Uber’s Problematic Economics

A few days ago I found the podcast episode “Taxi! Taxi!” from Grant’s Interest Rate Observer. The episode contains an interview with Hubert Horan about the economics of Uber, with a focus on the fundamentals of Uber’s business model and whether or not it will prove strong enough to make it possible for Uber to earn any sustainable profits going forward to support its lofty valuation.

This interview is definitely worth listening to since it provides a lot of great insights into the fundamentals of Uber’s business model and competitive capabilities. If you’d like to improve your understanding of the Uber business, check it out here.

Below, my own short transcript of the introductory parts of the interview.

Evan Lorenz: You’re work on Uber showing that most of the cost are variable, and that losses scale as revenue scales has been incredible. How did you come to your conclusion?

Hubert Horan: All I was doing was collecting numbers from other published reports, you know, and putting them into one place so you could see; “Wait a minute,” this has been unprofitable from day one and it’s still getting worse in year seven.

GIO: Yeah.

HH: And so, when you see a lot of the recent news reports you will now see something very in paragraph five or six, by the way you know, they lost billions of dollars last year. But you know, this is, none of this is confidential information, none of this, you know the accuracy of this has been confirmed completely. But the idea that this is a company that’s got, shall we say, problematic economics is still not of great interest to a lot of reporters.

EL: What actually made you start looking into Uber?

HH: Just having been in transportation my entire career, and on the sort of strategic business planning end of things. All of a sudden all of these stories started coming out about Uber five, whatever, years ago saying that it was the, you know, biggest most, you know, highly valuable private company in the world history. And it was going to compete and solve all the problems in urban transport and we’re going to replace private car ownership at some point. And I sort of scratched my head and said; “That’s interesting, wonder how they did that?” And everything that was being claimed in all of these articles completely contradicted everything that I and anyone else had known about the economics of transportation. And digging a little more, and digging a little more, and suddenly found sort of the empty core.

Hubert Horan has written a few articles on the subject of Uber worth checking out:

Disclosure: I am not receiving any compensation for any of the links provided. I have no business relationship with any company or individual mentioned in this article. 


Times Change and Moats Change With Them

Times change, and we change with them.

—Latin Proverb

Times Change and Moats Change With Them

In his 2005 letter to shareholders Warren Buffett discussed the topic of competitive advantage, or moats in his own words (emphasis added).

Every day, in countless ways, the competitive position of each of our businesses grows either weaker or stronger. If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength. But if we treat customers with indifference or tolerate bloat, our businesses will wither. On a daily basis, the effects of our actions are imperceptible; cumulatively, though, their consequences are enormous.

When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as “widening the moat.” And doing that is essential if we are to have the kind of business we want a decade or two from now. We always, of course, hope to earn more money in the short-term. But when short-term and long-term conflict, widening the moat must take precedence. If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the eight-ball in terms of costs, customer satisfaction or brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted. Take a look at the dilemmas of managers in the auto and airline industries today as they struggle with the huge problems handed them by their predecessors. Charlie is fond of quoting Ben Franklin’s “An ounce of prevention is worth a pound of cure.” But sometimes no amount of cure will overcome the mistakes of the past.

Our managers focus on moat-widening – and are brilliant at it. Quite simply, they are passionate about their businesses. Usually, they were running those long before we came along; our only function since has been to stay out of the way. If you see these heroes – and our four heroines as well – at the annual meeting, thank them for the job they do for you.

But, as sure as times change, the same goes for moats. So, if you manage to identify a moat that you may even assess as sustainable, remember that nothing lasts forever, not even wide moats (at least I’d say that’s the most probable and likely outcome if you were asked to make a bet on any given business).

As an example, let’s take a look at the newspaper industry and how it has changed during the latest decades.

Newspapers in the ’70s: Moat-Widening

Thanks to a reader of the blog, I was made aware of an article published back in 1977 in the Wall Street Journal and entitled The Collector: Investor Who Piled Up 100 Million in the ’60s Piles Up Firms Today. In this article the author wrote about Warren Buffett’s taste for cash-generating newspapers with moats:

Warren has been largely restricting himself to companies which he feels offer some protection against inflation in that they have a unique product, low capital needs and the ability to generate cash. Warren likes owning a monopoly or market-dominant newspaper to owning an unregulated toll bridge. You have relative freedom to increase rates when and as much as you want.

