“Gold! Gold! Gold from the American River!”
Shouting these few words, San Francisco newspaper publisher and merchant Samuel Brannan walked through the streets of San Francisco holding aloft a vial of gold. Rumours of the discovery of gold were confirmed in March 1848, and started the Californian Gold Rush, where 300,000 people came to California trying their luck in finding gold and the hope of making fortunes. Only a handful of them were actually able to do so, and Samuel Brannan was one of them. He became the first millionaire of the Gold Rush — not by mining the gold, but by capitalising on the needs of miners, and selling them picks, shovels, and pans.
Another fascinating story is that of Levi Strauss and Jacob Davis. The Levi’s story is the stuff of legends… During the Californian Gold Rush, these two men wanted to cash in on the action, but they did not head for the river grabbing their tin pans. They invented the riveted-pocket work pants we know as “jeans” today, and also sold picks, shovels and wheelbarrows. What they did not do is… pan for gold. When panning for gold, you have a slim chance for a huge payoff. Most miners went home with nothing after betting everything they have on mining for gold. Levi and Jacob however made money from every prospector who came to town wanting to pan for gold, regardless of what their gold haul is…
This important metaphor may help new startups navigate the waters of their business model. Instead of focussing their energy and efforts trying to become the next big hit with a handsome payoff, why not sell picks and shovels? You get paid every time someone buys from you…
For the tech industry, we’re in some really pretty unusual times. Valuations are sky high, and there is a new unicorn created every other month. Venture capital is flowing like never before, and exits are occurring at a higher rate than ever. These are fantastic times to be in now for entrepreneurs, as they get seduced by the siren song of software and the lure of riches…
In the modern age, the internet business is similarly liken to a gold rush. A lot has been written about the market potential of various Internet+ models and industry applications. But these rosy predictions and forecasts can only hold water if the companies in the space get it right. This is where the “gold rush” business model come into play… When you’re in a gold rush, sell picks and shovels. It’s the surest way to make money…
The wisdom behind this business model still held up even to this day, and there are underlying statistics supporting this proposition. Statistically speaking, only a few companies will ever make it to the finishing line and “strike it rich”, thus claiming their haul of gold. But there are thousands of companies who will go into the “panning of gold” and make the effort to become rich. And to find that gold, they will require some proverbial picks and shovels.
So, instead of trying to be the next WhatsApp or Youtube or SnapChat, why not think about what those companies need to be successful and build a company to support those efforts.
When a major new technology trend emerges, for example the rise of online video or social media, entrepreneurs can try to capitalise on this trend by creating a consumer product (mining for gold) or by creating tools to enable such consumer products (selling picks and shovels). Successful companies in the B2C and B2B segments in any technology breakout are quite evenly spread, however consumer facing companies tend to get more attention. In the online video segment, Youtube is thought to be a big winner, but infrastructure suppliers like Akamai have made more money from online videos.
B2B companies tend to require stronger technical and sales skills, whereas B2C companies tend to be more about predicting consumer tastes and marketing skills. Another consideration should be the supply-and-demand of startups in the space. Because B2C companies tend to be “sexier” and get more press coverage, more entrepreneurs are drawn to them. This tends to lead to greater competition even though the market opportunities might not justify it.
When you pan for gold, you are betting everything for a big windfall. One binary product — it either work or it doesn’t, customers either love it or hate it… the picks and shovels business is of course less glamorous, but the consistent upside has a higher chance for success. An example would be credit card processing companies like First Data Corp. They don’t care what you buy, they get paid a percentage of the amount spent, whether the times are good or bad. Another example would be Plaid, who was recently acquired by Visa for $5.4 billion. They are the engine behind successful fintech unicorn startups like Venmo, Robinhood and Coinbase.
What about commoditisation?
There is always the worry that your product may get commoditised. If you have been operating a successful business selling picks and shovels, nothing can prevent the guys next door from selling similar picks and shovels at cheaper prices. If the both of you have nothing to offer other than cheaper prices, then it is likely that you’ll race each other to the bottom before one of you goes out of business. Or maybe both of you…
Luckily there is a commodity killer — service. When we add service, expertise and brand loyalty to our picks and shovels model, we become a tollbooth and not a commodity anymore…
If someone wants a certain experience, then they have to buy their picks and shovels from me. They cannot get the same experience I deliver through any discount store or the neighbourhood mom-and-pop store. Coupled that with clever branding, and you’re in this business for life! That’s the reason why so many bottled water companies can stay in business, even though it is a brutal industry. The high-end water brands position themselves as the tollbooth business for a certain experience. The low-budge brands only compete on price.
Our picks and shovels are not beholden to trends. Fads will come and go, but everyone needs a place to sleep, a place to store their stuff, dishes to eat from, and jeans to wear while they are mining for gold that they might never ever find. Let others chase the tail-end of some trend or bet everything they have trying to create a new trend. We can stay in the background counting our sales.
Selling the same picks and shovels over and over again?
We cannot be selling the same picks and shovels over a prolonged period of time. Otherwise we will end up with no innovation and nothing cool to sell to our customers. As our customers keep moving forward trying to build the next big thing that will change our lives, we could also push forward by adding another pick and shovel as a second revenue stream. The new picks or shovels can be a new iteration with certain customised features for a bespoke customer.
Steady revenue streams versus one-time lottery winnings…
When we bet on a business to moon, we will get a limitless upside and sadly an inevitable downside. The pick and shovel business model will generate steady revenue streams month after month after month. And the one-hit wonder business is the lottery ticket that will most likely end up with nothing. Selling picks and shovels might not be glamorous, but they provide you with consistent income.
When we pick a “pick and shovel” business model, we are doing something more than immediate and consistent income, we are actually buying more time for ourselves. More time to build new innovative products, more time to tweak a product that didn’t work so well the last time, or more time to feed ourselves before embarking on the next big thing!
So that’s the surest business model to make money in a gold rush… and there are several significant gold rushes in various industry verticals in the internet space now. We are in the phase of transiting from “connected” to being “digital”, and hence the time is ripe now for some huge gold rushes in various verticals now.
“Gold! Gold! We found gold!”
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