Chapter 5
Amazon reported $236 billion in North American
sales in its 2020 annual report; if you Google “U.S. retail sales 2020,” you will find that the National Retail Federation
reports that total U.S. revenues were $4.1 trillion. Canada’s analogous site says that its retail sales were
$600 billion, for a total of $4.7 trillion in North American retail sales.
Amazon’s $236 billion in sales divided
by $4.7 trillion = 5% market share.
As Buffett said in Fortune,
rapid growth does not equal an edge, and conflating the two is a common
mistake that both momentum and growth investors make. It’s also one of the principal reasons these strategies
tend to underperform.
Buffett’s dictum, “Never confuse a growth industry with a profitable one.” You should be especially mindful of this warning if you’re thinking about investing in a tech hardware company: hardware is much more easily imitated than software
敘述美國航空業生態
Exposed to the same favorable tailwind of rising
worldwide air travel that HEICO, Disney, and American Express enjoy, passenger
airlines have nevertheless lost more money over their hundred-year history than
they’ve made. Why? Because Delta, United, and the rest never gained a real
edge over one another. None of the airlines
possess a compelling brand, and none operate
at a consistently lower cost than the competition. Lumped together in
mediocrity, the airlines have done what all average businesses do: compete to
serve the customer and give nearly all the gains to them. Occasionally, the
airline industry turns a profit, and occasionally the story that “this time it’s different” makes its
way around Wall Street. Every time, however, the airlines begin to compete on
price again, and profits again go in the tank. As is so often the case, the
ultimate winner is the consumer.
Even though they’re household names, Delta, American, and United have
all gone bankrupt at least once in their history. HEICO, meanwhile, an obscure niche of the airline works in business
but has grown its stock price five hundred–fold over the last generation.
How can that be? Through a
low-cost advantage, one of the oldest moats around.
Most tech companies, at least those powered by software, do not derive their competitive advantage from being a low-cost producer. Google and Orbitz don’t give you the cheapest plane fare from New York to Cancún; it leaves that to the airlines. Tech companies’ moats spring from phenomena like first-mover advantage and network effects, which we’ll explore later in the chapter
Understanding this, Buffett bought Coke stock in 1988, and he continues to hold the shares more than thirty years later. “Coca-Cola is associated with people being happy around the world,” he told students at the University of Florida in 1998. “You tell me that I am going to do that with RC Cola around the world and have five billion people have a favorable image in their mind about RC Cola, you can’t get it done. You can fool around, you can do what you want to do. You can have price discounts on weekends. But you are not going to touch it. That is what you want to have in a business. That is the moat.
A low-cost commodity business can continue to lower prices and widen its moat, but brand companies have no such levers to pull. Like Blanche DuBois, they rely on the kindness of strangers.
The Honest Company, founded a decade ago by actress Jessica Alba. New companies are using channels like TikTok and YouTube to scale up and challenge legacy brands with astonishing rapidity and ease
A tech company’s brand power, however, is
arguably much stronger than one that relies on fads or consumer tastes. Google
isn’t
marketing a status symbol or a fizzy drink; it’s marketing a
reliable search engine that consumers have become habituated to in their daily
lives.
Because a tech company’s brand has nothing to do with creating desire, it’s more likely to endure. As
long as a software company continues to deliver
value to its customers, it can rely on actual experience rather than perception
to sustain its hold on consumers. “We hold as
axiomatic that customers are perceptive and smart,”
When a company becomes the trusted, go-to
application for search, e-commerce, social media, or any of the other new
industries that have been born in the last generation, consumers tend to
gravitate 傾項選擇 toward it en
masse.
Many digital enterprises want to become platform
companies for the same reason banks want to sell you multiple financial
products: the deeper a company gets its hooks into you, the harder it is for
you to leave. In business school parlance, the switching
costs are high, and these switching costs constitute a corollary competitive
advantage to becoming a platform company.
So many people are accustomed to using Microsoft’s Word and Excel, and have archived so many
documents in both, that changing would cause months of agony. Anytime you spot
this kind of sticky relationship between company and consumer, your antennae
should go up. Like a brand, switching costs bind a consumer to a product—but, like a low-cost position, switching costs are more substantive than brands.
Customers hate to change once they’re comfortable
with a product.
