ValuePickr Forum

Finding more businesses like Coca Cola and Sees Candies

(kashif kidwai) #1

My attempt is to find more companies like Coca Cola and Sees Candies at a early stage in their evolution. In this article i have tried to capture characteristics which are common to these businesses as well as some relevant Indian counterparts. Inviting comments and views and criticism from others.

Introduction

In this article, I want to focus on two types of businesses which are terrific businesses in their own right. Coca Cola and Sees Candies are the best examples of the two types of businesses which I would like to discuss. We can refer to these two businesses as standardized product led competitive advantage (or just product led competitive advantage) vs quality led competitive advantage. I chose Coca Cola and Sees Candies because Warren Buffett invested in both of them and doesn’t stop singing praises of these businesses till date. These businesses have made Warren Buffet insanely rich. While many people may not have heard of Sees Candies but it has taught invaluable lessons to WB in terms of moat and business valuation.

My attempt here is to pick out the characteristics of these businesses which make them great and enduring. As a second attempt, I would try to see if there are some Indian companies which have similar characteristics. If there are, then what can we say about these businesses? Will they be as enduring as Coca Cola and Sees Candies? With this background lets get started.

Type 1 business

I refer to Coca Cola-type companies as standard-product companies. Let us try to see what are the common characteristics of business which fall in this category. One thing which stands out is that Coca Cola is a standardized product. One bottle of Coke is exactly the same as any other bottle in terms of its contents. There is something special about companies which manufacture products which are standardized. They do not have to spend their time and energy on a variety of products. They are focused on one or a few products. They devote all their energies to this one or a few products and over a period of time get really well at making the product(s). For example, compare a Jockey with let us say an Arrow. While Jockey manufactures a few designs of innerwear; Arrow has to spend time and effort to come up with new designs almost on a daily basis. Further, manufacturing just one product is relatively simple than manufacturing many different products. Additionally, it is relatively easier for these companies to scale up since they are manufacturing more of the same thing. This gives them an enormous advantage in terms of manufacturing price per product – technically referred to as economies of scale. As these companies scale up, they can reinvest a portion of the surplus funds generated into advertising and further building the brand. As they grow bigger, they have more funds which they can spend on advertising further increasing the strength of their brand. This is like a virtuous cycle and the competitive advantage of these type of companies increases as they grow bigger. Most of these companies build large distribution chains which increase in strength and size as they grow bigger. This becomes another competitive advantage for them. All of these factors reinforce each other and strengthen the business. Given long enough runways, these businesses can continue growing over long periods of time.

Coca Cola is probably the most standardized product I can think of. It possesses all the characteristics listed above. The product possesses such characteristics that its success is a foregone conclusion once it reaches a certain scale. It belongs to a group of companies which in the words of Warren Buffet, even an idiot can run. Its brand power is so strong that even an ineffective management can at the most slightly impair its value but cannot do lasting damage to the business/ brand.

All the characteristics mentioned above can work wonders and produce a lollapalooza effect if the business meets two additional criteria. One, if the product has a long runway of growth ahead of it. Second factor concerns the nature of the product and we need to understand if the product is conducive to building a brand. While the first condition is quite straightforward, let me explain the second condition. Let us take the example of Coke. When people want to buy a Cola, they will be loath to try a local Cola brand over Coke due to various reasons. We can not be sure that the local Cola has been produced in hygienic conditions. We are not familiar with the local Cola and might not like the taste. How can we trust the local Cola? When at the same place we have Coke, which is present everywhere due to its massive distribution advantage. Plus, it is a brand with which we are familiar with and have been drinking for a long time. Because of these reasons which have a lot to do with trust, Cola industry is conducive to building a brand. Charlie Munger has described the power of Coca Cola in a widely read and well known article. If you have not read it till now, please do so here.

Let’s take a second example. Page Industries, the licensee for Jockey brand in India, is one of the most admired companies and stocks in Indian stock markets. It manufactures a standardized product with all the characteristics mentioned above. In terms of demand, it doesn’t take an Einstein to figure out that innerwear has a long runway of growth. But is it conducive to building a brand? Yes. Innerwear is a unique product and has many typical qualities which make it conducive to brand building. It is something which we wear inside our clothes, which is stating the obvious. But it is because of this reason, people care more about the comfort and quality of the product and less about the design or look of their innerwear. Secondly, once people become used to a particular brand, they stick with it for several reasons. We rarely go for shopping exclusively for innerwear. It is something we pick up when we go shopping for clothes. When we go for shopping we want to spend maximum amount of time shopping for products which we can proudly display. As for innerwear, we want to spend as little time as possible. Hence, we go and pick up what we are comfortable with or what we are used to buying. Although there are no switching costs in innerwear but customers because of reasons elaborated above tend to stick with one brand for long periods of time. As we can see that innerwear has certain specific product attribute which make it uniquely suited to building a brand.

