In MBA lingo, consultants use the expression of “sustainable competitive advantage”. The less polished (like me) substitutes “unfair” for “sustainable”. Warren Buffett emphasizes the word “franchise”. When used in the context of Microsoft and Buffett’s billionaire best buddy, “monopoly” is used. The business expression “barriers to entry” conjures up a structural blockade, such as the walls of a castle, that keep the less advantaged from enjoying what the favored are trying to protect. The concept has many powerful descriptors because it is one of the most important keys to long term value creation.
Out of respect for Mr. Buffett (and because it is easier to write one word instead of three), franchise is the expression I will use. Franchise refers to the unique attributes and capabilities that a particular business enjoys which improves the likelihood it will generate better returns than its competitors. All things being equal, the company with a stronger franchise will prevail. They are more likely to find opportunities to earn excess returns for their investors. A strong franchise, Buffett stresses, also makes future cash flow streams more predictable. As we discussed in an earlier blog entry, predictable cash flows lead to making investment, rather than speculative, decisions.
A franchise can take many forms. A power brand identity, like Nike or Kraft, is one. Everyone know what a Kit Kat bar is and most people see it as a tasty treat. Feb Ex and UPS have vast distribution networks. ADT = security. Comcast has a coax cable attached to millions of homes. DOS/Windows made Gates a billionaire and earned his company the reputation of a monopolist. Wireless spectrum is a limited commodity—if you have a lot of it, you can pursue business opportunities that very few others can even contemplate. Warren Buffett places great importance in maintaining Berkshire’s reputation as a much better buyer of your business than a strategic buyer (who will gobble you up) or a private equity firm (who will chew you up alive).
Franchises provide an unfair edge. Nearly all businesses that do well for their investors over the long term have a strong franchise. It is much more likely that a business will have predictable cash flows if it has a franchise. In the next blog, we will continue the discussion of franchises.
Leave a response (0 so far)
Subscribe via RSS
