I like reading books on business history and biographies of business people. One thing that I feel is often a common thread in there stories is that substantial wealth creation often seems to stem from some combination of leverage and arbitrage.
I’ll elaborate. Often, the initial businesses are created around some sort of arbitrage. The arbitrage might be that the entrepreneurs have some information or ideas that others don’t. But an arbitrage usually doesn’t sustain. Once the word is out the trade gets crowded, which in turn erodes the profitability.
Some arbitrage are more sustainable than others and cane be ridden for longer. And I suapect that there are plenty of business people out there that found powerful arbitrages to take advantage of and did so for a long time. The reason we never heard about them, is because they were constrained. They were not scalable. They couldn’t not be levered.
If you have an arbitrage, however, that is defensible and has the potential to be leverad to a larger scale, you have the components of substantial wealth creation.
Here are a few examples:
- Sam Walton realized that by buying cheap and pricing low, he would create operating leverage, by maximizing inventory turns. He realized that the big stores would not go to smaller towns, an opportunity that he was able to arbitrage for a very long time.
- Kirk Kerkorian built his initial wealth through a unique albeit limited arbitrage. After WWII, Kerkorian borrowed money to bid on surplus bombers which he picked up abroad and flew home. At the time, there was a shortage of jet fuel and Kerkorian was able to sell the remaining fuel in the bombers’ fuel tank. Selling the fuel raised enough money to repay the loans he had taken. He essentially got the planes for free.
- Sam Zemurray made a fortune in the banana trade. In his early days, he took advantage of a brilliant arbitrage opportunity. When banana cargo came to New Orleans, bananas that were spotted were deemed unfit for the travel to metropolitan locations and were discarded at the port. Zemurray bought the ripe bananas very cheaply and sold them locally to grocers within a day of New Orleans. To get the bananas to grocers fast, he leveraged the train system.