Many people answer this question by naming their product or their industry. That is the surface layer, the substance. It is what the customer sees and what the operator spends time talking about. But substance is not the business. The business is the mechanism, or put more completely, the underlying game that sustains advantage over time.

Costco's substance is bulk retail. The business is something else: maximizing total margin dollars through volume. The membership model is not ancillary; it is the mechanism that aligns customers with throughput. Seen this way, Costco is not "a retailer" but a great machine that monetizes volume by turning shoppers into participants in its margin game. Costco is so skilled in this regard that shoppers are giddy to oblige them.

HVAC services offer another example. The substance is skilled labor applied to repair and installation. The business is the ongoing defense of the spread between billed rates and payroll costs. That spread never sits still. Wages rise, skills commoditize, competitors endeavor to bidirectionally compete on the demand side (by lowering prices) and compete on the supply side (by raising per-hour wages). A durable HVAC firm survives by continually resetting offerings, pricing, and workforce mix to stay ahead of the march of margin compression. Customer satisfaction and quality matter, but only insofar as they protect the spread.

Private equity is the same. The substance is buying and selling business, plus operational improvement and financial engineering in between transactions. The business, shaped by incentive structure, is merely fee collecting. A set of contractual management fees as a percent of the fund AUM forms the reliable core, and so the general partners seek to raise ever-larger total AUM to capture more absolute fee volume. Carried interest may add upside (and successful exits help raise future funds), but the mechanism that perpetuates the industry is fee extraction on the pool of committed capital.

Convential industry categories can easily mislead because they necessarily describe substance, rather than the actual mechanism at work that drives the business.

Car dealerships describe themselves as being "in cars," but their business runs on financing, warranties, and used-car arbitrage. The vehicles themselves are the facilitating substrate for these activities, much like General Electric in its hayday with GE Capital. Social media companies present connection and content as their substance, but their business is attention capture and resale via ad networks.

The useful question is not "what do they sell" but in a purely cold and rational world, "what do they optimize." Costco optimizes throughput. HVAC optimizes labor margins. Private equity optimizes fees. The surface answer is often true but not sufficient. The deeper answer is the one that explains why the company persists.

Not everyone does this well, and this fact is often perceptible in their operations. The culture and leadership are fundamentally confused, and so make decision after decision that draws them away from that which actually sustains them. Companies like this may not fail right away, but they certainly rarely thrive. Implicitly, these companies have chosen luck as their core business.

The distinction between substance and mechanism is not obvious largely because of social convention. Using everyday categories, substance is visible and mechanism is hidden - but it need not be this way to a savvy observer.

If you can name the mechanism clearly, you see the business for what it is and understand how it will likely endure, or fail.