Tag Archives: Competition Demystified

WMT 2003 and Coors Case Studies; Items of Interest

Posted on January 18, 2012 | Leave a comment

I got my driver’s license photo taken out of focus on purpose. Now when I get pulled over the cop looks at it (moving it nearer and farther, trying to see it clearly)…and says,” Here, you can go.” — Steven Wright

The Wal-Mart Stores in 2003 and the Adolph Coors in the Brewing Industry Case Studies are in the Value Vault.  If you just want me to email you the cases just write to aldridge56@aol.com with CASES in the Subject line–you will have them by tomorrow.

Other Items of Interest

Should we re-write the constitution every 20 years as Thomas Jefferson suggested? Check out: http://www.constitutioncafe.org/

How to strengthen willpower. http://artofmanliness.com/2012/01/15/how-to-strengthen-willpower/

Nassim Taleb’s New Book

Talk about Nassim Taleb’s new book, Antifragility, go here www.cafehayek.com and click on podcasts on left of blog.  Other interesting podcasts available.

Keynesian Economics is a Failure

Interesting lecture on classical economic theory: http://mises.org/resources/5278/Why-Your-Grandfathers-Economics-Was-Better-Than-Yours

  • A participant: “I really enjoyed this talk. Most of it is about Say’s Law and how Keynes was wrong. Keynes, in fact, got his idea from Thomas Malthus who was a contemporary of JB Say.”Here are some notes:Recessions are never due to demand deficiency.
    An economy can never produce more than its members are willing or able to buy.
    High levels of savings do not cause recessions.What causes recessions?
    – Structure of supply doesn’t fit the structure of demandGeneral Glut
    – Could you produce too much of everything? No.
    – Overproduction of particular goods can lead to a general downturnMen err in their production there is no deficiency in demand – David Ricardo

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A Different Analysis of Wal-Mart Part 1

Posted on January 18, 2012 | 3 comments

I bought a self-learning record to learn Spanish. I turned it on and went to sleep; the record got stuck. The next day I could only stutter in Spanish.                 — Steven Wright

A Different Professor’s Analysis of the Wal-Mart Case Study  (Part 1)

Try to jot down answers to the professor’s discussion. Part two of his lecture will be posted tomorrow.

A Professor Discusses Wal-Mart with his MBA class. The purpose of this analysis is to give you another approach of analyzing a case. Do you find Greenwald’s approach “better” or more thorough, precise and analytical or this professor’s approach? Can you answer his question at the end of this post?

The Professor: Much of my work with MBA students and companies involves helping them uncover the hidden power in situations. As part of this process often teach a case about Wal-Mart’s founding and rise, ending in 1986 with Sam Walton as the richest person in the US. In a subsequent session I will follow-upby discussing the modern Wal-Mart, pushing into urban areas, stretching out to Europe, and becoming the largest corporation on the planet in terms of revenue. But the older case portrays a simpler, leaner Wal-Mart—a youthful challenger rather than the behemoth it has become. Hard as it is to believe today, Wal-Mart was once David, not Goliath.

I write this on the Black-Board: CONVENTIONAL WISDOM: A Full-line discount store needs a population base of at least 100,000. The question for the group is simple: Why has Wal-Mart been so successful? To start, I call on Bill, who had some experience in sales during the earlier part of his career. He begins with the ritual invocation of founder Sam Walton’s leadership. Neither agreeing nor disagreeing, I write “Sam Walton” on the board and press him further. “What did Walton do that made a difference?”

Bill looks at my labeled box on the board and says, “Walton broke the conventional wisdom. He put big stores in small towns. Wal-Mart had everyday low prices. Wal-Mart ran a computerized warehousing and trucking system to manage the movement of stock into stores. It was non-union. It had low administrative expenses.” It takes about thirty minutes for six other participants to flesh out this list. They are willing to throw anything into the bin, and I don’t stop them. I prod for detail and context, asking, “How big were the stores?” “How small were the towns?” “How did the computerized logistics system work?” And “What did Wal-Mart do to keep its administrative expenses so low?”

As the responses flood in, three diagrams take shape on the white-board. A circle appears, representing a small town of ten thousand persons. A large box drawn in the circle represents a forty-five thousand square foot store. A second diagram of the logistical system emerges. A square box represents a regional distribution center. From the box, a line marks the path of a truck, swooping out to pass by some of the 150 stores served by the distribution center. On the return path, the line passes vendors, picking up pallets of goods. The line plunges back to the square, where an “X” denotes cross-docking to an outgoing truck. Lines of a different color depict the data flows, from the store to a central computer, and then out to vendors and the distribution center.

