Tag Archives: Competition Demystified

Competition Demystified Chapter 6: Niche Advantages and the Dilemma of Growth Quiz

I intend to live forever – so far, so good–Steven Wright

Questions on the reading in Chapter 6

Let’s test our comprehension of the reading.

What competitive advantages does Microsoft enjoy in the operating system industry?

Why have “box makers” not been able to establish a competitive advantage over other competitors? Why was the enormous growth in the market for PCs such a problem for Compaq specifically? Did it have any alternatives that might have worked out better than its chosen strategy? Did Apple?

Competition Demystified Continued; Hedge Fund Job; Hire an Ex-hooker

Experience is something you don’t get until just after you need it.–Steven Wright

Next Reading in Competition Demystified

Let’s tackle pages 113 to 136 or Chapter 6: Niche Advantages and the Dilemma of Growth–Compaq and Apple in the Personal Computer Industry. Good work to those who did the Coors Case Study.

Finding a Job at a Hedge Fund

The reader who wants to obtain a hedge fund job has received good advice from several of the readers this post yesterday: http://wp.me/p1PgpH-lm.

Everyone gives advice that they think will help but we have our biases and what has worked for us may not fit the advisees. Please take my advice with a heap of salt.

Let’s take a step back and ask a few questions—what is your ultimate goal? I assume your reason to work at a hedge fund is to be paid while you learn to become a better investor.  You have to be sure that you have unique skills or traits that would make you suitable for the work. Would you like to be alone sitting in a room all day reading, thinking and struggling to find answers to questions?  That is what I do, and I am one weird guy. I think of the country song, “Don’t let your babies grow up to be value investors.” http://www.youtube.com/watch?v=ePgnkVAM3L8&feature=related.

What do YOU really want to do and what combination of your life situation and skills will help you attain what you are seeking. Below is an excerpt from www.fool.com on a job search board http://boards.fool.com/that-is-awesome-that-you-have-been-able-to-do-25280669.aspx.

Where is the place to be in business today?

I don’t want to sound rude or negative, but that is the wrong question if you are looking for career advice. No-one can give a general form answer to that question. Everyone can try to answer that for themselves, but how does that relate to your own situation? Rather, you should be asking yourself:

– What do I enjoy doing? – What am I good at? – What are the skills that truly differentiate me from my peers? – What type of environment do I enjoy working in? – What level of interaction with others do I need on a day-to-day basis? – How important is money to me?

Once you have thought through these questions (and I suggest you do this in writing), you’ll be on the way to finding an answer to this question:

“Where is the place to be in business today for me?”

Regards,  Alex Dumortier (TMFMarathonMan)


Ok, I am back.

Read Snowball by Alice Schroeder. You will understand how focused, obsessed and hard-working Buffett is. Do you love the work THAT much? Because you will have to work extremely hard, but if you love what you do then it isn’t really “work.” Work hard for the moneyhttp://www.youtube.com/watch?v=Lnd7Urx28f8

Traits of a Money Manager: http://www.fool.com/news/foth/2001/foth010717.htm

Career Advice

Some videos meant in fun but there is helpful advice–Steven Spielberg’s career suggestions:http://www.youtube.com/watch?v=kBN9jpooZoM&feature=related

Do you have the talent or why most people fail at screenwriting: http://www.youtube.com/watch?v=gXPYhW8Q74w&feature=related

Advice to an actor–be yourself: http://www.youtube.com/watch?v=m_Ui2IGbqhY&feature=related

Find your passion:http://www.youtube.com/watch?v=HqC7sN1DQzw

Wall Street

To those who wish to work on Wall Street I would say that you will probably witness shrinking of the financial sector for awhile as regression to the mean sets in. There was too much leverage and with the de-leveraging and greater regulation, you will see lower ROEs for banks and other financial institutions. There will come a day when MBA students will not even bother to look at Wall Street. Remember when Wall Street was a wasteland in the 1940s? On August 19, 1940, the stock exchange volume totaled just 129,650 shares. Read James Grant’s introduction the Security Analysis, 6th Edition.

Not a Clue

Another point that might sadden, anger and shock readers is that there are many brokers, money managers, and analysts even from Harvard, Morgan Stanley, or even Goldman Sachs who do not know what they are doing. Exhibit A: recent financial collapse. Also, Wall Street exists to raise and move money, so few actually analyze businesses properly.

I spoke with a young analyst who works for a fund where the partners came from a fancy investment bank and they all have CPAs, CFAs and MBAs. Their fund is down about 10% CAGR since 2008! The fund has no investment process, method or discipline. This young analyst has learned from his own reading. Go to www.lmcm.com and click on the information there and you will be impressed with the credentials. Bill Miller did very well for himself and not so well for most of his investors these past five years. Why?

Working at a Fund

If you do land a job at a good value fund, I doubt the principals have the time, temperament or inclination to train you. If you want a sense of what it is like working for Michael Price, go to my book synopsis: http://www.scribd.com/doc/80246703/5-Keys-to-Value-Investing. This analyst worked for Price. He would present ideas and then defend his thesis in order to convince Price to place the investment in the fund. Certainly the questioning by an experienced investor is a valuable learning tool. If you didn’t do your work thoroughly beforehand, you were not there long. But I doubt Mr. Price will patiently explain what deferred taxes are to the aspiring analyst. You are there to help him make money.

thinking in a little box

The ad for a hedge fund analyst position I posted yesterday required either an MBA or a CFA.  I would offer $10 to 1,000 million to the fund manager or anyone to show any statistical evidence that having those degrees improves analytical or investment ability over other attributes. It is just another screening technique for the lazy and unimaginative. One of the best investors in history, Walter Schloss never studied past twelfth grade. Seems like he did just fine. His temperament, discipline, work with Graham (he went and sat in on Graham’s lectures), and study of Security Analysis were his assets.

Let’s say I interviewed a Harvard MBA who wanted to become a value analyst. I would ask him or her, “We will have superior performance because I am so smart, hard-working and experienced. Don’t you believe that as well?” If the analyst agreed, especially just to be polite, the interview would be over. You need to be driven by curiosity while having humble skepticism and be willing to disagree; question.  I seriously would rather hire an ex-hooker http://www.youtube.com/watch?v=ZivA_f7DRdE.

Successful, but Unconventional

Below are professional investors who all have excellent records but unusual backgrounds. They made their own path; YOU can too. Also, get the book, Free Capital by Guy Thomas. The book is better than The Buffetts Next Door because you will see how several others have been successfully investing in their OWN way.  Many never aspired to having a pedigreed background nor previous investing job.

Jim Chuong: http://www.ticonline.com/

Francis Chou (former telephone lineman): http://v1.theglobeandmail.com/partners/free/globeinvestor/investment/may08/chou.html


Michael Burry: Betting on the blind side (note his personality): http://www.vanityfair.com/business/features/2010/04/wall-street-excerpt-201004

Kupperman as an adventure capitalist: http://adventuresincapitalism.com/page/Whos-Kuppy.aspx  While in college he would visit obscure Canadian mining companies and uncover what no other analysts bothered to look at.

