Sunday, February 26, 2012

Competition Demystified: Chapter 4

The author of the excellent book for beginners, Value Investing: From Graham to Buffett..., is back, this time with a book about how to understand and analyze competitive advantages. Investors interested in better understanding what gives a company a competitive advantage must give this book a read.

In this chapter, the authors describe the three steps involved in assessing a firm's competitive advantage.

The first step involves developing an industry map. This separates the different segments of a given industry, identifying the leading firms in each segment.

Next, each segment should be tested for competitive advantages. The two tests the authors suggest are market share stability and return on capital metrics. High market share stability and strong returns on capital over a decade by the dominant firms in a segment suggest an advantage may exist.

Finally, the source of the competitive advantage must be determined. It may be due to proprietary technology, cheap resources, customer captivity, government intervention etc. The absence of such a source suggests the superior performance of the firm in question may be due to operational efficiency.

As an example, the authors perform this process for the PC industry from the point of view of Apple. They conclude that "[i]n the PC industry, Apple is going nowhere".

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