Colgate is another product which falls in the same category as Coca Cola and Jockey. It is a standardized product with a long runway for growth. But as is the case with Jockey, despite no visible switching costs customers tend to stick with Colgate. I have been using Colgate for as long as I can remember. But more importantly, I don’t foresee myself switching to another brand. Why are the reasons for customer stickiness? Again there are several factors which combine to produce this result. First, this has to do with oral hygiene and people will not put just anything in their mouth unless they trust it. Colgate has managed to build that trust and brand name over a period of time. Second, price elasticity for the product class is low because it forms a small proportion of our expenditure. Hence, lesser price is unlikely to be a reason for customers to shift to a different brand.

Relaxo is another company which has many although not all the characteristics of type 1 businesses. Relaxo is a manufacturer of footwear in India. In terms of standardization, they are not as standardized as Coca Cola since they have multiple products. On a scale of 1-10, let us assume Coke is a 10, Colgate will be 10 as well, Page Industries is 8, Relaxo is probably a 7. Needless to mention, the runway for their products is very long. Is this product conducive to building a brand? Well, unlike Coca Cola, Colgate and Jockey; a footwear does not have intrinsic property which prevents users from switching to other brands. However, in case of Relaxo the low price of the product prevents switching to other brands to a certain extent. Relaxo is able to maintain lower prices because of economies of scale.

Type 2 business

Let us turn our attention to a different type of business. These are companies which make products of quality which is far superior that that of competitors. As a result, they are able to command a premium pricing for their products and their customers gladly pay the higher price. Additionally, they can increase the prices at a rate higher than the rate of inflation. But quality is not something which is achievable through half measures. These companies are obsessed with quality and would go to extreme lengths to make sure that it is nothing short of extraordinary. Over a period of time, these companies have built a reputation for excellence and trust with the customers. Their customers swear by the products of the company. They buy the product themselves repeatedly but also act as brand ambassadors for the product. They tell their family, friends, and acquaintances about the product.

Sees Candies has all the characteristics of such a business. Warrant Buffett bought Sees Candies in 1972 and in his own words this business taught him a lot about the importance of moats. In Warren Buffett (WB) and Charlie Munger’s (CM) own words:

“WB: It’s one thing to own stock in a Coca-Cola or something, but when you’re actually in the business of making determinations about opening stores and pricing decisions, you learn from it. We have made a lot more money out of See’s than shows from the earnings of See’s, just by the fact that it’s educated me. If we hadn’t bought See’s, we wouldn’t have bought Coke. So thank See’s for the $12 billion. We had the luck to buy the whole business and that taught us a whole lot.”

“CM: We’ve learned that the ways you think and operate must involve time-tested values. Those lessons have made us buy more wisely elsewhere and make many decisions a lot better. So we’ve gained enormously from our relationship with See’s.”

See’s has an obsession or fanaticism about quality. They have a loyal set of customers who have come to trust them over long period of time. In the words of Charlie Munger, while speaking at a See’s company event.

“And of course the fanaticism about the quality of the product and service is at the heart and soul of business. I love the fact that this room is full of long time customers and long time suppliers. You get suppliers who are good and who are trusted because they deserve trust, and you behave the same way toward your own customer, then you are a little part of a civilization that is a seamless web of deserved trust. That is the way the world ought to work. It is a better example for everyone else. It is a right way to build a state or a civilization. It was just marvelous for us to become associated relatively early in our business careers with a culture that was so fundamentally sound. It is Ben Franklin (or his business philosophy) all over again, alive and well at See’s after all these years.”

The obsession with quality leads to pricing power, the holy grail in the world of business. Here we have Warren and Charlie talking about the importance of pricing power and See’s.

“The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.”

