There's an important rule to remember when you're choosing a business to go into or expanding an existing one: Businesses that look exactly alike to a casual observer may be completely different. If you don't recognize the difference before you take the plunge, you could wind up in serious trouble. Look closely at the economic and cultural conditions that surround a business opportunity, and you might find yourself seeing it in an entirely new light.
Recently, a friend wanted me to get involved in building hotels in Texas. The state is experiencing a boom in hydraulic fracturing (fracking), and my friend had obtained the rights to build a certain brand of extended-stay hotels in the state. He thought I'd want to invest, given my success in building extended-stay hotels in the Bakken shale region of North Dakota, where fracking has become a major industry.
I was curious enough to fly down to Texas with him and a couple of other people to check out five potential sites. We spent a day going from one site to the next and visiting hotels near each. Many of them appeared old and dilapidated. I also noticed that there was infrastructure everywhere we went--sewage, gas, electricity, water, and so on. In the Bakken region, you find that kind of infrastructure only in cities or in out-of-town locations where smart entrepreneurs have bought land and put in their own infrastructure.
When we finished our Texas tour, my friend asked me what I thought. I said, "It isn't for me."
"But it's the same as North Dakota," he said.
"No," I said. "It's nothing like North Dakota."
In fact, building hotels in the fracking regions of Texas is a whole other business. To begin with, the competition is different. During the critical first months, a new hotel would be competing against trailers and dingy motels charging $49 per night or less, as opposed to the $79 that my friend would have to charge to earn a profit. We didn't have to worry about either one in North Dakota.
Second, you'd be operating in a dissimilar commercial and political environment. When I built my first hotel in Tioga, North Dakota, I was welcomed with open arms by everyone in the community. The town used its limited resources to help us by fixing the roads near us and connecting its infrastructure to ours. You'd have no such advantage in Texas. Oil booms are old hat there. And there is already significant opposition to fracking in Texas.
Third, the presence of universal infrastructure changes the terms of competition. It allows anyone to come in and build. In particular, it opens up the territory to big chains like Holiday Inn Express. The scarcity of infrastructure in North Dakota has drastically limited the available space for building. We were able to buy land in 2011 that already had its own infrastructure. That land would be at least 30 times more expensive today.
Finally, if you succeed in Texas, you can expect a normal return on your capital of, say, 6 percent to 8 percent. In North Dakota, I knew going in that I had a chance to earn five times the normal return, because I was financing the first hotel myself at a time when most people couldn't raise the capital owing to the risk. That meant--if I succeeded--I'd have the market to myself for a while.
I don't doubt that people will make money building hotels in the fracking regions of Texas. I hope my friend will be one of them. But for now, at least, I'll be sticking to the business I know.