“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
Links
- The Collector: Investor Who Piled Up 100 Million in the ’60s Piles Up Firms Today, Wall Street Journal, March 31, 1977
- Letter to Shareholders 2005, Warren Buffett
- Letter to Shareholders 2012, Warren Buffett
- The U.S. Newspaper Industry in Transition, Congressional Research Service
- The Fading Newspaper, Bloomberg, April 19, 2016
- The Playbook Interview: Warren Buffett, August 11, 2016
- Newspaper Declines Accelerate, Latest Pew Research Reports Finds, Other Sectors Healthier, Poynter, June 15, 2016
- Who Killed the Newspaper, The Economist, August 24, 2006
- More Media, Less News, The Economist, August 24, 2006
Lay of the Land
Hurricane Capital 