There are many famed drop outs: Steve Jobs, Bill Gates, Mark Zuckerberg and Michael Dell. Surely one of the most famed serial entrepreneur and drop out is Richard Branson.
At 16, Branson gave up studies to start his own magazine business. The magazine was called ‘Student’. It was a mail order business, which created a revenue from advertising.
With a steady readership, Branson thought he could also sell other product within the magazines. That’s when he got the idea to sell records, via mail-order in his magazines. The idea was so successful in the first year that Branson decided to start his own record label and recording studio – Virgin Records.
His record company witnessed a huge success as high profile performers like the Rolling Stones and Sex Pistols signed under the label. Branson became millionaire by the age of 23. But it would seem like Branson had lost his mojo when he wanted to start up his own airline. Or so his business partners thought at the time.
Building an Airline
And to be honest, I can’t blame them for being sceptical.
One of the worst industries is the airline industry. Not only does it require huge amounts of start-up capital. You also have large ongoing costs; maintaining planes and hiring experienced staff.
This wouldn’t be so bad if airlines didn’t sell a service which has no difference to their competitors. No matter how much the flight attendant smiles or how little turbulence you experience, your only determining factor for picking one airline over the other is cost.
Airlines know this and they usually try to undercut competitors to increase sales. However, what happens is they go too far and end up cutting prices to operate at cost.
Yet in 1984, Branson was undeterred. He already had a bad experience with air travel. On his way to holiday with his then girlfriend, now wife, Branson showed up to the airport to see that the flight was cancelled.
Shortly after, by chance, Branson received a business plan. It was about starting an all business class airline flying between London and New York. The plan believe the market was being under severed and that there was a gap to exploit.
Richard knew nothing about airlines at the time. But he imagined that this business plan had already been sent to various airline executives. The only reason why it was in his hands was because they all had turned it down.
He thought it over during the weekend. Could he really crave out a speciality airline that could compete against established competitors?
Branson tried calling other major discount airlines that flew the same London to New York route. However, he could never get through. They always seemed to be busy or they simply didn’t care.
This told Richard two things: either they were lousy businessmen or they were overwhelmed with demand. Either way it was a position sign.
On Monday, Richard told his music record partners that he wanted to start an airline. And of course they told him to stick to records. “Don’t you know how much a 747 jumbo jets costs Richard? Not to mention the fierce competition.”
But Branson persisted with his idea. To get around the costly problem he decided to call up Boeing and ask if he could lease a plane. “Have you got a 747 jumbo jet lying around?” Branson asked.
They did. But he was told Boeing doesn’t just lease plane to anybody. Branson asked them to give him some ballpark figures, which they did. Branson went away with more information and figured out it would cost a relatively small amount to lease a plane on a 12-month contract. Of course he’d also have to pay for staff and advertising.
All up, Branson was looking at around $2 million to get his hypothetical airline off the ground. While this might sound like a huge bet, Branson’s record company was on track to earnings $12 million that year, and $20 million the year after that.
But what excited Branson about an airline was its cash flow. He figured that he would only have to pay for fuel 30-days after the plane had landed. He also wouldn’t have to pay wages until 15 to 20-days after the plane landed. But he could collect ticket sales before the plane even took off, sometimes 20-days before the plane went airborne.
With even more confidence now, Branson took the risk and started Virgin Atlantic. He managed to pack the first flight with far lower costs than his competitors. And by the time they woke up to what Branson was doing, it was too late. He had already established his company as a major competitor within the airline industry.
How to think about Investing
Since Virgin Atlantic, Branson has created many other businesses. And he uses a similar approach. Exceptional investor, Mohnish Pabrai describes this approach in his book ‘The Dhandho Investor’ as low risk, high uncertainty.
The idea is that the market has a horrible time of valuing uncertain situation. For example, if a company looked as if it was about to go bankrupt, Wall Street would likely sell down the stock to all-time lows.
However what Wall Street didn’t consider was huge piles of saleable assets, that the company could sell, raising capital and avoid bankruptcy. Once the uncertainty is gone, Wall Street piles into the stock as if nothing happened.
Low risk, high uncertainty is a power idea. And it’s how Mohnish has been able to kill the market returns over time. From 2000 to 2013, Mohnish beat the S&P 500 returns by more than triple digits.
How can you learn to do the same? Click here.