What Makes The Perfect Business (5 Things)
AAlex Hormozi
Small Business/StartupsAdvertising/MarketingManagementAdult EducationBeginning Investing
Transcript
00:00:00If I wanted to start the perfect business, these are the things that I would focus on.
00:00:02So think of these like the five advantages that make any business easier to grow and way more
00:00:06profitable. And this is what's helped me build a portfolio of companies that generated over $250
00:00:11million in revenue last year alone. And so for each one, I'll describe what it is. I'll give
00:00:15examples and I'll show you industries that excel in them and industries that suck. There are very
00:00:18few businesses that have all five and even having one of these makes the business that you have
00:00:22better than others. And so just think this video is like an S tier ranking for opportunity vehicles.
00:00:26So if you've ever heard or thought, man, like, I feel like I've got a level 10 skill set in the
00:00:31level two opportunity, then this video is for you. So let's get started with number one. Sticky. It's
00:00:35the most important thing. If you do not have what's called revenue retention, you have nothing.
00:00:39Revenue retention just means how much revenue from last year you retain to the next year. That's all
00:00:44it is. If you don't have that, you will always be in the sales business. So John Paul DeGiorgio,
00:00:47who started Paul Mitchell, he started Patron. He says this quote that I always remember. He says,
00:00:51you want to be in the resale business, not in the sales business. And so there's two types of
00:00:55retention that people discuss. One is logo retention, which is if you had a hundred customers
00:00:59in January, how many do you have now? And then the second is the revenue retention piece, which is if
00:01:03you made a hundred dollars from those customers in aggregate in January, how much do you make from
00:01:07that same cohort or group of customers today? And so logo retention, just to be clear, you almost
00:01:12never have a hundred percent logo retention. Like you can't get more than a hundred percent. You only
00:01:16have a certain amount of customers and it only decays over time. And so some reasons for that is
00:01:20that there's something called structural churn. So someone moves away, they die, their business dies.
00:01:26There's a, they fire the employee. If you do a payroll thing who use the subscription or the
00:01:30service, and this is called involuntary churn. It's because it's just structural to how businesses
00:01:35operate. On the other hand, there's something called voluntary churn. And this is the one you
00:01:38really want to avoid. That's when people leave because they just think you suck. And so those
00:01:43are kind of like from a logo retention perspective, how many of the number of people are still here.
00:01:48The revenue retention side, you absolutely can have over a hundred percent net revenue retention. And
00:01:53so that means that even if you lose some of those customers, the ones who stay increase how much they
00:01:57spend enough to make up for the ones you lost. And so the easiest way to do this is have a clear way
00:02:02for cheaper customers to spend more with you. And if you're a service, keep doing the thing they need
00:02:07you to do, which part of it is making sure that that person that you sell actually needs it in
00:02:11the first place. And this is why qualifying customers is so important. But for example,
00:02:16if I have a $9 a month membership and a $99 a month membership like school, if someone comes
00:02:21in at $9 and then goes up to 99, then I get an 11X in terms of value from that customer. And so even
00:02:28if 20% of customers leave from the nine, if I get even 10% of customers to take an 11X, I have more
00:02:34than a hundred percent revenue retention. And that means that when a customer enters the business,
00:02:38that means that the business will continue to grow whether we do nothing at all over time. And that
00:02:43becomes a very valuable company. Now, let me give some interesting data on school that manages
00:02:48hundreds of thousands of memberships that you can use for any recurring business. Number one is that
00:02:52the first amount of churn that's the greatest is month one. So if you ever have to focus,
00:02:56focus first on your first 30 days. Across all categories, it was over 20% plus churn in that
00:03:03first month. The next big kind of like drop-off point in churn is about 10% and that happens at
00:03:10about month three. The third and kind of final spot where you have a big drop in churn is month six.
00:03:16And so the big takeaway here is do whatever you can to get people to month six. So in your mind,
00:03:20you might be like, how am I going to keep them forever? It's like, you really just got to get
00:03:23people to that sixth month, which really means make sure the first 30 days are awesome. And then
00:03:26have a clear way to get them past that third month. And then you basically walk your way to month six.
00:03:32And at that point, churn drops to almost 2% a month. And that's across all categories. All right. So
00:03:36this is just structural to how people consume and value memberships or recurring subscriptions
00:03:41of any kind. And so please take this as like, this is where I'm going to focus all of my attention
00:03:46to get people that 2% churn, which means we just got to get them to month six. So let me give you
00:03:51examples of businesses that are not sticky. So education on its own is not a sticky thing. That's
00:03:57why you graduate when you go to school. Like you're not going to go retake the same math class over and
00:04:01over again. Roofing, car sales. These are businesses that do not have a lot of stickiness to them.
