This is Local Legends — a deep dive into the craft of building enduring small businesses. 🏆

Here, we share insights on constructing a business that's not just built for the short term, but soulfully crafted to withstand the test of time — and why that matters if you want to make an impact in your own entrepreneurial journey.

Last week, we demystified “niche businesses” in Unlocking the Potential of Niche Businesses: Part One. Today’s post goes further. Please enjoy.

IN TODAY’S EMAIL:

Unlocking the Potential of Niche Businesses: Part Two

The saying "riches are in the niches" rings true. I've seen it — up close.

Many of the niche businesses I've encountered are quietly amassing outsized earnings, free from the glare of media spotlight, and providing their owners with lives that are both meaningful and abundant.

They have a humble grandeur: unpretentious, yet financially strong.

But, let's get one thing straight: not all niche businesses are created equal.

This post breaks down the underlying attributes that make the best niche businesses great, how to unlock value in a niche business, and Decada’s general playbook.

Let’s start with four things we look for to tell the contenders from the pretenders in the world of small business…

The Four Essentials for Thriving in a Niche

1. Lower Competition

Big markets? They're flooded — like a rock concert everyone knows about. Niches, on the other hand, are the indie venues. Fewer people, sure — but a dedicated fanbase and less jostling for the mic. Their specialized focus keeps competition at bay, allowing for strong, stable margins.

When assessing the viability of a niche business, scrutinize its competitive standing.

💡 Conduct a thought experiment: What would unfold if the business raised its prices by 20%? This will help you gauge the strength of its market position.

2. Lower Capital Requirements

Here's the beauty of the right niche business: they typically don't need a vault of cash redeployed each year to maintain operations.

Beware the business that posts a paper profit on the P&L, but requires significant reinvestment in inventory, equipment, and machinery to keep the show going. We like businesses where the EBITDA to Free Cash Flow conversion is efficient — meaning there’s actually excess cash at the end of a good year.

Last year, I looked at acquiring a niche retailer on Main Street of a popular resort town. It had a great geographic moat (strong real estate on a long-term lease), awesome margins, and had been serving up a great product for over 10 years. The problem? The majority of its $800k annual EBITDA went back into capital expenditures every year. Real cash flow? $180k. Big difference — and you wouldn’t know it from the P&L.

3. Strong Moats

Evaluate the strength of the business’s moat. Businesses with great moats are fortified — not with stone walls but with unique advantages that competitors can't easily touch. Think of moats as a natural barrier that protects your business from outside threats.

What creates these moats? Expertise and specialized know-how can be one. If you're the only business that understands how to solve a very specific problem, you've got yourself a moat.

Another is a geographic. Imagine you’re a timber company with exclusive access to forests in a remote area. Or a retail business that owns its own real estate on a busy intersection.

Another can be specialized equipment. A foundry might have proprietary technology, expensive equipment, or highly-skilled labor that can produce parts no one else can — setting a high entry barrier for competitors.

4. Pricing Power

Pricing power is the Midas touch of business — and it’s my favorite one.

Pricing power is more than just slapping a higher price tag on your product. It's about having the room to increase prices and keep your customers. Why? Because you offer something truly differentiated your customer can't easily get elsewhere.

Consider the ingredients that make up this superpower:

• Brand Strength: When people trust your brand, they'll pay more. A strong brand sets you apart and adds an invisible value to what you offer.

• Unique Value Proposition: Whether it’s unrivaled quality, special features, or exceptional service, offering something distinct gives you pricing latitude.

• Customer Lock-In: Ever notice how some businesses make it hard to leave them? Whether it's a unique customer experience or deep integration into their workflows, make your business indispensable. This stickiness lets you up the price without losing your base.

• Scarcity: Be the rare gem. If what you offer is hard to come by, you’re in a prime position to charge more.

Pricing power is a blend of these factors. They work together to give you the leverage to command higher prices, thus fattening up those margins while keeping customers happily in your corner. It's not just business savvy — it's damn near alchemy.

Strategies for Unlocking Profits in the Niches

So you have a strong niche business. Here’s how to make it even stronger and unlock outsized profits as a result of specialization.

Unlocking profits in niche markets is a calculated endeavor, not a gamble.

Over the years, my team and I have identified a few key strategies that work remarkably well in extracting additional value in niche markets. Here are five:

1. Deep Customer Alignment

The beauty of niche markets is that they're not for everyone — and that's what makes them so lucrative.

Your mission: identify your ideal customer and double down on serving them. Understand their unique needs through surveys, interviews, and data.

That the easy part. The hard part? Cull the customers who aren't the right fit; they'll only dilute your brand and distract you. A niche business trying to market to all is a losing formula. Find and commit to your bullseye customer.

2. Strategic Positioning

Once you have your bullseye customer, build your company around them. Niches afford you the luxury of focus.

We acquired a business in 2021 that had scaled to a few million a year in revenue by saying yes to all kinds of jobs to all types of customers.

Our strategy post-close? Say no to everything except two well-defined areas. These two markets became our focal points.

Strategic positioning is about crafting an unbeatable value proposition around your areas of excellence and finding the very best ways to shout it from the rooftops.

