Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 135

Great businesses where customers do the work

What business would you like to own? For some, the dream might be McDonalds, Subway or even the local Laundromat, all potentially good businesses. But some new companies have more compelling operating models. Uber owns no cars, Facebook doesn’t pay for its media content and Alibaba, the world’s largest e-commerce site, has no stock to store. They’re all great businesses because they require little inventory and have low capital costs. They also become better businesses as they get bigger because of the network effect (see Facebook below). Some businesses like Tripadvisor have customers that do their work for them. That’s a fantastic business model - customers make the business better for free.

You are the content

Facebook doesn’t buy TV shows. It’s a reality show that is you. Your posts are the content. Unlike other media businesses, Facebook doesn’t pay money to produce shows or write off shows you don’t like. It makes money from your content by placing advertising within your newsfeed. On average, 1 in 20 posts have an advert. In the past 12 months, their global average revenue per user was $10.47. Australia is not broken out but the average US user brings in $34.

All those likes you click add up. Facebook needs 70 likes to understand your personality better than your friends. With 250 Facebook likes, a computer can know you better than your spouse. Facebook has a Superbowl-like audience every day where advertisers can target specific customers with a compelling alternative to television advertising. Facebook doesn’t need to market to sign up new users. Current users help Facebook grow for free as they send out links to sign up friends. The network effects are strong with one billion daily active users. A past example of the network effect is the telephone. The more people who own telephones the more valuable the telephone is to each user. Facebook is the same.

The average gross margin (sales minus costs of goods sold) for S&P500 companies is 33%. A large gross margin means greater potential profitability. Facebook’s unique business model delivers its 83% margin. The majority of expenses are employees researching and developing new services such as Instagram, instant messaging with WhatsApp and virtual reality with Occulus Rift. According to Nielsen, the average Australian spends 1.7 hours a day on Facebook. It’s easy to admire a new age media company that doesn’t pay for the content that drives the business.

Customers working for you

Tripadvisor is a similar user-generated model. It is the world’s largest travel site allowing travellers to plan and book their perfect trip. Tripadvisor doesn’t employ staff to write hotel reviews, their customers do it for them. Every day, the CEO wakes up and customers have added thousands of more reviews every night. I personally like the sound of this business.

Tripadvisor has 250 million reviews on 5.2 million places to stay, eat and things to do. You couldn’t hire enough staff to build it. Frequent reviewers receive virtual badges and you can guess how much that costs. Users are even willing to write reviews on small mobile screens. Like Facebook, it has a virtuous circle where more reviews lead to more traffic which leads to more reviews. Tripadvisor employs only 3,000 staff compared with 18,000 staff at Expedia and 12,700 at Priceline. Gross margins are even larger than Facebook’s at 96% (that’s not a typo). The majority of expenses are sales and marketing, such as television advertising. As the diagram below shows, customers (free employees) add 160 contributions a minute.

Source: Tripadvisor 2Q Investor Presentation

Can the business scale?

Apart from user-generated content, other good businesses involve companies that can grow and scale with little additional staff. As an ex-accountant and fund manager, I appreciate the benefits of scalability. Good people are hard to find. As accounting or law firms grow, they need to add more staff as they win new business. However, as a fund manager grows they don’t have to increase staff numbers commensurately. Look at the success of Magellan and Platinum. Magellan manages $39 billion with only 90 staff.

Another great business model is one that involves large-scale exchange traded funds (ETFs). There is none of the key man risk associated with star portfolio managers, and it’s hard to underperform a benchmark when you create it. In most sectors, ETFs are highly scalable with few of the limits to capacity evident for specialist managers such as hedge funds or small caps. In fact, as an ETF attracts more money it becomes more valuable to customers as liquidity and trading increases. For example, the US ETF provider, WisdomTree (represented in Australia by BetaShares), employs 124 people to manage $60 billion.

High gross margins and scalability

There are many great businesses out there but technology tends to top the list. The reason why the NASDAQ is one of the best performing indexes is because their companies tend to have high gross margins and scalable business models. Anyone in an operating business would love to have these characteristics. It’s hard finding good staff and attracting customers. Let your customers do the work and scale your business!

 

Jason Sedawie is a Portfolio Manager at Decisive Asset Management, a global growth-focused fund. Disclosure: Decisive holds Facebook in its fund. This article is for general purposes only and does not consider the specific needs of any individual.

 

  •   19 November 2015
  •      
  •   

 

Leave a Comment:

RELATED ARTICLES

Network effects: when big gets very big very quickly

Facebook, Google need new business model

Why the tech giants still impress

banner

Most viewed in recent weeks

Retirement income expectations hit new highs

Younger Australians think they’ll need $100k a year in retirement - nearly double what current retirees spend. Expectations are rising fast, but are they realistic or just another case of lifestyle inflation?

Four best-ever charts for every adviser and investor

In any year since 1875, if you'd invested in the ASX, turned away and come back eight years later, your average return would be 120% with no negative periods. It's just one of the must-have stats that all investors should know.

Why super returns may be heading lower

Five mega trends point to risks of a more inflation prone and lower growth environment. This, along with rich market valuations, should constrain medium term superannuation returns to around 5% per annum.

Preparing for aged care

Whether for yourself or a family member, it’s never too early to start thinking about aged care. This looks at the best ways to plan ahead, as well as the changes coming to aged care from November 1 this year.

Our experts on Jim Chalmers' super tax backdown

Labor has caved to pressure on key parts of the Division 296 tax, though also added some important nuances. Here are six experts’ views on the changes and what they mean for you.        

Why I dislike dividend stocks

If you need income then buying dividend stocks makes perfect sense. But if you don’t then it makes little sense because it’s likely to limit building real wealth. Here’s what you should do instead.

Latest Updates

Investment strategies

LICs vs ETFs – which perform best?

With investor sentiment shifting and ETFs surging ahead, we pit Australia’s biggest LICs against their ETF rivals to see which delivers better returns over the short and long term. The results are revealing.

Retirement

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

The ASX is full of broken blue chips

Investing in the ASX 20 or 200 requires vigilance. Blue chips aren’t immune to failure, and the old belief that you can simply hold them forever is outdated. 

Shares

Buying Guzman y Gomez, and not just for the burritos

Adding high-quality compounders at attractive valuations is difficult in an efficient market. However, during the volatile FY25 reporting season, an opportunity arose to increase a position in Mexican fast-food chain GYG.

Investment strategies

Factor investing and how to use ETFs to your advantage

Factor-based ETFs are bridging the gap between active and passive investing, giving investors low-cost access to proven drivers of long-term returns such as quality, value, momentum and dividend yield. 

Strategy

Engineers vs lawyers: the US-China divide that will shape this century

In Breakneck, Dan Wang contrasts China’s “engineering state” with America’s “lawyerly society,” showing how these mindsets drive innovation, dysfunction, and reshape global power amid rising rivalry. 

Retirement

18 rules for ageing well

The rules to age successfully include, 'the unexamined life lasts longer', 'change no more than one-eighth of your life at a time', 'nobody is thinking about you', and 'pursue virtue but don’t sweat it'.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.