, Michel identifies 15 ways to capture value in five clusters:
  1. Changing the price-setting mechanism.  Some people are used to the idea of setting price based more on the value received by the customer rather than the cost of the product or service.  Michel goes beyond that to identify other concepts such as (a) auctioning, (b) demand-driven pricing, and (c) name your own price that are worth considering in a value capture brainstorming session.
  2. Changing the payer.  Michel explains that this often comes up in two-sided markets, or in a market where multiple parties could benefit from a service or product which can create opportunities for multiple revenue streams.
  3. Changing the price carrier.  The price carrier is “the part of the experience you hang the price tag on.”  In today’s world, subscription services for snacks, make-up, men’s razor blades, and more are creating dramatic change.  I have seen the power of the subscription model in Massage Envy that charges a monthly membership fee for massage therapy rather than only a per massage model.  Michel expands this idea to bundling, unbundling, and all-inclusive offerings.
  4. Changing the timing.  Everyone knows the “razor-and-blades” model of business, and Michel explains how this is a way to capture more value by capturing the value from later in the series of transactions.
  5. Changing the segment.  This idea is adding a new customer base to a business.  As Michel writes, it starts with “identifying customers who are unwilling or unable to pay current prices but display a need for a given offering, So, then the business must determine how to create a profitable offering for them.”

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