To read the WSJ article, click here.

Newspapers Today: Moat-Erosion

Going back through the years and the letters to shareholders written by Warren, we find an extensive discussion about the state of the newspaper industry in his 2012 letter (emphasis added).

We Buy Some Newspapers . . . Newspapers?

During the past fifteen months, we acquired 28 daily newspapers at a cost of $344 million. This may puzzle you for two reasons. First, I have long told you in these letters and at our annual meetings that the circulation, advertising and profits of the newspaper industry overall are certain to decline. That prediction still holds. Second, the properties we purchased fell far short of meeting our oft-stated size requirements for acquisitions.

We can address the second point easily. Charlie and I love newspapers and, if their economics make sense, will buy them even when they fall far short of the size threshold we would require for the purchase of, say, a widget company. Addressing the first point requires me to provide a more elaborate explanation, including some history.

News, to put it simply, is what people don’t know that they want to know. And people will seek their news – what’s important to them – from whatever sources provide the best combination of immediacy, ease of access, reliability, comprehensiveness and low cost. The relative importance of these factors varies with the nature of the news and the person wanting it.

Before television and the Internet, newspapers were the primary source for an incredible variety of news, a fact that made them indispensable to a very high percentage of the population. Whether your interests were international, national, local, sports or financial quotations, your newspaper usually was first to tell you the latest information. Indeed, your paper contained so much you wanted to learn that you received your money’s worth, even if only a small number of its pages spoke to your specific interests. Better yet, advertisers typically paid almost all of the product’s cost, and readers rode their coattails.

Additionally, the ads themselves delivered information of vital interest to hordes of readers, in effect providing even more “news.” Editors would cringe at the thought, but for many readers learning what jobs or apartments were available, what supermarkets were carrying which weekend specials, or what movies were showing where and when was far more important than the views expressed on the editorial page.

In turn, the local paper was indispensable to advertisers. If Sears or Safeway built stores in Omaha, they required a “megaphone” to tell the city’s residents why their stores should be visited today. Indeed, big department stores and grocers vied to outshout their competition with multi-page spreads, knowing that the goods they advertised would fly off the shelves. With no other megaphone remotely comparable to that of the newspaper, ads sold themselves.

As long as a newspaper was the only one in its community, its profits were certain to be extraordinary; whether it was managed well or poorly made little difference. (As one Southern publisher famously confessed, “I owe my exalted position in life to two great American institutions – nepotism and monopoly.”)

Over the years, almost all cities became one-newspaper towns (or harbored two competing papers that joined forces to operate as a single economic unit). This contraction was inevitable because most people wished to read and pay for only one paper. When competition existed, the paper that gained a significant lead in circulation almost automatically received the most ads. That left ads drawing readers and readers drawing ads. This symbiotic process spelled doom for the weaker paper and became known as “survival of the fattest.”

Now the world has changed. Stock market quotes and the details of national sports events are old news long before the presses begin to roll. The Internet offers extensive information about both available jobs and homes. Television bombards viewers with political, national and international news. In one area of interest after another, newspapers have therefore lost their “primacy.” And, as their audiences have fallen, so has advertising. (Revenues from “help wanted” classified ads – long a huge source of income for newspapers – have plunged more than 90% in the past 12 years.)

Newspapers continue to reign supreme, however, in the delivery of local news. If you want to know what’s going on in your town – whether the news is about the mayor or taxes or high school football – there is no substitute for a local newspaper that is doing its job. A reader’s eyes may glaze over after they take in a couple of paragraphs about Canadian tariffs or political developments in Pakistan; a story about the reader himself or his neighbors will be read to the end. Wherever there is a pervasive sense of community, a paper that serves the special informational needs of that community will remain indispensable to a significant portion of its residents.

Even a valuable product, however, can self-destruct from a faulty business strategy. And that process has been underway during the past decade at almost all papers of size. Publishers – including Berkshire in Buffalo – have offered their paper free on the Internet while charging meaningful sums for the physical specimen. How could this lead to anything other than a sharp and steady drop in sales of the printed product? Falling circulation, moreover, makes a paper less essential to advertisers. Under these conditions, the “virtuous circle” of the past reverses.

