competition lecture

Competition and Firm Strategy

Chuck EesleyMorgenthaler Faculty Fellow

Assistant ProfessorStanford University

Management Science & EngineeringSchool of Engineering

cee@stanford.edu

How to be a Monopoly 101(building a company Warren

Buffett would invest in)

Bio

Excellent businesses

• What are some examples?

• What makes them excellent?

– In small groups of 3– 5-10 minutes

What is a competitive advantage?

Competitive advantage = barriers to entry

With no barriers, must constantly run firm as efficiently as possible

Competitive advantage

• Definition: Something a firm can do that its rivals cannot.

Examples• Moutai vs. Tsingdao• Sina Weibo QQ Tencent• Ebay Alibaba• Shanghai Jahwa vs. P&G\• Baidu Google• Whirlpool Qingdao Haier• Hanergy Traditional Energy - solar overcapacity• Guangxi Wuzhou Zhongheng Group vs. Pharma firms• YY vs. Google Hangouts• BYD?• Apple vs. Xiaomi

– Brand vs. low-cost

Traditional View

• Porter’s Five Forces• Long-term, durable competitive advantage• Manufacturing-based• Efficiency-based investments in manufacturing• Use of capital – quote about profits being all

the inventory/equipment vs. cash

Barriers to Entry/Growth

• In markets without barriers, competition is intense!

• Loss of traditional sources of competitive advantage– Low cost labor– Protected markets– Government ties (anti-corruption campaign)

Sources of Competitive Advantage

Monopoly• Government ties (关系 )• Cost advantage (Chinese manufacturing)• Regulations (Energy, Pharma)• Capital intensive industry• Brand (Coca-Cola)• Network effects (Microsoft Office)– 2-sided networks (Ebay, Facebook, Google, Media

companies)

• It is better to buy a wonderful business at a fair price than a fair business at a wonderful price.– Warren Buffett

Categories• Demand competitive advantages– Unequal access to customers– Customer captivity– Search costs– Switching costs– Government support/protection

• Cost (supply) competitive advantages– Superior technology– Patents– Larger scale + declining marginal costs– Special access to information

Competition with Barriers to Entry?

• With barriers to entry is life necessarily all good?– Airlines– Automobiles– Banking

• Avoiding competition that leaves every participant worse off is an especially enlightened choice – one that deserves to be called “strategic”.

Sketch of current macro-economic situation

• Export/import deficits• Chinese over-capacity in manufacturing• US over-spending

New View

• Series of short-term competitive advantages– Could be based on technology, but not necessary

• All strategy is local– Focus on Niche-markets – difficult to dominate global markets

• Services-based, retail – focus on one geography– Wal-mart, Grocery stores, Universities

• Manufacturing-based – focus on one niche product– Cannot dominate global automobiles in general– Intel – only chips– Nokia Apple Xiaomi?

Sources of competition

• Domestic competitors, same industry– Former employees

• Foreign low-cost competition (Africa)• Neighboring industry competitors (TV/Radio)• New industry competitors– AT&T VOIP– Hotels Airbnb– Taxi Uber– Newspapers/TV Social Media)

Adjacent markets

• Perilous to chase growth across borders• Dominate a set of discrete, contiguous

markets, expand only at the edges• Example of over-expansion Wal-Mart

How to get from here to there? (Tactics)

• New market, same product• New product, same market• Not a bad idea to date before marriage– Internal venturing (intra-preneurship)– Corporate Venture Capital– Joint Venture– Alliances– Investments in VC– Acquisitions

Circle of Competence

• Know the boundaries and push them slowly• Industry– Diversification typically hurts performance

• Geography– Wal-mart, Verizon

• Product– Apple, Microsoft, Intel

• Mode of entrepreneurship/investment– If you have no experience with joint ventures or

acquisitions, tread slowly with the first few

Internal Venturing

• Great option when it works• Fighting a war on two fronts sometimes

Corporate Venture Capital

• Tough to get right and maintain

The Intangible Element

• Strategy must be executed faithfully

• This is why company culture is so important

• It is also difficult to change

Trust

• The highest form that civilization can reach is a seamless web of deserved trust – not much procedure, just totally reliable people correctly trusting one another… In your own life what you want is a seamless web of deserved trust. And if your proposed marriage contract has forty-seven pages, I suggest you not enter.”– Charlie Munger (Wesco Financial annual meeting,

2008)

Joint Venture

• Reduces risk on both sides• Has been common for Chinese firms with

foreign companies (experience)– Step below an acquisition– Step above an alliance

• Other party must bring something to the table• Rotating leadership works best

Alliances

• Both parties have to bring something to the table

• Another form of dating before marriage

VC investments

• Great way to learn about technologies/new markets

• Beware: most VC firms lose money (only the top 25% make money)

• Can be a better idea than CVC– More independence– Might not wind up strategically related

Acquisitions

• Goal – but tricky to do well

• Only buy businesses whose value you understand.

