Warren Buffett distinguishes between commodity companies and non-commodity companies.
Commodity companies sell products or services that are indistinguishable from the products and services of other companies. Here the customer generally buys on price.
Take soap, for example. Different companies sell soap but their ordinary product is generally the same. The customer will buy from habit or personal choice but can swiftly change brands where there is a price advantage.
This makes the seller vulnerable to the trading practices of competitors and it has a limited ability to increase profits by raising prices. To stay alive, it must respond to its competitors.
Warren Buffett on commodity companies
In 1982, Warren Buffett said this about commodity companies, particularly those in industries that have surplus capacity:
‘Businesses in industries with both substantial over-capacity and a "commodity" product (undifferentiated in any customer-important way by factors such as performance, appearance, service support etc) are prime candidates for profit troubles.’
Other companies produce a product or service that is so different from its competitors, or so special, that the customer, and the distributor, cannot do without it. This allows the company what Mary Buffett and David Clark call a "continuing competitive advantage". They liken a competitive advantage to a moat surrounding a castle. The moat stops enemies attacking the castle; the brand name stops competitors taking away customers.
Having a brand name is not enough. The brand name, according to Mary Buffett and David Clark, must be lasting – it will go on into the foreseeable future without costly maintenance. There is no real competition for the product. This is a sustainable brand name.
The Coke brand name
A good example of a continuing competitive advantage of this kind is Coca Cola. The customer generally asks for a Coke by name; they do not buy a ‘cola’. Coca Cola is a long time investment of Berkshire Hathaway and one that Warren Buffet has constantly said is never for sale.
Some companies can obtain a continuing competitive advantage by having a monopoly, or being part of a marketing structure that operates as a monopoly. A good example of this is Freddie Mac, The Federal Home Loan Mortgage Corporation, established by Congress to buy and securitize mortgages, reselling them to investors as guaranteed mortgage pass-through certificates. This was an earlier investment of Warren Buffett.
Brand name companies
There are also some companies that market commodity products so well that they distinguish their commodity product from that of their competitors and so put their own special ‘brand’ upon their product. They can achieve this by marketing, continuous improvement, by quality production and service, or in many other ways.
McDonalds sells hamburgers and, if truth be known, their hamburgers are no better than those of their competitors. McDonalds has made itself a brand name primarily through marketing, uniformity of product, and accessibility.
Gillette sells razor blades, not a unique product. It has become dominant in the market, and a brand name, because it markets itself well, continually improves its product – track the progress of the shaving tool) – and its products are reliable.
Warren Buffett on competitive advantage
In 1993, Warren Buffett had this to say about companies with a continuing competitive advantage:
‘Is it really so difficult to conclude that Coca Cola and Gillette possess far less business risk over the long term than, say, any computer company or retailer? Worldwide, Coke sells about 44 % of all soft drinks, and Gillette has more than a 60% share (in value) of the blade market.’ Leaving aside chewing gum, in which Wrigley is dominant, I know of no other significant businesses in which the leading company has long enjoyed such global power.’
Brand name advantages
Time, of course, has moved on since 1993 – market shares change and, arguably, computer companies may have entered the brand name field (for example, Microsoft). However, Warren Buffet’s point is that there are big advantages in having a brand name like Coke, or Gillette:
- The customer knows the name and the product that the name represents
- Distributors have to stock the product (can you imagine a supermarket without Coke)
- The company can keep pace with inflation (or even jump ahead of it) with price rises;
The competitive advantage of a brand name company is also enhanced if the product needs continual replacement; food and beverages, razor blades, newspapers.
A brand name in itself is no guarantee of investment success. Conversely, a company can be successful without having a brand name.
What makes a good brand name: http://www.ecommercetimes.com/perl/story/9396.html