The Wall Street Journal went to a pay model early. But the main exemplar for local newspapers is the Arkansas Democrat-Gazette, published by Walter Hussman, Jr. Walter also adopted a pay format early, and over the past decade his paper has retained its circulation far better than any other large paper in the country. Despite Walter’s powerful example, it’s only been in the last year or so that other papers, including Berkshire’s, have explored pay arrangements. Whatever works best – and the answer is not yet clear – will be copied widely.

In a the recent Politico Playbook interview Warren Buffett shared his bearishness on newspapers.

Buffett is bearish on newspapers:
“Newspapers are going to go downhill. Most newspapers, the transition to the internet so far hasn’t worked in digital. The revenues don’t come in. There are a couple of exceptions for national newspapers — The Wall Street Journal and The New York Times are in a different category. That doesn’t mean it necessarily works brilliantly for them, but they are a different business than a local newspaper. But local newspapers continue to decline at a very significant rate. And even with the economy improving, circulation goes down, advertising goes down, and it goes down in prosperous cities, it goes down in areas that are having urban troubles, it goes down in small towns – that’s what amazes me. A town of 10 or 20,000, where there’s no local TV station obviously, and really there’s nothing on the internet that tells you what’s going on in a town like that, but the circulation just goes down every month. And when circulation goes down, advertising is gonna go down, and what used to be a virtuous circle turns into a vicious circle. I still love newspapers! You’re talking to the last guy in the world. Someday you’ll come out and interview me, and you’ll see a guy with a landline phone, reading a print newspaper.”

The table below shows how advertising revenue has declined between 2003 and 2014. A slide that most likely is going to continue.

As summarized by The 13th annual Pew Research State of the News Media Report about the current state-of-play when it comes to newspapers:

It has been evident for several years that the financial realities of the web are not friendly to news entities, whether legacy or digital only. There is money being made on the web, just not by news organizations. Total digital ad spending grew another 20% in 2015 to about $60 billion, a higher growth rate than in 2013 and 2014. But journalism organizations have not been the primary beneficiaries. In fact, compared with a year ago, even more of the digital ad revenue pie — 65% — is swallowed up by just five tech companies. None of these are journalism organizations, though several — including Facebook, Google, Yahoo and Twitter — integrate news into their offerings. And while much of this concentration began when ad spending was mainly occurring on desktops platforms, it quickly took root in the rapidly growing mobile realm as well.

In hindsight, everything looks pretty clear, right?

The trick is being able to continuously evaluate businesses and industries and identify any data that may indicate a coming, or ongoing, moat-erosion. But that’s some topic for another post.

Even though this blog post was about the past, the key take-away from it is that moats change, and we gotta be aware of this and make the best we can out of it we look into the unknown future. At least if we’re hunting for, and investing in, companies supposed to enjoy sustainable competitive advantages.

“Of all the ‘old’ media, newspapers have the most to lose from the internet.”

—The Economist


Peter Thiel’s Stanford Lecture Nr. 5: Competition is for Losers

«Escaping competition will give you a monopoly, but even a monopoly is only a great business if it can endure in the future.»

—Peter Thiel, Zero to One

Let’s Go to Class: Peter Thiel on Competition

Click here for slide deck.

A transcript of class nr. 5 is available here.

Also, Blake Master’s notes from the Thiel classes can be found here.

* * * * * * * * * * * * * *

«If I do my job right, this is the last class you’ll ever have to take.» 

—Peter Thiel

Additional Reading

VIP: Pat Dorsey on Investing in Companies with Economic Moats

The latest Value Investing Podcast is out, this time with an interview of Pat Dorsey on economic moats. Dorsey, earlier at Morningstar, now runs Dorsey Asset Management. To see their “Publications & Commentary,” go here.

This interview is really good, and well worth the time. The interview includes among other things, a few great examples of different kinds of moats, companies enjoying these moats, and some discussions about how to think and where to look to find companies with moats.

Check out this podcast interview with Pat Dorsey by clicking the image below.

Skärmavbild 2015-05-03 kl. 12.02.57

Also, if you haven’t already watched Pat Dorsey’s Talk at Google, see earlier post here (includes the slides from this presentation).

