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March 5, 2009

The top of the market

I am an avid studier of commodities firms. Mining, Oil and Gas, Petrochemical and other related companies. In my day jopb I work a lot with these guys so it makes sense to understand the operating environment of my potential clients.

While we think everyone is hurting and everyone is doing it hard - this isn't strictly the case. Gold is doing exceptionally well. As everything else comes crashing down Gold always shoots up.

Those who mine gold are making money hand over fist...which is why it wasn't surprising to see growing US gold miner Newmont buy out their partners, AngloGold Ashanti, in the giant Boddington gold project in Western Australia.

They have so far raised $1.56 billion in this pursuit.

This is a recurring theme. BHP Billiton, #1 resource company globally, went after #2 Rio Tinto at the top of the market. Rio in turn purchased Alcan at the top of the market, and SABIC purchased GE Plastics at the top of the market.

The Newmont deal is still ongoing, and no doubt as soon as the next Gold correction comes along (as it always does) their will be a lot of hand wringing there. The BHP Billiton deal was pulled due to debt, so we can't see how that turned out.

But the Rio purchase of Alcan - for cash mind you, has had disastrous consequences. Booms - it appears - aren't forever. (Who'd a thunk it) The SABIC deal for GE Plastics has a particularly tragic twist to it.

After paying a record amount, $11 billion if memory serves correct, SABIC are now the proud owners of a company whos markets have taken a terminal dive. Manufacturers in the plastics industry provide product for housing (oops), personal cars (oops), DVD's and CD's (oops, Apple is transforming that industry) and a range of lesser revenue areas.

Why would they do such a thing? Why would these supposedly wise leaders of industry take the bait and pay top dollar? Particularly given the well recorded and time honored tradition of cycles in resource industries?

The Lure of Success

They do it for the same reasons that we all follow the leader. The lure of success.

There are literally dozens of companies trying to knock Google out of the search market, several large players trying to dislodge ERP incumbent SAP and a legion of players challenging SaaS (and now Platform as a Service) provider Salesforce.com.

We notice success, we see it as something that is going to last forever, and we want to get in on the easy money.

But it ain't easy is it? Nobody to date has knocked off Microsoft, SAP, SaaS or Google. And nobody will unless they get incredibly  stupid. (A la Yahoo)

Your goal is to get $1.00 value for 50c price. Buying at the top of the market, or rushing into a booming space is only going to guarantee you an incredibly hard time trying to knock out the incumbent, and at best - a small percentage of the market.

You are far better served trying to create a separate market, just as Salesforce.com did. Or in trying to provide services around the edges, just as a plethora of companies are doing in the white space around SAP.

And remember - every boom busts. As I write desktop software is dying the death of a thousand cuts, ERP is under remarkable pressure, ( la Netsuite.com) and even books are starting to feel the impact from technological advances like audio books.

In fact - as technology moves forward it is far less risky to develop new spaces in the market, rather than to dive into well defended fortresses in success industries. Buying in at the top of the market has never been a great strategy, and recent corporate history proves this point.