Finally, as we discuss the management system, I draw the path of the regional managers as they follow a weekly circuit: Fly out from Bentonville, Ark., on Monday, visit stores, pick up and distribute information, and return to Bentonville on Thursday for group meeting on Friday and Saturday. The last two diagrams are eerily similar—both revealing the hub structure of efficient distribution.

The discussion slows. We have gotten most of the facts out; I look around the room, trying to include them all, and say, “If the policies you have listed are the reasons for Wal-Mart’s success, and if this case was published—let’s see—in 1986, then why was the company able to run rampant over Kmart for the next decade? Wasn’t the formula obvious? Where was the competition?”

Silence….This question breaks the pleasant five-and take of reciting case facts. The case actually says almost nothing about competition, referring broadly to the discounting industry. But surely executives and MBA students would have thought about this in preparing for this discussion. Yet it is totally predictable that they will not. Because the case does not focus on competition, neither do they. I know it will turn out this way—it always does.

Half of what alert participants learn in a strategy exercise is to consider the competition even when no one tells you to do it in advance. Looking just at the actions of a winning firm, you see only part of the picture. Whenever an organization succeeds greatly, there is also at the same time, either blocked or failed competition. Sometimes competition is blocked because an innovator holds a patent or some other legal claim to a temporary monopoly. But there may also be a natural reason imitation is difficult or very costly. Wal-Mart’s advantage must stem from something that competitors cannot easily copy, or do not comply because of inertia and incompetence.

In the case of Wal-Mart, the principal competitive failure was Kmart. Originally named the S.S. Kresge Corporation, Kmart was once the leader in low-cost variety retailing It spent much of the 1970s and 1980s expanding internationally ignoring Wal-Mart’s innovations in logistics and its growing dominance of small—tow2n discount. It filed for bankruptcy in 2002. After some moments I ask a more pointed question: Both Wal-Mart and Kmart began to install bar-code scanners at cash registers in the early 1980s. Why did Wal-Mart seem to benefit from this more than Kmart?

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Wal-Mart Discount Stores’ Operations 1985 Case Study Analysis

Posted on January 17, 2012 | 6 comments

 Capital isn’t scarce; vision is.

Each Wal-Mart store should reflect the values of its customers and support the vision they hold for their community.
High expectations are the key to everything.
I had to pick myself up and get on with it, do it all over again, only even better this time.
I have always been driven to buck the system, to innovate, to take things beyond where they’ve been.
Outstanding leaders go out of their way to boost the self-esteem of their personnel. If people believe in themselves, it’s amazing what they can accomplish.
There is only one boss. The customer. And he can fire everybody in the company from the chairman on down, simply by spending his money somewhere else.
We let folks know we’re interested in them and that they’re vital to us. cause they are.
We’re all working together; that’s the secret.
               — All quotes are from Sam Walton

Wal-Mart Case Study 1986

Analysis of Wal-Mart http://www.scribd.com/doc/78543427/WMT-Case-Study-1-Analysis

See: http://www.scribd.com/doc/78527294/Wmt-50-Year-Chart

Who wants to move deeper into analyzing WMT and see the HBS Case on WMT for 2003? …………or

Ready to move onto to the Coors Beer Case Study which is a lesson on what happens if a company loses its regional economies of scale advantage?

Lessons learned so far?

If you had read this case study when it was published in 1986 would you have bought WMT and held on for five or seven years?  What analysis would you need to do?

Tomorrow I will post another strategic view of Wal-Mart so you can see other perspectives.

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Greenwald Strategy Notes #1

Posted on January 9, 2012 | Leave a comment

 “If you don’t read the newspaper, you are uninformed. If you do read the newspaper, you are misinformed.” –Mark Twain

I stayed up all night playing poker with tarot cards. I got a full house and four people died. –Steven Wright

These notes should supplement your reading of Competition Demystified and your case study on Wal-Mart (in Value Vault).

http://www.scribd.com/doc/77722383/Greenwald-Strategy-Class-1

A book on moats and investing

Moats and filters: http://www.lulu.com/spotlight/4filters Neither have I read nor recommend the material on the web-site but I do want you to be aware of the book.

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Master Student Study Techniques for Competition Demystified

Posted on January 7, 2012 | 12 comments

IMPORTANT:

Practice becoming an expert student so you can truly master the material.