📚 Read: "Blue Ocean Strategy" by W. Chan Kim & Renée Mauborgne: This book explains how to break out of saturated markets and create new spaces, or "Blue Oceans", ripe for innovation. It is highly relevant to niche businesses that seek to escape competition by creating a market where there is none.

3. Tailored Sales & Marketing

With deep customer alignment and strategic positioning solved for, the name of the game is to build repeatable and scaleable ways to attract your customers.

And you’re going to have to spend to acquire them. We typically allocate 8-20% of revenue on sales and marketing.

When we acquired one business, we spent more on sales and marketing in the first 30 days than the business had its entire history. The name of the game was finding repeatable and sustainable channels to bring new customers in each month. This is a process, but once found it helps you secure your best customers and start to take away from the competition.

The best businesses have a repeatable and sustainable funnel for finding new bullseye customers.

4. Optimized Operations

Now that you’re acquiring the right customers, find ways to serve them more efficiently.

When it comes to operations, digitalization is your friend. Moving from pen-and-paper systems to digital ones not only cuts costs but also smooths out operational wrinkles. The idea is to make your operation lean and mean. Efficiency translates directly to wider margins.

⚠️ Caution: Avoid over-digitalizing with complex software. Start simple and iterate from there.

5. Premium Pricing Strategy

Now that you've honed in on your niche and optimized operations, it's time to adjust your pricing.

Think of pricing like scales of justice: one side holds your product or service's quality and the other its price.

As you enhance your offerings, the scales should tilt — calling for a price adjustment to restore balance. When perfectly balanced, you offer unmistakable value that your ideal customers are more than willing to pay for.

Take the iPhone as a case study. Despite its high price, consumers keep buying. That's the sweet spot:

• Some non-core customers might switch to competitors.

• You'll hear occasional complaints about cost, but these customers stick around.

• Your bullseye customers? They see the value and gladly pay.

In essence, the right price acts like a filter — encouraging your ideal customers while deterring the rest. Nail this equilibrium, and you've got your pricing strategy down pat.

Risk and Reward—The Niche Paradox

Niches, despite their allure, come with their own set of hazards. And there are real risks to evaluate as you look at a niche business.

• One of the key risks is market vulnerability. When you specialize, you put a lot of eggs in one basket. A sudden regulatory change or a disruptive competitor can make your specialized market evaporate overnight. Diligence external risks before acquiring or starting a niche business.

• And since niche businesses often rely on a smaller customer base, losing even one key client can be a harsh blow to your bottom line. Avoid customer concentration — this is one of the most common reasons for failure among acquisition entrepreneurs.

• Another common risk stems from how often these businesses are closely tied to their founders, making them harder to transfer without significant loss of knowledge or culture. Beware owner dependence.

• But the biggest risk may be the illusion of safety. Niches often feel secure, almost cozy. This can lead to complacency. The perception of lower competition can make businesses lax in innovation and customer service. Before you know it, a nimbler, hungrier competitor finds a way to serve your customers better, and you're left playing catch-up in a market you once owned.

Scaling up these businesses comes with its own set of challenges. The crux lies in growing revenue while preserving the core specialization — the very essence that defines them. Striking this balance is both an art and a science.

It's not about avoiding niches because of these risks; it's about entering them with eyes wide open. A well-strategized niche business accounts for these pitfalls and builds contingencies. That's not pessimism — that's smart planning.

📚 Read: "The Innovator's Dilemma" by Clayton M. Christensen: This book delves into why large companies can fail despite good management, due to technologies they do not adopt. It offers good insights into niche targeting and how small businesses can disrupt larger players.

Decada’s Playbook for Acquiring Niche Businesses

Today's post distills our playbook at Decada Group. We search for niche businesses that show promise to be exceptional — not just small businesses with limited differentiation.

The business you choose to start or acquire is pivotal to your long-term success. Knowing the industry, the market, and the business's ability to differentiate can save you a lot of headache.

You can succeed with less-than-perfect attributes — but life will be harder.

In a world focused on new technology and innovation, we prefer stable and enduring sectors. That’s the Lindy Effect for you — the longer something has been around, the more likely it will continue to be around.

Once you own and operate a niche business, there are ways to take it from good to great.

Our long-term strategy is to buy good niche businesses, then recruit great operators who care about the niche, care about the community the business serves, and work alongside them to help the business become a masterpiece small business. (I wrote about this in our 2021 Annual Letter)

Why niche businesses? They're an ideal fit for our holding company model. When an owner is generating significant returns, we don't pocket the profits. Instead, we reallocate that profit to fund future acquisitions of more niche businesses. It’s a long-term virtuous cycle.

To sum it up: Niche doesn’t have to mean small. It means focused, specialized, and teeming with potential. In the niche business world, size is secondary. The main event is your strategy.

By looking for these unique attributes, entrepreneurs can make more informed decisions, setting the stage for sustainable growth and diversification.

Niche businesses offer a realm of untapped potential — not just in monetary gains but in crafting a business model that is both enduring and endearing. They allow you to engage with communities deeply and provide genuinely valuable services, resulting in a win-win scenario for everyone involved.

And if you play it right, you're not just building wealth — you're building a legacy.