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. This article is informational and is in my own personal opinion.

Blocket: A Swedish Franchise

Blocket – Some Background

Blocket was founded in 1996 in Fjälkinge, a small Swedish town, by Henrik Nordström. It started out as a small local market place in the region of Skåne (the southernmost region in Sweden), from where it grew and started offering buy and sell ads for the whole country to become what it is today, Sweden’s biggest marketplace for for selling and buying stuff you need or want to get rid off. 


In 2003 Blocket was acquired for 183 MSEK by the Norwegian media company Schibsted. Already back in 2001 Schibsted had been negotiating with the founders to buy Blocket, but decided not to since the asking price of 90 MSEK was deemed to be too high. Instead Schibsted started their own version of Blocket, but it turned out to be a failure. Having had this experience Schibsted kind of adopted the motto “If you can’t beat them, join them.” In hindsight, the initial 90 MSEK looks superb, but at the same time the 183 MSEK still turned out to be a great deal too. Operating profits during 2008 to 2013 totaled approximately SEK 2 billion. 

At the time of the acquisition Blocket had revenues of 34 MSEK and a profit of 13 MSEK. Using these numbers to get some rough measure of the purchase price paid by Schibsted and by assuming a 28% tax rate, no interest-bearing debt and also no excess cash results in a P/E multiple of 14 and EV/EBIT multiple of 10.

eBay also wanted to grab a share of Blocket’s ever growing profits and most certainly came to the same conclusion as Schibsted. Unfortunately, eBay wasn’t able to “join them,” instead they acquired Tradera, a swedish business not really as good as Blocket—at least from looking at the earnings and profitability. 

Let’s have a look at a few more stats provided by Blocket.se.

Blocket vs. Tradera

To get a quick summary of Tradera and its business, let’s turn to Wikipedia: 

Tradera.com is one of the leading online commerce services in Sweden, with over 2,5 million members and about one million listings (2011). Although Tradera welcomes members from all over the world, most are Swedish. Tradera was founded in 1999 but was acquired by eBay Inc. in 2006. Tradera was originally based completely on private auctions but today visitors can purchase both new and second hand items through auctions as well as fixed price listings.

On 24 April 2006, Tradera.com, along with its sister site Traderamotor.com, was acquired by eBay for 365 million SEK (about 50 million US dollars)

The table below summarizes some financial metrics for Tradera and Blocket. From looking at the change in net sales, earnings and profitability we see that Blocket seems to be the more solid business. At least this has was the case during 2011-2013.

At the same time as Tradera posted an accumulated negative EBIT for this three year period, Blocket managed to earn an accumulated EBIT of SEK 1 128 billion. When looking at ROE in the table below, keep in mind that it may not tell the whole truth about the underlying profitability due to the capital structure and inter-company receivables and liabilities. At least this seems to be the case for Blocket. 


Blocket’s relative share of total net sales for both businesses has been slowly rising during 2011 to 2013, from 80% to 85%. Looking at EBIT, Blocket has posted great earnings at the same time as Tradera has had a hard time avoiding red numbers. 


The growth in Blocket’s net sales and profit before tax has been pretty consistent during the last ten years (Source: allabolag.se). Net sales for Tradera grew at a high speed between 2004 up until 2010, showing some decline from 2011 to 2013 and profit before tax has not been that impressive. 


A Profitable Growth Story

The financial statements speak for themselves and reveals a great growing business with high returns on capital. Net sales grew from 409 MSEK in 2008 to 786 MSEK in 2013, a compounded annual growth rate (CAGR) of 14%. Accumulated operating earnings during 2008 to 2013 approximated roughly SEK 2 billion, growing from 239 MSEK to 398 MSEK, a CAGR of 10.7%.

The question then is: How much investments were required to achieve this growth in sales and earnings? The answer: None. Net investments, that is investments in working capital and capital expenditures (both tangibles and intangibles) totaled a positive of 10 MSEK. Sound pretty good right? Earning SEK 2 billion in accumulated EBIT in a period of six years without having to invest anything in the business to make it happen, instead you get an additional 10 MSEK for doing it.  

