Types of businesses

Finding suitable companies to invest

In the sea of companies that is the stock market, one often times finds it hard to know where to start looking when wanting to invest. In my opinion, one should look at those companies that one is already familiar with, that one uses on a regular basis or knows that their friends or family also consume these brands on a regular basis. This is because companies of this sort are likely to take up a huge market share in their respective industries and likely have effective marketing and advertising campaigns. These brands are superb because they are deeply entrenched in the consumer’s mind when making a purchasing decision. The brand awareness of these companies could also be so strong that we tend to associate certain product categories with these brands. For instance, when you think of chocolate drinks, you think of Milo; when you think of fast food, you think of Mc Donalds or KFC; when you think of plastic containers, you think about Tupperware; when you think about soft drinks, you think about Coca Cola.

Once you have identified what sort of business you want to start researching about, you should first think about what type of business it is. Warren Buffett categorises businesses/industries into two separate types:

Consumer Monopolies

Consumer Monopolies are companies that have a unique product or service that the public constantly demands which can only be purchased from the specific company. Think of it as a toll bridge, and the only way to get across to the other side is through the toll bridge. The owners of these tolls can in return reap wonderful rewards from this sort of monopoly. Not only that, but the types of brands should be the sort that every retailer will offer, otherwise they will fear about of losing out on business. Go to any convenient store, and I’m sure you can recognise a few brands that every convenient store offers. These consumer monopolies have great economics in place, which always them to maintain high gross profit margins as there is no intense competition since they are the only supplier of these products. They also have low R&D cost as they already have a successful product and can mainly focus on advertising. This will in turn lead to high net profits, which will give great dividends to investors in these wonderful businesses.

But consumer monopolies must also have other strong suits in order to succeed. Michael Bloomberg, founder of the multibillion dollar company with his namesake stated in his phD studies that successful consumer monopolies also possess these few criterias:

a) convenient location, courteous employees, prompt deliveries and satisfactory products (to build goodwill among consumers)

b) persistent and alluring advertisement (to keep the brand on the consumer’s mind)

c) possess secret processes/patents (to supply unique products)

Commodity Type Businesses

Commodity type businesses are businesses that do not offer a unique product or service and the public can purchase from other companies to get the same product or service. In this case, the only driving factor of beating competition is through pricing rather than through brand loyalty. Such competition will lead to intense competition between companies in this industry and will lead to commodity type businesses lowering profit margins in order to make their prices seem more attractive. These companies will also have high R&D cost as they would want to invest heavily into developing cheaper and cheaper manufacturing processes to outcompete their rivals. Even if a company acquires such manufacturing improvements, their competitors are likely to follow up with the change so the company will not be able to gain a permanent advantage. These types of business will also be solely dependent on the management skills to gain an edge of their competitors. They would require management of high quality and intelligence to cut cost and create a profitable venture. But no good management is permanent, if the company fails to acquire such management, the company would quickly fall into calamity. Such examples include IBM whose incompetent management lead them to steadily fall out of the competitive technology sector. IBM’s disastrous policy to neglect R&D which is crucial in the technology sector will haunt them for eternity. In contrast, consumer monopolies have such economic strength that even a fool can run it. Therefore commodity type businesses will often lead to low net profits, and will obviously not be as an attractive investment as consumer monopolies.

Such industries may include but are not limited to:
a) airlines
b) steel producers
c) gas and oil companies
d) lumber companies
e) paper manufacturers
f) producers of foodstuff (rice, corn, etc)
g) automobile manufacturers

An exception to this could be consistent low cost buyers and sellers products. Companies of this sort will be able to beat competition in terms of prices while at the same time maintaining a handsome profit margin. The key is to be able to acquire products at the lowest cost possible. Companies such as Costco and Wallmart are able to do this by purchasing products in extremely large bulks. This gives them significant negotiating power in terms of pricing, so they are able to acquire products for relatively cheap prices.