I know this gentleman, Jordan Mariuma, who could barely read a balance sheet while in New York, but he had the guts to go to Romania. http://www.hedgefundsreview.com/hedge-funds-review/profile/1931806/worldwide-opportunity-fund-terra-partners

We will discuss again after others chime in or disagree with my “advice.” Don’t give up the faith. Good luck.

Of Interest

Fairholme 2011 Letter: http://www.gurufocus.com/news/159850/bruce-berkowitzs-2011-shareholder-letter

Canadian Investor in SUPER STOCKS

Competition Demystified Continued: Coors Case Study Analysis From Readers

My most surprising discovery: the overwhelming importance in business of an unseen force that we might call “the institutional imperative.” In business school, I was given no hint of the imperative’s existence and I did not intuitively understand it when I entered the business world. I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions. But I learned over time that isn’t so. Instead, rationality frequently wilts when the institutional imperative comes into play.

For example: (1) As if governed by Newton’s First Law of Motion, an institution will resist any change in its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.

Institutional dynamics, not venality or stupidity, set businesses on these courses, which are too often misguided. After making some expensive mistakes because I ignored the power of the imperative, I have tried to organize and manage Berkshire in ways that minimize its influence. Furthermore, Charlie and I have attempted to concentrate our investments in companies that appear alert to the problem.–Warren Buffett

Coors Case Study Analysis

My short write-up: http://www.scribd.com/doc/80155636/Coors-Case-Study

But readers’ comments are even better. These contributors posted here: http://wp.me/s1PgpH-1302. I reposted below. Good work.


  1. These were the numbers that jumped out at me:
    In the 3 largest areas that they operated, Coors had almost 50% market share in 1977. By 1985 they had only 14% in that region, however they expanded to almost all the states and sold 16% more barrels.
  2. Also in 1977 Coors had a 20% operating margin, far ahead of any competitor. By 1985 it was down to 8%. Marketing expenses were the cause of this, jumping from 2.6% of revenues to 15%, far more than any major competitor.
  3. While Coors was expanding, all of their competitors (mostly AB and Miller) were taking a major chunk of their market share in the markets they previously dominated.
  4. It seems that the marketing expenses are what killed Coors’ margins. If Coors expanded its local market share in 1977 instead of jumping around their marketing expenses would’ve been much lower per barrel than all of their competitors.

Herman | February 1, 2012 at 8:12 am | Reply | Edit

I fully agree with Dave’s analysis. Although there was advertising expenses were on an industry-wide rise since the late 70s (probably driven by PM’s takeover of Miller), Coors’ advertising expenses made up 15% of sales vs. an industry average of 10%. On a per-barrel basis, Coors spent $11/barrel on advertising in ’85, whilst AB spent $7/barrel.

Reason for these high expenses was that the advertising expenses are primarily regional, and Coors had lost market share in its heart land (Mountain, Pacific, WSC) – 25% in ’77 to 15% in ’85 against AB and Miller, and had insufficient foothold in other states (in all non-heartland areas except for NE Coors had <10% market share).

A crucial mistake Coors management made was to allow Miller and AB to fill the capacity gap in its heart-land (10 states west of Colorado), thereby losing market share and thereby weakening the EoS it had. It seems like Coors’ management was focused on its nation-wide roll and lost sight of defending its local market share.  EXCELLENT POINT.

It seems like AB enjoys EoS now.

It’s easy to play Monday morning quarterback, but if I were in Coors shoes, and saw the decline in market share I would have taken the following steps:

Step 1) Map out profitability per state to understand which states create a drag on Coors margin. My guess would be that this would be a combination of distance from its brewery and low ( <10%) market share) but this would require some further analysis.

Step 2) Cut fat – there seems to be fat everywhere in the value chain, which translates into lower margins. By cutting out this fat, more cash can be generated. Examples of potential areas of fat:

a) Coors strategy of maintaining full integration of its supply chain (e.g. owning its own transport company, generating its own power, etc). This may not be the best strategy in a mature market like beer. Other service-providers may have an cost-advantage, e.g. in transportation. Coors own transport company led to 10%-15% higher trucking costs thanks to low back haulage compared to independent transporters.

b) Maintaining so many brands – Coors ran 4 different super premium brands vs. an industry average of 1. Even though super premium brands generated cash to fund advertising campaigns, the costs were pretty high ($20 – $ 35 Mln launch costs, $10 M annually advertising maintenance costs, and costs associated with running so different many packages on its production lines).

Step 3) Abandon the ‘bleeder’ states, and focus on the strong states (its heartland). Defend market share aggressively by cutting prices, using the excess cash generated by having cut the fat as laid out in step 2 .

I of course completely agree with you but do you have any insight on why they may have pursued the strategy that they did at the time?

Coors Case Study that is Not Helpful

There is interesting information and background here on the beer industry, but this 64-page reports lacks logic and analysis.  On what basis does the author suggest that Coors go international? That advice is equivalent to giving a drowning man a drink from a firehose. Coors would only be worsening its position—further growth without profit. The readers above who contributed their analysis in a few paragraphs grasped the essence of Coors errors. Don’t be fooled by fancy terms like SWOT analysis–get at the nub of the problem like Hannibal Lechter http://richraths.com/files/CoorsCaseStudyAnalysis2004.pdf

VALUE VAULT; Moats, Coors CS Question, FDR & Obama, Grace under Pressure, Go Back

Reality is just a crutch for people who can’t cope with drugs.–Robin Williams

I attribute my success to seeing the world as it is, not the way I would like it to be–Warren Buffett (attribution by a friend)


In the VALUE VAULT I split up the videos into two major sections—the VALUE VAULT does NOT include the 2010 Greenwald Value Investing Class Lectures. Those 21 videos (1 semester) are in a separate folder. If you want the key to THAT folder then email aldridge56@aol.com and ask for 2010 Videos. When someone new asks for keys to the VALUE VAULT, I will automatically send keys for all separate folders. The vault will become better organized, manageable, and easier to access. The next step will be to categorize this blog.

Buffett and Moat Investing

I do not recommend this book since I have not read it, but want you to be aware of this video on Moats and the book about Berkshire Hathaway Businesses Competitive Advantages http://www.youtube.com/watch?v=kizM8UaqF_4

If anyone reads and likes the book, please post your comments. Thanks.

The author of the Moat book lectures on valuation models: http://www.youtube.com/watch?v=tp3FLQxcbws&feature=related

Valuation in a nutshell: http://www.youtube.com/watch?v=rSNNBrt-XfE&feature=related.

Of course, perfect in theory and difficult-to-impossible in practice. The point is to remind us why we are studying strategy—to understand the competitive advantages or lack thereof in the companies we hope to value.