The questions below are ones that YOU should ask and then answer without looking at the text again. If you read a page or a segment of the book, stop, then write down or record verbally your answers or explanation of what you just read. Then after you complete the chapter review again what you have learned–give a mini lecture on the chapter in your OWN WORDS. You need to answer in your own words not look up and repeat the text.

These questions for chapters 1-3 are the type you should ask as you read. The questions cover the first 51 pages, but you need to study up to Chapter 5 to complete the WMT Case Study.

Wal-Mart Case Study (in Value Vault, email aldridge56@aol.com)

You need to show in WMT’s financial statements, where is the source of  competitive advantage.  How do you know WMT has a competitive advantage and exactly what is WMT’s competitive advantage? Please show your analysis.

Questions about Competition Demystified
By Bruce Greenwald and Judd Kahn

These questions are intended to help you test your understanding of the book.

Chapter 1: Strategy, Markets and Competition
1. What are the differences between strategy and tactics?
2. What is the most valuable resource in any business?
3. What is the most important feature of the competitive landscape in which a business operates? (hint: one of Porter’s five forces)
4. What are the three sources of competitive advantages?
5. If your success is based on your ability to dominate a local market, how can you grow and still maintain high levels of profitability?

Chapter 2: Competitive Advantages I: Supply and Demand
6. Is product differentiation a means to high profitability?
7. Can product differentiation create strategic opportunity? Why or why not?
8. Is efficiency easier for differentiated products than commodity products?
9. What is the strongest barrier to entry? Why?
10. What is customer captivity and what are the three sources of customer captivity?

Chapter 3: Competitive Advantages II: Economies of Scale and Strategy
11. When we talk about the “size” of economies of scale, what are some of the ways of thinking about this? Explain the interaction of economies of scale and customer captivity: in manufacturing, in advertising & marketing, in distribution.
12. What economic conditions create the potential for economies of scale advantages?
13. If a crucial ingredient for competitive advantage is customer captivity, what are five tactics for intensifying customer captivity?
14. Why is Coca Cola one of the most valuable brands in the world? Why is Mercedes-Benz not?

STUDY HABITS and SKILLS

To learn more about study habits: http://www.garynorth.com/public/department95.cfm

Why does this technique work? Because of this inescapable fact: If you can’t put something in your own words, then you don’t really understand it. Simple, isn’t it? I think most people don’t want to face the fact that they don’t understand things. They don’t want to be reminded. — Gary North.

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What is Strategy?

Posted on January 4, 2012 | Leave a comment

Be deliberate; be thorough; be aware–Zen Master

Strategy is big – Bruce Greenwald.

Michael Porter

Greenwald credited Michael Porter for his work on strategy and his focus on competitors. Review here a Harvard Business School article: http://www.ipocongress.ru/download/guide/article/what_is_strategy.pdf

Five Forces Industry Analysis in Value Vault and here: http://www.scribd.com/doc/77131692/Five-Forces-Industry-Analysis

Mauboussin Articles on Strategy

Measuring the Moat on Michael Mauboussin’s website.
http://www.capatcolumbia.com/Articles/measuringthemoat.pdf

Network Economics: http://www.scribd.com/doc/77133968/CA-Network-Economics-Mauboussin

Review of Competition Demystified first 30 pages:

Anyone running a business knows that competition matters and that strategy is important.

Don’t confuse strategy with planning to attract customers or increase margins. Goals are not strategy.

Strategies are those plans that focus on the actions and responses of competitors. Strategic thinking is about creating, protecting and exploiting competitive advantages.

Some consultants call it singularity. What they mean is that for a firm to earn profits above a minimum normal return, a company must be able to do something that its competitors cannot.  With a universe of companies seeking profitable opportunities for investment, the returns in an unprotected industry will be driven down to levels where there is no “economic profit,” that is, no returns above the costs of the invested capital. If demand conditions enable any single firm to earn unusually high returns, other companies will notice the same opportunity and flood in.

Both history and theory support the truth of this proposition. As more firms enter, demand is fragmented among them. Costs per unit rise as fixed costs are spread over fewer units sold, prices fall, and the high profits that attracted the new entrants disappear. If the company is on a level playing field then competition will erode the returns of all players to a uniform minimum (Reversion to the Mean or “RTM”)

It is now 25 years ago that Harvard professor, Michael E. Porter wrote “Competitive Strategy“. Essentially Porter says you need to consider Five Competitive Forces to analyse the attractiveness of an industry for a company.