00:04:07They're one-time shots. On the other hand, a good example of sticky businesses is term life insurance.
00:04:12You sign up for life insurance and you pretty much just pay until you die. Alarm systems. Like you
00:04:17don't really think, oh, I'm going to shop my alarm system. You have it. As long as it works, you're
00:04:20good to go. Internet, phone providers, banking. And to use that kind of education, a different version
00:04:26of that for like school, for example, is if you have something that's based on community and
00:04:29something that's based on consumables, meaning people consume it month over month over month,
00:04:33then it means that they're going to want to pay month over month over month. And so if I could
00:04:37only have one thing for of these five, it would be this. And so think about it like this. Let's imagine
00:04:41company A and company B. So company one sells 100 customers year one and then loses 100 customers
00:04:46year one. Year two, they sell 200 customers because they get better at marketing and sales. And then
00:04:51they lose 200 customers. And then year three, they sell 300 new customers and then they lose 300 new
00:04:57customers. All right. Now, company B, same time period, sells 100 customers and then loses zero.
00:05:03Year two, they sell 100 customers again. They don't scale their sales and marketing at all.
00:05:07But now they have the original 100. So now they have 200 active customers, which means
00:05:11they actually have the same revenue. Year three, they sell another 100 customers. They still have
00:05:16the first two and they have 300 customers in total, meaning both of these businesses in each of these
00:05:21years is doing the same revenue. Of these, which would you pick? Company A or company B? Obviously
00:05:28company B. And so I'll give you two reasons, one that's personal and one that's math. On a personal
00:05:33level, the idea that you could just have no new customers at any given point and then every year
00:05:37after that, you still have your 300 customers who pay you over and over and over again, that helps
00:05:42you sleep at night great. Now from a math perspective, getting 300 new customers in a year is very
00:05:48expensive. So look at how many total customers this business needed to acquire over that period
00:05:53of time. So they had to acquire twice as many customers as company B. All that additional
00:05:58cost is taken out of the profit of the business. But on top of that, getting 600 customers versus
00:06:04300 and especially 300 in one year versus 100, the cost of getting that additional customer
00:06:09is not going to be just 1x more. Oftentimes it's two or three times more. So it's really almost like
00:06:14getting 900 customers from a cost perspective compared to that 300 that you had to get and
00:06:19spread it over three years. The cash flow of the business, the profitability of the business
00:06:23will be significantly higher. And as an owner, way more fun to own. And this is just like me talking
00:06:28to my younger self. Building a business that does this takes time, but what it unlocks is compounding.
00:06:34And so the reason that you don't usually want to do this B thing is because you're excited to
00:06:39jump from thing to thing because your current thing still feels month to month. Once you see compounding
00:06:44unlock and you see revenue lock in, you really never consider other vehicles because you can
00:06:49literally just Excel sheet out your wealth knowing exactly how big you're going to be in the future
00:06:53because you know the customers you have today are going to be there tomorrow. Real quick, I'm going
00:06:57to show you the exact 10 stage roadmap from zero to 100 million plus that less than 1% of companies
00:07:03finish. I've now done multiple times. And so I can say with a lot of confidence that these are the
00:07:07stages as headcount increases that you need to get through. And I broke each of these down by eight
00:07:12different functions of the business, what the constraint feels like, like what are the symptoms
00:07:16of it when you're going through it, and then what steps we actually took to graduate. And we've done
00:07:20this across software, physical products, service businesses, brick and mortar, all of this, and it
00:07:26works. And it's my gift to you. It's absolutely free. And so the link's in the description,
00:07:29but you just go acquisition.com/roadmap, just enter your info, and it'll spit it right back to you,
00:07:33all free. Now the second thing that I see is like a big advantage. You really never consider other
00:07:38vehicles because you can literally just Excel sheet out your wealth, knowing exactly how big you're
00:07:43going to be in the future, because you know the customers you have today are going to be there
00:07:46tomorrow. Now, the second thing that I see is like a big advantage is expensive. So what does that
00:07:52mean? In a perfect world, you'd want something that costs a penny that you could sell for a buck,
00:07:55right? High gross margins means that you can pay people better. Your cash conversion cycle is
00:08:00typically faster. You can reinvest that cash in more growth. And this typically has higher EBITDA
00:08:04margins. So if you have high gross margin, you'll typically have higher net margins. And so for
00:08:08example, if I had a $100 million revenue business with 10% margin versus a $20 million business with
00:08:1450% margins, you'd make the same money at the end. Now, you get five times the incremental EBITDA
00:08:21per dollar made. And that's certainly nice. It's less work for more money. Now, this was the topic
00:08:27of my money models book that I spent a lot of time on. And the goal was to see how you can combine
00:08:32up the money cycle and increase gross margins and cash flow in the business. So let me give you some
00:08:36examples of businesses that have low gross margins. So grocery stores, right, notoriously small gross
00:08:41margins, farming, restaurants. And you'll notice that all of these are kind of grouped around one
00:08:45thing is because food is one of the most elastic products. So take note to that. But fundamentally,
00:08:49it's really like things that are commodities, which is why the first chapter that I have in the
00:08:52offers book is how to decommoditize yourself so that you can increase your gross margins so you can
00:08:57ultimately get the cash you need to grow. Now, on the flip side, examples of good businesses that
00:09:00have great gross margins. Media. I mean, think about it. A podcast read that you do when you've
00:09:05got a thousand people listening or a million people listening takes the same effort. And all of the
00:09:09extra that you can charge is just profit, right? Information. That's one. Education itself.