Coors Case Study

Would anyone like to comment on what you learned? What numbers jumped out at you from Coors’ operations as it expanded nationally?  If you saw those numbers of competitors’ market share, what would you do as the management? What is the structure of the industry now and who has the dominant Economies of Scale or “EOS”?  What did management lose sight of?

By Wenesday, I will post the short write-up.

More on strategy

Why companies aren’t investing

Profits are strong, interest rates low, and bargains abundant, yet many companies aren’t investing. Uncertainty—about the economy, markets, and economic policy—no doubt ranks high among the reasons. But decision biases play a surprisingly important role.


Comparing FDR and Obama

Our Economic Past | Burton W. Folsom Jr.

Comparing the Great Depression to the Great Recession

June 2010 • Volume: 60 • Issue: 5 •

Interesting parallels to FDR and Obama. The author doesn’t mention that our fractional reserve banking system is inherently unsound. The government policies (actions of the Federal Reserve) exacerbate the boom and resulting bust while the government actions to alleviate the downturn simply prolong and deepen the agony. The mal-investment has to clear and the structure of production has to have time to adjust to changed time preferences of the consumer.

President Obama has often remarked that the Great Recession (2008–10) is the greatest economic crisis since the Great Depression. It’s interesting to study the many parallels between the Great Recession and the Great Depression.

Causation. The main causes of both crises lie in actions of the federal government. In the case of the Great Depression, the Federal Reserve, after keeping interest rates artificially low in the 1920s, raised interest rates in 1929 to halt the resulting boom. That helped choke off investment.

The seeds of the Great Recession were planted when the government in the 1990s began pushing homeownership, even for uncreditworthy people, with a vengeance. Mortgage-backed securities built on dubious mortgage loans became “toxic” when the housing market took a downturn, and many American banks verged on collapse. The government’s urgent desire to bail out various banks and corporations created uncertainty and instability, and this may have widened the recession.

Massive federal spending. Presidents Roosevelt and Obama responded similarly to the crises. They talked about balancing the federal budget, but instead resorted to massive spending. Earlier presidents, like Cleveland and Harding, cut spending when the nation was threatened with economic hardship. Hoover was the transition president, running deficits with record spending on public works, the first federal welfare program, and the first large-scale federal farm program. The results were budget deficits and 25 percent unemployment.

President Roosevelt became Hoover on steroids. FDR and his advisers, despite some early moves to cut spending and control the deficit that Hoover left behind, decided that ever-larger federal spending would trigger economic expansion and pull the country out of its economic slump. Thus Roosevelt began the Agricultural Adjustment Act (AAA), which paid farmers not to produce, and then expanded Hoover’s Reconstruction Finance Corporation, which provided bailout money to large banks and corporations. He also expanded spending on public works and targeted large subsidies to various special interests.

President Obama, who often cites FDR, followed his example of targeting spending to interest groups. He signed into law a $787 billion stimulus package that sent tax dollars to various cities and voting groups across the nation. He later supported an expensive “jobs bill” that would send money into key congressional districts. The President also campaigned for a cap-and-trade bill and universal health coverage, both of which promised to increase the federal debt substantially. In fact, the increase in federal debt under Obama and Roosevelt is similar. The national debt more than doubled in Roosevelt’s first two terms, and it is projected to double again in eight to ten years.

Spending fails. After the large increases in federal spending under Roosevelt and Obama, unemployment remained high. In the 1930s unemployment fluctuated, but recovery never occurred. In April 1939, toward the end of Roosevelt’s second term, unemployment was almost 21 percent. Treasury Secretary Henry Morgenthau complained, “We are spending more than we have ever spent before and it does not work.” Nonetheless, almost all of FDR’s programs continued—usually with annual budget increases.

When Obama took office unemployment was at 8 percent, and in the next year it steadily increased to over 10 percent before falling back just under that mark. He and his advisers were puzzled that large spending increases did not slash unemployment, and he argued that his spending was saving jobs that would otherwise have been lost.

Critics of Roosevelt and Obama insisted that it was impossible to spend our way out of a recession. During the New Deal, economics writer Henry Hazlitt observed that public-works spending destroyed as many jobs as it created. “Every dollar of government spending must be raised through a dollar of taxation,” Hazlitt emphasized. If the Works Progress Administration builds a $10 million bridge, for example, “the bridge has to be paid for out of taxes. . . . Therefore for every public job created by the bridge project a private job has been destroyed somewhere else.”

Tax rates raised. During the Great Depression Roosevelt raised both income and excise taxes. In 1935, with FDR’s push, the top marginal tax rate hit 79 percent. Few paid that rate, but thousands of Americans were in the 50-percent bracket. Entrepreneurs had to hand over more than half of any income above a certain level. Facing disincentives to make capital investments, many entrepreneurs used their wealth cautiously—investing in tax-exempt bonds, art collections, and foreign banks. Little wealth went into creating jobs, so high unemployment persisted. During World War II FDR raised taxes further, to 94 percent on all income over $200,000.

Most of the tax hikes under Obama are planned for the future. Thus far we have seen proposed tax hikes on products such as cigarettes, liquor, plane tickets, and soft drinks. He wants the tax cuts enacted under President Bush to expire. That will mean a spike in the capital gains tax, the income tax, and the estate tax. As FDR showed, tax hikes eventually follow large spending increases.

Scapegoats. The sequence of massive federal spending followed by a lack of recovery plus tax hikes is poison for a politician. Therefore Roosevelt sought scapegoats to explain his failure. Wall Street bankers were his favorites. He called them “economic royalists” and blamed them for causing the Great Depression. He also blamed America’s top businessmen for instigating a “capital strike”—they were refusing to invest in order to make him look bad. FDR then launched IRS investigations of key Republicans and used the newspapers to encourage hostility toward these targets.

Obama has followed FDR’s playbook of attacking Wall Street bankers and various corporate leaders. He condemns the raises these bankers sometimes receive and the profits earned by some large oil companies and health insurance companies.

Such emphasis on “class warfare” may be an inevitable part of redistributing wealth from one group to another. Perhaps Roosevelt and Obama believed that by increasing envy and resentment toward some Americans, they could capture the votes of larger groups of Americans and thereby win reelection (in FDR’s case there is evidence of this). True, this strategy guarantees that many wealthy Americans will attack any president who uses class warfare, but the campaign for redistribution will always supply large amounts of money to subsidize favored groups.

When Roosevelt was reelected in 1936 Senator Carter Glass, Virginia Democrat, admitted, “The 1936 elections would have been much closer had my party not had a 4 billion 800 million dollar relief bill as campaign fodder.”

Obama may be hoping his “stimulus” package and his health insurance bill will generate similarly large support among Americans receiving federal benefits and that these voters will go to the polls to overwhelm those who are paying the bills.

Grace Under Pressure

The FAA has released the audio tapes and transcripts of the radio communications between Flight 1549, the US Airways jet that crash-landed in the Hudson River on Jan. 15, 2009 and the various air traffic controllers in the area on the afternoon of the accident.