CM: “There are actually businesses, that you will find a few times in a lifetime, where any manager could raise the return enormously just by raising prices—and yet they haven’t done it. So they have huge untapped pricing power that they’re not using. That is the ultimate no-brainer. Disney found that it could raise those prices a lot and the attendance stayed right up. So a lot of the great record of Eisner and Wells came from just raising prices at Disneyland and Disneyworld and through video cassette sales of classic animated movies. At Berkshire Hathaway, Warren and I raised the prices of See’s Candy a little faster than others might have.”

WB: “We bought See’s Candy in 1972, See’s Candy was then selling 16 million 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.”

All this has established See’s as a solid brand name in the state of California. We all know and have seen the power of brands. Here is WB talking about the power of brands in connection with See’s business.

“Buy commodities, sell brands has long been a formula for business success. It has produced enormous and sustained profits for Coca-Cola since 1886 and Wrigley since 1891. On a smaller scale, we have enjoyed good fortune with this approach at See’s Candy since we purchased it 40 years ago.” “When we bought See’s Candies, we didn’t know the power of a good brand. Over time we just discovered that we could raise prices 10% a year and no one cared. Learning that changed Berkshire. It was really important.” “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.” “What we did know was that they had share of mind in California. There was something special. Every person in California 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.”

All of this was achieved with limited volume growth. There are two engines for propelling the growth of any businesss; one – volume growth and second – price increase. See’s did not have a long runway of growth so all its growth has been achieved with only one engine of price increase.

“The boxed-chocolates industry in which it operates is unexciting: Per-capita consumption in the U.S. is extremely low and doesn’t grow. Many once-important brands have disappeared, and only three companies have earned more than token profits over the last forty years. Indeed, I believe that See’s, though it obtains the bulk of its revenues from only a few states, accounts for nearly half of the entire industry’s earnings.”

“See’s sold 16 million pounds of candy in 1972. In 2007, it sold 31 million pounds. That’s a growth rate of about 2% annually. Yet the business created tremendous value. How? Because it generated high returns on invested capital and required little incremental investment. Growth creates value only when a business can invest at incremental returns higher than its cost of capital. The higher return a business can earn on its capital, the more cash it can produce, the more Value is created. Over time, it is hard for investors to earn returns that are much higher than the underlying business’ return on invested capital.”

Another company which immediately comes to mind and which is pretty high on the quality bandwagon is Apple. The growth of Apple has been phenomenal. The reason is that for Apple, both engines of growth, volume and price increase have fired simultaneously. However, Apple is a well known and much discussed brand and hence I will not delve into the details and will leave it at this.

Coming to India, which are the companies that come to mind when we talk about quality. Some companies which are really fanatic about quality which I can think of include – Hawkins, Ambika Cotton, and Oberoi Realty.

Hawkins is the manufacturer of cookware with a focus on pressure cookers. Hawkins is a company which is fanatical about the quality of its products. They spend considerable amount of time in bringing any new product to market. Even if it means that they are almost never the first to introduce a new product. They have never shied away from sacrificing profitability in the short term for the long term benefit of the company. The customers of Hawkins are loyal and love their products. They are willing to pay a premium price for its products. As a result, the return on equity of Hawkins has averaged an astounding 71% over the last 10 years. Such a return in a boring cookware industry is unheard of.

Ambika Cotton manufactures cotton yarn which is a used for the manufacturing of garments. Ambika produces the highest quality yarn which mostly goes in making premium work shirts. They use the highest quality PIMA cotton from the US or Giza cotton from Egypt for producing the yarn. They import more than 60% of the raw material requirements which is cotton. Their competitor on the other hand import around 20% of their raw material requirements. Because of the excellent quality of the raw material and manufacturing prowess, the yarn produced by Ambika is valued highly by its customers for its quality. The garments produced by the yarn are incredibly softer and stronger than the garments produced by average quality yarn. The customers are willing to pay a premium for the yarn, which sells at a premium of 40% or more to that of its competitors.

Oberoi Realty is a real estate developer focused on Mumbai market. Oberoi is an excellent developer and has a lot of credibility among the customers which they have built through good quality product and seamless delivery over a long period. It is because of the quality of their product and the trust that they managed to build with their customers that their houses sell like hot cakes. They are unique amongst real estate developers in India in that they require minimal external funding either in the form of equity or debt for their business. That is because their customers are willing to fund their operations through advances.

