What it means
The logic is simple. In a gold rush, only some prospectors find gold, and many find nothing, but every one of them needs picks, shovels, food and lodging.
The suppliers earn money from all of them, whether they strike gold or not. Modern examples follow the same pattern.
In a technology boom, the companies that make chips, servers and cloud infrastructure may earn more steadily than the many start-ups building products on top of them. In an energy boom, the firms that provide drilling equipment and services may profit regardless of which producer finds the best wells.
For investors, the approach can reduce risk because revenue comes from the whole sector rather than from one outcome. A supplier tends to have steadier demand, because customers keep buying as long as the industry keeps investing.
This can make the returns less dramatic than those of a big winner, but also less likely to be wiped out. There are risks.
Suppliers still depend on the industry's overall health, so a bust can hit them hard when customers cut spending. Competition among suppliers can also squeeze margins, and a very successful customer may eventually build its own tools, which removes the supplier's advantage.
For business owners, the idea is a strategic question: should you compete in a crowded market, or serve the people who do? Many successful firms have built strong, profitable businesses by providing software, payments, logistics or consulting to a fast-growing sector.
The key is to pick a sector with strong demand and a product with real advantages. A good pick and shovel business usually has recurring revenue, a product that customers find hard to replace and exposure to many customers rather than one.
Those features reduce the dependence on any single player in the industry. Investors should also look at valuation, because a supplier bought at too high a price can disappoint even in a booming sector.
In practice
Real-world examples.
Example
An investor expects a surge in electric vehicle sales but cannot judge which carmaker will win. She buys shares in a company that supplies charging equipment to all manufacturers, accepting lower upside in return for broader exposure. Her portfolio is less likely to be damaged if one of the vehicle makers fails, because the charging firm sells to all of them.
Example
A payments company provides card processing to hundreds of online retailers. Whether any single retailer succeeds matters less to it than the total volume of online shopping, and it earns a small percentage fee on every transaction it processes. Its revenue grows with the whole market, and it can serve the winners and the losers alike.
Example
A small consultancy specialises in regulatory compliance for new cryptocurrency firms. When the sector grows, it gains clients, and it earns fees even when individual firms fail. Its small team can grow quickly because demand is driven by regulation, which does not depend on the success of any single client.
Case study
Seen in the real world.
Highland Drilling Supplies is an illustrative, fictional company that sells specialised pipes and valves to oil and gas producers. During a boom, dozens of new producers entered the market, several of which later failed.
Highland's revenue grew 30% a year because every producer needed its equipment, and the finance director insisted on checking customers' credit before extending terms. When prices later fell and several customers stopped paying, the firm's losses were limited to a small portion of its sales.
The illustrative lesson is that the supplier benefits from the sector's growth but still needs discipline on credit and customer concentration. The board also adopted a rule that no single customer could exceed 15% of annual revenue, which kept the benefit of the sector without relying on one client.
Watch out
Common mistakes.
- Assuming a supplier is risk free, when its fortunes still depend on the health of the industry it serves.
- Buying shares in a supplier after a boom has already driven up its price.
- Depending on one or two large customers, which recreates the concentration risk the strategy is meant to avoid.
Questions
People also ask.
Where does the term come from?
It comes from the gold rush of the nineteenth century, when sellers of equipment, food and lodging often earned more reliably than most of the miners themselves.
Is this strategy only for investors?
No, business owners can use it too, by choosing to serve a growing industry instead of competing within it.
What makes a good pick and shovel business?
Steady demand from many customers, a product that is hard to replace and revenue that recurs, together with enough financial strength to survive a downturn in the sector.
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