Lesson for investors: Focus on what YOU can control in an often uncertain and random world. http://www.youtube.com/watch?v=YAD5xBgPTWQ&feature=related

I Wanna Go Back (Eddie Money on Sax)

High interest rates, the 1980s, let’s go back in time: http://www.youtube.com/watch?v=EbkowHt45yg

Free Resources on Value Investing; Kahneman Podcast on Uncertainty; Apple; Reader’s Questions

I’m sorry, if you were right, I’d agree with you.–Robin Williams


Free Value Investing Course Work here: www.Capatcolumbia.com

Kahneman Podcast on Uncertainty

Professor Kahneman uses a variety of examples to discuss the inside/outside view, statistics and stories and prediction. (1:02:45). This radical pessimist says, “The world makes more sense to us than it really is.”  Excellent Podcast! http://www.thoughtleaderforum.com/default.asp?P=909655&S=945705

Other interesting lectures as well at www.thoughtleaderforum.com

Key takeaway: As a value investor when investing in a franchise with a winner take all market-BE PATIENT.

Federal Reserve Lectures

Bernanke Lectures on the Federal Reserve: http://www.federalreserve.gov/newsevents/press/other/20120126a.htm

Counterpoint to Bernanke’s Lectures: http://www.economicpolicyjournal.com/2012/01/march-madness-bernanke-versus-rothbard.html

Austrian Value Investor, Jim Rogers

A value investor who incorporates “Austrian” economics into his investing: http://en.wikipedia.org/wiki/Jim_Rogers

The State of America Today

Oglala Sioux, Russell Means gives a State of the Union Address. http://www.economicpolicyjournal.com/2012/01/russell-means-endorses-ron-paul.html  More informative than Obama’s recent address to the nation last week. Forget the Paul endorsement and instead ask as an investor–if change occurs at the margin, does the Patriot Act and Obama’s recent rejection of the Keystone Pipeline (http://www.washingtonpost.com/opinions/obamas-keystone-pipeline-rejection-is-hard-to-accept/2012/01/18/gIQAf9UG9P_story.html) raise the cost of capital for American companies in general (P/E multiples become compressed).

Russell Charles Means (born November 10, 1939) is an Oglala Sioux activist for the rights of Native American people. He became a prominent member of the American Indian Movement (AIM) after joining the organisation in 1968, and helped organize notable events that attracted national and international media coverage. The organization split in 1993, in part over the 1975 murder of Anna Mae Aquash, the leading woman activist in AIM.[1]

Greenwald Student Discusses Apple’s Success

From his email: This is what Greenwald will probably say, which is partly true. But you can put anything to his framework (once successful), and say that is their core competency.

1. Apple’s core expertise is in design, and they extend this design to all products.

2. They don’t manufacture the hardware. They assemble them and wrap it in a much better design. Everything that goes into the hardware, CPU, Hard disks, Memory is not made by them.

3. They do software – some of it, like the OS, etc. They don’t do everything. Even steve jobs says, Focus, Focus, get rid of the things that we don’t want. He gave the Google guys the same advice. Don’t become like Microsoft – don’t try to do a lot of things. Stick to four or five things.

You can also think about Steve Jobs as someone who has come and reduced the inefficiencies. I mean when each person has three/four devices that he can access information from – it will be so much better if someone integrates the content. If you take a picture, and you can seamlessly see it on your iPad, Itouch, Mac, Apple TV (not yet released), customers would benefit. Same applies to email, contacts, etc. (rather than taking a usb stick and moving it around all the time).

They are creating products where there is a need like any entrepreneur.

Reader Question on Real Savings

In “Other Views on Inflation and Stocks” section from this post:http://wp.me/p1PgpH-kz, the Mises links talk about the pool of real savings. What is the author referring to? Does the real pool of savings track real changes in the exchange of goods and services?

My reply: Not exactly……see below. Savings is not the transfer of REAL goods and services being exchanged back and forth, but the postponement of present consumption for the future.

 Why Government Data on Saving is Misleading

The nature of the market economy is such that it allows various individuals to specialize. Some individuals engage in the production of final consumer goods, while other individuals engage in the maintenance and enhancement of the production structure that permits the production of final consumer goods.

We suggest that it is the producers of final consumer goods that fund — that is, sustain — the producers in the intermediary stages of production. Individuals who are employed in the intermediary stages are paid from the present output of consumer goods. The present effort of these individuals is likely to contribute to the future flow of consumer goods. Their present effort however, does not make any contribution to the present flow of the production of these goods.

The amount of consumer goods that an individual earns is his income. The earned consumer goods, or income, supports the individual’s life and well-being.

Observe that it is the producers of final consumer goods that pay the intermediary producers out of the existing production of final consumer goods. Hence, the income that intermediary producers receive shouldn’t be counted as part of overall national income — the only relevant income here is that which is produced by the producers of final consumer goods.

For instance, John the baker has produced ten loaves of bread and consumes two loaves. The income in this case is ten loaves of bread, and his savings are eight loaves. Now, he exchanges eight loaves of bread for the products of a toolmaker. John pays with his real savings — eight loaves of bread — for the products of the toolmaker.

One may be tempted to conclude that the overall income is the ten loaves that were produced by the baker, plus the eight loaves that were earned by the toolmaker. In reality, however, only ten loaves of bread were produced — and this is the total income.

The eight loaves are the savings of the baker, which were transferred to the toolmaker in return for the tools. Or, we can say that the baker has invested the eight loaves of bread. The tools, in turn, will assist at some point in the future to expand the production of bread. These tools, however, have nothing to do with the current stock of bread.

While the producers of final consumer goods determine the present flow of savings, other producers could have a say with respect to the use of real savings. For instance, the toolmaker can decide to consume only six loaves of bread and use the other two loaves to purchase some materials from material producers.

This additional exchange, however, will not alter the fact that the total income is still ten loaves of bread and the total savings are still eight loaves. These eight loaves support the toolmaker (six loaves) and the producer of materials (two loaves). Note that the decision of the toolmaker to allocate the two loaves of bread towards the purchase of materials is likely to have a positive contribution toward the production of future consumer goods.

The introduction of money will not alter what we have said. For instance, the baker exchanges his eight saved loaves of bread for eight dollars (under the assumption that the price of a loaf of bread is one dollar).

Now, the baker decides to exchange eight dollars for tools. This means that the baker transfers his eight dollars to the toolmaker. Again, what we have here is an investment in tools by the baker, which at some point in the future will contribute toward the production of bread. The eight dollars that the toolmaker receives are on account of the baker’s decision to make an investment in tools.

Note once more that the tools the toolmaker sold to the baker didn’t make any contribution toward the present income — that is, the production of the present ten loaves of bread. Likewise, there is no contribution to the total present income if the toolmaker exchanges two dollars for the materials of some other producer. All that we have here is another transfer of money to the producer of materials.

Obviously, then, counting the amount of dollars received by intermediary producers as part of the total national income provides a misleading picture as far as total income is concerned.

