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Rupert Hargreaves
Rupert Hargreaves
Articles (799)  | Author's Website |

Using Michael Porter to Find Good Businesses

Some tips for finding companies that create value

April 23, 2019 | About:

An investor's job is to find, and invest in, companies that will create value over the long term.

Finding these businesses isn't easy, particularly from an investor's perspective. But what if we flip the question on its head?

Rather than looking for companies that might be good investments, it might make sense to look for businesses that are attractive from the customer's perspective.

I'm not saying this is a one-step solution to finding good stocks, but there are plenty of examples where companies that focus on the customer above all else have proven to be fantastic investments.

Take Amazon (NASDAQ:AMZN), Costco (NASDAQ:COST) or Walmart (NYSE:WMT), for example; these businesses were built with the customer in mind. And once the customer has been satisfied, profits take care of themselves.

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It might be interesting to take this idea a bit further by considering some of the ideas around the value chain and creating competitive advantages, like those compiled by Michael Porter, who is widely considered to be the father of modern business strategy.

Creating a unique value proposition

When it comes to creating a unique value proposition, Porter believes that any business should be able to answer three questions:

  • Which customers are you going to serve?
  • What needs are you going to meet?
  • What price will provide acceptable value for customers while generating profits for the business?

If a business is serving the same customers as its competitors, with the same needs at the same price, it does not have a strategy. If the value proposition is not differentiated in some respect, and you are only offering the same product as many other businesses, how can you expect to attract and retain customers?

This feeds back into Warren Buffett (Trades, Portfolio)'s idea of a business moat. A company targeting a specific set of customers with a differentiated product, such as a strong brand and attractive pricing, will feature first and foremost in the minds of consumers.

But there is much more to creating a unique value proposition than just delivering unique value, according to Porter. A good strategy provides exceptional value through a distinctive value chain, performing different activities from rivals or similar activities in different ways. The goal of this is to prohibit competitors from gaining an advantage through differentiation or cost advantage. If the value chain delivers the same value proposition as other companies, it has no strategic relevance.

The value chain

In some respects, the value chain is more important than the value proposition because even if a product looks identical, there are many opportunities along the way where a business can differentiate from competitors, such as delivery, support, financing and design.

There are plenty of real-world examples of the value chain working effectively and giving a company a competitive advantage, even though its product isn't that different.

Take McDonald's (NYSE:MCD), for example. A few decades ago, Buffett said the fast-food chain as a brand was never going to have the same qualities as Coca-Cola (NYSE:KO) because there are so many other substitutes out there in the restaurant industry. McDonald's is just one place to eat in a highly overcrowded market (the success rate for restaurants is relatively low because the competition is so intense). However, the business has been able to differentiate itself through the value chain by giving customers more for less faster. Consumers also take a certain degree of comfort in knowing their food will be served to them in the same way as it is at home wherever in the world they are.

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The same is true for Costco and Walmart. Both companies offer similar products as many other stores out there, but their value chain allows them to differentiate.

So the next time you consider an investment, it is worth taking the time to review the company's value proposition and how it offers distinctive value compared to competitors.

Disclosure: The author owns no stocks mentioned.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website


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