Here’s a brand with a durable competitive advantage: Porsche (XTER:PAH3, Financial), the sports car designer, manufacturer and marketer. It was durable when Mary Buffett and David Clark published “The New Buffettology” in 2002 and it remains one today.
In chapter 11 of their book, the authors took a deeper dip into durable competitive advantages, as well as Warren Buffett (Trades, Portfolio)’s ability to make the most of them. We may think of durable moats as emerging out of intellectual property or some brilliant, copyrighted insight.
Yet, even companies locked into price-competitive businesses can develop durable competitive advantages. The authors provide several examples of the areas where Buffett goes hunting:
- Regional monopolies: Developing them was something newspapers could do in previous years (but rarely, now). A dominant newspaper would buy out the weaker paper, of weaker papers, giving it a moat. New competitors would find it expensive and time-consuming to establish a foothold, let alone a competitive position (this was before the internet overwhelmed most newspapers).
- Product specialization: Porsche got out ahead of the price-competitive pack through superior engineering and performance, giving it pricing power other auto manufacturers do not have. Interestingly, the authors noted, Porsche customers want their cars to be expensive and expensive models sell out more quickly than cheaper models.
Unlike diamonds, competitive advantages are not necessarily forever. For example, newspapers, as noted above, as well as traditional television networks have lost much ground in the past two decades. However, investors need not panic: such competitive advantages disappear gradually, over the medium to longer term. Some newspapers and most television networks continue to operate profitably, but the pricing power they once held is much diminished.
The authors also wanted readers to know that four areas of business are more likely than others to produce durable competitive advantages:
- Companies with “repetitive consumer services” that wear out or are used up quickly and have brand appeal. Think fast foods, for example.
- Advertising: Companies in this sector sell a service that manufacturers and retailers must continuously use.
- Businesses selling another type of repetitive consumer services. Think tax preparation, cleaning services and pest control.
- Low-cost producers of common products that are needed at some point in almost everyone’s life: jewelry, furniture and insurance, for example.
Repetitive consumer services include fast-food restaurants with brand names: Buffett likes to both own them and to eat in them. The authors say, “He knows from experience that nothing gets used up faster than fast food. The hungry consumer associates the taste pleasure of these particular foods with these companies’ brand names, which equates to many repeat customer visits.” Over the years, his holdings have included McDonald’s (MCD, Financial) and Yum Brands (YUM, Financial), which owns such brands as Taco Bell, KFC and Pizza Hut.
It also includes patented prescription drugs and, as the authors noted, the leading manufacturers earned high returns on capital, as well as equity, and have a history of strong earnings growth. In 1993, when health care reform was in the air, drug company prices tanked. Buffett was able to buy Bristol-Myers Squibb (BMY, Financial) for about $13 per share. Eight years later, the stock had climbed to $70 and Buffett came away with an average annual return of some 23% on the initial investment.
Other strong contenders in this category include brand name foods such as Kellogg (K) and Campbell Soup (CPB, Financial); brand name beverages; brand-name toiletries and house products; and brand name clothing.
Advertising businesses: According to the authors, “Warren found that once businesses begin to advertise, it is almost impossible for them to stop. Competition creates a repetitive need. If a company stops advertising, its competitors will step in and fill the void.” In this area, Buffett has invested in Interpublic Group (IPG, Financial) and the Ogilvy Group.
Other sectors in this group have seen their durability fade since “The New Buffettology” was published in 2002: Television, newspapers, magazine, direct mail and billboard companies.
Repetitive consumer services that are consistently needed includes companies such as Service Master (SERV, Financial), which provides professional cleaning, and Rollins (ROL, Financial) with its pest control businesses. Also in this category are home security businesses that hook up a customer once and then send monthly invoices for potentially forever.
It also includes credit card companies and, as we know, Buffett has been a big investor in them. American Express (AXP, Financial) gets to charge you a fee for getting the card, high interest rates on unpaid balances and the icing on top is to charge merchants a fee each time the card is used. In the words of the authors, “Little tolls on millions of transactions add up. Toss in the interest charges and you will soon see why Warren finds these companies so attractive.”
Low-cost providers of products and services we all buy at some point in our lives: Think of auto insurance and Geico. There is also Walmart (WMT, Financial), which is able to “earn quasi-monopoly profits by selling cheap and moving a lot of inventory.” The legendary retailer has built its brand on quality, service and low prices. One retailer that Buffett particularly liked, and bought, was the Nebraska Furniture Mart, which can buy in huge quantities and at steeply discounted prices. It, like Walmart, enjoys economies of scale that provide durable competitive advantages.
Buffett also bought Borsheim’s, a jewelry store in Omaha. It operated in a cheap downtown location and was able to sell expensive jewelry cheaper than competitors such as Tiffany (TIF). It also established a brand presence: Its owner had a reputation for honesty and great deals (low profit margins and higher volume). Ultimately, it became the biggest, single high-end jewelry store in the world.
About
Buffett and Clark are the authors of “The New Buffettology: The Proven Techniques for Investing Successfully in Changing Markets That Have Made Warren Buffett the World’s Most Famous Investor.”Â
(This article is one in a series of chapter-by-chapter reviews. To read more, and reviews of other important investing books, go to this page.)
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