Yet this if precisely what the NIPA framework does. Consequently, savings data as calculated by the NIPA is highly questionable.

The NIPA Follows the Keynesian Model

The NIPA framework is based on the Keynesian view that spending by one individual becomes part of the earnings of another individual. Each payment transaction thus has two aspects: the spending of the purchaser is the income of the seller. From this it follows that spending equals income.

So, if people maintain their spending, they keep income levels from falling. And this is why consumer spending is viewed as the motor of an economy.

The total amount of money spent is driven by increases in the supply of money. The more money that is created out of thin air, the more of it will be spent — and therefore, the greater the NIPA’s national income will measure (see Figure 2). Thus, an increase in the money supply on account of central bank policies and fractional-reserve banking makes the entire calculation of the total income even more questionable.

Since this money was created out of thin air, it is not backed by any real goods; income in terms of dollars cannot reflect the true income. In fact, the more a central bank pumps additional money into the economy, the more damage is inflicted on the real income. As a result, money income rises while real income shrinks.

Real Savings mentioned http://mises.org/daily/3640

Is there a glut of real savings? Money is not savings: http://mises.org/daily/1882

Good and bad credit: http://mises.org/daily/3151

From Frank Shostak: Do People Save Money?

Is it true that individuals are saving a portion of their money income? Do people save money?

Out of a given money income, an individual can do the following:

he can exchange part of the money for consumer goods;

he can invest;

he can lend out the money (i.e., transfer his money to another party in return for interest);

he can also keep some of the money (i.e., exercise a demand for money).

At no stage, however, do individuals actually save money.

In its capacity as the medium of exchange, money facilitates the flow of real savings. The baker can now exchange his saved bread for money and then exchange the money for final or intermediary goods and services.

What is commonly called “saving” is nothing more than exercising demand for the medium of exchange (i.e., money). This means that people don’t actually save money but rather exercise demand for it. And, when an individual likewise exchanges his real savings for money, he in fact only increases demand for money. The money he receives is not income; it is a medium of exchange that enables the individual to secure goods. In the absence of final consumer goods, all of the money in the world would be of little help to anyone.

My reply: The extent to which an individual will save is explained by his time preference. Savings is deferred consumption. Deferred consumption allows for resources to be used for longer stages of production which should boost productivity.

Read chapter 14 in Capitalism especially pages: 622-651.

For a graphical discussion of real savings read Man, Economy and State pages: 367 to 451 and 517 to 521.

I will speak to a real Austrian economist this week and ask what are REAL savings and see if I can give you a more concise answer.

Another Reader Question:

Also, let’s say that we have a world currency (dollars) and a world Federal

Reserve. If money is dropped from a helicopter into a jungle and every dollar is picked up by a group of 10 individuals, then those 10 individuals would benefit from essentially receiving free money, correct? Their savings would increase and they could use their new found money to purchase capital goods. Society as a whole would lose because REAL savings and REAL capital goods and services exchange would not increase. There would be more money in circulation chasing the same amount of goods, which would cause prices to rise and/or the value of the currency to decline? Does that sound correct?

My reply: Yes, they would benefit as would any counterfeiter would benefit spending the money first before prices can adjust fully. The gain of the early beneficiaries is matched by the losses in real purchasing power of the people who are the last to receive the money AFTER prices have adjusted.  You are correct that real savings would NOT increase. In fact, the structure of production is thrown off which in the end hurts society (boom and bust) in addition to the unfairness of inflation. The money printing distorts production causing mal-investment which depletes REAL savings.

Frank Shostak comments: Consider the so-called helicopter money case: the Fed sends every individual a check for one thousand dollars. According to the NIPA accounting, this would be classified as a tremendous increase in personal income. It is commonly held that, for a given consumption expenditure, this would also increase personal savings.

However, we maintain that this has nothing to do with real income and thus with saving. The new money didn’t increase total real income.

What the new money has done is set in motion the diversion of real income from wealth generators to the holders of new money. The new money that the Fed has created out of thin air prompts exchanges of nothing for something. Consequently, wealth generators have less real wealth at their disposal — which means that the process of real wealth and savings formation has weakened.

In the helicopter example we have a situation in which, for a given pool of real savings, an increase in nonproductive consumption took place. (By nonproductive consumption we mean consumption that is not backed up by the production of real wealth.) This means that the real savings of wealth generators, rather than being employed in wealth generation, is now being squandered by nonproductive consumption.

From this, we can also infer that the policies aimed at boosting consumer spending do not produce real economic growth, but in fact weaken the bottom line of the economy.

In the NIPA framework, which is designed according to Keynesian economics, the more money people spend, all else being equal, the greater total income will be. Conversely, the less money is spent (which is labeled as savings), the lower the income is going to be. This means that savings is bad news for an economy.

We have, however, seen that it is precisely real savings that pays — i.e., that which supports the production of real wealth. Hence, the greater the real savings in an economy, the more are the activities that can be supported.

What keeps the real economic growth going, then, is not merely more money, but wealth generators — those who invest a part of their wealth in the expansion and the maintenance of the production structure. It is this that permits the increase in the production of consumer goods, which in turn makes it possible to increase the consumption of these goods.

Only out of a greater production can more be consumed.

Can the State of Savings be Quantified?

What matters for economic growth is the amount of total real savings. However, it is not possible to quantify this total.

To calculate a total, several data sets must be added together. This requires that the data sets have some unit in common. There is no unit of measurement common to refrigerators, cars, and shirts that makes it possible to derive a unified “total output.”

The statisticians’ technique of employing total monetary expenditure adjusted for prices simply won’t do. Why not? To answer this, we must ask: what is a price? A price is the amount of money asked per unit of a given good.

Suppose two transactions were conducted. In the first transaction, one TV set is exchanged for $1,000. In the second transaction, one shirt is exchanged for $40. The price, or the rate of exchange, in the first transaction is $1,000 per TV set. The price in the second transaction is $40 per shirt. In order to calculate the average price, we must add these two ratios and divide them by 2. However, it is conceptually meaningless to add $1,000 per TV set to $40 per shirt. The thought experiment fails.

The Real Culprit

Rather than attempting the impossible, as far as calculating real savings is concerned, one should instead focus on the factors that undermine real savings. We suggest that the key damaging factors are central bank’s and government’s loose monetary and fiscal policies.

These policies are instrumental in the weakening of the process of real savings formation through the diversion of real savings from wealth generators to non-wealth-generating activities.

The US economy has been subjected to massive monetary pumping since early 1980 via the introduction of financial deregulations. The ratio of our monetary measure AMS to its trend jumped from 1.17 in January 1980 to 3.5 in July 2009. (The trend values were calculated by a regression model, which was estimated for the period 1959 to 1979, the period prior the onset of financial deregulations).

Likewise, the US economy was subjected to massive government spending. For the fiscal year 2009, US federal government outlays are expected to stand at $3.5 trillion.

The outlays-to-trend ratio (the trend was estimated for the period 1955 to 1979) jumped to 4.1 in 2009, up from 3.5 in 2008 and 1.45 in 1980.