You will notice that I have focused on the quality of the business. I have not talked about valuation. All the three businesses I discussed above are run by excellent management teams. Not only do they have extreme focus on their business and customers, but equally all of them run their business with a lot of integrity. All of them take nominal salaries from the company. All of them own more than 50% of their companies and hence a majority of their compensation comes from the dividends just like other minority shareholders. They are all focused on building sustainable businesses.

Conclusion

I have talked about the two types of businesses separately. However, many businesses will have characteristics of both. For example, Apple – while it firmly belongs to type 2 business because of its premium pricing. At the same time, it has similarities to type 1 businesses as well.

Which of the two businesses is more predictable? While it depends on the individual business but in general, I think type 1 businesses are more predictable. These are generally businesses producing a boring (not necessarily) product. All they have to do is to generate more demand and produce more of the same product. Whereas type 2 business are all about product quality. And quality is always under attack both from inside as well as outside the company. From the inside there is always the risk of mistakes and lapses in quality. From the outside, others are always in pursuit of the premium pricing and attempt to match or exceed the product quality. These businesses have to be on their guard always like Ninjas.

The holy grail of investing is to find a type 1 business which is selling just one product like Coke or Colgate. If we are able to find such a company relatively early in its lifecycle, we can sit on our asses and let compounding do its magic. However, it is incredibly difficult to find great ideas such as this. One of the reasons of writing the post was to invite comments from others who might have found something and are willing to share their ideas.

23 Likes
(Abhishek Basumallick) #2

The problem with this type of theoretical business analysis is that it does not account for mean reversion of a business. Coke, for example, has been in a bit of trouble the last few years due to the growing healthy eating culture. It can be very easily seen in the share price which has lagged significantly even the S&P 500 over the last 5 years.

I think the holy grail is in trying NOT to pigeon hole companies into types and get bogged down by them. Keeping an open mind and keeping on looking at how businesses are transforming themselves ( and they always are, either by acts of omission or commission) and then decide on a case-by-case basis.

6 Likes
(kashif kidwai) #3

I agree with you and I myself try to evaluate each business in a bottoms up approach and on its own merits. However looking for similar patterns and proven business models can be helpful. Of course, we analyse the business from different perspectives and do thorough research like we do for any business. This is just one additional perspective or angle from which we can look at the business. May be it fires our imagination and gives us more food for thought and broadens our horizons.

Just as an example, let me take the case of Ambika Cotton. I think one of the major concerns with Ambika has been the limited runway for growth. But can it be like Sees Candies which turned out to be a wonderful investment despite 2% CAGR volume growth during 1972-2007? I don’t know but it is worth reflecting.

2 Likes
(Abhishek Basumallick) #4

In my opinion, it is is not really beneficial to compare See’s Candy with Ambika Cotton. The two are completely different types of businesses, in two completely separate industries which have nothing in common. In fact, See’s candy is also not that great a business (not stock, I am talking about the core business being mediocre) as it is made out to be. As a chocolate and candy brand, it has failed in expanding beyond the California borders even after multiple attempts. So, it is at best a regional FMCG player with good base economics. The beauty of the stock like See’s is the amount of free cash flow, which Buffett has been able to channelize into more profitable businesses.

6 Likes
(KAMAL GARG) #5

I think there is whole set of confusion over what is “quality”, what is the “brand value” , what is “strategic strength” and what is “core competence”.
Producing same product constantly with same quality standard at a lower cost is a core competence and not a “strategic strength”. Life is made out to be simple but never simple. However, in Indian context, examples given of Hawkins, Ambika Cotton and Oberoi Realty are well taken. Hawkins and Oberoi Realty are into B2C business whereas Ambika Cotton is mostly into B2B business. All these things have different characteristics and requires different solutions for different problems and understanding of the problems.
Coca Cola’s strength is definitely not “producing same product consistently at same quality”. The core strength of Coca Cola is extreme brand value. You please see, what they sell at the end of the day. They simply “sweetened carbonated water” and nothing more. Similarly Colgate is definitely not a “same product at same quality”. It is nothing but brand power.
It is strange that WB is saying that he has made more money out of the investment rather than company earning money.