00:09:14Community. Access. These are things that have high gross margins. Data. Software. Pharmaceuticals,
00:09:21right? It costs them a penny to make a pill and they sell it for a buck.
00:09:23Lotions and potions. It doesn't cost a lot to create a supplement. You can sell it for a lot.
00:09:29All of these things are businesses that have high gross margins. Now, quick disclaimer. Many of you
00:09:33wonder what you should pick or whether you're in the right boat. And as a reminder, this doesn't
00:09:36mean you watch this video and then like jump ship in your business, but you should at least see the
00:09:40levers that you have available to you to improve the value of the business you have right now. And
00:09:44to be clear, all of these are continuums, not binaries. It's not, is it sticky or not sticky?
00:09:49It's how sticky is it? It's not like, oh, this has zero gross margins or a hundred percent gross
00:09:53margins. It's how big is the gross margin and all the way down. So that brings me to the third one,
00:09:58which is expansion. I want something that is growing, right? That's the best. It's the easiest
00:10:03way to grow is to go into something that's already growing. So if you just do a normal amount, you
00:10:06still grow by default. And so I'm thinking about this more as an industry growing rather than the
00:10:12business itself growing. The business growth will ultimately come down to marketing and distribution.
00:10:16And I can do that. So that's not something that I care as much about. This is a skill advantage
00:10:20to us as entrepreneurs picking the right markets, because once you know how to generate demand,
00:10:25then you don't need to always have a tailwind behind you. You just need to not be in a headwind
00:10:30fundamentally, right? Make sure you're just not fighting an uphill battle. I speak about this in
00:10:33the offers book. And the main reason is this. Even if you know how to market and sell, going into or
00:10:38staying in a space that's shrinking is an uphill battle. And this is why I use the example of
00:10:43newspapers. Most people are like, I don't really read the newspaper. Every single year it goes down.
00:10:46If you're like, hey, I want to get into formal education. Probably not the time to do it because
00:10:49it's going, it's shrinking by 6% a year, right? Tobacco, shrinking, alcohol, shrinking, right?
00:10:56Retail, like brick and mortar where you're selling stuff. Not to say you can't make money in it. It's
00:10:59just harder, right? Administrative roles, clerical, data entry. These are things that are shrinking
00:11:05because of technology. And this is just normal and how the world works. Now the flip side is what are
00:11:09examples of industries that are growing? Energy, going through the roof. AI, through the roof.
00:11:14Healthcare, through the roof. Cyber security, through the roof. E-commerce, through the roof.
00:11:18Alternative education, through the roof. And this is what fundamentally the bet that I made on school
00:11:23was about. The CAGR, so Compound Energy Growth Rate for alternative education is over 20% annually,
00:11:28right? People are tired of traditional education. This is why platforms like YouTube are proliferating
00:11:33like lazy. People want to learn specific niche skills that are useful to them. Which brings me to,
00:11:38drum roll please, number four big advantage that you want to have. Air. You want something that has
00:11:42operational scale or low operational complexity and low capex. So let me define each of those.
00:11:48So low operational complexity means the number of variables that you need to actively manage
00:11:53to expand production. So if I make a podcast, like I said earlier, and then I sell an ad read inside
00:11:58of that podcast, someone gives me money. I read it. And then I hit post. That's pretty much it.
00:12:03There's nothing else. And that scales all the way up, right? And so that's low operational complexity.
00:12:08Now, if I manage a hundred restaurants of a chain, I have thousands of employees. I have suppliers. I
00:12:14have inventory that goes bad. I have build outs. I have leases. I have parking. I have permitting.