The ever-expanding government outlays are also depicted by the federal debt, which stands at $11.6 trillion thus far into 2009. Against the background of massive monetary pumping and ever-expanding government, we suggest that this raises the likelihood that the pool of real savings could be in serious trouble.

That this could be the case is also suggested by the private sector debt-to-its-trend ratio. This ratio stood at 5.8 in first quarter, against a similar figure from the previous quarter. The ever-rising ratio raises the likelihood that the increase in the private sector debt is on account of nonproductive debt. Real savings, instead of funding wealth generating activities, have been supporting non-wealth-generating activities. This weakens the ability of wealth-generating activities to grow the economy.

We can conclude that, given prolonged reckless fiscal and monetary policies, there is a growing likelihood that the pool of real savings is in trouble. If our assessment is valid, this means that US real economy is likely to struggle in the quarters ahead.

In addition, if the pool of real savings is under pressure, none of the government and central-bank policies to lift the economy is going to work. Note that as long as the pool of real savings is holding its ground, such policies appear to be effective. In reality, though, it is the expanding pool of real savings that drives the economy — and not various stimulus policies.


According to latest US government data, the personal saving rate jumped to 4.6% in June this year after settling at 0.4% in June last year. We suggest that on account of an erroneous methodology, the so-called “saving rate” that the government presents has nothing to do with true savings.

Since early 1980s, the ever-rising money supply and government outlays have severely undermined the process of real savings formation. As a result, it will not surprise us if the US pool of real savings is in serious trouble. If what we are saying is valid then it will be very hard for the US economy to grow, for it is a growing pool of real savings that makes economic growth possible.

Furthermore, the growing pool of real savings is the reason that loose monetary and fiscal policies appear to be working. In reality, however, all that these loose policies achieve is a further depletion of the pool of real savings — thus reducing prospects for a genuine economic recovery.

Update on VALUE VAULT; Questions from a Reader; Apple and Strategic Logic

A lot of companies have chosen to downsize, and maybe that was the right thing for them. We chose a different path. Our belief was that if we kept putting great products in front of customers, they would continue to open their wallets.

A lot of people in our industry haven’t had very diverse experiences. So they don’t have enough dots to connect, and they end up with very linear solutions without a broad perspective on the problem. The broader one’s understanding of the human experience, the better design we will have.

Again, you can’t connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future. You have to trust in something – your gut, destiny, life, karma, whatever. This approach has never let me down, and it has made all the difference in my life.

An iPod, a phone, an internet mobile communicator… these are NOT three separate devices! And we are calling it iPhone! Today Apple is going to reinvent the phone. And here it is.

And it comes from saying no to 1,000 things to make sure we don’t get on the wrong track or try to do too much. We’re always thinking about new markets we could enter, but it’s only by saying no that you can concentrate on the things that are really important.
–Steve Jobs

Update on the VALUE VAULT

(contact: Aldridge56@aol.com with VALUE VAULT in subject line for the key)

I uploaded 21 videos of 2010 value investing lectures into a sub-folder in the VALUE VAULT.  The VAULT seems cluttered so unless anyone objects, I will place non-videos into folders with sub-categories for easier searching. I will choose a quiet time to work on the vault—probably Sunday.

If you are having trouble opening the folder, please contact www.yousendit.com customer service at 888-535-9442 or (outside the USA) 1-408-385-8491 and email me if the problem has or hasn’t been fixed.  I will #$%^&*! find out the problem. I am having no issues accessing the folder or videos so far.

If anyone has an idea for a more accessible storage option, let me know.

Question from a Reader

I’ve just started digging into the Competition Demystified PDF (in VALUE VAULT) and came across this passage (also mentioned in the “Strategy is Local” PDF) and couldn’t help but wonder what’s changed:

“Apple’s experience stands in stark contrast. From the start, Apple took a more global approach than Microsoft. It was both a computer manufacturer and a software producer. Its Macintosh operating system anticipated the attractive features of Windows by many years— “Windows 5 = Macintosh 87,” as the saying goes. Yet its comprehensive product strategy has been at best a limited and occasional success, especially when compared to Microsoft’s more focused approach.”

This strategy of controlling everything (operating system, hardware, software licenses/developers, content delivery, etc.) is, according to Greenwald, a competitive liability, yet today, as Apple is the most valuable company in the world and the most successful tech company, it is the very reason given for their massive success, and the “special genius” of the recently departed Jobs.

What gives? Is Apple just a fad? Is Greenwald making stuff up? Or is there some other piece of this puzzle I am not considering?

The Reader follows up with: “I thought of another strategic element for Apple. I read this somewhere a few months ago, don’t remember where, but Apple basically made exclusive contracts with its various suppliers such that they guaranteed them large volume up front in return for them not taking orders from competitors, essentially (some arrangement like that).

This resulted in two things:

First, conferred a competitive advantage in supply to Apple because they were able to achieve lowest cost in production.

Second, accomplished the strategic goal of totally denying their competitors access to suppliers of similar quality/cost. This meant that the only way a competitor could create something of Apple quality would be to pay (and charge) a lot more for it. But Apple commanded a brand premium in the market place while the competitors did not. This would be a good example of the Jarillo principle of the premium company charging less than they could, forcing competitors who don’t command a premium to price near cost.

I think normally the issue of “what suppliers do we use and how do we contract with them?” would be tactical. But because Apple interfered with their competitors’ ability to compete by working with suppliers the way they did, this seems to be a strategic consideration as well.

My reply: Like a lecturer before an audience, I was hoping no one would notice that my fly was unzipped. The reader is mentioning the elephant in the room–did Steve Jobs read Prof. Greenwald’s Competition Demystified and just do the opposite–Apple has a closed system for hardware and software. Has Apple been successful?

There are a number of possible answers:

  1. Prof. Greenwald has missed something in his approach to strategy.
  2. Apple may be using elements of strategic logic to be successful like economies of scale, customer captivity, network effect, and patents.
  3. Steve Jobs may be a genius who invented an industry or product beyond the immediate scope of strategic analysis. In other words, you can’t analyze the reasons for success of someone who invents the cure for cancer or a process that turns an element into a resource. You can’t predict genius.

Who said strategic thinking would be easy. Let’s take our time to look at a problem from all sides and go through our strategic logic process. We will soon discuss the Coors case study and then move on to Chapter 6: Compaq and Apple in the Personal Computer Industry or pages 113-136 in the book. Once we have finished the book and all the cases, let’s circle back and study Apple’s current success.

One question that should slap you in the face, “Why does Apple have such a low multiple of earnings and cash flow?” Perhaps the market does not believe that Apple can have real growth and/or the genius of Steve Jobs will no longer drive Apple’s future.

Should the government tell you how to live?

Freedom of choice: http://www.youtube.com/watch?v=A6a9549ZeqQ&feature=g-vrec&context=G22064f2RVAAAAAAAABA

Personal Prejudices

We all have our prejudices. Here is how to deal with them.