• Buy businesses for less than they are worth.

Acquisitions• On average acquisitions destroy value for the acquiring

firm• Beware:

– Paying a premium for “synergy”– Thrill of an acquisition/enhanced size– Paying in stock - "buyer sells part of itself to acquire seller"

• More successful when:– Within circle of competence - Related industry– Experience with acquisitions– Business can raise prices easily and has a high return on capital– Target is either left alone or thoughtfully integrated

Conglomerates that work?• (1) Berkshire would be a diffuse conglomerate, averse only to activities about

which it could not make useful predictions.• (2) Its top company would do almost all business through separately incorporated

subsidiaries whose CEOs would operate with very extreme autonomy.• (3) There would be almost nothing at conglomerate headquarters except a tiny

office suite containing a Chairman, a CFO, and a few assistants who mostly helped the CFO with auditing, internal control, etc.

• (4) Berkshire subsidiaries would always prominently include casualty insurers. Those insurers as a group would be expected to produce, in due course, dependable underwriting gains while also producing substantial “float” (from unpaid insurance liabilities) for investment.

• (5) There would be no significant system-wide personnel system, stock option system, other incentive system, retirement system, or the like, because the subsidiaries would have their own systems, often different.

• (6) Berkshire’s Chairman would reserve only a few activities for himself.– Then names several activities that Buffett does, mostly limited to managing investments, a

lot of reading, and CEO replacements when necessary.

• (7) New subsidiaries would usually be bought with cash, not newly issued stock.• (8) Berkshire would not pay dividends so long as more than one dollar of market value for

shareholders was being created by each dollar of retained earnings.• (9) In buying a new subsidiary, Berkshire would seek to pay a fair price for a good business

that the Chairman could pretty well understand. Berkshire would also want a good CEO in place, one expected to remain for a long time and to manage well without need for help from headquarters.

• (10) In choosing CEOs of subsidiaries, Berkshire would try to secure trustworthiness, skill, energy, and love for the business and circumstances the CEO was in.

• (11) As an important matter of preferred conduct, Berkshire would almost never sell a subsidiary.

• (12) Berkshire would almost never transfer a subsidiary’s CEO to another unrelated subsidiary.

• (13) Berkshire would never force the CEO of a subsidiary to retire on account of mere age.• (14) Berkshire would have little debt outstanding as it tried to maintain (i) virtually perfect

creditworthiness under all conditions and (ii) easy availability of cash and credit for deployment in times presenting unusual opportunities.

• (15) Berkshire would always be user-friendly to a prospective seller of a large business. An offer of such a business would get prompt attention. No one but the Chairman and one or two others at Berkshire would ever know about the offer if it did not lead to a transaction. And they would never tell outsiders about it.

Metrics

• Margins– Turnover

• Growth– Earnings growth– Return on capital

• Management– ROE

• Intrinsic value

Example: MOOCs and Universities

• MOOCs as potential disruptive technology• What is the source of the competitive

advantage/moat in academia?– Is this threatened by MOOCs?

• Christensen vs. Porter• Debate: Disrupt your own business or use tech

to extend your competitive advantage?

Beware the Institutional Imperative

• Analogous to Newton’s first law of motion• An institution (e.g. a business) will resist any

change to its current direction– Innovation is a dirty term in organizations

• Behavior of peer companies will be mindlessly imitated

• Corporate projects will materialize to soak up time (just as work expands to fill available time)

What to avoid

• Institutional Imperative• Purportedly strategic moves– Acquiring companies– Entering other markets– Lowering price (by reducing margins)– Pet projects (risky R&D)– First mover advantage– Everyone else is doing it…

Framework

• What business is worth being in?– Monopoly, not commodity (what is the source of

the moat?)• What price is worth paying to be in that

business?

• Claim:China would be better off copying Berkshire Hathaway than copying Silicon Valley.- Charlie Munger (Warran Buffett’s business

partner)

- Is this true?

Testing this claim

VC-backed returns

Outline – what we covered

• Excellent businesses• Strategy• Moats• Circle of Competence• Practical tactics• Beware the Institutional Imperative• Values

• Wisdom acquisition is a moral duty.

- Charlie Munger, USC commencement speech, 2007

Competition and Firm Strategy

Chuck EesleyMorgenthaler Faculty Fellow

Assistant ProfessorStanford University

Management Science & EngineeringSchool of Engineering

cee@stanford.edu

How to be a Monopoly 101(building a company Warren

Buffett would invest in)