Prof. Greenwald suggests, in most cases, studying only one factor will do: Potential Entrants. They claim the Barriers to Entry is by far the most important factor in business strategy.

“Either the existing firms within the market are protected by barriers to entry or they are not,” the authors write.”

Firms operating without competitive advantages should concentrate all their efforts on being efficient;

  • Companies that do have competitive advantages need to design strategy with their competitors in mind;
  • Most competition is over pricing or capacity, and there are established techniques for analyzing these situations and devising the right strategies to handle them;
  • Cooperation between competitors is possible and beneficial and can be accomplished without breaking the law;
  • In an increasingly global economy, competitive advantages still stem primarily from local conditions. Even large international firms need to understand and protect the local sources of their success.

Most importantly, according to the authors there are really only three sustainable competitive advantages;

  1. Supply. A company has this edge when it controls an important resource: in Hollywood, for example, it may mean having Julia Roberts or Tom Cruise star in a movie. Or a company may have a proprietary technology, like a prescription drug, that is protected by patent.
  2. Demand. A company can control a market because customers are loyal to it, either out of habit – to a brand name, for example – or because the cost of switching to a different product is too high. Companies often put off changing software vendors, for example, for that reason.
  3. Economies of scale. If your operating costs remain fixed while output increases, you can gain a significant edge because you can offer your product at lower cost without sacrificing margins.

The goal of this book is to present a step by step process for strategic analysis.”

Management time and focus are the most important resources of a firm.

WHAT IS STRATEGY?

Strategic decisions are those whose results depend on the actions and reactions of other economic entities. Tactical decisions are ones that can be made in isolation and hinge largely on effective implementation. Understanding this distinction is key to developing effective strategy.

STRATEGIC VS. TACTICAL ISSUES

Strategic choices, in contrast to tactical ones, are outward looking. They involve two issues that every company must face.

  1. The first issue is selecting the arena of competition
  2. The second strategic issue involves the management of those external agents.

You should have a firm foundation to complete your Wal-Mart case study. If I am going too fast, tell me.

 

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CASE STUDY on Wal-Mart Stores’ Discount Operations; Richard Feynman Video on An Original Thinker

Posted on January 3, 2012 | 11 comments

Feynman Video on No Ordinary Genius

Richard Feynman was one of my heroes. Start your 2012 on an inspiring note by watching the video (link) below.

Throughout history, the Ayn Rand pointed out, the greatest heroes of mankind have been original thinkers who rejected the core beliefs of their societies, formed new ideas, and struggled for years against social norms to have the new theories accepted. Socrates, Copernicus, Galileo, Darwin, and Pasteur are all examples of this phenomenon.

An individual—a thinking individual—is not a helpless pawn of his society, its educational system, and its core beliefs. He is able to look at the realities of the world, at nature, at facts, and think independently. This is how many individuals come to reject the beliefs of their families, their clergy, their teachers, their professors, their governments, and their societies in general. This is how independent freethinkers have arisen, battled against the entrenched conservative beliefs of their societies, and ultimately established the truth of their new theories. –Andrew Bernstein

Richard Feynman is no ordinary genius. He was one of the world’s greatest physicists who loved Go-Go Girls (yeah!) and bongo drums–an inspiring 90 minute video on a creative, free-thinker. Lessons for the investor?

http://youtu.be/Fzg1CU8t9nw

Wal-Mart (“WMT”) Case Study

Wal-Mart Case Study on its Stores’ Discount Operations (9-387-018).  Please read the first 112 pages of Competition Demystified in the Value Vault[1]. You will find the above case there. Please describe why you think Wal-Mart has been so successful? Please support your assumptions with data and figures from the case.  Will WMT continue to be successful? How would you determine if WMT will maintain its success.  What about competition? Hint: Sam Walton was a superb entrepreneur and CEO but leave him out of your analysis.  For those who wish to learn more about Wal-Mart and Sam Walton then go here: http://www.amazon.com/Sam-Walton-Made-America/dp/0553562835/ref=sr_1_1?ie=UTF8&qid=1325609378&sr=8-1

You have until Monday of next week to complete this case.  To get yourself in the mood to complete a case study: http://www.youtube.com/watch?v=Y4j25Pj4JyQ and part 2: http://www.youtube.com/watch?v=JJ7aVrtTbg0

Yes, it is lonely and hard work, but you can save $80,000 per year (yes, you don’t receive the MBA credential).

This case will take you a few hours but the effort will be rewarded because you must know the sources of competitive advantage for one of the greatest companies of all-time.