Without exaggeration, Blocket seems like a pretty decent little business. A fair question to ask then is: What competitive advantages does Blocket enjoy (at least during the last decade)? If someone else had been able to do it, I’m pretty sure they would have liked to take away some of Blocket’s earnings. 

To keep it short, it seems reasonable to assume that Blocket probably enjoy some combination of local economies of scale coupled with habit and switching costs from the network effect. If you are going to sell something you want to go where the buyers are. The same is true the other way around. As buyer you want to go where there’s a lot of sellers. Sellers and buyers seem to like Blocket, and most likely Schibsted love the business. And who would not, one just have to look at free cash flow margin, averaging almost 53% during 2008-2013. 


Free cash flow grew from 191 MSEK in 2008 to 417 MSEK in 2013, a CAGR of 17%. During 2008 to 2013 Blocket’s average operating margin was 55% and profit before tax margin 56% (the corporate income tax rate in Sweden during these years was reduced from 28% to 22%). In the same period the free cash flow margin was about 53%. 


Profitability has been great with pre-tax return on equity (ROE) and pre-tax return on assets (ROA) averaging 166% and 60% respectively.


If one was to account for the inter-company receivables and liabilities and adjusting for excess cash, it most likely would be the case that business doesn’t really require any invested capital (as measured by net fixes assets plus net working capital). But the point is already pretty clear. Blocket during the last decade has turned out to be a pretty good investment for Schibsted.

Schibsted has also used its ownership of Aftonbladet and its large number of unique visitors (number one of all media sites in week 9 according to http://www.kiaindex.se/), and by placing ads on Aftonbladet’s site driving traffic to Blocket. A great advantage when it comes to achieving the scale of Blocket’s network of sellers and buyers, that when achieved is pretty hard to overcome for any competitor.

Blocket has also expanded at the edges of its business, adding Blocket Jobb (in 2011, with the goal of becoming the biggest site for job ads) and Blocket Bostad (in 2014 with the goal of becoming the biggest housing site in Sweden).

Annual reports

All financial statement data taken from Blocket AB’s annual reports (click link to read PDF): 


Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

Buffett, IBM and Key Economic Characteristics

Berkshire’s Investment in IBM

Berkshire Hathaway started buying IBM shares during 2011, and has since increased its IBM investment. See table below for data of Berkshire’s IBM investment in 2014 compared to 2013. The one thing that did not increase during 2014 was the market value of the IBM investment. All other metrics showed a positive change.


No Surprises at IBM: Buffett

See here for the interview of Warren Buffett from CNBC quoted below.

[BECKY QUICK] Why are you buying more IBM?

[WARREN BUFFETT] Well, I buy it because I like it. It’s kind of been doing exactly what I like since we first started buying it. […] There’s been no surprises at IBM since we started buying a few years ago. […] The pleasant surprise is that the stock has been going down.

And then, later on in the interview about Buffett’s understanding of IBM’s competitive advantage…

[BECKY QUICK] You’ve often said though that you don’t understand technology, so what makes you think you understand IBM’s competitive moat?

[WARREN BUFFETT] Well, I don’t understand it, there’s no question I don’t understand technology as well as I understand the railroad or I understand insurance. But I don’t understand every aspect of insurance, I understand some of the key economic characteristics of insurance and the same way with the railroad. I know a lot of things about parts of the railroad that lead to an economic conclusion. But, there are a lot of things I don’t understand, I mean, and that’s true of industry after industry. We competed, I personally was chairman of the board of a company that competed with IBM for ten years in the 1960’s. And I didn’t understand all of IBM’s business then, but we actually did quite well competing with IBM in the tab-card business… I think I know enough about IBM to make an investment decision. But, whatever, whatever…

[BECKY QUICK] You just said we were competing with them in the tab-card business, that is punchcard, that is not the cloud, this is not the stuff that…

[WARREN BUFFETT] It changes, it changes, and IBM’s changed with it. And it was one time when they didn’t change so well with it, then they made enormous progress under Lou. So it is, the insurance business has changed. We used to sell at GEICO, we used to sell all by direct mail primarily, then it went to phone, then it goes to the Internet, now it goes to the mobile. Companies have to change. But, I think Ginni’s done a great job of fostering change at IBM, but it doesn’t happen overnight.


Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

Q&A: Case Study of See’s Candy

“There was something special. Every person in California has something in mind about See’s Candies and overwhelmingly it was favorable. They had taken a box on Valentine’s Day to some girl and she had kissed him… See’s Candies means getting kissed. If we can get that in the minds of people, we can raise prices.” —Warren Buffett


This post contains my answers to the questions posted at CSInvesting.org as part of the DEEP VALUE course and the case study on See’s Candy. Feel free to comment and share your own views, reflections and take-aways.

Company Overview

A brief description of See’s Candy as of today:

See’s Candy Shops, Inc. produces boxed chocolates and candies. The company offers chocolate assortments, nuts and chews, decadent chocolate truffles, milk and dark chocolates, brittles and toffees, truffles, lollypops, candy bars, gift cards, and kosher categories. It offers products online, as well as through its shops in the United Sates, Hong Kong, Japan, and Macau. The company was founded in 1921 and is headquartered in Carson, California. (Source: Bloomberg)

Financial Data and Operating Metrics

From the current description of the business, let’s turn back to the time when Buffett and Munger purchased See’s, that is in the beginning of the 70’s.

From the financials disclosed by Warren in his shareholder letters we can see that See’s development has been excellent. Growing sales revenues translating into higher operating profits. See’s excellence is, to a great extent, derived from its ability to raise prices along with and also above the rate of inflation and at the same time requiring very limited investment in tangible assets.

A look at the development in the number of pounds of candy sold shows that during the same time period (1972 to 1984) as revenues more than quadrupled, operating profit after taxes increased more than tenfold, the number of pounds of candy sold increased only 46%. That’s right, just 46% during this 12 year period, or at an average growth rate per year of 3.2%. So, the great growth rate shown by sales revenues, was not due to volume growth, but to price.


If we take a look at sales revenues, operating expenses (OPEX) and operating profit after taxes (OPAT) on a per-pound basis, it’s clear that at the same time as sales revenue grew, operating expenses were managed in a good way which resulted in great growth in operating profit after taxes.


Looking at the data broken down on a per store level the same can be seen even here. Rising revenues per store, rising OPEX (even though at a lower rate than the growth in revenues), which contributed to the great growth rate in OPAT per store. At the same time the number of pounds of candy sold per store was growing real slow, and even turned negative for three of the four periods for which averages are calculated (see table below).


And finally, from where can any support for the pricing power of See’s be derived? If growth in sales revenues is compared to volume growth from the number of pounds of candy sold, we get a rough measure of the price increase each year (before inflation, i.e., nominal amounts). Taking inflation into account in the next step then gives the real price increases, that is any amount of the total price increase each year that remains when inflation for the same period is taken into account.

A year-to-year comparison does not always show any clear signs, growth between single years can go in opposite ways even when the underlying trend during a couple of years tells another tale. Instead, from looking at longer time periods it can be seen that See’s has not just been able to raise prices to match inflation, See’s also was able to raise prices at a rate higher than inflation, i.e., in real terms. (Any input regarding the pricing power issue of See’s and how to derive it would be greatly appreciated. Does my thinking make sense, or should something maybe be reconsidered here in my attempt to try to find the key to the “untapped pricing power” of See’s (both in nominal and real terms) Feel free to comment!)


Describe the competitive advantages of See’s.

In our primary marketing area, the West, our candy is preferred by an enormous margin to that of any competitor. In fact, we believe most lovers of chocolate prefer it to candy costing two or three times as much. (In candy, as in stocks, price and value can differ; price is what you give, value is what you get.)

—Warren Buffett, 1983 Letter to Shareholders

See’s moat most likely stems from:

  • CAPTIVE CUSTOMERS through habit formation and maybe even some kind of emotional switching costs due to psychological reasons coming from the influence from mere-association tendency and the social proof tendency (both discussed by Charlie Munger in his speech The Psychology of Human Misjudgment), and
  • LOCAL ECONOMIES OF SCALE in advertising and distribution.

For a hint on why it seems likely to assume the presence of LOCAL ECONOMIES OF SCALE even some decades ago, take a quick look at the map below showing some 186 See’s stores in California AS OF TODAY (Source: ca.sees.com). This concentration reminds me of the Walmart map that I posted in another post (see here).