(phreak) #6

Very good opening post and I was thinking of what you are calling as Type 2 businesses and their pricing power today. Can a company abuse its pricing power to such an extent that it loses customers for good? iPhone has pushed past $1000 and the macbook pro line is priced way too expensive for what it offers. iPhone still offers cheap signaling (ah the irony) and could still continue being purchased as a vanity product but the idea of Apple products was mainly about utility done phenomenally well that there was value in it because of the longevity and also peace of mind due to AppleCare.

At present though, they are rolling back excellent innovation (magsafe gone from mbp lineup), having a pigheaded focus on the “thinness” metric to produce keyboards that are complete duds to type on, throttling CPUs so they can fit in that thin chassis without frying your thighs, cutting down ports and so on. AppleCare in India is a complete joke as well at present. I remember how well this worked 10 years back.

So many power users who have loved the mbp lineup since inception (I still remember by 2006 first mbp with an intel chip) are now moving away from the ecosystem. A bulk of the programmers moved into this ecosystem in the last 5 years because it was absolute no nonsense hardware and OS X was a joy to work with (still is). Are they going to still stay in this ecosystem when its time to upgrade?

I think Apple as a company has completely lost focus and Microsoft has taken the innovation baton well and truly from Apple in the last 3 years - look at the Surface line-up of products for eg. The same thing has happened with Intel as well, with AMD’s Ryzen being a superior performance chip for the price. When companies attain monopoly position and focus solely on pricing power, they tend to completely lose the plot, and hence the position.

2 Likes
#7

Any such examples that you can give for non-technical companies in India? Companies which ruled for sometime and focused solely on pricing power instead of holding on to the position they are in but went down and never recovered and fell down but triumphed again.

It would helpful for investors like us who sometimes blindly believe in the growth story and are willing to pay top dollar thinking nothing can wrong but the management loses focus and the story vanishes sooner than later.

(phreak) #8

Honda is a company that immediately comes to mind. Honda cars were known for quality, performance and reliability. They abused this position and continuously cut sheet metal thickness (build quality suffered too) in their cars - mainly the City line and tried milking customers with the brand value and pricing power. If I remember right they were #2 after Maruti in terms of sales and are currently at #5 after Hyundai, Mahindra and Tata.

2 Likes
#9

No way, you could cheat people like that, even people who have easy-money would not pay good price for inferior products. If quality deteriorates and price remains the same increases, no one in their right mind will be a buyer. One product may may fail and loyal customers may not mind but not the diminishing quality. And I guess when you lose such customer base, it is hard to gain the back unless some innovation happens.

Any example, where a company might have experimented and it backfired, so quickly resorted to their original quality? And could you name some companies where you are fairly confident that the management will not resort to such steps and always provide high quality despite losing some market share? Does Bata fit the bill?

(kashif kidwai) #10

Thanks @phreakv6 for reviving this thread. My thinking on this has changed somewhat since i wrote that post. I’m looking for companies which will increase their competitive advantage with time, quite like a fine whisky. There are mental models which we can use to identify such companies.

One of them is anti-fragile businesses, which is a model i learned from the book Anti-fragile by Nassem Nicholas Taleb. I wrote about it - here
The second is monopoly model which i learned from the book Zero to One by Peter Thiel. You can find my review of the book - here
The third is behavioral advantage for companies, ie identifying companies where customer behavior does not change much with time due to various reasons.
The fourth is the the technology model which i learned from Masayoshi Son. This refers to companies for which technology will act as a huge tailwind in the future. You can read an interesting article about it - here

In monopoly model the product is 10x better than the competition. It could be on a combination of parameters including performance, design, social signaling, etc. Google clearly belongs here. Apple has some aspects of monopoly business. The product may have been 10x better in the past but that is changing with more competition. In my view and this is subjective, Eicher belongs here, although this may change with the introduction of Java.

Today i would put Coca Cola, Page, Colgate, type of companies in the behavioral model. Another company which I will add to this group is UBL. I can see all these companies will be present and growing not only 10 but even 20 years from today. Maybe not Coke because there the behavior is gradually changing because of health reasons.

For the fourth category, there are not many companies in India with technology advantage. But I’m thinking that Bajaj Finance could be one of these.

5 Likes
(Bhaskar Bora) #11

Bajaj Finance is doing great because of networking effects

Big moat built by building good customer base where they can keep selling new products n also more loans

(Zero Point Someone) #12

One company which has eluded radar of analysts in Tata Global Beverages. It has good amount of brands and international exposure. Starbucks India venture is icing on the cake.