We will begin to review your 112 pages of reading this week plus include other case studies to reinforce concepts.

A blog on investing and competitive analysis from a student of mine and fine investor: http://thefallibleinvestor.com/

Quiz on Economic Thinking

We may have to read Capitalism by Reisman (in VALUE VAULT plus the Study Guide on Capitalism) to deepen our understanding of costs, prices, economies of scale and diminishing marginal utility.

Can someone reply to these questions?

  1. What is inflation?
  2. Do rising wages cause inflation?
  3. Should businesses pay an excess profits tax on the raising of prices of their products if excessive?

Take no more than three minutes.

May 2012 exceed your expectations.

[1] To enter the VALUE VAULT please email me at aldridge56@aol.com with VALUE VAULT in the subject heading.

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Questions from Readers-Emerging Franchises & Fusion Investing

Posted on January 2, 2012 | 9 comments

Questions from a Reader:

Subject: Competition Demystified+Fusion Investing

QUESTION

I am currently reading Bruce Greenwald’s Competition Demystified, and I am not finished. However, I remember asking you before about emerging franchise, and you replied that Prof. Greenwald covered this topic in the book. I would appreciate if you can direct me to this chapter and where he exactly tackles the strategic issue of emerging franchise and company strategic actions.

Answer: Let me be sure we have the same definition for emerging franchise. This would be a franchise in its early to middle stage of (typically rapid)growth like Wal-Mart (WMT) in the early 1970s and 1980s as it grew through local economies of scale on the edges of its local territorial advantage. WMT could earn high returns while also redeploying its capital at the same high  returns (high marginal returns to capital) thus funding its growth and compounding capital at high rates for a 20-year period. No wonder WMT created more millionaires than any other company in history.  Now, of course, WMT can not grow by redeploying its capital at the same rates since it has saturated the US market, and the company does not have unique cost advantages in foreign markets. The first two cases on Wal-Mart and Coors will cover local economies of scale. See pages 77 to 112 of the book, Competition Demystified.

Then you have entrant strategies for a company trying to enter against established incumbents like Kiwi enters the airline industry–see pages 238 to 254. The entrant has to go into niches that are not of interest to the larger incumbents, then build from there. Note the Japanese Car companies entrant strategies into the US auto market–from small, fuel-efficient cars to Lexus! The Japanese took market share from the Americans.

Now if you are thinking of smaller, dominant companies in their niches, you might enjoy reading, Hidden Champions of the 21st Century: Success Strategies of Unknwn World Market Leaders by Hermann Simon (2009)

QUESTION 

  1. What is your take on Fusion investing approach (blending Fundamental (value approach) +Technical + Quant+ behavioral + intermarket ). I noticed some successful money managers who are in the minority adopted this approach successfully over long periods of time. Names like : John Palicka, who this week published his book on fusion investing, John Bolton and Michael Burry).. http://www.amazon.com/Fusion-Analysis-Fundamental-Technical-Risk-Adjusted/dp/0071629386#_

Mr. Palicka is  a CFA and CMT. The value of a CFA designation: http://www.businessweek.com/bschools/content/apr2011/bs20110426_844533.htm

Answer: I don’t know if John Bolton and Michael Burry use technical analysis, but any tool which helps you understand who is on the other side of the trade from you is helpful. If I saw Seth Klarman, Einhorn, and Buffett on the Buy-side against my short position, I would seriously recheck my work or at least find out their reasons for owning the company. You have to respect the other side or else you discover the fool is you.

I am not an expert on technical analysis but I do know that when I traded soybeans and T-Bonds on the trading floor in Chicago (1980s) finding out who the supra-marginal buyer or seller was and then doing the opposite was almost a guarantee of making money at least in the short-term (one hour to three days). The price would rally up for two or three days into long-term resistance and the chart breakout players would come into the market following the price, and I would sell responsively into their demand because the market orders were from small, weaker speculators whom were buying from commercial hedgers. I wanted to be with the strong against the weak.

If you see prices flat-lining for several years, it means that there is little new supply or demand, and people become used to this price level. If there is a breakout to the upside (especially if the marginal cost of production is above average costs), then I would buy on the higher price. There are economic reasons behind the price rise. However, what possible edge can you have (Barriers to Entry?) reading charts since everyone sees the same thing as you do? nGo where you have the biggest edge.