Prejudice: http://www.youtube.com/watch?NR=1&feature=endscreen&v=9aVUoy9r0CM

Sensitivity Training: http://www.youtube.com/watch?v=iliNaspGVDg&feature=related

More posts to follow…………

Wal-Mart Analysis Post 1985; Money and Credit; Short Seller Blog

 I was trying to daydream, but my mind kept wandering. — Steven Wright

Wal-Mart Post 1985 Analysis


My Greenwald notes on Wal-Mart should help you understand how regional economies of scale work. You see returns on capital decline as Wal-Mart grows larger in assets and sales but into areas with less regional economies of scale and more competition.

Money and Credit

A short synopsis on The Theory of Money and Credit http://mises.org/rothbard/money.pdf

A reader suggested this financial blog on short selling and focus on financial statement analysis: http://www.thefinancialinvestigator.com/


How does Kyocera (KYO) http://americas.kyocera.com/ir/index.html earn high operating profits on its core business of ceramics?  You will have to separate out non-operating assets like cash and investment in other companies to peel away the onion.  Are there economies of scale in R&D here?   Not a recommendation but some of you may want to have a current example to work on.

Study Break; Course on Money and Credit, J. Rogers on Rating Agencies

Experience is something you don’t get until just after you need it.–Steven Wright

Study Break

Let’s take a study break and return to the Coors case study this weekend.  You have a strong foundation of strategic logic to study the case. You learned from Wal-Mart that management did not expand from Arkansas into California or the Northeast back in 1985, but expanded at its periphery (like an amoeba), where it could readily establish the customer captivity and economies of scale that made it dominant. And it defended its base.  What did Coors do?

Mises Academy Course on Money and Credit

I mentioned the course with links to the books and study guide here: http://wp.me/p1PgpH-ix

This article by Professor Murphy discusses the course in more detail. I hope some of you join me in taking this rigorous tour of money and credit. http://mises.org/daily/5878/Mises-on-Money-and-Banking

“Is This Course Going to Be Really Hard?”

Let’s be frank. Mises’s writing at times can be difficult, especially his earlier work when he was writing for other economists, rather than the lay public. The amateur fan of Austrian economics who flips through The Theory of Money & Credit might recoil, thinking it is too hard and that anything important from the book would have been distilled by Rothbard in Man, Economy, and State.

If I’ve just described your view, I suggest doing the first week’s reading (the first two chapters from Mises) with my study guide as a companion. You might be pleasantly surprised to discover that Mises’s prose, though a bit formal, is still accessible to the layperson. If — using my study guide for help — you can get through the first week’s readings, then I believe you have what it takes to get through the whole class. It’s true, we will get into material that is more complicated than what Mises lays out in the opening chapters, but then again that’s what you have me for, to explain it for you.

Now if you determine that you are capable of digesting the material, I would urge you to take the plunge and sign up for the course. Yes, Rothbard and others have explained the Austrian theory of the business cycle in other venues. However, by exploring the Misesian framework of money and banking, you will walk away with a much deeper understanding of his theory of economic fluctuations. For example, the typical objection that “we had business cycles before the Fed, so the Austrians are obviously wrong” will seem quite ludicrous after studying Mises’s classic work.

 Jim Rogers Savages the Credit Rating Agencies




Part 2: A Professor Provides a Different Perspective on WMT

I’ve missed more than 9000 shots in my career. I’ve lost almost 300 games. 26 times, I’ve been trusted to take the game winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed.–Michael Jordan

What is a Moat?

Moats are structural characteristics of a business that are likely to persist for a number of years, and that would be very hard for a competitor to replicate.  Management is not a moat. The best poker player with a pair of deuces can’t beat a beginner with a straight flush.

Moats are not great products, strong market share, great execution and good management.

Part Two: A Professor discusses WMT Case Study

See Part 1: http://wp.me/p1PgpH-j0

Part Two: The Professor continues his talk on Wal-Mart’s success.

First used in grocery supermarkets, bar-code scanners at retail checkout stations are now ubiquitous. Mass merchandisers began to use them in the early 1980s. Most retailers saw the bar-code scanner as a way of eliminating the cost of constantly changing the price stickers on times. But Wal-Mart went further, developing its own satellite-based information systems. Then it used this data to manage its inbound logistics system and traded it with suppliers in return for discounts.

Susan, a human resources executive, suddenly perks up. Isolating one small policy has triggered a thought. I gave a talk the day before on “complementary” policies and she sees the connection. “By itself,” she says, “it doesn’t help that much. Kmart would have to move the data to distribution centers and suppliers. It would have to operate an integrated inbound logistics system.”

Good,” I say, and point out to everyone that Wal-Mart’s policies fit together—the bar codes, the integrated logistics, the frequent just-in-time deliveries, the large stores with low inventory—they are complements to one another, forming an integrated design. This whole design—structure, policies, and actions—is coherent. Each part of the design is shaped specialized to the others. The pieces are not interchangeable parts. Many competitors do not have much of a design, shaping each of their elements around some imagined “best practice” form. Others will have more coherence but will have aimed their designs at different purposes. In either case, such competitors will have difficulty in dealing with Wal-Mart. Copying elements of its strategy piecemeal, there will be little benefit. A competitor would have to adopt the whole design, not just a part of it.

The professor suggests that WMT incorporated the bar-code scanners into an integrated process that a competitor couldn’t copy at least in the short run. When a company invents a process advantage, competitors can eventually copy that. I see WMT using a technology to lower costs within the company’s regional economies of scale advantage. Even if Kmart could lower its costs with the same technology, it was still at a disadvantage in terms of cost structure versus WMT.

There is much more to be discussed: first-mover advantages, quantifying its cost advantage, the issue of competence and learning developed over time, the function of leadership, and whether this design can work in cities. We proceed.

With fifteen minutes to go, I let the discussion wind down. They have done a good job analyzing Wal-Mart’s business, and I say so. But, I tell them, there is one more thing. Something I barely understand but that seems important. It has to do with the “conventional wisdom”—the phrase from the case I put on the whiteboard at the beginning of the class: “A full-line discount store needs a population base of at least 100,000.”

I turn to Bill and say: “You started us out by arguing that Walton broke the conventional wisdom. But the conventional wisdom was based on the straightforward logic of fixed and variable cost. It takes a lot of customers to spread the overhead and keep costs and prices low. Exactly how did Walton break the iron logic of cost?”

I push ahead, putting Bill into a role: “I want you to imagine that you are a Wal-Mart store manager. It’s 1985 and you are unhappy with the whole company. You feel that they don’t understand your town. You complain to your dad, and he says, ‘Why don’t we just buy them out” We can run the store ourselves.’ Assuming Dad has the resources, what do you think of his proposal?”

Bill blinks, surprised at being put on the spot for a second time. He thinks a bit, then says, “No it is not a good idea. We couldn’t make a go of it alone. The Wal-Mart store needed to be part of the network.”