Once customers get used to a product, the drawbridge over the moat goes up, and it’s fair to say
that the drawbridge is up in any number of digital sectors today. Whether it’s Apple with mobile phones, Google in search, or
Intuit in small-business accounting software, tech has gone through its early
dot-com spasm and reached what innovation scholar Carlota Perez calls a “bedding-in” period. Consumers have now become so accustomed to tech
applications they like and trust that this cozy relationship will prove very,
very hard to disrupt. This is true even when actual switching costs aren’t high. It’s not hard
for people to change from Google to Bing—but the psychic switching costs are huge. People are
used to Google, and it works. Why would they switch?
In times of slow technological progress and change,
being the first mover is often enough to establish a durable competitive edge.
During the Great Depression, a 3M engineer named Richard Drew invented Scotch
Tape. Despite its enormous mass-market potential, innovation was so feeble
after the crash that no company tried to imitate and improve upon 3M’s product. With no
competition, Scotch Tape remained the market leader even though 3M made no
material improvements to the product for more than thirty years.
Can you imagine a modern company creating a new
product, leaving it unimproved for more than a generation, and remaining the
market leader? In today’s economy, a
company that doesn’t
continually innovate won’t
stay on top for thirty months, let alone thirty years. This is
especially true since the advent of the Digital Age, when the pace of change is
brutally fast. In times of technological transformation, speed and innovation
matter much more than in times of stasis. That’s why Mark Zuckerberg’s motto has been to move fast and break things, and
it’s why Elon Musk has adopted a
launch-first, upgrade-later business model for both Tesla, his electric vehicle
company, and SpaceX, his rocket company.
For this reason, “first-mover advantage” is perhaps better described as “fast mover
advantage.” HEICO wasn’t the first to make generic airplane spare parts,
but the Mendelsons were the first ones to act urgently on the opportunity.
you should be careful not to rely on a first- or
fast-mover advantage to sustain your investment thesis. Being the first mover may establish a competitive advantage, but it
will never perpetuate one. HEICO, GEICO, Amazon, and others have all
established secondary advantages—a
low-cost position, a trusted brand, an extensive distribution network—to supplement their first- or fast-mover advantage.
Although Musk pooh-poohs moats, he has used Tesla’s early lead in
electric vehicles to build not only customer loyalty but also a low-cost
position as well
Network effects
Venmo, which is owned by PayPal, is a great example
of a company that enjoys network effects. A decade or so ago, Venmo moved
fast to build technology that allowed people to access their bank accounts from
their smartphones and quickly pay one another. Somehow, Venmo developed a loyal initial following, a nucleus that
began to exert a gravitational pull on others. The more people joined,
the more it encouraged others to join. I got the app after enough friends said “Venmo me” when we were
splitting a restaurant bill or settling up Yankees tickets.
The old-fashioned term for network effects is “virtuous circle,” although tech people prefer to call it “the flywheel effect.” A flywheel is a circular device that dates back to
the Stone Age. It was used as the driver of the earliest water-powered mills
and then later refined for the steam engines of the Industrial Age. A flywheel
is heavy, so it’s difficult
to get it going, but once it begins to spin, the flywheel is equally difficult
to stop. “Each turn of the flywheel
builds upon work done earlier, compounding your investment of effort,” business author Jim Collins writes. “A thousand times faster, then ten thousand, then
a hundred thousand. The huge heavy disk flies forward, with almost unstoppable
momentum.”
Note: this exponentially higher value of digital
networks is merely a theoretical construct. Like John Burr Williams’s theory of discounted cash flow, we can’t use Metcalfe’s law to value digital companies. However, the law
highlights the immense value of the new businesses born in the Digital Age.
Even Metcalfe’s law doesn’t fully
capture the power of digital networks, because the calculation doesn’t account for the fact that
Facebook, Google, and similar businesses spent almost no money to build them
out. Tech platforms are unique in history thanks to their global reach,
but they are unique in another important respect:
their networks run on infrastructure built and paid for by someone else.
Unlike Britain’s early network of industrial waterways, tech software companies didn’t have to spend
billions to dig canals; tech hardware companies did that for them, competing
against one another to make ever more powerful routers and long-haul internet
connections. Unlike a telephone network, tech networks were not
required to string wires and cables up and down mountains and over river
gorges. Those wires already existed—and when they
didn’t, phone companies like
AT&T and Verizon built expensive wireless networks to supplement them. Hardware companies like Cisco, Alcatel, and Lucent have
made tremendous contributions to human progress by manufacturing the gear
essential to such networks, but because these businesses produced
commodities—wires, routers, and so on—their shareholders were never rewarded. Most of the
value of the network we call the internet accrued to the software companies
that made it easy to search, shop, chat, and perform other important functions
online.
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