But I do not know in what exact proportions to “fuse” all the different methods.  All I am trying to do is figure out what something is worth and then pay a whole lot less for it. For most companies and for much of the time, I can’t figure it out. But there are certain times when the world goes crazy and prices become extreme then even I can find opportunity.

I can guarantee that too much complexity will hurt your results.  Also, I am extremely skeptical that Mr. Palicka with a CFA, CMT writing a book will provide anything new.  Having a CFA, CMT may not hurt you, but I do believe those designations are neither necessary nor sufficient to help you as an investor. I know that comment may find much disagreement, but I am happy to post such rebuttals in the comments section. At the risk of alienating some readers, I will call it; like I see it–like the umpire says.

I have heard Joel G. explain that despite going to Wharton MBA school, he learned value investing through Graham and Buffett and then his application of those principles.  There is no secret to investing–just relentless application over years with the right framework and independent thinking.

If you want a philosophical background to think for yourself then read, Atlas Shrugged or The Fountainhead by Ayn Rand.

QUESTION

I would also appreciate if you can share your reading list with us.

Do you mean a recommended list or what I am reading now? My current reading list is below. Since I live five blocks from a good research library, I can check out many interesting books on diverse subjects.  Also, I often just skim books.

  1. The Rise and Fall of the Third Reich by William Shirer–with the passage of the expanded “Patriot” Act, the U.S. President can arbitrary detain, torture and execute American citizens without Habeas Corpus and Due Process provided that they are “Terrorists.” How convenient. I don’t like my neighbor because his dog uses my motorcycle like a fire-hydrant.  He makes the perfect terrorist suspect don’t you think? …….So I want to study the lessons of Fascism and totalitarianism.
  2. The Great A&P and The Struggle for Small Business America by Marc Levinson. This books shows that corporate goliaths are not immune to the insistent forces of competition and change. Perhaps I can find a case study here.
  3. The Ikea Edge by Anders Dahlvig. Some people read Wall Street Research, but I find business histories on companies and CEO’s  a great education for studying competitive advantage and how companies evolve–the inevitable ebb and flow of success and failure.
  4. Uprising by George Magnus. Will emerging markets shape or shake the world economy? I have traveled and worked in Brazil, Cuba and other countries. I am not so enthused as the public hype about emerging markets.  Take China–how does a dictatorial regime that is directing the banking sector (similar to the Fed in the US) not go through a massive boom/bust? Brazil’s business regulations require 200,000 pages of fine print. Absurd! No wonder large segments of the economy operate on the black market. Using the best lawyers, we opened a business in Brazil after ten months–ten months of paperwork, delays and denial.

Thanks for the questions.

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Why the Study of Competitive Advantage and HAPPY NEW YEAR

Posted on December 29, 2011 | 6 comments

Life is my college. May I graduate well, and earn some honors.” –Louisa May Alcott, American writer

I will be posting almost exclusively on strategic logic as we study Competition Demystified by Bruce Greenwald (in the Value Vault, see ABOUT, http://csinvesting.org/about/) in early 2012. Now is the time to voice a complaint, comment or suggestion if you have reservations about our impending trek. Understanding financial statement analysis, studying market history and other great investors are all part of your investment journey.  The gap, I see, in the education of many is in understanding competitive advantages. There is no way around studying case studies and thinking hard about the subject.

The most profound effect studying competitive analysis, franchises, and barriers to entry as an investor has been to understand how rare structural competitive advantages really are. And the great businesses that can grow and redeploy capital at high rates are precious and difficult to find. Companies are often non-franchise, asset-type investments that an investor should buy only when there is a huge discount (read: massive disappointment, despair and disgust with the business) between reproduction and earnings power value (See Greenwald Lecture Notes here: http://wp.me/p1PgpH-23). If you are similarly influenced, you will be much more discerning in your investments. You may even invest as Buffett suggests, with a 20-hole punch-card.  Much of your investment life will be spent reading while waiting for the perfect pitch.

BUFFETT

Back to why our study of Competition Demystified is critical. Buffett is a keen student of business franchises as he was tutored by Charlie Munger when they bought See’s Candy.

(Source 1983 Berkshire Annual Report and Letter to Shareholders). Despite the volume problem, See’s strengths are many and important.  In our primary marketing area, the West, our candy is preferred by an enormous margin to that of any competitor (Regional/Local Economies of Scale).

You also alluded to getting a return on the amount of capital invested in the business.
 How do you determine what is the proper price to pay for the business?