Could this be a faster growing business if See’s sold through other marketing channels?

See’s most likely would be able to increase its growth rate (in volume) if it was sold through other marketing channels. But, would it still be as profitable? Probably not. But as we can see from an analysis of See’s moat and its sources, the moat sources are most favorable in California, and thus probably less so in other parts of the U.S.

How does Buffett analyze this business?

  • Poundage volume
  • Units sold per store

The poundage volume in our retail stores has been virtually unchanged each year for the past four, despite small increases every year in the number of shops (and in distribution expense as well). Of course, dollar volume has increased because we have raised prices significantly. But we regard the most important measure of retail trends to be units sold per store rather than dollar volume. On a same-store basis (counting only shops open throughout both years) with all figures adjusted to a 52-week year, poundage was down .8 of 1% during 1983.

—Warren Buffett, 1983 Letter to Shareholders

  • Per-pound realization
  • Per-pound costs
  • Same store-volume

During 1984 we increased prices considerably less than has been our practice in recent years: per-pound realization was $5.49, up only 1.4% from 1983. Fortunately, we made good progress on cost control, an area that has caused us problems in recent years. Per-pound costs – other than those for raw materials, a segment of expense largely outside of our control – increased by only 2.2% last year.

Our cost-control problem has been exacerbated by the problem of modestly declining volume (measured by pounds, not dollars) on a same-store basis. Total pounds sold through shops in recent years has been maintained at a roughly constant level only by the net addition of a few shops annually. This more-shops-to-get-the-same-volume situation naturally puts heavy pressure on per-pound selling costs.

In 1984, same-store volume declined 1.1%. Total shop volume, however, grew 0.6% because of an increase in stores. (Both percentages are adjusted to compensate for a 53-week fiscal year in 1983.)

—Warren Buffett, 1984 Letter to Shareholders


What price did Buffett pay and why?

See’s is a slow grower, but its growth is steady and reliable—and best of all, it doesn’t take additional infusions of capital.

—Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger

Purchase price for See’s amounted to $25 million, a business earning $4 million pre-tax and $2 million after-tax, from $8 million in tangible assets (25% after-tax ROC or 50% pre-tax ROC), which translates into these key ratios:

  • 12,5 times after-tax earnings (8% yield)
  • 6,3 times pre-tax earnings (16% yield)
  • 3 times invested capital

In comparison, the 10-year treasury rate in January 1972 was 5.95 percent.

Harry See’s asked for $30 million, but Buffett and Munger weren’t willing to pay more than $25 million, since this was a lot higher than the capital invested in the business. Harry See’s finally accepted the price of $25 million and Buffett and Munger, through Blue Ship Stamps, acquired a great franchise.


Measuring the Moat: Value Creation Checklist

“The most important thing to me is figuring out how big a moat there is around the business. What I love, of course, is a big castle and a big moat with piranhas and crocodiles.” ―Warren Buffett


Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation

Below is an excerpt of “a complete checklist of questions to guide the strategic analysis” published in the paper Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation, written by Michael J. Mauboussin and Dan Callahan.

See here for full PDF.


Value Creation Checklist

  • What stage of the competitive life cycle is the company in?
  • Is the company currently earning a return above its cost of capital?
  • Are returns on capital increasing, decreasing, or stable? Why?
  • What is the trend in the company’s investment spending?

C2Lay of the Land

  • What percentage of the industry does each player represent?
  • What is each player’s level of profitability?
  • What have the historical trends in market share been?
  • How stable is the industry?
    • How stable is market share?
    • What do pricing trends look like?
  • What class does the industry fall into—fragmented, emerging, mature, declining, international, network, or hypercompetitive?

C2The First Three of the Five Forces

  • How much leverage do suppliers have?
  • Can companies pass supplier increases to customers?
  • Are there substitute products available?
  • Are there switching costs?
  • How much leverage do buyers have?
  • How informed are the buyers?