00:12:20And there are many more pieces that I need to actively manage in order to expand production,
00:12:24even a small incremental unit. The other side is capex, which is just a fancy way of saying
00:12:29capital expenditure, meaning how much money you got to spend to get the business to keep growing.
00:12:32Now there's a little asterisk on this because I'm explaining why it can be a good thing when I bring
00:12:37up my very last point. So wait and pay attention to the end because it's going to be very important
00:12:41for number five. Now, the reason that this is valuable as a founder is you typically will need
00:12:45less capital, which means you can dilute less for your ownership for equity, for cash to continue
00:12:51expanding, which means you can expand faster without needing money from the outside. So Warren
00:12:55Buffett talks about this because he wants businesses that generate lots of cash, not ones that generate
00:13:00it and then have to consistently reinvest that cash in order to maintain competitiveness in the
00:13:04business. And so this is the important caveat. If you raise capital grow faster, you could have
00:13:09all the correct economics. You just want to grow faster. That is a strategy. It's an advanced one.
00:13:14But if you're trying to capture market share and capture market share has actual advantages beyond
00:13:18the economics of scale, like we'll make it up in volume. It's rarely true. But if it actually
00:13:23is true, then there is reason to go get market share actually have some sort of network effect.
00:13:27That makes sense. In my experience, it's very rare, right? School is a great example of actually it
00:13:34doing it right. Additional users to school do not cost very much. But getting everyone on school is
00:13:40worth doing because there are strong network effects. And so it's worth us putting more cash
00:13:45in now rather than taking distributions. Said differently, taking that cash and putting it
00:13:50into the business yields tremendous ROIC, which means return on invested capital. And if you have
00:13:56great ROIC, then you become a magnet for money. So this is just a little pro tip. You should never
00:14:01have any difficulty raising money if you are in a business that's like that, because if you do,
00:14:06it means that you need to make the deal better. Let's say you have a restaurant chain and you want
00:14:10to grow it. And to be fair, I think it's a very tough thing to do. But if you wanted to grow it
00:14:14and if you're like, man, I can't get people to invest in my franchise or one of my franchise
00:14:18locations, how do I have a better marketing strategy? For sure, there's things you could do
00:14:22to market and sell better. But if you come to somebody and say, hey, it costs a hundred grand
00:14:26to open my thing. It'll take three years in order for you to get your money back. That's like a
00:14:30mediocre-ish offer. If you say it's going to cost a hundred grand to do my thing, and then you're
00:14:34going to make $300,000 back on average in the first year, that's going to be a significantly more
00:14:38enticing offer. And so for most people who want to use outside capital in order to scale, the reason
00:14:44they can't raise it is not because they don't lack some big skills, because the core economics of the
00:14:49thing they're trying to scale just aren't that good. And so the fifth and final is unique. So you want
00:14:54a competitive moat, something that no one else can build. Now, part of what can raise the bar and
00:14:59create a larger moat is the number of people who can afford to enter the market. So if you have a
00:15:03market that has virtually no barriers to entry, you'll have a lot of competition. And this can be
00:15:07a huge driving factor. So for example, social media marketing agencies, the bar is virtually nothing.
00:15:12It can be sticky. It can be high gross margin. It is kind of an expanding thing. People always want
00:15:19more customers. It can be air from a capex perspective, but from an operational drag
00:15:24perspective, it's not as good. Now with AI, it can actually become really interesting.
00:15:27But the main issue is so many people can do it. And that's what makes it so competitive. And that's
00:15:34ultimately what drives down the price case. It's very difficult to differentiate. Now, let me explain
00:15:38what I was saying earlier about capex as a way to have a moat. So if you are competing against every
00:15:44human being who has hands to dig holes, if you buy a shovel, you'll be significantly better than people
00:15:50who don't have a shovel. And that'll cost you a little bit of money. That'll make you more efficient.
00:15:54And so in a way, you can actually use capital that you do to invest upfront into building things that
00:15:59make it less competitive for you and more competitive for other people to try and enter
00:16:02your marketplace. This is why I like building a power plant. It's probably very profitable.