Buffett: It is a tough thing to decide but I don’t want to buy into any business I am not terribly sure of. So if I am terribly sure of it, it probably won’t offer incredible returns. Why should something that is essentially a cinch to do well, offer you 40% a year? We don’t have huge returns in mind, but we do have in mind not losing anything. We bought See’s Candy in 1972, See’s Candy was then selling 16 m. pounds of candy at a $1.95 a pound and it was making 2 bits a pound or $4 million pre-tax. We paid $25 million for it—6.25 x pretax or about 10x after tax. It took no capital to speak of. When we looked at that business—basically, my partner, Charlie, and I—we needed to decide if there was some untapped pricing power there. Where that $1.95 box of candy could sell for $2 to $2.25. If it could sell for $2.25 or another $0.30 per pound that was $4.8 on 16 million pounds. Which on a $25 million purchase price was fine. We never hired a consultant in our lives; our idea of consulting was to go out and buy a box of candy and eat it.

See’s Candy

What we did know was that they had share of mind in California. There was something special. Every person in Ca. has something in mind about See’s Candy and overwhelmingly it was favorable. They had taken a box on Valentine’s Day to some girl and she had kissed him. If she slapped him, we would have no business. As long as she kisses him, that is what we want in their minds. See’s Candy means getting kissed. If we can get that in the minds of people, we can raise prices. I bought it in 1972, and every year I have raised prices on Dec. 26th, the day after Christmas, because we sell a lot on Christmas. In fact, we will make $60 million this year. We will make $2 per pound on 30 million pounds. Same business, same formulas, same everything–$60 million bucks and it still doesn’t take any capital.

And we make more money 10 years from now. But of that $60 million, we make $55 million in the three weeks before Christmas. And our company song is: “What a friend we have in Jesus.” (Laughter). It is a good business. Think about it a little. Most people do not buy boxed chocolate to consume themselves, they buy them as gifts—somebody’s birthday or more likely it is a holiday. Valentine’s Day is the single biggest day of the year. Christmas is the biggest season by far. Women buy for Christmas and they plan ahead and buy over a two or three-week period. Men buy on Valentine’s Day. They are driving home; we run ads on the Radio. Guilt, guilt, guilt—guys are veering off the highway right and left. They won’t dare go home without a box of Chocolates by the time we get through with them on our radio ads.  So that Valentine’s Day is the biggest day.

Can you imagine going home on Valentine’s Day—our See’s Candy is now $11 a pound thanks to my brilliance. And let’s say there is candy available at $6 a pound. Do you really want to walk in on Valentine’s Day and hand—she has all these positive images of See’s Candy over the years—and say, “Honey, this year I took the low bid.” And hand her a box of candy. It just isn’t going to work. So in a sense, there is untapped pricing power—it is not price dependent. (Source: Buffett’s 1998 Speech to Univ. of FL Business School Students)

Charlie Munger on the Mental Model of Microeconomics

Strategic logic or microeconomics is one of the mental models that Charlie Munger suggests you know cold.

http://www.tilsonfunds.com/MungerUCSBspeech.pdf

Too Much Emphasis on Macroeconomics

My fourth criticism is that there’s too much emphasis on macroeconomics and not enough on microeconomics. I think this is wrong. It’s like trying to master medicine without knowing anatomy and chemistry. Also, the discipline of microeconomics is a lot of fun. It helps you correctly understand macroeconomics. And it’s a perfect circus to do. In contrast, I don’t think macroeconomics people have all that much fun. For one thing they are often wrong because of extreme complexity in the system they wish to understand.

Case study: Nebraska Furniture Mart’s new store in Kansas City

Let me demonstrate the power of microeconomics by solving a microeconomic problem. One simple problem is this: Berkshire Hathaway just opened a furniture and appliance store in Kansas City [www.nfm.com/store_kansascity.asp]. At the time Berkshire opened it, the largest selling furniture and appliance store in the world was another Berkshire Hathaway store, selling $350 million worth of goods per year. The new store in a strange city opened up selling at the rate of more than $500 million a year. From the day it opened, the 3,200 spaces in the parking lot were full. The women had to wait outside the ladies restroom because the architects didn’t understand biology. (Laughter). It’s hugely successful.

Well, I’ve given you the problem. Now, tell me what explains the runaway success of this new furniture and appliance store, which is outselling everything else in the world? (Pause). Well, let me do it for you. Is this a low-priced store or a high-priced store? (Laughter). It’s not going to have a runaway success in a strange city as a high-priced store. That would take time. Number two, if it’s moving $500 million worth of furniture through it, it’s one hell of a big store, furniture being as bulky as it is. And what does a big store do? It provides a big selection. So what could this possibly be except a low-priced store with a big selection?

