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Weekly Thoughts: Paradox of Place

Here is something that caught our eye this week:

Paradox of Place

We recently attended an event where it seemed like everybody lived in either New York, Boston, or San Francisco. Since Chenmark is headquartered in the 519th largest city in the country, the observation caused us to spend some time thinking about how geography impacts business and we were interested to read a report from Bain & Company which suggested that as certain cities focus on attracting affluent residents by supporting industry clusters (e.g., technology in Silicon Valley, finance in New York and London), association with these locations provides a signaling effect about economic status and business prospects. SmallBizLabs elaborates further on this phenomenon with what it calls the ‘paradox of place‘:

“The paradox is that even though the Internet and connective technologies have made working remotely easier than ever, people and companies are increasingly clustering together in fewer, more valuable locations. This is happening because in our knowledge-intensive world, industries and people cluster in order to share information, generate ideas and cut deals. These activities are all still better done face to face. Talent also clusters, both to share information and also to have access to networks and new opportunities. Often this clustering is happening in urban cores (think SF, New York, etc.), which in addition to business opportunities offer a variety of other amenities.”

While we acknowledge some truth to the positive impact of such clustering, we also believe that living outside of these high-profile cities is actually beneficial to our business. First, since we are primarily doing deals with sellers who live outside major urban centers, our being from a smaller metropolitan area helps us find common ground more quickly. Second, our location differentiates us from most other financial buyers, which as Howard Marks reminds us, is a necessary step towards creating something special. Third, it allows us to be more flexible with our business model since we are able to function with dramatically lower overhead costs. Take, for instance, the simple matter of office space. If we were thinking about operating in San Francisco, we’d be faced with finding space in a market where the average cost is north of $70 per square foot and build out costs can add an extra $25 per square foot. A Medium post with a San Francisco commercial real estate broker provides insight into how this pricing can impact a budget:

“Let’s say you’re a company that’s just raised a $20 million Series B and you need 20,000 square feet and you’re moving on up from 5,000 square feet. You need space that can house 200 people that you’re either going to outgrow or never fill and sublease in the next 18 to 24 months. In this market, you’re looking at five-year leasing deals that probably cost $1.5 million a year. If you are not profitable and need to raise another round to fulfill the entire lease, you may spend up to $1 million just in security deposit. You’ve just committed to spending $10 million. You’ve just wiped out half your round on a lease!”

For those who know us, spending that amount of money on something that doesn’t independently generate cash flow from day one is simply laughable and we feel fortunate that we have been able to establish our business while maintaining a minimal burn rate. Furthermore, thus far we have been able to attract talented individuals who prefer, like us, to live in a location that provides a high quality of life (i.e., the Eastern Prom is part of our commute) and a lower cost of living (i.e., more free cash for compounding). As such, going forward, we will continue to press our location related competitive advantage, since we believe many of the benefits associated with large city clustering are currently being overvalued.

SmallBizLabs, Medium, Bain

 

Have a great week,

Your Chenmark Capital Team

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