C2Barriers to Entry

  • What are the entry and exit rates like in the industry?
  • What are the anticipated reactions of incumbents to new entrants?
  • What is the reputation of incumbents?
  • What is the level of asset specificity?
  • What is the minimum efficient production scale?
  • Is there excess capacity in the industry?
  • Is there a way to differentiate the product?
  • What is the anticipated payoff for a new entrant?
  • Do incumbents have precommitment contracts?
  • Do incumbents have licenses or patents?
  • Are there learning curve benefits in the industry?


  • Is there pricing coordination?
  • What is the industry concentration?
  • What is the size distribution of firms?
  • How similar are the firms in incentives, corporate philosophy, and ownership structure?
  • Is there demand variability?
  • Are there high fixed costs?
  • Is the industry growing?

C2Disruption and Disintegration

  • Is the industry vulnerable to disruptive innovation?
  • Do new innovations foster product improvements?
  • Is the innovation progressing faster than the market’s needs?
    • Have established players passed the performance threshold?
    • Is the industry organized vertically, or has there been a shift to horizontal markets?

C2Firm Specific

  • Does analysis of the value chain reveal what activities a company does differently than its its rivals?
  • Does the firm have production advantages?
    • Is there instability in the business structure?
    • Is there complexity requiring know-how or coordination capabilities?
    • How quickly are the process costs changing?
  • Does the firm have any patents, copyrights, trademarks, etc.?
  • Are there economies of scale?
    • What does the firm’s distribution scale look like?
    • Are assets and revenue clustered geographically?
    • Are there purchasing advantages with size?
    • Are there economies of scope?
    • Are there diverse research profiles?
  • Are there consumer advantages?
    • Is there habit or horizontal differentiation?
    • Do people prefer the product to competing products?
    • Are there lots of product attributes that customers weigh?
    • Can customers only assess the product through trial?
    • Is there customer lock-in? Are there high switching costs?
  • Is the network radial or interactive?
  • What is the source and longevity of added value?
  • Are there external sources of added value (subsidies, tariffs, quotas, and competitive or environmental regulations)?

C2Firm Interaction—Competition and Coordination

  • Does the industry include complementors?
  • Is the value of the pie growing because of companies that are not competitors? Or, are new companies taking share from a pie with fixed value?


  • Do customers want to “hire” the brand for the job to be done?
  • Does the brand increase willingness to pay?
  • Do customers have an emotional connection to the brand?
  • Do customers trust the product because of the name?
  • Does the brand imply social status?
  • Can you reduce supplier operating cost with your name?


Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

Seth Klarman Defines What Constitutes a Good Business

What constitutes a good business?

Let’s turn to Seth Klarman for some advice.


In other words, a good business is one that enjoys the following characteristics:

  • Strong barriers to entry
  • Limited capital requirements
  • Reliable customers
  • Low risk of technological obsolescence
  • Abundant growth possibilities
  • Significant and growing free cash flow

Keep these six characteristics in mind as a mini-checklist when thinking about and analyzing a certain business, trying to decide if the business in question meets these requirements for what constitutes a good business.

Bruce Greenwald Lecture: Strategic Valuation Analysis

Bruce Almighty

Professor Bruce C. N. Greenwald holds the Robert Heilbrunn Professorship of Finance and Asset Management at Columbia Business School and is the academic Director of the Heilbrunn Center for Graham & Dodd Investing. Described by the New York Times as “a guru to Wall Street’s gurus,” Greenwald is an authority on value investing with additional expertise in productivity and the economics of information.

Greenwald has been recognized for his outstanding teaching abilities. He has been the recipient of numerous awards, including the Columbia University Presidential Teaching Award which honors the best of Columbia’s teachers for maintaining the University’s longstanding reputation for educational excellence. His classes are consistently oversubscribed, with more than 650 students taking his courses every year in subjects such as Value Investing, Economics of Strategic Behavior, Globalization of Markets, and Strategic Management of Media. (Source: Columbia Business School

Bruce Greenwald is the author of the great book Competition Demystified – A Radically Simplified Approach to Business Strategy, that I highly recommend to everyone interested in understanding the competitive dynamics of different industries and businesses.

Check out the posts discussing the chapters of this book over at CSInvesting.org, the best source (as far as I know) for everyone who wants to improve ones knowledge and understanding in the area of investing and analysis.

Bruce Greenwald Video Lecture 

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. This article is informational and is in my own personal opinion.