00:16:06It also costs a lot of money, right? And so these are things that you can do to any business. If you
00:16:12find a way you can have return on invested capital for things like technology, for things like
00:16:16equipment, those become moats that make it more difficult for other people to enter, which means
00:16:20that you'll have more pricing power. And so once you start to see some success, I like getting into
00:16:25businesses that cost some capital to expand because it just means that I have fewer people that I have
00:16:30to compete with. Now, up to this point, I've only talked about capital as a kind of moat. Now, to be
00:16:34clear, it's not indefensible, but it's better than nothing. But the best kind of moats are the things
00:16:38that you know how to do, but no one else can do. So for example, Nvidia chips. This is something that
00:16:43costs a ton of money and has incredibly specialized skills. So as a result, they're one of the seven
00:16:48most viable companies in the world, right? Pretty wild. Nuclear energy costs a lot of money and is
00:16:53something that's super proprietary. Not a lot of people know how to do. If you didn't have the
00:16:57capital, then it would be recipes, processes, patents. These are trade secrets, your special
00:17:01sauce. And just as a side note, you're like, what differentiates, you know, like a trade secret from
00:17:06a patent? Well, patent just requires three things. It's got to be new. It's got to be non-obvious and
00:17:10it's got to be useful. Those are from the patent office. All right, so if you're thinking about
00:17:13what are the things in my business that are brand new that I only do that are not obvious and that
00:17:17are useful, those things are patentable, right? Kind of cool. Now you have to defend patents,
00:17:21which is another story, but that's a way of creating a boat. Now, one of my favorite ways
00:17:26of creating a boat is creating a brand. You can make anything that's commodity unique by adding
00:17:31a brand to it. So for example, Revlon is kind of like a mass market brand for beauty stuff. You can
00:17:37get it at CVS, whatever. And you might think, oh, that's a, that's a cheap brand. Now the point though
00:17:41is that even if Revlon is cheap, it's still a little bit more expensive than white label
00:17:47generic. So CVS might have some CVS brand makeup, right? Revlon's can be a little bit more expensive
00:17:54than that, but they literally will come off the exact same manufacturing belt and they'll stamp
00:17:58on Revlon and they'll stamp on CVS and they'll ship them there. And that premium converts a higher
00:18:02percentage of people at a higher price and increases the stickiness. And so a brand is one of my favorite
00:18:07ways of taking something that's otherwise a very normal service and making a moat or making
00:18:11something unique about it. So let me give you a different example that, that manages some of these.
00:18:15All right. So Coke requires capital to enter new markets, but it gets great returns on capital. So
00:18:20people are happy to provide it or it can provide capital to itself and get returns on its own
00:18:24capital. And it has patents for the flavor of Coke and the brand itself. And so these are things,
00:18:29and if we're looking at this, right, when people start drinking Coke, they usually keep drinking
00:18:33it for a long time. It costs a few pennies to make a can of Coke in terms of the liquid inside of it,
00:18:38but they can sell for a lot more than that. Now, is it expanding as a marketplace? I think Coke's
00:18:43pretty global. And I guess the only expansion is just more human drinking stuff. So I guess there's
00:18:47probably right now still some expansion that's happening. From an operational scale perspective,
00:18:52this is one where it's a little harder. Now, is it easier than scaling an accounting firm globally?
00:18:57Absolutely. Is it harder than scaling software globally? Yes. And so it's kind of like in the
00:19:01middle on this one. And then unique, what it does to create that uniqueness, so Shasta Cola doesn't
00:19:07take over the market, right, is it has the brand and it has its recipe. And so those are the ways
00:19:12that it creates something that is harder to usurp, which is why Warren Buffett's been a long-time
00:19:17investor in the business, and it just continues to grow and print money. And so that's what you want.
00:19:21Now, you're not going to have something that has all of these. It's very, very hard to do that. There
00:19:26are trade-offs. But the perfect business would include many or all of these. And if your business
00:19:31includes none, that's okay. Work at retention first, and then backfill the rest. But if you're
00:19:36in an industry that has no retention, then switching to one that does, if you're early
00:19:40in your career, may not be the dumbest decision. And so if I were starting it all over again,
00:19:44this is what I would look for in a business that I'd want to start, ideally something that
00:19:47people keep buying, something that is expensive relative to what it costs me. It's in a market
00:19:51that's not going down at the very least. There's less operational complexity in order to scale.
00:19:56And it's unique to me, or at least I know a way to make it unique to my customer. Real quick,
00:20:01I'm going to show you the exact 10-stage roadmap from zero to 100 million plus that less than 1%
00:20:07of companies finish. I've now done multiple times. And so I can say with a lot of confidence that
00:20:11these are the stages, as headcount increases, that you need to get through. And I broke each of these
00:20:16down by eight different functions of the business, what the constraint feels like, what are the
00:20:20symptoms of it when you're going through it, and then what steps we actually took to graduate.
00:20:24And we've done this across software, physical products, service businesses, brick and mortar,
00:20:29all of this, and it works. And it's my gift to you. It's absolutely free. And so the link's in
00:20:33the description, but you just go acquisition.com/roadmap, just enter your info, and it'll spit
00:20:38it right back to you all free.