I turn back the whiteboard and stand right next to the boxed principle: “A full-line discount store needs a population base of at least 100,000.” I repeat his phrase, “The Wal-Mart store needs to be part of the network,” while drawing a circle around the word “store.” Then I wait.

With luck, someone will get it. As one student tries to articulate the discovery, others get it, and I sense a small avalanche of “Ahas,” like a pot of corn kernels suddenly popping. It isn’t the store; it is the network of 150 stores. And the data flows and the management flows and a distribution hub. The network replaced the store. A regional network of 150 stores serves a population of millions! Walton didn’t break the conventional wisdom; he broke the old definition of a store. If no one gets it right away, I drop hints until they do.

When you understand that Walton redefined the notion of “store,” your view of how Wal-Mart’s policies fit together undergoes a subtle shift. You begin to see the interdependencies among location decisions. Store locations express the economics of the network, not just the pull of demand. You also see the balance of power at Wal-Mart. The individual store has little negotiation power—its options are limited. Most crucially, the network, not the store, became Wal-Mart’s basic unit of management.

In making an integrated network into the operating unit of the company, instead of the individual store, Walton broke with an even deeper conventional wisdom of his era: the doctrine of decentralization that each kettle should sit on its own bottom. Kmart had long adhered to this doctrine, giving each store manager authority to choose product lines, pick vendors, and set prices. After all, we are told that decentralization is a good thing. But the oft-forgotten cost of decentralization is lost coordination across units. Stores that do not choose the same vendors or negotiate the same terms cannot benefit from an integrated network of data and transport. Stores that do not share detailed information about what works and what doesn’t can’t benefit from one another’s learning.

If your competitors also operate this kind of decentralized system, little may be lost. But once Walton’s insights made the decentralized structure a disadvantage, Kmart had a severe problem. A large organization may balk at adopting a new technique, but such change is manageable. But breaking with doctrine—with one’s basic philosophy—is rare absent a near-death experience.

The hidden power of Wal-Mart’s strategy came from a shift in perspective. Lacking that perspective, Kmart saw Wal-Mart like Goliath saw David—smaller and less experienced in the big leagues. But Wal-Mart’s advantages were not inherent in its history or size. They grew out of a subtle shift in how to think about discount retailing. Tradition saw discounting as tied to urban densities, whereas Sam Walton saw a way to build efficiency by embedding each store in a network of computing and logistics. Today we call this supply chain management, but in 1984 it was as an unexpected shift in viewpoint. And it had the impact of David’s slung stone.

Compare this discussion with Greenwald’s analysis of WMT in Ch. 5 of Competition Demystified. Do you agree with the professor that WMT has a network effect?

Hint: You are most likely to find the network effect in businesses based on sharing information (Amex), or connecting users together (Ebay, CME), rather than in businesses that deal in rival (physical goods). Of networks there will be few.

Cost advantages matter most in industries where price is a large portion of the customer’s purchase criteria.

A Typical View of Wal-Mart’s Advantages. Again!

If you have an important point to make, don’t try to be subtle or clever. Use a pile driver. Hit the point once. Then come back and hit it again. Then hit it a third time – a tremendous whack. –Winston Churchill
We will discuss Wal-Mart in the next few posts before moving on to the Coors case study.  Think of reviewing these cases as you develop more experience with analyzing competitive advantages. In fact, do not be afraid to read the cases again! Think of these guys: http://www.youtube.com/watch?v=T9AajQn7b18

Now give me fifty push ups! Does power corrupt?

A Typical View of Wal-Mart’s Advantages


The Limits of the Local by Steven Horwitz

Critics of the market often point to the increased globalization of production and consumption as one of the problems that economic freedom can generate. This criticism has a number of elements. One is that multinational firms like Wal-Mart or McDonald’s turn the United States, as well as the rest of the world, into one commercial culture, destroying the local stores that provided a distinct identity to small towns and cities across the globe.

Large chain stores and franchises do affect local businesses, especially in small towns, but note that it’s mostly a shift rather than destruction: Some businesses find ways to compete effectively by filling niches that the larger stores can’t fill, particularly with respect to distinctly local products, such as restaurant food.

However, larger chains have at least two big advantages worth discussing.

First and perhaps most obviously, their size normally gives them the ability to buy in larger quantities, keeping their costs and prices down. Wal-mart grew to the size it did through highly effective inventory management; it pressured suppliers to keep their input prices low and passed those low prices on to consumers.* Low prices are a big part of what lures people to shop there rather than at the smaller boutique stores. Chains like McDonald’s work in similar ways; a burger, fries, and drink there is usually no more expensive (especially if you count the lack of a tip) than the diner up the road.

Known Commodity

The second advantage is less commented on. The very similarity of chain stores and franchises nationwide, and even worldwide, is a big attraction to many customers because they are a known commodity. If you’re hungry in a strange town, you know that you can always go to a national fast-food chain and get a meal of nearly identical quality to what you’re used to at the chain’s restaurant at home — and for a good price. If you are sufficiently risk-averse, the consistency of a national brand is very valuable. In an economy where national chains were more difficult to operate, we would be far more at the mercy of the unknown.

And it’s not just about food. On a recent trip I forgot to pack dress socks. Thankfully, in a strange town 2,500 miles from home there was a Wal-Mart five minutes up the road. I happen to like Walmart’s in-house Faded Glory cotton dress socks, so I was able to buy several pairs of exactly the socks I like and usually wear (for less than $2 per pair). In a “local only” economy, not only would I have had to spend more time searching for a store that carried dress socks (and was open at 8:30 a.m.!), I would also have faced uncertainty over whether those socks would be the kind I like. And I probably would have paid considerably more. A highly local economy constantly puts strangers in a similar position to the traveler with car trouble who knows he is at the mercy of a mechanic he’ll never see again. Chain stores and franchises bring reputation and repeated dealing into the equation, removing uncertainty and reducing the seller’s power over the buyer.

Freedom of Choice

One final advantage of a global economy is that it still permits people to “buy local” if that’s what they prefer. I love living in a small town with a Wal-Mart ten minutes away and a farmer’s market during the summer and a top-notch restaurant that serves lots of local beef and produce. In a world where everything is local, those of us who want to “buy global” presumably would be prohibited from doing so — in the name of preserving the local character. Just as markets allow pockets of voluntary socialism, but socialism cannot abide capitalist acts between consenting adults, so a global economy has room for the local, while mandatory localism cannot meet the needs of those who prefer to buy global.

Whether it’s food or socks or pretty much anything else, the freedom of the marketplace allows for firms of varying size and composition to meet the equally varied wants of consumers.

*Has the writer accurately assessed the competitive advantages of Wal-Mart—the source of Wal-Mart’s cost advantage? Will going global help or hurt Wal-Mart’s profitability? How? (See 2003 Wal-Mart Case Study for help).  And if the writer is correct, then why do Sears, Kmart and other large retailers struggle? What does this article illustrate about most business writers or analysts? Lessons?