But, you may wonder, why wasn’t it done before, preventing its being done first now? Again, the answer just pops into your head: it costs a fortune to open a store this big. So, nobody’s done it before. So, you quickly know the answer. With a few basic concepts, these microeconomic problems that seem hard can be solved much as you put a hot knife through butter. I like such easy ways of thought that are very remunerative. And I suggest that you people should also learn to do microeconomics better.  END.

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You should read the first three chapters of Competition Demystified to explain how Mrs. Bee developed Nebraska Furniture Market’s advantage.  We will review those chapters in the next several posts while delving deeply into minimum efficient scale and economies of scale.

Whether you learn about microeconomics here or elsewhere, it is critical to apply these mental models in your business analysis.

HAPPY NEW YEAR!

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Greatest Company Analysis, Studying Franchises and More………….

Posted on December 20, 2011 | 3 comments

“The average person can’t really trust anybody. They can’t trust a broker, because the broker is interested in churning commissions. They can’t trust a mutual fund, because the mutual fund is interested in gathering a lot of assets and keeping them. And now it’s even worse because even the most sophisticated people have no idea what’s going on.” –Seth Klarman

I’m passionate about wisdom. I’m passionate about accuracy and some kinds of curiosity. Perhaps I have some streak of generosity in my nature and a desire to serve values that transcend my brief life. But maybe I’m just here to show off. Who knows? –Charlie Munger

Best Company Analysis

Several experienced investors (including charlie479) have called the lecture in the link below one of the best company analysis ever done. A Charlie Munger speech about worldly wisdom in solving the problem of building a trillion-dollar business almost from scratch.  http://www.scribd.com/doc/76174254/Munger-s-Analysis-to-Build-a-Trillion-Dollar-Business-From-Scratch

Analysis of a Franchise: Linear Technology

An analysis of Linear Technology’s franchise characteristics: http://www.valueinstitute.org/viewarticle.asp?idIssue=1&idStory=109

Do you agree with the above analysis? The five companies below are considered by some to be franchises. Build a database of franchise companies to eventually purchase at the right price for you. Write down what you think are the sources of competitive advantage. Can you arrive at a ball-park value?  If not now, then set aside for future reference. Note the level of ROIC, operating margins, use of excess capital, growth and investment needed for growth and the history of returns.

Linear:                      LLTC 25 Year    LLTC_VL

Balchem:                  BCPC_35 Year   BCPC_VL

Applied Materials: Charts 35 year AMAT  AMAT_VL

Analog Devices:      ADI_35 Year  ADI_VL

Intel:                         INTC_35 Yr   INTC_VL

Now is the time to dig into the Value Vault and read, Competition Demystified by Bruce Greenwald. A study guide is offered here (Thanks Sid): http://competitiondemystified.com/index.htm

Be the Best

To be the best, you will need to have character, be independent and tough like Joker: http://www.youtube.com/watch?v=gYxEIyNA_mk&feature=related

You will need to develop your skill in understanding and recognizing franchises. Eventually you will show skill like this: http://www.youtube.com/watch?v=HwtMPdMFXQA&feature=related or take it to the hoop like Jordan: http://www.youtube.com/watch?v=U17x7gJ33bY&feature=related

I have never held a ball in my hands, but even I know Jordan is practicing magic not basketball–but, then again, he almost didn’t make his high school team.

 A Good Data Source

Accounting, business studies, and data here: http://mgt.gatech.edu/fac_research/centers_initiatives/finlab/index.html

Freedom vs. Tyranny

A satellite view of tyranny vs. freedom: North vs. South Korea    http://mjperry.blogspot.com/2011/12/legacy-of-n-korean-dictator-kim-jong-il.html

Answer to Economic Question Posed in previous post

The European Central Bank (“ECB”) is offering euro zone banks loans of up to 3 years on Dec. 21 at a rate of 1%. A Wall Street/City of London Whiz can buy Spanish paper at plus 2% on money borrowed from the ECB at 1%. Brilliant! This is going to deluge the Euro zone with money and become extremely bullish for the Euro zone markets and price inflationary.  How else do central bankers know how to deal with a financial crisis. Print.

A viewpoint of America’s involvment in the Euro crisis: http://www.thedailybell.com/3379/Ron-Paul-Beware-the-Coming-Bailouts-of-Europe

Have a good evening.

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